The Politics and Economics
of International Energy
© Copyright Giacomo Luciani
(Spring 2009- E657)
Lecture 5
The Oil Companies: National and
International
Prof. Giacomo Luciani
© Copyright Giacomo Luciani
What are Oil Companies?
 Companies are the main protagonists in
the international oil and gas industry
 Companies are living organisms that take
time to develop and grow, acquire a
specific know-how and develop their own
culture
 Companies are different – main cleavage
between IOCs and NOCs, but certainly
not the only important distinction
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© Copyright Giacomo Luciani
The Oil Industry
 The system of companies constitutes
the organisation of the industry
 Key issues: vertical integration and
horizontal concentration
 The industry has gone through
several waves of integration/disintegration, and
concentration/fragmentation
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© Copyright Giacomo Luciani
Vertical integration
 Vertical integration is a consequence of
the presence of a “strategic segment”
 If markets do not work properly
companies controlling the strategic
segment have an opportunity and
incentive to integrate
upstream/downstream in the value chain
 Doubts about the benefits of vertical
integration
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© Copyright Giacomo Luciani
Horizontal concentration
 Historically, oil and gas have been
abundant, conditions for “excessive”
competition have existed
 Large up front investment encourages
high capacity utilisation even in
negative market conditions
 Periodic waves of financial difficulty
lead to disappearance of companies
through mergers and acquisitions
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© Copyright Giacomo Luciani
Beginnings in the USA
 Law of capture: low barriers to entry.
 Booms and busts: the rigidity of oil
supply and demand in the short term
 Rockefeller and the strategic
importance of pipelines and refining
 The Standard Oil Trust
 Spindletop and the Texas Railroad
Commission
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Outside the USA
 More limited demand, competition
from town gas
 Developments in Russia and the Far
East
 Initial developments in the Ottoman
Empire
 Initial interest in Persia
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The coming of Gulf Oil
 D’arcy and Churchill: the birth of
Anglo-Persian as a political object
 The negotiations for IPC
 The Red Line Agreement
 The Great Depression and the
Achnacarry agreement
 Result: slow down the development
of Gulf oil
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© Copyright Giacomo Luciani
Further Developments in the
Gulf
 Kuwait and British-American relations
 Bahrain and Saudi Arabia: the US and
the formation of ARAMCO
 The golden age of the Seven Sisters
 The Iranian crisis and the formation
of the Iranian consortium
 Newcomers: Libya, independents,
NOCs
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Equity participation in the main
producing companies before 1972
© Copyright Giacomo Luciani
Kuwait Oil
Company
(KOC)
Royal Dutch - Shell
Standard Oil New Jersey
Standard Oil California
Texaco
Mobil
British Petroleum
Gulf
CFP
Altri
Iraq
Petroleum
Company
(IPC)
23,750
11,875
50
50
100
11,875
23,750
Arabian Abu Dhabi
Iranian
American
Marine Consortium
Company
Areas
(Aramco)
(ADMA)
30
30
30
10
23,750
5,000
100
66,66
33,33
100
100
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7
7
7
7
40
7
6
5
100
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Companies change names
© Copyright Giacomo Luciani
Standard Oil
Company
Standard Oil
New Jersey
Standard Oil
New York
Standard Oil
Indiana
Standard Oil
Ohio
Standard Oil
California
ESSO
Mobil
Amoco
Sohio
Chevron
EXXONMOBIL
Anglo-Persian
Anglo-Iranian
British Petroleum
BP
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© Copyright Giacomo Luciani
Middle East Oil is Underexploited
 This has been the case from the
beginning, and a cause of considerable
conflict
 The international oil industry has
consistently had to deal with the threat
of oversupply and price collapse
 Reserve additions do not come in small
increments and supply is rigid in the
short term
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© Copyright Giacomo Luciani
Oil Companies Control
 Vertical integration
 Joint Production companies based on
agreements aiming at maintaining
production under control
 Contract typology: concession
 Very large concession territory
 Blatant asymmetry of information
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Vertical integration - up
to 1970’s
© Copyright Giacomo Luciani
 Companies were present in all stages:





exploration
production
shipping
refining
retail distribution
 Balanced presence in all stages was
key to profitability
 An oil market existed, but was neither
transparent nor efficient
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Refining
The Eight Majors’
Market Share,
1970
Gulf
Mobil 4,6%
Exxon 12,4%
B P 5,4%
CFP 1,9%
© Copyright Giacomo Luciani
altri
Production
Socal
4,8%
Texaco 8,3%
Mobil 5,4%
6,6%
Mobil 5,4%
15,7%
Exxon
Shell 13,0%
49,3%
Products Sales
Gulf
8,3%
Texaco 6,4%
Shell 11,9%
(in percent)
Socal
4,1% Socal 4,1%
Shell 13,1%
Gulf
4,2%
Texaco 7,3%
Exxon 14,2%
BP 5,4%
CFP 2,0%
29,1%
BP 10,4%
CFP 3,2%
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altri
altri 43,7%
© Copyright Giacomo Luciani
Conflict and evolution
 Tax assessment
 Relinquishment
 Posted price
 Nationalization
 Smaller concessions and multiple
operators
 OPEC
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© Copyright Giacomo Luciani
OPEC - a cartel by chance
 OPEC was created in 1960, but had
little impact for a decade or more
because of conflict over production
targets.
 In 1969-73 some countries lost
interest in increasing production and
imposed unilateral limitations.
 Prices exploded.
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Nationalisations
 Early nationalisations: Russia and
Mexico
 Mossadegh nationalises APOC
 Qaddafi nationalises BP, Hunt
 Kuwait, Algeria, Qatar, Iraq: 100%
nationalisations
 Abu Dhabi, Libya: IOCs remain
 Saudi Arabia: negotiated takeover
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0
2001
1997
1993
1989
1985
1981
1977
1973
1969
1965
1961
1957
1953
1949
1945
1941
1937
1933
1929
1925
1921
1917
1913
'000 b/d
© Copyright Giacomo Luciani
Historical Production of 4 Main Gulf
Producers
12000
10000
8000
6000
Iran
Iraq
Kuwait
S. Arabia
4000
2000
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Evolution of contractual relations
 Concession:

Company pays royalty and taxes but is in full control of
production and marketing
 Production sharing agreement:
© Copyright Giacomo Luciani

IOC carries all investment costs; if a commercial find is
declared, production is divided: “cost oil” to IOC, “profit
oil” shared bet. IOC and NOC
 Service contract:

IOC develops field and gets a fee
 Iranian contracts:

IOC develops field then transfers “operatorship” and
gets predetermined volumes of oil
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© Copyright Giacomo Luciani
Concession vs PSA
 A concession is more likely to lead to
conflict because of issues of tax
assessment or management of
production.
 A PSA is more easily enforceable but it is
very difficult to write a PSA that will be
“fair” at any level of oil price.
 Both can be combined with NOC
participation
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The PSA is versatile
© Copyright Giacomo Luciani
 A PSA is a very versatile contract – it
can mean anything, depending on the
numbers.
 Key issues are:
 How much of early production will be
considered as cost oil?
 What is the split of profit oil? Is it a
function of volumes produced and/or oil
price?
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Access to World Proven Oil Reserves
end-2005
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National Companies Only
Limited access
Production sharing
Concessions
Iraq
30
11
13
Source: IEA
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© Copyright Giacomo Luciani
Fiscal tightening
 Production sharing contracts which used to be
based on simple sliding scales of production at varying
thresholds have now in the main been superseded by
rate of return based contracts. Such contracts are
awarded to the company which offers the lowest rate of
return on the concession.
 This has the merit of effectively capping the reward to
the IOC when oil prices are very high and maximising the
rent to the host government. The extent to which IOCs
are prepared to push down rates of return was
highlighted in the recent bidding round in Libya where
many companies bid a percentage rate of return of just 7
per cent on a number of blocks, very close to their
weighted average cost of capital.
 Therefore, even in the event of exploration success, it is
very unlikely that these companies will add shareholder
value from the concessions they were awarded.
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© Copyright Giacomo Luciani
Following 1973…
 Following 1973, the International Oil
Industry was forcibly dis-integrated: the
7/8 sisters lost most of their reserves.
 Some disappeared fast; other attempted to
recreate a vertical equilibrium by divesting
downstream and looking for new reserves.
 Hence came the investment boom in nonOpec countries – but not all were “open”.
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© Copyright Giacomo Luciani
Consequences of disintegration
 Notwithstanding moves to recreate vertical
integration, the industry continues to be
disintegrated.
 NOCs have divergent attitudes towards
downstream integration (PDVSA and KOC
vs. Aramco)
 The IOCs concentrate their investment in
the upstream.
 A lot of crude is exchanged at arm’s length
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© Copyright Giacomo Luciani
Oil Market Development
 Disintegration encouraged oil market
development – and vice versa
 Oil market development changed the
concept of security and eroded the
rationale for NOCs of the importing
countries
 Privatisation, profit maximisation,
shareholders value
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© Copyright Giacomo Luciani
Pressure from financial analysts
 The financial market has become
increasingly demanding
 Companies have made imprudent
promises
 The M&A logic
 The opportunistic behavior of
shareholders and managers –
preference for the short term
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© Copyright Giacomo Luciani
Recent Mergers
 BP acquired Sohio, Amoco, Arco, Castrol,
Veba Oil, TNK
 Exxon acquired Mobil
 Chevron acquired Gulf, Texaco, Unocal
 Total acquired Elf and Fina
 Phillips acquired Tosco, merged with Conoco
 Shell acquired Enterprise
 Eni acquired Lasmo
 Repsol acquired YPF
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Degree of Established International
Portfolio
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© Copyright Giacomo Luciani
Vertical Integration in Doubt
 The development of crude and other
markets raises doubts on the benefits
of vertical integration
 Companies have tended to get out of
less profitable/more volatile
segments: transport, refining,
petrochemicals
 Investment has been heavily
concentrated on the upstream
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Capital Rotation 1990 to 2001
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Persistence of vertical integration
 Nevertheless vertical integration has
persisted
 Pure upstream companies have not
fared very well
 Independent refiners have also
succumbed
 Pure retailers are rare
 Service companies have multiplied
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© Copyright Giacomo Luciani
BP - a case study
 BP is the company that has found the
most oil
 It has also suffered most from
nationalisations: Iran, Nigeria, Libya,
Kuwait…
 Discovered Prudhoe Bay in 1968
 Discovered Forties in 1970
 …just in time to compensate for
nationalisations…
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© Copyright Giacomo Luciani
BP and Sohio
 BP initially acquired a minority
interest in Sohio when it decided to
associate the latter to the
development of Prudhoe Bay
 Eventually, BP’s interest grew to be a
majority in the company
 Bought out the minority interest in
1987
 Enter KIO
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Privatisation problems
 The British government sold its 31.5%
remaining participation in BP in October
1987
 The sale was a flop because of negative
stock market conditions – KIO bought
 The MMC found that KIO’s holding could
operate against the public interest; a cap
of 9.9% was imposed on KIO’s holding
 BP bought back KIO’s excess shares
incurring in a major financial burden.
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BP Amoco
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Russian industry position
2002 production
mboed
1600
1200
800
400
Lukoil
Yukos
NewCo
Surgutneftegaz
TNK
Sibneft
Tatneft
Sidanco
0
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BP and TNK-BP Plan Strategic
Alliance with Gazprom as TNK-BP
Sells its Stake in Kovykta Gas Field
 Under the terms of the agreement signed by all parties,
TNK-BP agreed to sell Gazprom its 62.89 per cent stake
in Rusia Petroleum, the company which holds the licence
for the Kovykta gas field in East Siberia. It will also sell
its 50 per cent interest in East Siberian Gas Company
(ESGCo), the company constructing the regional
gasification project.
 TNK-BP said a longer-term 'call' option for TNK-BP to
buy a 25 per cent plus one share stake in Kovykta at an
independently verified market price, had also been
agreed with Gazprom. This option could be exercised
once a significant joint investment or asset swap has
been agreed under the terms of today's memorandum of
understanding.
(June 22, 2007)
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The new protagonists
 The companies of the producing
countries – mostly state owned, some
privately owned – are the new
protagonists of the international oil
industry.
 How many will evolve into major
international oil companies?
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© Copyright Giacomo Luciani
The ambiguous IOC/NOC relations
 IOCs and NOCs are rivals
 However, they also live in a symbiotic
equilibrium
 Can this dichotomy be progressively
overcome?
 What forms of partnership?
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The merits of going with IOCs
Crude Oil Production in Selected OPEC
Countries, 1969-2004
4000
3500
2500
Algeria
2000
Libya
Qatar
1500
United Arab
Emirates
1000
Venezuela
500
0
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
1,000 b/d
© Copyright Giacomo Luciani
3000
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A rush to open?
© Copyright Giacomo Luciani
 In the 1990s the impression was created
that resource nationalism was obsolete
 However:
 Some expected openings never materialised
(Kuwait, Iraq, partially Russia)
 Other were disappointing (Brazil, China,
Azerbaijan)
 Key players never considered opening (Saudi
Arabia, Mexico)
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© Copyright Giacomo Luciani
The return of nationalism
 Resource nationalism is back alive
and kicking
 Venezuela changed strategy entirely
under Chavez
 Russia is increasingly pursuing a
nationalist agenda in oil and gas
 Iraq will not open indiscriminately
and remains a distant prospect
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© Copyright Giacomo Luciani
What is wrong with IOCs?
 In the eyes of producing countries, IOCs
are dangerous if they are not needed
 In the new price climate, IOCs profits seem
excessive, countries feel cheated
 There is divergence of views on optimal
drawdown of reserves:
 Companies maximize short-term profit
 Governments want “sufficient” revenue for
as long as possible
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