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Financial Times: State-owned groups from countries such as China, Brazil and India are making deals at home and abroad that increase their challenge to the 'majors'. There could be changes in the way partnerships are built, write James Boxell and Kevin Morrison: “Malcolm Brinded, head of exploration and production at Royal Dutch/Shell, says: "The competitive landscape is changing and the national oil companies will play an important part. There are fewer international companies than a decade ago because of consolidation, but there are new competitors, and we don't underestimate their capabilities or appetite." ( 9 Dec 04


Published: December 9 2004


For years executives at western oil companies have been waiting for the opportunity to get into Libya. Now they have their chance. Next month the government of Colonel Muammer Gadaffi is poised to award 15 exploration and production contracts to international oil companies, the first fruits for the global oil industry of the lifting of international sanctions against Tripoli this year.


But oil "majors" from the US and elsewhere - anxious to boost reserves by sharing in an estimated 100bn barrels of easily accessible crude - know such a prize may come at a high price.


Like many of the state-owned national oil companies that hold sway over many of the world's most coveted energy assets, Libya's National Oil Corporation is likely to take a muscular approach in its dealings with its international competitors. Executives believe that, to win favour, international companies will have to guarantee the NOC a bigger share of the spoils than might have been the case just a few years ago.


"The Libyans will no doubt be the big winners in this . . . theinternational oil companies will only be there at the margin," says an international oil company executive who works in the region.


Such an outcome would confirm an important shift in the balance of power in the global oil industry. The interests of international oil companies - such as BP, ExxonMobil and the other "majors" - are increasingly being challenged by the growing power of oil-producing governments such as Libya when striking deals.


"This is the issue the chief executives of the major oil companies think about before they go to sleep and when they awake," says Vahan Zanoyan, chief executive of PFC Energy, the Washington consulting group.


The prospect of declining reserves in their traditional fields of operation means that international oil companies need better access to reserves such as those in Russia and in the Middle East. But this will not be easy. Increased nationalism in oil-producing countries means they are less welcome, while higher crude prices have reduced many governments' need for international assistance. The international oil companies also need to preserve the returns their investors expect.


"A decade ago the major oil companies could go to countries and say: 'Give us attractive terms or we will go somewhere else'," Mr Zanoyan says. "That is not the case any more."


At the same time international oil companies are dealing with the growing threat of national oil companies moving beyond their borders to compete on deals. This is especially true of state-owned Chinese companies, which are scouring the globe to secure energy supplies to fuel the country's breakneck economic growth.


Lord Browne, chief executive at BP, sees the Chinese state-controlled oil companies, CNOOC, Sinopec and PetroChina, as "real competitors for the future. They are very important companies and I can't see why they can't become more involved in government-to-government deals."


Ambitious national oil companies from countries such as Russia, India, Malaysia, Brazil and Algeria are also expanding international operations. In Russia, meanwhile, Moscow seems intent on turning Gazprom, the state-owned gas giant, into an international competitor to the oil majors through the takeover of much of the country's independent oil sector, including Yukos. Western oil groups looking to buy into Russian companies will find the government willing to give up only small stakes.


Malcolm Brinded, head of exploration and production at Royal Dutch/Shell, says: "The competitive landscape is changing and the national oil companies will play an important part. There are fewer international companies than a decade ago because of consolidation, but there are new competitors, and we don't underestimate their capabilities or appetite."


The balance of power in the oil industry has frequently swung between the oil majors and state-owned national companies. Until the 1960s the international companies were dominant, but that changed in the 1970s, when members of the Organisation for Petroleum Exporting Countries (Opec) began a wave of nationalisations. The international companies gradually rebuilt their dominance through technology and discoveries in places such as the North Sea and Alaska. Now the pendulum may be swinging again.


Ali Naimi, Saudi Arabia's oil minister and one of the most influential men in the oil sector, points out that government-owned companies control 72 per cent of the world's oil reserves, 55 per cent of its gas reserves and half of its production of oil and gas.


This year, Mr Brinded says, an upsurge in international deals has brought the aspirations of some state-owned oil companies, and the governments behind them, into sharper focus. China and India's national oil groups have recently signed huge gas and oil deals in Iran and are exploring further collaboration.


Mr Brinded has seen about 50 exploration and production transactions involving national oil companies in the past 10 years, concentrated in the Middle East and Africa. The state-owned China National Petroleum Corporation, which owns PetroChina, is estimated to have spent $40bn in recent years on overseas developments, while India's Oil and Natural Gas Corporation has spent $3.5bn. Petronas, the national oil company of Malaysia, has operations in 35 countries and is one of the biggest foreign investors in west Africa.


A growing number of national oil companies are working with each other instead of doing deals with the "majors". Pemex, the national oil company of Mexico, has an alliance with Petrobras, Brazil's state-controlled oil company, to explore deep water oil reserves in the Gulf of Mexico. Petrobras and Sonangol, the Angolan national oil company, also signed a co-operation pact this year to work closely together.


Vittorio Mincato, chief executive of Eni, the Italian oil group, is more dismissive of the new competitors than some of his peers. "I don't think they will be a major problem," he says. "The Chinese companies offer a possible threat but you need a lot of money to bid in our sector. They will be there on relatively small projects, but when you are talking about multi-billion dollar projects it is very difficult to find money like this. They have low liquidity and poor access to capital markets. They will not substantially change the oil competitive scenario."


But with oil prices rising for the past six years national oil companies appear to have little trouble raising finance. Pemex has raised more than $6bn this year in the bond market, while PDVSA, the national oil company of Venezuela, has raised $3bn. CNOOC, the state- controlled Chinese group that has been linked with a bid for Shell's 34 per cent stake in Australia's Woodside Petroleum, recently raised $1bn in a bond sale. This week six banks led by Deutsche Bank started putting together a $13.4bn loan to Gazprom to fund its disputed acquisition of the main production unit of Yukos.


"When private oil companies use this argument about access to capital, they are skating on thin ice," says Robert Arnott, senior research fellow at the Oxford Institute for Energy Studies.


Many analysts, consultants and investment bankers say the world's "supermajors" need to accept the more challenging competitive environment and loosen their purse strings when deciding whether to invest in projects - or face the prospect of declining oil production and shrinking reserves.


Stewart Johnston at Charles River Associates, a consultancy, says: "We've spoken to a number of international oil companies who realise they have structured themselves for a low-cost, low oil price environment. This will not allow them to get the growth the market requires. They are too obsessed by capital discipline. They need to be quicker, nimbler and think about more innovative ways of doing deals."


The international oil companies are returning tens of billions of dollars in excess cash to shareholders as a result of the oil price bonanza. But this comes at the expense of investment in projects that do not fit their investment criteria and raises concerns about growth and reserve replacement.


In deciding long-term investments, international oil companies have stuck to assumptions of a long-term oil price of around $20 per barrel, even though many oil group chief executives, including Lord Browne, predict a shift in the medium-term price to more than $30. "They are still talking about $20 when the price has been more than $40," says Mr Arnott. "If they lowered their internal rate of return then they would find a lot more access open to them."


There is a belief that aggressive national oil companies from China, India and elsewhere will be able to outspend their international rivals when paying for licences, and accept lower returns on capital, because their investments are driven more by their governments' desire to secure energy supply than by a need to keep shareholders happy. here is no doubt, then, that the biggest international oil companies are grappling with some fundamental questions about how they run their businesses into the next decade. But their increasingly confident state-owned rivals will not have everything their own way.


First, Mr Brinded points out that some of these companies, such as Sinopec, PetroChina, CNOOC and Petrobras, have opened up to investors and are "increasingly subject to the rigours of the market too. They have large private shareholdings and that puts the same pressure on returns on capital".


Second, some question whether national oil companies will have the expertise to bid for licences, explore and produce in a cost-effective manner. The Gulf-based executive from one of the majors says aggressive bidders are prone to "winner's curse, where a winning bidder has paid far more than the competition because they thought they could get more out of it, when in fact they really didn't fully understand the geology".


Third, it is difficult to see how national oil companies will be able completely to forgo co-operation with international counterparts. The International Energy Agency estimates that $16,000bn needs to be invested in the world's energy-supply infrastructure over the next 30 years to meet global demand. "The industry needs a 15 per cent increase in upstream [exploration and production] investment this decade," says Mr Brinded. "And that will only come if everybody contributes, and that means the national oil companies and the international oil companies."


International oil companies will concentrate on areas where their size, access to capital, marketing expertise and distribution networks give them the clearest advantages, such as the production and supply of natural gas. The IEA predicts that global gas usage will double over the next 26 years, but the costs for building infrastructure - especially for liquefied natural gas, the boom area of the industry - are enormous. This is one of the areas where countries such as Saudi Arabia have opened up.


Even so, international oil companies are beginning to concede that they need to find new mechanisms for doing business with their increasingly empowered national company counterparts. So far, co-operation has often taken the form of production-sharing deals that leave ownership of oil fields with governments and assign part of the production to an international oil company as a partner.


BP's Lord Browne stresses the need for "different relationships between the international oil companies and the state oil companies. Perhaps they will not involve barrels and production as in the past." Rather, Lord Browne believes, state-owned oil companies could simply pay international companies to run projects.


The Gulf-based international oil executive says: "Although there is this Mexican stand-off, it will break, but right now no one knows in what shape or form . . . The world needs to find a new way that can open up new access, just the way production-sharing agreements did more than 30 years ago."


Caution rules the day


After years of having their profits squeezed because of cost-cutting by international energy companies, oil service groups such as Halliburton and Schlumberger of the US could be forgiven for a lack of loyalty to their biggest customers.


But, despite suggestions that service groups can compete with international oil companies such as Shell and ExxonMobil for contracts, they are reluctant to bite the hand that feeds them.


Ron Mobed, who worked at Schlumberger for 22 years before heading IHS Energy, the consultancy, says that, while the service groups expect to play a bigger role in deals with state-controlled companies, they do not wish to be seen to be aggressive in pursuing contracts that would usually go to international oil companies.


The oil reserves of countries such as Saudi Arabia and Kuwait are relatively easy to access and their national oil companies are technically advanced enough not to need assistance from international companies.


One banker who works in the Gulf says: "Somewhere such as Kuwait only really needs service companies. The development required does not need advanced technology, so there could be competition even from Chinese and Russian service companies."


Schlumberger recently won contracts in Saudi Arabia to carry out seismic surveys. The kingdom has also awarded a contract to repair wells to the services arm of China's Sinopec oil company, a further sign of China's competitiveness in the industry.


But these are standard deals for oil service groups and do not yet signal a challenge to the international companies. Stewart Johnston at Charles River, the consultancy, says: "There is kudos for national oil companies in having strong relations with IOCs [international oil companies] because of the transfer of technology and knowledge, which would not happen if Halliburton or Schlumberger were there - or especially the Chinese or the Russians."


In addition, the governments of some oil-producing countries are particularly concerned with creating jobs to keep their young populations away from radical political movements. Countries such as Nigeria give international oil companies quotas for the number of local people they must employ. The banker says: "It is more likely an IOC will create local employment than a service company."


Executives at international companies see a changing relationship between themselves, state oil companies and services groups, with each needing to demonstrate the value they add to a project in a way that was not needed when national oil companies were less sophisticated and the international companies were less desperate for access to oil reserves.


Malcolm Brinded, head of exploration and production at Royal Dutch/Shell, says: "This is not just a question of money but also what else we bring to the table. What we try to bring is much broader than the oil service companies. The key thing for the country is the creation of a capability within their national oil company."

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