The history of the oil and gas industry through the 1980s has been described as the greatest industrial epic of our time. As the 1990s come to a close, its history to date would not be complete without comment on the new dominant players, privatization, and the landmark consolidation activity. And perhaps as we enter the next century a most important question to consider is this: How will these significant developments help define the industry going forward?
The quest to control the world's oil industry has been the subject of best-selling books and popular documentaries. Once dominated by the giant, private oil companies or the Seven Sisters and then by the Organization of Petroleum Exporting Countries, the industry is going through yet another shift of power as state-owned oil companies move to the top ranks as the largest oil companies in the world. These new giants are no longer operating solely within their own borders but are expanding internationally in efforts to increase revenues and market share.
In the US, for example, Saudi Aramco, the world's largest oil company, is part of a three-way alliance with Texaco and Shell for refining and marketing petroleum products on the East Coast and in the Gulf Coast region. Russia's Lukoil also has a downstream alliance in the US. Venezuela's PDVSA holds major stakes in the US retail market through its affiliate Citgo Petroleum. And, in addition to its Deer Park, Tex., refinery joint venture with Shell, Mexico's Pemex has entered into four long-term contracts and one joint venture with US refineries to secure a market for heavy Maya crude oil. With nearly a quarter of the US oil retail market now controlled by foreign oil companies, some say this competitive expansion activity by the state-owned companies is partially fueling the megamergers going on in the industry today.
This activity is not solely a US-based phenomenon, however, as producing nations' state-owned oil companies are "internationalizing" into the downstream operations in other consuming nations as well. For example, Kuwait operates refineries in Europe along with over 6,000 fuel distribution stations under the Q8 trademark. And PDVSA has shares of nine refineries and marketing joint ventures with Germany's Veba and Sweden's Nynas in Europe and the US.
Private sector capital
Even though three of the top five oil companies listed on Energy Intelligence Group's ranking of world oil companies are state-owned with no signs of change in government control, privatization efforts worldwide continue to reduce the number of state-owned companies. These new private entities are able to seek necessary capital to run more efficiently, purchase new technology, and provide better service to consumers.
The basic goals of a privatization program are largely to generate funds for the government, to improve the quality of services offered, and to show that the government is committed to supporting the private sector. Argentina's former state giant Yacimientos Petroliferos Fiscales encompassed all these factors in its carefully planned privatization process in 1993, which accounts for its status as a landmark success.
The most important elements contributing to YPF's achievement were the elimination of nonstrategic activities and the redefinition of core businesses, restructuring the organization and its human resources to fit the new business, and promoting the company to private-sector investors, both local and foreign.
What makes YPF's privatization so compelling is that its restructuring didn't happen solely on its own. It was part of an arduous process that included the state reform laws, breaking down resistance to privatization, company transformation, handling pressure groups, corporate restructuring, and its initial public offering in 1993.
The government's privatization objective was to transform the unprofitable, ill-managed, state-owned company into a competitive international oil company. Because the government was willing to change and YPF's new management was eager to learn from other leading companies, the privatization process succeeded in its objectives and became a benchmark for other countries to follow. Today, an independent YPF dominates Argentina's oil and gas sector with almost 50% of the hydrocarbons industry.
In June of this year, YPF hit another landmark when it was acquired by Repsol, Spain's largest petroleum company. The deal is considered the most spectacular in terms of size and policy implications in the history of Argentina and Spain. According to Argentina's industry secretary, Alieto Guadagni, the YPF-Repsol merger creates a giant controlling 59% of all fuel sales and 71.2% of all gas sales on the Argentine market.
In Brazil, the government is poised to follow in Argentina's footsteps as it contemplates selling a portion of its stake in state-owned Petrobras, retaining a controlling interest in the company of about 50%. Due to a recent change in company bylaws they, too, may open the sale to include foreign investors.
Russian production sharing
Russia and the former Commonwealth of Independent States have had a difficult year of economic crisis. The Russian oil and gas industry has suffered as well.
Western companies once rushing to invest in Russia's oil industry have backed off considerably, creating a dramatic shortage of investment capital. This has forced many Russian petroleum companies to step up their exports abroad and to neighboring countries where they get substantially more hard currency for their product. Nearly half of all Russian fuel oil produced during the second quarter of this year was exported. The irony of this is that a country known to be one of the largest oil producers is now plagued with fuel shortages at gasoline stations.
To secure growth capital the government has begun selling off more of its ownership in the country's major oil and gas companies in an effort to keep them from closing their doors. It is also likely that consolidation will take place in Russia's oil industry as larger, stronger, private companies like Lukoil take over smaller, weaker companies.
According to Irik Amirov, a director at the Fuel and Energy Ministry, Russia needs $5-15 billion/year for support and development of its oil industry. Production-sharing agreements and joint ventures are considered vital for Russia. However, early production-sharing legislation was extremely frustrating for companies due to its many conflicts with other laws.
The harsh realities of the financial crisis motivated the Russian government into improving the legal environment for western oil company participation; therefore, many of the problems associated with the earlier production-sharing laws have been eliminated. This is a significant step by the government as it shows that it will continue to allow exploration activities by western companies. Predictions are that the new legislation could bring up to $200 billion in investment in the oil and gas sector over the next few decades.
In fact, analysts are saying that during the next decade western companies are ready to invest around $100 billion in development of Russian oil fields. However, only time will tell if the political climate will allow these large agreements to be successful.
China could be facing shortages in coming years, but for different reasons than that of Russia. Statistics show that at its current economic growth rate, China's energy demand should grow at about 4.5%/year through 2010, outpacing its own resources. Once an oil exporter, China now imports about 30% of the oil it consumes, and that number stands to grow. A recent Baker Institute study shows China oil imports could rise to 2-4 million b/d by 2010, depending on the country's economic development.
One of the ways China is trying to mitigate its dependence on foreign oil is by internationalizing the national oil companies. In other words, the government is exploring international opportunities to acquire experience, gain exposure to advanced technologies, and have access to foreign supplies.
In the past couple of years, several of China's major oil companies have begun participating in a variety of exploration and production projects beyond Chinese borders. China National Petroleum Corp. (CNPC), for example, has completed a number of deals in Canada, Kazakhstan, Venezuela, and Sudan.
In efforts to raise additional funds and assistance for expansion, three of the country's largest oil companies, China National Offshore Oil Corp., CNPC, and China Petrochemical Corp. are all preparing for public offerings.
In other parts of Asia, the Indonesian oil company Pertamina is on the road to privatizing. Japan, South Korea, the Philippines, and Thailand are in the process of liberalizing their oil industries, but progress is slow. The maladies of the Asian oil industry could benefit from opening markets to international competition, but currently this is an unpopular solution with the established national giants.
These national companies are, however, competing with other independent majors by branching out into global markets. Malaysia's state-owned Petronas, for example, invests in oil and gas industries all over the world. Petronas also has invested in nearly all aspects of the oil industry, including exploration, refining, and retailing. Experts say Petronas will soon start acquiring assets of smaller oil companies.
It is the expansion of state-owned oil companies beyond traditional boundaries that is partially spurring the trend of industry megamergers. However, there is also the need for oil companies to drive the costs out of doing business, especially in a low oil price environment.
Companies can't control oil prices, but they can take measures to control costs and protect themselves. They can restructure by becoming involved in mergers, acquisitions, forming alliances, swapping of assets, and selling off noncore businesses. Exxon-Mobil and BP-Amoco-Arco, through their mergers or by reorganizing internally, are hoping to cut costs by $2.8 billion/year and $2 billion/year respectively.
Companies that can find ways to access the high-risk production opportunities in challenging areas at a lower cost will have the best chance for survival. This is why the mergers will continue. Mergers will give companies the size to compete efficiently for the same world oil reserves. With size comes the capital and technology needed to operate more efficiently in difficult areas and marginal fields.
The future is likely to see a few major players emerge - a new Seven Sisters - but this new family will probably contain several national oil companies. The role of the current majors could change to that of a strategic partner transferring technology and experts for a fee. The owners of the oil reserves will be less likely to turn over their reserves to foreign partners and will likely pay a fee to the foreign "contractors" to produce the reserves, utilizing their expertise and technology.
There will also continue to be the push for downstream operations in consuming nations as oil-rich countries search for outlets in the retail markets. And, even with all the recent alliances, mergers and acquisitions, and privatization activities, there are still players to be heard from such as National Iranian Oil Co., Iraq National Oil Co., and Nigeria National Petroleum Corp. as their political situations stabilize.
Consolidations are not limited to the large oil companies but will begin to reach into smaller segments of the industry such as oil field services and second-tier oil and gas companies. However, it is likely that the industry will see one or two new megamergers usher in the new millennium.
James Crump is chairman of the Global Energy and Mining Group and office managing partner in Houston for PricewaterhouseCoopers . He has overall responsibility for services to companies in the petroleum, natural gas, independent power, public utility, and mining industries. Crump has more than 30 years of experience in the energy industry, mainly in tax planning and compliance and industry globalization consulting. He was appointed to the firm's Global Leadership Committee in 1998.