IOCs, NOCs Facing Off Over Scarcer Resources

Ross McCracken, Editor, Platts Energy Economist

The balance of power between producing countries and International Oil Companies is shifting with both resource nationalism and aggressive competition from National Oil Companies. Governments of energy-rich nations want ever-more control over commercial expolitation of their resources in far-flung parts of the globe. Heading into 2007, the commercial descision-making of IOCs will increasingly be pitted against the power of states.

INTERNATIONAL OIL COMPANIES (IOCs) ARE poorly named. They operate internationally and aim to serve the interests of shareholders. They are divorced from national interest and make decisions on a commercial basis. However, they are almost entirely U.S. and European in origin, and they retain clear national identities, their internationalization having been built around the exploitation of foreign oil and gas assets to supply their respective national domestic demands. They may be commercially independent, but they are nonetheless the representatives of the "Western World" in the oil and gas industry. Their success internationally is of strategic importance to western energy-importing nations, as is their ownership, a fact amply demonstrated by China National Offshore Oil Corp's failed bid for U.S.-firm Unocal in 2005.

The term National Oil Company (NOC), meanwhile, groups an extremely diverse range of companies, the common strand for which is not explicitly that they are state-owned, but that they serve the interests of the state and are directed by the state. They may lack the commercial efficiency of an IOC, but in any contractual negotiation they are backed by sovereign power. The growth of energy demand in developing countries has created a new breed of NOCs which are aggressively competing for far-flung upstream assets. In addition, the rise in oil and gas prices since 2002 has seen a resurgence in resource nationalism within producing countries. The combination of political and economic bargaining that NOCs can bring to bear abroad, alongside their unassailable position in often protected domestic markets, represents a significant challenge to commercially-oriented IOCs and by extension to western security of supply.

Resource Nationalism

Resource nationalism is nothing new. As oil and gas prices rise there is always a scramble for the spoils, and IOCs run up against the intractable problem of dealing with sovereign powers, which can effectively re-write the rules of the game at any time. To be fair, IOCs have not been shy about using the same strategy in reverse—when prices fall they threaten to stop production, withhold investment or pull out until contractual conditions are made more amenable. From both sides, oil and gas contracts carry the ever-present risk that they are ultimately renegotiable.

At the heart of resource nationalism is the belief that the host country, rather than the IOC, should reap the upside of oil and gas prices. Producer governments argue that if companies were happy to invest on the basis of a long-term oil price of $15 to $18/barrel, they do not need to get more when prices exceed their expectations. In this sense, producer governments view IOCs as vertically-integrated service companies rather than as asset owners. Even if a contract was negotiated on a different basis, a rise in oil and gas prices provides the opportunity to make this relationship more explicit with less risk of repelling the IOC altogether.

The degree to which IOCs are forced into the role of a service company reflects the producing nation's ability to exploit the resources themselves. Where this is low, for example in Nigeria or Angola, IOCs are needed for every facet of development from exploration to production to marketing. Where it is higher, for example in Venezuela, Saudi Arabia or Russia, governments have more options and can dictate the degree of foreign participation or restrict IOCs to more technologically challenging areas.

Russia Goes it Alone

After months of deliberation and postponed announcements, Russia's state-owned gas company Gazprom Oao announced in October that it would develop the giant Shtokman gas field without a foreign partner and that it would pipe the gas to northern Europe. While the direction of the gas flow will be welcomed in Europe, the decision reinforces the powerful swing towards resource nationalism under President Vladimir Putin. Not only has Gazprom's position been reinforced by its expanded ownership of oil as well as gas assets, but the state-directed break-up of Yukos put back into the hands of state-owned oil companies many formerly privatized assets.

This has been backed by legislation such as the subsoil law, which says that oil and gas fields deemed "strategic"—read "large"—must be at least 51% owned by Russian interests. This has left TNK-BP, which is 51% owned by BP, looking like a token big foreign investor.

The Russian oil pipeline system remains under the state monopoly Transneft, while Gazprom controls the gas infrastructure. Hostile moves against the foreign partners involved in the various Sakhalin projects are widely seen as an attempt to leverage a greater role in these developments for Gazprom. At the same time, the nascent democratic institutions of the Russian state have atrophied and civil society is failing to develop institutions that can balance the power of the state. The apparent contract killing of investigative journalist Anna Politkovskaya in October is a worrying sign of the direction in which Russia is moving. The Shtokman announcement indicates there is every likelihood that the trend will continue.

However, Russia has taken resource nationalism one step further by redefining itself as an energy power. Control of gas pipelines and infrastructure is at the heart of its relations with the countries of the former Soviet Union, which in large part control the transit infrastructure for delivering Russian oil and gas to markets. The negotiation of market gas prices with countries like Ukraine and Belarus are accompanied by thinly disguised or simply overt attempts to gain control of the energy infrastructure in neighboring countries, particularly in the former Soviet Union's sphere of influence. So far as Russia's position in the world is based upon the state's control of the energy sector, there is little chance of any meaningful liberalization. At the same time, however, Moscow is insisting on equal treatment for its state-owned companies within the single European market.

Latin Nationalism

Resource nationalism has been resurgent in Latin America, most notably under Presidents Hugo Chavez in Venezuela and Evo Morales in Bolivia. Presidential hopefuls with similar agendas have also done well in Ecuador and Peru. While for the most part, governments have been content to pursue a larger share of the rent from oil and gas assets, Chavez has used the income from oil and gas to promote his country's prominence within the region and internationally.

All Caribbean nations except Barbados, Trinidad and Tobago, and Haiti have signed up to Chavez' PetroCaribe initiative which supplies crude and refined petroleum products at preferential prices. As part of the process, Venezuela's state-owned oil and gas company PDVSA is helping to upgrade or build new refineries in a number of Caribbean countries including Cuba.

Chavez has signed energy cooperation pacts with Angola, Syria and China, as well as agreeing to send India 2 million barrels of crude a month. He has also asked a wide range of state companies to participate in quantifying reserves in the Orinoco heavy-oil belt. This year saw Argentina's Enarsa and Uruguay's ANCAP added to invitations made in 2005 to Brazil's Petrobras, China's CNPC, Spain's Repsol YPF SA, India's ONGC, Iran's Petropars Ltd., and Gazprom and Lukoil from Russia. The right to certify blocks does not guarantee production rights, but Chavez clearly hopes to provide IOCs currently active in the area with greater competition.

Venezuela is keen both to diversify the market for its crude away from the U.S. and to attract inward investment in its oil and gas sector. The nation is finding willing partners in the NOCs of consuming nations as well as other producers. Energy Minister Rafael Ramirez has said that China is prepared to invest $5 billion in Venezuela's domestic oil industry, with a goal of delivering 500,000 barrels/day of Venezuelan oil to China by 2009 to 2010. Closer to home, Chavez is pushing the development of new pipelines to take Venezuelan gas south to meet burgeoning demand in Brazil, Argentina and Chile.

In Mexico, the state oil company faces intense political opposition to opening up the country's oil and gas sector to foreign participation, despite the move having the support of President Felipe Calderón. The state oil company Pemex does not have the capacity to develop deepwater assets by itself, but needs to do so if it is to stem the decline in the country's crude production.

A possible way around the stalemate may be the participation of Brazil's Petrobras, which has extensive deepwater experience. Petrobras has been held up by many Mexicans, including Calderón, as an example for Pemex, which continues to operate like a government department rather than a private company. Petrobras is already present in Mexico as a multiple service operator, but has stated its desire to work as a producer. Mexico's resource nationalism means there is little opportunity for IOCs despite the experience and technology they could deploy. Cooperation with foreign state-run companies may prove more politically achievable when domestic resource nationalism is so strong.

Consumer Competition

Even where resource nationalism is less evident—for example in sub-Saharan Africa—IOCs face an intensified challenge for oil and gas resources from state-owned companies, but this time from competing energy-importing countries. Driven by aggressive checkbook diplomacy on the part of both China and India, Asian NOCs are prepared to accept higher levels of political risk and lower returns to achieve the strategic goal of securing upstream assets, which is at the core of their security of supply objectives. Some analysts have even argued that India's and China's willingness to extend credit to African countries risks reestablishing a new vicious cycle of debt on the continent, which had been in the process of alleviation through debt forgiveness programs.

Sudan's oil industry is completely dominated by Asian NOCs. The security and political risks have deterred IOCs, while a combination of China's CNPC, OVL of India and Malaysia's Petronas have raised national output from near zero to 375,000 b/d within a decade. The ministry of oil estimates that production will reach 750,000 b/d by the beginning of 2008 as new fields are brought on stream.

The United States already sources 15% of its oil imports from Africa and many analysts see this rising to 25% by 2015. Unconstrained by strategic chokepoints, Africa appears to offer the U.S. a relatively safe source of supply. However, with U.S. foreign policy focused on an unstable Middle East, China in particular has been filling the void. China already sources 28% of its oil imports from Africa, the main suppliers being Angola, Congo-Brazzaville and Sudan, and it is also investing in Nigeria.

China currently imports about 40% of its oil consumption and this is expected to grow steadily. Beijing hopes that African producers can supply much of the increase in oil supplies that China will require over the next decade. Foreign Minister Li Zhaoxing's visit to Nigeria and other West African states in January was just one strand of a diplomatic push to strengthen relations with the region.

Beijing is prepared to offer aid packages and deals on a whole host of infrastructure projects and consumer goods in return for oil deals. China funded a variety of projects during the 1970s and 1980s in an effort to spread its authority, to counter U.S. influence and to support southern African states in the struggle against Apartheid-era South Africa. It is now making the most of this influence by offering infrastructure deals and other forms of financial and human support in order to boost its oil diplomacy—offers which IOCs cannot hope to replicate.

Tough Challenges

Rising world energy demand has prompted expansions in the productive capacity of state-owned oil and gas companies, while higher commodity prices have provided an influx of capital. At the same time, technology has become increasingly available through the growth of oil and gas service companies, eroding a core advantage enjoyed by IOCs in gaining contracts and forming partnerships. Meanwhile, security of supply concerns have galvanized the governments of energy-importing countries into using their NOCs as the most effective means of securing strategic goals.

Squeezed between the twin pressures of resource nationalism and the state-sponsored NOCs of energy-hungry nations, IOCs are being locked out of the easier-to-exploit resources because NOCs can do it themselves, particularly with services companies that have technology for hire. This pushes IOCs towards conventional hydrocarbon frontiers—deep and ultra deepwater, harsh environments like the Arctic, and super-deep wells—that require cutting-edge technology. Or they can go for unconventional sources like oil sands, oil shale, ultra heavy crude, coalbed methane, or even methane hydrates, which require technological expertise that NOCs do not have.

On a wider scale, the common interests of developing countries are gaining new dimensions. The rise of the BRIC countries—Brazil, Russia, India and China—as economic powers provides alternative consumer markets for the petro-economies of Latin America, the Middle East and Africa. This is a seismic shift in the historic trade patterns of the 19th and 20th centuries and one that provides an economic underpinning to the ideological leanings of leaders like Chavez. The BRIC countries are able to provide new leadership for the developing world in areas such as climate change mitigation policies and security of energy supply. As a result, as they move into 2007, IOCs find themselves operating within an increasingly complex set of political and economic parameters, not all of which will be to their advantage.