Independent exploration and production (E&P) companies are elbow to elbow with yet more pure-play peers at investment symposiums and in securities analysts' coverage lists this year, and more are coming. ConocoPhillips shocked the integrated-oil club this summer, announcing that it will join Marathon Oil Corp. in leaving the small, exclusive group of giants for membership in the circle of independent (that is, un-integrated) E&Ps.

They join Questar Corp.—another integrated, albeit smaller, energy company—that spun off its E&P unit into a pure-play, QEP Resources Inc., from its gas-distribution business last year. Also, midstream operator El Paso Corp. and international conglomerate Williams Cos. Inc.'s new E&P stocks are scheduled to roll out by year-end. Meanwhile, Murphy Oil Corp. plans to sell its refining and marketing assets, leaving it with a hefty E&P unit with a global footprint and a fuel-station business.

Essentially, integrated oil companies explore for, produce, transport, refine and market oil and gas. Or, in a broader sense, they do more along the energy chain than pure E&Ps do. Independents mostly pursue E&P, while some may also have oilfield-service interests and, possibly, interest in pipelines that carry their production to refiners and processors.

The former's heavyweight ranks include ExxonMobil Corp. and Royal Dutch Shell; the latter, thousands of producers, ranging from the largest, such as Anadarko Petroleum Corp. and Chesapeake Energy Corp., to the smallest one- or two-man E&P shops.

By spinning off its refining and marketing (R&M) business to existing shareholders, ConocoPhillips will catapult its E&P profile from lagging that of ExxonMobil, BP Plc, Shell, Chevron Corp. and Total SA in daily output to being No. 1 in its new "mostly E&P only" class. Its 1.7 million barrels (bbl.) of oil equivalent (BOE) per day of production in the first quarter is only a third of ExxonMobil's 4.8 million—but it is 2.4 times that of some of the leading independent E&Ps such as Apache Corp., Occidental Petroleum Corp. and Anadarko, which each make some 700,000 BOE per day from wells worldwide.

In that light, it's no wonder Marathon began pursuit of de-integration in 2008 and finally—after suspending this move during the subsequent capital-markets disarray and commodity-price collapse—completed it this summer. Within its old peer group, it was among the smallest in the E&P space, making some 400,000 BOE per day or 8% that of ExxonMobil. But, it wasn't the largest among the independents either—putting out less than Apache, Occidental and Anadarko as well as Devon Energy Corp. and EOG Resources Inc.

Even smaller than Marathon, though, is Murphy Oil Corp., which expects to finish selling its R&M assets by year-end. Murphy's first-quarter production was some 200,000 BOE per day, ranking it on the small end of the largest indies.

Unlocking value

But why de-integrate now? That's what Arjun Murti, energy analyst and managing director for Goldman Sachs, wanted to know in July during ConocoPhillips' conference call upon news of its plan to split.

"Is there something about being an integrated that hindered the E&P businesses to, say, convert resources into reserves or to grow faster?...Maybe being part of a big integrated was some hindrance…?" he asked Jim Mulva, ConocoPhillips chairman and chief executive.

To date, each of the integrateds has cited a common reason for its split announcements—creating pure-play stocks that are more transparent to investors. Thus the value of each business is unlocked from the "sum of the parts is greater than the whole" phenomenon.

But, each also has its own unique reasons for its split, as well.

For ConocoPhillips, owning refining and marketing (R&M) assets is no longer translating into greater access to explore for resources, Mulva says. "In the past, the view was that being integrated and having downstream would lead you to get access to more investment opportunities. We think that has changed."

ConocoPhillips has E&P operations in 15 countries. "We see increased competition and more challenging terms. We believe more value is created in the formation of two very clear, stand-alone companies, versus accomplishing our objectives of rationalizing our downstream within the integrated-oil structure."

And, it helps that the R&M business—often very marginal—happens to be going gangbusters this year. A quick look at Murphy Oil's quarterly financials, for example, makes this clear. In the first six months of this year, Murphy's R&M margin in the U.S. averaged $2.73 per bbl. processed. In the first six months of 2010, it averaged a loss of $1.23 per bbl.

Oftentimes in the past, integrateds' downstream units needed profit from the upstream E&P division, or other business units, to tide them over. For example, shares of pure-play R&M company Valero Energy Corp. have risen since 1982 from some $3 to $27, or just 900% in 30 years. And, $16 of that gain was achieved in only the past 10 years.

E&P and midstream operator El Paso Corp. is also playing into a hot market: investors seeking yield-producing investments. It announced in May that it will split the company by year-end—into the dividend-producing midstream and the higher-risk E&P that will gain pure-play attention from oil and gas commodity-price-volatility players.

The company had become mired earlier this century in the gas-trading debacle that brought down Enron Corp. and put companies with less exposure in dire straits. Doug Foshee, chairman, president and chief executive, joined the company in 2003 and went to work reprofiling El Paso's business.

He says of the split, "With the completion of what was an $8-billion pipeline backlog, the elevation of our E&P business to one of the top independent producers, outstanding leadership and employees in each of our businesses, and the accelerated improvement of our balance sheet, we are ready to take this important step."

In El Paso's case, the E&P business will be spun out as the new stock. It will have more than 10 years of low-risk, repeatable drilling inventory to assure growth, and its positions in South Texas' Eagle Ford and West Texas' Wolfcamp shales and in Altamont Field in northeastern Utah are expected to nourish its oil-production profile.

Post-split valuation

What kind of valuation will these new E&Ps receive on the Street? The proof of investor appetite for energy pure plays is in Marathon. Its lead this summer, in spinning off its midstream and R&M business as Marathon Petroleum Corp., has already shown the money. Marathon shares were roughly $37 at the beginning of 2011. Yet, upon the split on July 1, a Marathon Oil share closed at $33 and one Marathon Petroleum share was $42, for a combined $75—or more than double the pre-split value!

Investors in Questar, the integrated gas producer and distributor that spun off its E&P business as QEP Resources last summer, have seen the same "sum of the parts" windfall. Questar began 2010 at about $43 a share. At press time, one Questar share was about $19 and one QEP share was about $45, for a combined $64 or some 50% more than a Questar share pre-split.

But for ConocoPhillips, how its new R&M stock is received may not play out as well as Marathon's, says Robert Kessler, analyst for Tudor, Pickering, Holt & Co. Securities Inc. (TPH). First, Marathon's share price was depressed earlier this year, compared with those of its peers. "Marathon's E&P business now post-split arguably does not trade at an appreciable premium to ConocoPhillips' pre-split business," Kessler says.

Also, Marathon's R&M assets are almost entirely focused on North America-produced crude oil. R&M margins are strong across the U.S., particularly for refiners whose feedstock is produced domestically. The price for seaborne oil—or the Brent price, in short—has been as much as 20% more this past year than the Nymex price that is based on West Texas Intermediate.

For example, while Murphy is reporting a profit from its U.S. R&M assets this year, in the U.K. it reported a 2011 first-half loss of $24.5 million. That follows a first-half 2010 loss of $10.6 million. There, the harder its refineries work, the more money it is losing.

Kessler adds that Marathon's E&P business has more growth scheduled—6%per year compared with ConocoPhillips' forecasted 0% in the near term, net of E&P asset sales—and it has twice the exposure to U.S. shale oil and gas plays, relative to the size of each company.

Other candidates

Another split candidate could be Hess Corp., which was making some 400,000 BOE per day in the first quarter—less than Apache, Occidental, Anadarko and Devon.

John Herrlin, Societe Generale's head of oil and gas equity research, asked John Hess, the integrated's chairman and chief executive, during a recent investor conference call, "Refining: Why stay with it? We're seeing a lot of dis-integration of late."

Hess replied, "Yes, it's a good question. Obviously, there have been some restructuring moves by other companies. We've done a lot of work over the past 10 years to restructure our own company significantly to where we are E&P-led."

Some 88% of Hess' capital is spent on E&P, just 12% on R&M, he said, adding, "And, of that number, 10% is marketing and 2% is refining. So, in terms of how we shape our portfolio, we feel good about where we are now. There is always room for improvement."

And what about BP? Group chief executive Robert Dudley told Bloomberg this summer, after the ConocoPhillips news, that "all options" are possible.

"We are open to all kinds of ideas, but they have to be ones that build long-term value for shareholders, not a short-term pop. We will continue to look at those options," he said.

ConocoPhillips and the others that are de-integrating will no longer be able to access cash from the tills of whichever business is performing better lately to deploy in the one that needs more love. How will the separation work for the R&M and E&P units at ConocoPhillips? Each should be better for it, Mulva says.

"We have gone through periods of time that there has not been too much contribution from the downstream. And then we go through a period of time when there is. But…we really think that we can better accomplish our objectives of funding upstream and downstream by being separate, than having to be combined in the integrated model."

Use of proceeds

What will these new indies or mini-majors do on the E&P M&A front? Kessler and colleagues at TPH expect the new E&Ps will be "run by more financial guys who are more likely to do corporate deals."

Among the integrateds that are creating E&P pure plays, Murphy is the only one that is outright selling its R&M business. For a refinery in Wisconsin, it is set to receive $214 million in cash, plus market price for inventory at closing.

Valuation of a refinery depends in part on the plant's Nelson Complexity Index (NCI). The more sophisticated the plant, the greater-value products it produces, thus a higher NCI. Murphy's Wisconsin refinery, which has a middling NCI, is set to receive the equivalent of $3,000 per bbl. of daily capacity. Murphy's remaining plants have NCIs in the uppermost range, according to the TPH analysts. By comparison, Valero stock is currently trading at the equivalent of $7,000 per bbl. processed.

What does Murphy plan to do with the eventual proceeds of its refinery sale? Spend it on its E&P business, including in the Eagle Ford shale and Gulf of Mexico, and on the fuel-station retail business it plans to retain. Its oil and gas production has been hovering at between 170,000 and 193,000 BOE per day during the past few quarters. It plans to exit 2011 at 220,000 BOE per day, and its target is 300,000 by 2015.

"The streamlining and refocusing in our upstream business will help us on our goal to meet and beat future targets," says David Wood, president and chief executive.

It has added acreage in the Eagle Ford oil and gas shale play in South Texas recently. There, Murphy was making 7,200 BOE per day in July. It added more than 20,000 acres in the heart of the play in the second quarter.

"I would like to…add something meaty to our program, and so we have an effort underway to do that," Wood says. "I do believe that we will be successful in exploration and maybe in something on the cheap that I'm looking at…But, yes, we're a looker and, hopefully, we'll be a buyer."