Breaking New Ground: The Evolving Relationship Between Multinational And National Oil Companies
James W. Simpson, Vice President and Managing Director, New Ventures
Chevron Overseas Petroleum Inc.
1998 Annual Convention of the American Association of Petroleum Geologists (AAPG)
SLake City, Utah
This morning you've heard my esteemed colleagues on the panel talk about what they think the future holds for certain segments of our industry: the growing importance of alliances, the importance of managing technology, and the significant role that contractors and service providers will likely play in the coming years.
The next few years will be interesting. Perhaps one of the most interesting trends to watch will be the subject I have chosen to talk about: the evolving relationship between multinational oil companies and national oil companies.
By most people's definition, national oil companies are entities that are 100 percent-owned by the state. However, for today's discussion, I'd like to stretch that definition a little bit and include those companies that were at one time 100 percent-owned by their governments but today are either partly or completely publicly owned. It is still reasonable to think of these companies as national oil companies, since they retain much of their culture and influence in many parts of the world because of their prior existence as government entities.
What is the current relationship between national oil companies and multinational oil companies, and where is that relationship headed? Will these two entities cooperate more? Or will they compete head-to-head for the best projects?
Perhaps an even more basic question is: Will the international pie be big enough for everyone to get a piece? Or will some players be forced out of the game? I think that's a particularly interesting subject -- one that will become even more so in the years ahead.
Ken Burns, the documentary filmmaker, has said. "We can't know where we're going if we don't know where we've been." And in keeping with that sentiment, I'd like to begin with a brief review of history to see how relationships between the multinationals and government companies have evolved over the last 25 years.
Most of you -- if not all -- are familiar with this story, but I think an occasional retelling is useful. We all -- myself included -- have a tendency to forget that the traditional petroleum industry has been buffeted by incredible change over the last few decades. And this change has stripped the old petroleum industry of much of its size, power and influence.
After a brief look back, I will offer some thoughts on some of the current trends in our business. And finally, I'll offer a few personal views on where I think the relationship between the multinationals and the government companies is headed and what the impact on the industry might be.
Prior to the oil embargo of the early 1970s, the private multinational oil companies basically had the oil patch all to themselves. Their power and influence was unequaled and unchallenged. As you recall, the seven largest multinationals were known as the Seven Sisters.
Back in those days, the national oil companies, including those that are now part of the Organization of the Petroleum Exporting Countries (OPEC), existed mainly to offer an equity share of the oil produced in their countries to the private multinational oil companies.
In return, the multinationals -- dominated by the Seven Sisters -- invested in exploration and production infrastructure, transported the crude, and marketed it through their downstream operations. That was the fundamental relationship between the multinationals and the national oil companies.
Royal Dutch Shell was producing over 6 million barrels a day back then, while Chevron (then Standard Oil of California) was producing a little over 3 million barrels a day. All together the Seven Sisters controlled about 70 percent of the world's oil trade. For their part, the national oil companies controlled basically none of the critical aspects of the hydrocarbon production stream. But the 1973 embargo changed all that.
Oil was used as a political weapon for the first time -- aimed directly at the market mechanisms that were controlled by the multinational oil companies. The embargo also forced a gigantic shift in the power structure of the industry.
In a matter of months in late 1973 and early 1974, the levers of control passed from the multinationals to the government-controlled national oil companies. And those countries that didn't have national oil companies put them together quickly. Why?
Basically there were two reasons.
First of all, these countries wanted to reduce their dependence on the multinationals because of a new sense of national pride as well as a growing independence. And secondly, these countries wanted to increase their knowledge of the petroleum industry so they could someday get a bigger piece of the pie I referred to earlier.
In their new book entitled The Commanding Heights, Daniel Yergin and Joe Stanislaw chronicle the driving forces that led to the creation of government-owned businesses. The phrase "commanding heights," coined by Vladimir Lenin, conveys in a few descriptive words what motivated governments to create strong national oil companies. Governments wanted to control the commanding heights, the most important elements of their economies. And I think you'll agree that for several countries, oil holds an important position at the commanding heights.
Because the reasons for their formation and continuing existence often differ from that of the multinationals, the national oil companies often take a different approach to producing, transporting and marketing their resources. For example, standard economic analysis often takes a back seat in the daily operations of many national oil companies. Things like operating cost, return on investment, and inventory control are not treated as they are in the multinational companies.
I'll never forget a meeting I had a few years ago with a high-ranking official of a Middle Eastern government oil company. I kept talking about efficiency, productivity and the other things that motivate multinational companies. The official responded to me by saying, "What makes you think we would be motivated by things like that?"
Of course, I was stunned. I hadn't imagined that a big oil company would be motivated by other things. So I explored the subject a little bit more with him, and I found that the government oil company was running its business by what it perceived to be its own national interests, which were driven by political forces. Here was a huge national oil company and a potential competitor that had motives completely different from those of the company I represented.
Now let's get back to the embargo and the story of the early 1970s.
The national oil companies, especially those in OPEC, began to set the prices for their own oil -- something that had always been the exclusive domain of the multinational companies and the Texas Railroad Commission. The first price run-up occurred during and just after the embargo. That one was followed by an even bigger jump in 1979.
You probably recall those days. Everyone felt that prices would continue to rise throughout the 1980s and beyond. At Chevron, we were running our project economics using $50, $60, $70 per barrel oil - and even higher.
What happened as a result of those high prices? As we all know, the marketplace reasserted itself. And there were some hard-earned lessons for everyone in what followed.
In the wake of higher prices, oil-importing nations began to diversify their supplies. They made plans to produce synthetics and to build more nuclear plants. And conservation efforts were stepped up, especially in the area of fuel-efficient cars.
But most important, higher oil prices spurred the search for oil everywhere, especially in non-OPEC areas.
The OPEC national oil companies, seemingly invincible during the 1970s, began to lose market share. Oil demand began to fall and continued to decline until the price collapse of 1986.
When prices hit bottom in late 1985, free-world oil demand had fallen by 7 million barrels a day from former peak levels. And by the end of 1985, the OPEC national oil companies' share of the market had plummeted by more than 20 percent.
The price collapse brought other significant changes to the industry as well. The equity arrangement, traditionally offered to the multinational oil companies by the producing countries, began to lose favor. As a result, oil traders and others began to move in to fill the gap. They became the new intermediaries between the national oil companies and the refiners and marketers. Spot markets began to grow in importance. Oil futures and commodity markets were established. And oil prices became much more volatile.
The price collapse also ushered in a new phase in the history of the multinationals: the era of cost-cutting, restructuring, downsizing and asset sales that we all know so much about. As an industry, we were forced to adopt a new approach in our relationship with national oil companies.
Let me give you an example from my own company, Chevron. In the early 1990s, we decided that we couldn't deal with the national oil companies the way we had in the past. We couldn't simply show up, offer our services, take charge and run everything from start to finish. In 1991, we declared that what we wanted to be was the partner of choice.
This "new" approach has worked well for us, because we've been able to show the national oil companies and the host governments that we can be responsive to their needs.
As a result of the price collapse, the big national oil companies also had to look for new approaches, mainly because they lost much of their ability to set prices. However, this time they were able to steadily gain back market share by keeping production up, which kept prices low.
Today, with a few exceptions, the cast of publicly held multinational oil companies reads about the same as it did in the 1970s and 1980s. But the cast of national oil companies has some major new players. With the demise of the Soviet Union, the mix of private and government-owned companies has taken on a new look. The historic multinational oil companies have been pushed further down in the pecking order.
Do you remember what Shell's production was in 1972? It was about 6 million barrels a day. By the end of 1996, its share of production had been reduced to just over 2 million barrels a day. The reserves picture was much the same. Today the 10 largest national oil companies control more than 70 percent of the world's reserves. By contrast the 10 largest multinational oil companies control less than 2 percent.
There have also been some fundamental shifts in the way that national oil companies go about doing their business. Many are now tuned into the market forces that drive today's global economy, and their managers are pushing them to compete. To do this successfully means that they've had to alter their basic strategies and, in some cases, privatize and completely restructure their business. This process is continuing and will result in some major new players joining the community of international oil companies. And these new players will change the face of global competition.
So much for the history lesson. As I said, it's a familiar story. But I've tried to show what's motivating national oil companies -- and the multinationals as well -- to behave the way they are these days. Change has had a profound effect on what's happening to our industry. And that's what I'll talk about next.
Although there will always be room for independent oil companies to find and fill gaps in the business, the huge national oil companies and the huge multinationals will exert the most influence on our future -- primarily because of their enormous combined capital.
As I've shown you, there are some really big government companies out there. But many of them are not ready to leap into the international arena and probably won't be for some time to come. Part of the reason is culture. Culture can't be changed overnight -- I can testify to that.
The surviving, large multinational companies have been battered and toughened by market forces over the last few years. They've had to change their way of doing business and their culture in order to survive. Many large national oil companies have yet to go through that experience.
Any one wanting to join the high-stakes international exploration and production game these days has to be nimble and quick. Size alone won't make the deals come any easier.
In my recent dealings with national oil companies, I have found that they seem to fall into several loosely defined groups.
First, there are the national oil companies I'll call the new multinationals. These are the types of companies that I referred to in my opening remarks. They have been significantly privatized and restructured in the last decade or so, but they still have their roots as government-owned entities. And they have been very active on the international scene for many years.
Although their respective governments retain a partial share, these companies basically run their businesses in a market-oriented way. Elf and Agip fit this category. These types of national companies, if you can still call them that, brought along some natural advantages when they made the transition to publicly held companies.
Namely, they've benefited from the influence they cultivated and nurtured during their previous stints as nationals -- most notably in West Africa. But they're still learning what it takes to be a public company. For example, they have to deal with the Security and Exchange Commission, boards of directors, stockholder groups and lending agencies.
I've found it interesting to watch some of these companies adjust to the new environment of corporate governance. They're obviously seeking new business opportunities, they're forming joint ventures, and they're a force to be reckoned with.
The next group of national oil companies I'll define as emerging. These are companies that have tested the international waters only recently, and they appear to want more. They're suddenly very aggressive. These are companies with what I call big bucks and big aspirations. They are fully integrated and only lack a land position outside their borders. Companies like Norway's Statoil, China National Petroleum Corp. (CNPC) and Brazil's Petrobras fall into this group.
I'll never forget how stunned I was when I heard that CNPC had won the bid on two fields in Venezuela during the Third Marginal Fields Round there last year. It was suddenly clear to everyone that a major new player had joined the international scene.
Talking about Venezuela brings up another story that gives us some insight on where emerging national oil companies are headed.
Two years ago, I gave a talk at the AAPG's conference in Caracas. While I was there, I happened to meet Johan Nic Vold of Statoil. Over lunch we shared our views on where we wanted our companies to grow.
To make a long story short, we decided that we might be able to help each other achieve our own objectives if we swapped some assets. That rather simple luncheon conversation resulted in Chevron exchanging a portion of its Alba Field in the UK North Sea for a percentage of Statoil's Draugen Field in Norway and some exploration acreage earlier this year.
These were complex negotiations. There were times when I wondered whether we would get it done, but the excellent working relations we had cultivated won the day. Bottom line -- Statoil got what it wanted, and Chevron got what it wanted -- in a strategic sense.
I think that multinationals like Chevron will seek in the future to build partnerships with these types of emerging companies. They have a lot to bring to the party. These partnerships will include not only standard joint ventures but also regional alliances and possibly other creative forms of cooperation. And it could all begin with a casual discussion over lunch.
Next, there are the national oil companies that have yet to step onto the international stage, but they are giving clear indications that they'd like to. They, too, are often fully integrated with a fairly extensive operational experience that's only within their own borders. Suddenly they have global aspirations. Companies like Indonesia's Pertamina, India's Oil and Natural Gas Corp. and Russia's LUKoil are part of this group. In their bids to go international, they'll encounter the same obstacles that the emerging companies will face.
One way these companies might ease their transition from domestic to multinational, especially if they lack the necessary capital, is to swap assets. And it seems likely that the multinationals will form joint ventures and other long-term relationships with this type of government company as well. However, developing these relationships won't be easy, because today most multinationals have a culture markedly different from this type of government company.
A recent article in Platt's Oilgram News suggested that a clash of cultures was at least partly responsible for the breakdown in joint venture negotiations that reportedly took place between British Petroleum and Mobil late last year.
If that can happen between two multinational companies, imagine merging the culture of one of today's multinationals -- a company that has honed its free-market skills -- with that of a government company that was created in a planned economy. That would be an incredible undertaking even for the most intrepid of companies. Perhaps ARCO's purchase of a share of LUKoil is a way to enjoy the benefits of union without having to completely merge two different business cultures.
The final group of national oil companies are those that probably will stay behind their own borders, at least for the foreseeable future. These are companies that lack extensive operational experience. They need training for their national employees. They need to upgrade their operating systems. And of course, they need the money to fund those efforts. Companies like the State Oil Co. of the Azerbaijan Republic and the Nigerian National Petroleum Corp. fall into this group.
For the meantime, these types of companies will continue to farm out their existing assets to the multinational oil companies and others for a share of the hydrocarbons produced. However, the forces that are driving the other national oil companies are at work here too. I think this type of company will go international when it has gained more experience and has raised the capital necessary to be successful outside of its own borders. Since it's presently cash-poor, it might be willing to sell some equity or swap some assets in order to enter the international arena.
Where does all this lead? Because of their access to massive reserves and the natural drive to compete in the global marketplace, the largest national oil companies will continue to grow in influence. Obviously, not all of the current national oil companies will expand beyond their borders. Some of them, such as Aramco, don't need to.
But the entry of some of the more aggressive and successful government companies onto the international scene will certainly change the competitive nature of the business. Some of the less successful entrants, however, could fail, retreat or become takeover targets.
The multinationals, on the other hand, will have to carve out a competitive advantage between themselves and their competitors in order to remain successful. They will have to focus even more on their core competencies. That might involve selling some of their current assets or specializing their operations in certain parts of the world.
The most dramatic developments, however, could come in the form of megamergers. Some people, including Morgan Stanley's Doug Terreson, feel the next few years could turn out to be the era of the supermajor, resulting in various combinations between majors, mini-majors and independents.
Mr. Terreson expects the supermajor format to be the prototype for the integrated oil industry in the years to come, mainly because the current supermajors - namely Shell and Exxon - enjoy superior risk-adjusted returns and premium valuation, compared to their peer group and to the Standard and Poor's 500. There's an economy of scale at work here, and sheer size is apparently an important consideration in the market today.
Although there are some dissenting views regarding Mr. Terreson's predictions, there probably will be at least some movement toward the formation of additional supermajors in the next decade. It might even include mergers between the emerging national oil companies and the existing multinational oil companies.
At the same time, there will continue to be a place for the smaller, more specialized independent companies. They'll still be able to carve out their own special niche as they always have, because they'll be able to provide those services that the large multinational companies will either be unable or unwilling to provide.
All the changes I've described -- both past and future -- present all the players in the industry with various opportunities and threats. Some of the national oil companies will undoubtedly continue to grow in size and influence. The multinationals will continue to expand their international experience and expertise. Competition between the two will surely intensify.
But cooperation will also be an important ingredient in their ongoing relationships. By working hard to understand each other's culture, strategic interests and capabilities, the national oil company and the multinational oil company will be able to find new and innovative ways to create value. By pooling financial, technical and operational competencies, they both can reap the rewards of a true partnership.
Updated: May 1998