State-owned enterprises (SOEs) have assumed an increasingly significant role in the global economy, representing some of the largest companies and majority of economic activity in some countries. For example, Indian Railways is the largest non-military employer in the world after Walmart. In no sector have SOEs had a greater economic impact than in the oil sector. According to the World Bank, 18 of the top 25 oil and gas producers are National Oil Companies (NOCs), controlling 75% of oil production and holding 90% of the world's oil reserves.
With energy demand, predicted to rise 20% through 2025, NOCs are poised to have even an greater impact on the global economy, and in shaping oil producing countries' foreign policies. In the course of the next decade, the landscape of the oil industry will see fundamental changes that could result in the decline of private-sector oil majors and a corresponding rise in dominance of NOCs.
NOCs fall into two basic categories: those that are resource-rich and those that seek resources. Although the resource-rich have been an historical presence within the oil industry for decades, resource-seeking governments have assumed a growing presence. China's CNOOC, for example, has purchased a staggering amount of oil and gas resources and reserves globally, accounting for nearly 50% of all acquisition spending in 2011. Its highest profile pending acquisition is Canada's Nexen for $15 billion, an attempt to access North America's lucrative oil sands market. If it proceeds, Nexen will be the largest foreign acquisition by a Chinese company.
NOCs are giving international oil companies (IOCs) a run for their money by developing competitive technologies and productive resource capacity that will in time give some of them the potential to overtake the largest IOCs in size and scope. Brazil's Petrobras, Malaysia's Petronas and Norway's Statoil are prime examples of NOCs which have specialized in deepwater drilling technologies - once monopolized by the IOCs. NOCs have also set their focus on unconventional oil plays - particularly in the Americas - by leveraging themselves as strong financial partners and acquiring a large number of shale oil and gas plays around the world.
NOCs' deep pockets are giving them a distinct advantage in the bidding war for access to reserves, creating a rivalry with IOCs currently being played out for offshore deposits in Brazil and East Africa. IOCs' internal rate of return limitations have kept them from some bidding rounds altogether; this is where NOCs have a built in advantage. In the first half of 2012, NOCs spent more than $16 billion globally and have allocated more to exploration and production spending budgets than their IOC counterparts. IOCs' control of hydrocarbons has decreased dramatically from more than 80% of the world's resources in the 1970's to only 8% today.
That said, NOCs' shortcomings and conflicting priorities are leaving a gap in the energy industry that IOCs are quick to recognize. IOCs have more consistent access to capital and have turned their focus towards developing ever more innovative technology and downstream activities, allowing them to absorb a greater amount of risk. But NOCs have access to reserves that IOCs cannot compete with. As a result, joint ventures have become the most economical method to efficiently explore and produce oil plays - particularly in under-explored regions - with an estimated 80% of NOC undertakings now occurring through joint ventures.
China's CNPC has acquired a number of shale assets this year, including a stake in Royal Dutch Shell's Groundbirch shale project in British Colombia and signing an agreement with Shell to share production in developing shale gas in the Chinese Sichuan Basin. China understands the potential shale gas represents within its borders but recognizes that the technology and expertise must be transferred through such partnerships in order to exploit it. Undoubtedly, once this expertise has been obtained, China will be less likely to sign such agreements with IOCs in the future.
Such 'marriages' take the form of strategic alliances, mergers, acquisitions, or simply mutual cooperation between energy firms. One of the most recent and best known is between BP and Russia's Rosneft's, a long-awaited deal which turned over 50% of BP's stake in TNK-BP for $17 billion and resulted in an increased stake in Rosneft (19.75%). This deal propels Rosneft into the leading position as the largest publicly traded oil company, surpassing ExxonMobil, which held the title for many years.
So the landscape of the energy industry is shifting dramatically, with NOC's soon predicted to account for half of the worldwide capital expenditures in the industry. Going forward we should expect to see the largest and most sophisticated NOCs develop projects without IOCs, particularly in their home countries. Russia may be expected to be a prime example of a sharp decrease in foreign companies' involvement in domestic oil and gas operations, as the perception is that IOCs may not have anything meaningful to contribute becomes more commonplace.
NOC influence is also politicizing countries' economic relationships, with the greatest impact occurring as a result of NOC/NOC partnerships. China has agreed to cooperate on potentially lucrative oil and gas ventures with India in response to an increasingly expensive rivalry for resources. An agreement between India's ONGC and China's CNPC translates into cooperation in upstream exploration activities, refining, and distribution of petroleum products. At the same time, competition for energy resources and income derived from it has prompted leftist leaders in Bolivia, Ecuador and Venezuela to nationalize foreign-owned oil and gas assets in the name of the state. Argentina's nationalization of Spanish-owned Repsol's stake in YPF was followed by the more recent seizure of Chevron's assets in the country this year. So one natural result of NOC competition for nationally owned energy resources is an increased propensity for expropriation, which has impacted many companies and will impact many more in the future.
The net result of the rise of the NOCs is the decline in dominance of the IOCs, which face an uncertain future - particularly in places where NOCs are either based or operate with any degree of significance. IOCs must reevaluate their business models in order to identify and prioritize the competitive value addition proposition. Industry pundits are paying considerable attention to ConocoPhillips' recent decision to separate upstream from downstream activities into two separately traded companies. BP and ExxonMobil are also rumored to be considering the same strategy. What will continue to emerge in the course of this decade is a battle for supremacy between the public and private sectors for control of the world's most vital natural resources. NOCs have the upper hand.
*Daniel Wagner is CEO of Country Risk Solutions, a cross-border risk management consulting firm based in Connecticut (USA), and author of the book "Managing Country Risk". Bethany Johnson is a research analyst with CRS.
Follow Daniel Wagner on Twitter: www.twitter.com/countryriskmgmt