Big Oil, massive future?

Following BP’s environmental disaster in the Gulf of Mexico, it wasn’t long before the obituary of ‘big oil’ was drafted. Offshore drilling was a goner, environmental tightening will squeeze the life out of the majors, and lumbering corporate structures can no longer cope in a world of localized and specific operational risks. Big oil R.I.P. It sounds plausible, but it is wrong. If anything, big oil will continue to get bigger thanks to a number of compelling commercial and political reasons on the back of the BP catastrophe.

Still from the award winning movie 'There will be blood', about the early days of the oil business.
First of all, big oil is no longer just big oil, it’s ‘big gas’. Seven of the eight projects ExxonMobil completed last year were natural gas developments, with a similar ratio slated for this year. Shell has claimed that 55% of its overall output will come from gas by 2012, and firms such as Chevron, ConocoPhillips and BP have been gobbling up gas prospects and companies of late. Australia has been a hot target, but the revolution in unconventional gas production across America has been the real fillip. The prizes could get even bigger in Asia, and to a lesser extent Europe, where international oil companies (IOCs) are well placed to provide the technical knowhow and expertise to bring resources online. China certainly thinks so; Royal Dutch Shell has is helping Beijing ramp up nonconventional production to 30 billion cubic metres in future.

This technological edge matters, as it gives IOCs a second bite at the upstream cherry, both for conventional and unconventional gas. If long term gas demand develops as expected, and climate change policies begin to bite a little more, then gas remains a very good bet for IOCs to place. This means that the tightly guarded national oil fields of the Middle East are not quite the Holy Grail they once were, nor are they in Russia, Central Asia or Latin America.

Wiggle room

But this is not to say that oil is passé for the Western majors, far from it. Non-OPEC supply will become increasingly desirable for Western and Eastern consumers to bring to fruition, not unless they really want to give OPEC a free hand to whack them. The infamous statistic that ‘over 80% of the world’s oil reserves are now in national hands’ remains absolutely true. But this is precisely why OECD and indeed non-OECD states will continue to open up offshore prospects wherever possible – be it the UK, Norway, or indeed, newer finds in places such as Brazil for greater wiggle room over producers. The idea that such reserves will now be deemed ‘off limits’ by legislative moratorium is about as likely as developed countries ever signing off on any serious emissions policies. Political bluster says one thing; political logic tells Congress (et al) another. Analysts should duly take note: we can expect to see offshore drilling, lots of it, and in very deep waters.

This thinking also comes in handy when looking at the Arctic, or indeed Canadian tar sands when considering whether environmental musings or market realities will hold sway. ‘Traditional’ producers have already given their answer; plans for offshore drilling continue apace in Mexico, BP is cracking on with prospects in the Gulf of Sirte in Libya and has signed off on a $9bn deal for offshore gas in Egypt. Rosneft has also hinted that BP will be able to start work on Arctic prospects should the British company waive its right on German refining installations in order to let the Russian entity drift further downstream. Moscow has similarly earmarked 47 offshore licences for its energy giants to develop towards 2020. And the offshore list could go on, not least in America where US oil majors diligently noted to Congress that offshore drilling remains entirely safe. Particularly if US companies are drilling US oil for US consumers: a ‘homerun’ for American big oil.

Petro-states

But the prospects are not only good for ‘unconventional’ oil. For internationally minded ‘big oil’, the good news is that more and more states are finding ‘black gold’ and they all want to rapidly turn proven reserves into actual output. Ghana, Uganda, Sierra Leone, Liberia and Argentina are amongst the latest finds, and they all have the same decision to make: go with tried and tested IOCs, or take a chance on inconsistent production records of national oil companies (NOCs)?

One thing aspiring ‘petro-states’ know is that the days of big oil steering clear of perceived ‘high risk’ markets are over. Garnering international investment is an easier score these days, for if the BP disaster illustrated anything, it was that political risk remains most acute in the most advanced markets of all. And no matter how ‘autonomous’ corporate entities might be when drilling foreign oil, if things go wrong the reputational and political flack will ultimately end up at HQ doors. Getting centralized operating procedures in place is therefore critical to big oil’s success, not wishful thinking that fragmented corporate structures will provide a protective foil should things go wrong. Be very big, and be very organized to prosper.

Indeed, the only reason BP has been able to weather Washington’s storm is precisely because it’s a big beast. It has a diverse global portfolio to hedge risk, spin off assets, and stave off hostile takeovers. Yet even here, the ‘British’ firm is now painfully aware that 25% of its revenues are dependent on TNK-BP, a fragile Anglo-Russian entity, after its environmental lapses in the US. Expect the new CEO, Bob Dudley, to rapidly diversify BP’s portfolio and spin off depleting assets as a result. And expect other IOCs to follow suit. Diversity is critical to survival and success; placing too many eggs in mature markets is not the way of the future.

Smarter move

The logic is compelling; big oil will get bigger
This provides an interesting rub of course; the ‘high risk’ propositions of old might actually become ‘lower risk’ bets for the industry. The contrasting fates of Shell’s operations in the Gulf of Guinea and BP’s Gulf of Mexico’s mishaps could not be more telling. Both are environmental bloopers, although the former is a ‘systemic’ problem, the latter a ‘temporal’ blow out. Yet it’s been on the shores of Florida, rather than the swamps of the Niger Delta, that the share prices have been hit. A political tale of two Gulfs one might say; one was a near-death experience, the other remains a mild irritation. The upshot is that oil majors will increasingly get their upstream hands dirty in ‘exotic’ places rather than playing out time in politically capricious and depleting developed markets. Big oil can’t just morph into static ‘utilities’ or indeed rely on piffling cash returns from refining. They have to get back out into the ‘new world’ for the juiciest finds.

And this is where things start to get really interesting. ‘Going it alone’ is no longer a risk IOCs necessarily need to take upstream, it’s just a credible option. The smarter move will be to work with big oil of the future; namely Asian entities. All the bluster about equity ownership and physical control of oil for Asian players remains largely that; the real priority for them is to bring new oil to market rather than seeing it languish in the ground. It’s the only way India and China can defuse long term demand forecasts rather than seeing them blow up in their faces. Beijing is starting to appreciate this, which explains why PetroChina has been listed and why it has instilled a competitive logic across its national champions. India is similarly thinking hard about whether ONGC should have greater help from Delhi to underwrite the company’s upstream deals or let it flourish under market conditions.

‘IOC-NOC’ joint ventures thus make sense on a number of levels in third countries. For NOCs, they get technological prowess turning concessions into output that they would otherwise lack. They can also be seen to be playing by market rules and paying market prices for assets. This will undoubtedly help them enter more mature markets down the line, just ask the privately owned Mumbai based RIL which is busily snapping up shale gas prospects in the United States.

Conversely, IOCs gain real political cover from working with national counterparts to iron out the risks involved. Would the Kremlin really want to mess with China over natural resources in an international consortium? Would Tehran want to alienate hydrocarbon investment across the board should Eastern and Western investors join forces? Would Central Asian leaders be able to play off competing foreign interests for maximum commercial gain? Probably not; if nothing else it would put a new spin on the old game of producer states cutting up rough on Western investors when the oil starts to flow, and the revenues roll in.

Size matters

IOCs would also retain access to assets at market prices rather than contending with political mark-ups NOCs would inevitably otherwise offer. CNPC’s work with BP in Iraq could be amongst the first of many future deals operating along such lines. It’s only a service contract to develop the Rumaila field, but more lucrative deals have been signed in Latin America where IOCs and NOCs are now working side by side on the Orinoco belt. There is no reason why more tie ups of this ilk can’t be made to fly in the Middle East, Central Asia and Africa, all regions where Asian NOCs are upping their game.

Joint ventures therefore shouldn’t be seen as the death knell of big oil, but rather one potential future where national companies learn to play by international rules and Western oil majors continue to diversify their upstream footprints. Competition for the same assets would be reduced, both sides could gain a comparative advantage they previously lacked. Overall, consumers would ‘win’, big oil would ‘win’, and producers would have to play with a straighter bat to maintain consistent investments rather than playing prospective investors off for maximum gains.

So while BP’s disaster might have been primarily environmental, it has taught the oil industry far more important lessons about the perennial political risks they face – and indeed provided a blueprint to navigate them. The logic is compelling; big oil will get bigger. Size matters, as does geographical and technical diversity into oil, products and gas. The outlook for big oil thus remains big, and could get considerably bigger if big (Western) oil of today learns to work with big (Asian) oil of tomorrow as the smart play. Under this scenario, the outlook for big oil is not just big, it’s positively massive.

About the author

Matthew Hulbert is a Senior Research Fellow at the Center for Security Studies working on energy and political risk. He previously worked in the City of London advising on energy markets and political risk, as Senior Energy Analyst at Datamonitor for leading global utilities, and headed up the Global Issues Desk at Control Risks Group, specializing in political risk, geopolitics and security analysis for multinational companies (FTSE 100), governments and institutional investors. Prior to this, he held political consulting positions at Weber Shandwick Worldwide advising multinational companies on political and reputational risks and governments on public diplomacy, including speech writing for various governments at the World Economic Forum, Davos. He has written policy and advisory papers on political risk issues for amongst others the UK government, World Bank, IMF and Commonwealth on Nations.