The IOC Response to the Government/NOC Competitive Threat

RelevanceI have written many times on the rise of the NOC and the potential decline of the IOC. My focus has been to highlight the new competitive edge of government backed NOCs and the reduced competitiveness of the IOCs. The latter’s traditional advantages of capital, technology and access to markets are much reduced today. The NOCs have plenty of capital, and much of the technology resides with service companies. Some NOCs also have gained access to the downstream markets of the major consuming nations. The longer the period of high oil prices lasts, the stronger the NOCs become. The issue is, at last, receiving public recognition by the IOCs. There has been the public letter from Shell’s CEO and acknowledgement from Total that a part of its future will be in nuclear. BP’s Tony Hayward in December’s Petroleum Review addresses the issue head on. Below I have highlighted the potential nature of the IOC response, drawing on my earlier articles and Hayward’s speech.

AnalysisWhile the challenge of the NOCs is undoubtedly strong, it is not all doom and gloom for the IOCs. The challenge of the 1950-70s period of nationalization (when IOC dominance ended and their share of production was reduced) proved the resilience of IOCs that learned to earn a living on the geographical and technological frontiers of the industry. They were driven by the market to become independent, global and more entrepreneurial.

As the IOCs consider their response to the NOC challenge, it’s helpful to consider the undoubted competitive advantages they still enjoy:

  1. Access to a large share of the major downstream markets.
  2. Global integration. This allows IOCs 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, for example.
  3. Potential for reciprocity, i.e. access to western markets for NOCs, in return for IOC access to resources.
  4. Taking and managing risks. IOCs are founded on risk capital (equity investors). Investors expect and demand that the IOC take on and reward risk, and shareholders hold the companies accountable for doing just that. IOCs generally have better access to financial markets, allowing them to raise risk capital.
  5. Intellectual capital. IOCs have 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.
  6. Speed and flexibility to act in a wide range of technically and politically challenging operating environments.
  7. Portfolio diversification. IOCs portfolios are generally global, rather than concentrated in one region, country or sector. This helps mitigate many of the risks that face the industry.
  8. Branding. IOCs have learned to develop company brands that transcend national boundaries and that reflect the values of the firm itself. Thus IOCs can often be seen as independent and politically neutral.

Future IOC strategies are like to be drawn from the following:

  1. A continuation of the pioneering model. Continue to push back the industry’s boundaries (geographical or technical). Examples would be the exploration of the Arctic, ultra deepwater, tight gas or heavy oils.
  2. A continuation of the traditional model. Seek out partners that find the traditional capital + technology IOC offer and PSC/licensing arrangements attractive (e.g. Nigeria).
  3. Bring technology back “in house”. Invest heavily in technology R&D in the belief that a technology breakthrough(s) will be found. This option could include obtaining ownership of existing technology and capabilities through the purchase of service companies.
  4. NOC partnerships. Create much closer partnerships with NOCs and resource holding governments to exploit difficult-to-access resources, e.g. the recent BP deal with the Libyan Investment Corporation and Libya’s national oil company. Such partnerships could involve cooperation with NOCs as they invest beyond their home country. From the IOCs perspective, such arrangements should involve reciprocity, i.e. the right of access for both NOCs and IOCs to world markets.
  5. Industry Consolidation. Even the mighty ExxonMobil only produces about 3% of the world’s oil. Consolidation amongst the majors (and a BP-Shell tie up has been in the news recently) would allow huge cost saving synergies; great high grading of assets; a balance sheet strong enough to take a larger share in very big projects; the financial strength to go head to head with the NOCs; and a lower cost of capital.
  6. Project Manager. Add value through the coordination of all aspects of an investment (engineering, operations, commercial, finance etc). This is a skill that is in short supply within the industry, and clearly IOCs have an edge here over the service companies. The IOCs may or may not put capital at risk or book reserves. At the extreme IOCs would become service companies themselves.
  7. Super Contractor. Become the ultimate contractor to NOCs/governments, bringing together the efforts or all subcontractors and service companies. In this case IOCs may not invest, and would not be able to book reserves. Such a move would facilitate immediate access to conservative oil provinces such as Mexico.
  8. Focus on one part of the value chain. This approach would appeal to Jim Collins, the respected business researcher and author. He says that great companies focus on one thing, and do it better than anyone else. So for example, in this model, BP, the great explorer, and ExxonMobil, the great developer would focus on these areas as the source of their competitive advantage. This advantage may be appealing enough to NOCs to allow access.
  9. Deal Making. Similar to points 6. and 8. above, IOCs have great expertise in putting together and financing complex commercial structures for investments. LNG projects are a good example of the IOCs expertise in deal making, and their skills in accessing downstream markets.
  10. Focus on Downstream. Clearly, IOCs have a competitive advantage in their access to the markets of the large consuming nations. Historically, downstream has not enjoyed the returns available in the upstream, but it is much lower risk. A disproportionate amount of rent accrues to the upstream through the actions of OPEC (so called “monopoly rent”), but this could be altered through government policy of the consuming nations.
  11. Focus on Mature Assets. The IOC’s niche has traditionally been large, capital intensive, high risk projects in technically and geographically demanding environments. A refocus towards mature areas along with an increased investment (per point 3. above) in technology to increase recovery factors would give upside in assets already owned by the IOCs.
  12. Lastly, IOCs could use profits from oil and gas exploitation to invest in other forms of energy, particularly low carbon energy. The growing demand for low carbon energy could provide a significant opportunity for IOCs that already have a firm understanding of the dynamics of the energy market.

The role of IOC home governments is also important and has been covered in my earlier articles.


1 February 2008

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