INTEGRATION PROJECT GALP IN SPAIN1

At the beginning of 2010, Ferreira de Oliveira, CEO of Galp, reflected on the successful integration of Galp Spain with the AGIP and Esso operations, the former acquired in December 2007 and the latter in April 2008. This operation had allowed Galp to become a relevant player in the Spanish oil market, particularly in the areas of retail and non-retail (wholesale). It had also attained market shares of 7 and 15%2, which placed the company as the third-ranking player in the Spanish and Iberian markets. In addition, the company had successfully surpassed the complex challenge of managing the simultaneous integration of three corporations, through a careful process, which created a new organization incorporating the best practices of each company. Throughout 2010 the new organization would begin its first joint operational year. There were great expectations based on the ability of the new company to achieve the qualitative leap expected in the positioning of Galp in Spain, placing it on an equal level in competition with the leading Spanish market companies.

The Spanish oil market

In the eighties, the Spanish oil market was strongly concentrated in three large companies which were dominant in the market: REPSOL YPF, CEPSA and the British BP. In the early nineties, the Spanish government decided to follow the international tendencies to deregulate the oil market, opening a door to the entrance of new national and international players. However, this liberalizing experiment was compromised, as the companies already in the market were powerful enough to prevent the new players from attaining the necessary critical mass to become competitive, and so the great majority left the market. In 2007, although there were more operators in Spain than in the eighties, the market was still strongly dominated by the large companies, with REPSOL maintaining its position of uncontested leader, with a market share of 42% and a network of 3,500 filling stations. CEPSA had the second largest quota, with 1,500 filling stations and a market share of 18%. BP
1

Case by the AESE Research Centre for Company Policy. Prepared by Prof. Adrin A. Caldart and by Pedro Leo, in June 2010, to be used as a basis for academic discussion, and not as an example of adequate or inadequate management of a concrete situation. Total or partial reproduction forbidden without written permission. Copyright 2010 by AESE. Before the acquisitions, Galps market shares in Spain, in retail and non-retail, were 2 and 4%.

2 came third, with a network of 640 filling stations, holding a 9% market share (Exhibit 1). The fuel distribution business in the Iberian Peninsula was characterized by low margins and limited expectations of growth (Exhibit 2 and 3). In the retail segment, competitors set their prices almost daily (two or three times a week), but varying geographically according to the laws of local offer and demand. Particularly from 2000, Galp was the only operator which managed to maintain growth, supported by its logistical base in Portugal, and taking advantage of the high level of integration of the Iberian oil markets. It carried out a policy of continued acquisitions and of opening new stations with the Galp brand, and also moving gradually into the aviation and auto LPG sectors. In the Canary Islands DISA was an operator with a good competitive position, and it managed to buy Shells assets between 2004 and 2005, thus gaining a relevant status on the continent and positioning itself as a player with a market share of about 4%. In 2006 the Spanish market was predominantly an importer of oil products, mainly diesel and fuel oil, from countries such as Italy, the USA, countries of the former Soviet Union and the United Kingdom. Petrol was the exception, in which Spain was a net exporter, with sales to non-OECD countries, USA, Mexico and Canada. For twenty years, practically until 2005, the Spanish market had one of the highest European growth rates, and later had a more modest growth, due to the crescent maturity of the Spanish economy. In European terms, Spain had in 2006 one of the largest refining markets, with a market share of 9% in the region, owning nine large refineries and a refinery for specialties. In 2007 the Spanish network of pipeline for the distribution of oil products, was based on a 3,835 km network operated by CLH1, bringing the products from the coastal refineries to the high consumption areas of the interior, stretching from Bilbao in the North to Cadiz in the Southern Atlantic coast, also connecting the refineries of the Western Mediterranean (Tarragona) to the central zone. The fuel retail business was essentially based on the supply station network and on the logistic operational support network. In the case of Spain, this had undergone an important evolution with the de-regulation process initiated in the nineties, a fact which led to the increase of the number of filling stations from under 5,500 in 1992 to over 9,000 in 2007, including some 500 stations outside continental Spanish territory. The commercial markets was essentially focused on diesel (automotive, agricultural and heating oil).

The history of Galp in Spain

Galp Energia, SGPS, SA, was created in on April 22, 1999, under the name of Galp Petrleos e Gs de Portugal, SGPS, SA, as a result of the restructuring of the energy sector in Portugal, to operate in the oil and natural gas sectors. Until its capital was opened to private companies, Galp was the incumbent company in the area of oil and gas in Portugal, and was leader of this sector (Exhibit 4). In 2007 its shareholders included the Portuguese State, the Italian group ENI and the Amorim Energia company, as well as other small shareholders (Exhibit 5).

See Glossary.

3 Galp Energia brought in Petrogal, the only refining company and the main distributor of oil products in Portugal, and GDP, the company responsible for the importation, transport and distribution of natural gas in Portugal, and became the main integrated group for oil products and natural gas in the country, with a growing presence in Spain and a developing activity in the area of production and supply of electric energy. In 2007 the activity of the Galp Energia group (Galp) included the business of prospection and production (upstream), mainly in Brazil and Angola, refining and distribution of oil products (downstream), natural gas (supply, sale and distribution) and power (electricity) including renewable energies and co-generation units. In 2007 Galp was among the largest Portuguese companies, controlling about 50% of the fuel trade in the country and all of its refining capacity and quoted in the PSI20, the main index of the Lisbon stock exchange. In Portugal Galp had about 5,800 employees in 2007 and a 37% market share in retail (well above its competitors), 51% in the wholesale market and 72% of the natural gas market. However, the situation in Spain was quite distinct, in spite of having been the only foreign firm to grow in a sustainable way in the Spanish market. In 2007 Galps market shares in Spain were a mere 2.5% in retail and 4% in the wholesale segment. Although it had maintained a noteworthy growth since its entry into Spain in 1991, growing in a sustained manner through a series of acquisitions complemented by some organic growth, the fact was that the dimension and visible presence of the Galp brand in the Spanish market were not significant until the year 2007. For this reason, Galp had until then kept up an operation which obtained positive results, but without providing an adequate return. This was confirmed by the brand familiarity index of 4% in Spain, a sharp contrast with the company image in the Portuguese market. Although it entered the Spanish market in the nineties, Galp only defined this market as a real target after reformulating the companys strategic vision, a process which took place from 2000 to 2001, and in which all the business areas were examined to establish the values of several potential projects. The project of entering Spain in grand style was given first priority. As it was notoriously difficult to grow organically in Spain, Galp attempted to go around the situation by negotiating swap contracts for filling stations with Total and Cepsa, while at the same time trying to buy companies which might want to leave the market (Shell and Esso). In 2008 Galp defined its strategy of developing an integrated energy company with interests in oil, gas and electricity. The Spanish market presented itself as an excellent opportunity to improve the relation between Galps refining capacity and its capacity to distribute fuels, which would not be possible operating only in the Portuguese market. Also, the geographical proximity of the Spanish market, as well as the high level of integration of the Iberian oil industry, would allow for significant economies of scale.

The operations of Agip and Esso in Spain

Agip Agip Espaa belonged to the Italian ENI. This was a large economic group in the oil and gas industry, with over 78,000 workers in 70 countries, with a cap market around 60

4 billion euros. ENI was also a shareholder of Galp in Portugal, owning 33.34% of its shares in 2007. Agip Espaa based its operations on three business segments: car-fuel retail, nonretail and specialties sales, mainly lubricants.
1

Sales and market shares. In 2007 Agip Espaa had sales of some 1,720 million euros in the non-oil business2 and possessed a considerable network with 311 filling stations, of which 80 as COCO, 109 as CODO and 122 as DODO3. The total volume of 969,000 m3 of fuels sold in the retail segment gave it a 3.1% volume market share of the Spanish market. In Agips strategy for its station network, the company should be perceived by the market as a quality player, with a price policy in line with the market average, or slightly above, whenever conditions allowed this. Operations. In 2006 Agip Espaa imported 63.9% of products directly from ENI Spa in Italy, with the remainder being bought from local players. In order to optimize its costs structures and to obtain advantages from the geographical dispersion of the filling station network, Agip Spain had several partnership agreements with other market players in logistics and supplies areas. Outstanding among these, were the product swap agreements4 with Repsol and BP and the agreements to supply products with Cepsa and Repsol. Esso The operations of Esso in Spain belonged to the ExxonMobil Corporation, a North American multinational with 125 years of history and a global position, and a member of the exclusive club of the six supermajors. Esso Espaola had a relevant position mainly in the area of retail fuels and in the aviation sector. The strength of ExxonMobil was mainly expressed in the lubricants area, where its premium positioned global oil brands Mobil 1 and Mobil SHC were widely recognized by their characteristics of quality, dependability and technical qualities, apart from being developed in close partnership with the most prestigious world level car makers. This fact allowed the flagship product Mobil 1 to be recommended by the main car brands, and to maintain a constant presence in the great motor competitions (Le Mans, Nascar, F1, etc.). The Mobil brand was also considered the lubricant brand with the greatest number of certifications approved by motor car constructors. Sales and market shares. In 2007 Esso Espaola sold about 397.6 million euros and had a fuel retail network with 86 filling stations (72 COCO, 12 DODO and 2 COAG), with a total sales volume of 410,000 m3, representing 1% of the Spanish market. The Esso station network had an aggressive price policy, slightly below the market average. The company positioned itself in the price-sensitive segment of demand, in a way similar to that of independent and hyper-market stations. On the other hand, the management of the nonoil business (shops, washing, etc.) was more aggressive than that of Galp and Agip. We paid a lot of attention to the non-oil business, as we had more profit from the sale of a chocolate bar
1 2 3 4

Wholesale segment which included large clients. Sales of convenience products in filling station shops. See Glossary. See Glossary

5 than from filling a 50 litre tank remembered an executive who had come from Esso. The filling stations. Esso Espaola had yearly supply contracts with various local players, such as BP, Cepsa, Repsol and Petronor, which supplied its filling stations. It also made extensive use of the pipeline and terminals network belonging to CLH and DISA, through yearly contracts with fixed deliveries, buying from the suppliers who carried the product by tanker to the final destination The sales of jet fuel in Spain were made directly by ExxonMobil Corporation, through the sales team of the ExxonMobil Aviation division. Typically, the air companies invited jet fuel suppliers to offer tenders for contracts to supply fuel to a given airport or group of airports, normally for one year. ExxonMobil did not produce the full range of lubricants in Spain. To satisfy the needs of the Iberian market, Esso imported the products from other divisions of the ExxonMobil Group. In the case of supplies for Spain this was done through Essos French subsidiary. Purchasing operations After carrying out some M&A operations in 2008, with the acquisition of Shells distribution assets in Mozambique, Gambia and Swaziland, which provided a certain degree of international experience, Galp decided to invest on a large scale in the Spanish market, as the future destination of its internationalization projects. Buying Agip and Essos assets in Spain corresponded to a new concept of Galp. During 2006 Galp decided it should be an integrated energy company, active in the oil, gas and electricity sectors. Thus stated Joo Pedro Brito, from Galps Board of Directors and leader of the project for the integration of Galp with Agip and Esso in Spain. In the particular case of the oil business, Galp aimed at being a company present throughout all the value chain. As Galp was a company mainly positioned in refinery, implementing the new aims implied the increase of its activities of prospection and extraction (the so-called upstream), as well as of its distribution business. Galp felt the need to grow in distribution, but it was not possible to do so in Portugal recalled Pedro Galhardos, Manager of the Integration Project. The distribution business allowed the reduction of the refining business risks, since the correlation between the margins of this activity and those of the distribution one was usually negative, and also had lower margin volatility levels. The logic of growth was grounded on obtaining dimension in the Spanish market, becoming a relevant player in terms of market share. For Galp, Agip Espaa and Esso Espaa represented an excellent platform, thanks to their network of 397 filling stations and to their position in the non-retail fuel segment. The increase in the number of stations not only allowed Galp to grow in critical mass in Spain, but also balanced its refining capacity with the groups fuel distribution activities. Altogether, the two acquisitions would allow Galp to increase its network in Spain from some 200 stations to about 615, equivalent to 8% of the market in number of filling stations. Industry specialists maintained that from a market share of 8 to 12% of supply stations, there would be network effects, resulting from the increase in number of clients. Beyond this, the acquisitions would allow Galp to achieve scale economies which would be instrumental for

6 the improvement of the companys competitive position, as well as short-term gains due to operational synergies from the business integration. Lubricants. The acquisition of Esso offered, additionally, a base of specialties, particularly lubricants, belonging to a group with a technological lead in the market, which Galp intended to use strategically as a lever for its brand in the Spanish market. The sale of the assets of Esso Espaola to Galp also included an agreement, through which Galp might become a producer, seller and distributor of Mobil Oils prestigious lubricants in the Spanish market for two years. The lubricant business was managed by an organization distinct from that of fuel distribution, with a strong international profile and essentially managed from Brussels and London. In Spain it had its own business network for both large and small accounts, such as small and medium size companies, small distributors, farmers and condominiums. Galp already relied on its own lubricants line, positioned in the market with a lower price range than that of Mobil Oil. Galp considered that distributing Mobil Oils lubricant range would help to give credibility and visibility to the Galp brand in Spain. This operation surprised ExxonMobils staff to some extent, and there was some uncertainty among staff and clients as to what would happen to the brand once the agreement ended in 2011. It was hoped that these agreements might be renegotiated in 2010. The plan called for the process to begin with the acquisition of Agip and, later, Esso. In October 2007, the board of Galp decided to move forward with the Agip operation and in February 2008 also to proceed with the Esso acquisition. Agip was formally bought in December 2007 and for Esso the final agreement was in April 2008. The operations were closed in October and December 2008, as in the case of Esso the European Commission only gave its permission on October 31, 2008. Including some assets in Portugal, these acquisitions represented 750 million euros, to be financed entirely by Galp, without resorting to debt or fresh share capital. In the case of Esso, the price was established by competitive bidding, which Galp won. In the case of Agip, there was a previous agreement in the Galp shareholders agreement, by which Eni and Galp had accepted that the base value for negotiation would be determined by a pool of three investment banks, each party naming a bank it trusted, and these two would agree on the choice of the third bank. Except for minor adjustments of stock taking place between the beginning and the end of the due diligence process, the parties agreed to the final price found by the arithmetical average of the three bank evaluations.1 In essence, the evaluation of both companies was based on the acquisition of the retail network factor, where the trade margins are higher, although in the case of Agip the non-retail or wholesale business was equally important. As the factor with most weight in the evaluation of Galp at that time came basically from news channeled by the upstream business, and as these were operations in the downstream segment, the acquisitions were seen by the analysts as being of moderate interest within the market parameters, and liable to create value, apart from being seen as strategic acquisitions for the positioning of Galp in Spain. In order to validate all the business assumptions underlying the operations, the M&A team planned and structured due diligence processes for both deals, structuring the operations in such a way that it might be possible, from the beginning, to obtain some level of meshing between the companies and to provide a good way to get to know capacities, sensibilities, perceptions and personal agendas, among other aspects of the teams from the target companies.
1

As a precaution against a possible more tendentious evaluation by one of the banks, the parties agree that in the event of one of the evaluations exceeds a given percentage in relation to the arithmetical average, it would be disqualified.

7 As a sector strategic for the economy and with a potential impact on the general population, the oil sector was strongly regulated in what concerns competition and market power, demanding special care on presenting the operations in order to obtain approval by the European Committee authorities. There was a particular emphasis on this aspect, namely concerning conformity to regulation 139/2004 of January 20, 2004, on control of company concentrations. Galp also resorted to the services of a well-known law firm, to organize and present the dossier of the operations to the European authorities. From the point of view of competition, even considering the restrictive European directives in matters concerning competition and market power, the Agip acquisition did not represent an increase which might infringe the limitations imposed by regulation of the area, as in none of the business segments could one find aggregate Iberian market quotas above 25% (increases of 44 points in the HHI index1). Even in the fuel retail segment, the post-acquisition Iberian market quota proved to be below 10%, of which Agip represented less than 3%. In the case of Esso, the operation represented an increase of only 1.5% of the market share in the area of car fuels.

Integration plan for the three organizations

The Galp integration plan had as its premise to carry out the integration of the three companies in a gradual and evolutionary manner, after which would follow a new stage of consolidation of the new integrated organization. With the integration plan, Galp aimed at answering two types of strategic challenges. One was to simultaneously integrate three companies with similar operations and of similar size, but with different organizational cultures. On the other hand, to attempt to build an organization which might effectively put into practice a management model capable of providing equal opportunities for all collaborators based on meritocracy, simultaneously incorporating the best practices from each company. Pedro Galhardas added that these two challenges aimed at avoiding three short-term risks which are characteristic of these processes: the risk of losing key collaborators, the risk of loss of operational efficiency and the risk of not obtaining the synergy initiatives foreseen in the plan. To answer both challenges, Galp retained the services of an international consultancy with experience in this kind of operations, and also organized an internal team to be responsible for the management of the integration project. The first phase of the work on planning the integration of the three companies included the discussion of the conceptual model for the structure of the project, clearly identifying: 1. the guiding principles, 2. the objectives, 3. the critical factors for success, 4. the synergies to be attained, 5. the organic structure of the team in charge of the project and 6. the models for reporting and communication, among other matters.
1

See Glossary.

8 Four main transversal processes were chosen to be the pillars of the integration process. The model for managing transition; operations continuity management; capturing of synergies; and implementation of the new organization (Exhibit 6). These four pillars were to sustain the achievement of three key objectives in the project, namely, 1) to preserve the value of the operations, in order to safeguard the economic and strategic rationale of the acquisitions; 2) to bring the synergies into effect; 3) to gradually integrate the organizational structures, in order to gradually build the new organization, which would in its turn ensure the continuity and the efficiency of operations. The schedule foresaw that the project would be divided into three phases, with different objectives and durations. PHASE 1 (Q1 to Q3, 2008) corresponded to preparing the integrations. PHASE 2 (Q4, 2008 to Q4, 2009) corresponded to most of the integration effort, during which the coordinated management of the three organizations was attempted, and the four great parallel and transversal processes were defined. Lastly, in PHASE 3 (2010 to 2012), the objective was to consolidate the integration of the three companies so as to position Galp as a reference operator in the Spanish market (Exhibit 7). In operational terms, the integration strategy was based on a phased approach, in which initially the three companies were operationally managed independently by two chief operations officers (COO), who reported to the committee for the management of operations in Spain (CGOE).1 The CGOE was in charge of defining the coordination mechanisms for the three firms. The CGOE was formed by top managers from the organization, demonstrating the engagement of Galps management in the process (Exhibit 8). At the same time, nine multicompany transversal integration teams were set up, under the manager for the integration project, who reported to the CGOE. The teams were divided into areas: network, supplies and logistics, purchasing, aviation, marketing, lubricants, ex-network (large accounts), ex-network (small and medium-sized companies and B2C) and cards. Approximately 100 people in all, to which another 200 reported, made up the integration teams. Top management of the integration process fells to the CGOE. He was responsible for defining objectives, establishing coordination mechanisms, implementing transversal orders for the three companies and also designing the future organization. The job of full-time manager of the integration project was handed to Pedro Galhardas, an executive already experienced in consulting in the oil sector. He was responsible for the global detailed planning, the planning and management of the synergy plan (plano de captao de sinergias PCS, synergy capture plan, SCP), the operational management of the several integration teams and the definition of the transversal communication mechanisms among the three companies. The integration teams were set up with the objective of giving impulse to the coordination of the companies, so as to attain the synergies objectives. The teams were made up of the companies key staff in each business area or function. In terms of hierarchical dependence they operated as a matrix, answering to their functional director in their organization and at the same time to the project manager, in the context of the integration team they belonged to. The strategy underlying the configuration of the governance model of the new organization was based on five directing principles: I. To strengthen the role of the CGOE as the only body for global coordination and management, with the boards of directors as merely formal bodies during the integration process.
1

Comit de Gesto de Operaes em Espanha CGOE. The original intention was to rely on three COO, each one in charge of the organization of his company of origin. However, after the COO responsible for AGIP left for Italy, Galp decided that the COO of Galp Spain could accumulate the management of the AGIP operations.

9 II. To give the COOs of the three companies control of the day-to-day operations, reporting to the CGOE. III. To strengthen mechanisms for fast activation and management of the integration teams, under the direct responsibility of the manager of the integration project, who answers to the CGOE. IV. To give centralized areas/functions full responsibility for the management of all activities in their several areas, under the supervision of the CGOE. V. To ensure the distribution of the centralized areas/functions to the several members of the CGOE, in order to stimulate transversality and team-spirit within this body. These structures established the grounds for the effective management of three critical aspects of the integration process, namely, operational continuity, capture of synergies and organizational integration. In a later phase, throughout 2009, plans were made for a series of centralized areas/functions, organizational units with the objective of starting off the phased creation of the new organization, bringing together in a first phase the functional areas of support (marketing, legal, etc.), and the business functions which required greater coordination, such as supply, evolving from the matrix structure of the integration project to the future functions of the integrated company (Exhibit 9).

The integration process

At the beginning of 2009, Galp launched the integration process of Galp Espaa, Esso Espaa and Agip Espaa, according to the rules set out in the integration plan. This process developed through all of 2009 and was concluded in December with the establishing of the new integrated organization. There were five tasks central to the process: Evaluation and selection of human resources, and development of policies to attain common practices in the three companies; Communication strategy; Management of information systems; Obtaining results from the plans to capture synergies; The rebranding of the Esso and Agip filling stations.

Human Resources Beyond the already defined coordination and management structures, and given the complexity and dimension of the integration of the three companies, systematically demanding maximum performance from all company units, Galp set up a team dedicated to human resource matters (HR team) led by a manager from the groups central HR management and involving those responsible for the three HR areas of the companies, which carried out a major task, analyzing, selecting and harmonizing HR policies in all the integration process. In a first phase, the participation of the HR team involved due diligence measures concerning the companies which had been bought. Their staff was evaluated with the help of an

10 external consultant. In a second phase, the focus was on preparing the consolidation of the company, to be effective in early 2010. All this involved adjusting HR policies for the three companies, equalizing time schedules and incentives systems, among many other matters. There were two quite distinct labour conventions. For Agip and Esso the chemical industry agreement was used, with a strongly industrial style, more restrictive and more difficult to manage than the agreement in force in Galp. Galps goal was to create and sign with the three companies a single agreement with the Galp stamp, unifying labour relation matters in the future new company. The approach to the HR integration consisted, first, in getting to know and retain the value of the human capital, ensuring the continuity of day-to-day operations and, later, to rationalize resources. This approach had the advantage of keeping the client base quiet, with no great surprises in terms of the faces they were used to deal with every day, and it also allowed for a better acquaintance with the three companies human resources as a whole. However, as this was an acquisition of two companies with different cultures, the approaches were different for Esso and for Agip, as Esso had Spanish top management. So Galp did not feel the urgent need to take over direct control, realizing that the Galp style had only to be applied in the Esso operations. In the case of Agip, the great challenge was to manage the void which resulted from the exodus of the top Italian management. This implied an effort to take the reins of the company, and Galp chose to appoint a COO from the Galp structure. As one executive remarked about his experience in the selection process, For me, it was a constant feeling of being on a roller coaster, with ups and downs; the hardest part was laying off, but in general things went well, and I feel comfortable. Managing relations with the workers unions. To manage relations with the workers unions, Galp set up a strategy of clear definition of objectives, appointing a single liaison spokesman for all the unions, which facilitated the negotiations. However, when the first phase of unwilling layoffs occurred in December 2009, relations with the unions soured more perceptibly and there was an unilateral suspension of negotiations by the unions. This was a clear move to increase pressure on Galp. Anyway, at the close of 2009, Galp expected that by the second semester of 2010, these negotiations would be closed, and the labour matter stabilized. Adjustment of the incentives system in the three companies. Obtaining uniformity in the staff remuneration packages of the three companies was a challenging problem, as they all had different policies and methods. For example, in the case of Esso, there was a salary policy which did not consider variable bonuses, which meant that the variable component was part of the fixed salary, being paid in cash, weighing on the base pay package. It also had a pension plan which did not exist in the other companies. The solution found to provide a pattern for remuneration packages implied measures which made the short-term management of balances possible, in some cases resorting to pay freezes, until other staff in corresponding functions rose to the same level. The strategy of selection of key staff. On this matter, Pedro Brito states, Galp did not believe in the 100 days strategy to finish the selection process for key staff, recommended by consultants, and, as a strategy, it preferred to retain the operational management teams, and to create multi-disciplinary and multi-company teams, defining the priorities in real time with total focus on the client. This strategy allowed Galp to keep the essentials of the business, which was structural to capture the planned synergies, and at the same time to construct the bases of the new organization. From March to June 2009, the key collaborators of the three companies were selected, under the leadership of the HR team, supported by the CGOE. This involved in a first phase the analysis and definition of first and second line management posts, leaving the definition

11 of the remaining structure for a later phase. It was expected that the new managers would be involved in this process, which started off with an initial staff of 2,000, 1,600 of which were filling station workers and about 600 were managers belonging to the three companies, 100 from Esso, 300 from Agip and 200 from Galp. The HR team studied and analyzed the skills of the existing staff, noting team synergies, involving collaborators and analyzing the manner in which they handled their tasks and how they faced the challenge of creating a more competitive company. The adopted strategy stipulated that the whole of the structure would be evaluated, from managers to salespeople (120) as well as all the technicians critical to the operation, involving the evaluation of the abilities of 250 employees. A distinctive aspect of the process was making and carrying out a promise that staff from Galp Energia would be evaluated in exactly the same way as that of Agip and Esso, something which impressed more effectively the spirit of meritocracy which was intended to be implanted into the new company. In parallel with this process, the CGOE filled out the base structure of the company, and the phase of putting the top management in place was finished in July 2009. Having determined who was responsible for each business area, the other positions in the defined structure were filled in, always relying on the key role of Galps HR as a reference, which provided the process with its necessary independence. The first tactic adopted was to present for each potential position a pool of three candidates, one from each company. The HR team also adopted another tactic, which allowed for a balanced mix of resources from each company, defining an objective of quotas based on the number of employees in each company. Not being absolutely rigid, this established a greater heterogeneity in the new company, also fitting in the HR according to their skills and competences.1 One concern was a hypothetical raid from the competition on the more critical employees and with greater potential. This, however, did not happen. According to Pedro Magarreiro, HR director for Galp Portugal, The staff with talent and ambition felt the challenge and was stimulated by the idea of facing the big companies like REPSOL, CEPSA and BP, and this was a factor for greater motivation. Magarreiro added that It was also certain that the merging was happening in a context of extremely delicate economic situation in Spain, reflected in its labour market. None of our competitors was in a growth phase. The operation to select the best resources went off generally well. Of the 600 initial employees, only 10 showed interest in leaving because they were not in step with the spirit of the acquisitions. Of these, only one joined the competition. Pedro Brito remarked in this process, it was crucial the determination about the objectives, measuring and checking the sensibility of the organization and tactically managing the daily challenges. During the first phase of rescinding contracts, scheduled for December, about 80 people left, from the three companies, and in January 2010 of the initial 600 about 510 were left out. An executive from Esso remarked that the departure of some staff from Galp in this phase gave credibility to the spirit of meritocracy the company wanted for the new organization. According to Galp, there was care and concern to dignify this process as much as possible.
1

In those cases in which the potential candidates to a given position had similar profiles and quality, the option was to select the employee who would contribute to the rule of balancing the numbers from each company.

12 The CGOE had direct involvement and responsibility along with the HR Team and was the spokesman for the management committee. Integration of the three companies. One of the great challenges of the process was to integrate three different company cultures. According to an executive of the new Galp Espaa, we started from three completely distinct positions. Galp brought 40% of the network, positioned itself in the Spanish market as a follower of the leaders, without confronting or distorting the sector, with some urban and motor-way presence. Agip also brought 40% of the network, was strong in fleet card and in the motorways, focusing on market opportunities at the level of occasions, quality and service. Esso brought 20% of the network, had an urban network with a very strong non-oil, and its objectives were to grow in volume and market share. In terms of cultural integration, Galp felt some mind-set shocks at an early stage. Esso had a culture more turned towards management of the process1 and less towards performance, Agip had a performance culture mainly imbued in its sales force and Galp appeared to have a less defined posture. Another distinguishing aspect was the attitude towards home-based work, which was instituted in Esso and to a certain degree in Galp, but which was rather foreign to the former Agip and Spanish staff. The leaders of the teams agreed that there were constant remarks of the type that one is a former Galp person or ex-Esso or ex-Agip. One of the leaders summed up the characteristics of each culture Esso had a procedure culture, American, of introductions, public relations They were most used to international markets and had their chiefs in London or Brussels. Agip was a company in which tasks would be done rather at the last moment. Galp was a company used to operate with few resources, in which the employees did a little of everything. Strategy of internal communication Another crucial aspect was the process of internal communication. This was identified as one of the aspects from which some conclusions should be drawn after the closure of the operation. Galps communication strategy was defined as follows: Keep the staff focused on the delivery of the day-to-day objectives. Provide internal feedback on how the operations were developing. Communicate, monitor and provide feedback on the development of the synergies plan and the centralized units. Pay attention to the way in which communication reached the employees.

To support its communication strategy, Galp held meetings every two months with 50 top staff, who reported directly to the CGOE, and started a monthly newsletter, transversal to the three companies, with three main objectives: to comply with the cascading flow of information defined in the bi-monthly meetings, to transmit Galp transversal values and to begin to pass on key messages on the operation (environment, quality and security, among others). Analyzing the way in which the internal communication occurred, Galp concluded that communication did not always flow at adequate levels, with the speed and contents intended.
1

The Esso operation was managed by two distinct organizations, one responsible for the fuel business and the other for lubricants.

13 The communication process brought out the limitations of communication systems based on group broadcast, versus face-to-face systems, which in some fashion limited the control over the intended flow of internal communication along the companys hierarchical layers, with reflexes upon the motivation and alignment of the personnel. In some cases Galp set off excellent initiatives which were not communicate effectively, losing the opportunity to obtain the positive impact they deserved, remarked an executive from one of the acquired companies. Information systems In a first phase, this process was simply intended to provide the new organization with a basic information system that might guarantee current operations. In the case of Esso, it was necessary to set up information systems in a hurry and on a large scale, as ExxonMobil had established by contract that all information systems would be cut off, with a total physical disconnection, on the day after the operation was finished. This situation obliged to do some adjustments in the organization, in order to integrate rapidly within Galp several functions formerly executed in Esso Seaside Centers spread around the world Pedro Galhardas recalled the difficulties associated to this process, which some Galp directors considered the greatest technical challenge of the integration process. The total migration of Essos systems required an extraordinary preparation effort over the last months of 2008. Esso disconnected all the systems of its Spanish operation from its centres in Brussels and Budapest on December 1, 2008, and everything had to be ready to start off with our systems without problems. Moreover, Esso did not allow us to study its information system during the due diligence period. Through all of December, a daily committee followed the performance of the new system. Finally, the system started and ran successfully. The situation was rather different at Agip. It would remain autonomous after the acquisition. Later, it would be necessary to obtain a uniform platform of information systems for the three companies, as a part of the process leading to their effective integration. Synergy Capture Plan (SCP) This plan was a challenge from the beginning, and the teams were given eight weeks to draw up their SCP, which would prove to be a fundamental tool for both acquisitions. Dealing with matters quantifiable and objective, the SCP became one of the aspects which called for most attention on the part of project team, involving nine integration teams in charge of 70 schemes to capture synergies, defined before the acquisition, and the direct involvement of over 100 employees from the three companies. A very detailed plan of synergies to be obtained was drawn up and, once these were agreed upon, the objective values to be obtained were included in the budgets for each area. This increased the commitment of the teams, remarked Pedro Galhardas. The integration teams met once a week and reported weekly to Pedro Galhardas. I had four to five meetings a day every Wednesday and Thursday he recalled. The SCP was meant to mobilize people for a single and transversal objective, building within the groups a feeling of team dynamics and a sense of urgency of carrying things out. In April 2009, the Galp executive committee went to Madrid where it held a day-long discussion exclusively on the subject of synergies, which included presentations by all the teams and a message from the Galp CEO, Ferreira de Oliveira, expressly mentioning the importance of the SCP. The main synergies were associated with the reduction of product buyers prices, resulting from a greater volume of imports, greater efficiency of human resources, reduction of

14 costs associated with buying, such as O&M contracts, as well as the implementation of a new transport model, which also permitted a significant volume of savings. At the filling station level, the synergies also involved bringing in Galps top range product (fuels with additives) to the Esso and Agip stations, which did not stock that kind of products. Out of a total of 70 originally identified and planned actions, 69 were carried out, which had an impact on EBIDTA of about 35 million euros, an amount which went far beyond the synergies originally planned for, when of the companies acquisition. Galp expected 75% of the synergies to come from improved efficiency, and the remaining 25% from increased sales or margins. The matrix-type organization between the integration teams and the business areas worked well, due to two factors. It was motivating for people to be in the integration team because of the visibility it brought. Besides, the project leaders had made it very clear that integration was very important remembered one of the team leaders. Another team leader remarked that we learned to adapt. At first it was very difficult and we had to pursue people to ask for information and decisions. Rebranding of the filling stations. The rebranding process took place between June and September of 2009. It was considered to be one of the components with greatest impact potential on the operation, mainly on image, with the uniformity in the layout of the some 400 filling stations that had been bought. The process implied an average of 20 remodeled stations a week. The stations were classified into four segments, from A to D. Segment A included the stations which would receive the heaviest investment, because they had better offer and were more lucrative, while at other extreme were those who would only get small retouches of their external image and other minor aspects. The task of rebranding fell upon two subcontracted companies, one responsible for 65% and the other for 35% of the stations. Another company cooperated with Galp in preparing the image changing process, which included 250 items. The tasks were complicated by the heterogeneity of the Spanish filling stations. The man in charge of the rebranding team, Ablio Madalena, remarked that there were many distinct types of counters and display-cases and all kinds of shops. The change of image was carried out at a significantly lower cost than had been foreseen, as a result of the economic crisis, which affected manufacturers and installers. Ablio Madalena added that all was done on time, without closing the filling stations for a single hour, (Exhibit 10).

Pending challenges
The integration process had taken place successfully over 2009 (Exhibit 11). However, there were still unfinished business, mainly tasks concerning human resources policies and legal matters substantive to the fusion of the three companies. So, the new organization had barely started operations, and there were already unanswered questions. How would it be possible to build an organizational culture, starting from three distinct cultures? How would Galp manage to position itself vis--vis the Spanish consumer, when changing from a marginal player to one of the main actors in the market? How would the competition react to Galps strategic move?

15

Glossary
COAG Expression used by Esso, equivalent to the CODO concept. COCO Company Owned Company Operated. This was the type of filling station which allowed the retail petrol companies greater control, as they were not dependent on third parties. CODO Company Owned Dealer Operated. A type of filling station based on a mixed management model, in which the station belonged to the fuel company, but the running of the concern was based on an exploitation contract with third parties. DODO Dealer Owned Dealer Operated. A type of filling station with less control by the fuel company, in which the commercial relationship was based on a supply contract for fuels and/or specialties, and which stipulated the trade conditions of buying and selling, among other matters. Downstream Final activity in the value chain of the oil industry, dedicated to distribution and retail of final oil-derived products, such as fuels (petrol and fuel) and lubricants, among others. HHI Herfindahl-Hirschman Index, which gives an idea of the dimension of the concentration of power of a given market. CLH The Compaia Logstica de Hidrocarburos handled the basic logistics for refined oil products, destined for the Iberian Peninsula or the Balearic Islands, of the main oil companies present in the Spanish market. These in turn held the company equity. Its activity consisted in receiving oil products from the refineries, basically petrol, diesel, fuel oil and aviation fuels, in its 38 storage facilities and in its transport, through a network of pipelines which in 2010 was over 3,800 km long, and tankers, until their final delivery to clients. By 2008, 78% of the light products consumed in Spain were handled in the company's facilities. Market Cap Market value. Midstream Intermediate activity in the value chain of the oil industry, normally dedicated to the refining of oil specialties. Non-Retail / Extra-Network Wholesale business area of the oil industry. Oil In English language literature, designation used for the oil industry. Platts World leader company for providing market information. Ex-Refinery Prices Price on leaving the refinery, not including transportation and other services. Storage Trade agreements among companies, usually between a company with no storage facilities in a given location, and another company with logistical capacity in place, typically aimed at complying with compulsory legal norms for local storage in various countries. Supermajors An exclusive club composed of the six largest companies in the oil industry (ExxonMobil, Royal Dutch Shell, BP, Chevron Corporation, Conoco Phillips and Total). Supply Purchase of product and sale to internal business areas. Product Swap Agreements for reciprocal exchange of products, in which one of the parts agrees to make available to the other a product in its geographical region of activity, in exchange for an equal availability in the geographical region of the counterpart, thus allowing markets to be served where no local installations for refining and/or storage exist. Toll Blending Typical agreement in Esso, which aimed at exchanging raw materials for lubricants of the Gava factory in Spain. Upstream Initial activity of the value chain in the oil industry, dedicated to prospection and drilling of oil wells, on land or sea.

16 EXHIBIT 1

INTEGRATION PROJECT. GALP IN SPAIN

Fuel distribution in the Spanish Market. Retail market shares (%) 2004 2007

2004 Repsol YPF Cepsa BP Galp Agip Disa Esso Texaco Hypermarkets Outros Others 42 19 10 3 4 4 1 1 5 11 100

2005 42 19 10 3 3 4 1 0 6 12 100

2006 42 19 10 3 3 4 1 0 6 12 100

2007 42 18 9 3 3 4 1 0 6 14 100

17 EXHIBIT 2

INTEGRATION PROJECT. GALP IN SPAIN

Business margins for fuel distribution in Spain

Gross margin (c/l) Retail Petrol 95 2001 2002 2003 2004 2005 2006 2007 2010 (E) 2015 (E) Net margin (c/l) Stations 2010 (E) 2015 (E) Margin Fuel 10.3 10.8 Margin Non-oil 2.2 2.4 Costs 7.8 8.0 Margin Net 4.7 5.2 10.1 9.8 10.3 10.5 10.2 10.9 10.2 10.5 11.0 Diesel 10.3 10.3 9.9 9.6 9.9 10.1 10.2 10.2 10.8 Trade Gasoil 4.2 4.4 5.2 4.2 4.3 4.8 5.1 6.5 6.0

Trade Gasoil 2010 (E) 2015 (E)

Souce: Galp.

Margin Fuel 6.5 6.0

Costs 4.9 5.0

Margin Net 1.6 1.0

18 EXHIBIT 3

INTEGRATION PROJECT. GALP IN SPAIN

Fuel consumption. Estimate of demand until 2020

Spain 2000-2005 Annual growth rate (%) LPG Petrol Jet fuel / kerosene Gas / diesel oil Fuel oil Total fuels -1.9 -3.2 3.5 5.7 2.4 2.4 2005-2010 (E) 2010-1015 (E) 2015-2020 (E) 0.9 -3.4 4.5 2.4 -2.5 0.9 0.1 -2.2 2.8 1.0 0.9 0.9 0.0 -1.1 1.3 0.0 -0.2 0.1

Portugal 2000-2005 Annual growth rate (%) LPG Petrol Jet fuel / kerosene Gas / diesel oil Fuel oil Total fuels -3.1 -3.2 2.1 2.6 -3.4 0.4 2005-2010 (E) 2010-1015 (E) 2015-2020 (E) 0.7 -5.7 4.0 2.1 -3.9 -0.4 1.0 -3.1 1.9 1.7 -0.3 0.7 2.1 0.1 0.7 0.7 1.1 0.7

2000-2005 2005-210 (E) 2010-2015 (E) 2015-2020(E)

19 EXHIBIT 4

INTEGRATION PROJECT. GALP IN SPAIN

Main indicators

2009 Balance sheet and other financial statements1 Sales and services rendered 12,008 Operational costs -11,283 2 EBITDA RCA 619 Operational results 459 Net results 347 Sales by segments Exploitation & production Refining & distribution Gas & power Others Consolidated balance sheet Fixed assets Stock Other assets and liabilities Cash Short term debt Long term debt Total debt Cash and equivalent Net debt Own capital Employees Exploitation and production Refining and distribution Gas & Power Others Total employees Filling station employees 168 10,620 1,425 111 4,154 575 -24 -389 424 1,747 2,171 244 1,927 2,389 2009 78 6,340 468 607 7,493 3,761

2008 15,086 -14,698 975 167 117 200 13,200 1,942 127 3,881 480 -29 -248 687 1,304 1,991 127 1,864 2,219 2008 70 6,686 476 585 7,817 3,918

2007 12,560 -11,341 891 1,011 777 233 11,115 1,455 104 2,584 566 -170 180 334 506 840 106 734 2,426 2007 62 4,747 462 527 5,798 2,243

2006 12,193 11,262 977 968 755 141 10,838 1,396 102 2,413 453 -149 207 587 513 1,100 212 888 2,037 2006 48 4,790 491 540 5,869 2,245

Results for 2006 and 2007 include profits of about 200 million euros from the transport of natural gas, a business sold in 2008. Adjusted replacement cost.

EXHIBIT 5

INTEGRATION PROJECT. GALPIN SPAIN

21 EXHIBIT 6

INTEGRATION PROJECT. GALP IN SPAIN

Integration plan (I) Model for the integration

Challenge Simultaneous integration of three companies, with similar dimension and operational structures, but distinct cultures Creation of an organization which might give equal opportunities to all employees (meritocracy) and also incorporate the best practices of each company

Pillars for the integration process

I

Objectives 1. To preserve the value of operations stand alone value 2. To render synergies effective, compromised by acquisitions - creation of value 3. To integrate organizational structures gradually, based on a clear target model and on the assimilation of common values and objectives - creation of a new, single, culture

Model for transition management

II

Operations continuity management

III

Capturing synergies

IV

Implementation of the new organization

22 EXHIBIT 7

INTEGRATION PROJECT. GALP IN SPAIN

Integration plan (II) Gradual integration process

Phase 1 Preparation

Phase 2 (ongoing) Coordinated management of the three operations Q4 2008-Q4 2009 I

Transition management model
z Management committee, Spain z Responsibilities matrix

Phase 3 Consolidation

Q1-Q3 2008

2010-2012
z Model for companies governance z 2009 budgets, by company z Business management and control of results

II

Operations continuity management

III
Capturing synergies
z Synergies capture plan z Carrying out decisions during 2009 & 2010

GALP SPAIN

IV
Implementation of the new organization
z Detailed assessment process z Definition of the new organization, functions and staff

Control of operations by Agip and Esso

Present date

Integration concluded

23 EXHIBIT 8

INTEGRATION PROJECT. GALP IN SPAIN

Integration plan (III) Integration project, governance structure

Managing committee for operations in Spain Planning and program control (Jose Eduardo Nunes)
z

z z z z

Definition of project objectives Definition of inter-company coordination mechanisms Management of integration process Implementation of transversal actions

Joo Pedro Brito (leader) z Pedro Galhardas z Joo Fiadeiro z Aldo Valdecantos z Jos Eduardo Nunes
z

Control of synergies and results obtained by companies

Project management (Pedro Galhardas + full-time competencies)

of Galp of Galp Comercializacin Espaa (Joo Distribuicin Oil Espaa Fiadeiro) Person Espaa (Aldo responsible for (Joo Fiadeiro) Valdecantos) the management Person z Daily management responsible for of companies with the management focus on budgets
control Getting things done at company level Facilitating the work of integration and centralized area / functions teams

z z z z

Detailed plan for obtaining synergies using bottom-up methodology by multi-company teams Operational management of the integration teams Definition of transversal coordination mechanisms between companies Coordination of the execution of the synergy capture plan

z z

Person responsible for Galp Energia

24 EXHIBIT 9

INTEGRATION PROJECT. GALP IN SPAIN

Integration plan (IV) Structure of centralized areas

Centralized areas / functions

Committee for management of operations in Spain (CGOE) Areas / centralized functions
Supplies & logstics Purchases Network ...

Characteristics of centralized areas / functions

z To integrate the organization and take

Objective
COO GEE COO GDOE COO GCOE

over executive management within its scope of action

z Executive responsibility for the

Functions

management of operations and synergies within its scope of action z Through the CGOE, coordination with those responsible for the three companies

1. Requisites for the constitution of a centralized area / function: z To have a person responsible for the area and with a team
z Not to place at risk the obtaining of synergies, or the

z Migration of resources to an integrated

continuity of operations, in each one of the identified areas.

z Coordination mechanisms with the remaining areas are

already established

Operational model

2. The constitution of a centralized area / function should

include the whole of the functional scope of the future organization

area which operates as a functional unit in single location z Hierarchical dependency only from the committee for management of operations in Spain, with delegation of functions in one of its members z Functional dependence from the project director, in matters concerning synergies z Coordination of resources for the functions remaining in each company (functional dependence)

25
EXHIBIT 10

INTEGRATION PROJECT. GALPIN SPAIN

Rebrancling of filling stations

EXHIBIT 11

INTEGRATION PROJECT. GALPIN SPAIN

Data on Galp Espaiia (2010).