Topic 4: The International Oil Industry. () Global Energy Issues, Industries and Markets 1 / 51

Transcription

1 Topic 4: The International Oil Industry () Global Energy Issues, Industries and Markets 1 / 51

2 Introduction To understand oil industry, focus lecture on its history General themes of relevance today: Cartels/monopoly power Importance of oil in economy/geopolitics Resource nationalism, state ownership Pricing and markets Future of oil: new sources and new technology () Global Energy Issues, Industries and Markets 2 / 51

3 Additional Readings Course outline has several conventional academic readings on this topic But oil is a topic on which many popular writers have written: Daniel Yergin has written two excellent popular books: The Prize and The Quest The Prize about history of oil industry, The Quest about modern energy industry Private Empire: ExxonMobil and American Power by Steve Coll another recent popular book If you like audio material, there is even a podcast History of OIl ( () Global Energy Issues, Industries and Markets 3 / 51

4 Characteristics of the Oil Industry Remember from initial overview lecture: Oil has been predominant fuel of the 20th century In 21st century oil s share is falling, but it is still large BP forecast: in 2035 oil, gas and coal roughly equal share of energy produced from fossil fuels And fossil fuels forecast to account for 80% of energy production (unless major change in policy due to global warming) Oil is mostly used for transportation (energy dense) () Global Energy Issues, Industries and Markets 4 / 51

5 Characteristics of the Oil Industry Some similarities with electricity industry: Several stages in industry: exploration, extraction, refining, distributing and retailing Companies often vertically integrated Monopoly/cartel concerns Some differences to electricity: Oil is storable Oil is relatively easy to transport (pipelines, or in tanks whether truck/trains/ships) International trade common (no need for anything like electricity grid) () Global Energy Issues, Industries and Markets 5 / 51

6 Characteristics of Oil In this lecture, I will simply refer to oil as a fuel and ignore many (interesting) subtleties But let me briefly note the following: Oil comes out of the ground as crude oil of varying compositions (sweet/sour, light/heavy, etc.) Crude oil is used to produce many types of fuel (gasoline, fuel oil, aviation fuel, diesel, kerosene, etc.) Also used to produce things unrelated to energy (e.g. plastics) In terms of producing CO 2 emissions oil is cleaner than coal, but dirtier than natural gas () Global Energy Issues, Industries and Markets 6 / 51

7 Who Makes Money from Oil? Oil industry is a complicated mix of ownership structures Private companies (oil majors dominate, but many smaller oil companies esp. in exploration and production) Countries with oil try to make money through: State ownership (but of what? Entire value chain or only production?) Royalties and taxes, auctioning of exploration rights/concessions Note: remember fuel subsidies discussion of previous lecture () Global Energy Issues, Industries and Markets 7 / 51

8 Who Makes Money from Oil? Forced joint ventures between international oil company and state owned company Joint ventures between international oil company and (privately owned) national champion Note: international oil companies considered more effi cient, access to latest technology, etc. National oil companies in some cases politicized and ineffi cient Recent news: Mexico is changing constitution to allow some role for international oil companies OECD governments make money from oil through taxation (politically controversial) () Global Energy Issues, Industries and Markets 8 / 51

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10 Early Days, Oil used for various purposes in small ways for thousands of years But big commercial use began when oil discovered in Pennsylvania Used largely for lighting (kerosene) and gasoline largely a waste product (pre-car era) Chaotic oil rush led to over-supply, price collapse, bankruptcies, price volatility, etc. Also wastefulness (excessive drilling led to low recovery rates) This era largely in USA () Global Energy Issues, Industries and Markets 10 / 51

11 Rockefeller and the Standard Oil Monopoly, John D. Rockefeller decried wasteful competition Through expansion, buying out of competitors, predatory practices driving competitors out of business, etc. sought to control oil industry Soon Standard Oil company directly or indirectly controlled much of oil This allowed it to control prices and quantities (near monopoly) Interesting to note that Standard Oil achieved control of refining and distribution, not actual production of oil Share of world oil refining 80-90% (and up to 95% control in the US) Refining and distribution more liable to monopoly (increasing returns to scale) Producing of oil more competitive (always new oil wells opening up) Economic concepts: monopoly/cartel, vertical versus horizontal integration, predatory pricing () Global Energy Issues, Industries and Markets 11 / 51

12 Rockefeller and the Standard Oil Monopoly, Prices much less volatile and Rockefeller richest man in the world (maybe richest man in history) Gradual breaking of Standard Oil s grip through: International discoveries Baku (then in Russia) and Dutch East Indies (now Indonesia) New world companies such as Royal Dutch Company and Shell Company (later merged to form Royal Dutch Shell) Big US discoveries in Texas led to new American competitors (esp. Gulf Oil Company and Texas Fuel Company, later Texaco). Gulf merged with Standard Oil of California in 1985 and renamed Chevron Texaco also later merged with Chevron Increasing competition undermined Standard Oil monopoly () Global Energy Issues, Industries and Markets 12 / 51

13 Rockefeller and the Standard Oil Monopoly, But big blow to Standard Oil monopoly was political/legal Anti-trust/restraint of trade laws passed in USA (era of trustbusting president and muckraking journalism) In 1911 Standard Oil found in violation of anti-trust laws and forced to break into smaller companies In 1911 Standard Oil controlled 70% of refined production, but only 14% of crude oil supply Standard Oil of New Jersey (later Exxon, now ExxonMobil) Standard Oil of New York (later Mobil, now ExxonMobil) Standard Oil of California (later Chevron) Standard Oil of Indiana (later merged with BP) Standard Oil of Ohio (now the American arm of BP) plus some more smaller ones () Global Energy Issues, Industries and Markets 13 / 51

14 Internationalization of the Oil Industry Big expansion in use of oil (beginning to displace coal) Expansion of automobile, use of oil for navies, etc. Great international expansion in production (finds in Mexico, Venezuela, Iran, etc.) Geopolitics of oil E.g William Knox D Arcy negotiated an oil concession with Shah of Persia Exclusive rights for 60 years in most of Iran. Shah received financial payment, shares in Anglo-Persion Oil Company and 16% of future profits. Big oil finds in 1908 Geopolitical point 1: such deals led to many fights between oil companies and governments wanting to re-negotiate () Global Energy Issues, Industries and Markets 14 / 51

15 Internationalization of the Oil Industry Geopolitical point 2: Increasing importance of oil for military and economic reasons Coal versus oil for navies in Britain Oil = faster ships, coal = secure supply (Britain had little oil) UK government bought 51% stake in Anglo-Persian Many company decisions made for security of supply reasons rather than economic effi ciency Anglo-Persian eventually evolved into BP () Global Energy Issues, Industries and Markets 15 / 51

16 Internationalization of the Oil Industry Important development: cartels, anti-competitive arrangements Over-production led to drop in oil prices Achnacarry Agreement among major oil companies Markets divided by geography (not US) and in each markets shares allocated to each oil company Thus, in each market a company could only produce more if entire market grew Uniform selling price (American Gulf Coast price plus transportation cost) Economic theory: cartelization, avoiding price wars, undercutting, etc. Did not work well (too many agents outside the agreement), but similar attempts will recur in later history () Global Energy Issues, Industries and Markets 16 / 51

17 The Seven Sisters and Rising Resource Nationalism: Seven Sisters = Standard Oil of New Jersey, New York, California, Texas Oil Company, Royal Dutch-Shell, Anglo-Persian and Gulf. Seven Sisters dominated all parts of the industry (exploration, production, refining, distribution) Various attempts at collusive behaviour (Red Line agreement) and government intervention (quotas, etc.) in response to price volatility Large new finds in US (Texas, Oklahoma, etc.), wildcatters, hot oil, etc. Texas Railway Commission (state energy regulator) had huge impact on world oil prices (some say it set world oil price). () Global Energy Issues, Industries and Markets 17 / 51

18 The Seven Sisters and Rising Resource Nationalism: Rising resource nationalism: Shah of Iran cancelled oil concession of Anglo-Persian in 1932 Re-negotiated better terms Mexico nationalized oil industry (new company = PEMEX) in 1938 Venezuelan government cut better deal in 1943 (50-50 split of profits plus lump sum royalty) Other countries also cut deals Profits equally shared between oil company and state () Global Energy Issues, Industries and Markets 18 / 51

19 But profits calculated based on posted prices In production: big story was the emergence of Middle East (esp. Iraq, Saudia Arabia a bit later) as big oil producers, also Soviet Union Supply increased, market prices dropped. Market prices less than posted prices Hurt international oil companies (since money paid to governments calculated using posted prices) International oil companies cut posted prices (less money going to governments) Producing governments unhappy, which set the stage for OPEC () Global Energy Issues, Industries and Markets 19 / 51

20 The OPEC Era Organization of Petroleum Exporting Countries OPEC started in 1960 (Iran, Iraq, Kuwait, Saudi Arabia, Venezuela) Major oil producing countries Eventually grew to 14 countries, but now back down to 12 (Indonesia and Gabon left) Large (but varying) influence on the price of oil Economic theory: cartel Remember: perfect competition leads to economically effi cient outcome with no excess profits Monopoly: can achieve higher profits by reducing output, forcing price up (until MR=MC) If cartel can get together to act as a monopoly, can increase profit () Global Energy Issues, Industries and Markets 20 / 51

21 The OPEC Era But agreement can be diffi cult Must reduce output, agree on quotas If all cartel members exceed quota, price falls and profits fall But if one member exceeds quota while others maintain, cheater can benefit Since monopoly equilibrium has P>MC, small increases in output will earn P but only cost MC Each cartel member has incentive to cheat High prices for oil can hurt global economy (reduce demand for oil) High prices for oil can encourage consumers to improve energy effi ciency (reduce demand for oil) Cartel needs to balance short term benefits with longer term costs of high oil price Summary of issues in history of OPEC: need for agreement, stopping cheaters and balancing short versus long term profits () Global Energy Issues, Industries and Markets 21 / 51

22 The Early years of OPEC, OPEC arose at time of rising resource nationalism Aspirations of non-western countries to control own resources Early OPEC focussed on: Nationalization of oil concessions Controlling production Change in tax systems OPEC was disunited and achievements were modest Note: OPEC s share of world oil output 28% in 1960, rising to 41% in 1970 () Global Energy Issues, Industries and Markets 22 / 51

23 The Early years of OPEC, OPEC countries had to sell oil to international oil companies or get money from deals Mostly oil companies still produced the oil Based on posted prices (heavily influenced by Seven Sisters) Posted prices set too low? Various negotiations to increase prices Quotas started in 1965 but abandoned in 1967 () Global Energy Issues, Industries and Markets 23 / 51

24 Oil Price Shocks, Following Arab-Israeli war, Arab countries imposed oil embargo against USA, the Netherlands, Portugal and South Africa 25% cut in production Big increase in prices first oil price shock Prices increase fourfold, many economies go into recession (theme: oil has big impact on macroeconomy) Nationalization proceeded. E.g. Saudi government acquired 25% stake in Aramco in 1973, then 60% in 1974, with 100% by 1980 (renamed Saudi Aramco) But international oil companies still needed for exploration, development, transport and marketing of oil Oil price shock (partly) caused recession in OECD Energy effi ciency/alternative energy sources/renewables on policy agenda End of era of cheap oil, end of posted price system, OPEC starts offi cial price mechanism () Global Energy Issues, Industries and Markets 24 / 51

25 Oil Price Shocks, Second oil price shock in (Iranian revolution + Iran-Iraq war) OPEC diffi culty maintaining its offi cial price Market price diverged from OPEC offi cial price Eventually much OPEC oil sold in spot markets at higher prices Prices more than doubled Increasing pressure in oil consuming countries () Global Energy Issues, Industries and Markets 25 / 51

26 Return of Cheap Oil, Oil price shocks led to reduction in demand, increase of non-opec supply Result: falling oil prices Energy diversification (decline in importance of oil) In 1970s OPEC produced 40-50% of oil Early 1980 s dramatic drop to 20%-30% Some details: Production quotas introduced in 1982, but disagreements in 1983 Saudi Arabia emerged as swing producer to try and keep stable prices But then price war as OPEC tries to regain market share Third oil shock as prices plunged by 1986 to less than $10 per barrel () Global Energy Issues, Industries and Markets 26 / 51

27 Return of Cheap Oil, Throughout 1980s OPEC used quotas to try and keep reasonable oil price Kept prices from collapsing, but still low But significant cheating on quotas Emergence of non-opec players (we will discuss North Sea Oil shortly) FSU = former Soviet Union Within OPEC, Saudi Arabia has most influence on price Saudi Arabia = biggest producer plus has excess capacity (expand/contract output to push prices down/up) () Global Energy Issues, Industries and Markets 27 / 51

28 The New Era of Volatility? 2001-present Oil prices dropped with financial crisis/recession late 2008 caused demand to drop Apart from this, oil prices have (in general) been high over period Mostly demand-driven, emergence of non-oecd countries (esp. China) as industrial powers Despite various shocks (wars in Kuwait, Iraq and Libya), general trend to gradually increasing oil prices However, in autumn 2014 the price fell (roughly halved) Demand is down (slightly slowing Chinese economy, slightly less use for transport) Supply has been hit by shocks in Syria/Iraq/Libya but US production strong () Global Energy Issues, Industries and Markets 28 / 51

29 The New Era of Volatility? 2001-present Lower oil prices are having big negative impact in some countries (e.g. Russia, Venezuela, Canada) But positive impact elswhere (e.g. European consumers benefitting from lower petrol prices) Big effects on oil industry Many companies cancelling expansion products US tight oil projects more flexible, but projects in Canadian Oil Sands hard to change Oil sands plans made in era of $100 cannot easily be adjusted IEA s July Monthly Oil Report says: As US tight oil output flattens and then starts to fall back, Canadian oil sands emerge as the engine of North American supply. What will future bring now that sanctions on Iran may be lifted? () Global Energy Issues, Industries and Markets 29 / 51

30 Case Study Topic: The Pricing of Oil In my history of the international oil markets, I have mentioned pricing a bit In a general sense, price is determined by demand and supply But the details of price determination offer fascinating history Good place to start: Fattouh, B. (2011) An Anatomy of the Crude Oil Pricing System Oxford Institute for Energy Studies Working Paper 40 Financial Times article: Later lecture will discuss financial markets for energy in more detail But I briefly mention a few points here () Global Energy Issues, Industries and Markets 30 / 51

31 The Pricing of Oil A theme of recent decades is: increasingly oil just traded as commodity Before 1980 much oil contract traded (e.g. long term contract negotiated directly between buyer and seller) But now market trading common (or formula pricing which use prices taken from markets) Spot markets: oil sold for cash and delivered immediately Future markets: promise to purchase at a specific date in future at price agreed now Oil commonly traded in spot and futures markets Advantages of markets: price discovery and transparency () Global Energy Issues, Industries and Markets 31 / 51

32 The Pricing of Oil: ICE and Brent Crude Futures But oil is not a homogeneous good (different densities, sulfur content, etc.) Various pricing benchmarks and exchanges, here give one example ICE = IntercontinentalExchange trades oil price futures (and many other things) One contract equals 1,000 barrels of oil But what "barrel of oil"? Brent Crude Brent Crude is classification of sweet light crude oil comprising Brent Blend, Forties Blend, Oseberg and Ekofisk crudes Financial Times, 5 July, 2012: Crude jumps to one month high on Norwegian lock-out...the country s production of high quality, low sulphur crude oil is particularly important for the Brent market as it is part of the Brent benchmark. () Global Energy Issues, Industries and Markets 32 / 51

33 The Pricing of Oil Formula pricing also popular Links price of long-term contract to spot price prevailing at time oil changes hands I will mention Saudi formula pricing later on But formula pricing uses a spot price (taken from one of the markets) This is a very superficial over-view of oil pricing, if interest in more detail do a case study on it The Economist, May 5, 2012 headline: Riddles, mysteries and enigmas: Amid international concern about the integrity of the global oil markets, we report on the Kremlin s favourite oil trader Article worries about manipulation of Urals crude price by Gunvor (Russian oil trading firm) Concerns about manipulation of benchmarks possible case study for this course () Global Energy Issues, Industries and Markets 33 / 51

34 Increasing Role of State Oil Companies Biggest oil companies by reserves? National oil companies of Saudi Arabia, Iran, Qatar, Iraq, Venezuela, Abu Dhabi, Kuwait, Nigeria, Libya, Algeria Biggest oil companies by production? Almost the same list, but Russian and Mexican state oil companies enter Russia has several state-owned oil companies and partly state owned (state owns majority of shares in Gazprom and Rosneft) Seven Sisters not on either list, decreasing role of international oil companies Of publicly-traded companies PetroChina recently surpassed ExxonMobil (in production terms) to be biggest in world Increase of joint ventures (state company + international oil company) Table on next page lists top oil+gas companies (not including fully state owned) by various financial metrics () Global Energy Issues, Industries and Markets 34 / 51

35 Top 15 Oil-Gas Companies (not including state co.) Company State/Geograph Region Assets Revenues Profits 1. Exon-Mobil Texas/Americas $302,510 mil $341,578 mil $30,460 mil 2. Chevron California/Americas $184,769 mil $189,607 mil $19,024 mil 3.Gazprom OAO Russian Federation/EMEA $330,261 mil $118,401 mil $32,443 mil 4. PetroChina Co Ltd China/Asia-Pacific $254,914 mil $220,177 mil $21,034 mil 5. Total/EMEA Total/SA $206,640 mil $189,153 mil $14,234 mil 6.Royal Dutch Shell Plc UK/EMEA $322,560 mil $368,056 mil $20,127 mil 7.Conco-Philips Texas/Americas $156,314 mil $175,752 mil $113,58 mil 8. China Petroleum& Chem China/Asia-Pacific $153,143 mil $281,981 mil $10,788 mil 9.Rosneft Oil Company Russian Fed/EMEA $93,829 mil $61,942 mil $10,400 mil 10. Lukoil Russian Fed/EMEA $84,017 mil $104,956 mil $9,006 mil 11.Statoil ASA Norway/EMEA $119,203 mil $89,523 mil $6,473 mil 12. Petrobras-Petroleo Brasilier Brazi/Americas $328,193 mil $125,937 mil $20,779 mil 13. E.ON AG Germany/EMEA $219,815 mil $125,833 mil $9,007 mil 14.Repsol YPF SA Spain/EMEA $97,241 mil $74,779 mil $6,319 mil 15.CNOOC Ltd Hong Kong/Asia-Pacific $50,464 mil $27,280 mil $8,175 mil Source: Platts Energy 2012 () Global Energy Issues, Industries and Markets 35 / 51

36 Oil in the Future Two big issues hang over future of oil: Decarbonization and future supply Both will affect quantity of oil used and its price Will world bring in policies (carbon tax, carbon trading, etc.) to reduce CO 2 emissions? If yes, then this will reduce oil s role Oil is cleaner than coal, but dirtier than natural gas Fossil fuels: oil produces roughly 50% more CO 2 emissions than natural gas in electricity generation (coal produces even more) But oil is still best for transport Decarbonization will be discussed in detail in a later lecture It is probable (but uncertain) that climate change will cause pressure to reduce role of oil in energy mix () Global Energy Issues, Industries and Markets 36 / 51

37 Future Supply of Oil Peak oil debate, will we run out of oil? An interesting topic for a case study? Estimates of reserves are unreliable, but... Most projections suggest no shortage, at least in medium term Next slides are BP s and OPEC s future projections () Global Energy Issues, Industries and Markets 37 / 51

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41 Future of Oil: Existing Fields Most of today s oil come from fields that have been producing for decades. More than 95 percent of the crude oil produced today was discovered before the year About 75 percent was discovered before Many large fields can hold decades of supply. E.g. Ghawar field in Saudi Arabia began production in 1951 and still is producing nearly 5 million barrels a day. () Global Energy Issues, Industries and Markets 41 / 51

42 Future of Oil: New Finds Brazil (Petrobras, pre-salt fields) and Caspian basin are important growth areas (but Petrobras is a company with troubles) Sub-saharan Africa: Nigeria and Angola already big oil producers, but recent newspaper articles: FT, 5 July, 2012: Tullow Oil said a big oil discovery made in Kenya earlier this year was even larger than initially thought. BBC, 21 February, 2012 New oil finds off Liberia and Sierra Leone Arctic (Russia, US, etc.) potentially huge amounts of oil and gas (see Economist, June 12, 2012, case study?) () Global Energy Issues, Industries and Markets 42 / 51

43 Future of Oil: Technological Improvements and Non-conventional Sources Previous slide shows increasing importance of non-conventional sources Advances in technology means more oil Improvements in deepwater production But risk of environmental damage due to oil spills Extraction of oil from sands (Canada in particular) But costly and environmental consequences Improvements in extraction technology (get more out of existing fields) Sophisticated technology, will national oil companies need technical skills of international oil companies? tight oil () Global Energy Issues, Industries and Markets 43 / 51

44 Future of Oil: Tight Oil Next week lecture on natural gas and talk more about shale then Shale gas revolution? Big issue (possible case study) Large expansion in USA in oil production Note: confusing terminology Most common: tight oil = shale oil = crude oil occurring naturally in shale (these are the important ones) Oil shale = something different = type of rock which contains a different hydrocarbon (but can be turned into crude oil at some cost) () Global Energy Issues, Industries and Markets 44 / 51

45 Future of Oil: Tight Oil Lots of shale around world (US and Canada is where most development has been) Bakken shale, Eagle Ford Shale big US shale plays Potential huge, but unclear how much oil can be recovered (3% recovery rates used in most calculations) Tight oil extracted using hydraulic fracturing ( fracking ) Expensive to extract ($30-$80 per barrel) so needs high world oil price to be viable Environmental concerns about hydraulic fracturing Summary: at least in next few decades, won t run out of oil, but worries about whether it should be extracted and at what cost This is a possible case study. () Global Energy Issues, Industries and Markets 45 / 51

46 Case Study Topic: Policy Relevance for Future Chapter 5 (written by Paul Stevens) on Oil Markets and the Future in The New Energy Paradigm (edited by Dieter Helm) written before 2007 Provides a list of Issues in the Oil Market which are Likely to Prompt Demands for a Policy Response This is possible case study you can do for this course. Are all of his concerns still relevant almost 10 years on? Did he miss any important issues? () Global Energy Issues, Industries and Markets 46 / 51

47 Case Study Topic: Reducing Consumption of Oil from Transportation Starting point: C. Knittel (2012). Reducing Petroleum Consumption from Transportation, Journal of Economic Perspectives, 26, In this lecture, have focussed on oil supply and markets Little said about consumers of oil (largely for transport) If interested, do a case study on this Issues relating to: energy effi ciency, taxation of petrol, regulation (fuel effi ciency standards for cars), technology (hybrid/electric cars) and alternatives (biofuels) () Global Energy Issues, Industries and Markets 47 / 51

48 Case Study Topic: Canada s Oil Sands Costs and benefits of Canada s development of its oil sands Note: environmental costs are large Also could discuss transportation issues (building of pipelines) Note: Shell has a carbon capture and storage project in oil sands, will it be commerically viable? Reading to get you started: The Economist, January 20, 2011, Muck and brass IAE publications, including World Energy Outlook and have some material Canadian Energy Research Institute s website ( has interesting material Royal Society of Canada (2010), Environmental and Health Impacts of Canada s Oil Sands Industry (available on the Royal Society of Canada s website) () Global Energy Issues, Industries and Markets 48 / 51

49 Case Study Topic: The Oil and Gas Industry in Nigeria Nigeria is increasingly a big player in oil and gas markets Facing many interesting challenges (technical, economic and political) Discussion of these could form the basis for an interesting case studies Reading to get you started: Finanical Times, Special Report: Nigeria: Oil and Gas 2012, Financial Times, Special Report on Oil Futures: covers many countries/companies () Global Energy Issues, Industries and Markets 49 / 51

50 Case Study Topic: The Movement of Oil Within and Between Countries I have said little in this lecture about the mechanics of trade in oil Oil tankers, pipelines, etc. Pipeline: ensure open access at common price? In lecture on natural gas will discuss pipelines (similar issues arise) But a potential case study could focus on the details of the international oil trade Chapter 14 of Dahl (2004) OPEC World Energy Outlook (2011), section on It s in the Pipeline Keystone pipeline? (The Economist has recent articles) () Global Energy Issues, Industries and Markets 50 / 51

51 Summary Discussed history of oil industry to show economic issues which arise Issues: Industry structure Cartels/monopoly power/opec Impact of oil in world economy (and world politics) Rising resource nationalism, state ownership Pricing and markets Future of oil: Tight oil, oil sands, etc. () Global Energy Issues, Industries and Markets 51 / 51