Reshaping the oil and gas industry

John V. Mitchell, associate research fellow at Chatham House, the Royal Institute of International Affairs, sketches the changing shape of the global oil and gas industry – and concludes that there are no certainties

The oil and gas industry is changing to a “multipolar” structure. This comes after the “bipolar” model of the international oil companies and OPEC (Organization of Petroleum Exporting Countries) which dominated the last quarter of the 20th century, and the earlier monopolistic regime of the so-called “seven sisters” oil giants.

These structures floated on the geopolitics of imperial and colonial power in the 30s, the rising nationalism of the 60s and 70s in developing countries, and will now ride on the current integration of Russia and China into the world economy. The strategic local choices of industry players will decide who gains and loses in the new game.

The industry now faces:

• Higher oil prices – around $100 a barrel – which open the door to new suppliers and substitution

• Application of new supply technologies, which reduce the effect of depletion and cut off the peak of “peak oil”

• Flattening and even reversal of growth in demand for oil in developed countries, as a result of higher prices, new technology in the automobile and other user industries, and above all in the increasing strength of policies to restrict greenhouse gas emissions

• New focus of downstream growth questions of security of supply in Asia rather than in the Organisation for Economic Co-operation and Development (OECD)

• Mismatch between the opportunities for investment, the funds available, and corporate structures through which funds and opportunities are brought together.

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The balance within the oil industry is changing. The advantages of the largest international oil companies lie in the past. They have strong generation of funds, but their opportunities are limited geographically to high-cost and difficult exploration and production. The strength of local and national companies excludes them from most of the downstream growth in developing markets.

In 2006 there were six international private sector companies among the world’s top ten oil producers. In 2012 there was one. There are now only 19 private sector companies in the top 50 oil producers and their share of production has dropped by 5 per cent to below 20 per cent, less than the growing share of smaller, private sector companies outside the top 50. The share of production from the wholly-owned state companies in the top 50 has fallen slightly, to around 46 per cent, though the biggest companies have increased their part of it.

The critical factor for success is to match local needs and institutions with appropriate foreign resources

More and more large state-controlled companies are being partially listed in financial markets; for them the traditional international company package of “money plus management and technology” no longer hangs together. They can raise finance directly, and hire management and technology from the service companies. These “mixed” companies, state-controlled but with listings on public stock exchanges, now supply about 13 per cent of world liquid production.

There remains a large section of the industry, controlling about 50 per cent of world oil reserves, where private companies participate as contractors to state companies. These do not offer the kind of “bookable reserves” which large international companies have been seeking, but small and mid-cap [mid-market capitalisation] companies have been successful in striking new deals with new producers outside OPEC.

The critical factor for success is to match local needs and institutions with appropriate foreign resources. The smaller private sector and state companies may find it easier to focus than big, bureaucratic corporations whose bureaucracies may not offer the same continuity of attention.

About 70 per cent of world gas consumption is supplied from within each consuming country. Growth depends on finding prices in each market which simultaneously expand demand and supply to that market. Transportation costs separate markets. Investors in the international gas trade face volume and price risks from the different government policies for power generation from renewables or nuclear energy.

The key uncertainties for the major players are do the no-growth OECD downstream businesses add value, and are upstream investments cornered into high-cost projects, which will be vulnerable if in fact global demand levels off and eventually declines?

Investors can no longer assume an escalator in oil demand or prices. It is not difficult to generate scenarios in which strong emissions policies lead to oil being left in the ground at the end of the century. It will be the most expensive oil in the world, on the books of those companies who invested in it.