The Impact of Diversification of Production Activities by Major Public Oil Companies on the Value of Their Shares

This study aims to identify a system of factors that influence the market value of the largest oil companies. In order to create the most robust analysis with real-world applicability, we test several hypotheses which aim to establish those patterns of behavior and composition within oil company structures that interact most predictably with market trends and processes.<br><br>To achieved this, we collected quarterly data on the 5 largest private oil companies (BP, Chevron, Exxon Mobil, Royal Dutch Shell, Total) for the period from Q1 2006 to Q3 2016. The financial indicators for these companies were calculated based on data from the Thomson Reuters Eikon database, as well as from the quarterly reports of the companies themselves. An econometric analysis using panel data was used to test hypotheses.<br><br>The following results were revealed. First, the capital structure of the largest oil companies has a direct impact on the value of shares. Second, the increase in capital costs attributable to the downstream segment relative to total capital costs adversely affects the price of shares. Third, we discovered that with the growth of Tobin’s Q, the share price of the largest oil companies increases. It was also revealed that factors such as the conclusion of mergers and acquisitions, profitability in the downstream segment, and the dividend payout ratio were insignificant in the model.<br><br>These results confirm that any study assessing the value of companies in the oil industry ought to evaluate influential variables affecting the capitalization of companies operating in both upstream and downstream segments, while also considering companies engaged in production in only one such segment. It is also imperative to conduct a separate analysis of the influence of factors on the capitalization of companies with respect to the prevailing trends in the oil market.<br><br>The novelty of this study relates to the immediate applicability of the real-world data utilized. We focus on such fundamental econometric variables from market-leading companies as profit levels, returns on sales, debt burdens, capital costs, and the effects of mergers and acquisitions. These factors are relevant at every level of business and academic analysis in every commercial endeavor. As such our conclusions may be instantly implemented into business strategies, research, and economic analyses related to the oil industry as well as other markets. Additionally, since there are no significant discrepancies between our results and established academic consensus, our contributions require little further interpretation to be instrumental.


Introduction
Assessment of prospects of the future rise in value of investment projects is the basis for beneficiaries when making an investment decision. In order to define the current value of an asset and its capability to generate dividends within the chosen time horizon it is necessary to carry out a complex analysis of the factors which influence directly its value. The purpose of the present paper is revealing the group of such factors using an oil company as an example.
A distinguishing feature of defining the investment potential of resource-extracting companies is the necessity of analysis of their dependency on the raw materials prices and considering of their mechanisms of protection from reduction of the amount of financial receipts with the existing risks of high volatility in the raw materials markets. The macroeconomic analysis of the petroleum industry and its prospectives will give us an opportunity to answer the important question of expediency of purchase of oil companies' shares in crucial respect.
Due to a rapid growth of the global economy from 1965 to 2017 the demand for oil increased almost thrice from 1,524 до 4,470 million tons. The biggest contribution in the growth of the composite demand was made by Asia region where the considered indicator increased within the above period more than 9 times (from 163 to 1,598 million tons), while in North America the oil demand increased less than twice (from 620 to 1,056 million tons). This is due to a rapid development of the economies of Asia region. A notable increase of the share of oil consumption in this region also confirms this fact. From 10 % of the total world amount in 1965 it rose to 34.7 % by 2015 and in 2017 it amounted to 35.7 %.
As the results of predicted values of the global oil demand presented in the reports of the global analytical organizations (BP, IEA, OPEC, Institute for Energy Studies of the Russian Academy of Sciences) show the average value of demand by 2040 will be 4,916 million tons, and it exceeds the corresponding value of 2016 by 13%.
It is important to note that in spite of differences in predicted values of demand for energy resources represented in analytical reports of various agencies and organizations an overall trend of oil demand in the coming decades can be seen. It means that development of the oil industry will go on and it will continue to generate profits for its shareholders.
When taking the optimal investment decision stock market traders use the methods of defining the fair value of public companies. Carrying out such analysis it is necessary to take into consideration as much factors influencing the share prices as possible. At present the issues related to assessment of capitalization of oil companies are of greatest relevance due to a high price volatility in the oil market which emerged in 2014.
One of the mechanisms which protect capitalization of oil companies from decline is diversification of production activities into upstream and downstream segments. Figures 1 and 2 illustrate a collapse of operating income in the upstream segment for the largest oil companies Exxon Mobil, Chevron, BP and Total in 2014-2015 when oil prices fell significantly, while the same indicator in the downstream segment showed growth within the same period. The presented diagrams show that operating income in the downstream segment is unresponsive to the changes of the oil market which, in its turn, explains why prices of the companies' shares were not reduced pro rata with the fall in oil price.  The mechanism of activities diversification of the largest vertically integrated oil companies from the point of view of analysis of financial flows' cost-effectiveness in the upstream and downstream segments has not been studied before. Apart from diversification it is necessary to define and analyze other factors on which capitalization of oil companies depends.

Review of Literature
The majority of researches dedicated to assessment of influence of various factors on capitalization of oil companies are focused on detecting of influence of financial indicators which are external for the companies, for example, change of oil price [6; 7; 10; 12; 15], movement of stock indexes [14], inflation fluctuation and industrial production index [17].
Another group of papers considers not just external factors which are independent of the company operations, but also internal ones -financial and production indicators of companies [8; 11; 13]. Conclusions on existence of the asymmetric effect of influence of the oil price change and cost of companies' shares are stated in the following econometric papers. Research [15] makes the conclusion that growth of oil prices influences the prices of oil companies' shares more than fall of these prices.
However, it should be noted that the final conclusion in the paper was made on the basis of analysis of the selection which comprised large vertically integrated companies (BP, Roya Dutch Shell), as well as the companies which conducted business only in the upstream segment (Pharos Energy, Tullow Oil, Afren etc.). In this regard it is reasonable to carry out a more thorough econometric analysis using a homogeneous sampling which consists only of vertically integrated companies. Besides, among the independent variables applied by the authors of the research there are only financial indicators such as market risk calculated using the London Securities Exchange index, expected daily profitability of shares, oil price. Operational and financial indicators of the companies themselves are not included in the research.
In the other paper dedicated to revealing the asymmetric effect of influence of oil price change on share prices of oil companies the authors conducted the econometric analysis separately for the companies of the upstream segment and those from the downstream segment [17]. The research also states only external factors such as oil prices (Brent, WTI and Dubai) and macroeconomic indicators (inflation, industrial production index). The main conclusion of the paper made by the authors is that share prices of oil companies react asymmetrically to change of oil prices irrespective of the macroeconomic environment in the market, for which reason the authors think that investors should assess oil companies in more than one way in case of diversification of risks of the portfolio they build up.
In paper [12] the authors study external and internal factors and make the conclusion that different structure of amounts which account for the upstream and downstream segments of large vertically integrated companies results in a differently directed movement of shares' price of these companies in case of oil prices growth. However, just as in previous researches the authors focus on the cost of shares and their dependency on oil prices (the difference between the future and spot prices for oil) not including operational and financial factors of companies. However, unlike in previous papers the authors study six Higher School of Economics largest vertically integrated companies (including Chevron, Exxon Mobil, Eni) but the econometric analysis is conducted for each company individually.
The authors of research [13] found out that irrespective of the sector of a resource-extracting company the revenue, mineral resource price and EBITDA are the underlying determinants which influence the value of securities. Just as in previous studies macroeconomic factors are not presented in this paper, in article [12] an individual approach to companies is applied -four companies from various sectors, including the power industry, thus it does not give a full picture of the sector because the obtained results may be accounted for the considered companies' leadership or range of activity (capitalization of each company exceeds 25 billion US dollars). Revealing of the diversification effect is not considered.
To sum up the results it should be noted that in the majority of the considered researches dedicated to analysis of the factors which influence capitalization of oil companies' operational and financial indicators which are important indices of assessment of a company development potential have not been considered. In this paper we will carry out the econometric analysis to find out external and internal factors which influence capitalization of the largest vertically integrated oil companies and we will use profitability ratios for the upstream and downstream segment for the first time in order to verify the hypothesis of a positive influence of activity diversification on the above segments.

Research Methodology
For the purpose of our research the following model was used as a basis [13]: where it m -ratio of EV (enterprise value) to DACF (debt-adjusted cash flow), i A -a set of dummy variables specific for the company (fixed effects), t P -price for Brent oil, it KPI -vector of key performance indicators (production volume, costs, expenses for exploration and exploitation of deposits, Reserves Replacement Ratio and others), it R -RoACE.
This model was chosen because it meets the criteria necessary to conduct our research. It comprises the most essential indicators of oil companies' activity, companies' value, besides, the model is intended for using panel data. For the purpose of our research we specified the model as follows. In the furtherance of our objective we will verify the following hypotheses: • Increase in profits in the downstream segment has positive effect on securities value; • Growth of profitability of sales in the upstream and downstream segments has positive effect on companies' share value; • Increase of debt load depreciates share value; • Increase of capital expenditures for the downstream segment has positive effect on company capitalization; • M&A deals influence share value.

Data Analysis
Before drawing up the regression we preprocessed the obtained data, the results are presented in Table 1. On the basis of the analysis, one can conclude as follows: 1) the company Exxon Mobil has the maximum value of Tobins'Q of 2.14 and it is the only company which has the mean value and median value of Tobins'Q above 1. Further, it means that this company for a long time has been assessed by the investors as more attractive for investment and this resulted in its overestimation; 2) the average of S_ratio in the selection amounts to 0.59, i.e. on average a little bit over 50% of companies' assets are comprised of debt capital. Such significant size of the share of raised funds is accounted for investment projects which are characteristic of oil industry and are distinct in capital capacity and longtermness; 3) Exxon Mobil shows the highest mean and median value of return on share capital which indicates efficiency of its business activities; Higher School of Economics 111 On the basis of the submitted data one may make a conclusion of existence of moderate significant positive relations between the following factors: Prof_down and Down_income, TobinQ and ROE, Prof_up and TobinQ, Prof_up and ROE. There are no strong relations between the dependent variable and independent ones, as well as there are no such relations between independent variables themselves (modules of obtained correlations do not exceed 0.8) which is indicative of absence of multicollinearity. Nevertheless, let's calculate variance inflation factors ( Table 2). As long as VIF of each explanatory variable is less than 10 it indicates absence of multicollinearity between the variables [24, p. 39]. We conducted a Breusch-Pagan test for heteroscedasticity where Prob = 0.1946 which exceeds 0.05. So, the null hypothesis is not rejected, hence we can make the conclusion of absence of heteroscedasticity.
The final results of the developed models are presented in Table 3. Developed model 1 of pooled regression is significant at any reasonable level of significance because Prob is less than 0,01. R-squared amounts to 0.69. As judged by the model such independent variables as Prof_down, DPO, Down_income, ROE turned out to be insignificant at the level of significance of 10%.
In order to take into consideration the time component model 2 with fixed effects was developed which is significant at any reasonable level of significance (Prob < 0,01); R-squared (within) amounts to 0.2895. On the basis of the obtained results one may make the conclusion that inter-individual differences between companies manifest themselves stronger than dynamic ones. As long as all predicated variables vary with time all ratios have been evaluated.

Conclusion
The results of verification of hypotheses in accordance with the regression analysis using the fixed effects model are presented in Table 4.
Analyzing the influence of the production activities diversification by the largest vertically integrated companies applying the approach which divides factors into profitability in the upstream and downstream segments it should be noted that growth of profitability in the upstream segment results in increase of shares' price while profitability in the downstream segment turned out to be an insignificant factor which adversely affected the dependent variable.
The obtained results indicate that investors pay more attention to the financial indicator related to the upstream segment leaving aside the downstream segment and this may cause underestimation of oil companies and subsequent correction of shares' prices. This conclusion is confirmed by behavour of oil companies' securities ( Figure 3).
Companies' capitalization follows change of oil price but it does not decline so much as the price for the above energy source. Since 2013 and by 2015 the oil price had slumped by 60%, while within the same period the price for shares of the companies Chevron, ExxonMobil and Royal Dutch Shell, taken as an example, reduced by 28%, 23% and 36% respectively. It should also be noted that as a part of price recovery which started in 2015 the price of oil companies' shares bounced back almost to the figure of 2013.
Higher School of Economics 115 *** -the factor is significant at the 1% level of significance, ** -the factor is significant at the 5% level of significance, *the factor is significant at the 10% level of significance.
Source: comprised by the author.  Probably, the issue of influence of M&A deals on share prices should be studied in more detail using monthly data instead of quarterly data Source: comprised by the author.
The following may be added to the results represented in Table 4: • changes in the capital structure of large oil companies influence share price: debt growth leads to price decline; • growth of investment costs in the downstream sector as compared to the aggregate investment costs has an adverse effect on the companies' value. It stems from the fact that when oil price declines large oil companies cut investment costs in the upstream sector simultaneously increasing the investment costs in the advanced petroleum refining sector; • when Tobin's Q increases the price of shares of large oil companies grows. This suggests that investors are ready to invest their money in the shares of the companies which are overestimated from the market point of view as compared to the shares of other oil companies.
In order to promote the research of assessment of oil companies' value it is reasonable to carry out the analysis of influence of the considered factors not just on capitalization of the largest vertically integrated oil companies but also of the companies carrying out production separately in the upstream and downstream segments. This will let us describe in more detail and explain the obtained conclusions as well as to conduct the comparative analysis of the factors which influence oil companies conducting production in various segments.