petroleumworld.com: Hydrocarbon nationalism

By Jean-Pierre Séréni:

States claim back their energy reserves

In the race to secure access to the world’s remaining oil, international companies are being left behind by national companies and states. Venezuela is renegotiating concessions and Russia is taking back the gas industry it sold off during the 1980s. State interests are on the rise.

Petrochina, China’s leading oil company, which is quoted in Hong Kong and on Wall Street, may be no more than a subsidiary of the major state-owned China National Petroleum Corporation (CNPC), but last December it overtook Shell to become the world’s sixth-largest company by market value. Two other Chinese companies follow closely: the China Petroleum & Chemical Corporation (Sinopec) and the China National Offshore Oil Corporation (CNOOC). These companies now operate in 40 countries; in 1999 they were present only in Venezuela, Sudan, Azerbaijan, Kazakhstan, Burma and Indonesia.

China and India, where demand for hydrocarbons has increased most strongly over the past three years, are now trying to coordinate their expansion abroad to their mutual advantage. This is just one sign among many that a major shakeup is happening in the global oil industry, behind the yo-yoing oil prices that excite speculators, depress motorists and alarm consumers across the world.

Among the four groups involved in prospecting and exploiting the world’s oil and gas reserves, the balance of power is tilting dramatically. The five surviving, mostly Anglo-Saxon, majors, ExxonMobil, Royal Dutch Shell, BP, Total and Chevron (see “The leading players”), control barely 9% of fields. The new giants are the national oil companies (NOCs) of the member countries of the Organisation of Petroleum Exporting Countries (Opec), 10 of which have the security of knowing that they control 53% of reserves.

Far behind them, the other NOCs (many from countries such as China, India, Brazil or Malaysia, where demand is increasing at the same spectacular speed as economic growth) control 16% of reserves. Finally there are the smaller independents, which are mostly private companies and often, but not exclusively western; they control 20% of worldwide hydrocarbon reserves.

Apart from Opec (1), the other groups face an uncertain future as the reserves that they own diminish inexorably. The decline is alarming for the independents (34% of world production against only 22% of reserves), but also for those NOCs who do not belong to Opec (25% against 16%) and the majors (13% against 9%).

‘In deficit’

Three of the four groups find themselves in the uncomfortable position of pumping out more oil than they are acquiring through new discoveries or purchases from other companies. In industry jargon, they are “in deficit” since they are unable to maintain their reserves. If they fail to acquire new reserves fairly soon, their future is in question, especially those groups which are quoted on the stock exchange. Their share prices could plummet even faster than their reserves, making them vulnerable to hostile takeover by a competitor. Hence the tendency to deliberately overestimate reserves. In 2004 Royal Dutch Shell was forced to admit that it had massaged up its estimates by 20% to present a more rosy picture to its shareholders.

According to PFC Energy, an influential international consultant, 77% of the world’s hydrocarbons are owned by NOCs, therefore by the public sector. From a geopolitical perspective, companies in consumer countries tend to be located to the north and east, while the reserves are to the south. Negotiations have to take place between the former, the international oil companies (IOCs) and the governments of exporting companies. These negotiations are becoming difficult.

Under the traditional concession, companies owned the oil fields. But since the 1970s that model has disappeared outside the United States and a few European countries such as Britain, the Netherlands and Norway. Elsewhere, in Colombia, Thailand and the Gulf, the last contracts that granted concessions before the great wave of nationalisations during the 1970s have ended or are about to end. In Abu Dhabi, the authorities have already notified the majors that three concessions, due to expire in 2014 and 2018, will not be renewed.

After the second world war a new system developed to replace the concession: the production sharing agreement (PSA). The idea is simple: a contract between the state and a foreign company sets the conditions for the exploration and development of resources for a set period and within a determined area, the minimum investment in exploration, and the tax framework. The investor pays an entry fee, the bonus, and accepts the risk that it will not discover anything; if successful, it shares the production yield with the state. It also meets the costs of exploring and developing the field, reimbursing itself out of production.

A clear advantage

PSAs are more profitable than concessions and present a political and legal advantage: since unanimous public opinion – right and left, nationalists and Islamists – in oil states now demands that natural resources remain national property. The most recent demonstration of this was the miscalculation by the majors in Iraq: the US had no difficulty in rewriting the occupied country’s constitution to suit itself, but all its attempts to overturn the 1972 law that nationalised oil and revert to a system of concessions have so far failed.

PSAs allowed the IOCs to get back in to countries that had long excluded them, including Venezuela, Algeria, Burma (Myanmar), Iran and the former Soviet Union. But that was a time when oil prices were low, when Opec seemed to be falling apart and the exporting countries lacked the money to invest in their oil sectors. Any oil source will exhaust itself over time. If new wells are not sunk regularly to make up for this inexorable process, overall production will fall and budget receipts with it.

At the time, the companies held the whip hand and secured tax benefits, sometimes, as in Russia, to an outrageous degree. When the Russian treasury was exhausted in 1995, Shell was able to secure prior reimbursement of its costs in developing the massive Sakhalin II gas project in eastern Siberia; 100% of receipts went to Shell until it had recouped all its investment (the figure is usually 50-60%).

Last autumn Shell had to admit that, compared with the contractual agreement, its expenses had almost doubled, to $22bn rather than $12bn. Russia had to wait 10 years, twice the expected time, before it saw a single dollar. Soon after the Russian government ran out of patience and took unopposed control of Sakhalin II for next to nothing.

The return to higher oil prices after 2000 has led to a general re-examination of the oil taxes paid by operators. The question of how the extra profits should be shared was raised. The British government took the lead in 2002 with a 10% rise in tax on companies operating in the North Sea; by 2005 tax had risen to 60%, compared with a rate of 30% before 2002.

The US Senate Budget Committee, which had a Republican majority, suggested an additional levy on US companies to reduce the national budget deficit. The Democrats made oil taxes one of their six priorities during their first 100 hours after their victory in last November’s mid-term elections. The US government’s take from oil is around 40%, compared with a world average of 60-65%. The Bush administration introduced subsidies for offshore exploration but these seem to have had little effect and the Democrats intend to abolish them.

No one wants to be left out

The producing countries do not want to be left out. Jean-Marie Chevalier, of the respected consultants Cambridge Energy Research Associates, supports their claim that their share is inadequate compared with that of the tax authorities in consumer countries, the operators, the banks and other financial intermediaries. Companies operating under PSAs have agreed, gracefully on the whole, to the discreet renegotiation of the tax regimes under which they operate; but little or nothing has filtered out. Changes in market conditions have helped the process. A simple calculation will show that 25% of a $60 barrel of oil is worth more than 33% of a $30 barrel.

The only serious conflict over taxes has been in Venezuela, where it has accompanied a dispute over the contracts. Relations have deteriorated. According to Patrick Pouyanné, senior vice president at the French oil giant Total: “Ours is a high-risk business, hence the importance of our contract with the host government, because that is the basis upon which we would invest billions over 25 years or more.” At ExxonMobil, biggest of the majors and the largest company in the world by market value, they talk of the “sanctity of rights”.

The major western oil companies see Hugo Chávez and Vladimir Putin as rivals for public enemy number one status. Chávez, after his victory in the 1999 presidential election, persuaded his Opec partners and Mexico to cut production in order to force up the price of crude, which Saudi Arabia’s mistakes had reduced to less than $10 a barrel. It worked. Prices rose for more than five years. In 2002 Chávez weathered a political two-month lockout at the state-owned oil company, the PVDSA. Half of its 40,000 workers participated in the strike, whose failure cost 18,000 of them their jobs.

Chávez took the advice of the oil expert Bernard Mommer, a former Oxford mathematician. Chávez demanded that foreign companies which, as part of the opening up of oil production to multinationals in the 1990s, had entered into repayable service contracts for undiscovered oil, should migrate to joint ventures in which the state held at least 60% of the capital. All agreed, except Total and the Italian company ENI, which refused to see the PDVSA share rise to 75% and theirs fall to 13% and 12%.

The French are particularly nervous that this could be a precedent for their main Venezuelan investment, Sincor 1, a project 10 times larger at $2bn, which involves ultra-heavy crude from the Orinoco belt. After several months of fruitless negotiations, the Venezuelan government threatened to nationalise.

The new wave of nationalism has reached Ecuador (where Occidental Petroleum was summarily expropriated), Peru and Bolivia, where foreign companies, in particular the Brazilian Petrobras, accepted the nationalisation of gas fields without a fight. When the rightwing opposition in Brazil accused President Lula da Silva’s government of taking a submissive attitude towards its neighbour, the foreign minister, Celso Amorim, replied: “Brazil cannot behave like a 19th-century power.”

Negotiations were suspended for a while, since Bolivia’s president, Evo Morales, did not want to risk damaging Lula during an election. But once Lula was safely back in office, talks resumed and on 15 February a preliminary agreement was signed. The price of Bolivian gas sold to Brazil’s Mario Covas thermoelectric power plant, at Cuiabá in Mato Grosso, will rise by 285% from $1.09 to $4.20 per million BTU. In June 2006 Argentina had agreed to a 50% increase in the price of imported Bolivian gas.

The Putin treatment

Vladimir Putin’s treatment of the majors has been even more brutal. Jean Lemierre, the president of the European Bank for Reconstruction and Development, which is active in the former Soviet Union, explained: “Russia has always said that energy was a strategic sector.” Putin needs oil revenues to pay for his plans for the radical reform of Russia, to secure equal economic relations with other countries and to guarantee his place on the stage of international diplomacy (2). He has had enough of the small group of oligarchs who have plundered Russia’s natural resources with impunity since Boris Yeltsin’s presidency, and who are suspected of planning to give the majors complete ownership of Russian oil fields.

Marshall Goldman holds the chair in Russian studies at Harvard and is the author of a recent book The Piratisation of Russia (3). He describes how, as president, Putin was outraged by the disparity between the price received for Russian hydrocarbon exports and that paid by consumers. Where was the money going? Gradually and systematically his government took back control of the energy sector, starting with Gazprom. The government’s stake in the old Soviet gas ministry had fallen to only 38% in the 10 years after its privatisation in 1992, the majority of its capital having been creamed off by Yeltsin’s prime minister and his cronies. Gazprom’s directors had also mislaid an average of $2bn every year, along with 10% of reserves.

In June 2000 Putin put his own man in charge of Gazprom, which controls 25%, maybe even 33%, of the planet’s natural gas reserves. In December 2005 the state became the majority shareholder, with 51% of the company’s capital. Gradually Gazprom recovered its assets: by purchase or expropriation, by demanding astronomical back taxes, by imposing record fines for imaginary ecological crimes, or by KGB-style dirty tricks.

The spectacular fall of Mikhail Khodorkovsky and his Yukos group demonstrated the extent of Putin’s ambitions, and his willingness to ignore intense pressure from the US, whose vice-president, Richard Cheney, denounced Russia’s use of oil and gas as “tools of intimidation or blackmail”. The new allies of the US among the former Soviet republics and satellites relayed this message, reviving what the Russian writer Viktor Erofeyev described as “a new cold war; an image war”.

A worrying state of wealth

For the majors, faced by shareholder demands for ever-higher returns and excluded by the leading producer countries from the most promising reserves, the good times may be over. But they are richer than ever. ExxonMobil, the most powerful major, had a turnover of $370bn in 2005 ($450bn in 2006, according to Wall Street estimates), more than the GDP of 180 of the 195 members of the United Nations.

But far from being a sign of good health, this financial wealth is symptomatic of an inability either to reinvest these enormous profits effectively or to find projects that meet the extravagant demands for profitability imposed upon engineers.

BP’s recent misfortunes illustrate the paradox. In 2005 one of its US refineries exploded, killing 15 workers and injuring 170. In Alaska it was forced to stop pumping oil from one of the largest fields in North America when its worn-out pipelines began to leak. In January 2007 a group of experts, nominated by BP, condemned its failure to invest enough money and effort to guarantee the safety of its US refineries. The US authorities are investigating whether this underinvestment was not, in fact, deliberate.

Any future lack of oil is likely to be due more to lack of investment than to lack of reserves. It takes billions of dollars to turn a discovery into actual production, and the richest operators, the majors, represent barely 20% of investment in exploration and production. Yet that is where the most skilled experts are working, those best qualified to conceive projects at the cutting edge of technological research.

The companies prefer to devour each other in stock market cannibalism. The last wave of consolidation started in the late 1990s, when Lord Browne created the first super-major by merging BP and Arco, forcing Exxon, Total and Chevron to follow so as not to be left behind. According to a veteran of this stock market battle: “In the lean years, when the price of a barrel of crude fell to $10, we quietly set about reviving the great days of the seven sisters (4), by taking over more recently created small state companies and by stifling Opec.”

Today the financial markets are full of rumours of new mergers, with BP the likely prey since the surprise resignation, early this year, of its president. A merger between Shell and BP, the second- and third-largest, is possible. In December, Statoil and Norsk Hydro merged their offshore activities “to meet the challenges of the oil industry”. Repsol, the big Spanish company, has been on the market for several months; it had no success so far, and financiers afraid of the Chávez effect regard it as overextended in South America. There is also speculation about how long the Italian group ENI, founded by Enrico Matteir, can sustain its independence.

So far the speculators have had a free run. Globally there has been no significant collective response to all the events that have shaken the oil business since 2000. Governments in developed and emerging countries are mainly concentrating upon securing access to reserves by building links with the few producer countries that remain accessible. The prevailing every-man-for-himself ethos was demonstrated to the point of caricature in December, at the burial of the dictatorial Turkmen leader, Saparmurat Niyazov (who called himself “the father of all Turkmens”). According to Transparency International, Niyazov’s regime was corrupt even by central Asia’s unexacting standards. But the recently discovered Iolotan South gas field was enough to persuade the western democracies to forget their commitments to human rights and send ambassadors and ministers.

Angola, Nigeria, the Gulf of Guinea and all of Africa from the Cape to the Sahara are as enticing as central Asia. According to predictions from its National Intelligence Council, by 2015 the US could find itself importing 25% of its oil from Africa, compared with 15% today, reducing its dependence upon the Middle East. Africa presents two advantages: contracts there are reasonable and national oil companies, unlike those in the Middle East, lack the financial means to buy up the shares of the majors as Putin did in Russia or Chávez in Venezuela.

But are changes like these enough to withstand the current shockwaves?

~ Translated by Donald Hounam

(1) The statistics quoted relate to only 10 of Opec’s 12 members; as well as Iraq, they exclude Angola, which only joined at the beginning of this year.

(2) See “Tsar Putin’s Russia”, Le Monde diplomatique, English language edition, February 2007.

(3) Marshall I Goldman, The Piratisation of Russia: Russian Reform goes Awry, Routledge, London and New York, 2003.

(4) The seven sisters were the seven global oil companies that dominated the industry between 1914 and the first oil crisis of 1973. Three (Exxon, Shell and BP) survived, absorbing the other four (Texaco, Mobil, Socal and Gulf).

English language editorial director: Wendy Kristianasen – all rights reserved © 1997-2007 Le Monde diplomatique.

Jean-Pierre Séréni is a journalist and author, with Pierre Péan, of ‘Les Emirs de la République. L’aventure du pétrole tricolore’ (Seuil, Paris, 1982). Petroleumworld does not necessarily share these views.

Editor’s note: : This commentary was originally published by Le Monde diplomatique – English edition, March 2007. Petroleumworld reprint this article in the interest of our readers.

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Petroleumworld News 03/19/07

Copyright© 2007 Jean-Pierre Séréni. All rights reserved.

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