Energy Issues

As many of you know, my father was a life-long employee of Gulf Oil Corporation (or “The Big Orange Meatball,” as he called it). I grew up in a hydrocarbon world controlled by the Seven Sisters, comprised of Exxon, Texaco, Shell, Mobil, Chevron, Gulf and Total, also known as the International Oil Companies (IOCs).

Refreshing the memories. Those memories, for me, were brought back to life by a research paper released in May entitled, “International Oil Companies: The Death of the Old Business Model” (Paul Stevens, Energy, Environment and Resources, Chatham House, The Royal Institute of International Affairs). In it, Stevens confirms many of my memories, noting that “between 1945 and 1970, outside the United States and communist countries, the majors (IOCs) controlled virtually all crude production, 70% of refining capacity, every important pipeline, and about two-thirds of the privately owned tanker fleet. In this period, international crude oil trade moved almost entirely within their integrated operations or through long-term contracts between them. There was no commodity market in the modern sense.”

The IOCs were characterized by vertical integration, from initial exploration to pump sales in the station forecourt. And it didn’t stop there. I grew up with Gulf tires, batteries, bug spray, sealing wax and probably a hundred other products I have forgotten. I know they didn’t make clothes (with the exception, of course, of Gulf jackets and hats worn by service station employees), because I did not have to wear Gulf clothes. Life within Gulf, like life within any of the Seven Sisters, was stable and structured. But, it would not remain that way.

Changes in IOC functioning. As the 1970s settled in, a new business model began to emerge across the globe, fueled by growing uncertainty and a shift of focus. Gone were the post-war boom, and the drive to rebuild and expand an existing economic structure built on pre-war perceptions, generated by the Great Depression. Instead, according to Stevens, “net changes in booked reserves, or the reserve replacement ratios, became key indicators of a company’s future. This put huge pressure on the IOCs to increase the bookable reserves. It also meant that, for senior management, production growth (with reserve replacement acting as something of a lead indicator) became an obsession, to the exclusion of almost everything else.”

Included in this focus was a strong emphasis on cutting costs. This mindset “coalesced into trying to increase returns to shareholders by encouraging higher share prices through good performance, and paying out as high, and stable, a dividend as could be sustained,” notes Stevens. It was a mindset that shifted emphasis from long-term growth to quarterly financial performance.

The result was a new set of goals which, if met, would satisfy quarterly performance expectations, but severely alter the IOCs and their playing field. These included outsourcing services and technologies, and curbing consensus thinking among the IOCs. They were exacerbated by the rise of the National Oil Companies (NOC) which, in turn, limited IOC access to lower-cost reserves.

Beginning in the 1970s, IOCs began to reduce in-house R&D. The result, notes Stevens, was that “service companies, especially in the upstream, gained this technological edge. Producer governments no longer had to depend on the IOCs for their technology; they could simply bring in the service companies. This effectively neutralized a major advantage the IOCs previously had when bidding for upstream acreage.”

Consensus thinking also contributed to these new goals. Similarities in thinking included believing the oil price would remain stable, because oil demand would perpetually rise. Another example put forth by Stevens was the brisk round of investment by IOCs in companies outside the oil industry. While there have been exceptions to the general consensus—such as BP’s purchase of Amoco that kick-started the round of mega-mergers—it has been a crucial factor in the redefinition of the IOCs.

The NOC effect. Perhaps the most important factor in the transformation of the IOCs, however, has been the rise of the NOCs and the loss of access to low-price reserves now controlled by that group. By the end of 2014, Stevens’s notes, “57.3% of global proved oil reserves were in five countries, Saudi Arabia, Iraq, Iran, Kuwait and Venezuela.” Access to oil reserves in these countries is either closed or severely limited by NOCs.

So, where does that leave the traditionally powerful IOCs? First, is global reaction to climate change, and what oil companies can do with what Stevens and others call “unburnable” hydrocarbons, or those hydrocarbons that should not be burned to prevent further contributions to global warming from the carbon bubble.

“The carbon bubble argument suggests that the IOCs’ assets will be stranded, because policies designed to prevent climate change will prevent the reserves from being burnt,” says Stevens, a situation that may not apply to NOC reserves. But, given the lower reserves-to-production ratio (13 years) of IOCs, it is debatable that much will be done over a short time period to curtail burning of IOC reserves.

Secondly, the price of oil. Recent, low oil prices have forced an additional level of flexibility upon IOCs, resulting in significant mergers, acquisitions and divestitures, such as those surrounding the IOCs’ re-entries into the Permian basin, and major cost-cutting initiatives. Lean and mean is an admirable target, but it may not be sufficient, if Chevron’s first posted annual loss since at least 1980, and Exxon’s ninth straight quarter of year-over-year profit declines—the longest such streak since at least 1988—are indicators. In short, the drama is still playing out. 

About the Authors

William J. Pike

World Oil

William J. Pike has 47 years’ experience in the upstream oil and gas industry, and serves as Chairman of the World Oil Editorial Advisory Board.