Are the Energy Majors in Decline?

The title
of this article may seem rather provocative and overstating the
tendencies that are only emerging in the global economy. Yet these
tendencies are rooted in objective processes that, should they
persist, may drastically change the overall situation in the world
economy.

Gazprom’s
recent refusal to set up an international consortium for developing
the Shtokman offshore deposit in the Barents Sea sparked uproar
around the world. This deposit, boasting the biggest reserves of
hydrocarbons under the seabed – its estimated resources stand at
over 3 trillion cubic meters of natural gas – is really unique. It
is located about 600 kilometers away from the shore, in an area
that is prone to icebergs. Thus, experts from this field realized
in the early 1990s that its development would require
unconventional technological solutions. However, since the
discovery of this deposit in the 1980s, few practical steps have
been made to prepare this deposit for commercial use.

Discussions over the Shtokman gas field have been underway
since 1991 when the first consortium (then consisting entirely of
foreign companies) submitted its initial feasibility study to a
board of government experts. As the economic and political
situation in Russia at that time was highly unstable, Western
corporations – with their experience of hydrocarbon production in
the North Sea – hoped to make the project a fully export-oriented
one.

The plan
called for the installation of platforms in accordance with Western
technologies that would deliver gas shipments via pipelines to the
European continent, thereby minimizing dependence on “Russian
risks.” In 1992, liability for implementation of the project was
handed over to a new Russian company on the scene called Rosshelf,
which brought together Gazprom and several defense producers. The
latter were meant to manufacture equipment for the offshore mining
of hydrocarbons in line with the then popular policy of converting
defense production to civilian use.

The
project, however, had a low start. In the mid-1990s, Russia had
enough operational gas fields to meet a sizably diminished domestic
demand, as well as in the former Soviet republics and East European
countries. In the meantime, the growing demand for gas in Western
Europe was supposed to be met by ramifying the pipeline
infrastructure rather than launching the extremely expensive
Shtokman project. But the second half of the 1990s saw a sharp
decline in the price of crude oil. As a result, Gazprom’s financial
situation deteriorated and, in order to remedy the falling
production levels, it was forced to focus on an immediate
commissioning of the Zapolyarnoye deposit in north
Siberia.

The
beginning of the new century witnessed a steep growth in the demand
for liquefied natural gas (LNG). Today, novel technologies help to
considerably reduce the cost of its production and delivery by sea,
and its competitiveness with the transportation of gas via
pipelines (in areas where the two methods of transportation can be
used alternatively) continues to grow. Add to this the growth of
gas prices on the North American gas market (where prices remained
rather low after liberalization for many years). The biggest U.S.
corporations that had receiving terminals, contract portfolios and
a history of deepwater hydrocarbon resource development (above all,
in the Gulf of Mexico), displayed great interest in organizing
wide-scale supplies of LNG. It should be no surprise that they
turned their eyes to the Shtokman deposit.

The
Europeans also took an interest in the project, although just a few
years before this market seemed to be at a standstill, with
outdated terminals in Britain mothballed and hardly any new
terminals being built. Thus, the participation of European
companies in the project looked not only as a way of bringing
liquefied gas to the European market at an earliest possible date,
but also as a counterweight to U.S. influence. Moreover, Norwegian
companies, which showed the biggest interest in the Shtokman
project, really had much to offer in terms of
technology.

The
decision to change resources to LNG has made the Shtokman project
one of the biggest global enterprises in this sphere. However, the
scale of this initiative does not match the gas field’s potential.
Initially, the international consortium was supposed to implement
the entire integrated project – from developing the deposit, to
building a liquefaction plant, to exporting the gas, most of it to
the U.S. The shortlist of potential Gazprom partners included five
foreign companies: Conoco and Chevron of the U.S., Total of France,
and Statoil and Norsk Hydro of Norway. The announcement of the
winning contender was put off numerous times until an unexpected
notification came that Gazprom had undertaken to develop Shtokman
on its own.

Gazprom’s
rapidly growing foreign liabilities, together with the markedly
expanding capacity of the domestic market, have put full-scale
development of the Shtokman deposit to the top of the agenda once
again. Early tests suggest this project will have an annual output
of around 90 billion cubic meters (bcm), as opposed to 22 bcm
estimated for the LNG supplies. Importantly, “pipeline gas” will be
channeled to the Unified System of Gas Supplies, which pools
together gas supplies for foreign and domestic consumers. This
project stands in dramatic contrast to what was envisioned
previously: namely, it targets an altogether different market (it
is no accident that a decision was made to reorient main exports to
the North-European Pipeline System). Also, the new project concept
makes it difficult to estimate contributions and interests of
participating companies, should their number be great; at least
this would require too much time.

Another
important factor is the volatility of the U.S. gas market where
prices are not pegged to oil. Thus, the recent start of a price
slide there poses tremendous risks for the LNG project.

Arguments
in favor of the recent decision to exclude foreign energy companies
from the Shtokman project vary, yet all observers agree that the
latest developments were very abrupt.
And why were such actions taken against the largest international
oil and gas corporations? It would be an oversimplification to
explain the situation by Gazprom’s style of conduct.

The
largest oil and gas projects are traditionally implemented by a
limited number of the most powerful – and mostly transnational –
corporations (the ‘majors’ as they are often collectively referred
to in English), or they are carried out under their guidance. The
reason for this standard practice is simple: large-scale and
technologically sophisticated projects require huge investment.
Their implementation demands the concerted effort of numerous
contractors, together with their extensive production experience.
Such projects also require a steady position on relevant markets of
commodities and services.

Over the
decades, only the majors have had the capabilities to meet all of
these conditions. They are capable of drawing the best financial
resources since they have high financial ratings, as well as good
reputations. Their capitalization power puts them in the ranks of
the biggest global companies. The majors clearly have the knowledge
and skills required for such projects, especially since the
specific skills necessary for organizing business activities are
often not directly linked to oil or gas.

However,
it is a big question whether the majors hold leading positions in
the field of innovation. It is a popular belief nowadays that the
majors should focus on their core business, i.e. their main and
narrowly specialized sphere of activity. This suggests they should
outsource knowledge, skills and services. Innovations are highly
specific and risk-prone, so the majors often assign them to
technological, servicing and engineering companies that are
specialized in these fields. As for the skill of operating on
modern energy markets, the latter are becoming increasingly more
open to new suppliers, due to high prices and the fear of resource
shortages.

Still, the
majors are able to maintain their status due to the expansiveness
of their activities, of which capitalization plays an integral
part. They draw their power from the amounts of resources they
control. The resources are easily recalculated into capitalization
and form the long-term basis for their business activities. Whereas
the business of the servicing companies is contingent on the
success at bidding for specific customers’ orders, the majors enter
these contests as certain winners by having secured huge
resources.

The
struggle for resources, of course, runs through the history of the
global corporations. Propped up by overt support from political
circles in Western countries, the majors for decades fought against
the tide of nationalization and put up obstacles to the formation
of OPEC as an association of countries where the production of oil
and gas had been nationalized. However, in a large number of
countries, they had to reconcile themselves to the roles of project
operators, not owners.

A new
generation of the largest oil corporations – like Statoil and Norsk
Hydro in Norway, Petronas in Malaysia, CNPC and CNOOC in China –
have surfaced across the world in the past few decades. This
phenomenon was the result of state policies of strengthening
“national champions” in the oil and gas sector; in other words, the
ones that would eventually replace the “invited
coaches.”

Norway
offers an illustrative example. Unexpected wealth poured into this
country when oil and gas deposits were discovered in the North Sea.
Since the Norwegians did not have either the experience or
personnel in that sphere, they pursued active cooperation with
foreign companies. At the same time, they endorsed rigid tax
regulations (which brought to existence the ‘future generations
fund’ – experience that Russia decided to follow).

Furthermore, serious efforts were made to develop national
research centers and production facilities, as well as to
assimilate novel technologies. Large integrated projects embraced
key areas of oil and gas technologies, such as construction of the
biggest marine platforms, the extraction of deepwater resources,
etc. All of the major international companies that worked on
Norway’s continental shelf joined in this activity (unfortunately,
the realm of cooperation has not been exactly copied by
Russia).

From the
very start, the Norwegians realized that oil and gas wealth is
finite and it must be used in a way that could ensure long-term
results. Today, the output of crude on the Norwegian shelf is
decreasing and the output of gas will soon reach its peak. In the
meantime, Norway’s largest producers, Statoil and Hydro, which are
co-owned by the government, have achieved the rank of global
technology leaders. Statoil built Europe’s first gas liquefaction plant on the Snovit
deposit, while Hydro engaged in subsurface development of the Ormen
Lange gas deposit, located in the Norwegian Sea at a depth of about
1,000 meters. In their offer to join the Shtokman project, they
planned, primarily, to contribute novel technological
solutions.

Other
resource-rich countries have set for themselves the similar goal of
turning their leading oil and gas companies that possess highly
qualified technical personnel into major international players.
These companies seek to export their skills and even force the
traditional giants to make room not only at home, but also on the
world market in general. True, an opposite trend is observable as
well: oil companies in the OPEC countries, for example, also
receive super-profits on crude, but lack potential in research,
technologies and organization that might grant them a new stage of
growth. Russian oil and gas majors should consider these examples
if they seek to become powerful and independent global players in
the foreseeable future.

The
formation of new energy majors has received a new incentive of late
after oil prices surged, which gave the oil and gas producing
countries and their largest companies huge financial resources.
Public companies (even those where the governments have sizable or
dominant stakes) have beefed up their capitalization. The leading
ones, like Gazprom, have taken over the top positions in the
rankings, pushing aside the traditional majors. Their
capitalization, together with growing revenues and the attendant
rise of ratings, are paving the way to greater financial
might.

The newly
emerging majors – or at least the most advanced of them – have good
prospects for replacing the traditional majors on the global
market. This may be accomplished, for example, by them becoming
powerful organizers and operators of projects, first in their own
countries and then globally. Their main advantage over the
traditional competitors is national mineral resources, which serves
as a prerequisite for gaining strength, as well as a launching pad
for further expansion. Incidentally, the traditional majors
developed in much the same way at the dawn of their history. They
relied on their own resources (like European resources that have
been exhausted or are waning now), or on the resources of the
colonies.

If one
views the current developments as a long-term tendency, the
older-generation majors are heading for very tough competition. The
governments of the resource-rich countries, and national companies
enjoying governmental support, are interested in reducing the role
of transnational corporations to that of ordinary contractors in
developing large deposits. Naturally, the majors deem it
unprofitable, since work on contracts brings virtually nothing in
terms of capitalization. What is more, they will have to compete
with specialized servicing companies even for these
contracts.

Undoubtedly, it
would be premature to write off those corporations that have
dominated the energy market for over a century. Challenging
projects are a tricky business. Also, it cannot be ruled out that
the traditional majors will start restructurings in order to expand
the scope of their core business and win back their market
positions. For instance, they may focus on gaining control over
crucial cutting-edge technologies. If this happens, one can expect
some form of a battle between the existing resources (possessed by
the new majors) and the new technologies. Whatever the case, the
Shtokman project may be a forerunner of critical changes in the
global energy sector.