The petroleum industry underwent major change in the last years of the 1990s. Fluctuations in oil and gas prices and increasing competition forced energy companies to reshape themselves to reduce costs.
They had already trimmed their organizations in the first part of the decade. And, faced with the oil price crash of 1998 and early 1999, companies accelerated a long trend of mergers and acquisitions. By the end of 1999, the global roster of energy companies looked much different than it had in late 1997.
At the end of the 1990s, many factors were working to change the face of the petroleum industry. The national oil companies of key producing countries that had once seemed all-powerful began aggressively to court multinational private firms and their investment capital. This shift in the relationship between the resource owners and the capital and technology providers brought global politics to the forefront of the industry landscape.
At the same time, a change was taking place in the division of work between operating companies and service-supply firms. With oil companies watching costs closely, upstream service companies and downstream engineering and construction contractors were taking a growing role in technology development and were increasingly required to shoulder more of the technical risk in industry projects.
Amid these intercompany changes, shifts were taking place within companies, as well. By the late 1990s, petroleum firms were, by necessity, exhibiting a growing awareness of social and environmental issues and the important role they play in financial success; they were viewing good performance in environmental and social matters as a strategic competitive advantage.
All of these influences were portending a new era in the global petroleum industry-one in which the definitions of a national oil company, a multinational major, and a service-supply firm would change dramatically.
National vs. multinational
At the 1999 Offshore Technology Conference in Houston, a panel of industry experts considered the changes at work in the energy industry and their implications for the new millennium.
Luis Giusti-former president of Petroleos de Venezuela SA and senior advisor and consultant with the Center for Strategic and International Studies in Washington, DC-characterized the industry environment at the end of the 20th Century as one of growing demand, technological evolution, and increasing competition.
"This is a welcome result," he said. "It`s what societies and governments want."
But what implications does it have for the future structure of the petroleum industry?
In mid-1999, national oil companies (NOCs) owned 90% of the world`s oil and gas reserves and were responsible for 70% of oil and gas production. But the NOCs were in need of technology, management skills, capital, and markets, said Robin West, chairman of Petroleum Finance Co. This is why countries with state petroleum companies had been inviting outsiders to participate in exploration and development projects as well as in refinery and petrochemical plant construction.
In 1999, for example, Brazil opened up its upstream sector to private Brazilian companies and foreign oil operators; India held the first exploratory licensing round under its New Exploration Licensing Policy at the same time its first two private-sector refineries were preparing to start up; and Iran was seeking foreign investment in support of an aggressive expansion of its petrochemical sector. Meanwhile, Saudi Arabia and Kuwait-countries whose exploration and production sectors had long been closed to outsiders-also revealed that they were considering opening to foreign investment.
"The situation where the money is held by the private firms and the resources are held by the NOCs is insupportable," said West. "This will drive a fundamental change in the structure of the industry."
What this means is that, over time, international oil companies will take over a greater percentage of global oil production, even though the NOCs will still own the majority of the resources.
Managing oil markets
Giusti noted that the industry had crossed over a threshold, with oil traded more than before as a commodity. Such trading meant low prices in the long run, and when prices remain low, supply is at risk, he said.
This principle was illustrated by the events that took place in the global oil market in the months succeeding Giusti`s remarks at OTC in May 1999. Two months earlier, the Organization of Petroleum Exporting Countries had, together with key non-OPEC producers, agreed to restrict oil supplies as a result of an extended price collapse. In the months that followed, OPEC maintained its compliance with the pledged supply constraints at unprecedented levels, and oil prices responded, more than doubling by late September 1999 from levels of the preceding February.
The oil industry has always been subjected to some kind of supply constraint, said Giusti. When several producers agree to implement a supply management regime, he added, it is for one of two reasons: Either they think it is sustainable, or they do it as a short-term response to a financial crisis.
The latter was obviously the case with OPEC`s March 1999 agreement. And the tactic worked. But what is the price of equilibrium? Giusti asked.
The failure of a similar supply management system led to an oil price shock in the 1970s, he said. At that time, the 10 largest producing countries controlled 80% of oil production; now they control less than 60%.
"I think they have proven that there is no way they can maintain a stable supply management system in the long run," said Giusti. "Not even OPEC countries are going to do it."
Another OTC panelist-Max Lukens, chairman, chief executive officer, and president of Baker Hughes Inc.-agreed. A supply increase of 2-4 million b/d could "throw the industry back into chaos," he said.
In September 1999, London`s Centre for Global Energy Studies was making a prediction that also indicated a lack of faith in OPEC`s supply-management abilities.
At a joint CGES/Oil & Gas Journal conference in Houston, CGES Chairman Sheikh Ahmed Zaki Yamani said that, unless OPEC quickly eased oil production constraints, oil prices would rise high enough to entice non-OPEC producers to raise output, thereby causing OPEC to lose market share and possibly triggering a price decline.
Giusti believes that supply management schemes such as the one OPEC implemented in 1999 are unnecessary, and that prices will eventually stabilize. Although producers may continue to attempt some form of supply management, he said, "We should prepare for a different kind of world."
At the OTC panel discussion, Tony Hayward, group vice-president of BP Amoco Exploration, said the industry had reached a point where, in general, supply will remain permanently high and prices permanently low. And, in a world where supply tends to exceed demand, business success comes from stimulating demand.
"This is clearly what is going to happen in the gas business," said Hayward.
In late 1999, the long-term oil price forecast of Fesharaki Associates Consulting & Technical Services Inc. agreed with Hayward`s prediction of low oil prices and Giusti`s expectations of stabilization (Fig. 1).
OPEC`s role
OPEC played a key role in the oil industry for 4 decades. Hayward described the organization`s evolution in an article in Oil & Gas Journal in December 1999.
"OPEC, which was founded in 1960, has gone through a history that can be thought of in two parts: first, a period of isolation following the expropriation of assets and the expulsion of most of the majors from the majority of OPEC countries; and second, a period of partnership, starting with Venezuela, Algeria, and others inviting the international industry back to participate alongside the national oil companies in the early 1980s (Fig. 2).
"This period of re-engagement is continuing, with Iran, Kuwait, and, most recently, Saudi Arabia indicating their willingness to offer some opportunities for foreign oil company involvement. Looking forward into the next century, we see this phase transitioning to a third phase, with the international industry managing increasingly more of OPEC`s production under various types of service contracts based on incentives."
In the final years of the 20th Century, there was much speculation that OPEC`s era of influence was coming to a close. But the role OPEC played in rescuing the industry from the extended period of low oil prices in 1999 would seem to indicate otherwise.
"Two years ago, everyone said OPEC was dead," said West of Petroleum Finance. "But only 2 months ago (in March 1999), no one was saying it." He said OPEC would continue to play an important role in world oil markets.
Post-consolidation
The late 1990s brought a series of mergers and acquisitions that also promised to change the nature of the oil industry. Independent upstream firms were merging to create "superindependents," and a new league of "megamajors" was formed through two sets of serial mergers.
The megamajors group, formerly occupied only by Royal Dutch/Shell and Exxon Corp., was joined by the newly merged BP Amoco, which quickly announced plans to swallow up ARCO. Meanwhile, French major Total merged with Belgian integrated firm Petrofina SA, creating TotalFina SA, which then launched a takeover of Elf Aquitaine.
In mid-1999, most in the industry were expecting the wave of mergers and acquisitions to continue for a time. This caused some concern that petroleum would soon be dominated by a small number of private-sector monopolies.
The OTC panelists agreed that this was not a likely outcome. BP Amoco`s Hayward noted that his company`s oil production was equivalent to only 3% of global demand in early 1999. In other commodity industries, the top four or five companies control 75-80% of the market, he said. Consolidation "hasn`t gotten (the industry to) the efficiency level it needs to get to yet," he said.
Lukens added, "Consolidation, to date, has done a wretched job of raising...prices"-a fact that supports the argument that oil industry mergers won`t lead to market monopolies.
Major vs. independent
West described the changes occurring in the boundary between small independent firms and major oil companies.
Before 1992, he said, companies were divided into three categories: global majors, such as Royal Dutch/Shell and British Petroleum PLC; international majors, such as Amoco Corp. and Elf Aquitaine SA; and emergent firms, such as Lasmo PLC, Amerada Hess Corp., and Enterprise Oil PLC.
What developed as a result of the consolidations in the late 1990s was what West called "the size imperative." At the end of the decade, companies could be categorized in one of four ways: little little firms (independents), big little firms (superindependents), little big firms (integrateds), and big big firms (megamajors).
Hayward said this division was unstable and therefore short-lived because the companies in the two middle categories-big little firms and little big firms-would tend to make deals catapulting themselves into the next category.
West agreed, calling the category of little big firms "the Bermuda triangle of this business"; he didn`t believe it would exist in 10 years.
What has all the consolidation gained those companies that took part in it? Not a lot, said the panel, at least not by mid-1999.
Hayward pointed out that, in mid-1999, when consolidation was already well under way, the upstream, downstream, and petrochemicals sectors were all at the bottoms of their respective cycles simultaneously. This, he said, indicated that integration had had little apparent benefit. The benefits existed, he added, but were tough to quantify.
At that time, said West, the independents hadn`t responded yet to the changes in the industry by readjusting their strategies.
"Cost cutting really isn`t a strategy," he said.
"Companies need new strategic directives in the new times." The petroleum industry has, in the past, been graded on a volumetric basis, he said, but Wall Street is less interested in quantities than in financial metrics.
"There`s going to be a new class of competitors (that is) well-capitalized," West predicted. His list of critical success factors for this successful group of energy companies is shown in Table 1.
Maarten van den Bergh, president of Royal Dutch Petroleum Co., concurred with West`s view that cost cuts were not enough to ensure financial success. Speaking at the annual Pacific Petroleum Insiders meeting in Singapore in September 1999, he said, "In recent years, the industry has been fighting for competitiveness by stringent cost-cutting. There is no doubt that strong emphasis (on this) will remain essential, and technological developments will expand the possibilities for this. But today, cost control must be allied to new ways of getting value from operations.
"Traditional competition among the integrated oil majors is still strong. Now, we also contend with competition from niche operators in refining, independent gasoline marketing, and...natural gas. Those operators have no cost heritage of capital employed in integrated, globally spread operations. In general, they are fast-moving and responsive to specific opportunities."
As a result of this increased competition from smaller, niche firms, integrated companies must seek new competitive approaches, said Van den Bergh.
West also saw room for improvement in company efficiencies. He noted, for example, that "most oil companies are very bad at portfolio management."
A properly designed portfolio would have segments that perform differently under different market scenarios, he said. This will help companies weather the storms that inevitably arise in a volatile industry like energy.
"To think in portfolio terms will be a clear differentiator," said West.
Operator vs. service
Another fundamental shift taking place was in the relationship between operators and service companies.
During the 1990s, said Hayward, service companies took a growing role in operations. "I don`t see this as a bad thing, a threatening thing. I think it`s a healthy development and one that is likely to continue."
As West saw it, in the new industry paradigm, service companies will manage the technical and operating risk while the international firms manage the financial and political risks and the NOCs manage their national interests and resources.
West illustrated the changing relationship between operating companies and service-supply firms with the example of Venezuela`s Dacion project. After winning the project, Lasmo signed an agreement with Schlumberger under which Lasmo would manage the financial and commercial issues and Schlumberger would do essentially all of the physical work.
"More and more of these kinds of things are going to be carried by the service companies," he said.
Lukens agreed. If his firm can help an operator reduce costs and increase production, and do so in a socially and environmentally responsible way, he said, then it will wager the quality of its service on its promise to improve the operator`s cash flow.
"We`ll bet the process, if you will, rather than provide discrete products and services," he said.
The same sort of shift was occurring in the downstream sector, where the "build, own, and operate" type of contract-a sort of outsourcing arrangement for an entire unit or plant-was becoming common.
In addition, according to representatives of the service-supply industry, operators had become brutal in the way they structured contracts. In the environment as it emerged at the end of the 1990s, every detail is checked carefully, and any hint of a cushion is removed, thereby leaving no room for error. And, as in the upstream sector, downstream deals are often based on performance improvement rather than work done.
Much has been made of the transfer of more and more responsibility for technology from operators to service firms, leading some to conclude that oil companies will eventually abandon their research efforts. Lukens said this is not likely.
"The customer has not abandoned technology." They`ve outsourced it in many areas, he said, and they often help with funding and direction.
Other forces
Another force threatening to change the ways petroleum companies conduct their business was growing concern for the environmental and social effects of industry operations.
John Elkington, chairman of the UK consulting firm SustainAbility Ltd. and one of the world`s leading experts in this area, asserted that, increasingly, companies must think in terms of what he termed the "triple bottom line," or TBL: economic prosperity, environmental quality, and social justice.
Companies used to think of environmental and social issues as necessary evils-unpleasant matters that cost money and must be managed. But progressive companies-BP Amoco and Shell are notable examples-were increasingly looking to this as an area in which to differentiate themselves from their competitors.
Elkington saw it as even more important. To refuse the challenge of thinking in TBL terms is to risk extinction, he said.
These are not issues reserved for major multinational corporations, said Elkington, who moderated the OTC panel discussion. Increasingly, the pressure will be passed down the supply chain to smaller suppliers and contractors.
"These changes flow from a profound reshaping of society`s expectations and, as a result, of the local and global markets business serves," said Elkington. His summary of the wholesale changes expected to result from a shift to triple-bottom-line thinking is shown in Table 2.
Hayward countered that, while society expects something to be done to clean up the environment, it is not yet willing to pay for it. Rather, it expects industry to foot the bill.
And West noted that, while the TBL goal is certainly valid, it is very difficult for weak companies to focus on it. "In the end, they will be dragged toward the money."
Increasingly, however, it is unacceptable for companies to make loads of money and still have "crummy environmental performance," said West. "I think the days of the robber baron are over."
He added that the three components of the TBL are not yet rewarded equally. Hayward agreed, saying that the ability to attract capital is driven by financial performance, not by social or environmental performance. Until companies are rewarded and punished for poor environmental and social performance as much as they are for poor financial performance, there won`t be a level playing field for the three legs of the TBL concept, he said.
But at least one company-Innovest Strategic Value Advisors Inc., an investment advisory firm that specializes in environmentally oriented finance and investment opportunities-believed this was changing in the late 1990s.
Innovest evaluates the performance of companies in various industries in the areas of environmental risks, opportunities, and management skills. It assigns firms an "Ecovalue 21" rating.
Superior ratings reflect below-average risk exposure, above-average risk-control capability, and an ability to capitalize on environmentally driven business opportunities, said Innovest. Companies at the low end of the scale have poorer environmental performance records, higher risk, and less capacity to manage risk.
Innovest said its ecovalue scores are intended to project future stock market performance.
"Among petroleum companies, wide variations exist in environmental risk exposure and management capability to manage risk and capitalize on environmentally driven business opportunities," said the firm. "These differences have strong implications for stock price performance yet are not captured by conventional analytic methods. (This is) evidenced by the frequently large diversity in Innovest ratings among companies with similar debt and equity ratings."
The firm was confident in the ability of its ratings system to predict market performance, which indicated that environmental performance does have an effect on the bottom line.
"In every sector rated by Innovest, companies receiving above-average Ecovalue 21 ratings outperformed below-average companies by 300-1,800 basis points (3-18%), as measured by total stock market return. Investor returns can be substantially improved by investing in companies with superior eco-efficiency," said Innovest.
"Going forward, the stock market performance differential between top and bottom environmental performers will likely expand as environmental regulations, public concerns about the environment, and market demands for more environmentally responsible products and corporate policies continue to increase."
Innovest`s list of key environmental issues is shown in Table 3, along with the firm`s recommended areas of focus for improved environmental performance.
In this area, Elkington saw need for major change.
"This is an industry that needs to reinvent itself," he said. "Sustainable development and the triple bottom line...are increasingly the way your companies are going to be judged."
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Iran announced a major initiative in 1999 to draw private-sector investment into its petrochemical industry. To kick off the program, National Petrochemical Co. held its first Iran Petrochemical Forum, at which it presented its expansion plans and fiscal incentives to potential investors from major international petroleum and petrochemical firms. Iran is one of several countries with largely state-owned petroleum industries now opening its doors to foreign investment. Shown here is NPC`s petrochemical complex at Tabriz.
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Table 3
Environmental strategy recommendations
Top environmental issues:
- Global climate change
- Increasing restrictions on refinery emissions
- Changing petroleum product specifications
- Growing exploration restrictions
- Increasing waste management and emissions disclosure requirements
- Site remediation liabilities
- Offshore facility decommissioning
- Tightening chemical regulations
Environmentally driven business opportunities:
- Increasing focus on natural gas reserves and production
- Alternative fuels (non-fossil fuels, low-emissions fuels)
- Power generation
- Renewable energy
Environmental management strategies:
- Expand environmental strategy beyond compliance with requirements, to take advantage of environmental business opportunities
- Implement environmental risk-management systems (environmental policy statements, ISO 14000 certification, strong commitment from upper-level management)
- Stakeholder communications (company environmental reports, interaction with citizens groups, social communication in sensitive areas)
- Eco-efficiency programs (energy efficiency, waste recycling and minimization, wastetreatment, emissions reductions)
- Technological innovation (fuel switching and management, improved petroleum products, low-emissions processing techniques, gas-to-liquids conversion)
Source: Innovest Strategic Value Advisors Inc.
Operator-contractor alliance helps redevelopment project in Venezuela
LASMO PLC WON THE DACION REDEVELOPMENT project in eastern Venezuela with a $453 million bid in Venezuela`s Third Operating Agreement Round in June 1997. The block is in the Oficina trend, one of two prolific trends in eastern Venezuela.
Lasmo had long been considering investing in the country and had bid-although unsuccessfully-in its first exploration round in 1996. When Lasmo saw the high quality of the projects on offer in the Third Operating Agreement Round, the company established an alliance with Schlumberger that gave Lasmo the technical support it needed during the evaluation phase.
The alliance provided for continued technical and managerial support in the event that Lasmo won the redevelopment project.
The agreement was innovative and thought by some in the industry to be a model for future cooperation between operators and service-supply firms.
Schlumberger did not participate in the bidding and was not an equity partner in the project. Instead, the oil field service-supply firm was to provide services on a fee basis, with fees linked to the economic return generated by the Dacion project.
Project success
The Dacion block contains four oil fields, of which Dacion is the largest. Original oil in place (OOIP) was reportedly 2.2 billion bbl at the time of the third round.
In February 1998, production from Dacion Block was 10,000 b/d, and about 15% of OOIP had been extracted during the 50 years the field had been producing. The block was 70% unexplored when Lasmo won the project, however, and the firm considered the block to have considerable exploration upside. It won exploration rights on the block for 7 years.
Lasmo assumed operatorship of Dacion Block on Apr. 1, 1998. It divided its redevelopment plan into two phases.
The first phase, to end in 2001, involved a planned investment of $750 million to reach a production level of 90,000 b/d and increase reserves by more than 500 million bbl. This was to be achieved by applying high-resolution 3D seismic, infill drilling and horizontal wells, modern logging techniques, integrated reservoir management, frac and pac sand-control techniques, field-wide water injection, gas lift and electric submersible pumps, and expanded, upgraded surface production facilities.
Lasmo also expanded the block`s oil processing facilities to handle the increased production.
Target production following the second redevelopment phase was 120,000 b/d.
With the help of Schlumberger, Lasmo had exceeded its goals for Dacion. In mid-1999, after working over 52 existing wells and drilling 7 infill wells, Lasmo had increased Dacion production to more than 20,000 b/d. This was beyond what it had expected to achieve by that time.
By the end of 1999, Lasmo expected to reach a production level of 30,000 b/d.
In fact, Lasmo said that, based on its success in 1999, it expected to achieve 120,000 b/d of output from the block in 2001, compared with the original plan of 90,000 b/d.
"The Dacion bid brought Lasmo into a unique technology alliance with oil contracting specialist Schlumberger," said Lasmo in a 1999 project update. "Its technological expertise and (70 years of) experience in the country proved invaluable to Lasmo in evaluating the potential (of Dacion) and formulating its bid. The relationship will continue, with Schlumberger proportionally sharing in the profits from the area."
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Lasmo PLC and Schlumberger formed an innovative alliance to redevelop Venezuela`s Dacion block. Shown here is a workover well in Dacion field, one of four on the block. Photo courtesy of Lasmo.
