In
Oil Producers' Brave New World,
a Key Word Is 'Partnerships'
By
Knowledge@Wharton
In
Venezuela, President Hugo Chavez is threatening to
snatch control of several major projects from American
and European firms. In Russia, the government recently
strong-armed Royal Dutch Shell into relinquishing control
of a large field called Sakhalin II. In developed countries,
home to the six so-called "supermajor" oil
producers, politicians have debated imposing windfall
profits taxes.
Across
the oil-producing world, governments are responding to higher
petroleum prices by imposing new taxes on oil companies and
forcing the renegotiation of contracts giving foreign firms
access to critical reserves.
According
to speakers at the 2007 Wharton Economic Summit, such developments
augur a new age for the oil business. The time is over when
major oil companies can dictate the terms of development
deals to host countries. About four-fifths of the world's
reserves are already controlled by state-owned firms, and
political strongmen like Chavez and Russia's Vladimir Putin
seem intent on tightening their hold on their countries'
oil wealth. Russia has the world's largest oil reserves,
after Saudi Arabia.
"The
ability of major oil companies to exert their muscle has
diminished," said David Fleischer, a principal with
Chickasaw Capital Management in Memphis, Tenn. "They
still bring a lot of technology and expertise, but that's
less important in today's world. Countries like Venezuela
don't care as much as they should about maximizing their
revenues. They care about control of their resources."
Finding
New Deals
Yet
the situation isn't as dire as the headlines can make it
seem, said Mohammad Azam Ali, chief executive of Dubai-based
Orient & Gulf DMCC. Oftentimes, politicians' threats
are just posturing intended to appeal to local people, and
not genuine declarations of intent. "The governments,
most of them anyway, are aware of what they need the companies
for. There are many examples of major U.S. oil companies
doing very well in the Middle East despite problems between
the U.S. government and various Middle Eastern governments."
Consider
Oman, a sultanate on the Arabian Peninsula, he said. It recently
entered into a long-term contract with Los Angeles-based
Occidental Petroleum to develop a billion-barrel field. Occidental
approached Oman and committed to investing more than $1 billion
and drill more than 1,000 wells -- far more than Oman could
have managed alone. The government of Abu Dhabi, the largest
of the United Arab Emirates, helped to broker the deal and
ended up taking a 15% stake. By inviting Abu Dhabi in, Occidental
found a way to more closely align its interests and Oman's. "If
Oman decides that it wants to retrade the deal with Occidental,
it will also have to do it with one of its neighbors," Azam
Ali pointed out.
Marathon
Oil also intends to have its projects work for both itself
and its host, said Janet Clark, the Houston, Tex., firm's
chief financial officer. In today's world, oil producers
must embrace state-owned oil companies as partners, not try
to squeeze them out of projects, she said.
Marathon
is making a virtue of necessity, Clark admitted. "We're
not Exxon or Chevron, and we can't push people around." Marathon
last year reported revenues of $65 billion, compared with
$378 billion for Exxon Mobil. But Marathon's executives also
believe that fair dealing creates good will that can yield
unexpected dividends later. Libya's government, for example,
recently invited Marathon back into the country two decades
after it had left the country because of economic sanctions
imposed by the U.S. government. "In 1986, we had to
walk away from 300 million barrels in reserves," Clark
said. "Because we had a good relationship, they held
that for us."
Marathon's
development of a liquefied natural gas plant in Equatorial
Guinea typifies its efforts to cooperate with local governments,
Clark noted. Marathon has committed to training local people
and employing them in skilled jobs. It has also undertaken
an anti-malarial campaign in the region where it operates.
The African country, for its part, has been investing in
the plant to secure a 25% stake.
Of
course, not every deal works out so well. True partnerships
require two willing participants. And governments like Chavez's
and Putin's have shown themselves to be more interested in
expropriation than cooperation. When confronted with these
sorts of tactics, some experts have urged oil producers to
exhaust every legal remedy. Courts could interpret a failure
to do so as a voluntary relinquishment of ownership rights,
these people say.
Fleischer
counseled humility over legal machismo. "The humble
approach -- letting [state oil companies] own the reserves
and you bringing the capability and technology -- makes more
sense," he said. That way, no potential partner is alienated.
And sooner or later, most oil-producing nations will have
to call for the big firms' help. "Many of these OPEC
countries are already spending all the resources they are
getting from $60 oil and not reinvesting" in their production
infrastructure, he noted. "And there are countries in
the world -- Iraq is a prime example -- that just have no
local talent. So they need the technology and capabilities
that the major companies can bring."
A
recent Marathon experience ratifies Fleischer's advice. The
company recently won a bid against one of the supermajor
firms for the right to own and operate a section of a big
field. "I don't think the government in question thought
our technical program was superior," Clark said. "That
other company had taken an approach in prior negotiations
that made it unwelcome as a partner."
A
wild card in these sorts of strategy discussions is the growing
role of China's state-owned oil producers, which are expanding
aggressively. Though not as technologically advanced or experienced
as Western firms, they have the financial backing of their
government and might appeal politically to America-bashers
like Chavez. "We can't compete in the same way the Chinese
national oil companies can, because we don't have a government
that's going to go into Angola and build a railroad or hospitals," Clark
said. "If anything, we have a government that beats
up on some of these countries because they don't have the
kind of evolved democracy that we have here."
The
High Profits -- and Costs -- of Oil
Underpinning
much of the current debate about the oil industry is public
outrage at the high profits that oil companies are earning,
thanks to the recent rapid rise in prices. In the last three
years, the price of a barrel of oil has doubled, hovering
lately at about $60. In developing countries like Nigeria
and Venezuela, high prices have created resentment and the
perception, real or imagined, that resources are siphoned
off while few dollars are ending up in local pockets.
A
worldwide oil shortage compounds the problems, explained
Wharton management professor Witold Henisz. Developed countries
continue to consume oil, while demand surges in China and
India. "Spare capacity globally is getting down below
one million barrels a day," he noted.
Clark,
for her part, took issue with the popular perception that
oil wells gush greenbacks. The business looks lucrative now,
but oil prices zigzag routinely and therefore profits do,
too. "My second year as CFO was in 1998, when the price
of oil hit $10. I was focused on how we could ... meet payroll." From
1972 through 2004, the industry's average return on invested
capital fell short of that of U.S. manufacturers, she added.
And even during the last two years, as prices have soared,
the industry's average profit margin didn't beat the average
of all U.S. companies by that much -- 9.5% vs. 8.2%. "If
you look over an extended period, the oil industry hasn't
generated excess profits."
Part
of the reason, besides volatile prices, is that oil exploration
and extraction costs a lot. Those costs have lately risen
because oil companies have exhausted most of the easy-to-reach
reserves. "We are going to deeper and deeper water and
deeper [oil] reservoirs," Clark said. "We're drilling
25,000 feet below the earth's surface."
Offshore
drilling, in particular, has seen surging costs, Clark added.
Three years ago, a company would have paid about $170,000
a day to operate a deep-water drilling platform. A comparable
well now costs about $500,000 a day. "These days, $50
million wells are pretty routine for deepwater drilling.
And if you have problems, you will have a $150 million or
$175 million well."
Fleischer
agreed with her analysis: "I was around in the 1980s,
when the price of oil went to $10, and all I saw for 15 years
was companies going out of business."
Given
the volatility of the oil business and the unpredictability
of foreign governments, a member of the audience asked whether
major oil companies should undertake coal gasification or
oil shale exploration. In coal gasification, coal is pulverized
and transformed into a gas fuel, while oil shale is a form
of rock containing a material called kerogen that can be
distilled into oil and gas. The United States has abundant
supplies of coal and oil shale.
Clark
pointed out that the volatility of oil prices undermines
attempts to pursue alternative fuel sources. A project that
looks prudent when oil is $60 a barrel might look profligate
at $30. In addition, coal produces even greater pollution
than oil. "If you are someone who worries about energy
security, you want us to be mining all the coal we can. But
if you are worried about the environment, coal is much more
carbon intensive than either oil or natural gas. Before you
ever see gasified coal become a significant energy source,
they are going to have to solve the carbon sequestration
problem."
