The Peak Oil Crisis: Dividing a Growing Pie

Falls Church News-Press

By Tom Whipple
June 1, 2006

In recent weeks, there has been a spate of stories about oil-producing countries either nationalizing their oil industry or unilaterally announcing new contract terms for international oil companies (IOCs) operating in their countries.

As the price of oil increased rapidly in recent years, exporting nations that had foreign oil companies operating within their borders looked at the unprecedented profits being earned by IOCs and began asking, “Why aren’t we making that money; it’s our oil?”

This is not a new issue. Nearly 70 years ago the Mexicans asked the same question as they nationalized their oil production. In the decades after World War II, most Middle Eastern producers took control of their own oil resources, either peacefully as with Saudi Arabia or accompanied by turmoil as in Iran and Iraq .

The current wave of nationalization/renegotiation began in 2004 when the Russian government moved to bring its giant Yukos oil company, that had been in private hands since the collapse of the Soviet Union , back under state control. This of course was an internal matter for the Russians.

This year has seen more pressure on the IOCs as Venezuela, Bolivia, and Ecuador either announced nationalization, in the case of Bolivia’s gas fields, or new contract terms that would bring the government more control and a greater share of the profits.

Last week the spotlight swung back to Russia when Moscow floated the notion that it should have 51 percent ownership in three of the biggest foreign oil projects in Russia — Shell's Sakhalin-2 field, Exxon's Sakhalin-1 and the Kharyaga license held by Total. The Russians claim these projects are all behind schedule, over budget and short on Russian involvement.

Although there has been no movement as yet, there is speculation other oil producers with a significant foreign oil company presence will be either announcing or asking for contract renegotiations.

The reason the foreign companies are present at all is because they alone have had the resources and technical expertise to find, produce, and market the oil. In many cases, the host government’s major function is to collect and spend the revenue check. Now, the tightening world oil supply and spiraling prices have brought a whole new dynamic to the revenue sharing question.

Most of the relationships between producing nations and the IOCs go back many years if not decades. Production and revenue sharing contracts were written back in the days of $10 or $20 a barrel oil. Contracts usually provided for the IOCs to make all the investment in return for some share of the profits. If the deal were for a 50-50 split, and the oil sold for $10 a barrel, then each partner might make a couple of dollars a barrel after a expenses.

The problem came when the value of oil quickly rose to $70 a barrel with little increase in perceived expenses. Then the IOC and the host government could each be making $30+ per barrel. From the host government’s point of view, the question became why should the IOC that was satisfied with a couple of dollars per barrel profit be entitled to a profit of $30 or more.

The question shifts to one of how much leverage the producing government has to demand more of the revenue pie. This, of course, requires a careful analysis and a lot of luck on the part of the government seeking a bigger share of the revenue. Given that most oil companies are making money, in some cases a lot of money, from their foreign operations, it is obvious that they have a lot of give. Naturally, they want to continue profitable production contracts and they already have made multi-billion investments in their projects.

In many cases, there are other factors to consider besides the profitability of the IOC. What other economic or political relations does the host government have with foreign oil importers? Should the government feel that its national security rests on good relations with Washington or some other importer, then it is going to be reluctant incur the problems of breaking existing contracts in hopes of gaining more revenue. The size and potential for a nation’s oil production would enter the equation. If oil production is minimal by world standards, an IOC could easily close up shop and leave the host country on its own.

Another new factor in the equation may be technically competent countries such as China , Japan , and South Korea who are becoming concerned about the future of their energy supply. In many situations, these countries would be more than happy to assist exporting nations with their oil production in return for access to the product.

Yet another complicating factor is that most new oil production is coming from deep-water fields these days. Finding and producing oil from beneath deep waters is a difficult task that requires huge investment, many years of effort, and much technical expertise. Losing access to the money and know-how of the IOCs is something a country that wants to continue in the oil production business should not take lightly.

Much debate is taking place as to whether recent grabs for a bigger piece of the profits will pay off in the longer run. Venezuela , which is currently producing about 2.7 million barrels a day but has large reserves of hard-to-produce heavy oil, is the most interesting. Having unilaterally announced major increases in their share of the revenue and control over heavy oil production, Caracas is awaiting a response as the whether the IOCs will acquiesce in the unilateral breaking of long-term contracts.

If the IOCs pull out or reduce their efforts in Venezuela , at stake are US imports of 1.6 million barrels a day plus long-term access to large quantities of geographically close heavy oil. If there is a break in the oil relationship, both countries are likely to suffer for an indefinite period.

Most observers hold that Bolivia and Ecuador have made mistakes in breaking their contracts with foreign oil companies. Their production is relatively small and they lack the capital and expertise to increase production without outside help.

Are any other nations likely to succumb to the lure of more pie and seek revisions to existing contracts? In reviewing the list of major producers, most such as China, Mexico, Norway, Canada, and Saudi Arabia either do not have production sharing agreements or are unlikely to get into the contract-breaking business.

There are others in the world such as Nigeria and Angola who might be tempted but in these cases other overriding factors could come into play.

As oil depletion sets in and the price of oil moves up, pressures on producing nations to get all they can, while they can, will increase. In this situation there is much opportunity for miscalculation. This would probably come in the form of the IOCs either pulling out of a country under pressure or a reluctance to make major new investments while under threat of expropriation. In either case future oil production will suffer and the day of peak oil will move a little closer or worldwide depletion will be a little faster.

http://www.fcnp.com/613/peakoil.htm