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Global Oil and Gas Industry: Shell UK Company Evaluation Essay

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Updated: Aug 6th, 2019

Introduction

Shell is one of the largest companies in the global oil and gas industry. The company focuses on production and distribution of petroleum, engine oil, and lubricants. The company has over 87,000 employees and operates in more than 130 countries (Shell 2014).

Shell has over 70 years of experience in the manufacture and distribution of high quality engine oils and lubricants. In 2012, the company’s revenue totaled $467 billion, whereas its net income was $27 billion (Shell 2014). This paper will analyze the competitive environment of Shell in the UK.

The analysis will begin with an overview of the company’s products and the relevant market in which they are sold. This will be followed by analysis of the demand and supply characteristics of the market.

The market structure and the possibility of expansion will also be analyzed. Based on the analyses, recommendations will be made to enable the company to improve its competitiveness.

Product Background

Shell has three main brands of engine oil and lubricants namely, Shell Helix, Shell Rimula, and Shell Advance. Shell Helix oil and lubricants are used in cars and medium-sized trucks (Shell 2014). The products were developed nearly six decades ago through a partnership with Scuderia Ferrari’s Formula One team.

Shell Helix was developed to clean car engines, to reduce friction, and to alleviate wear. The oil has superior cleaning capabilities that enable it to clean car engines while they are in use. As a result, it is able to eliminate more dirt and sludge than most of its competitors.

Shell Advance oil and lubricants are used in motor bikes. The oil is used to clean bike engines, whereas the lubricants are used to lubricate the gearbox and the bike chain. Shell Rimula oil and lubricants are used in heavy-duty diesel engines (Shell 2014).

Their superior cleaning and lubricating properties help in improving the performance and durability of diesel trucks. Lack of restrictive regulations in the oil and lubricants industry enables Shell to collaborate with lead-users to manufacture products with advanced capabilities.

Customers prefer Shell’s products because they help in reducing carbon emission, thereby conserving the environment.

The Relevant Market

Product Market

The relevant product market refers to the category of goods and services that consumers can use as substitutes. The products are selected by customers based on their use, price, and quality (Taylor & Weetapana 2011, p. 45).

The UK market consists of engine oil and lubricants that are manufactured using fossil fuels (crude oil) and those that are produced using vegetables. The vegetable-based oil and lubricants provide excellent functionality in terms of lubricating and cleaning car engines (Lee 2007, pp. 132-136).

However, their capabilities tend to reduce in environments that are characterized by high heat, pressure, and metal catalysts. This weakness limits the application of vegetable-based oil and lubricants in modern car engines.

The petroleum-based oil and lubricants also have excellent cleaning and lubricating capabilities. In addition, they can withstand high pressure and heat in modern car engines. However, their contribution to emission of greenhouse gasses makes them undesirable (Maleque, masjuki 2003, pp. 137-143).

Overall, high competition exists among various brands of petroleum-based engine oils and lubricants. The main brands that Shell’s products compete with include ExxonMobil’s lubricants, GB’s oils and lubricants; Aztect’s oils; Total’s oils and lubricants; and Fuchs’ oils and lubricants.

These brands are highly differentiated in terms of their chemical composition and engine protection capabilities. This leads to high competition as customers search for the best product.

Geographic Market

A relevant geographic market is composed of firms that face homogenous competitive conditions. The UK is a relevant market for Shell’s products since the government has put in place stringent rules and regulations to enhance competition among firms.

In addition, the government has focused on eliminating the production and distribution of fake oil and lubricants in the shadow economy. This involves implementing high quality standards that must be met by both locally produced and imported oil and lubricants (Shell 2014).

Although the UK market is clearly demarcated, it can be extended by including the entire European Union since the UK’s competition laws are based on those of the EU.

Demand and Supply Characteristics and the Effects of Recent Events

Repeated Demand Shifts

The demand for engine oils and lubricants reduced significantly from 2009 to 2011 due to the global financial crisis. The crisis led to a reduction in the number of cars that were manufactured and sold in the UK (Bandinelli & Gamberi 2013, pp. 87-102).

In addition, the financial crisis had negative effects on citizens’ purchasing power. This led to reduced expenditure on engine oil and lubricants as citizens opted to use public transport systems rather than their cars.

Vehicles and engine oil/ lubricants are complementary goods. Thus, a reduction in vehicles’ sales leads to a downward shift in the demand curves for oil and lubricants (Cowen 2011, p. 67).

The government has successfully revived the economy through implementation of effective economic stimulus programs. This has led to increased sales for cars and trucks in the UK. The increase in vehicle sales has improved the demand for engine oils and lubricants in the last three years.

The demand is expected to continue growing at an annual average rate of 2.4% up to 2017 (Bandinelli & Gamberi 2013, pp. 87-102). Since petroleum-based engine oil and lubricants lack effective substitutes, their demand curve is expected to shift upwards in the next three years.

Price Elasticity

Price elasticity measures “the responsiveness of the demand for a product or service to a percentage change in its price” (Schotter 2008, p. 78). The price elasticity of Shell’s oil and lubricants is high due to the intense competition in the industry.

Manufacturers and distributors of oil and lubricants have had to reduce their prices in order to attract and retain new customers.

The price-based competition has been exacerbated by poor economic growth that has forced individuals and businesses to reduce their vehicle maintenance budgets. Generally, consumers prefer to buy cheap oil and lubricants.

Price elasticity is high among the low-income earners and moderate among the middle class customers. The affluent and most of the middle class customers are interested in the quality of oil and lubricants rather than price.

They are also concerned about the environmental impacts of using various brands of oil and lubricants (Maleque & Masjuki 2003, pp. 137-143). As a result, the affluent and the middle class tend to buy Shell’s oil and lubricants even if their prices are high.

Income Elasticity

Income elasticity measures “the responsiveness of the demand for a given product to a percentage change in consumers’ income” (Ranchhod & Marandi 2005, p. 91). Oil and lubricants are normal products because their demand is expected to rise when income increases.

Individuals and businesses tend to spend more on oil and lubricants during periods of high economic growth and vice versa. Thus, the demand for Shell’s oil and lubricants is expected to increase as economic growth improves in future.

Customers are likely to purchase Shell’s products when their disposable income is high to keep their vehicles in sound mechanical condition. The resulting reduction in mechanical problems enables customers to save money.

The savings enable customers to maintain a high purchasing power when economic growth is declining (Cant & Strydom 2009, p. 98).

Supply Capacity

There is overcapacity in the UK’s oil and lubricants industry. This is attributed to the removal of tariff and non-tariff barriers to entry in the UK market. As a member of the EU, the UK has to allow producers of oil and lubricants from most European countries to sell their products in its territory.

Similarly, the bilateral trade agreements between the EU and major economic blocs such as the Gulf Cooperation Council have led to increased importation of oil and lubricants (Pongsiri 2008, pp. 431-442). Imports from countries such as China are able to penetrate the market easily because of their low prices.

The overcapacity in the industry is a threat to the competitiveness of Shell’s oil and lubricants. Specifically, the possibility of increasing revenues through increased production of oil and lubricants is limited due to oversupply.

Moreover, the company might be forced to reduce the prices of its products in order to attract new customers. This is likely to happen if major producers such as Total and GB Lubricants are able to produce high quality products at a low cost. Reduction of prices will cause a decrease in the company’s profit margins.

Competitive Environment, Market Structure, and Performance

Monopoly and Perfect Competition

The market for oil and lubricants in the UK is based on perfect competition. The market is has hundreds of small, medium-sized, and large producers and distributors of oil and lubricants. In addition, the UK market has millions of customers who buy oil and lubricants on a regular basis.

The producers have adequate information about the prices that consumers are willing to pay for their products. Similarly, the consumers have adequate information concerning the prices that sellers are charging for their products.

Buyers and sellers are able to access information concerning market conditions at a low cost through digital platforms such as the social media and online stores. As a result, firms in the industry are price takers (Cowen 2011, p. 112).

Monopoly is not likely to exist in the industry in future because of the laws that have been enacted by the government to enhance competition. Competition benefits consumers by compelling producers to maintain high product quality and to charge fair prices (Schotter 2008, p. 121).

However, perfect competition limits the extent to which Shell can increase the prices of its products in order to boost its profits.

Competitive Forces

According to Porter’s five forces model, the factors that influence the competitiveness of Shell’s products include the following. To begin with, buyers (users of oil and lubricants) have high bargaining power.

This means that Shell and its competitors must focus on product innovation and competitive pricing in order to defend their market share (Cant & Strydom 2009, p. 134).

Suppliers (manufacturers) have a moderate bargaining power because most companies drill crude oil on their own. This enables them to access reliable supply of crude oil, which they use to manufacture lubricants at a low cost.

The threat of substitutes is low. This perspective is based on the fact that the performance of petroleum-based oil and lubricants is better than those for substitutes such as vegetable-based lubricants (Lee 2007, pp. 132-136). This means that Shell is not likely to lose its market share to substitute products.

The threat of new entrants is also low. The high cost of joining the industry and the economies of scale that the incumbents enjoy are credible barriers to entry in the industry. The low threat of new entrants is an opportunity to Shell to develop innovative products to serve new markets.

Competitive rivalry is very high due to the large number of firms and the low growth rate of the industry. Moreover, the industry is characterized by high product differentiation and fixed costs such as labour and warehousing expenses.

The high competition means that Shell is likely to lose its customers if it fails to meet market needs.

Possibility of Expansion: Mergers and Acquisitions

In the last decade, mergers and acquisitions have been the norm in the oil and lubricants industry. Major international companies have been using mergers and acquisitions as a strategy to join the UK market (Pongsiri 2008, pp. 431-442).

Moreover, small companies have focused on consolidation to achieve synergies in production and distribution of their oil and lubricants.

In the 1990s Shell focused on acquiring small and medium sized companies that produced various petroleum products. This strategy changed after the recent global financial crisis, which had negative effects on the company’s financial performance. From 2009, Shell has focused on selling most of its downstream businesses.

This involved selling its refineries, service stations, and manufacturing plants. For instance, in 2013, the company sold its refinery, import terminals, and over 870 service stations in Australia (Shell 2014). It also sold most of its downstream assets in major markets in Africa and Asia.

The company intends to raise adequate capital through disposal of its downstream assets in order to concentrate on upstream activities.

Shell’s divestiture strategy is a threat to its oil and lubricants business in the UK. For instance, selling service stations will force the company to depend on independent distributors to sell its products.

Most car owners buy engine oil and lubricants at service stations rather than retail shops. This means that the company’s sales will decline significantly if it sells all its service stations in the UK.

The company can expand by acquiring small and medium-sized oil companies to increase its revenue in the UK. For instance, it can acquire companies such as Miller Oils, which have worldwide distribution networks. This will enable Shell to reach more customers in the UK and other parts of the world at a low costs.

Market Failures

Quality of Oil and Lubricants

In the last decade, companies have focused on rationalizing their production to reduce operating costs. Companies that are not able to achieve cost efficiency in the UK have moved their manufacturing plants to China and India where labour costs are low (Pongsiri 2008, pp. 431-442).

However, outsourcing production has negatively affected the quality of oil and lubricants in the industry. For instance, towards the end of 2013 Miller Oil recalled most of its engine oil and lubricants because they did not meet the required quality standards.

Innovation, Patents, and Monopolies

Innovation is one of the factors that determine success in the oil and lubricants industry. Industry leaders such as Shell and ExxonMobil have to collaborate with their major customers and leading research institutions to develop high-end synthetic and petroleum-based lubricants.

Manufacturers protect their innovations through patents and trademarks. This helps manufacturers to maintain their competitiveness by preventing their competitors from accessing their technologies (Ranchhod & Marandi 2005, p. 93).

Unlike the pharmaceutical industry, patents have not created monopolies in the oil and lubricants industry.

One of the factors that limit manufacturers’ ability to create monopolies through patents is that virtually all major producers in the industry have access to cutting-edge production technologies (Baninelli & Gamberi 2013, pp. 87-102).

Thus, there is no single producer whose products are significantly superior to others in the industry. In addition, brand loyalty limits manufacturers’ ability to create monopolies through patents.

Companies such as Shell and Total enjoy high brand loyalty, which enables them to avoid losing their customers to their competitors.

Black Market

The black market for oil and lubricants is very small because of the rising concern over accidents and damage of car engines. Road safety campaigns have created awareness concerning the risk of using uncertified oil and lubricants that dominate the black market.

Low quality oil and lubricants can damage car engines. This leads to increased expenditure on car maintenance (Lee 2007, pp. 132-136). In addition, oil products such as brake fluid can cause fatal accidents if they do not meet the expected quality standards.

In this regard, businesses and car owners have the incentive to purchase original and high quality oil and lubricants in the mainstream market.

Advertising

Advertising is a major marketing tool that companies in the oil and lubricants industry use to improve their competitiveness. Advertising is mainly used to create brand awareness (Ranchhod & Marandi 2005, p. 231).

Thus, most companies focus on highlighting the unique features of their products through adverts in order to increase sales. Thus, advertising is a positive externality in the following ways.

First, advertising has enabled the public to identify and to use oil and lubricants that improve engine efficiency. The resulting reduction in emission of greenhouse gasses improves the quality of the environment.

This is an externality to businesses that heavily depend on trucks for transportation by reducing their carbon emission costs (Lee 2007, pp. 132-136).

Reduced emission of greenhouse gases improves sustainability in the industry by enabling car manufacturers and producers of petroleum-based oil and lubricants to avert resistance from environmentalists.

Second, advertising has created awareness on the importance of servicing vehicles on a regular basis using high quality engine oil and lubricants. Individuals who are able to change their vehicles’ engine oil and brake fluid benefit from reduced maintenance costs.

Recommendations

Competing in the oil and lubricants industry in the UK is a challenge because the market is saturated and the competitive rivalry is very high. Thus, Shell should consider the following recommendations to improve its long-term competitiveness.

First, the company should focus on product differentiation in order to improve its competiveness in the UK. This can be achieved through incremental innovation that results into improvement of product quality.

Thus, the company will have to increase its investments in research and development in order to produce innovative products that satisfy market needs (Schotter 2008, p. 124). Producing high quality products will enable Shell to maintain its premium positioning strategy in the UK.

Furthermore, it will enable the company to sell its products based on perceived value rather than price. As a result, the company will benefit from high profit margins and customer loyalty.

Second, Shell has to establish an effective distribution network in order to distribute its products outside the UK. Since the company has already sold most of its service stations, it has to identify reliable distributors in overseas markets to sell its products.

The distributors should have adequate market coverage to enable the company to reach as many customers as possible. In addition, they should have adequate product knowledge in order to improve sales.

Finally, Shell should reconsider its decision to exit several markets in the Asia-Pacific region. The region consists of several emerging market economies that have immense growth opportunities.

Specifically, high economic growth and improved demand for oil and lubricants in emerging markets will enable Shell to increase its market share. The company can join overseas markets by merging with or acquiring established oil and lubricants manufacturers.

Mergers and acquisitions will reduce the time required to join new markets (Schotter 2008, p. 127). They will also enable the company to get instant access to a large customer base.

References

Bandinelli, R & Gamberi, V 2012, ‘Servitization in oil and gas sector: outcomes of a case study research’, Journal of Manufacturing Technology Management, vol. 23. no. 1, pp. 87-102.

Cant, M & Strydom, W 2009, Marketing Management, McGraw-Hill, New York.

Cowen, T 2011, Modern principles of economics, Palgrave, London.

Lee, C 2007, ‘Energy savings through use of advanced biodegradable lubricants’, Industrial Lubrication and Tribology, vol. 59. no. 3, pp. 132-136.

Maleque, M & Masjuki, H 2003, ‘Vegetable-based biodegradable lubricating oil additives’, Industrial Lubrication and Tribology, vol. 55. no. 3, pp. 137-143.

Pongsiri, N 2008, ‘partnerships in oil and gas production-sharing contracts’, International Journal of Public Sector Management, vol. 17. no. 5, pp. 431-442.

Ranchhod, A & Marandi, E 2005, Strategic marketing in practice, McGraw-Hill, New York.

Schotter, A 2008, Microeconomics, John Wiley and Sons, New York.

2014, Annual report: FY 2013. Web.

Taylor, J & Weerapana, A 2011, Principles of Economics, McGraw-Hill, New York.

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