Original Seven Sisters: Old & Struggling

From Newsweek, a timely reminder of the struggles facing the original Seven Sisters and the rise of the new oil majors.  As the article notes:

“…The escalating [BP] dispute is emblematic of the problems facing Big Oil—shrinking access, falling profit margins, underinvestment in equipment and technology and a business model that’s increasingly questioned. Major Western oil companies like BP, Exxon and Shell have dominated the industry for more than half a century, but the skyrocketing price of crude has shifted power to the countries owning the oil in the ground. They favor their own national oil companies, and are demanding an increasing slice of the pie—when they deign to share it at all. It’s no wonder investors seem to be losing confidence in Big Oil’s business model: last week, after Exxon reported the largest quarterly profit in global corporate history, its share price fell by 2 percent, and has now fallen 12 percent so far this year. With Exxon struggling to bring new fields on line, gas and oil production was actually down by 8 percent. The company spent a record 66 percent of last year’s cash flow on stock buybacks and dividends—for lack of better investment opportunities.

It is by now fairly common knowledge that the Western majors today own a mere 5 percent of the world’s oil reserves, compared to more than 70 percent in the 1970s (the rest is controlled by governments). That shift is sharply cutting into Big Oil’s share of joint projects (more than 20 countries have taken a higher share of oil revenues in the past five years, according to Wood MacKenzie analyst Graham Kellas), or forcing them out of countries altogether. In May 2007, Venezuela kicked Exxon out of South America’s largest oil field, the Orinoco Belt. The same year, Russia’s Gazprom seized control from Shell of a majority stake in the $22 billion Sakhalin 2 oil and gas project. The power shift seems permanent and more squeeze outs are set to follow. “Governments and national oil companies are now setting the rules and the international oil companies can either follow them or get out,” says Robin West, chairman of PFC Energy, a Washington-based consultancy.

National oil companies have also become tough competitors outside their home markets. Because state-controlled companies like Petrochina have a mandate to secure resources for their countries rather than extract profits for shareholders, they can often make the highest bids. When Libya recently auctioned off offshore-drilling licenses in the Mediterranean, Asian oil companies outbid the Western majors on many parcels by offering ultrasweet deals to the Libyans—in effect giving away their profits just to get their hands on the oil.

One remaining advantage of the Western oil companies is their technology and expertise in running complex and difficult projects. Few of the national oil companies can do deep-sea drilling, for example. Extracting the vast deposits on Russia’s Arctic shelf or in the rough conditions off Kamchatka is not something Russian companies like Gazprom or Rosneft can yet successfully handle on their own, says Vladimir Nesterov, an oil analyst for Troika Dialog in Moscow. But even these deals often hit a brick wall. In Mexico, oil production is in sharp decline because its national oil company, Pemex, can’t do deep-sea drilling in the Gulf—but Mexican fears of selling out to the Brits and gringos have prevented any deals with Big Oil.

Meanwhile, thanks to a decade of technology underinvestment by Big Oil, it’s specialized oil-services companies like Schlumberger that hold the most patents and have the best technology. Governments can hire them directly, circumventing Big Oil. The majors have finally begun boosting R&D budgets again, focusing in particular on ways to up the extraction rate of existing fields, which now averages just 35 percent. One patent that significantly boosts this rate could be worth more than a Saudi oil field, says West.

What happens if none of this is enough for Big Oil to keep growing? In June, France’s Total gave its answer, announcing it had signed a deal with nuclear-power company Areva and French utility Suez to build nuclear reactors in the Middle East. Shell has been investing heavily in liquefied-natural-gas technology. But Big Oil has been talking about diversification for years (remember BP’s Beyond Petroleum campaign?). The obvious question is what value an oil company like Total can add in the nuclear industry. Mature oil companies aren’t going to turn into nimble nuke, wind or solar specialists, just as the railroads in the 1950s didn’t suddenly grow into airlines. Then there’s a problem of scale. Alternative power can’t rival Exxon’s $40.6 billion in profit for 2007.

Despite their dwindling access to production and reserves, the majors still have valuable distribution networks and refining capacity, which the national oil companies need to sell their goods. Already, companies like Russia’s Gazprom and Rosneft are striking deals to exchange production sharing for downstream assets. Sooner or later, some of the rising players (three of the top five oil companies by market cap are already national oil companies) will likely want to buy them outright. Given the assets, politics and emotions involved—remember when Cnooc tried to by Unocal?—that will be a battle that will make BP’s Russian adventures seem like a minor skirmish.”

This entry was posted on Sunday, August 10th, 2008 at 6:24 am and is filed under China, ENI, Gazprom, Petrochina, Rosneft, Russia.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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Wildcats & Black Sheep is a personal interest blog dedicated to the identification and evaluation of maverick investment opportunities arising in frontier - and, what some may consider to be, “rogue” or “black sheep” - markets around the world.

Focusing primarily on The New Seven Sisters - the largely state owned petroleum companies from the emerging world that have become key players in the oil & gas industry as identified by Carola Hoyos, Chief Energy Correspondent for The Financial Times - but spanning other nascent opportunities around the globe that may hold potential in the years ahead, Wildcats & Black Sheep is a place for the adventurous to contemplate & evaluate the emerging markets of tomorrow.