GUEST EDITORIAL

The Winds of Change: Resource Nationalism Shifts the Balance of Power to National Oil Companies
Pete Stark, Vice President of Industry Relations, IHS Inc.

The oil and gas industry is in the midst of a critical transition driven by a series of factors, including the Asian energy-demand crunch of 2004, the 2005 hurricanes in the Gulf of Mexico, and recent low discovery rates. These factors, coupled with political uncertainties, threats to petroleum infrastructure, production disruption resulting from civil unrest, and limited access by international oil companies (IOCs) to giant resources in the Middle East and the former Soviet Union, have ushered in what has been referred to as the Age of Energy Supply Anxiety. In addition, higher oil prices and mounting political pressures, combined with a bit of anti-Americanism and rapidly growing demand for energy in the Asian market (particularly in China), are stimulating producing countries to increase control of their oil and gas resources and move toward resource nationalism. The resulting global scramble by both IOCs and national oil companies (NOCs) to secure hydrocarbon resources has altered the industrys competitive landscape significantly, which in turn has caused a major shift in the balance of power favoring the NOCs, mandating new perspectives on negotiations and partnerships. No longer are NOCs managing only state-owned hydrocarbon resources to their nations long-term benefit, they are also expanding internationally to secure the additional energy resources necessary for sustainable economic growth for their countries. In other words, NOCs are becoming international exploration companies, competing with IOCs at home and in the world marketplace. The Effect of a Paradigm Shift Considering that governments and NOCs control more than 80% of the worlds remaining oil reserves, are expanding and upgrading refineries and infrastructure, and are developing gas resources, the effect is considerable. But that has not always been the case. In the past, when oil prices were low, investments in exploration dropped, and governments were eager to create incentives to attract investmentsincluding reducing tax rates and state participation, or providing royalty relief. All that changed in 2003 when oil prices began to soar. Many countriesprimarily those with immense resources such as Russia, Nigeria, Libya, Angola, and Venezuelareversed gears and raised taxes and/or increased state participation in hydrocarbon licenses. In Latin America, where the publics perception was that oil and gas companies made excessive profits at their expense, energy policies have become highly regulated. Increases in state-take range from 2% in Angola to 24% in Nigeria and 43% in Argentina. In Algeriaformerly known for being one of the most welcoming countries for foreign energy investorsa new government decree was enacted at the beginning of September 2006. Arguing that this decree safeguards the role of Sonatrach, Algerias NOC, it specifies that Sonatrach will be given a 51% stake in all upstream development projects as well as midstream pipeline and refinery projects. More recently, Vladimir Putins government unexpectedly rejected the bids of all five foreign suitors (ConocoPhillips, Chevron, Statoil, Norsk Hydro, and Total) still vying for a stake in the development of the supergiant Shtokman gas field in the Barents Sea. To gain further resource-holder control, the Russian government also revoked environmental permits relating to Phase 2 of the Shell-led Sakhalin 2 project and is pursuing the ExxonMobil-led Sakhalin 1 venture on similar grounds. The bottom line: As long as oil prices remain above U.S. $50/bbl, producing countries will be under a great deal of pressure to take more control over their hydrocarbon resources, which does not bode well for IOC participation.

Pete Stark is Vice President of Industry Relations for IHS Inc. in Denver. He was an exploration geologist for Mobil and has served in various management positions for IHS and its predecessors. Stark has published on exploration techniques, petroleum resources, natural gas, and giant fields, and he serves as moderator and speaker for several forums that address global petroleum industry trends and outlook. He earned a PhD degree in geology from the U. of Wisconsin.

34

JPT JANUARY 2007

The Resource Holder Advantage After a decade of unparalleled international NOC expansionmost notably by the Asian NOCsthe competitive challenge for the IOCs is daunting. The magnitude of the NOC expansion is indicated by their position as operator for approximately 30% of the large potential prospects (more than 250 million BOE) targeted to be drilled during

20062008. This is on a par with shares of these prospects held by supermajors and large independents. Operating under a separate set of rules, motivated by different drivers, and backed by their governments, NOCs are able to leverage government-to-government or favored NOCto-NOC relationships. This symbiotic relationship gives NOCs the ability to

negotiate deals that basically can eliminate the competition. And unlike IOCs, NOCs typically do not have shareholder accountability, nor do they report to a board of directors. The focus for the NOC is not on profits, but on securing energy resources to sustain their nations growing economies. This provides them with the financial advantage of being able to bid low on shares of production or low rates of return, allowing them to operate on razor-thin margins. With government support, NOCs also may offer substantial bonuses in the form of infrastructure investments that cannot be matched by an IOC. With access to inexpensive capital, cheap labor, and inplace policies that restrict IOC access to state-controlled resources, NOCs definitely have distinct bargaining power. The impact of aggressive bidding by Asian NOCs, primarily Japanese and Indian companies, on Libyas EPSA IV Round I is a prime example. In May 2006, Irena Agalliu, Senior Legal Analyst with IHS, reported that the average production-share bid in this round was 13% and almost half of the blocks received bids of less than 10%. Asian NOCs submitted all of the single-digit bids. Using the average bid of 13%, a 20-million-bbl field, and a planning price of U.S. $40/ bbl, the EPSA IV Round II state-take increased by 30%, and bidder internal rate of return decreased by 31%, compared to the EPSA Round III. How Can IOCs Compete? It will not be easy, but IOCs must adapt their businesses to work within the new model, which requires innovative thinking and flexibility. The IOCs technologies, know-how, and projectmanagement skills will allow them to compete in the deepwater and arctic environments; in large, leading-edge projects in nonconventional reservoirs; and in other niche plays where their unique expertise can spell success. Regardless of ones view of the energy elephant, one thing holds true: The world has changed, and there is only one global oil market. It is no longer possible for countries, NOCs, or IOCs to operate in a vacuum or for short-term gain. Creative collaboration and partnerships are the most likely route to a win-win situation for all concerned. JPT
JPT JANUARY 2007

36