Is this the End for Big Oil?

Relevance: Rising costs, falling production, less than 100% reserves replacement – it’s easy to see why some oil industry observers and investors are pessimistic about the future for large oil companies. Add into the mix rising taxes, resurgent NOCs and erosion of their traditional competitive advantages (capital, technology and access to downstream markets) and it’s obvious that Big Oil has a serious challenge on its hands. Even the recent sustained period of relatively high oil prices, normally good news, has conspired to increase the strength of the NOCs while delivering smaller than anticipated profits, due to sophisticated PSA contracts. Meanwhile, proponents of Peak Oil suggest that the long term trend in growth in global oil demand is set to end soon.

This article argues that it is not all doom and gloom for Big Oil. Companies such as ExxonMobil, Shell, BP, Chevron and Total will rise to the new challenge in the same way that they have done in the past. Big Oil has and will continue to be driven by the market to be independent, global and entrepreneurial. If we look closely enough, we see that there are many opportunities for large oil companies.

Analysis: The current challenge facing Big Oil is comparable to that of the 1950-70s period of nationalisation (when IOC dominance ended and its share of production was reduced). The 1970s however proved the resilience of Big Oil – it learned to earn a living on the geographical and technological frontiers of the industry.

As the Big Oil considers its response to the latest challenge, it’s helpful to consider the undoubted competitive advantages it still enjoys:

  1. Big Oil will enhance its expertise in pushing back the industry’s boundaries (geographical or technical). Big Oil has made a living by being at the forefront of geographical and technological innovation, examples include the exploration of the Arctic, ultra deepwater, tight gas and heavy oils.
  2. Many still predict growth in global oil consumption over the medium term. Even if the Peak Oil theory proves to be correct there will still be a tremendous demand for oil investment to replace existing production as it declines. In this scenario, static production volumes are likely to be mitigated by firmer prices. Furthermore, Big Oil will be in an advantaged position to take part in any industry consolidation that follows.
  3. Big Oil has technical and financial capabilities that it could exploit in the traditional way. It must be recognised, however, that partners seeking these capabilities are reducing in number, and stiff competition is provided by some NOCs. One area where Big Oil does have an edge is in deal making: it has significant expertise in putting together and financing complex commercial structures for investments.
  4. Big Oil still has access to a large share of the major downstream markets. While NOCs have made in roads here, Big Oil still enjoys significant control over access to markets for fuel products, especially within the consuming nations.
  5. The growth of gas within the portfolios of Big Oil continues and it has a track record of managing the greater complexity in getting gas to market compared to oil. Big Oil has established integrated gas transportation and marketing businesses (e.g. in consuming nations) which are attractive to gas resource rich countries (some parts of the gas value chain have not matured enough to be run as separate businesses). Big Oil also has the technology for difficult gas extraction and transportation that others lack.
  6. Big Oil is globally integrated allowing it to exploit synergies across the value chain, apply skills from one region to challenges faced in another and to develop relationships with customers across the globe.
  7. Big Oil can offer potential partners the potential for reciprocity, e.g. access to western markets for NOCs, in return for access to resources.
  8. Big Oil is founded on risk capital (equity investors) and investors expect and demand that companies take on and reward risk. Shareholders hold the companies accountable for this. The market therefore brings better oversight and discipline, and companies generally have better access to finance, allowing them to raise risk capital.
  9. Big Oil has a wide breadth and depth of intellectual capital to draw upon. They employ the world’s best scientists and engineers, increasingly important as the industry faces up to a shortage of skilled people.
  10. Big Oil’s portfolios are generally global, rather than concentrated in one region, country or sector. This portfolio diversification helps mitigate many of the risks that face the industry.
  11. Big Oil has learned to develop company brands that transcend national boundaries and that reflect the values of the firm itself. Thus, to a certain extent, Big Oil can often be seen as relatively independent and politically neutral.
  12. Lastly, IOCs could leverage profits from oil and gas exploitation and a firm understanding of the dynamics of the energy market to invest in other forms of energy. The growing demand for low carbon energy could provide a significant opportunity for Big Oil which already controls many channels to the energy market (e.g. global retail networks). It must be recognised however that the renewables industry will take many years to mature, has had very thin profit margins to date and often requires significant government subsidies.

28 January 2010

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