THE OXFORD INSTITUTE FOR ENERGY STUDIES A RECOGNIZED INDEPENDENT CENTRE OF THE UNIVERSITY OF OXFORD A/k*Ao\ UNIVERSITY OF OXFORD Companies and Governments James Henderson April 2017 Industry Demographics Company Categorisation: - NOC (National Oil & Gas Companies) - IOC's - International Oil & Gas Companies • The Majors (Shell, ExxonMobil, BP, Total etc). • The Mid Sized Players (ENI, Marathon, Occidental etc) • The Independents (Anadarko, Plains Petroleum etc) Upstream/downstream - Some companies purely upstream focussed; some integrated through the oil and gas supply chain. Most companies engaged in both oil and gas.^^ Oil and Gas Companies and Host Governments Ownership of oil and gas is vested with the State apart from certain areas of the US and Canada where mineral rights reside with landowners. Governments, on behalf of the nation, delegate the stewardship of resource management to a Ministry. Exploration and Development of hydrocarbon resources is undertaken by International and State Oil & Gas Companies. Ministry of Oil & Gas International Oil & Gas Companies Participation in the oil and gas sector ■ Market structure and entry regulation / openness NOC ■ Level playing field / privileges POC monopoly ■ Degree of direct state participation ■ Role of state companies (operators/investors) w competition Governments have important choices to make over governance of their energy sectors - How much state control? - How much foreign help required? - How much competition? - The balance of revenues between state and industry - Who to trust with the country's strategic resources? - How much bargaining power is there and what is the balance? NOCs can provide a balance to the perceived power of experienced private international oil companies, as well as an initial institutional framework 71K Top 30 Oil and Gas Companies in the World 1 Saudi Aramco Saudi Arabian Oil Co. Saudi Arabia State-ow ned 2 NIOC National Iranian Oil Co. Iran State-ow ned 3 Exxon Mobil Exxon Mobil Corp. US Private 4 PDV Petroleos de Venezuela, SA Venezuela State-ow ned 5 CNPC China National Petroleum Corp. China State-ow ned 6 BP BP pic UK Private 7 Royal Dutch Shell Royal Dutch Shell pic The Netherlands Private 8 Chevron Chevron Corp. US Private 9 ConocoPhillips ConocoPhillips Co. US Private 10 Total Total SA France Private 11 Pemex Petroleos Mexicanos SA Mexico State-ow ned 12 Gazprom OAO Gazprom Russia 50% State 13 KPC Kuw ait Petroleum Corp. Kuw ait State-ow ned 14 Sonatrach Enterprise Nationale Sonatrach Algeria State-ow ned 15 Petrobras Petroleo Brasileiro SA Brazil 32.2% State 16 Rosneft OAO Rosneft Russia 75.16% State 17 Lukoil OAO Lukoil Russia Private 17 Petronas Petroliam Nasional Berhad Malaysia State-ow ned 19 Adnoc Abu Dhabi National Oil Co. UAE State-ow ned 20 Eni Eni S.p.A. Italy 30.30% State 21 NNPC Nigerian National Petroleum Corp. Nigeria State-ow ned 21 QP Qatar Petroleum Corp. Qatar State-ow ned 23 EGPC Egyptian General Petroleum Corp. Egypt State-ow ned 23 INOC Iraq National Oil Co. Iraq State-ow ned 25 Libya NOC National Oil Corp. Libya State-ow ned 26 Sinopec China Petroleum & Chemical Corp. China 75.84% State 27 Statoil Statoil ASA Norway 70.13% State 28 Surgutneftegas OAO Surgutneftegaz Russia Private 29 Repsol YPF Repsol YPF, SA Spain Private 30 Pertamina Perusahaan Pertambangan Minyak Dan Gas Bumi Negra Indonesia State-ow ned NOCs dominate oil and gas production 14000 12000 10000 Q. X2 8000 6000 4000 2000 Top 20 oil producing companies o u u " o o III..... ■ ■■■■■■ Ü u u < CD Q- Q- l/l c Z ^ > o l/l u — o c < s <" ~ a i- M re 3 3 00 45000 40000 35000 30000 £ 25000 u I 20000 15000 10000 5000 0 Top 20 gas producing companies E u o O 13 Mini 111111111 J3 O CO £ < I/) £ 3 Q CD ^ National Oil Companies accounts for more than 50mmbpd of global oil production, or around 61% Saudi Aramco is the dominant player, with liquids output approaching 12 mmbpd In the gas sector, NOCs account for a similar share of total output, with Gazprom the leading player The share of NOCs has been rising as countries seek to avoid dependence on international oil companies (lOCs) ^yy^ Rationale for forming a National Oil Company General reasons for creating State-owned Companies Objective Rati Quale Overcome market failure Market failure can occur in economic activities that involve: ■ Natural monopolies (electricity, water) ■ Public goods (law and order, national security) ■ Merit goods (education and health) ■ Externalities (positive or negative) ■ Information asymmetry Overcome regulatory failure State ownership is desirable if and when: ■ The state does not have the capacity to regulate effectively ■ The economic activity renders the drafting of contracts incomplete ■ The state cannot credibly promise not to confiscate or tax excessively Industrial economics ■ Sustain industrial sectors of particular interest for the national economy ■ Safeguard employment ■ Launch emerging industries with significant start-up costs when future property rights are uncertain ■ Control the decline of senile industries ■ Help the private sector cany nsk Development economics ■ Boost the economy of the less developed region(s) of the country ■ Pursue equality and social goals Fiscal policy and redistributive obj ectives ■ Invest in a sector, control entry, impose monopoly prices, then use the revenues as fiscal income; or ■ Sell at reduced prices to targeted populations and distribute subsidies ■ Maintain employment ■ Substitute for under developed welfare systems Source: OECD (2005) NOCs have been around for over a century, starting in the UK Year Country Company 1914 UK BP 1922 Argentina YPF 1924 France CFP 1926 Italy Agip 1938 Mexico Pemex 1951 Iran NIOC 1953 Brazil Petrobras 1956 India ONGC 1960 Kuwait KNPC 1962 Saudi Arabia Petromin 1965 Algeria Souatrach 1967 Iraq ESTOC 1970 Libya LNOC 1971 Indonesia Pert anuria 1971 Nigeria NNOC 1972 Norway Statoil 1974 Qatar QGPC 1974 Malaysia Petronas 1975 Venezuela PdVSA 1975 Vietnam PetroVietnam 1975 Canada Petro-Canada 1975 UK BNOC 1976 Angola Sonangol 2002 Equatorial Guinea GEPetrol 2006 Chad SHT • Privatisation has moved some into private hands, while others have become hybrid semi-privatised state companies The pros and cons of NOCs Pros Useful when nationalising industry Control over strategic assets that are vital to the economy Political power, gained from controlling major revenues Monitoring role for overall industry operations Petroleum rent maximisation Socio-economic issues and priorities Foreign policy issues Sense of country pride and status Major source of employment Vehicle for technology acquisition Cons Susceptible to political ideology and interference Economic cost of political control Inherent bureaucracy and inefficiency Risk of corruption Operational inefficiency Lack of competitive challenge Subsidies and non-commercial objective can undermine corporate goals Weak corporate governance Funding strategy and requirements Conflicts of interest and control1 Russian Arctic development a classic NOC role The Northern Sea Route set to become the "Cold Silk Road" to Asia The Russian Arctic holds vast hydrocarbon potential (240 billion boe), which could sustain the country's oil output beyond 2030 and form the basis of an LNG hub The Russian government is keen to develop the economic potential of its Northern regions, and plans to use the oil and gas industry as a foundation for this - New tax regime based on sliding royalty to incentivise investment The Kremlin has clear geo-political ambition in the region, which goes beyond commercial logic -control of the northern sea route is a core strategy and Soviet military bases are being re-opened Oil production has started (2 fields), the Yamal LNG project is set to come online in 2017 and a , major discovery has been made in the South Kara Sea ^UU^ Countries most reliant on oil revenues Figure 2: Fuel exports as percentage of merchandise exports, 2013 unless otherwise indicated C CD Ea CO All the countries in the chart above have state oil or gas companies, or both Hydrocarbons are viewed as a strategic asset that cannot be left in the hands of foreigners 71K Efficiency is a key issue for NOCs Revenue per employee Cashflow margin 180 160 140 120 100 u 80 cd 60 40 20 yy yss/s///** y y NOCs are notoriously more inefficient than private companies, although this is partially to do with the constraints placed upon them NOC objectives include operational and financial efficiency, but also cover wider social and political goals However, corruption and bureaucratic disorganisation tend to be consistent themes in most oil producing countries The ''resource curse" has become an often repeated theme, which argues that the presence of hydrocarbons can undermine political and economic development 7m Major oil companies known as lOCs Integrated global oil and gas companies Operations across the value chain from exploration to consumer sales Broad international operations bp E^onMobil Chevron Extensive experience of operating in different environments and political regimes Able to deal with significant risks across a broad range of parameters ConocoPhillips Total IE LUKOIL Huge financial resources 7ÜK IOC business model being questioned, but competitive advantages are still relevant Extensive management experience on large industrial projects Broad geographical experience - diversified portfolios both vertically and horizontally Significant technical experience built up from years of research and development work Ability to raise finance and share risk in global partnerships Ability to co-ordinate a wide range of contractors and partners to develop large projects on schedule and on budget Long history of M&A activity which has provided synergy benefits through consolidation of companies into "supermajors" Technology transfer is a key selling point for lOCs, and most host governments insist on it Influence with government Understanding of business environment Access to resources IOC Project management, cost control etc. HSE culture Governance culture Specific technology Management skills Part of the entry fee for lOCs is to ensure a number of forms of technology transfer These range from specific technical skills to softer governance issues In return, they receive access to assets and the ability to operate in a new domestic environment ^yy^ Key issues for lOCs • Historical baggage of colonial past - OPEC was formed to fight back against western companies seeking to dominate the world's oil resources - lOCs still sometimes seen as vehicles for western power • Access to resources now a major issue - NOCs tend to dominate, especially in the home countries • Increasing competition from NOCs and Independents • Rise of contractors who can bring expertise to NOCs without asking for access to resources • Reputation sullied by accidents such as Macondo and Exxon Valdez Challenge of new energy environment Upstream "Independent" Oil and Gas Sector Also called Exploration and Production companies Main objective is to find and also to produce oil and gas Take higher risks to increase asset base Monetisation can also take the form of exit via sale of assets or company, if discoveries are too large to finance Often involved in "wildcat" exploration - high risk drilling in new virgin territory Very innovative, both scientifically and financially Early operations almost always financed by equity rather than debt, especially in the early stages (Q)^ - US shale companies the exception (again) ^jj Independent oil companies drive the US oil industry groundbreakingenergy.com Bakken: Well Permits by Operator As of 1/15/12 11% 35% Continental ■ Hess Brigham ■ Petro-Hunt Enerplus ■ Marathon Burlington BXTO Kodiak ■ Slawson Other ■ Whiting B EOG Source: North Dakota Department of Mineral Resources groundbreakingenergy.com • Small oil companies dominate US shale development • They have been innovative and highly efficient US reserves by company type (mmbbls) Small Independents, 6391, 27% Integrated, 6384, 26% Large ndependents, 11373, 47% US net cashflow by company type (US$mm) Small Independents, 34020, 29% Integrated, 29486, 25% Large Independents, 53962,46% Key Risks for Oil Companies • Geological • Technical • Price • Costs / inflation • Commercial / Economic • Legal • Levels of taxation • Business environment • Macro-economic (global GDP, foreign exchange) • Geo-political A risk shared is a risk mitigated, especially if your partners can influence some of the outcomes Standard JV model IOC IOC Joint Venture Partnership - IOC I Asset Government Legal Institutions Regulatory Agencies Joint Venture Groupings Co A 10% Co B 20% CoD "Co E NOC 20% 25% Cash call for Funding Revenue from Sale of Oil CoC Operator 25% Joint Operating Agreement Concession or Production Sharing Agreement Typical IOC view of partnership Industry Collaboration Model Feedback * Business Develpoment Exploratior Appraisal development 2 C Partner Oil Companies, Contractor Companies and Suppliers Governments, Regulators, Universities, Local People physicalteams ► molgroup virtual teams Focus on operational issues, standard industry practices and assumption 22of a strong regulatory and legislative environment Key issues generally addressed by foreign partners • Governance and control • Compliance with various legal requirements • Appointment of senior executives • Valuation • Dividend policy and other financial issues • Management responsibility or independence • Operational issues • Non-compete issues • Export rights • Technology and technology transfer • Training and employment of local staff Corruption and Politics are often problems in oil producing countries: The "Triangle of Tension7' NOCs often delegated IOC Engagement Strategy Protection Proactivitv [ Reality j Rigour Everything revolves around Foreign Partner Releva Government control • Thanks to their geographical and geological good fortune, hydrocarbon owning countries have control over a major strategic asset • Host governments have to make key decisions over: - Allocation of licences for exploration and development - Terms for finding and exploiting any resources - Terms for rent-sharing (in other words the tax regime) - Partnership rules - Depletion strategy - Abandonment rules (the cost of removing fully-utilised equipment) - The social contract for oil industry operations The bargaining strength of oil companies and host governments shifts over time - When the risk is highest (no oil has been found) the company can extract good terms - When the oil is flowing, the government has a strong case for increasing its share of revenues 71K United Nations Declaration on Natural Resources 1952, 1958, 1962 1. The right of peoples and nations to permanent sovereignty over their natural wealth and resources must be exercised in the interest of their national development and of the well-being of the people of the State concerned. 2. The exploration, development and disposition of such resources, as well as the import of the foreign capital required for these purposes, should be in conformity with the rules and conditions which the peoples and nations freely consider to be necessary or desirable with regard to the authorization, restriction or prohibition of such activities. 3. In cases where authorization is granted, the capital imported and the earnings on that capital shall be governed by the terms thereof, by the national legislation in force, and by international law. The profits derived must be shared in the proportions freely agreed upon, in each case, between the investors and the recipient State, due care being taken to ensure that there is no impairment, for any reason, of that State's sovereignty over its natural wealth and resources. • ......(continues)........ http://www.ohchr.org/Documents/Professionallnterest/resources.pdf ^][^ Depletion policy - how fast to exploit a resource The "net present value" of an investment diminishes the longer it takes to exploit lOCs are motivated to explore and produce oil as fast as possible Governments have other motivations - Long-term future of oil resource - Preserving rent for future generations - Maximising returns over the long-term in the belief that oil prices would rise inexorably - Retain control over oil revenues to prevent undermining the rest of the economy (Dutch disease) - Slower development of oil resources to allow for technology transfer to domestic companies - Slower development allows more potential control of oil market - both prices and costs Depletion policy ideas are changing as neither oil nor gas longer appear to be a finite resource _ „ Security of supply and security of demand China's oil production and consumption, 1993-2015 China's crude oil i™P°rtsby source, 2014 Governments are concerned to secure energy supply in order to maintain economic and political stability Equally, producing countries need to find sources of demand, in competition with other countries lOCs are often caught between the two, and need to find a way to satisfy both This can often lead to difficult political negotiations ^ 9IR Licensing rounds used to award exploration acreage Government confidence in companies, and company confidence in future government policy are key elements for long-term relationship I E (0 o Reserves and Resources u (0 0 (/) 0 DC w (0 O (0 < i- LU _l g I-LU 0. > o o to □ < o a: LU o o ■ m 3 CO Q_ a LU CC LU 5 O CO a 1C CONTINGENT RESOURCES ■ 2C 3C UNRECOVERABLE PROSPECTIVE RESOURCES Best Estimate UNRECOVERABLE *- Range of Uncertainty http://qeodc.aapq.org/PRMS Guidelines Nov2011.pdf, Page 7 f E £ o o o a> o £ O ai c "to TO Not to scale Country and Company Reserves Booking • Country level reserves are collated by organisations such as the IEA, EIA and others. Many countries do not provide supporting technical 'evidence' for their declared reserves. There is significant scepticism regarding those of some OPEC countries in particular. • Companies, certainly those listed on major stock exchanges are required to comply with rules and guidelines: - BP estimates proved reserves in accordance with SEC Rule 4-10 (a) of Regulation S-X and relevant Compliance and Disclosure Interpretations (C&DI) and Staff Accounting Bulletins as issued by the SEC staff Companies are always keen to book reserves, as these then sit as assets on their balance sheet and provide a basis for valuation by shareholders Oil and Gas Upstream Investment Frameworks Concession (Tax & Royalty) Agreement Production Sharing Agreement Ministry of Oil & Gas Royalty Oil & Gas Company (ies) Ministry of Finance Debt repayment, shareholder dividends, retained profits Ministry of Oil & Gas State Share of Profit Oil Oil & Gas Company (ies) Revenue from Sale of State Profit Oil State Oil & Gas Company Debt repayment, shareholder dividends, retained profits Assessing the cost of a new development Tanker $8/bbl Main Export Pipeline Capital Costs Appraisal Wells Export Pipeline Production Facilities Development Drilling Abandonment Total Capital Costs Export Pipeline 2010 2011 100 2012 100 $ Millions 2013 2014 2015 2016 2017 500 500 1,000 2,000 2,000 500 500 500 100 100 1,000 2,500 3,000 500 500 $8.2 bn Capex Concessionary tax scheme Company is granted rights to reserve base via a fixed term lease Tax system based on a royalty paid on extraction, plus profit tax Countries occasionally impose additional taxes to supplement the royalty payment Companies can book the reserves in the fields which they are developing they effectively "own" the reserves Russian example of a tax and royalty scheme: - Revenue - (royalty + export tax + social taxes) - operating costs = operating profit - Operating profit - depreciation - profit tax = Net Profit Key issue for oil companies here is cost recovery and exposure to oil price - Royalties often have a sliding scale to reduce impact of lower prices Production Sharing Agreements - a unique legal framework TYPICAL PSA Companies recover costs and share in profit Government share increases once costs have been paid off Individual legal document that provides reduced risk for both parties, as the commitment is typically for the life of an investment Title to the oil and gas reserves remain with the state Service contract Government Oil company pays for development of field Oil company paid a fixed fee for work done on a field May have some upside potential if targets are exceeded Company has no oil price exposure Government retains full ownership of field Much lower incentive for oil company to perform well 7&K Upstream Investment Frameworks 250 200 150 100 50 0 -50 -100 -150 -200 -250 Tax & Royalty Regime '4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 I Opex I Royalty I Tax lCapex ■ cflow ■ Revenue IRR = 13.5% in both cases Production Sharing Agreement I State Profit Oil I Company Profit Oil I Company Cost Recovery Oil I Opex ICapex ■Company Cashflow Governments can generate significant revenues from the downstream business too HOW FIGURES ADD UP TO REACH THE PRICES AT THE PUMPS A PETROL i Pump price IEOEIHI pence per litre Wholesale price*24p Delivery and iqn distribution U9p Retail margin" 8.1 p \\\ Duty 57.95p NAT (at 20%) 18.4p Predicted price in 2 weeks (Based on analysis of historical data) 107.6p ±2.3p Percentage of the pump price that is duty & VAT 69.2% DIESEL Pump price IDDQia pence per litre Wholesale price* 28 p Delivery and ? ?n distribution *'*p Retail margin** 9.8p Duty 57.95p WAT (at 20%) I9.6p Predicted price in 2 weeks (Based on analysis of historical data) 115p tup Percentage of the pump price that is duty & VAT 66% 'Comprising oil production & refining. S-day average "Forecourt costs & profit SOURCf: UK pump prices and RAC Petrol and diesel prices often contain a high level of taxation In addition, governments often retain the right to limit price increases, or to insist on price declines, in times of perceived crisis Governments subsidise domestic consumption with low fuel prices Economic value of fossil-fuel consumption subsidies by fuel Note: MEK = market etc ha nje rate. bo 100 Billion dollars ■ Oil Gas ■ Coal ■ Electricity ■* Total subsidies as share of GDP (MERf I top axis) Governments of fossil fuel producing countries reserve the right to subsidies prices for domestic consumers - This is a key political tool in many countries This strategy inflates demand and reduces returns for oil companies The oil industry faces geo-political risk as a global strategic resource Geopolitical disruptors Trump's America: unilateralism, protectionism, transactionalism China: escaping Thucydides Trap Russia: revising post-Cold War order EU: towards European disintegration MENA: Thirty Years' War North Korea: always the disruptor Energy companies are often caught up in geo-political conflict They can either be directly involved (their assets are affected) or can be caught up in the economic and political consequences mm Sanctions on Russia have a direct link to energy US Treasury EO US Treasury EO US Commerce EU Finance EU Technology 13662 Directive 2 13662 Directive 4 Dept. Export Restrictions Restrictions (Financing) (Technology) Controls Transneft Yes Yes Yes Gazprom Yes Yes South Kirinskoye field Yes Yes (Sakhalin 3 - Gazprom) GazpromNeft Yes Yes Yes Yes Yes Lukoil Yes Yes N ovate k Yes Rosneft Yes Yes Yes Yes Yes Surgutneftegas Yes Yes Activity in specific regions has been sanctioned - Arctic - Deep water offshore - Shale oil Finance has also been restricted - US and EU sanctions limit the duration of debt to 30-90 days Any companies with business in the US and EU must now think twice before doing any oil business in Russia 9IR Impact of fossil fuel subsidies on renewable energy Electricity generating costs in the Middle East onshore Motes-: MWh = megawatt-noun CGGT = combined-cycle gas turbine; PV = photovoltaic [utility-scalef: CSP ■ concentrating solar power. Generating costs are for new plants coming online in 2fl£0; assumptions are available at wk^.wi^f^energy^tfook.org/weomodefAnvvstmentcoits. • Fossil fuel subsidies undermine renewables by reducing the cost of gas and oil-fired power generation • However, this may no longer be a viable strategy, given other constraints Subsidising new energy Support method Support mechanism 1 1 1 1 s s 1 1 I 1 1 I i Price premiums Providing additional revenue Cash grants • • • Green certificates Net metering • • Feed-in tariffs • • * • Providing a guaranteed price Power purchase -agreements • • • • Auction tenders • • • • • Required share or amount* • • Reducing total costs Tax credits or exemptions • • • • • • Preferential financing rates • • 1 • Accelerated de preciation * * • * Policies may specify a required share |e.g. renewable* in total generationjor minimum amount of installed capacity or generation. ^Accelerated depreciation lowers total discounted costs by delayingthe tax burden. Note: • ■ primary driver of renewable* deployment: ■ secondary d river of renewable* deployment. Sources. IEA/lHENAJoint Policies and Measure* database; lEAanalysi*. 71K Global subsidies for renewables set to continue Renewables-based electricity support 1007 2C2 0 2050 450 Scenario: ■ ■ "otal support New Policies Scenario: other CSP" ■ Solar PV P Mnergv ■ Wind off: hore wind onshore 2040 Cumulative generation excluding large hydro 200 150 ICC NPS 150 2016-40 Whiie support for renew-obre efecrricify wfJr" be needed for years to come. Iranssfio ran g fo a ^ow-carbon pathway con be achieved for just 15%- more support • Geographical spread of subsidies will broaden from OECD to non-OECD countries • At the same time fossil-fuel subsidies are likely to fall to encourage increased energy efficiency 7m Saudi Arabia is diversifying - a sure sign of dramatic change Increase wi non-oil revenues (rem SR163.5bmn20.15to SR530bn by 2020 Privatizing many and investing the proceeds of privatization in a diversified manner through the PIF. Improving ranking in the ease of doing business Preparing lor 30 million Umrah visitors and promoting Red Sea tourism wilh resorts Entrepreneurial opportunities and training tor young Saudis and creating vocational centers -----------------------------a After IPO, Saudi Aramco will enjoy better efficiency and higher productivity as foreign investors demand higher profitability Employment and activity expansions in various sectors for the benefit otSMEs ! Increasing efficiencies ! in the industrial cities : as government is | planning to rationalize subsidies AMBITIOUS VISION 2030 GOALS/ vision ci_igj 2ft30 djjgfiujjl djJ|flJI fiSlrtnll KINGDOM OF SAUDI ARABIA • Triple non-oil revenues by 2020 • Privatise Saudi Aramco, the state oil company • Rationalise subsidies across the economy • Increase domestic production of renewable energy • Improve the business environment for domestic and international companies Conclusions • The role of NOCs is increasing - lOCs are increasingly struggling to find a unique selling point • Governments of hydrocarbon producing countries are finding it more difficult to balance tax with financial incentive - Really need more oil revenues - Still need companies to invest in new production - Can't afford continuing subsidisation of domestic fuel prices - Need to incentivise new investment in renewables Partnership is increasingly taking place between lOCs and NOCs, but this carries greater governance risk for lOCs Geo-political risk to energy economy is increasing Even Middle Eastern countries are having to anticipate an increased role for renewables and a diversification away from oil and gas 71K