by Arif Fazil
In the United States, the majority of oil and gas market share are conquered by major private international oil companies (IOC)[1] with Conoco Philips as the top oil corporation holds 10.8% of U.S oil and gas market proportion. Subsequently, Chevron Corporation acquires 8.8%; British Petroleum surmounts 6.2%; and Shell Group obtains 2.6% of oil and gas market share in the United States (Butler, 2010, p.22). All of these five companies are categorized as a major player in oil and gas industry and are considered as the most profitable companies in the world. Formerly, these five companies used to control and produce 100% of oil production percentage before the fall of Soviet Union (Energy Institute, 2009, p.40). Surprisingly, nowadays these companies only account 3.8% of global oil reserves (Pirog, 2007, p.3). Majority (90%) of global oil reserves nowadays are owned by national oil companies (NOC)[2] with Saudi Aramco holding 19.5% oil reserves in the world, making Saudi Aramco as the largest oil reserve holder in the world (Scaroni, 2010, p.2). Even though, NOCs such as Saudi Aramco owns more oil reserves than IOCs, major IOCs such as BP, Shell, and ExxonMobil still generate more revenue compare to NOCs (Refer to Figure 1). Such condition questions whether NOCs are still relevant in today oil industry and whether NOCs should be privatized in order for them to move forward and to be in the same status as IOCs. This paper will analyze the reason why NOCs are not generating revenue as much as IOCs, focusing on efficiency and investment problems. Finally, the decision whether NOCs should be privatized will be argued.
[1] IOC are oil companies that are “predominantly or exclusively privately-owned”(Linde 2000; Stevens 2004, cited in Wolf, 2008, p.9)
[2] NOC are oil companies that “are owned in part or in whole by the government. The most widely-accepted criterion of NOC is that if a government owns 30% or more of the firm, then this should be sufficient equity to control the firm". (Al-Obaidan and Scully , 1991,p.238)
The main reason why NOCs are not performing as well as IOCs in term of revenue generated from oil reserves is because NOCs are less efficient compared to IOCs. Al-Obaidan and Scully (1991) in their research that studies the efficiency between forty four IOCs and NOCs in 1980’s, find that IOCs are 65% more technically efficient than NOCs (p.244). In other words, with the same inputs, IOCs can generate 65% more outputs compared to NOCs. Furthermore, Eller, Hartley and Medlock III, (2007) in their article that analyzes the efficiency of top 100 oil companies for the years of 2002 throughout 2004 also agree with Al-Obaidan and Scully’s data and they project a current efficiency data that state, the major fives IOCs (ExxonMobil, BP, Shell, Chevron, and ConocoPhillips) are 70% more efficient than the average score for NOC (p.27). Based on both of these data, it can be concluded that there are no improvement of NOCs’ efficiency even though two decades has passed; in fact, the efficiency of NOCs has worsen by 5%. In order to be competitive and proficient in the global oil and gas market, the NOC must take further action to reduce the level of inefficiency in their firm.
The inefficiency that occurs in NOCs can mostly be categorized as labor inefficiency. Labor inefficiency in NOCs occurs due to the excessive amount of inputs (workers) that are employed to generate the same amount of outputs compare to an efficient firm. One of the reasons why labor inefficiency occurs in NOCs is because NOCs have too much labor forces to create a certain amount of outputs. NOCs are expected by their national government to provide lucrative employment to their citizens. Moreover, NOCs are pressured by their national government to employ their citizens instead of experts from other country for a position in the company even though the citizen’s personnel are not qualified and capable to complete the job that was given to them (Young, 2003, p.35). Consequently, this action has led to inefficiency in NOCs because NOCs employ more workers than their proficient capacity and NOCs face with scarcity of skilled workforce.
Other reason that causes inefficiency in NOCs is managerial inefficiency. Managerial inefficiency in NOCs occurs due to the fact that NOCs are owned by the government and are controlled by the political figures of the country. Often, these political figures use NOC as a tool to give political benefits to them. Eller, Hartley and Medlock III, (2007) point out that the national government’s act to force its NOC to sell oil products such as gasoline and cooking gas at subsidized price in the domestic market is the major factor that causes inefficiency in NOCs. Data in Eller, Hartley and Medlock III (2007) study shows that nation with a NOC generally has the lowest domestic price for gasoline (Refer to Appendix 2). For example, in 2004, Venezuelan government subsidized the gasoline for its domestic market and sold it for US $0.11 per gallon, while in the United States gasoline is sold at US $2.10 per gallon (Eller, Hartley & Medlock III (2007). Furthermore, as mentioned before, the national government also pressures its NOC to over-employ its citizen. Both of these measures are used by the political figures in NOC’s country to gain political benefits and to stay in power of the country by gaining publics support in the constituency. It can be said that these measures are beneficial for its citizen; however, the act of over-employing workers and subsidizing oil products in the domestic market could compromise the capability of NOCs to generate profit and to become more efficient.
Additionally, corruptions and nepotism that occur in NOCs management also contribute to the managerial inefficiency in NOCs. For example, when Pertamina, Indonesian national oil company, was audited by PricewaterhouseCooper in 1998, it is reported that the company lost US$6.1 billion due to corruption that is done by Indonesian political figures (Linde, 2000). In Malaysia, there was allegation that the Prime Minister of Malaysia has used Petronas, Malaysian national oil company to bail out his son shipping company (Mehden & Tronner, 2007, p.13). Both of these examples show the severe condition of corruption and nepotism occurs in NOCs. The full authority that the political figures have in NOCs is the factor that leads to the corruption and nepotism in NOCs. Evidently, the political corruption and mismanagement of NOC have negatively affect NOC’s efficiency and potential in oil and gas sector.
Although, it is evident that IOCs are more efficient than NOCs; however, when comparing the efficiency of NOCs to IOCs, it must be realized that NOCs and IOCs are very different in term of their principals, objectives, ways of operation, and owner. As a private-owned firm, IOC’s aims and objectives are more toward maximizing profits and increasing shareholders’ value. Whereas, NOCs that are largely owned by their national government have other national agendas that need to be done instead of just to maximize profit. Pirog (2007) in his report that examines the role of NOC in the international market states that most of NOC function as an income and employment generator of the country. Since, lawfully, in every nation except the United States, “the mineral rights to what is underground belong not to those who own the land above, but to the national government” (Scaroni, 2010). Therefore, it is NOC’s responsibility to distribute the wealth of nation’s oil resources back to its nation and citizens. Pirog (2007) explains that the acts of redistributing of oil wealth are done by NOCs through “fuel subsidies, employment policies, and social welfare program” (p.6). Given the fact that most NOCs focus more toward their national agenda rather than profit maximization, economists argue that the methodology to calculate NOC’s efficiency by using standard performance and profitability measures are not accurate enough to portray the efficiency of NOCs (Bozec et al., 2006 cited in Wolf, 2008, p. 20). Based on this statement, it can be concluded that the actual efficiency score of NOCs that was analyzed by Al-Obaidan and Scully (1991) and Eller, Hartley and Medlock III, (2007) before, might be more precise if the qualitative factor such as non-commercial objectives of NOCs are taken into account for their efficiency measurement.
Underinvestment by NOCs not only will endanger their business performance, but also will negatively affect global oil industry. International Oil Agency (2003) in its report entitled, “World Energy Investment Outlook” claims that over the period from 2001 to 2030, oil industry needs US $16 billion worth of investment to ensure that the supply of crude oil in the market is sustainable. Investment in capital expenditure, especially in new technology development is important in oil industry because currently, only 35% of oil can be extracted from an oil reservoir (Scaroni, 2010). If NOCs, as the major holder of global oil reserves do not take major action to invest in technological improvement, the supply of oil will be depleted and oil prices will increase dramatically; global energy crisis can occur and lead to war and conflict between countries.
Even though underinvestment still occurs among NOCs, many business experts believe that numerous NOCs have accomplished successful result in their effort to invest in technological improvement and capital expenditure for their long term benefits. Famous example is Petrobras, the Brazilian’s NOC; Petrobras is the pioneer in developing technology for deep-water drilling. Petrobras nowadays has the capabilities to extract oil deeper than 1000 meters on the sea level (Energy Institute, 2010, p.36). Petrobras investment in geosciences technology is really valuable for the firm’s business performance because it is reported by Hoyos (2007) in Financial Time magazine, that Petrobras these days is competing with major IOCs such as ExxonMobil and BP to extract oil reserves in Angola and Gulf of Mexico. By investing in technological development especially in oil production and extraction, NOCs can enhance their competitiveness to be at the same level with IOC.
Malaysia’s Petronas also is one of NOCs that have been successful to manage its funds, and to invest in capital expenditure for its survival in the oil and gas market. The company has taken drastic step to increase its revenue and competitiveness by investing in overseas production. The Economist Intelligence Unit of Malaysia (2009) reports, currently, 42% of Petronas corporate revenues are gained from overseas operation and the company has business in more than 35 countries overseas (p.1). The leadership of Petronas realizes that they cannot solely rely on their national oil resources as their revenue generator; they also need to invest and act like IOCs that have international operation across the globe. Petronas is not only well-known for its vast international operation, but it also owns the largest integrated liquefied natural gas (LNG) complex in the world (Bonn, 2008, p.30). Bonn (2008) further explains that the vast investment by Petronas in its LNG production has increased its efficiency in distribution where Petronas “has not missed a single cargo delivery in its 25 years of operations”. Nowadays, Petronas is considered as the major exporter of LNG in North East Asia (Bonn, 2008, p.31). The efficiency and the competence of Petronas in dealing its petroleum product have made Petronas as the preferred supplier for their customers. Evidently, investment in technological development and capital expenditure is important to ensure that NOCs can compete with IOCs.
It is apparent that inefficiency and underinvestment are the two factors that hinder NOCs to generate revenues as much as IOCs even though NOCs own more oil reserves compared to IOCs. Many business experts believe that state ownership in NOC as the major factor that obstructs NOC to move forward in oil and gas businesses. Al-Obaidan and Scully (1991), Eller, Hartley, and Medlock III (2007), Pirog (2007), and Fischer (2008) agree and suggest that by privatizing NOC, the inefficiency and underinvestment problems in NOC can be overcome. Al-Obaidan and Scully (1991) in their research that measures and compares the efficiency of NOCs and IOCs using statistical and econometric measurement, found that by privatizing NOCs, NOCs can “satisfy the demand for their output with something less than half of their current resources” (p.237) Eller, Hartley and Medlock III (2007) have constructed an economic model to show the effect of NOCs with and without government intervention (Refer Appendix 4) and their finding agrees with Al-Obaidan and Scully result. BP is one of the famous examples to explain the success of privatizing NOCs. Initially in 1914, Anglo-Persian Oil Company, later renamed BP, has been established and it is owned by British government to ensure the national energy security. Subsequently, in 1977, British government has taken drastic action to make BP as a wholly private-owned company (Wolf, 2008, p.50). The act of this privatization has made BP as one of the major oil company in the world with operating revenues more than US $ 287 billion (Victor, 2007, p.11). Conclusively, by referring to economic and commercial factors, NOC are better off if they can be privatized.
However, when arguing about the topic whether NOCs should be privatized or not, the objectives of the establishment of NOCs at the first place must be taken into account. It must be recognized that NOC is a NOC; profit maximization is not the only objectives that NOC has, but it also has national agenda to be fulfilled. NOC’s decision to create large employment opportunities to its citizens, to subsidize the petroleum products in the domestic market, and to contribute for government budget in term of royalties and taxes are beneficial to the NOC’s nation itself. Marcel (2006) in his book entitled “Oil Titans: National Oil Companies in the Middle East” claims that if NOCs want to be private, a lot of actions that contradict with the nationalism spirit need to be taken such as “firing employees, imposing strenuous work hours and instilling a competitive (almost combative) work environment” need to be done (p.72). For example, BP as an IOC is persistently pressured by its shareholders to increase profit and shareholders’ value. According to Scaroni (2010), this has place pressure on BP to reduce its production costs by “laying off thousands of experienced staff (BP laid off 22,000 staff in two years)” (p.2). The world does not need another multibillion company that only cares about its profit and neglect the society, but what the world needs is a company that plays an important role in the improvement of society, especially in developing world, where most of these NOCs come from. Therefore, by privatizing NOCs is not the best way to improve NOC’s business performance because it neglects and overlooks the social responsibilities of NOCs.
In order for NOCs to move forward and to be in the same status as IOCs in the oil and gas market, NOCs need to evaluate their company management to ensure that they have strong values of integrity and commitment in their work ethics. With strong values of integrity and commitment in NOC’s personnel, it can ensure that there will be less corruption in managing firm’s funds and the efficiency of the company can be maximized. NOCs also need to collaborate with successful IOCs and adapt their strategies that are suitable and beneficial for NOC. For example, Abu Dhabi National Oil Corporation and State Oil Corporation of the Azerbaijan Republic have formed series of joint ventures and partnerships with BP (Young, 2003, p.28). According to Young (2003), this partnership has helped these NOCs to acquire valuable skills in managing complex oil operation and also technological knowledge in deep-water drilling. Through collaboration with IOCs, transfer of technology, skills and capital can happen, and this will be beneficial for NOCs. There are strong evident that show that NOCs will overcome IOCs, if NOCs are lead in an efficient and well-organized way because NOC have more oil resources compare to IOCs.
Conclusively, inefficiency and underinvestment problems are major factors that hinder NOCs to be successful in oil and gas market. The inefficiency in NOCs occurs due to excessive labor and mismanagement in NOC’s funds. These problems can be overcome by NOCs if the correct strategies and visionary leadership are infused in the NOCs management. Also, it must be realized that the effort to privatize NOCs is not the best way to improve NOC’s business performance because it neglects and overlooks the social responsibilities of NOCs. The world must recognize than NOC is a NOC; it has national agenda to be fulfilled and that is the reason why it has been established in the first place.
Appendices:
Appendix 1: Revenues for Top 50 NOCs (red) and IOCs (blue) in 2004
Figure 1 Revenues for Top 50 NOCs (red) and IOCs (blue) in 2004: Victor (2007), p.12
Appendix 2: Simple average domestic motor fuel prices
Figure 2: Simple average domestic motor fuel prices in 2004 : Eller, Hartley and Medlock III (2007)
Appendix 4: Effect of NOC with and without government intervention
Figure 5: Revenue as a function of government ownership Eller, Hartley and Medlock III (2007)
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