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Financial Times: International oil companies: Big shift in balance of power

By Ed Crooks
Published: November 9 2007 04:36 | Last updated: November 9 2007 04:36

November 5, 2007 deserves to go down in history as a momentous day in the the world’s energy industries: it was when ExxonMobil was displaced as the world’s biggest quoted company by market capitalisation by PetroChina. The thin float and volatility of PetroChina’s shares arguably render the standard calculation of its market value misleading. But the symbolism of the moment still stands: the most admired of all western oil companies is no longer king of the hill.

The transition comes at a time of unprecedented agonising about the future of international oil companies, which is all the more remarkable for coming when the price of oil is close to its all-time high, even in real terms. Past periods of soul-searching inside “Big Oil” have generally coincided with cyclical lows in prices. The trough at the end of the 1990s, for example, prompted the wave of consolidation that joined BP to Amoco and Exxon to Mobil.

Today, however, the threat seems more profound. IOCs are facing structural challenges that cannot be fixed by a simple cyclical upswing. The global balance of power in the industry has shifted, and the IOCs are fighting for their futures. As Jonathan Stern of the Oxford Institute for Energy Studies puts it: “Their business model is now highly questionable.”

Some of the industry’s problems will pass, although even these temporary factors could take several years to resolve. Poor results for the oil majors for the third quarter of the year, in spite of the high oil price, in part reflected soaring costs, caused by shortages of skilled staff, equipment and steel. A survey from IHS, a consultancy, found that capital costs for projects in the upstream end of the oil and gas industry – exploration and production – were rising at an annual rate of 14 per cent in the six months to March this year.

However, the industry is recruiting hard, and there is a lot of investment going into new equipment such as drilling rigs, adding to capacity and easing shortages. Andrew Gould, the chief executive of Schlumberger, the world’s biggest oil services company, said recently he expected the rate of cost inflation to slow.

The more fundamental question for the IOCs is how they will manage to get access to the oil and gas resources they need to grow. Output from mature fields will usually decline steadily, meaning oil companies run to stand still. And most of the world’s resources are controlled by countries that are, to varying degrees, sceptical about the need to offer western companies a share of the proceeds.

PFC Energy, another consultancy, calculates just 7 per cent of the world’s oil and gas reserves are freely available to IOCs, with another 16 per cent held by Russian companies, 12 per cent by national oil companies prepared to offer equity access and 65 per cent by NOCs that offer little or no equity access.

As the price of oil has risen, countries including Algeria, Russia and Venezuela have seen the opportunity to take greater control of their resources, and are no longer prepared to allow IOCs access on terms that were acceptable in the past. Prof Stern says: “The IOCs’ value proposition has always been: ‘We’ve got the capacity to handle major projects, we’ve got large financial resources and we’ve got technology.’ When you look at the countries that have resources, you have to question whether that proposition works any more.”

Technology for everything from surveying territory to processing products is available from Schlumberger and the other services companies, so IOCs no longer have any particular advantage there. Finance has rarely been a problem for countries enjoying huge cash inflows as a result of high prices.

The responses of IOCs have varied. European companies such as Eni, Total and BP have placed more stress on having good relationships in the countries where they operate, as seen for example in Eni’s willingness recently to renegotiate its contracts in Libya to allow the government more generous terms.

But for all of them, the bottom line is the same: IOCs have to show that they can offer something that NOCs and service companies cannot. That means two things: securing access to markets, and enabling the exploitation of difficult resources, such as unconventional oil and gas, or production in deep water or the Arctic that would otherwise be inaccessible.

“There are a couple of things that the IOCs can do. They are the still the principal sources of risk capital for investment in challenging projects such as deep water exploration and development. And they have the greatest ability to manage large, complex, capital-intensive projects,” says Robin West of PFC. “Being able to manage the complex integration of projects, all the way from exploration to marketing, is very valuable.”

The success of Total and StatoilHydro in being invited to join Gazprom’s Shtokman development, a difficult project involving Arctic production and liquefied natural gas exports, looks like a harbinger of the sort of deals that IOCs are likely to be able to win in the future. For that reason, it is particularly serious for IOCs when their project management skills are called into question by spiralling costs, as they were at projects such as Sakhalin 2 in Russia, operated by Royal Dutch Shell, and Kashagan in Kazakhstan, led by Eni of Italy.

The IOCs that succeed in minimising that kind of slip-up should still have a future, although it is likely to be tougher than their past. For those that fail, the outlook is bleak.

Copyright The Financial Times Limited 2007

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