International Oil Companies: The Challenges Ahead

In their Q2 earnings reports earlier this year, major International Oil Companies, IOCs, presented large earnings decline despite the doubling of global crude oil prices between Q1 and Q2. In their Q3 reports, earnings also declined significantly in spite of the spike in crude oil prices. In both cases, weak demand was the principal culprit and according to Anglo Dutch Shell (RDS.A), a quick recovery is not in sight.

Global crude oil inventories have been high, in addition, an estimated 125 million barrels of crude oil and fuels are held in unconventional (eg floating) storage around the world. Normally, only a negligible quantity is held in such storage. With such high stockpiles, global demand has been expectedly weak, reportedly falling by 1.6% and 1.7% in July and August 2009 respectively while showing an annual decline rate (in countries making up 70% of world demand) of 2%.

IOCs are currently in a rather precarious situation. They face three principal issues:

First is the increasing difficulty to the profitable discovery and production of oil, an issue often masked by the current oversupply. For example, according to recent research reports, over the past 10 years, growth in cashflow per barrel (15%) has lagged the compound annual growth rate (18%) for discovery and production. Worse still, their recycle ratios have dipped significantly. In a subsequent post, l suggested that cost-cutting measures present one of the best viability options for these IOCs. The oil major Anglo Dutch Shell, in announcing a less-than-expected 73% decline in Q3 earnings, indicated that it reduced costs by US$1 billion. Having shed 20% of its top managers, the company is set to cut 5,000 jobs from less senior levels. Conoco (COP) has outlined plans to sell assets worth US$10 billion while British Petroleum (BP) has identified 22 U.S. properties for divestment both as efforts to boost profitability.

Secondly, even when discoveries have been made, these IOCs face rising resource nationalism (the increasing domiciliation of reserves and exploitation proceeds in National Oil Companies, NOCs). The largest, recent additions to global crude oil reserves have come from developing nations. While the massive pre-salt discoveries of Brazil’s Santos Basin and Saudi Arabia’s Khurais fields are well-known, current international interests lie in the equally massive, Atlantic, petroleum provinces of Africa, which are considered less politically volatile than the Middle East.

Various projections put Africa’s share of world hydrocarbon growth at about 30% by next year. NOCs, (having doubled the number of licences held in the last ten years), however, are playing increasing roles at the expence of IOCs. From Angola through Nigeria, Ghana, Sierra Leone to Guinea, large oil discoveries have been made. However, these countries are insisting on greater control of, and much higher shares of production proceeds from, their oil resources. For example, IOCs have very vehemently decried the Petroleum Industry Bill currently before Nigeria’s legislature as economically asphyxiating and inimical to their investment interests.

The bill provides for even higher government take from production proceeds among others. In Brazil, Petrobras (PZE) the country’s NOC is angling to retain control of most of the fields of the massive Santos Basin, a situation that IOCs have equally decried. An earlier proposal provided for acquisition of all unassigned rights (about two thirds of total) in the sub-salt. Countries such as Russia, Iran and Venezuela with massive oil reserves are even less palatable to the IOCs. Many of these developing countries are adopting the more lucrative production sharing contracts over outright concessions.

Finally, the intimidating entry of China’s NOC (enter the dragon?). With a massive financial war chest and an equally cavernous thirst for oil, China is offering better deals to these producer-nations than IOCs realistically can. For example, as many exploration and production contracts between Nigeria and major IOCs come up for renewal, China is raising the stakes, offering the country better terms than IOCs for control of a large share of her (about 30 billion-barrel) proven oil reserves. In such tight fiscal regimes as these, it would be difficult for any country to overlook such an offer. The Nigerian government is expected to employ this offer as a bargaining chip in her negotiations with IOCs.

Moreover, it is not just Nigeria. Petrobras, Brazil’s NOC, in its bid to raise the necessary operational capital independent of IOCs has entered into a US$10 billion-dollar, ten-year contract with a Chinese NOC for the supply of crude oil at up to 200,000 barrels per day. China also reportedly “gate-crashed” (though denials have been made) negotiations between Ghana and some IOCs; the negotiations were for Ghana’s 1.8 billion-barrel, Jubilee oilfield. Then there are also Guinea, Sudan, Angola and many others.

Many of these IOCs have been accused of a cavalier attitude towards host countries, a situation that China, with her added global political and military might, often exploits.

For the IOCs then, while these cost-cutting measures just might be effective in the short term, the lingering and weighty issues of licences and the economics of discovery and production must be resolved if they must remain viable in the long term.

One emerging trend however is the establishment of joint ventures between IOCs and Chinese NOCs. With superior financial muscle, cheaper labor and materials and shear “guts” for operation in higher (political and other) risk zones, such ventures may be worthwhile. British Petroleum, for example, recently won co-development rights with the Chinese company CNPC (CKKHF.PK) for an oilfield in Rumaila, Iraq.

Disclosure: None

Comments

[nerfer:]

Interesting read, although I'm not sure what the recycle ratio is. I heard on the news radio this morning about the EIA overstating future supply in recent years due to political pressure. Big surprise there.

Nov 10 10:30 AM

[Dennis U. A...:]

Recycle ratio refers to the ratio of the proceeds from sale of one unit of crude oil to the cost of discovering and producing a new unit. When this ratio is 100, it means the proceeds from sale of say one barrel of oil equals the cost of discovering and producing a new barrel. To stay in business a ratio of 100 is necessary. To grow reserves, meet tax, shareholders' and other obligations, a ratio of 200 would be more like it. At say 110 or 120, the company would be teethering on the edge.

Nov 11 08:15 AM

[jarco:]

Interesting but pretty much a confirmation of recent disclosures. This debacle will surely manifest itself further as Western (mostly US) technology is sold and/or given away to the oil rich developing nations. Technology developed in the US by such firms as Shlumberger is one of several such give-aways.

Nov 11 10:11 AM

[NoGambler:]

Dennis, this article was fascinating.

I believe the oil crunch is coming in 2-3 years or sooner.... and there will be hell to pay in consuming nations like the US.

What NOC stocks can I buy in America besides PBR (Brazilian Petrobras)? I would like to be aboard before crunch time arrives.... I wonder, is a list available anywhere?

I'd be especially interested in participating in African growth. Dennis, anything you might offer in this regard would be most appreciated!

Thanks for the thoroughly researched article. I would like to benefit from your experience and views.

Brian

Nov 11 10:18 AM

[jg1945:]

dennis..good read.

Nov 11 12:18 PM

[GimliJan:]

Dennis,
A very good analysis of the political, economic and business ethics and attitude of IOC's and NOC's. China's CNOOC is certainly flexing it's muscles in just about every oil producing region including the Canadian Oil Sands in Alberta. I wonder when our government and oil companies are going to wake up and realize that it's no longer "their sandbox" to drill in anymore? I have read some very good articles here about the trends in oil. Keep up the good work!

Nov 11 12:47 PM

[Dennis U. A...:]

Petrobras does look good. Still evaluating others. You may want to stay tuned.


On Nov 11 10:18 AM NoGambler wrote:

> Dennis, this article was fascinating.
>
> I believe the oil crunch is coming in 2-3 years or sooner.... and
> there will be hell to pay in consuming nations like the US.
>
> What NOC stocks can I buy in America besides PBR (Brazilian Petrobras)?
> I would like to be aboard before crunch time arrives.... I wonder,
> is a list available anywhere?
>
> I'd be especially interested in participating in African growth.
> Dennis, anything you might offer in this regard would be most appreciated!
>
>
> Thanks for the thoroughly researched article. I would like to benefit
> from your experience and views.
>
> Brian

Nov 16 02:53 PM