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A Piece of the Action

World Energy

By Richard R. Loomis and Susan Salter

People have a lot of impressions, largely negative, of governments. They can be corrupt. They can be bureaucratic. They can be elitist. But, in general, governments are not foolish. They know a good cash source when they see it, and right now several national governments are seeing it in oil.

And why not? Oil has peaked in price over the past year. As per-barrel prices continue to flirt with the plus-$70 level, public companies like ExxonMobil have reported record profits. But the influence of traditional international oil companies (IOCs) seems to be waning. As ChevronTexaco CEO Dave O’Reilly attempted to explain at last year’s congressional hearings, large IOCs have control of only 6 percent of the world’s reserves and can currently gain open access to less than 30 percent. The rest of the oil is locked up in countries that are less friendly to the United States than IOCs, and increasingly more nationalistic.

In oil-rich countries, some of which struggle with ongoing poverty and internal conflict, the temptation to line the national coffers can understandably be a strong one. "As energy-rich countries have become wealthier," says Carola Hoyos of the Financial Times, "they have also grown increasingly assertive. Russia has threatened to cut off supplies to its biggest customers unless they agree to higher prices while others, such as Venezuela, have jeopardized investment by imposing onerous new contracts on international companies." But from another perspective, they are just pursuing their economic interests with the same vigor as their more capitalistic customers are.

For Profit or Politics

Nationalization, or taking assets into state ownership, has been an issue in business and government for decades. In postwar France, the automaker Renault – the object of scandal for having used its factories to aid Nazi Germany – was taken over by the French provincial government and subsequently enjoyed great success (the infamous Le Car notwithstanding). Other governments have also bailed out struggling companies, as was the case with British Leyland in the 1970s.

In the United States, railroads were briefly nationalized for security reasons during World War I, as were electrical services during World War II under the auspices of the Tennessee Valley Authority. After September 11, 2001, privately run airport security businesses were consolidated and nationalized by the Transportation Security Administration (with, to put it kindly, mixed results).

The difference between most of these cases and that of oil is, of course, that oil is a commodity, subject to being bought and resold to the highest bidder. What follows are some stories from the nations that, for better or worse, are strongly associated with nationalizing the energy industry.

Russians Bear with the YUKOS Drama

Until two years ago, Russia enjoyed double-digit growth in oil output. But that was before Russian President Vladimir Putin took the reins of YUKOS – then one of the world’s largest non-state oil companies – and effectively dismantled the organization, disengaged its employees and incarcerated its senior management.

Some observers argued that YUKOS had it coming – that CEO Mikhail Khodorkovsky’s oligarchic profiteering and the company’s alleged tax evasion made it a target. But the outcome has followed the pattern of other nationalized oil concerns: a decline in the top fields, an increase in export taxes and the limitation of outside oil companies. The results are also predictable: According to the Financial Times, production growth fell last year to just 2.3 percent from 9 percent in 2004 and 10.7 percent in 2003. When Rosneft, the largest state-owned oil company, acquired YUKOS assets, the stage seemed to be set for an old-fashioned Kremlin rule.

And, under Putin’s rule, "history has repeated itself as a farce," as an Economist writer put it. "The Kremlin’s campaign against [Khodorkovsky] … has been economically damaging and politically embarrassing."

The pursuit of YUKOS "transferred a mainstay of the economy from what had become an efficient private business to opaque state control," noted the Economist. So who in their right mind would bait such a Russian bear with foreign investment? Well, the potential payoff of Russian oil is proving too lucrative to ignore. Russia’s recent reemergence as an oil powerhouse, despite the in-fighting, extends to new discoveries in the Arctic, far to the north of Moscow. Rosneft is embracing foreign technology, writes Andrew Kramer of the New York Times, "and inviting in Western advisors, crucial ingredients in YUKOS’ recipe for success."

To Gabe Collins, writing in Oil & Gas Journal, Russia has much to gain from practicing flexibility where other countries impose iron rule. "Organizing oil and gas production along ‘51% state – 49% private’ lines likely will strengthen the Russian state producers’ finances, and could greatly reduce their need for cash-rich, but reserves-poor Western partners." Like the United States?

This question has relevance at a time when our companies are seeking new locations where they can replace an ever-accelerating decline curve. Prior to this move by the Russian government, Russia looked like it was going to be our next frontier for investment. The BP-Tueman oil merger and the creation of TNK seemed to lead the way for greater investment. However, Rosneft and the other giant, Gazprom, seem to be calling the shots in this market today. Russia has been able to make a stiffer and more restrictive marketplace while remaining competitive as global companies search for places to bid. However, is this sustainable? Or is it just a matter of IOCs perceiving Russia as the lesser of multiple evils when looking around the world for opportunities?

Chávez Muscles into PDVSA

If there were ever any doubt remaining about Venezuelan President Hugo Chávez’s clout and agenda, it was laid to rest this past March 31. That was the day of a ceremony at Venezuela’s presidential palace, where, according to Stanley Reed of Business Week, "Chávez took pleasure in bringing representatives of the world’s oil elite – companies such as Chevron, Royal Dutch Shell, BP, and Repsol – to heel. The occasion: the signing of documents that gave the state control over much of Big Oil’s existing production in Venezuela."

The Chávez model of anti-American, anti-capitalistic government control of industry has been well documented in World Energy Monthly Review. As we reported in February of this year, Venezuela’s strong-arm president has long intended to use energy as a means to gain influence with neighboring countries. Chávez, like Putin, has shown a willingness to punish oil companies that resist government policies.

Last April, according to a Christian Science Monitor article, Venezuela’s energy ministry "gave private firms one year to eliminate 32 operating service agreements that governed mostly marginal fields accounting for about one-fifth of the country’s production." Chávez argued the previous agreements violated Venezuelan law prohibiting majority private participation. "With oil prices skyrocketing," the article noted, "the state said it was suffering losses because the contracts ordered PDVSA to pay private firms generous operating fees based on the price of oil."

Perhaps one could argue that the oil company punished most is Venezuela’s own PDVSA. The once-robust organization has suffered from shrinking production capacity, nearly a million barrels per day below what the company produced in the last pre-Chávez year, 1998. At the same time, a lack of maintenance and has led to deterioration in the work environment – with a resulting loss of life and otherwise avoidable accidents.

PDVSA has tried to remain independent. In December 2002 many of its managers and employees led a lockout/strike to persuade Chávez to call early elections, and they virtually stopped oil production for two months. The government fired 19,000 employees, the strike pushed unemployment up to a peak of more than 20 percent, and production was restored with employees loyal to the Chávez government.

Then there’s PDVSA’s embattled U.S. subsidiary, Citgo. Threats of liquidation and sell-off have been following Chávez for months, and last year CITGO announced the largest dividend payment to PDVSA in over a decade, $400 million.

It is very obvious that Venezuela, our fifth-largest import partner, does not have the best interest of the United States in mind. To say that hoping to acquire our share of the world’s reserves by working with PDVSA and the Chávez administration is risky is an understatement.

Bolivia and Ecuador Make Their Moves

As reported in World Energy Monthly Review (March 2006), Chávez’s strong arm has swept across Latin America, with the influential president investing his oil money into the presidential campaigns of fellow nationalists.

In Bolivia, President Evo Morales chose May 1 – yes, May Day, and his 100th day in office as president – to "lead troops into his country’s biggest natural-gas field," an Economist article reported. Morales donned his oilman’s hard hat and "read out a nine-point decree under which the Bolivian state proclaimed its control of the country’s oil and gas industry." Quoth the president: "The plunder has ended."

Bolivia’s nationalized energy industry left foreign companies in the lurch. Spain’s Respol YPF claimed that no negotiations had preceded Morales’ move, while France’s Total and Britain’s BP stood to lose the billions they had already invested in the country.

As Latin America’s second-largest natural gas reserve (after Venezuela), Bolivia had until recently teetered between socialism and a more capitalistic approach. Morales has cooperated with the more moderate leaders of Brazil and Chile, while not ignoring mentor Chávez and the granddaddy of all populists, Fidel Castro. But Morales has of late taken a decided turn to the left, signing a "people’s trade agreement" with Castro and Chávez.

But it’s tough to be a socialist when it takes large portions of cash to make your quotas. "Bolivia needs outside capital and technology to develop its gas industry," the Economist reported, citing a consultant, Carols Albert Lopez, as saying that without the new investment, the country could find itself unable to fulfill its export contracts with Brazil and Argentina.

Enter Ecuador. This country’s considerable petroleum reserves, high inflation and low tolerance for the democratic process (three democratically elected presidents failed to finish their terms during the 1990s) have left an opening for nationalization. In May President Alfredo Palacio, with the blessing of the Venezuelan Oil Minister Rafael Ramirez, sent in his state-owned Petroecuador to take over the installations of U.S.-based Occidental Petroleum.

In an official statement, Ecuadorean officials said the seizure of Occidental "does not mean the Andean nation is nationalizing its oil industry," according to an Associated Press report. Tell that to the United States representatives who called the move "confiscation" and broke off free-trade talks with Ecuador. That, in turn, brought the wrath of the Organization of American States (OAS), who took the United States to task for overreacting. "Latin America is not a baby," stated José Miguel Insulza, secretary-general of the OAS. "When the left or right win in Europe, nobody pronounces about the destiny of the continent or anything like that. You have to let the political process take its course." Not to mention that a U.S. pullout from Ecuador could cost that country 30,000 jobs a year.

Who’s Nationalizing Next?

Will other Latin American nations follow in the footsteps of the Bolivarian revolution? Or should we be looking elsewhere around the world? "While it is anyone’s guess as to which energy-rich developing nation will be next to assert greater state control over its oil or natural gas assets," noted Associated Press writer Brad Foss, "analysts say it is only a matter of time before the actions of Russia’s Vladimir Putin, Venezuela’s Hugo Chávez and Bolivia’s Evo Morales inspire a copycat."

That cat may be residing now in Nigeria. That country’s barriers to outside energy forces are threatening to become the stuff of investment nightmares. Under the Nigerian Investment Promotion Commission Decree of 1995, according to northern Nigeria’s Daily Trust, the nation "allows 100 percent foreign ownership of firms outside the petroleum sector. Investment in the petroleum sector is limited to existing joint ventures or production-sharing agreements." The National Petroleum Investment and Management Services agency set a target of 60 percent local content for oil-related projects by 2010.

Those investors brave enough to enter Nigeria will find themselves contending with "poor infrastructure, complex tax administration procedures, confusing land ownership laws, arbitrary application of regulations, corruption, and extensive crime." What’s more, the Nigerian administration "has shown no interest in pushing for government reforms in the troubled, oil-rich Niger Delta," Los Angeles Times writer Rosa Brooks commented. "Disputes over the share of oil profits that are returned to impoverished local communities have led to severe disruptions in production." That conflict has led to crime, including a pipeline explosion in May that killed more than 150 people and is thought to be the result of an act of vandalism.

Perhaps equally interesting is who will not privatize. Mexico has long been seen as a country that might be ripe for change and allow private investment in its industry. However, with an election coming the candidates seem reluctant to pick a side on that most passionate of issues.

What does this mean for the American consumer? Get ready for a rocky road. To affect the price at the pump, the United States must have greater control over the feedstock. As we have pointed out in previous issues of World Energy Monthly Review, 51 percent of the price is accounted for in the price of the barrel. The largest U.S. companies collectively control less than 6 percent of the barrels produced on a global basis. In a "free market" this can work to our advantage. In a decidedly "unfree" global market, where access is harder and harder to attain, this becomes a liability. While, as consumers, we Americans would like to blame our "big oil" for not providing a low enough cost for our fuel, we have done very little as citizens to pressure our government to get into the game and apply leverage on our "allies" to let U.S. companies have a fair shake.

Last year the United States signed into legislation the first energy bill in a number of years, yet the legislation did very little to increase domestic production or assist in acquiring reserves globally. This year President Bush declared the nation "addicted to oil" and announced that we must break this addiction. However, quitting cold turkey is not an option for the American consumer, and for the foreseeable future we will be dealing with hydrocarbons as our major source of energy.

Securing the supply and controlling enough of the reserves to effectively keep the price down should be priority number one. Removing the power over the U.S. economy from countries that are decidedly unfriendly to the United States should be priority number two. Our other issues can line up behind these.

Nationalism Concerns at OPEC Meeting

There’s no such thing as an ordinary OPEC conference, but this May’s forum was decidedly spiced up by the presence of anti-capitalist gadfly Hugo Chávez. El Presidente represented Latin America’s only OPEC nation, but if he has his way, that status will change. Chávez used some of his time in Caracas to stump for the admission of Bolivia, and the re-admission of Ecuador after 14 years, into the cartel. At the same time, Chávez spoke up in favor of cutting OPEC production quotas, a suggestion that didn’t sit well with other oil-rich nations.

The efforts "to enlarge OPEC," says Simon Romero of the New York Times, "play directly into the ambitions of Mr. Chávez. He has been pushing for more nationalistic energy polices in Venezuela and other countries in South America."

It was, after all, a Venezuelan, Juan Pablo Perez Alfanso, who essentially created OPEC in the early 1960s. When prices rose in the 1970s, Alfanso lost his love for the business, eventually calling oil "the devil’s excrement." Now, 30 years on, "the price of oil is soaring again and oil-rich countries are following the same route of aggressive nationalism that led the father of OPEC to disown his creation," wrote Javier Blas and Carola Hoyos in a Financial Times piece.

Still, to some OPEC participants, the meeting was "more about Venezuelan politics than … about OPEC policy," Antoine Halff, director of global energy at Fimat USA, remarked. And Chávez’s call to cut production flies in the face of increasing global demand. But it is in character. "When national governments strengthen their grips," according to Blas and Hoyos, "the outcome is more often than not a deterioration in the country’s industry and a drop in output – a trend the world can ill afford."

And in the words of William Ramsay, deputy director of the International Energy Agency, "the rise of nationalism is a concern for future production."

Why would Venezuela be looking for more Latin American presence in the OPEC camp? In particular, why Bolivia and Ecuador? As Venezuela ups its reserve counts on the sticky tar in the Orinoco, Chávez could see his power in OPEC increase. By adding friendly nations to his camp, he may be able to swing policies that are more to his liking.

However, Ali bin Ibraham al-Naimi may have recognized this on his own and identified the appropriate counter measure. After the conference in Venezuela, he left for Mexico. According to Mexican Minister of Energy Fernando Canales, the meeting’s intent is to strengthen Mexico’s ties with Saudi Arabia. Perhaps Minister al-Naimi recognizes the need for a Latin American OPEC nation that is more aligned with free-market thinking – and Mexico, that swing player, is a natural choice.

Slippery Slope

Nationalism in the oil industry, says William Ramsay of the International Energy Agency, is "a dangerous path." Ramsay told the Financial Times that the trend in Latin America has shaken production in Venezuela. "This is the price to be paid," he said. "If you don’t get the balance right between the companies’ interest and the country’s interest, the country ultimately will lose."

At the same time, who is to say that these countries cannot follow their own paths and make these decisions with duly elected governments? It is our economy that suffers if we cannot feed our "oil addiction," and the poverty in these countries cannot get much worse.

The path a country chooses to follow is inherently its own. However, we do not have many examples where nationalization as a strategy has been successful. One might mention Saudi Arabia, but without open data statistics and access to that market, it is hard to say what might have been.

As more and more countries follow this path, the United States will feel an ever-increasing pressure to increase its own domestic production. Can we ever secure our energy future? We need to begin now – and relying on the rest of the world to keep our best interest in mind is paramount to no strategy at all.

 

Richard R. Loomis is President & CEO of World Energy Source and Editor-in-Chief of World Energy's Monthly Review, Susan Salter is a World Energy's editor. Petroleumworld not necessarily share these views.

Editor's Note: This article was first publish by World Energy Monthly Review:June 2006. Petroleumworld reprint this article in the interest of our readers.

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Petroleumworld 06/18/06

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