Old Partners, New Competitors – Shift in the Upstream Strategic Landscape

In the past few decades, the upstream sector has been observing a steady shift of control over majority of the oil and gas reserves from large integrated oil & gas companies (IOC) to national oil companies (NOC). The other gradual shift is that the oilfield service companies (OSC) have started to provide risked based services (or performance based contracts) and even beyond that production performance services to the market and mainly to NOCs. The combination of these forces is changing the strategic landscape of the upstream sector. It may be the time for the IOCs to revisit their share production business model and be proactive in leading the change by formulating alternate strategies.

Let`s set the context first. The increasing rate of global energy demand is hovering around 1.0 to 1.5 per cent and oil and gas resources are accounted for majority of it (EIA, 2012). Technology advancements in deep-water drilling and completion, and 3D seismic have resulted in higher number of offshore discoveries, but this will also have a limit and is expected to dry out by the end of this decade.

naft_energy_consultants_upstream_strategy_Canada_CalgaryTo meet the reserve and production commitments the IOCs had no choice but to develop challenging resources – oil sands, arctic, deep water – that meant investing in projects with higher capital-intensity, higher Opex and lower net margins.

According to IHS CERA, capital expenditure and operating-expenses have increased by 127% and 89%, respectively, from 2000 to the first quarter of 2012. The result is clear, lower margins and poor share price performance. The average production of top IOCs have been declining and despite of their effort their cheap barrels are being replaced by expensive ones. Erosion of their net operating margins is well reflected in their stock price performance (see the below comparison to S&P500).





NOCs on the other hand, are not willing (yet) to take the risk of entering into the unconventional resource development independently, so they have taken the back seat by securing the resources through silent partnership, JVs or through corporate acquisition which would allow then to share the risk and have access to technology, know-how, talent and infrastructure. They seem to be in learning mode.

naft_energy_consultants_upstream_strategy_Canada_CalgarySource: EIA

Exploration, reservoir management, project development and other expertise needed for a full-cycle field development that have been in monopoly of few IOC are now widely available to NOCs. The NOCs have been very proactive in hiring mid-career technical and leadership staff to enrich their know-how capabilities and to elevate their knowledge base. This coupled with increasing support of the OSCs and their flexibility to take performance and production risked contracts have given greater confidence to the NOCs in executing small to medium size projects themselves, both in terms of size and complexity. Aramco’s JV with Sinopec, Gazprom’s JV with PDVSA, ADNOC-KNOC-GE partnership to develop 3 fields and several similar partnerships over past 3-5 years indicates that the leading NOCs have already started to step out of their traditional financier role and actively take operatorship in new horizons. In 2011 the combined investment of NOC group (top 10 NOCs) in technology development exceeded the one for IOCs. Their other advantage is that, NOCs have better access to capital market.


naft_energy_consultants_upstream_strategy_Canada_CalgaryR&D Investment by Group (2011) (Source: Deloitte, Oil & Gas Reality Check 2013)

On the M&A side, NOCs have been actively positioning and acquiring footprints in conventional and unconventional resources all over the map. Few decades ago the IOCs were eager to open new markets and secure reserves through signing PSA agreements with NOCs. While the IOCs and independents still are actively optimizing their portfolio, the big part of the upstream M&A transactions belong to NOCs securing reserves in the open markets, mainly in North America, offshore Africa, SE Asia and offshore Brazil (NOC Monitor, Q1 2012, ey.com). In 2011, 76% of NOCs investments (in value) are accounted to their foreign investments. Chinese national oil companies were responsible of 50% of NOC acquisitions in 2011 while the NOCs were responsible for 24% of total upstream deal value.



NOC Global M&A Activity by Deal Value (Source: PLS: Oil & Gas M&A Database, Jan 2013)

NOCs ambition to grow and develop their resources outside of the traditional PSC framework has been a great opportunity for OSC. Major service companies (Schlumberger, Baker Hughes, Halliburton and Weatherford) have opened new divisions to formulate and offer new package services to the NOCs. They are targeting billion dollar deals in Iraq, Venezuela, Mexico and other politically unstable geo-markets. In other markets such as Saudi, Russia and Malaysia (and other Asian basins) they target bundled services and share-production contracts including project development, planning, reservoir management and production optimization.


The shift is far from over and the question that come to mind is would the resource-ownership model that IOCs have been promoting will come to an end soon? How do you foresee the future of the upstream sector and what strategic shift do you advise to IOCs?


More to read:

Oil & Gas Reality Check 2013, Deloitte

Financial Performance of Major Oil Companies, 2007-2011

National Oil Companies Reshape the Play Field, Bain & Co.