The Changing Role of National Oil Companies in International Energy Markets

On March 8, 2007, the Carnegie Endowment hosted an event entitled "The Changing Role of National Oil Companies in International Energy Markets."  The meeting featured the participants of a Baker Institute Study group that completed working papers on national oil companies.  Martha Olcott, senior associate at the Carnegie Endowment, and Amy Myers Jaffe, director of the Baker Institute's Energy Forum, co-chaired the session.  A summary of the event is included below, and the working papers for the study can be found at the Baker Institute's website. IMGXYZ687IMGZYX  

One of the key questions when one examines the state of global energy security is who controls world oil today—that is, who controls the actual reserves.  The so-called Seven Sisters—the major western oil firms that divided up world oil after WWII—now control only a small proportion of international reserves. Rather, state monopolies and emerging partially privatized firms now have control of the lion’s share of world oil.  The Baker institute’s study is the first to take a look at how these national oil companies (NOCs) will affect the development of the global oil market. 

The role that NOCs play and will play is especially important given growing demand for oil.  The International Energy Agency’s (IEA) forecasts show that $2.2 trillion of investments in oil infrastructure alone will be needed between now and 2030 to keep up with this world demand, but so far investment has not kept pace.  Are NOCs affecting these investment trends, and can they really keep pace?  The IEA states that unlike the last 30 years, which saw over 40 percent of all oil come from publicly traded companies within the OECD, 90 percent of production over the next 30 years will come from the developing world—that is, from NOCs.  Will they be able to amass enough capital to keep up with the market? 

The case studies looked at the history, organizational structure, levels of privatization, and several other variables to try to answer some of these questions.   The key conclusion reached by the study may seem a bit like common sense, but is actually quite important: almost without exception we found that NOCs have priorities that are important national goals beyond maximization of returns for the shareholders.   These goals include redistribution of wealth, fuel subsidies, technology transfer, rules on local content, and are not just held by NOCs in importing countries, but also by NOCs in producing countries as well, which many times need to ensure the availability of fuel for domestic consumption.

NOCs also usually play a role in and are affected by the politics, both domestic and international, of their host country.  NOCs are many times the tools of a country’s foreign and strategic policy, and in almost all cases, at least, the NOCs had to heed the foreign and strategic policies of their governments.  In several cases, NOCs were used to form alliances.   On the domestic front, NOCs participated in national level politics, and changed their priorities because of domestic politics.  Many leaders of NOCs have political goals, and use NOCs to increase their power. 

The troubling aspect of these divergent priorities is that in many cases they did affect the NOCs ability to carry out the traditionally key function of an oil firm—replacing reserves and expanding production. 

Priorities in some cases have also changed over time.  For example the current policies in Venezuela are much different now under Chavez than they were under Luis Guisti, the former president of Venezuela state oil firm, PDVSA.  Under Guisti, PDVSA was viewed as the model of a state firm, but during the same period the number of people under the poverty line in Venezuela increased from 10 to 65 percent.  Under Chavez, priorities have now changed and a lot of oil money has been invested in infrastructure and welfare programs, but oil production has fallen.

The study also found that if an NOC must compete in the domestic market against other private or semi-private actors, it improves efficiency.  The Russian firm Rosneft and the Kazakh firm KazMunaiGas are not the only game in town and must compete with other oil companies, including international majors.  This has led them to invest in new technologies and adopt labor standards to stay competitive.   Competition in the global market also increases efficiency by encouraging capital discipline. 

On average, NOCs that are fully government owned and sell petroleum products at subsidized prices are only 35 percent as technically efficient as a comparable firm which is privately held and has no obligation to sell refined products at discounted prices. While individual firms may vary in efficiency, on average government held firms exhibit only 60 to 65 percent of the efficiency as the privately held international oil majors.

These trends in the market have important policy implication for importing countries.  If a larger share of global oil investment in oil production capability could be impeded by NOCs’ noncommercial socioeconomic priorities, then importing nations need to adjust their national energy strategies to reduce vulnerability to changes or instability in NOC reinvestment. Consuming nations need to promote free trade and utilize multilateral frameworks to press NOCs to adopt institutional structures to enhance their efficiency, promote market competition, and curb interference in commercial investment decisions by their national government.

NOCs as a Means to Economic Development and Industrialization:

Kazmunaigaz: Kazakhstan’s NOC
Martha Olcott, Carnegie Endowment for International

KazMunaiGaz (KMG) deserves to be included in this study because it really does represent a new style NOC.  It is an NOC that strives to meet both commercial and social goals based on a Statoil model, and KMG has indeed progressed a long way in its short history since 2002.  Moreover, KMG de jure controls Kazakhstan’s considerable reserves.  Kazakhstan is and will remain a key swing producer in the former Soviet Union, and by all projections is expected to produce 3 million barrels per day by 2010. 

KMG hopes to be a driver of long-term and sustainable socio-economic development.  That said, the Kazakh government can’t just take money from KMG.  The money goes into a national oil fund, which is invested offshore and is aimed at long-term development projects.  The company also provides subsidized oil and gas to some of Kazakhstan’s economically depressed areas.

KMG recently privatized part of its producing arm, but still remains firmly controlled by the government.  It also represents the government’s interests through a legally defined status, which allows it to negotiate PSAs for offshore projects and gives it the right to a 50 percent stake in all onshore projects. Nonetheless, it does not receive any favoritism in the legal system: our study found that KMG received favorable court rulings only half the time. 

The goal of the company is to maximize benefit by leveling playing field with foreign actors.  The government created it in 2002 as a national champion and furthered legalized it in 2004.  Its special privileges mentioned above were given to it in order to give a Kazakh oil company a key role in the market.  It has also served to balance the role played by international actors in the Kazakh market. 

The company has an impressive business model with short, medium and long-term strategies, and recently signed up to the EITI.  It aims to get its foot in lucrative downstream markets and toward that end has tried to obtain refining capacity in Central Europe. 

KMG’s system of control consists of three levels.  A national holding company, Samruk, was just formed to give the president more control over national industries, and root out corruption on the part of mid-level managers.  All of KMG’s assets have been transferred to that holding.  KMG actually sits on the second tier of this system as the parent company of KMG’s main production asset KMG EP.

Despite what some may say, corruption at the highest reaches of the Kazakh system really doesn’t present a major problem any more.  It persists at the mid-levels, but KMG is no longer the vehicle for personal enrichment of ruling family. 

Looking ahead, the main question that KMG must answer is whether to remain a producing company or simply become a partner to different western firms producing in Kazakhstan and focus on downstream markets. 

NOCs and Domestic Politics: Iran as an example
Daniel Brumberg, Georgetown University

Barriers to entry for national oil companies into market where a single NOC holds a monopoly are great.  NOCs receive considerable support from both public and private actors, which benefit from their subsidies.  In Iran for example, semi-private cab drivers benefit from subsidized gas that remain priced around 10 cents per liter. Tehran would halt is those prices rose, and a revolution of sort would erupt.

The political cost of removing subsidies is almost always high, and often times the middle class, which would be a fan of reform, depends on those subsidies. In such a system, there emerges a contradiction between political reform on the one hand and economic reform on the other.  In Iran’s case, Khatami was a great political reformer, but represented a coalition that did not welcome economic reform.  At the same time, Iran’s leaders are painfully aware of the fact the efficiency in the hydrocarbon sector is on the decline.  The infamous stern report just restated an already obvious fact. Low production numbers continue to embarrass them.

All of this points to the fact that Iran is not a totalitarian regime, but rather, a neo-patrimonial authoritarian one, with a supreme leader.  The supreme leader serves as the final arbiter in a fight between competing interests, and usually makes decision based on the lowest common denominator between two or more positions.   Ultimately, this system causes reform to come to halt or squeak along at a painful pace. 

The lack of efficiency that arises from this system was painfully clear in the way that the state approached the process of nationalizing the oil company through “buy back agreements.” The constitution mandates that the state will maintain ownership in the oil sector.  Buy back agreement were created to get around this provision, but few international oil companies (IOCs) picked up on them because the deals were lousy and the risk high.

A second crucial point related to the nature of an authoritarian regime like the one in Iran arises in connection with the process of privatization: when pressure for privatization begins, because of lack of interests in the international community, the system morphs from a pure monopoly to a sort of state oligopoly. So-called private investors from the home country begin to buy stakes on behalf of the state, and economic reforms remain stunted.
 
Thirdly, rather than autocratic states leading to a shedding of coalition partners as one supreme leader emerges, more people are co-opted into the ruling structure.  In Iran for example, the Iranian revolutionary Army and certain charitable organizations are beginning to demand a piece of the NOIC pie.  All of this refutes the thesis that Iran is some sort of police state, moving toward a totalitarian system. President Mahmoud Ahmadinejad is on the defensive because of his actions around the world, and other players are gaining strength.

In short, international sanctions on Iran have impeded investment, but the true barriers are found in the nature of Iran’s regime.  Nothing will change that regime short of a catastrophe. 

NOCs, Energy Security and Geopolitics:

China’s NOCs
Steve Lewis, James A. Baker III Institute for Public Policy, Rice University

China has three NOCs: CNPC, Sinopec, and CNOOC. We decided it was pertinent to include all three in our study because they were made to compete with one another.  It is impossible to talk about the development of one without talking about the development of the others.   This competitive structure, however, has advantages and disadvantages, which will be elaborated on below. 

The oil industry in China constitutes a large part of the economy.   CNPC, for example, while only technically employing  400 or 500 thousand employees, in reality employees many more through firms that provide services to it.  Sinopec also is an employer of consequence.  All three produce a substantial amount of oil, and pay a significant amount in special taxes levied by the state.

Because the Chinese state has still not developed a refined tax system, it still relies on state owned enterprises for its revenue.  It collects that revenue through those special taxes mentioned above.  The pattern of privatization in China adheres to the logic of this scheme as the state tends to privatize its poor-performing industrial assets and keep those that are most profitable like its oil companies.

The Communist Party for its part also wants to keep potential power bases close, in order to maintain its control over them.  Thus in 1998, when CNPC and Sinopec both presented it plans to merge all three of China NOCs into one vertically integrated companies, it rejected those plans and instead decided to form three vertically integrated companies set in competition against each other.  Sinopec up to that point was mostly a downstream company, CNPC an upstream company, and CNOOC controlled offshore assets.  All three were forced to trade some of their most valuable assets.

The important fact to keep in mind in all of this is that the oil companies are essentially a part of the Communist Party.  Their managers are almost all members of the party, and as such, the industry lacks efficiency.  The largest fields in the country are in decline, and the three NOCs have started searching for supplies overseas.

They have had limited success in this pursuit, and what success they have had was largely the result of previous relationships, and the work of the Ministry of Foreign Affairs, especially in Africa. 

The competition between these companies has both positive and negative results.  The competition is completely opaque, and is often corrupt.  But since the federal government has cut off money supplies, the companies have started looking for money in other places.  They are now turning to capital markets and have embarked upon a campaign to increase their public image among the Chinese population, which is looking for places to invest its money.   This quest for branding has led the companies to start adopting transparent practices.  It is possible that this could lead them to adopt more sustainable business models. 

LUKOIL: a Private NOC?
Isabel Gorst, The Financial Times of London

Lukoil unlike the other companies in this study is not a national oil company, but it is still important to the study of NOCs because it receives many of the benefits of a national oil company. 

Lukoil was the first integrated oil company to emerge from the Soviet Oil Ministry in the 1990s, when Vagit Alekperov served as minister.  Alekperov had received the idea to form an integrated company in meetings about economic reform, and pulled together assets in Siberia to form Lukoil.  He wanted to build a firm that emulated and rivaled Exxonmobil, and while Exxonmobil still dwarfs Lukoil, the later has come a long way.  It will produce some 4 million barrels of oil a day by 2016, has moved into markets in Africa, and is talking about moving into China. 

Lukoil is really Russia’s flagship oil company, known throughout the world, and it is unlikely to follow the path of Gazprom.  Nonetheless, it will undoubtedly have to make some compromises with the Kremlin.

Lukoil also constitutes a major factor in world energy security.   It now produces 20 percent of Russian oil, and has ambitious gas production goals.  The West has, nonetheless, begun to doubt the security of oil supplies from Russia, especially after the Russia’s rows with Ukraine and Georgia.  However, the true threat arises not from such momentary disruption form supply; it is Russia’ growing domestic demand, driven by economic growth, that could really affect its ability to continue supplies to Europe.

Lukoil will ultimately do what the Kremlin tells it to, and may eventually end up providing subsidized oil to domestic markets, but not everything the Kremlin tells it to do is bad for business.  Lukoil has cheerfully fallen in behind the Kremlin’s plan to refine more oil at home both for export and domestic use.  In many ways, if the Kremlin plan is fully implemented Lukoil is set to become the national leader.  Its refining figures were up 6 percent last year, and its strategy from the 1990s of sitting on certain key oil fields is beginning to pay off.

The company also plays an important geopolitical role for Russia as well.  It is the only Russian company to have internationalized widely, and took up many of the former Soviet projects. As such, it serves as a sort of ambassador overseas.

It has a natural advantage in some of the markets it has entered.  For example, Lukoil’s refining capacity in Central Europe was essentially created for Russian crude, and a large series of pipelines, like the Druzhba pipeline, connect that capacity with Russia.  Many countries in Europe are beginning to look elsewhere for oil supplies, but it is unlikely that they will succeed in completely weaning themselves off Russian oil.

Lukoil was also entrusted with shoring up Russia’s influence in the Caspian in the early 1990s, and made sure to take some of the best plots for itself.  It even entered the AIOC consortium in Azerbaijan, and took some properties in Kazakhstan. 

In the future, Lukoil will undoubtedly grow, and if all goes according to plan, it will shift to the downstream market.  Of course, along the way it will try to avoid ruffling the Kremlin’s feathers.

Saudi Aramco: Saudi Arabia’s NOC
Amy Myers Jaffe, James A. Baker III Institute for Public Policy, Rice University

Saudi Aramco has three fundamental goals.  The first is to maintain a certain amount of spare capacity in order to serve as a swing supplier in case of some sort of cut in world supplies. If supplies from Iran or Iraq are for some reason cut off, it wants to be able to fill the gap in supplies, and win geopolitical clout in the process.  Of course, the insistence on keeping this spare capacity has led Saudi Arabia leaders to question the actual rate of decline in the Kingdom.

A second goal set for the national oil is to serve as a vehicle for economic growth.  How this goal pans out was seen in 1998, when the company was tasked to implement the Saudi gas initiative.  The process was heavily politicized and proved unsuccessful. Nonetheless, creating jobs and producing industries lies at the heart of the company’s strategy.

The third goal is to sustain a long term market for oil.  It wants to make sure that oil remains competitive with other alternative sources of energy for both private and corporate consumption. 

Overall, Saudia Aramco has been a successful NOC, but it doesn’t have the same trapping of Statoil or Lukoil.  It is not traded through ADRs and has not been privatized through an IPO.   It has somehow managed to meet its noncommercial goals and somehow keep a strong technical base. This maybe because it was once a private oil company and has largely kept a Western model of management.  

Oil & Natural Gas Corporation of India
Sumit Ganguly, Indiana University
 
The Oil and Natural Gas Corporation of India is important because it fuels India breakneck economic growth.  In the last quarter, the Indian economy grew at the rate of 9.2 percent, and is expected to continue to grow at that rate if it can break certain bottlenecks.  Oil constitutes 34 percent of India’ s current total energy consumption, and India is the world’ s sixth largest consumer of energy.

ONGC dominates India’s energy sector. It employs nearly 40,000 workers and produces 77 percent of India’s domestic petroleum and 81 percent of its natural gas.

It was created in 1956 as an arm of the Geological Survey of India in the heyday of import-substitution, but has managed to avoid the privatization chopping block.  Privatization remains a difficult issue because of the strong union that dominates the company.

ONGC Controls 57 percent of the country’ s hydrocarbon acreage with its largest offshore oilfield, Bombay High generating some 14 percent of India’ s total oil requirements and 38 percent of all domestic production.

The Government of India is the principal stakeholder controlling nearly 85 percent of the ONGC. Because of this government control, the company lacks fiscal and organizational autonomy.  It is subject to the vagaries of the finance, energy, and natural gas ministries.  Appointments to key posts in the company are usually politically motivated, and its pricing policies are subject to fiscal restraints. In addition, labor laws prevent the company from shedding redundant workers.

India’s appetite for energy has many geopolitical implications and has made ONGC a direct competitor with China.

To shore up supply, India will continue in a wide range of controversial projects, including the pipeline from the South Pars field in Iran.  These projects may strain India’s nascent relationship with the US, but India will continue to put its energy needs above any moral considerations.