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FT REPORT – FT FUND MANAGEMENT: Testing times for oil’s biggest names

By Mike Scott, Financial Times
Published: Jul 02, 2007


The oil and gas companies bestride the world, the biggest and most profitable companies on the planet acting as a law unto themselves as their products fuel the global economy. This is a common perception of the sector but the energy companies do not have it all their own way. In the 1960s, the oil majors had access to 85 per cent of the world’s oil reserves – now they have access to only 16 per cent as governments assert control over their national assets. The contrast between the list of the world’s biggest oil companies by revenue and by access to reserves (barrels of oil equivalent) is striking. Exxon- Mobil may be the biggest and most profitable company but it ranks only 16th in terms of reserves, well below the likes of Gazprom, Lukoil and Petrochina, according to Petrostrategies, the consultancy. “There has been a resurgence in oil nationalism, partly because of the high oil price and partly because oilproducing countries now feel more comfortable taking control of projects,” says Keith Morris, oil and gas analyst at Evolution Securities. “Ten years ago, for example, Russia was flat on its back and needed western companies – now there is plenty of money around and they are better able to cope on their own.” This has led to companies such as Shell and BP coming under pressure to sell assets in Russia to domestic companies, with Gazprom a notable beneficiary of this trend. In fact, says Elizabeth Eaton, portfolio manager, emerging markets equities at Credit Suisse, there are many opportunities in Russia and Kazakhstan, but “we believe that the best way to access this growth is by purchasing domestic companies rather than global names”.

National oil companies no longer need to rely on the western oil majors because these companies have subcontracted much of their research and development to the oil services companies such as Schlumberger, Halliburton and Baker Hughes, which have grown in size and prominence enormously. The industry is mature and all the easy oil has gone, Mr Morris adds. This means companies must look to sources that are more dangerous, technologically challenging and bordering on the inaccessible. These include deeper wells offshore and unconventional sources of oil, such as tar sands and oil shales. “The trouble with these sources is that the costs of extraction are very high and it is a very energy intensive process,” says Vicki Bakhshi, oil and gas analyst at F&C. According to Goldman Sachs, more than 40 per cent of new legacy assets are in high-risk countries. These present challenges including human rights, bribery and corruption, security and the rights of indigenous people. Shell’s travails with militants in the Niger Delta show that these issues can be a serious drag on performance. There are ways to deal with these issues – Statoil has provided training in human rights to judges in Venezuela and Nigeria, says Stephanie Maier of the Ethical Investment Research Service. While the largest companies mostly have policies in place for dealing with these issues, smaller companies are operating in high-risk areas such as Africa and Turkmenistan without the scrutiny that faces the supermajors.

“We have not seen these risks come home to roost, but one day they will,” says Ms Bakhshi However, says Paul Mumford, senior fund manager at Cavendish Asset Management: “Until now, smaller players have found it much easier to penetrate foreign markets as they are considered less of a threat to local organisations and have shown a much greater ability to form meaningful partnerships.” One smaller company making the most of its size is Gulfsands Petroleum, which has operations in Syria and is active in Iraq. Working in these countries poses challenges, including a US ban on exporting technology that prevents the company from using American equipment or workers in Syria. However, the risk of expropriation of contracts is low, says John Dorrier, chief executive. “Syria has a long history of fair and straightforward dealing with oil companies. They have never broken a contract, to my knowledge.” The other big issue the industry must deal with is its environmental impact; and dealing with climate change has emerged as the main challenge in recent years. This involves increased regulation, costs from initiatives such as the European Union’s emissions trading scheme and pressure to reduce environmental impacts.

“Companies are increasingly seeking to differentiate themselves on the basis of their product portfolio and strategic activities in lowercarbon projects,” says Goldman Sachs. This is benefiting a number of alternative energy companies. Aim-listed Clipper Windpower has seen its shares surge since it announced a joint venture with BP, for example, while German solar production company SolarWorld was able to buy the crystalline silicon solar assets of Shell after the oil company decided to focus on thin-film solar technology. Biofuels is an area where oil groups’ distribution and refinery infrastructure could provide opportunities, and companies involved include Chevron, Shell and BP, while a few oil groups are looking at marine energy – Total has taken a 10 per cent stake in Scotrenewables Marine Power and Chevron has links with Irish group Wavebob. The focus on cutting greenhouse gas emissions favours groups such as Gazprom and the UK’s BG. They are entirely focused on gas, which is 50 per cent cleaner than oil. The growth of the liquefied natural gas industry has boosted UK group Hamworthy, which makes systems that enable shipping of LNG. The industry also expects to benefit from moves towards carbon capture and storage. Statoil recently said it expected revenues from CCS would eventually outweigh its oil and gas income.

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