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The Pueblo Chieftain: Record profits from oil may soon ooze away


The doubling of oil prices over the past few years has produced enormous windfalls for oil companies. But those record profits are likely to recede in the years ahead – even if oil prices don’t – as oil-producing nations increasingly demand a bigger share of the wealth.

Last year, the five largest U.S. and Western European oil companies had a combined profit of $120 billion, roughly double what they earned in 2003, and they are likely to be rolling in cash for some time to come.

But the production contracts they are signing today aren’t likely to be as lucrative as the ones they signed in the 1990s.

Some of the new deals essentially give the oil companies a fee for their services, leaving them little room to gain if oil prices soar. Countries like Algeria and Venezuela have gone a step further, altering existing contracts to claw back some of the profits from high oil prices.

As these changes take their toll, it may be that the oil industry is enjoying its last run of windfall profits. A severe disruption in supply could send oil prices above $100 a barrel and yield staggering returns, but an increasing percentage of those profits would flow into state coffers, bypassing the big Western oil companies.

In the past, oil companies typically generated profits by taking on the risk and expense of finding new underground sources of oil or natural gas. In return, they got part ownership of the new fields and the potential for a windfall if prices soared.

Today, oil-producing nations can demand better deals because they have the upper hand. Three-quarters of global oil reserves are under the control of increasingly capable state-owned oil companies, and the West’s investor-owned oil companies – like Chevron Corp. and ConocoPhillips – typically have to accept much less generous terms to gain access to those reserves.

As a result, the major oil companies are being forced to operate less like wildcatting entrepreneurs and more like service companies. These days, says ConocoPhillips Chief Executive James Mulva: “Big Oil is not so big.”

The trend toward squeezing oil companies spans both geography and ideology. Last year, the anti-American socialist government of Venezuelan President Hugo Chavez raised the royalties on Venezuela heavy crude. Meanwhile, near the opposite end of the political spectrum, the U.S. and Britain raised their offshore royalty and tax rates in the Gulf of Mexico and North Sea, respectively.

“There is resurgence, a new focus on a higher government take as a result of higher prices,” says Pedro van Meurs, a Nassau, Bahamas, consultant who has negotiated contracts for producer governments for more than three decades. “If I were an investor, I would carefully monitor this.”

One reason: Many national oil companies have picked up valuable technical expertise, and are now able to tackle complicated projects on their own.

“National oil companies now have the competence to do things, so why should they pay others to do these things,” said John Browne, chief executive of BP PLC, in an interview last year.

The trend moved into the spotlight in late 2006 when Russian natural-gas giant OAO Gazprom said it didn’t need outside help to develop the giant Shtokman gas field in the Barents Sea, turning away suitors such as Chevron and ConocoPhillips of the U.S. and Total SA of France.

Gazprom subsequently invited the Western oil companies to participate as technical advisers, without an equity stake in the project or the potential for a windfall profit. Discussions are continuing.

Behemoths like Exxon Mobil Corp. may be able to hang tough for a while, avoiding contracts that don’t offer equity stakes. Even so, Exxon Chief Executive Rex Tillerson says he expects governments to continue pressing for better terms as long as oil prices remain high.

Even some nations new to the oil game are demanding stiff terms. Some of the biggest finds in recent years have been in Angola, which has popularized an oil-production contract built on progressive taxation. As oil prices rise, boosting an oil company’s rate of return, Angola’s share of the proceeds also goes up.

On top of tougher demands, Western oil companies are getting into bidding wars for the limited prospects open to them, giving up potential future profit.

In a December round of bids for exploration rights in Libya, most successful bidders offered the state more than 85 percent of any future oil revenue right off the top, despite what an energy analyst for Scottish oil consulting firm Wood Mackenzie termed “inferior” acreage.

Gazprom offered 90 percent and won the license.

In some nations where contract terms were set years ago, governments have realized they can raise taxes retroactively without fear of chasing the big oil companies away. In December, Algeria imposed an exceptional profits tax and passed a law giving its state-owned oil company a majority stake in all energy exploration contracts.

Marathon Oil Corp. faces a new requirement in Equatorial Guinea that foreign producers be required to pay “any windfall tax that may be imposed by the state.”

Some producer nations are simply taking majority stakes in existing projects away from Western oil companies. Even when the Western company is paid for its property, future profits are erased. In December, Royal Dutch Shell PLC was forced to turn over a majority stake in Russia’s giant Sakhalin 2 project to Gazprom.

Venezuela has raised taxes and royalties and is now requiring Western companies to cede a 60 percent stake in heavy oil projects to the state. These projects were among the most profitable in the world for Western oil companies, according to industry analysts.

To grab more of that profit for itself, the Venezuela government broke existing contracts. Income taxes on heavy-oil projects over the past couple years rose to 50 percent and royalty rates doubled to 33 percent, having previously been raised from the original 1 percent. The government also legislated that the state-oil company, Petroleos de Venezuela SA, be given a 60 percent stake in existing fields by May – and thus a majority of future profits.

Fadel Gheit, senior energy analyst at Oppenheimer & Co., says Venezuela’s response to the oil companies’ windfall profits wasn’t unreasonable from Chavez’s point of view.

“This is like drafting a kid to the major league and he’s making $100,000 a year,” Gheit says. “All of a sudden, he is hitting 50 home runs. Guess what, he wants to renegotiate his contract – and under the circumstances, one can understand the way Chavez feels.” and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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