Shifting Sands - The future of the oil industry

A challenging environment

If you want to see why the balance of power in the oil industry has changed, you only need to compare the largest IOC with the largest NOC.

ExxonMobil is the world’s largest public-listed company, with a market capitalisation of more than $400bn, and has 20 billion barrels of proven reserves. Saudi Aramco, the world’s largest NOC, has 300 billion barrels of proven reserves.

This balance of power is expected to shift further in favour of NOCs over the coming decade, because of the location of proven reserves and strategic plans of countries such as China and India.



At the Energy Institute’s 2006 International Petroleum Week, Paolo Scaroni, CEO of Italian energy conglomerate ENI, was surprisingly candid on the tensions now developing between IOCs and NOCs. He said that assertive and competent NOCs were increasingly challenging IOCs for control of reserves and markets. This is not surprising when the combined reserves of the top five IOCs would still only place them ninth in the list of the biggest asset holders. However, he added that the proven flexibility and adaptability of IOCs would enable them to maintain their position and work with NOCs, provided they were not blinded by“resources nationalism.”

This nationalism is not just the preserve of the oil-rich nations, with developing nations also looking for security of supply. China’s CNOOC created a stir when it bid $18.5bn for Unocal, a mid-sized American oil company – a move that caused concern in Washington. CNOOC eventually lost out to US rival Chevron.

But that did not dent its ambitions and CNOOC has been buying up reserves around the world. In January 2006, for example, it paid $2.6bn for a 45% interest in a Nigerian offshore field, a move that CNOOC chairman Fu Chengyu said was “aligned with our prudent M&A strategy, driven by value creation and growth.”

There is fierce competition for these assets, with IOCs looking for new sources to build up their reserves. In 2003, BP broke new ground when it signed a deal to invest £4.1bn in buying 50% of TNK in Russia. In 2005, TNK-BP increased oil production by 6.4% to an average daily production of 1.58 million bpd.

Total proven reserves, applying SEC methodology on a life of field basis, increased by 137%, driven by targeted drilling and well-work activity and exploration successes. "This is a clear demonstration of the benefits of investing in new technologies and applying them to our existing asset base,” said Robert Dudley, President and CEO of TNK-BP.

In order to continue competing in a market where they no longer hold the balance of power, IOCs must now continually look to deploy their technological expertise to enhance recovery from existing oil reserves and technically challenging fields, an area the IEA believes could contribute more than 20 million bpd by 2030. CERA
predicts that ultra deepwater production will rise from 3.4 million bpd in 2005 to 9 million bpd by 2010. Again this increase will mostly come from IOCs.



In May 2006, Rex Tillerson, chairman and CEO of ExxonMobil, said that technological progress has “enabled us to consistently grow the world’s commercially viable
resource base in defiance of so-called ‘peak oil’ predictions.”

IOCs are also investing heavily in alternative sources of energy, particularly in non-conventional hydrocarbons, because growth in oil and gas supply is the only way that global energy demand can be satisfied. IOCs will have to adapt and develop new models to work in partnership with NOCs and innovative new service and E&P cxompanies.

Historically, NOCs have turned to IOCs for capital, expertise and technology, entering into production sharing agreements with the oil majors, who played the role of service contractor – but this is changing.

A good example of the new breed of NOC is Statoil. Whilst it is majority owned by the Norwegian state, it displays behaviours, practices, operations and governance of a fully quoted company rather than the traditional bureaucratic and inefficient image of an NOC. In recent years, delegations from NOCs from OPEC countries have visited Statoil to see what they can learn. Saudi Aramco, for example, is a company attempting to distance strategic decision making from politics.

“Now, NOCs are saying they don’t need the capital and have access to qualified people,” says Sword. He believes the challenge for service companies is to find the model that best fits the needs of the NOCs: “Whoever comes up with that model is going to be in a highly privileged position.”



Service companies have the opportunity to develop new business models with NOCs, while at the same time ensuring their existing relationships with IOCs are maintained. “Schlumberger is an excellent example of a supply chain major well versed in working directly with NOCs,” says Sword. “It foresaw the trend that is now starting to gather momentum and has relationships with NOCs that date back 30 years.”

Petrofac, a provider of facilities solutions to the oil and gas production and processing industries also identified the trend. When 3i invested in Petrofac in May 2002, it was a $391m turnover business. Now listed on the London Stock Exchange with a market capitalisation of more than $1.5bn, its turnover is more than $1.49bn. Much of the growth is a result of working with NOCs.


Graeme Sword, Partner and Head of 3i Oil, Gas and Power

Vetco is another company in the 3i portfolio with long-running relationships with IOCs and NOCs. CEO Dr Peter Goode says the company has a strong presence in the parts of the world where NOCs dominate, especially Asia and the Middle East.

“Although our competitors are now going out there in numbers and making large investments, we’ve been in Asia and the Middle East longer and have good relationships,” says Goode.

The more advanced NOCs now have plenty of access to capital and have invested heavily in developing their people. Access to technology and services is their highest
priority, and they are seeing less reason to go through the IOCs. By going direct to the service companies, they can reduce costs and develop better relationships.



Change brings opportunity

The more progressive developing countries are also opening up to direct participation from foreign companies. In China, for example, the state-controlled sector is being reformed, with the aim of opening parts of the supply chain up, albeit slowly, to foreign ownership.

Malaysia also ranks as an attractive emerging E&P market and is a significant regional player in terms of offshore activity. But, like China, there are initiatives that promote indigenous suppliers. All companies supporting the upstream sector must be licensed by Petronas, the country’s NOC, and those wishing to supply equipment, services or materials to the upstream sector must collaborate with a local firm run by indigenous peoples (Bumiputras).

“This represents a considerable opportunity for foreign service companies to compete in the marketplace,” says Sword. “The key will be to develop working relationships with indigenous companies.” Sword believes that the lessons learned in more mature markets will be vital for service companies as the markets in developing countries open up.

“3i started investing in UK assets in the North Sea when we saw the changes taking place in the market. Now we are seeing the same changes in Norway and Asia and are investing there. With NOCs, it is still a little early and they will need to go through a period of contracting directly and realigning their business models with regard to the IOCs. This will provide opportunities to create new business models for entrepreneurial independents and will be where private equity becomes more important.”

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