the politics and economics of international energy (spring 2009- e657)

© Copyright Giacomo Luciani

The Politics and Economics of International Energy

(Spring 2009- E657)Lecture 5The Oil Companies: National and International

Prof. Giacomo Luciani

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What are Oil Companies? Companies are the main protagonists in

the international oil and gas industry Companies are living organisms that take

time to develop and grow, acquire a specific know-how and develop their own culture

Companies are different – main cleavage between IOCs and NOCs, but certainly not the only important distinction

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The Oil Industry

The system of companies constitutes the organisation of the industry

Key issues: vertical integration and horizontal concentration

The industry has gone through several waves of integration/dis-integration, and concentration/fragmentation

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Vertical integration Vertical integration is a consequence of

the presence of a “strategic segment” If markets do not work properly

companies controlling the strategic segment have an opportunity and incentive to integrate upstream/downstream in the value chain

Doubts about the benefits of vertical integration

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Horizontal concentration

Historically, oil and gas have been abundant, conditions for “excessive” competition have existed

Large up front investment encourages high capacity utilisation even in negative market conditions

Periodic waves of financial difficulty lead to disappearance of companies through mergers and acquisitions

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Beginnings in the USA

Law of capture: low barriers to entry. Booms and busts: the rigidity of oil

supply and demand in the short term Rockefeller and the strategic

importance of pipelines and refining The Standard Oil Trust Spindletop and the Texas Railroad

Commission

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Outside the USA

More limited demand, competition from town gas

Developments in Russia and the Far East

Initial developments in the Ottoman Empire

Initial interest in Persia

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The coming of Gulf Oil

D’arcy and Churchill: the birth of Anglo-Persian as a political object

The negotiations for IPC The Red Line Agreement The Great Depression and the

Achnacarry agreement Result: slow down the development of

Gulf oil

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Kuwait and British-American relations Bahrain and Saudi Arabia: the US and

the formation of ARAMCO The golden age of the Seven Sisters The Iranian crisis and the formation of

the Iranian consortium Newcomers: Libya, independents,

NOCs

Further Developments in the Gulf

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Royal Dutch - Shell Standard Oil New Je rsey Standard Oil California Texaco Mobil British Petroleum Gulf CFP Altri

23,750 11,875

11,875 23,750

23,750 5,000

30 30 30 10

Kuwait Oil Company

(KOC)

Iraq Petroleum Company

(IPC)

Arabian American Company (Aramco)

Abu Dhabi Marine Areas

(ADMA)

Iranian Consortium

14 7 7 7 7

40 7 6 5

100 100 100 100 100

50 50

66,66 33,33

Equity participation in the main producing companies before 1972

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Companies change names

Standard Oil Company

Standard Oil New Jersey

Standard Oil New York

Standard Oil Indiana

Standard Oil California

Standard Oil Ohio

ESSO

EXXON-MOBIL

Mobil Amoco Sohio Chevron

Anglo-Persian Anglo-Iranian British Petroleum BP

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Middle East Oil is Under-exploited

This has been the case from the beginning, and a cause of considerable conflict

The international oil industry has consistently had to deal with the threat of oversupply and price collapse

Reserve additions do not come in small increments and supply is rigid in the short term

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Oil Companies Control Vertical integration Joint Production companies based on

agreements aiming at maintaining production under control

Contract typology: concession Very large concession territory Blatant asymmetry of information

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Vertical integration - up to 1970’s

Companies were present in all stages: exploration production shipping refining retail distribution

Balanced presence in all stages was key to profitability

An oil market existed, but was neither transparent nor efficient

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The Eight Majors’ The Eight Majors’ Market Share, Market Share,

19701970

Exxon

TexacoGulf

Socal

Mobil

Shell

BP

CFPaltri

15,7%

8,3%8,3%6,6%

5,4%

13,0%

10,4%

3,2%

29,1%

Exxon

Texaco

GulfSocalMobil

Shell

B P

CFP

altri

12,4%

6,4%

4,1% 4,1%4,6%

11,9%

5,4%

1,9%

49,3%

Production

Refining

Exxon

Texaco

Gulf

Mobil

Shell

BPCFP

altri

14,2%

7,3%

4,2%4,8%

5,4%

13,1%

5,4%

2,0%

43,7%

Products Sales

(in percent)

Socal

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Conflict and evolution Tax assessment Relinquishment Posted price Nationalization Smaller concessions and multiple

operators OPEC

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OPEC - a cartel by chance

OPEC was created in 1960, but had little impact for a decade or more because of conflict over production targets.

In 1969-73 some countries lost interest in increasing production and imposed unilateral limitations.

Prices exploded.

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Nationalisations

Early nationalisations: Russia and Mexico

Mossadegh nationalises APOC Qaddafi nationalises BP, Hunt Kuwait, Algeria, Qatar, Iraq: 100%

nationalisations Abu Dhabi, Libya: IOCs remain Saudi Arabia: negotiated takeover

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0

2000

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120001913

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/d IranIraqKuwaitS. Arabia

Historical Production of 4 Main Gulf Producers

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Evolution of contractual relations

Concession: Company pays royalty and taxes but is in full control of

production and marketing Production sharing agreement:

IOC carries all investment costs; if a commercial find is declared, production is divided: “cost oil” to IOC, “profit oil” shared bet. IOC and NOC

Service contract: IOC develops field and gets a fee

Iranian contracts: IOC develops field then transfers “operatorship” and

gets predetermined volumes of oil

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Concession vs PSA

A concession is more likely to lead to conflict because of issues of tax assessment or management of production.

A PSA is more easily enforceable but it is very difficult to write a PSA that will be “fair” at any level of oil price.

Both can be combined with NOC participation

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The PSA is versatile

A PSA is a very versatile contract – it can mean anything, depending on the numbers.

Key issues are: How much of early production will be

considered as cost oil? What is the split of profit oil? Is it a

function of volumes produced and/or oil price?

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Access to World Proven Oil Reserves end-2005

37

1311

30

9

National Companies OnlyLimited accessProduction sharingConcessionsIraq

Source: IEA

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Fiscal tightening Production sharing contracts which used to be

based on simple sliding scales of production at varying thresholds have now in the main been superseded by rate of return based contracts. Such contracts are awarded to the company which offers the lowest rate of return on the concession.

This has the merit of effectively capping the reward to the IOC when oil prices are very high and maximising the rent to the host government. The extent to which IOCs are prepared to push down rates of return was highlighted in the recent bidding round in Libya where many companies bid a percentage rate of return of just 7 per cent on a number of blocks, very close to their weighted average cost of capital.

Therefore, even in the event of exploration success, it is very unlikely that these companies will add shareholder value from the concessions they were awarded.

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Following 1973… Following 1973, the International Oil

Industry was forcibly dis-integrated: the 7/8 sisters lost most of their reserves.

Some disappeared fast; other attempted to recreate a vertical equilibrium by divesting downstream and looking for new reserves.

Hence came the investment boom in non-Opec countries – but not all were “open”.

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Consequences of disintegration Notwithstanding moves to recreate vertical

integration, the industry continues to be disintegrated.

NOCs have divergent attitudes towards downstream integration (PDVSA and KOC vs. Aramco)

The IOCs concentrate their investment in the upstream.

A lot of crude is exchanged at arm’s length

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Oil Market Development

Disintegration encouraged oil market development – and vice versa

Oil market development changed the concept of security and eroded the rationale for NOCs of the importing countries

Privatisation, profit maximisation, shareholders value

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Pressure from financial analysts

The financial market has become increasingly demanding

Companies have made imprudent promises

The M&A logic The opportunistic behavior of

shareholders and managers – preference for the short term

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Recent Mergers BP acquired Sohio, Amoco, Arco, Castrol, Veba

Oil, TNK Exxon acquired Mobil Chevron acquired Gulf, Texaco, Unocal Total acquired Elf and Fina Phillips acquired Tosco, merged with Conoco Shell acquired Enterprise Eni acquired Lasmo Repsol acquired YPF

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Degree of Established International Portfolio

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Vertical Integration in Doubt

The development of crude and other markets raises doubts on the benefits of vertical integration

Companies have tended to get out of less profitable/more volatile segments: transport, refining, petrochemicals

Investment has been heavily concentrated on the upstream

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Capital Rotation 1990 to 2001

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Persistence of vertical integration

Nevertheless vertical integration has persisted

Pure upstream companies have not fared very well

Independent refiners have also succumbed

Pure retailers are rare Service companies have multiplied

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BP - a case study BP is the company that has found the

most oil It has also suffered most from

nationalisations: Iran, Nigeria, Libya, Kuwait…

Discovered Prudhoe Bay in 1968 Discovered Forties in 1970 …just in time to compensate for

nationalisations…

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BP and Sohio BP initially acquired a minority interest

in Sohio when it decided to associate the latter to the development of Prudhoe Bay

Eventually, BP’s interest grew to be a majority in the company

Bought out the minority interest in 1987

Enter KIO

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Privatisation problems The British government sold its 31.5%

remaining participation in BP in October 1987

The sale was a flop because of negative stock market conditions – KIO bought

The MMC found that KIO’s holding could operate against the public interest; a cap of 9.9% was imposed on KIO’s holding

BP bought back KIO’s excess shares incurring in a major financial burden.

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BP Amoco

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0

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Tatn

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2002 production mboed

Russian industry position

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i BP and TNK-BP Plan Strategic Alliance with Gazprom as TNK-BP Sells its Stake in Kovykta Gas Field

Under the terms of the agreement signed by all parties, TNK-BP agreed to sell Gazprom its 62.89 per cent stake in Rusia Petroleum, the company which holds the licence for the Kovykta gas field in East Siberia. It will also sell its 50 per cent interest in East Siberian Gas Company (ESGCo), the company constructing the regional gasification project.

TNK-BP said a longer-term 'call' option for TNK-BP to buy a 25 per cent plus one share stake in Kovykta at an independently verified market price, had also been agreed with Gazprom. This option could be exercised once a significant joint investment or asset swap has been agreed under the terms of today's memorandum of understanding.

(June 22, 2007)

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The new protagonists

The companies of the producing countries – mostly state owned, some privately owned – are the new protagonists of the international oil industry.

How many will evolve into major international oil companies?

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The ambiguous IOC/NOC relations

IOCs and NOCs are rivals However, they also live in a symbiotic

equilibrium Can this dichotomy be progressively

overcome? What forms of partnership?

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The merits of going with IOCsCrude Oil Production in Selected OPEC

Countries, 1969-2004

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Algeria

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A rush to open? In the 1990s the impression was created

that resource nationalism was obsolete However:

Some expected openings never materialised (Kuwait, Iraq, partially Russia)

Other were disappointing (Brazil, China, Azerbaijan)

Key players never considered opening (Saudi Arabia, Mexico)

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The return of nationalism

Resource nationalism is back alive and kicking

Venezuela changed strategy entirely under Chavez

Russia is increasingly pursuing a nationalist agenda in oil and gas

Iraq will not open indiscriminately and remains a distant prospect

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What is wrong with IOCs? In the eyes of producing countries, IOCs are

dangerous if they are not needed In the new price climate, IOCs profits seem

excessive, countries feel cheated There is divergence of views on optimal

drawdown of reserves: Companies maximize short-term profit Governments want “sufficient” revenue for

as long as possible

the politics and economics of international energy (spring 2009- e657)

Documents

cent stake

kovykta gas field

tnkbp plan strategic

iocs profits

producing countries

new protagoniststhe

international oil industry

new price climate