Phillips to buy Tosco in $7b stock transaction

Phillips Petroleum Co said late Sunday it would buy refining and marketing company Tosco Corp in a $7 billion stock deal aimed at transforming Phillips into a stronger integrated oil company.

If approved by regulators, the deal would be the latest in a wave of mergers in the energy sector, including a proposed deal between Chevron Corp and Texaco Inc and the transactions that created heavyweights Exxon Mobil and BP Amoco.

The oil exploration and production company said in a statement it will exchange 0.8 Phillips shares for each Tosco share and assume approximately $2 billion of Tosco's debt. The Phillips offer values each Tosco share at $46.50, a 34 premium to Tosco's Friday closing price of $34.61.

The combined company will become the second largest U.S. refiner in the United States and third largest marketer, with a refining capacity of 1.7 million barrels per day.

"We want to position each of our business lines into a position that they are more competitive, and have that size and scope that can compete," said Jim Mulva, Phillips' chairman and chief executive officer, said in a conference call.

"If you're going to be a major integrated petroleum company, you must have strong upstream, and you must have strong downstream," Mulva added.

Phillips said the transaction is expected to close by the end of the third quarter of 2001, and said that its board of directors also authorized a $1 billion share buyback programme. The company said it expects the transaction to be accretive to earnings per share, taking into account anticipated annual pre-tax synergies of $250 million and the stock buyback and that it will also improve net cash flow.

Phillips currently employs 12,400, while Tosco employs about 25,000. As a result of the deal, there will be a reduction of employees that will impact both companies, the details of which were yet to be determined.

Tom O'Malley, Tosco's current chairman and chief executive, will become the CEO of refining, marketing and transportation business for Phillips, which will be headquartered in Tempe, Arizona. O'Malley will also be vice chairman of the Phillips board and a member of the board of directors.

The company said in its conference call it expects to receive all regulatory approval for the transaction. The company said it anticipates its year-end 2001 debt-to-capital ratio will be in the range of 37 percent, and said the acquisition will not impact the current 2001 capital spending plans of either Phillips or Tosco.

The transaction has been approved by both boards, and is subject to customary regulatory reviews and shareholder approval. Phillips' shock deal to buy Tosco represents a big gamble that refiners' glittering recent profits will turn out to be the rule, not the exception, analysts said yesterday.

After a decade in the doldrums, U.S. refiners finally made hay last year as a lack of the hi-tech facilities needed to meet tough new environmental rules on gasoline and diesel fuel suddenly left supplies short across the nation.

Phillips' purchase of Tosco, at odds with all its recent strategy, bets that consolidation across the refining industry will keep supplies tight - and profits strong - for years to come, the analysts said. "The margin environment for next 12 to 24 months will be good," said Prudential Securities analyst Andrew Rosenfeld. "Will it be good for the next five years? It's impossible to say."

A merged Phillips-Tosco will be the nation's second largest provider of gasoline, heating oil and diesel fuel, and will compete with the industry powerhouses created by a wave of industry mergers - Exxon Mobil, BP Amoco, and the pending Chevron Texaco.

The deal aims to make the most of a shake-out which threatens more closures of small, old refineries and bigger profits for modernized plants that can cope with upcoming green restrictions.

Tosco, the top U.S. independent refiner with roughly 1.3 million barrels of daily (bpd) capacity, has been a role model for refiners, squeezing out profits by cutting overheads to a minimum and making shrewd purchases of sophisticated plants in high-demand areas such as the East Coast and California.

New federal environmental regulations that would virtually eliminate sulphur content in fuels by 2006 have forced smaller refiners to consider selling or shutting down their plants to avoid costly upgrades.

The trouble is the U.S. is running short on capacity to meet these new rules after years of poor returns choked off investment to make the costly plant upgrades. A leading independent refiner Premcor USA permanently closed one of its four refineries in January - an 80,000 bpd plant in Illinois that supplied Chicago - citing the looming rules, while Farmland Industries Inc put its Kansas refinery up for sale.

Signs of a shake-out, combined with a lack of new refinery construction since the 1970s, has sparked worries that U.S. refining capacity will fall even further behind consumer demand in the coming years.

"This merger restates the need for quality refineries in this country," said Rich Friedman, analyst at Texas-based Red Meteor. "We're relying increasingly on imports, and domestic production is going to become more valuable in the coming years."

U.S. consumers use roughly 20 million bpd of refined oil, including gasoline and heating oil, 2.15 million barrels of which is imported. Despite high prices and a downturn in the U.S. economy, demand is expected to continue growing in 2001, putting additional pressure on domestic refiners who have been operating at breakneck pace for the majority of the past two years.

The U.S. Department of Energy's statistical wing, the Energy Information Administration, predicts that U.S. demand for refined products in the first quarter of 2001 will be up 3.5 per cent over the same period last year.

While the many the industry agrees that the new environmental rules will lead to more refinery shutdowns among smaller companies unable to afford upgrades, some analysts believe that "refinery creep" will offset some of the lost capacity.

Refinery creep, which refers to increases in capacity at existing refineries due to upgrades and expansions, could add about one per cent per year to domestic capacity in the 2001-2002 period, according to Prudential Securities.