A new dawn for petrol majors

UNDERMINED BY NATIONAL OIL COMPANIES IN TERMS OF RESERVES AND THE ABILITY TO EXPLOIT THEM, THE FIVE INTERNATIONAL MAJORS HAVE TO CHANGE THEIR STRATEGY IF THEY WANT TO CONTINUE TO BE LEADERS OF THE SECTOR

by Roberto Grant, Contract Professor Senior, Department of Management and Technology

The oil price collapse of the past two years has devastated the oil and gas sector.  The net profits of the five “supermajors” (Exxon Mobil, Shell, Chevron, BP, and Total) shrank from $105 billion in 2013 to $20 billion in 2015. “The worst crisis in a generation” according to one oil executive.

Yet, price volatility is an ongoing feature of the industry. With demand and supply price inelastic, small shifts in either cause large movements in price. Low oil prices are nothing new: Brent crude was trading at $32 at the end of 2008 and was below $30 for most of 1985 to 2002—hitting a low of $9.10 in December 1998.

This volatility masks a stable long-term growth of global demand:  oil at 0.9% annually and natural gas at twice this rate. Efforts to limit global warming will do little to dent this trend. BP estimates that in 2035 fossil fuels will provide 80% of global energy needs.
Yet, while the future of the industry looks secure, that of the international oil and gas majors does not.  Low oil prices have exposed their strategic weaknesses—especially the erosion of their competitive advantages.

Success in the oil and gas industry depends critically on one key resource—petroleum reserves—and one core capability—the ability to find and exploit those reserves. In both, the international majors are lagging.

In terms of reserves, the international majors are second-tier:  the world’s top-10 are all national oil companies (NOCs) led by the National Iranian Oil Company, Saudi Aramco, PDVSA and Kuwait Oil—their production costs well below those of the international majors.

In terms of in exploration and production capabilities, the majors are being overtaken by the oilfield service companies. The industry’s R&D/sales ratio is a mere 0.3%—far behind other mature sectors such as automobiles (4.4%) or chemicals (2.8%). Of this, oilfield service companies account for a growing share. During 2013-15, Schlumberger’s R&D expenditure exceeded that of every oil and gas major except Shell.

Squeezed on these two fronts, the oil majors must redefine their role.  Preoccupied with reserve replacement, the majors have pursued frontier exploration with its massive technical, economic and environmental risks.  Yet, low oil-prices may render many of these reserves stranded assets. The alternative is for the majors to do a better job of partnering with the owners of the world’s major proven reserves—the NOCs and their host governments.

Such a role would require reformulating their strategies—not only forsaking equity oil in favour of service contracts and minority stakes in joint-ventures with NOCs, but shifting their strategic priorities from building reserves to building capabilities.  Such rebasing would require re-establishing leadership in exploration and production technologies and reaffirming their presence throughout the entire value chain—especially important in natural gas. As development partners, the majors must also acquire the capabilities needed for the broader economic, social, and human advancement of their host countries. As Eni has demonstrated in Congo and elsewhere in Sub-Saharan Africa, this requires engaging with government at multiple levels and accessing the capabilities of partner organizations—including NGOs.

Recommitting to vertical integration is reinforced by the majors’ reappraisal of their downstream businesses. After decades of channelling investment upstream and selling downstream assets, the tables have turned: in 2015 Exxon Mobil’s return on capital upstream was 4.4%; downstream it was 28.2%.

Strategy reformulating offers the oil majors the chance to transform their public images. Demonized as agents of global warming and allies of corruption and autocracy, the majors can become allies of development and human progress in countries where oil wealth coexists with low indices of human development—epitomized by Nigeria and Equatorial Guinea.