Petroleum industry faces tectonic shifts changing global energy map

The past is not prologue. New forces are reshaping the energy industry's structure, its organization, and markets, driving it toward a future that will be very different from anything it has ever seen. These forces are focused on the real issue-energy. Not just the energy used to cook food, generate heat and air conditioning, and move people and things from one place to another, but energy in all its meanings and implications-global, political, economic, and technological-that will determine who controls it in the future.

Success for an upstream energy company will depend to a great extent on how well it anticipates, understands, and takes advantage of emerging opportunities while maintaining its focus on the primary goal of finding and producing oil and gas and transporting, processing, and marketing the commodities that result from that effort.

Structural shifts

The oil and gas industry is undergoing a massive structural shift driven by four major changes that influence the fundamentals of today's energy marketplace and that will mold the petroleum industry of the 21st century:

• Supply. Despite the recent reassertion of OPEC (Organization of Petroleum Exporting Countries) influence over changes in production volumes, reviving prices from historic lows, the growing competition between oil and other fuels will produce continued price and margin pressures.
• Globality. The emergence of globality-the worldwide linkage of economies-has increased the speed and volatility of business worldwide, opening new markets and customers for companies, while giving customers global access to products, services, and information.
• Technology. Technological innovations will continue to play a key role, from information technology and operating technologies that have vastly improved downstream, midstream, and upstream capabilities to the technologies that shape how energy is used.
• The consumer. Growing in importance are the increased power of consumer demands and expectations and how the industry is thinking and reacting in response.

Developments and activity in each of these areas is a significant influence in current day-to-day industry operations, and their long-term implications need to be at the top of each management team's agenda in planning structural alignment, strategic direction, and capital needs for the coming decades.

Supply

While today's supply-demand picture is almost certainly not be a permanent situation, it is a clear indication of the influence a coherent producer strategy can have on the market.

Oil prices have improved because countries belonging to or aligned with OPEC are holding back a significant amount of production. The global oil surplus still exists, even though the oil is not physically in the market. It will come back one day; the only question is whether it hits markets in a controlled or uncontrolled manner.

However, even without the actions of OPEC and the critical non-OPEC countries, there is some question whether oil can withstand the growing competition from other fuel sources. The growing electric power generation capacity in North America, Europe and other regions of the world, combined with increasing natural gas resources seeking markets, provide a large energy resource. The result is plenty of energy seeking markets and competing in the same marketplace, posing a real challenge for the industry.

As the global economy recovers and expands at uneven rates and in response to varying needs in different regions, one of the most difficult competitive challenges will be to align a company's growth plan to meet future needs and opportunities with the optimal set of answers while delivering cost-effective solutions ahead of competitors and with a satisfactory return for shareholders.

There may remain some companies and organizations able to survive and thrive with an isolated concentration solely on their own operations and performance. But when ubiquitous, interchangeable btus can move virtually instantaneously across borders and through markets, traditional pricing and competitive models can quickly become outmoded.

Globablity

Globality addresses the concept of a hyperconnected, 24-hr/day world in which citizens anywhere have access to products from any other part of the world. As markets expand and become increasingly deregulated, the opportunities and challenges expand exponentially. It is a world in which governments have decreasing leverage over their own economies.

With the growth and acceptance of the internet and e-commerce, more and more energy companies will find themselves on-line, interacting directly with consumers, understanding their needs and wants, turning commodities into customized products and services that fill their demands.

Managing, competing, and surviving in this new environment can require radical new thinking. We have seen a preview in the kinds of adjustments-and the consequences of not being able to make them-that are resulting from deregulation in the US natural gas and electric power markets.

Technology

Technological advances have historically produced dramatic improvements in the petroleum industry's bottom line. Whether in operations or in administration and communications, the result has been a spectacular improvement in the power of companies to explore for and produce, refine, and transport liquids and natural gas; run plants and pipelines, manage their entire inventory and product management system, and sell gasoline and consumer products.

From the technology that goes into the ground-coiled tubing, horizontal drilling, new geophysical techniques-to IT as a facilitator of productivity and performance improvement, companies can do virtually everything better and less expensively than they did just 5 years ago.

Technology is also dramatically affecting the volumes of energy used and the ways that energy is used. New measurement and communications technologies enable manufacturers to maximize efficiency in both the production process and in product use.

New technologies will reshape the competitive landscape in every area-transportation, power generation, storage, monitoring, and use - that affects the industry's future, primarily by making it possible for the ultimate consumers to exercise an unprecedented influence in the design, marketing, pricing and ultimate acceptance of the industry's products and services.

Customer demand

The technology of using energy has changed, dramatically expanding the power of energy choice to many sectors of society. The distribution of energy has reached the point where individuals can buy energy in several different forms for delivery right to their home or business. Or they can make their own energy, using improved batteries or microturbines. It is possible that the new energy issue of the coming decade is that control of technology to use energy is more important than the control of the natural resources.

In order to compete successfully, companies will have to focus more than ever on understanding the market, not in terms of whether or not it will grow, but in terms of who the consumer is. What is the consumer buying, how do you distribute to the consumer more than the consumer wants, and how do you, the company, increase your value to the consumer in terms of providing service that is more valuable than simply delivering the raw material, the btu?

Geopolitical forces

Layered on top of increasing structural change is the geopolitics of energy. The Middle East has been the oil focus of the world for years, but a major shift is taking place in Iran, Iraq, Kuwait, and Saudi Arabia as they consider whether to allow private international companies to enter their oil and gas markets.

But not all companies would have access to these markets, so this could change the face of the entire industry. It would set new standards for the companies allowed to claim Middle East resources and assets as part of their portfolios and for those wanting to change the nature of their portfolio management by acquiring more Middle East assets and selling assets outside the region.

While the Middle East is important, however, it is just one chapter in the global story. With the worldwide linkage of economies, no single economy can be viewed in isolation. What happens in one part of the world affects countries in other regions, only faster and with more volatility than ever before. Commodities such as oil, natural gas, and electric power are traded interchangeably and instantaneously in an electronic web that connects every country around the globe.

State-owned energy companies have been disappearing as countries privatize the assets, bringing in outside capital and companies. The industry has been involved in an explosion of mergers, acquisitions, and divestitures as companies restructure to gain scale or develop niche opportunities and become more competitive.

Russia and the former Soviet republics will be a huge oil and gas resource, but they are still waiting for political stability and direction in order to bring the resources to market. With the opening of natural gas and electric power markets in Western Europe, large state utilities have been able to sell power to other nations, increasing the competition in the entire region and benefiting individual consumers at the same time. Deregulation of power markets in Germany has produced a decline of 60-70% in electricity prices, an amazing change in a short period of time. And this will happen throughout the European marketplace for electric power.

While the Asia-Pacific economic crisis was a major depressing factor for global energy markets, it appears the worst is over. However, the question of a major recovery in the region depends on China and continued strong growth in India, as well as the durability of reform efforts in Southeast Asia. Japan also will have to work out its continuing problems with its banking system and lack of demand in its domestic markets.

The strong economy of the US and demand in North America has been the backbone of worldwide oil and energy demand during the past 18-24 months.

However, a question that continues to hang over the world economy is how much longer this situation can continue, and how much stronger can the US economy become? The markets have been forecasting the next US economic downturn for the past 3-4 years, so the possibility that this forecast will come true becomes more likely the longer growth continues.

If it happens, will there be another shift in the energy markets or another price collapse? If there is any major downward movement in the North American markets, it could be offset by Western Europe, which is beginning to show strong gains.

Drive for size

Another force producing great change in the industry is the drive for size. All energy companies, whether large or small, are focused on the same marketplace. The impact and result may be different for each company, but they are ultimately competing with one other.

The drive for size helps companies cut costs by spreading them over greater areas and taking advantage of greater economies of scale. Unfortunately, this strategy often has the unintended consequence of driving down the basic value of the raw materials, oil and gas, which requires that more resources be found and better technology used in order to reduce costs so that the process of finding the raw materials can continue.

But big is not the answer for all. The industry now has several tiers of companies, including a new "super league" of three or four companies. In all these tiers, there is room for companies to be successful in the new energy markets, but they have to become more than companies that find, produce, and deliver commodities such as oil, gas, and electricity. They must become "service" companies, playing by new rules that focus on:

• Consumers-understanding who they are, what they want, and delivering services matched to their needs and desires.
• Service rather than products-turning commodities into customized services that respond to customer demands, delivering added value.
• Technology-to cut costs, to develop innovative products and services for customers, to deliver better products and services faster.

This is a more exciting period for the energy industry than any in decades. Energy companies that are successful in the future will be those that become energy service companies. They will have a global perspective, looking to the entire world for opportunities to expand their customer base. They will become as much technology companies as they are energy companies, finding innovations that cut costs and new ways to communicate with customers and discover what they want. They will develop innovative products and services to meet those demands and deliver added value on top of it all.

Companies will be forced to look at their products differently, applying evaluations based on criteria of "sustainable development." Considerations such as environmental integrity and social equity will receive increased emphasis among many significant constituencies. Companies that have been accustomed to addressing only a central government for required permissions will increasingly have to face local citizens and pressure groups in connection with decisions to locate energy facilities.

They will have learned three key lessons from other business sectors-including technology, telecommunications, and financial services companies-that have preceded the energy industry through this massive transition:

• Use technology to cut costs; then convert the cost savings into innovative products and services.
• View globality as an opportunity to expand the customer base and tailor services to match local needs.
• Shift from products to services, turning commodities into customized services with value to customers searching for a better quality of life.

The energy industry can and will do the same. Its history is one of adapting, surviving and prospering in the most difficult and changeable environments. But it's safe to expect that the oil and gas industry of 2025 will bear even less resemblance to today's industry than today's business does to that of 1975, or even 1950.

It will be a most exciting, interesting and-if managed intelligently and constructively-a most productive transition period for the worldwide energy industry.

The Author

Joseph A. Stanislaw is cofounder and President of Cambridge Energy Research Associates, a leading international energy research and advisory firm. He is an internationally recognized authority on economics, energy markets, geopolitics, and corporate strategy. As president, he oversees the global operations and the management for CERA. His latest book The Commanding Heights: The Battle Between Government and the Marketplace That Is Remaking the Modern World, coauthored with CERA cofounder and Chairman Daniel Yergin, examines the diminishing role of the state and the growing role of private enterprise in the world economy. Stanislaw was a professor and lecturer in economics at Cambridge University and a member of the Energy Research Group in the university's Cavendish Laboratory and subsequently senior oil economist at the International Energy Agency. He holds a PhD in economics from Edinburgh University and a BA from Harvard University.