From 2002 through 2007, the petroleum industry witnessed major divestitures. According to UBS Investment Research, Global Oil Companies at present have a disposal value that is 75% higher than their acquisition value. This indicates that scale economies cannot benefit a company unless it is accompanied with other strategies such as careful asset selection. At the domestic level, limits imposed by natural resources and depletion strategies adopted by states can often hinder effective partnerships in E&P within the sector. For example, a country such as the Netherlands has attracted more investments than it requires in the areas of oil refining, oil trading, and storage.
Vertical integration is equally evident within the petroleum industry. Vertical integration can assume two primary forms: operational vertical integration where companies physically exchange crude and final products between the successive stages of the value chain (Stevens, 2005). Vertical integration can also occur in the form of financial vertical integration where one company owns and controls successive stages of the value chain and controls their cash flows.
1.3 Local Content Policies and Value Creation
Local content policies influence both private oil corporations and national oil corporations even though the degree of impact may vary. The use of local content policies dates back to the 1970s when they were used in the North Sea in a variety of activities ranging from creation of national oil corporations to restriction of imports. Their roles have evolved from the initial creation of backward linkages to creation of forward linkages. As a result of latest developments, local content today includes the broader economic diversification, thereby moving beyond the traditional oil and gas value chain. A number of instruments exist at the disposal of the government that can be employed to implement local policy content. These include contractual requirements designed to favor local goods and services. Others include taxation, regulation, and protectionist tendencies that favor domestic industries. The government can also make use of contractual and regulatory obligations that encourage technological transfer from foreign to local companies, and enforce bidding requirements that emphasize local content as a basis for winning oil and gas exploration and production contracts.
1.4 The Creation of a NOC: Advantages and Issues
Decisions related to the development and management of national oil corporation is evaluated within the framework of government intervention in the economy.
1.4.1 History of National Oil Corporations
The critical role that the petroleum industry plays has been largely appreciated from the beginning of the 20th century when the nascent automotive sector and internal combustion engines made a significant contribution to the extended boom in the demand for oil. The resulting boom offset the losses associated with the traditional kerosene lighting market following the intervention of the light bulb. The use of natural oil was common in Central Asia and China. From 1850s, oil was collected only when it emerged naturally on the surface. However, in 1859, a pioneer modern oil well was successfully drilled in Titusville, a region in Pennsylvania.
1.4.2 Industry Participation
At the start, private oil corporations and charming business magnets dominated the industry. In the United States for example, John D. Rockefeller founded a refining company; the Standard Oil Company in 1870 and for several decades, the company remained the dominant player with approximately 95% of the U.S. refining market. It equally dominated shipping, drilling and pipeline business. The company later formed the standard oil trust in 1879 with 30 affiliates. The company developed financial and political muscle to the extent that it formed a Trust to monopolize and limit trade. In 1911, the company was dissolved giving rise to 36 independent firms among them Mobil, Exxon, Amoco, Arco, and Chevron. Following the 1901 discovery of oil in Texas, oil companies such as the Gulf Oil Company (GOC) and Texaco were created with GOC opening the first ever filling station in the world in 1913 at Pittsburgh (Tordo, Tracy & Arfaa, 2011).
Outside the U.S., other major oil production areas were Russia and Caspian even though production and exploration was fully owned and controlled by the state. However, in 1872, oil properties were auctioned catalyzing a wave of significant investments in production, refining and infrastructural network. Entrepreneurs who spearheaded the Russian oil industry include the families of Rothschild and Nobel. By early 20th century, a network of railroads had been developed to deliver oil to the West. For a short period, Russia became the world`s largest oil producer surpassing the United States. On the other hand, privately owned European oil companies made use of the protectionist policies in their home countries to produce oil in their respective colonies. In 1890s, Royal Dutch and Shell joined the Indonesian market. In 1907, the two oil companies merged and expanded their operations to Venezuela, Egypt, Mexico and Trinidad in 1910, 1911, and 1913 respectively.
1.4.3 The Rise of National Oil Corporations
Fig 1.4- Founding dates for selected National Oil Corporations
Source: Center for Energy Economics. (2007).
It is believed that the pioneer national oil corporation was created in Austria-Hungary back in 1908 when crude oil supply exceeded the refining capacity of privately owned oil producers. Emperor Franz Joseph endorsed the building of a state owned topping plant that was to be operated by the government. This helped in the processing of the excess crude supply and widened the market for oil products (Heller, 1980). As oil gained recognition as a product of strategic importance, many states developed interest in the oil sector. European states especially the colonial powers initiated or became actively involved in oil companies to manage their local markets and seek upstream operations in their colonial territories. In 1914, the UK government injected a total of £2.2 million to purchase 51% stake ownership in Anglo-Persian Oil Company.
In 1914, the government purchased it and later transformed it into British Petroleum. The purchase was motivated by the need for securing supply of oil given that World War I was just about to begin. In 1924, with the support of the French government, a privately owned Company Française des Pétroles was created. In 1926, Agip was created in Italy and become the first major attempt by a consuming country to neutralize the influence of foreign petroleum companies in the domestic market. At this time, Latin American countries specifically Venezuela and Mexico, where significant petroleum discoveries were made in 1920s, spearheaded the creation of national oil corporations in developing countries. Among the first NOCs was Yacimientos Petrolíferos Fiscales in Argentina in 1922. Chile, Uruguay, Peru, and Bolivia followed suit in 1926, 1931, 1934, and 1936 respectively. In 1938, Mexico created the Petróleos Mexicanos (Pemex) to assume the operations of foreign private oil companies in the country. This was the first major nationalization within the petroleum industry (Tordo, Tracy & Arfaa, 2011).
1.4.4 Post-Colonial World and OPEC Revolution
1959 saw the world leading oil exporting countries convene a meeting in Cairo. An agreement was reached that the parties were to consult each other on issues of common interest. As part of the agreement, the members suggested the creation of national oil corporations as a way of guaranteeing direct state involvement in the oil sector. The members equally agreed that concessionary contracts include a royalty payment to the host nation plus a 50% income tax. Following the price cuts in 1959 and 1960 by privately owned oil companies, oil producing countries thought of better ways to represent their shared interests. Consequently, the Organization for Petroleum Exporting Countries (OPEC) was formed in 1960. The founder members were Iran, Kuwait, Iraq, Venezuela, and Saudi Arabia. Later, they were joined by Qatar in 1961, Libya and Indonesia in 1962, UAE in 1967, Nigeria 1971, Ecuador in 1973, Gabon 1975, and Angola in 2007. Having significantly reduced its oil reserves, Indonesia left the organization in 2008.
At the onset, OPEC offered very little to its members as privately owned oil corporations negotiated separately with the host governments with the companies taking a different stand as far as contract terms, extent of oil revenue dependence, and spare production capacities were concerned. However, with increased economic growth across the world, followed by a peak in the U.S.’s oil production, the bargaining power for oil producing countries was significantly strengthened. By 1965, Saudi entered the first contracts governed by national law and tax legislation as opposed to international law and contractual arrangements. In 1968, OPEC issued a comprehensive declaratory policy that was to govern member countries regarding tax reference points, equity participation, area relinquishment, and host country independence. Member countries were further encouraged to directly develop their hydrocarbon resources. However, if they assigned this function to outside contractors, then a provision had to be made that permitted for future revisions.
The 1970s saw a number of nationalizations and forced equity participations. The 1973 Arab-Israeli war and the subsequent oil embargo by Arab countries against their western counterparts resulted in the first oil price shock that further ruined the mutual relations between the Arab world and the western world. By 1974, all international oil operations in the Middle East had been nationalized with only the legal arrangements taking time to effect. The second price shock was a direct result of the 1979 Iranian revolution and the subsequent Iran-Iraq war in 1980. The growth of the oil sector in OPEC states was part of the wider global wave of territorial emancipation in the post-colonial world given the inclusive membership of OPEC that included countries from Africa, Middle East, Asia and Latin America. The rise of nationalized companies was a major step in changing the ownership structure of the oil and gas sector.
1.4.5 The Reaction of Consumer States
Following the oil price shocks in the 1970s, western countries significantly reduced their demand for oil that resulted in slow growth in the sector. This was further worsened by the slow growth in the global economy. The 1973-1974 and the 1978-1980 oil price shocks is estimated to have cost the OECD countries approximately 2.6% and 3.7% of their gross domestic product (Mommer, 2002). As an attempt to mitigate the adverse effects of the oil price shocks, oil importing countries founded the International Energy Agency (IEA) in 1974. This agency was charged with the responsibility for formulating energy strategies and policies for the developed oil importing nations. Its first rule was related to mandatory levels of petroleum stocks that were to be kept by the members. Later on in 1976, the agencies proposed a long-term program for reducing the demand for oil and instead offer incentives for alternative energy sources and increase domestic supply of the same. Another significant achievement registered by IEA was the creation of a new kind of national oil corporation in petroleum producing western countries such as Canada and the United Kingdom. These measures were to control the domestic development of hydrocarbon resources following the loss of control in foreign markets. In 1975, the British government formed the British National Oil Company as a tool for implementing the national petroleum policy (Vickers & Yarrow, 1988). By late 1970s, all the net importing industrialized countries had set up their national oil corporations except the United States (Linde, 2000).
2.0 A New Agenda and Privatization Liberalization
Following the dismal performance of many state owned Enterprises in the western world, economic researchers began evaluating the likelihood of government failure. As Stevens (2004) reports, governments admitted that they failed as efficient producers and as having been weak in monitoring the performance of state owned enterprises. The oil and gas sector took the lead in privatization and liberalization particularly in net importing and industrialized countries. In 1979, the British government reduced its ownership stake in British petroleum from 68% to 51%. And the company was stripped of its special powers only for years after its establishment. This was followed by the privatization of its oil producing assets in 1982. It took long for the net oil exporters to realize the benefits associated with privatization and liberalization. However, the low oil prices in the late 1980s exerted pressure for institutional reforms in many countries that owned national oil corporations.
In an attempt to reduce oil price volatility, a quota system was introduced by OPEC in 1982, a strategy that kept prices stable until 1985. However, Saudi`s move to introduce the netback pricing in the same year resulted in a substantial drop in oil prices and marked a paradigm shift from the supplier`s market to the buyer`s market. Oil producers outside the OPEC block who had less resource endowments and unfavorable production costs became more exposed to changes in the global macroeconomic environment. Their situation was further worsened by mounting pressure from the Breton woods institutions and other international creditors that emphasized the need for stabilization programs. Argentina became the first major oil exporting country to privatize its companies following its 1989 declaration that 32 state owned firms were eligible for privatization including its NOC, Yacimientos Petrolíferos Fiscales, that was at the time Argentina`s largest company. In the same year, the country fully liberalized its oil sector, abolished monopoly privileges and price controls, opening up the sector to private companies' participation. Other Latin American countries that followed Argentina's example were Bolivia, Venezuela, Ecuador and Brazil.
2.1 The End of History and Developments from 2000
From the year 2000, two opposite trends have characterized the importance and status of national oil corporations. On one end, the political and economic agenda of privatization and liberalization has consistently influenced decision making across the world. As stated earlier, major players in the world economy have privatized their national oil corporations, such as Brazil, India, China, Norway, Japan, and Pakistan, while other countries are contemplating doing so. Although many major oil producers rubbished privatization, significant regulatory landmarks have occurred in some of these countries for example, Indonesia. Others like Saudi Arabia, Mexico and Kuwait have taken initial moves toward permitting foreign participation. On the other hand, the high petroleum prices more so between 2003 and 2008 arising from supply side shocks in the late 1990s, geopolitical concerns and the growing growth in demand within Asia has shifted the bargaining power in favor of the exporting countries. The desire to increase government stake of the existing petroleum rents has promoted widespread tax increases and nationalization of petroleum activities especially in Venezuela, Russia and Bolivia. In some cases, it has promoted the development of national oil corporations in emerging oil regions for example, Uganda and Chad. In addition, countries such as India and China have supported their national oil corporations to acquire foreign petroleum sources (Victor, 2008). As a whole, the political aspect in energy decision making has become more pronounced not only for oil exporting, but also for the importing countries. Currently, oil price volatility, a world emerging from the worst recession, and the uncertain economic future make it difficult to accurately characterize the future for energy demand and international trade policy. As of today, the volatility in oil prices, the global recession, the uncertain economic outlook, petroleum supply, global trade, or even the geopolitical setting all of which have a direct influence on the political and economic role of national corporations.
3.0 Arguments in Favor of National Oil Corporations
Given the various forms assumed by National Oil Corporations namely monopolies, competitive markets, financial holding companies, and asset operators, the arguments put forward in this section are premised on the assumption that national oil corporations possess substantial, and in some cases dominant role in their respective domestic petroleum sectors. Based on literature review, a number of factors have been identified as key factors that motivate states to set up national oil corporations.
3.1 Historical Context
Hartshorn (1993) argues that in many states, the setting up of national oil corporations happened at the same time governments were nationalizing their assets. During this period, privately owned corporations were viewed as having an invisible imperialist hand that opposed the interests of the host nation. In an attempt to restore domestic autonomy over natural resources, it made sense for governments to set up a domestic company not only to replace the activities of the foreign companies, but also act as a national symbol of sovereignty (Stevens 2004). To some extent, the “Veblen effect” explains the creation of national oil corporations. In the post-colonial era, it was quite fashionable to create a national symbol of independence (Jaidah 1980). Yergin and Stanislaw (2002) argue that the wide-spread creation of NOCs in the post World War II period was largely a direct result of the popular political view that the government can, and in fact, should solve all economic and social problems.
3.2 The Significance of the Petroleum Sector
In states where either consumption or production of petroleum products account for a significant portion of the country`s gross domestic product, there are significant incentives for either complete state participation or direct control to safeguard the economic and political benefits. As Robinson (1993) notes, petroleum is regarded as one of the most influential commodities in the international context. Such a strategic commodity can be used positively and negatively as both a political and an economic tool.
3.3 Political Gains Associated With State Control
From a historical perspective, petroleum has significant political importance. Because of this, the political motives for direct state control are often very strong. At the global scale, petroleum dollars can be used to equip the nation economically, militarily and politically. Similarly, a country that has control over its oil and gas industry enhances both its standing and bargaining power. At the local level, state engagement in the sector through a national oil corporation gives the government an upper hand in controlling the petroleum sector along the value chain. The government can exert its influence on decisions that are technical and commercial in nature for example depletion policy, resource development, subsidies, product prices, and employment. McPherson (2003) highlights that control over pricing is very important politically given that oil prices directly affect the lives of the electorate. For oil importing countries, the presence of a national oil corporation ensures the security of supply, while some, especially the industrialized western countries, use their NOCs as a tool for balancing the power of oil exporting countries and other major privately-owned oil companies.
3.4 Efficiency and Monitoring of Operations
The existence of a strong national oil corporation enhances the general efficiency levels within the industry leading to enhanced value creation. It is often acknowledged that NOCs reduce information asymmetries that could otherwise exist if private companies control the market. This in turn facilitates better regulation and reduces exploitative business tendencies. In government-private sector oil dealings, the private sector usually posses more information on the geology, the optimal production schedules, environmental impact, technology and costs involved in the project. To efficiently perform its oversight role in the industry, it would be necessary for the government to match its information and expertise level to that of the private sector that cannot be achieved without direct operational participation in the sector (Stevens, 2004). Through NOCs, governments are in a position to gather accurate information on financial and operational facing all players in the sector. Based on the information, the government can establish a benchmark for evaluating the performance of privately-owned oil companies (Grayson, 1981).
3.5 Maximization of Petroleum Rent
The total rent that the state captures is a function of two variables: the sum total of rent created within the petroleum sector, and the relative proportion attained by the state and its agent (national oil corporation). In the determination of fiscal policy, the state must reach a compromise between short term financial gains and long-run policy implications for pulling incremental investment. That notwithstanding, it is always in the interest of the state to obtain the highest possible portion of the economic rent, and it is often reluctant to permit private companies to obtain a significant return on their investment. Tordo (2007) argues that both contractual and fiscal policies can be well formulated and implemented to boost industry development and value creation while delivering part of that value to the state. However, for a country to have an effective fiscal system, it must possess the administrative potential and regulator expertise to oversee the operations of private petroleum companies. In the absence of such competencies, states especially the developing countries resorted to the creation of a dominant NOC as an alternative to effective regulation.
3.6 Socio-Economic Issues and Priorities
NOCs can be used in meeting the socioeconomic needs, for example, employment creation for the nationals, creating technical and commercial capacity, providing social services, developing infrastructure, redistribute income through price subsidies, and make it easy for the state to borrow (Horn 1995). In states where welfare systems are either under developed or do not exist at all, jobs created by NOCs can be a significant social safety net, while oil subsidies can be used as the main tool for redistributing incomes. Through NOCs, states can secure the funds to start up and run social welfare programs, while other programs can be directly undertaken by the NOCs, for example, wealth redistribution initiatives. However, Marcel (2006b) observes that contemporary NOCs tend to focus on their core areas of business, leaving the non commercial aspects to be catered for by funds channeled to the state.
4.0 Practical Difficulties and Setbacks with National Oil Corporations
Despite the significant advantages associated with setting up of NOCs, the commercial and performance efficiency of the state owned enterprises has often been dismal and largely disappointing.
4.1 Historical Context and Ideology
As already noted, NOCs were established based on historical factors. Because of this, the process of making decisions is largely influenced by ideology which in turn affects the attainment of optimal economic efficiency and maximization of societal welfare. Historical memories of countries that were dominated through international conglomerates and the grueling nationalization process some states had to go through still impact on decision making and perceptions more so in the Middle East. Privately-Owned Oil Corporations (POCs) have a tendency of seeking title to production and reserves, laying emphasis on the significance of property rights. On the other hand, NOCs have made deliberate attempts in stopping the POCs from getting equity rights. POCs have often been accused of deleting reserves too soon with their main objective being short-term profitability at the expense of long-term wealth for the host country (Marcel, 2006b). Because of the difference between NOCs and POCs, rational decisions making and positive cooperation becomes more difficult.
However, over time the operational and cultural differences between POCs and NOCs seem to have narrowed. State companies from China such as Sinopec and PetroChina have signed joint venture contracts with Western POCs to develop petrochemical plants in China, develop retail networks, and manage upstream operations across the globe. National oil corporations in the Middle East, for instance, Kuwait Petroleum Corporation and Saudi Aramco, have purchased equity shares in private refining and marketing assets in foreign countries. A good example is the Showa Shell in Japan. In addition, large scale takeovers of private companies through NOCs that was traditionally considered undesirable politically and culturally has become an inherent characteristic of the sector.
4.2 Economic Cost Associated with Political Control
The significance of the petroleum sector is often used as the basis for direct state involvement. However the argument is more political than economic because political advantages associated with state control involve significant economic costs. Economic costs include costs associated with production, resource depletion costs, and opportunity cost. Like any other state controlled enterprise, the NOCs suffer a principal-agent problem between the government and the citizenry one side and between NOC management and the government on the other. Because of this, it is often difficult to completely sign management contracts resulting in incompetent behavior (Shleifer, 1998). In the past, developing nations lacked the capacity to put in place competent contractual, regulatory, and fiscal frameworks. However, with the improvements registered over the recent years, it makes economic sense for states to pursue competitive markets with well developed fiscal systems instead of setting up a NOC (Tordo, 2007). Sharma (2012) highlights some of the economic costs associated with political control. He identifies Nepal Oil Corporation (NOC) as the biggest loss maker among all public enterprises in Nepal. In February 2012, the company registered a loss of approximately Rs1 billion ($11 million) due to political reasons. For example the political parties in Nepal do not allow the NOC to alter its prices to conform to international prices because of political interests. In addition, the company is overstaffed, with its administrative costs on the rise, and the top executives are still awarded bonuses. The company incurs significant costs in the form of price and movement costs paid to suppliers and distributors. According to Sharma (2011), for each litre of petrol and diesel the company makes a loss of Rs4.94 ($0.05) and Rs9.06 ($0.1) respectively.
Whenever the company makes losses, the government comes in to fund it so that it can recover from the losses; the management as a result, lacks motivation for making profits. This is worsened by the government`s belief that it is its duty to offer petroleum products to its citizenry at a subsidized rate. The use of public funds in subsidizing petroleum products consume the much needed funds that could have otherwise been invested in infrastructure, security, education and health programs (Opportunity costs). This is worsened by the fact that the subsidized products (petrol and diesel) are mainly consumed by the rich segments of the population, as the poor are content with kerosene. If the NOCs could be privatized, they can they can think of better avenues of delivering better products at affordable rates and the benefit will flow to both the government and the consumers.
4.3 Operational Inefficiencies
If NOCs could be more operationally efficient than POCs it would be a sound reason to champion for their existence. However, in practice, NOCs are characterized by sub-optimal operational efficiency because of lack of managerial and technical competence, and poorly designed human resources policies (Gochenour, 1992). Following the nationalization wave in the 1970s, many POCs lost their assets. However, the high oil prices in the later years offered an unmatched opportunity for the POCs to restructure their operations and enhance their efficiency levels. These companies invested a significant amount of their abnormal profits into research and development that led to the development of new state of art technologies that significantly reduced production and operational costs and increased productivity gains. As Linde (2000) observes, the price at which POCs could source and produce non-OPEC oil was $25 per barrel in the 1980s, by 1999, the price had dropped to only $10. While the POCs were registering such high levels of success, the NOCs managed and maintained the assets acquired through nationalization and few states upgraded their facilities or even bought new technologies. With time, NOCs became technically incompetent and were unable to independently undertake advanced projects (Stevens, 2004). Waelde (1995) observes that NOCs equally suffer from overstaffing with the wages set above average compared to other government sectors. According to Sharma (2012), Nepal Oil Corporation is one of the overstaffed NOCs with administrative expenses on the rise. In addition, in NOCs such as Nigeria National Oil Corporation (NNOC) recruitment was characterized by nepotism and tribalism with performance and qualification receiving secondary importance (Al-Mazeedi, 1992).
Figure 4.3 Revenue Employees versus Number of Employees, 2004
The international oil corporations are generally more efficient in process and management skills. Based on figure 4.3, the IOCs have fewer employees generating more revenue compared to the NOCs with many employees generating less revenue. This implies that revenue dollars per employee in IOCs is much higher compared to revenue dollars per employee in NOCs. For the NOCs to attain operational efficiency, venturing into alliances with the IOCs to tap into their expertise, technologies, human resource, and management skills might be the way forward given the increasing competition.
4.4 Lack of Competition
Competition has significant advantages that include permitting enhanced monitoring through by comparing managerial performance, promoting innovation of processes and products, and makes companies to be disciplined by working hard to attain market share and overcome the risk of bankruptcy (Yarrow 1988). Palmade (2005) argues that the absence of competition is the greatest hindrance to economic growth in developing states. States often granted monopoly powers to their NOCs or at the very least offered them a highly protected business environment despite the availability of potential competitors particularly in the downstream market. By manipulating the regulatory environment that was designed in their favor, NOCs managed to create substantial entry barriers (Stevens, 2004). Furthermore, influential interest groups within public corporations among them unions, employees, and management had the drive to oppose the introduction of competitive forces. On the other hand, segments that were interested in competition for example the general public and the potential entrants lacked the capacity to argue their case (Mati, 2008).
4.5 Subsidies and Non Commercial Objectives
In many oil exporting and importing states, NOCs foot the subsidies burden of the petroleum products. For net oil importers, subsidies is often one of NOC`s primary non-commercial commitment. Coady et al. (2006) argue that such NOCs often face financial pressures in times of high oil prices. According to the study by IEA (2008) energy subsidies in 2007 for 20 largest countries outside the OECD are approximated at $310 billion. Subsidy costs impose significant economic burden and contribute towards environmental degradation. In states that lack sufficient capacity in public investment management and strong social safety nets, NOCs may be required to undertake projects that far beyond their corporate social responsibility projects. Helller (2009) and Hodges (2003) argue that making NOCs to undertake social expenditure projects leads to inefficiency and ineffectiveness, and promotes political patronage. The pursuit of commercial and non-commercial objectives by NOCs imposes substantial costs on these corporations limiting their capacity in profit maximization. The non-commercial aspects are better performed by other public sector agencies (Hartshorn, 1993).
4.6 Weak Corporate Governance
The corporate governance standards for NOCs have poor scores compared to other state owned enterprises and POCs. This is attributed to the lack of incentives among politicians and NOC managers to implement governance standards. According to Stevens (2004), while NOC managers may try to the best of their ability to maximize their decision making, the state may have incentives to influence how cash is used. NOC`s board of directors have less discretionary decision making power compared to their counterparts in state owned enterprises. This is because membership to NOC boards is based on political patronage. It is these weak governance structures that promote inefficiency and breed corruption. Jaffe and Elass (2007) note that some states encourage their NOCs to fully disclose to the relevant authorities while at the same time limiting disclosure to the outside world.
Sustainability issues are of concern to stakeholders. For this reason, the strength of a company`s corporate governance systems is often reflected in the quality of its disclosures. Stakeholders pay particular attention to what is disclosed and how it is disclosed. Basic components of disclosures often include the significance of good governance as part of the organization`s leadership, responsibilities and duties of board of directors, along with the bibliographies of the members, information on the executive committees including their remuneration, governance, audit, and risk management, and issues related to integrity, anti-corruption, whistleblower polices and transparency. In the absence of these elements in a company`s disclosure, the organization is considered to have weak corporate governance. It may be perpetrating corruption, recruitment may be based on tribalism and the executives may be earning more than the competitive wage.
4.7 Funding Requirements and Strategy
NOC's level of autonomy in financial and budgetary affairs has a significant impact on its efficiency and marketing strategy. Financial arrangements for NOCs fall within three broad categories:
a) Low level financial and budgetary independence: under this arrangement, the NOC passes over all its revenues or at least, a significant portion of its profit margin, to the state and has to present financing request to get the cash for its operations.
b) Some level of budgetary and financial independence: under this, the NOC retains the right to reinvest a portion of its profits. However, borrowing and investment decisions that surpass a certain minimum have to be endorsed by the government agency that enjoys the ownership rights of the state or any other authority acting on behalf of the state.
c) High level of financial and budgetary independence: under this arrangement, the NOC holds the discretion on whether to reinvest all or part of its profits. Borrowing and investment decisions are endorsed by the board of directors.
As a whole, the absence of autonomy adversely affects the timeliness and effectiveness of investment decisions, and may result in high cost of doing business in addition to political peddling in the operations and management of the NOC. However, excessive autonomy can limit incentives for cost savings and efficiency gains. Given the capital intensive nature of the industry in which the firms operate, it can result in a budgetary shortfall for other social programs such as education, health, and transport leading to poor societal welfare. According to estimates by the International Energy Agency, governments globally spent a total of $409 billion in 2010 to subsidize their oil and gas sectors, in 2009 the figure stood at $300 billion (Duffy 2012). This implies that resources that could have been used to fund other public sector programs are instead consumed by NOCs. Yet, many communities in "Oil Exporting Nations" lacks clean water, healthcare facilities, and quality education, all of which reduce societal welfare.
4.8 Conflict of Interest and Balance of Control
Conflict of interest has adverse effects on the mandate and efficiency of NOCs. In many states, the NOC formulates and executes sector policy; even in states where the ministry of energy is responsible for undertaking this function, the NOC usually contributes significantly to the decision making because of its superior industrial expertise and resources. In Iran for example, the boundaries between the ministry and the National Iran Oil Company is almost non-existent (Marcel, 2006b). However, at present, most countries have embraced reforms that have seen the transfer of some licensing roles and regulatory authority from NOC to an independent body with the ultimate intention of creating an independent institution that separates corporate strategy from policy making (McPherson, 2003). This framework is often referred to as the “Norwegian model”.
According to Ertel (2006), Norway has substantial wealth in oil and natural gas. While other countries are suffering from the resource curse phenomena, Norway is a resource success story that offers a model to other countries. A significant portion of the country`s oil wealth is invested in programs that improve the livelihoods of Norwegians. The country`s pension fund that is administered by its central bank is financed almost entirely by the booming oil and natural gas sector in the country. Each year from 2001, the oil and gas sector contributes 4% of its revenues to the state budget. The funds are used to finance programs and finance shortages that improve the well-being of ordinary citizens. The remaining portion of the funds are invested for posterity- when Norway's petroleum resources are depleted. It is estimated that the Norwegian fund holds approximately 0.3% of all stocks that are traded globally. In addition, the fund has shares in over 3200 companies. Besides the Blue Chip corporations, the fund has also diversified its portfolio through investing in companies in different sectors, for example, Porsche, Adidas, Volvo, BASF, Siemens, and Zürich Financial Services.
The use of independent regulatory bodies as the basis for overcoming conflicts of interest is very appealing. However, the implementation of such a framework requires specific arrangements that may not be present in some countries, for example, strong principles of governance, regulatory independence, adequate training and human resources policies to adequately staff the two institutions. It is because of these reasons that we still observe the presence of prominent NOCs that have complete authority over the petroleum sector, such as, Sonangol in Angonal and Petronas in Malaysia. Lahn et al. (2007) asserts that though there is growing consensus on the need to separate operations from regulatory role, it is still unclear whether such an objective can best be achieved through separate departments within NOC, the ministry concerned, or through a wholly independent body (Thurber, Hults & Heller, 2010).
Even though the primary objective for setting up NOCs was to reduce asymmetries in information between government on one hand and foreign companies on the other, the NOCs have grown to become major players on their own (Waelde, 1995). It is because of their inherent strength that NOCs often leverage on the principal-agent problem and the existence of information asymmetries between itself and the government. In some countries however, control systems are intended to keep away conflicts of interests or corrupt dealings that may adversely affect the commercial decision making process of the NOCs. To date, striking a balance between the entrepreneurial independence of the NOCs on one side and efficient control and monitoring on the other remains a greater challenge.
5.0 Creation of value and National Oil Companies
National oil companies perform both direct and indirect role in the process of value creation. As a major player and controller of the value chain, whether it performs this function alone or under joint venture arrangements, the NOC directly controls costs and operating efficiency. The prime objective that NOCs pursue is maximization of value addition. However, unlike international oil companies, NOC equally has a number of national goals that supersede the ordinary commercial concerns of an international oil corporation.
5.1 The National Mission
In evaluating company performance, emphasis is placed on the benchmarks (objectives) set by the owners. For an international oil corporation, stockholders are the owners and as a result, the firm aims at maximizing the value for the shareholders subject to specific environmental and ethical constraints. However, for NOCs, the government is the owner. Because of this, NOCs are required to do more than just production of oil and gas for the country (McPherson, 2003). Among the NOC objectives is the national mission that can often be complicated and contradictory in nature. The complexity originates from the nature of the government, the sole shareholder.
5.2 NOC`s indirect Role as Advisor and Regulator
NOCs perform an indirect role both as a regulator and advisor within the hydrocarbon value chain of a nation. One of the major reasons why NOCs were set up in 1970s was the existence of information asymmetries between the government (principal) and International Oil Corporations (agents). Proponents of NOCs argued that through NOCs, governments would exert adequate control over the IOCs. Surprisingly, after the nationalization wave in the 1970s, the NOCs assumed the position of the agents and it was in their interest not to disclose all information to permit more rent seeking behavior. That notwithstanding, NOCs offer advice to other government departments especially the energy ministry.
6.0 Conclusion
The petroleum value chain involves various processes among them exploration, production, storage, refining, marketing, processing among others. Each stage in the value chain has risks with exploration and production presenting the greatest level of risk but with the highest value in the chain. Governments formulate policies that shape the operating environment. These policy choices include petroleum contracts, resource depletion, taxation, and local content, which have a significant impact on the value created by NOC.
To appreciate NOCs, one must take into consideration the political, historical, and socioeconomic contexts under which they were formed. Direct state involvement can be justified based on: the historical context upon which the decision was made; the significance of the industry to the country`s economy; the political gains associated with state control; the benefit of NOCs on industry wide economic efficiency; improved rent capture by the state, and the potential to pursue broader socioeconomic programs through the efforts of NOC's financial and operational strength. Despite the optimism and the valuable reasons for setting up NOCs, their performance in practice has been largely disappointing. Some of the key failures include the economic costs associated with political intervention, NOCs' operational inefficiencies, poor delivery on the non-commercial objectives, weak corporate governance systems, as well as the poor organization of the sector.
Moving into the future, NOCs are expected to encounter insurmountable challenges in the area of governance and risk management that will continue to shape perception, value creation, and performance for the NOCs. The specific challenges include:
The raise of Chinese NOCs: while other NOCs are attempting to create demand for their oil and gas sector, the Chinese NOCs are focusing on securing resources for the country. In the last 15 years, China has been expanding its acreage holdings particularly in Africa. From 1995, it is estimated that NOCs from China have signed approximately70 exploration and processing contracts in 16 different African countries with 646,000 square kilometer of acreage. However, Chinese NOCs' ambitions to become global leaders will have to face the strong competition between the existing IOCs that are striving for new resources and reserves; creating a more challenging environment for smaller NOCs to become international, such as Qatar Petroleum.
Talent retention and development: many NOCs are suffering from high staff turnover especially in the upstream segment in Europe and North America. Chinese NOCs are equally losing their talented staff to international oil companies. In addition most of the workers in the oil and gas sector are aging (over 45). The younger generation is not willing to work in the industry due to its finite-life nature making staff replenishment difficult.
Environmental factors and climate change: Environmental concerns and the effects of global warming have been accorded significant importance in many countries. As NOCs expand their geographical presence and investment horizons, they must protect the environment not only domestically but also in their overseas operations. While NOCs have achieved significant landmarks in matching their environmental practices to the demands of the consumers, they must continue to do more if they are to remain relevant in the eyes of the public. Negative environmental perception at home, can reduce a company's prospects of securing overseas markets.
Supervising remote operations: As NOCs expand their operations and investments overseas, they face the challenge of garnering and preserving the cooperation and trust of their stakeholders. Any mistake especially in the areas of labor practices, health, and safety can attract the attention of non-governmental organizations, activists and global media. These groups are interested in identifying any inconsistencies between the NOCs practices at home and overseas. Both NOCs and IOCs are expected to observe high corporate standards, and exhibit care for the environment, their workers, and commit themselves to the communities within which they operate.
Relations with international oil companies: NOCs have demonstrated a strong desire to expand their operations beyond their national borders. To expand globally, NOCs have to be in good relations with IOCs. Given the technical expertise and practical experience in the international arena, IOCs are the most attractive venture partners for NOCs. With increased complexity in oil production, NOCs are leveraging on their IOC relationships to develop the needed institutional knowledge in a number of technical area that include reducing corrosion, handling complicated geology, and use of artificial lifting technologies. As the NOCs forge into the future, more alliances, acquisitions, and integration agreements between them and the IOCs are expected. The shape of relationships is however changing from the traditional long-term relations to short-term project based dealings.
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