x Abu Dhabi, UAEThursday 27 July 2017

Occidental's Phibro buy is double-edged surprise

The deal has raised eyebrows for two main reasons. First was the low price, which smacked of political coercion.

Occidental Petroleum, the fourth-largest US oil company, made headlines at the weekend with a US$250 million (Dh917.5m) agreement to buy Phibro, the commodities trading division of Citigroup. The deal has raised eyebrows for two main reasons. First was the low price, which smacked of political coercion. For just two-and-a-half times the roughly $100m pay cheque due this year to Phibro's head trader, Andrew Hall, Occidental would get its hands on a top-notch professional trading outfit that has earned an average of $371m annually for the past five years.

Phibro had become a "political hot potato" for its former owner, Citigroup, which is 34 per cent owned by the US government after it accepted a $49 billion bailout package last year from US taxpayers, sources close to the deal said. Mr Hall's remuneration had attracted unwelcome Treasury department scrutiny, as had the inherent risk attached to Phibro's main business of taking large financial bets on the direction of oil and gas price movements.

"There obviously was some pressure from the government to do this," said Richard Kline, a spokesman for Occidental. "If they [Citigroup] had liquidated the business, they would get about what we're paying." The second surprise was that Occidental, which has a reputation for playing things safe, would so readily jump into a high-stakes game of speculative commodities trading. While it has a modest in-house trading division that mainly markets the company's own oil and gas production, it has shown little appetite for buying and selling other firms' output, let alone a stomach for the paper-swapping poker game that is Phibro's stock in trade.

"Oxy historically has not been an aggressive hedger or trader," noted Ben Dell, an oil analyst at the investment manager Sanford Bernstein. "It has no history of managing a business in oil trading and I think it will be challenging to argue that Phibro adds incremental value." Even in its core business of oil and gas production, Occidental is not much of a risk taker. The Los Angeles-based firm at first built up a solid business exploiting hundreds of small oil pools in its Californian backyard. Later, it ventured overseas, but generally shunned the high-risk exploration plays sought by its competitors.

According to an insider, one of the company's favourite offshore ventures is its Dolphin Energy partnership with the Abu Dhabi Government's Mubadala and the French oil group Total. Dolphin produces gas and condensate, a type of light oil, from Qatar. With the backing of an intergovernmental trade agreement, it sells the gas under a long-term contract to customers in the UAE and Oman, while the condensate is exported internationally. Both businesses generate large, predictable profit streams.

While other big oil firms may have been less risk averse in the field than Occidental, the focus of their trading activity is usually on selling their own oil and gas and securing physical crude for their refineries. "These companies don't typically throw a lot of capital into what they deem is a risky or zero-sum business, which is what trading is," said Ken Medlock, an energy expert at the Baker Institute at Rice University in Houston.

However, when crude is in the doldrums and enticing oil plays become harder to find, the potential profits from speculative oil trading can seem seductive. "The return on investment for us is better than an oil well," said Stephen Chazen, the president of Occidental. That is, unless the twists and turns of a volatile market unseat even Phibro's wily traders. Sooner or later, that tends to happen in energy trading, sometimes with disastrous consequences. Many former employees and shareholders of a US company called Enron know that only too well.

Enron was the king of American gas and electricity marketing in its heyday, with a bulging portfolio of physical energy assets and an army of savvy traders. It had started out in 1932 as the Northern Natural Gas Company, a staid operator of gas pipelines, which later added electricity operations. In the 1990s, a newly installed chief executive, the late Kenneth Lay, renamed and rebranded the company, moved its headquarters to Houston from Omaha and refocused its business on energy marketing.

For years, Enron seemed to prosper. By August 2001, flaws in its financial strategy were beginning to show. After the company filed for bankruptcy in December 2001, it transpired that it had used a network of offshore subsidiaries to hide billions of dollars in trading losses. Along the way, it had colluded with big energy operators to create a phoney electricity crisis in California, manipulating the state's wholesale power market for trading profits.

Just before the end, the company's top managers secretly dumped their Enron shares while continuing to urge ordinary employees and the general public to invest in the stock. Until last year, when the US investment bank Lehman Brothers folded, the Enron bankruptcy was the largest in corporate history. Although Occidental may avoid Enron's mistakes and shun its management's duplicity, it is worrying that a US-led campaign to clean up risky banking practices is now sending handsomely compensated oil traders scurrying from desks at financial institutions to the protective embrace of oil producers.

While some may express concern that Big Oil will escape the regulatory scrutiny being lavished on the banks, the bigger risk is that unforeseen trading losses may disrupt the ability of the world's most technically sophisticated oil and gas producers to invest in new energy supplies. @Email:tcarlisle@thenational.ae