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Buying shares of integrated oil companies has traditionally been a way for investors to instantly diversify their holdings through the ownership of oil production, refining, and usually chemicals manufacturing assets. The diversity of the integrated approach extends geographically as well, since the large integrated petroleum companies tend to earn most of their profits abroad. Industry giants, such as Chevron (CVX - Free Chevron Stock Report), ConocoPhillips (COP), Exxon Mobil (XOM - Free Exxon Mobil Stock Report), and Royal Dutch Shell (RDSA) are investing overseas, notably in Asia, to take advantage of the higher economic growth rates available.

Making the integrated model work has often proved difficult in practice, though. True enough, strength in refining can offset weakness in oil prices, and vice-versa. However, the refining and chemicals businesses in Europe and North America are mature, and plagued by overcapacity, leading a number of companies to de-emphasize those segments. Moreover, investor preference has clearly shifted to favor "pure plays’’ in energy, a trend that pushed Marathon Oil to partition its asset base to focus on specific business lines. 

Conservative investors still strongly favor shares of the big, integrated oil companies. For one thing, the way ConocoPhillips, Chevron, Exxon Mobil, and Royal Dutch Shell are internally hedged provides their stocks with more stability. The scale provided by a larger asset base enhances financial strength, too. And, of course, dividends are a major attraction of the integrated companies.

Under the best of circumstances, integrated companies can use the cash flow from refining to support dividend payments and help pay for drilling operations, which are expensive. In late 2010, Chevron announced plans to spend $4 billion to develop an oil and gas field in mile-deep Gulf-of-Mexico waters, for example. Independent producers without the extra cash flow that a retail customer base can provide through refining and marketing aren’t in a position to be as generous with their dividends. They need the capital for drilling. 

Shares of independent oil producers and free-standing oil refiners, on the other hand, offer more simplified exposure to energy sector pricing conditions. Those conditions are, in turn, largely determined by the strength of the economy. Shares of independent producers generally offer better appreciation potential than shares of integrated companies for a given move in oil prices, but with less stock-price stability and lower dividends. Notable names in this space include Anadarko Petroleum (APC), Apache (APA), Devon Energy (DVN), Newfield Exploration (NFX), and Southwestern Energy (SWN). Chesapeake Energy (CHK), meanwhile, is a premier natural gas producer.
 
Independent refiners, such as Valero Energy (VLO) and Tesoro (TSO) probably have the toughest time achieving standout results, since the cost of crude oil is a large, and often volatile, expense. Low margins in refining lead to a reliance on volume, which can fluctuate materially with changes in the economy. Periodic mandates to produce cleaner gasoline are another headache. But, from time to time, conditions are ripe for refiners’ shares to make a bullish run.

In sum, shares of integrated petroleum companies are suited for investors looking for relative safety, an income source, and long-term capital gains possibilities. In contrast, shares of independent producers and refiners are a better fit for those looking for appreciation potential through a cyclical move in oil prices or refining margins.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.