Part 1: How control of oil and gas chains has evolved

EDITOR’S NOTE: This 5-part series of articles explores how different sectors of the oil supply chain are generically controlled by different international groups and how these controlling factions influence prices and fuel geopolitical tensions. This first part provides an outline of how current controlling influences have evolved and contrasts the oil and gas supply chains.

From the early days of the oil industry through the first global oil crisis of the mid-1960s and 1970s, the major international oil companies (all originating from the United States and Europe) had control of the oil supply chains and were able to dictate the price of crude oil to the major producing nations, primarily located in the Middle East. The host governments of those producing nations were unable to influence prices and were marginalized from participation in midstream and downstream activities, which were conducted in the consuming markets.

Lifting costs to export points were very low in the main producing countries, indeed less than the transportation costs of moving the crude to Europe and the US in some cases. By establishing an industry structured in such a way, the vertically integrated, international oil companies (IOCs) were able to drive a wedge between the producing nations and the value-adding downstream activities within the main OECD consuming markets, a situation that has persisted to the present day.

This series of 5 articles reviews how these parties (i.e. producing nations and IOCs) control key upstream and downstream sectors of the oil industry and how that has historically impacted crude oil prices, market shares, and value extracted from oil.

Who controls the oil supply chain?

The IOCs have gained control of cost, value, and price of the world’s most important energy commodity. Pre-1970s the IOCs were referred to, and referred to themselves, as “the” oil producers without, or with just a cursory reference to the producing nations themselves. They were able to do this because the long-term licenses and contracts signed with producing nation governments granted IOCs concessions over vast tracts of land, including title to hold, develop, and produce any reserves resulting from successful exploration. Also it was the IOCs that conducted exploration, managed the physical lifting and transportation of the oil and developed the technology to make such operations possible and efficient.

In such circumstances, it is little wonder that the producing nations perceived this as arrogance and exploitation by the consuming nations and the IOCs and saw the need to exert their influence and control over at least the upstream sector. This was done, mainly in the early 1970s, through nationalizations of reserves and infrastructure and offering IOCs access to those reserves though production sharing contracts (PSCs) in which the IOCs at no stage held title to the reserves themselves.

The formation of the Organization of Petroleum Exporting Countries (OPEC), which operated as a strong cartel for the main producing nations - not just in the Middle East, enabled them to wrest control of reserves and in some cases production from the IOCs. The extent to which the OPEC nations dominate proved oil reserves holdings globally is illustrated in Figure 1. But, as this series of articles will demonstrate, holding title to reserves is quite different from extracting value from them.

OPEC’s new power was placed under the management of newly formed national oil companies (NOCs) controlled by a petroleum ministry. This whole process led to political instability, an almost tenfold increase in oil price (~US$4/bbl to ~US$40/bbl) and global recession in the mid-1970s and early 1980s.

This action precipitated for the first time an international standard or benchmark price for oil (the OPEC basket price), which was outside the control of the main consuming nations and their IOCs. At the same time this action also cost OPEC nations a significant loss of market share as the non-OPEC consuming nations and IOCs invested in finding and developing alternative supplies of oil from non-OPEC countries.

Nevertheless, the IOCs still held control over production operations and technology in most producing nations and crucially the IOCs, together with major consuming nation (OECD) governments, retained full control over the downstream value-adding sections of the supply chain. Attempts by OPEC to exert control further downstream with refiners, for example, the netback pricing initiative of Saudi Arabia offering crude oil prices to refiners that delivered them a “risk-free” guaranteed netback from their product prices, proved to be disastrous from OPECs perspective.

By 1985, netback pricing had led to oversupply in the world markets and a collapse in crude prices to close to $10/bbl. Producing nations now had control of their reserves, but had lost market share, failed to extend their influence downstream, and volume sales could only be sustained until the end of the 1990s at modest prices (i.e. some $12 to $20/bbl).

Some would argue that what emerged from the events of the 1960s to 1980s was an industry polarized by two cartels: OPEC controlling upstream reserves; and IOCs controlling the rest of the supply chain, with the independent oil companies providing small-scale competition and the appearance of an open and competitive supply chain beyond reserves.

That is not to say that the downstream sectors in OECD countries are not open for the national oil companies of major producing nations to participate, and some have done so by buying the publicly traded stock of companies operating in those markets (e.g. PdVSa of Venezuela acquired US refiner and petroleum retailer CITGO; KPC of Kuwait operates a chain of retail fuel service stations under the Q8 brand in the UK and elsewhere across Europe).

However, for the most part, it is the IOCs that have elected to maintain control of the downstream infrastructure, particularly the refineries that they built, even when on a stand-alone basis refineries have in the past often appeared to be providing them with only marginal returns. The value of OECD located refining infrastructure is not just in the net returns from products sold, but also in providing access and controlling the flow of oil into the key OECD markets, which provides some power over crude oil prices.

Contrasting controls of oil and gas supply chains

The natural gas industry, in contrast with oil, did not develop along such lines. Indeed in most OECD countries until recently state-owned utilities held, and in many case still retain, monopolies on distribution and marketing of gas to consumers, which prevented IOCs taking significant interests in that sector.

In recent years they have taken some gas marketing and infrastructure positions, but do not enjoy a dominant position. Also some producing nations are now seeing the value of taking infrastructure positions in the OECD gas markets (e.g. Gazprom and Qatar Petroleum).

Until the recent rapid growth and global diversification of the liquefied natural gas (LNG) trade, now some 25% of the international traded global gas market, the gas industry could not be considered as a global or intercontinental market. It remains predominantly regional in nature and, unlike the refining of oil; natural gas has few opportunities to add value in the downstream sectors of the supply chain, except for gas storage, peak shaving, and using gas as feedstock for petrochemicals and, potentially, gas-to-liquids.

Comparing the global distribution of proved oil and gas reserves (Figures 1 and 2) emphasizes some key differences that go some way to explaining the lower level of influence that the Middle East has on the gas supply chains, and conversely, the greater influence and competition offered by Russia and the Former Soviet Union (FSU) nations with respect to gas.

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Figure 1 shows how remaining oil reserves are distributed among international groups. OPEC controls about 75% of those remaining, and the Middle East OPEC nations alone control approximately 60% of global proved oil reserves.Click here to enlarge image

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Figure 2 shows how remaining gas reserves are distributed among international groups. Middle East nations control some 40%, with Iran and Qatar accounting for 15% and 14%, respectively, of global remaining proved gas reserves. However, it is the 32% of global gas reserves controlled by the Former Soviet Union (FSU), with Russia alone controlling 27% that really distinguishes the global distribution of gas reserves.Click here to enlarge image

A large fraction of costs in the gas supply chains are associated with moving the gas long distances particularly in building and operating the transportation and distribution infrastructure (i.e. pipelines, LNG vessels, storage tanks, and regasification terminals) as well as in the cost of developing and producing the commodity. This lack of value-added opportunities provided few incentives for the OECD consuming nations and IOCs to take control of, and attempt to monopolize on a global scale, the downstream gas sector in a similar way to their positions in the oil supply chain.

Indeed global price benchmarks for natural gas are still lacking with trading mainly taking place regionally in long-term contracts and large-scale spot trading confined to the liberalized US and UK markets. However, recent development in terms of citing gas-to-liquid (GTL) plants and modern petrochemical plants at the upstream end of the gas supply chain (e.g. Qatar) suggest that the producing nations are laying the ground work to secure control of value-added activities as they materialize.

Also in LNG, Qatar Petroleum in joint venture with Exxon Mobil Corp. is taking equity positions in regasification plants under construction in European and US market locations.

About The Authors

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David Wood [woodda@compuserve.com and www.dwasolutions.com] is an international energy consultant who specializes in the integration of technical, economic, risk, and strategic information to aid portfolio evaluation and management decisions. He holds a PhD from Imperial College, London. He is based in Lincoln, UK but operates worldwide.

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Saeid Mokhatab [saeid_mokhatab@hotmail.com] is an advisor of natural gas engineering research projects in the Chemical and Petroleum Engineering Department of the University of Wyoming. He has published more than 50 academic and industrial papers, reports, and books. In addition to his technical interests, he has written extensively in wide circulation media in a broad range of issues associated with LNG, LNG economics, and geopolitical issues.

Control & influences on world oil price

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