IOCs face competition as increasing nationalization and abundant reserves propel NOCs to be 14 of the top 20 oil producing companies.
Jeremy Cresswell, Energy Editor, Aberdeen
Energy is rocketing up the global agenda, driven by political tensions, the climate change debate and persistently tight oil supplies as output struggles to pace rising demand - a situation clearly reflected by barrel prices soaring past $100 and persisting. While there are signs of appetite moderating among a growing number of OECD nations, especially in Europe and the US, oil demand is growing vigorously in others, notably China, India and, largely overlooked, the Middle East itself where economic diversification is now advancing rapidly.
Estimates suggest that the countries responsible for 37% of overall consumption of oil account for 80% of the growth in demand. In the case of the Middle East, this means that countries like Saudi Arabia no longer export almost every barrel of oil they produce-they are becoming substantial consumers as well.
China and India are quickly becoming large consumer bases that will only continue to grow, as India begins to see affordable automobiles.
There is a curve - as economies grow, automobile ownership moves along that curve. Western economies are already well up the curve. China (population 1.3 billion) is at the very bottom, and so is India (pop. 1.1 billion). When these two large nations start climbing the curve as their economies grow and become more sophisticated, demand will increase. These factors pose a challenge for the petroleum industry, not just in terms of increasing oil and natural gas production, but finding reserves needed to underpin that output.
In 1985, worldwide production was a little over 60 million bbl and there was about 10 million bbl spare capacity. There was a real cushion in the market. Global production is now at about 85 million bbl and there appears to be about 3.5-4 million bbl spare capacity, most of it in Saudi Arabia. It is no surprise that the OECD West feels insecure about supply security, especially with China and India increasingly competing for the same resource base.
The situation is exacerbated by the fact that few mega-giant oil fields have been discovered in the past 20-25 years. Kashagan, located offshore Kazakhstan, was discovered a decade ago, and most recently, Jack in the US Gulf and the Brazilian deepwater subsalt finds Tupi and Bem-te-Vi. Some sizeable cluster discoveries are also being made off West Africa, especially of BP’s Block 31 successes offshore Angola are a fresh example.
However, while deep subsalt stunners like Jack and Tupi might lead to a rewriting of the oil resources book, delivering substantial wins to both IOCs and NOCs, for now there is a growing consensus that conventional oil resources are being consumed more rapidly than they are found, let alone developed.
Compared with conventional crudes, natural gas resources are perceived as plentiful, and very large discoveries continue to be made, with India’s Bay of Bengal sector offering a good example.
FEELING THE PINCH OF BRUTAL REALITY
However, from the Western perspective, most resources, oil or gas, are held by national oil corporations such as Saudi Aramco and Gazprom and not by international oil companies such as BP, ExxonMobil and Shell. And as resource pressure grows, major producing countries like Russia, Saudi Arabia and Venezuela, where NOCs clearly take precedent, are becoming increasingly disinclined to share their petroleum resources with the IOCs.
In some cases, the majors are feeling the impact of re-nationalizations reminiscent of several decades ago. In Russia, the fall of communism and break-up of the Soviet empire appeared to herald big changes. With the exception of natural gas, which remained the preserve of Gazprom, it seemed that IOCs would be needed and welcomed.
But the green shoots that appeared during the 1990s and early 2000s appear to be withering as Moscow toughens its stance, not just on Western majors like BP (through BP-TNK) and Shell (Sakhalin Island), but its own IOC-style players, of which the dismembering of Yukos and jailing of its top man, Mikhail Khordokovsky, is the prime example.
That said, Moscow has been content to allow Gazprom to take StatoilHydro and Total as minority partners in the Barents Sea Shtokman gas development. They have technology and experience that Russia needs, hence the Kremlin’s willingness to let them into the project.
Oddly, even within industry circles, it continues to surprise people that more than 90% of known oil reserves are controlled by NOCs, and over 80% of oil and gas resources combined. The entire top-10 petroleum companies are state-owned enterprises. By comparison, ExxonMobil, BP, Chevron and Royal Dutch/Shell are ranked 14th, 17th, 19th and 25th, respectively, according to a study published in late 2007 by the Baker Institute. Of the top 20 oil producing companies in the world, 14 are NOCs (wholly state-owned and with a privatized element), Fig. 1.
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Fig. 1. Leading reserves holders in 2007. Source: Global Pacific & Partners.
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An illustration of where the real power lies is to zoom-in on ExxonMobil, sometimes referred to as the US’s unofficial NOC. ExxonMobil is the world’s second largest market-listed company (PetroChina is No.1) with a market capitalization noted as being $511.9 billion in the 2007 PFC Energy 50 listing. The super-major stated that it had 22.7 billion bbl of proven reserves at the end of 2007, split fairly evenly between liquids and natural gas.
By way of comparison, Saudi Aramco claims in the order of 260 billion bbl of oil alone, though this figure should be treated with care as other estimates place that resource figure nearer 150 billion. Either way, the vast bulk of Saudi Arabia’s oil resources are in the hands of its NOC.
Regardless of the veracity of reserves estimates, there are a number of NOCs with a larger reserves base than ExxonMobil. That balance is expected to shift further in favor of the nationals over the coming decade, largely because of the pivotal position of the Middle East in terms of proven oil reserves and Russia in the context of natural gas; therefore, they hold most of the resources, even if they are considered less efficient at running their businesses than IOCs.
NEW WORLD ORDER
In short, a new world order has emerged over the previous couple of decades.
Read back into the history of petroleum, and once the so-called “Seven Sisters” were Standard Oil New Jersey (now Exxon), Royal/Dutch Shell, BP, Gulf, Texaco, Mobil and Standard of California (now Chevron).
Today, they are Saudi Aramco, Gazprom, CNPC, National Iranian, PDVSA, Petronas and Petrobras-all NOCs.
PFC Energy notes that these companies are overwhelmingly state-owned (some are partially privatized) and control about 30% of the world’s oil and natural gas production. They account for more than 33% of total reserves. As for the former Seven Sisters, now condensed to four through the late 1990s consolidation, they account for roughly 10% of the world’s oil and gas output, yet hold only 3% of reserves.
J. Robinson West, founder/chairman of PFC Energy, suggested recently at a meeting in the UK that IOCs directly control only 5% of known conventional crude resources, though of course, they have access to more through agreements with various NOCs, Fig. 2. Factor in Canada’s vast oil sands deposits, and IOCs gain a few more percent.
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Fig. 2. IOC’s access to proved oil reserves at the end of 2005: 1.29 trillion bbl. Source: International Energy Agency.
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His view of the pecking order is unequivocal: the resource holders (NOCs) are the rule-makers in this business, which means the IOCs are the ones that must do as they’re told; thus, the question of resource access is central to their future. West’s is not the only estimate. Baker notes in its report that, of worldwide proven oil reserves of 1,148 billion bbl, “about 77% of these resources are under the control of NOCs with no equity participation by foreign IOCs.”
No matter which analyst determines the resources split, the inescapable conclusion of all is that NOCs command so much that they leave only a small wedge for the IOCs, whether in oil or natural gas. NOCs have done so for decades, but the difference today is that they increasingly flaunt their power and no longer hesitate to flex their muscles, albeit generally vicariously through or directly involved with the government.
A prime example in that regard is Gazprom, which has wielded its power on a number of occasions over the past five years, apparently directly, but almost certainly always tacitly backed up by the Kremlin.
OPEC is also gathering strength. So often castigated by the West and willed by analysts to make mistakes, the cartel has done a remarkable job of managing oil prices since the two quota cuts of 1998 and one of 1999 that pulled oil prices out of the mire of sub-$10 oil.
Of course, it should never be forgotten that IOCs have played a background role in OPEC’s broadly effective resource management discipline given their role as contractors in numerous Production Sharing Agreements/Contracts (PSAs/ PSCs).
IS THE GAME UP FOR IOCs?
So, is it over for IOCs? That depends on whom one listens to. The CEO of Italian energy conglomerate Eni, Paolo Scaroni, believes that is the case and is very clear about it. He might even have shocked his audience at the UK Energy Institute’s 2006 International Petroleum Week when he talked boldly of “reserves nationalism” and a “face-off” between the different camps.
This was not banal “Eni-speak” prepared by PR-minders. Scaroni meant what he said.
“IOCs are increasingly challenged by a breed of assertive NOCs in the quest for global control of oil and gas reserves and markets,” Scaroni said.
“IOCs seem to be under siege on many fronts, facing problems that stem from both internal and external forces. On the internal factors side, the IOCs are paying the price for their obsession with short-term financial performance, which overwhelmed their strategies from the mid-1980s into the beginning of the new century.
“In part, that obsession was quite logical, given the industry’s gross mistakes since the 1970s, when it plunged into foolish investment options and diversification strategies that later turned out to be pure nonsense.
“As a result, from the mid-80s onwards, they engaged in a seemingly endless race to please skeptical investors and could not avoid surrendering to outside financial pressures.”
Scaroni, who hammered out the same message on April 20 at the 2008 International Energy Forum, pointed out that, during the 1990s, the IOCs had allowed investors to push them into calculating value creation by using a long-term oil price of about $16 per bbl in nominal terms. To make matters worse, stock markets expected that, in such a price scenario, the companies would produce a Return On Capital Employed (ROCE) at least 4-5% in excess of their weighted average cost of capital, which was generally in the range 7-8%.
In Scaroni’s opinion, this was an impossible situation at the outset and the ROCE obsession did damage to the oil majors and led to endemic short-termism, though there are signs of longer-term thinking and decision-making slowly coming back. Scaroni’s attack on the financial community is intriguing as the Baker Institute claims that, while individual NOCs may vary in efficiency, on average government held corporations exhibit only 60-65% of the efficiency of IOCs. The inference is that, if IOC performance has been poor in Scaroni’s opinion, using the Baker’s metrics, the performance of NOCs has been very bad, which is hardly surprising in some instances given the way that governments frequently siphon off revenues and give little or nothing back. Pemex is a case in point.
Of the market’s obsession with ROCE, Eni’s CEO said, “Silently, this phenomenon further aggravated the basic long-term challenge facing the IOCs ... reserves replacement, which has emerged as their nightmare in the last few years.”
“Put simply, the IOCs are denied access to the largest and cheapest reserves in the world, while their cash-cow legacy assets are dwindling. Today, IOCs have access to and control of far less than 10% of conventional oil reserves and less than 30% of global gas.
“Reserves available for private investments are not only limited, but are also increasingly costly and technically challenging, especially in the new frontiers of conventional hydrocarbons ... like ultra-deep offshore or in the whole area of unconventional oil (oil sands).”
Scaroni also warned that there is a growing realization among NOCs that the bulk of Western expertise is now held within the supply chain as a result of the huge structural changes brought about from the global oil price crash of 1986 and late 1990s slump.
“Outsourcing has led them [the IOCs] to shed expertise so that, over the last 15 years, a group of oil service companies have developed technological leadership in drilling, exploration, engineering, construction ... taking this away from the traditional oil companies that have so irresponsibly surrendered this expertise.”
And yet Scaroni said that only a limited number of NOCs had the ability to cope with the extreme complexity and technological challenge of many energy projects. So, paradoxically, IOCs still had a role.
What he did not say was that some of the smartest oil companies are in fact NOCs, particularly Saudi Aramco, Petronas, Petrobras and StatoilHydro.
However, Scaroni warned that the IOCs “possess a resilience that must not be underestimated”, which was why energy provinces as harsh as the North Sea and the Alaskan North Slope had been successfully developed 40 years ago. This gave them a great advantage on today’s energy stage, if only they get the chance to apply it.
His summation was that, if the NOCs succeed in overcoming the taboos of the past and are smart enough to escape the trap of reserves nationalism, if the IOCs refrain from being too greedy and sometimes arrogant, and if both NOCs and IOCs realize that they have a significant common environmental responsibility, then they can work together successfully.
WHEN IS AN NOC AN IOC?
Remember, what defines an NOC is not necessarily as obvious as one might think; consider Norwegian companies Norsk Hydro and Statoil, prior to their merger.
Both were listed on the Oslo bourse, yet both were also regarded as state companies; 70.9% of Statoil and 43.8% of Norsk Hydro were held by the Norwegian state, defining one as an NOC and the other not quite. To all intents and purposes, they behaved as IOCs, but could behave as NOCs when it suited their purpose.
Today, as StatoilHydro they retain those chameleon-like characteristics, with the state holding a 62.5% interest through the Norwegian Ministry of Petroleum and Energy.
Will the Norwegian government dilute its share in this highly successful group at some future date? If recent moves to strengthen the public ownership element of Norway’s already state-controlled hydro-power generation capability, then dilution is highly unlikely. Rather, the reverse is possible.
In that regard, Norway presents a sharp contrast to the UK energy scene where both petroleum production and power generation are left to the market. However, the state does hold 35% of British Nuclear’s stock, plus a “golden share” that allows it to outvote any other stakeholder in this nuclear power company whose asset base comprises of former state-built and owned generation plants. However, that ownership has less to do with the UK’s security of energy supply than it is a reassurance to a marketplace that remains skeptical about the viability of wholly privatized nuclear power.
A further example of a company with chameleon qualities is Brazil’s Petrobras, the partial privatization of which started in the 1990s with the state making an initial public offering of 16%. In 2000, a further 28.5% stake was sold off, resulting in the Brazilian state diluting its total ownership of common shares to 55.7%. Then, in 2001, the state-owned national development bank BNDES sold a further 3.5% of the company’s total capital, taking state ownership to 52%.
Even before the privatization process began, Petrobras had a global reputation for its subsea prowess, but the company was starved of capital. Today’s Petrobras is vigorous and successful with access to the capital it needs, and it has built on its position as a global subsea leader.
Moreover, it looks as if the company’s two huge subsalt discoveries could result in Brazil’s proven oil reserves near doubling. Prior to the Tupi and Bem-Te-Vi finds, the reserves estimate was just over 14 billion bbl. To give Petrobras such a high degree of freedom suits the purpose of the Brazilian government in its multiple ambitions of making Brazil self sufficient in energy, the tiger economy of South America, and extending the country’s sphere of international interference, partly through the NOC taking acreage interests elsewhere, including the US Gulf.
But, in both the Norwegian and Brazilian cases, or even Italy, while analysts previously denied easy access speculated that it would be only a matter of time before partially privatized NOCs were wholly privatized. After all, it happened in the UK with BP under Prime Minister Margaret Thatcher. But this mostly did not materialize for a complex set of reasons.
Governments, with Norway as a prime example, instead decided to play one set of advantages against the other, while still considering retrenchment an option, should that prove necessary at some point in the future.
With the previous trio, the crucial difference between the Norwegian and Brazilian companies vs. Eni is that each of the former commands significant domestic hydrocarbon resources, but the Italian company does not; it relies on access deals around the globe, many through PSAs with NOCs.
CHINA SYNDROME
While China has vast coal reserves and is reputed to be commissioning a new coal-fired power station every week, and apparently still has significant natural gas resources, this huge country is very short of oil.
There are three basic solutions to this problem:
- Buy oil on the open market and/or strike long-term supply deals with a producer nation at a price that satisfies both parties. The US has used this approach successfully with Saudi Arabia.
- Encourage Chinese petroleum companies to buy into reserves around the globe, sure in the knowledge that China will be able to outbid others, especially the IOCs, though not necessarily Russia.
- Acquire other petroleum companies with reserves.
China is applying all three approaches through the four big petroleum entities that emerged from the late 1990s restructuring: China National Offshore Oil Corporation (CNOOC), Sinopec, China National Petroleum Corporation (CNPC) and its spin-off PetroChina, which today ranks as the world’s largest listed petroleum company with a market cap of more than $720 billion in the 2007 PFC Energy 50 table.
However, acquisitions have been limited, though there are growing concerns in the West that the Chinese are hoping to have an unacceptably large position in Africa, where they have a long track record of successful major infrastructure projects such as railroads to their credit. They are also very active in the Caspian Region and are courting Latin American leaders like Chavez.
CNOOC attempted to buy US independent Unocal, but its $18.5 billion cash bid was ultimately blocked by American protectionism, even though the bulk of that modest company’s reserves were in Asia-Pacific. However, while the US appears leery of China’s NOCs, Canada is thus far more receptive, at least in the context of oil sands. Doubtless the embryonic relationship may come to be tested over time.
Some 500 years of European history are characterized internationally by colonization and exploitation. Colonization was about planting the national flag before extracting resources.
Economic colonization is the new approach, and the Chinese are at the front of the charge. In essence, Beijing is using “soft power,” building a network of economic and political links to extend their influence. China is not, however, using thinly disguised gunboat politics, such as the US is applying in West Africa, to win friends.
For example, according to PFC Energy’s West, there are more than 1 million Chinese in Angola, and yet Angola’s population is just 13 million. That’s a lot of Chinese in a relatively small country, and one might suspect that their considerable influence will grow. However, this is not neo-colonialism. It’s different and possibly more insidious.
New energy architecture is being created and it is one that excludes most of the OECD West. The balance of energy power is shifting. More and more, West African oil is heading east to China, and those volumes will grow. In addition, OPEC’s influence in that region is spreading, as Angola became a member at the start of 2007.
DELIVERING NATIONAL BENEFIT
An aspect of the NOC that must not be overlooked and that surely gives IOC presidents nightmares is NOCs frequently held desire to deliver national benefit, though underlying corruption has often destroyed good intentions.
Third World governments, weary of wealth heading West and natural resources being exploited by foreign companies, are getting smarter at managing terms, using as their tools, royalties, taxation, insisting on increased levels of local content, obliging the establishment of infrastructure such as roads, schools, clinics and so-forth.
NOCs are interested in building national champions and desire great national institutions. They want to control the oil sector, and create jobs and human capital around them. And finally they want to develop their economies. Some of these places are just wasting the money as petroleum revenues not so mysteriously evaporate, only to re-condense thousands of miles away in Swiss bank accounts. But others are trying to create a sustainable, broad-based economy. Malaysia and Norway are two examples in that regard.
Each has a highly successful, entrepreneurial NOC: Petronas of Malaysia and StatoilHydro of Norway. Both countries operate a market system, but it is tightly managed and regulated, not unfettered, and is one that takes measured account of sustainability. Prior to oil, both could be regarded as subsistence economies.
Another example according to the Baker Institute is KazMunaiGaz (KMG) of Kazakhstan.
“It is an NOC that strives to meet both commercial and social goals based on a Statoil model, and KMG has indeed progressed a long way in its short history since 2002.”
“Moreover, KMG de jure controls Kazakhstan’s considerable reserves. Kazakhstan is and will remain a key swing producer in the former Soviet Union, and by all projections is expected to produce three million barrels per day by 2010.”
Baker points out that KMG hopes to be a driver of long-term and sustainable socio-economic development in Kazakhstan, the largest and most hydrocarbon-rich of the northern Caspian basin states.
Like Norway, the Kazakh government has established a national oil fund, which is invested offshore and is aimed at long-term development projects. The company also provides subsidized oil and gas to some of Kazakhstan’s economically depressed areas; anathema to the ruling principles of IOCs, but the NOC model frequently displays a socio-economic linkage.
Interestingly, KMG recently privatized part of its producing arm, but still remains firmly controlled by the government, according to Baker.
“The goal of the company is to maximize benefit by leveling the playing field with foreign actors,” said the institute.
“The government created it in 2002 as a national champion and furthered legalized it in 2004. Its special privileges were given to it in order to give a Kazakh oil company a key role in the market. It has also served to balance the role played by international actors in the Kazakh market.”
Kazakhstan has not been afraid to show power, see for example the calling to accounts over the much-delayed, no longer Eni-operated Kashagan development and also the start of what could become a deep probe into the affairs of the consortium running Karachaganak.
LIFE IN A NUTSHELL?
There in a nutshell is the challenge of life going forward for the IOCs. Industry headlines are littered with what is seen in the West as Russia’s re-nationalization of its oil resources, the tough stance that President Hugo Chavez has taken in Venezuela, and Bolivia’s threats.
But we should also remember Scaroni’s words: “IOCs possess a resilience that must not be underestimated.” That suggests that when the going gets tough, the tough get going. And, boy, the IOCs are a tough, resourceful clan. 
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THE AUTHOR
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Jeremy Cresswell is editor of the Scottish publication Energy and an associate of Scottish economists Mackay Consultants. He has specialized in upstream, offshore petroleum since 1989, with a particular interest in the geopolitics of the sector. He has authored three books linked with energy, is a regular contributor to various energy and maritime affairs journals and has spoken at and chaired energy and maritime conferences worldwide.
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