The Future of National Oil Companies

In the next decade, National Oil Corporations (NOCs) will be confronted with avenues to enhance their strength and cement their primary status in the sector. Within their respective national boundaries, NOCs should be in a position to benefit from the high oil prices in the international market, and the changing landscape being experienced in the industry. These developments are projected to avail more options for partnerships in developing their resources.

To date, many governments still prefer to keep their NOCs intact. Traditionally, the arguments put forward in favor of NOCs included: the historical context argument where states would regain control over the control of domestic oil and gas resources; the primacy of the petroleum sector, where oil and gas are regarded as the most influential commodities both, politically and economically. The third reason for the creation of NOCs was because of the political benefits associated with state control, the authorities can influence the price for the product to benefit the local population, and NOCs are assigned economic responsibilities over and above their social responsibility requirements.

Despite the advantages listed, future challenges exist that will shape the sector. While some NOCs will prosper, others may not achieve their growth targets. Each NOC faces a specific set of challenges, for example, the geopolitical landscape of the country; however, other challenges particularly risk management and governance is shared by almost all NOCs. While Chinese NOCs becoming more global and focusing on securing resources, other NOCs are still attempting to create demand for their oil and gas sector. Moreover, talent retention and development has become an increasing issue as many NOCs are suffering from high staff turnover, especially in the upstream segment in Europe and North America. This problem is worsened by the fact that the workforce is aging, with the generation Y showing reluctance to join the sector.

Besides, environmental factors, climate change, and the effects of global warming are exerting significant pressure on the NOCs whenever they attempt to expand their geographical presence, let alone their social and economic responsibilities as revenue generators for the economies in which they are operating. Therefore, these companies are consistently under the watchful eye of local and international media, as well as the international economic committees and organizations. This paper will discuss in detail the value chain of the petroleum industry and the factors that may likely shape the future of NOCs in the globalized energy market.

Whereas the role of the state in nearly all sectors of global economic activity is declining, in the oil sector the paradigm is quite different, state controlled oil companies often referred to as National Oil Corporations (NOCs) remain tightly in control over the immense majority of the globe’s hydrocarbon resources. Governments in some countries have been losing control of some of the firms owned by the state that they initially controlled.

This has been possible through changing management rules and regulations for operation with the outcome being a renaissance of the roles of the firms in the Oil Industry, especially, in the last decade. Increased cost of energy has acted as an incentive both to the government and the NOC managers to channel clout to the corporations in the industry owned by the state. This has been more pronounced in Venezuela and Russia, while many other states have cancelled plans to liberalize their hydrocarbon sectors. The primary roles for National Oil Corporations appear more secure than ever. States are working hard to formulate the right set of policies for their national oil corporations.

Overview of the Petroleum Sector Value Chain

The energy sector is a function of various processes and activities that together contribute toward the conversion of the inherent petroleum resources into valuable end products. The different activities and processes are networked with each other not only physically, but also contractually and conceptually within or across companies, and national borders.

Given these interrelationships, it is important to understand and appreciate how value is created along the energy sector value chain. Governance and organization often have a direct and significant influence on value creation; yet governance and organization are often determined by state policy decisions. The significant policy decisions that affect the value chain include: industry participation, licensing and contracts, taxation, depletion policy, value creation through integration, local content policies and value creation.

Industry Participation

Each policy that the state implements directly influences the ability and the willingness of the participants to create social value. On the far left is a pure monopoly held and controlled by the state with no outside participation in the affairs of the company. On the far right, is a perfect competitive market with no entry barriers or government intervention.

In between the two are a set of possibilities that include oligopoly, duopoly among others. In practice, no country implements either pure monopoly of perfect competition. Mexico and Saudi Arabia for instance have state oil monopolies yet still impose limited restrictions on private oil contractors. On the other hand, even the most open economies have prerequisites that firms have to meet before they participate in auctions and this has the effect of limiting competition.

Licensing and Contracts

Majority of the technical and commercial decisions made by petroleum companies for example where to invest, the amount to be invested and whether incentives for cost efficiency exist or not are largely based on the terms and conditions of the petroleum contracts. As a tool for control, the government makes use of its licensing authority to shape industry structure.

For example, it can set up incentives that attract private participants or make it a must for government involvement in the operations. Mommer (2002) notes that in many jurisdictions other than the United States, the subsoil is owned by the state. In cases where the subsoil is not owned by the state, the state often makes the final decision on its use. Where the state owns the subsoil, the state can use its licensing power to grant monopoly ownership or allow the participation of several players. Tordo (2009) argues that recent developments indicate that countries have adopted licensing regimes based upon their unique regional and historical preferences. Petroleum contracts often stipulate how revenue is to be shared, risk assignment, control and management.

Taxation

Given the high prices for petroleum products, the sector is one of the most highly taxed. Taxation has a direct impact not only on the contractual relationships but it also influences the selection of assets, it determines behavioral incentives, shapes demand and supply dynamics and affects the financial position of the parties to the contract. Taxation is desired not only as a source of government revenue, but also because it does not alter the efficiency in resource allocation and can at times be used to correct market failure, for example increasing the private costs of environmental pollution . As a whole, it maximizes overall welfare and promotes efficient behavior. However, if a taxation regime increases costs or promotes excessive investment welfare losses result.

Johnston (2007) argues that the proportion of government revenue in various oil and gas projects across the globe ranges from 40% to over 90%. Following the upsurge of oil prices between 2002 and 2008, governments have increased the tax rate on oil and gas revenues. Fiscal policies in any given country can change in various ways that include contractually, when new agreements are awarded to companies based on different terms from the earlier ones through competition as oil companies bid for the tenders and through enactment of a statute. In determining the tax rate, governments take into account the tradeoff between the short term tax revenue and value creation in the longer term.

Tordo (2007) argues that the uncertain nature of oil wells discourage governments from maximizing their present value of taxation as oil companies may be discouraged from undertaking the investments thereby affecting future revenue streams. In addition to taxing the crude oil, governments equally levy taxes on the final consumers. For instance, the 2003 consumption weighted average for petroleum refined products within the European Union indicate that 62% of the final market price was accounted for by taxes compared to only 28% that was due to the cost of crude oil. The balance of 10% represents both company profits and the cost of refining the product (Organization of Petroleum Exporting Countries, 2005).

Depletion Policy

Oil is a non-renewable resource. Because of this, a country has to decide on the whether the petroleum resource should be explored, the speed of exploration, and who should be awarded the exploration contract. If the volume of oil reserves is known with certainty, then social welfare can be maximized through a planned pattern of production over time (Tordo, 2009). The pattern of using the available resources is measured by the rate of production represented as (annual production/total reserves)*100. This forms the basis for a depletion policy. In formulating the deletion policy, a number of factors are taken into account that includes: state budget, domestic economy, politics, good oilfield practice, institutional framework, resource course, time value of money, cost and price expectations.