When is an oil company not an oil company?
Question: When is an oil company not an oil company?
Answer: When it’s a security contractor, a bank, a derivatives trader or manipulator of stock market value…
The news this week that Heritage Oil was quietly advertising itself to those in the know as advisers to the new Libyan government, beginning with the advice that they, the Libyans, place private security operatives all across the oil fields, was hardly surprising. Of course they were. Their chief executive Tony Buckingham is, after all, a former leading light of the private security firm, Executive Outcomes . The Petroleum Economist article certainly gave graphic detail, not the least of which was that British Foreign Minister William Hague met executives from Heritage at a West End gentleman’s club in the Arab Spring. The National Transitional Council has been quick to squash this rumour, commenting that it would not be appropriate for non-Libyans to guard the country’s oil installations, and you can be as suspicious as you like about that but I believe them. The Foreign Office has been as leaky as a sieve on this, suggesting that even mandarins feel that Heritage is not quite our kind of oil company.
But the broader reflection it triggered was – is Heritage in fact a security company that calls itself an oil company, or the other way round, a private security firm which has reinvented itself as an oil company, AIM listed, technicians to hand, because it recognises that security is the bottleneck skill in a bunch of places were oil is produced?
And that prompted the broader reflection still – when is an oil company not an oil company? It sounds like a daft question to ask. We all know what oil companies do. That’s why we line up on both sides of an ideological divide, into tribes that hate Big Oil for raping the planet or nod gruffly to it (because *we’re* not sentimental) as a triumph of human engineering and ingenuity that keeps the modern economy ticking over. Every day oil companies suck 85 million barrels of oil out of the ground and ship it all over to be burnt, drive the capitalist machine, and climate change, and earn so much money that economists actually have a separate word for it – rents, as opposed to the profits that a firm in consumer electronics, or maritime reinsurance, or undertaking, might earn. As in the $120 million profit ExxonMobil posted for every day in 2008 , still a global record.
But it’s exactly the nature of rents that means this is a simplistic view of what oil companies do. At some stage, for sure, oil companies have to book oil reserves and arrange for it to come out of the ground. But the value stream is so pure, so unsullied by normal considerations of premium or discount, diminishing rates of return and, paradoxically, commoditisation (which it turns out you need not fear if you are the Uber Commodity), that all kinds of other value – known to you and me as money – accretes just by standing in its shadow. In pretty much any way whatsoever.
BP was not behaving like an oil company in that classic sense – cabalistic geopolitics in deep leather armchairs – when under John Browne it became a major trader of energy products and derivatives. As Tom Bergin outlines in his excellent, and fair, biography of the last 30 years of the company , as financial markets were deregulated in the 80s and 90s, all kinds of options and futures contracts were developed around shipments of oil, like every other commodity. BP developed a strong trading department which used its knowledge of physical oil markets to speculate – oh, did I say that? trade – on these derivative financial products. They frequently, Bergin says, employed “squeeze” tactics, buying physical shipments of oil at higher than necessary prices in order to drive up the value of financial products based in that shipment that they held, to many times the value of the original physical commodity. You know, like the market trader who gets his pimply little cousin to stand in the front row and buy the first lot of lamb cutlets off the back of the lorry so all the rest pitch in. At one stage BP were earning more in profits from their paper trading than from all their refining and downstream distribution – gas stations and the like. If that sounds like the wild fantasy of an anti-globalisation radical, it’s worth mentioning that Bergin is himself a former oil trader, now the head of Reuters energy coverage, and has significant top-level access to all the key players.
Then there’s oil company as bank. I have an Arab friend, let’s call him Samir, who has worked for 30 years in the industry in the Middle East, including management positions with both national and international oil companies, who has a bee in his bonnet about this. It’s a long story but basically the majors are big enough to go to the market to raise financing, in normal times, at low interest through corporate bonds. They do this to raise funds for capital expenditure in developing and producing out of oilfields. This is mostly a very expensive business, so they often need billions just to bring a couple of fields online – and development costs are only likely to go up with the end of “easy oil” and the push into more forbidding environments like deep offshore, the Arctic, and so on. The main justification for status quo in the oil industry is from companies talking about the risk-reward equation. We risk billions to explore and develop energy resources, the argument goes, so when it pays off we need adequate compensation for that risk. Fine. Except that in most arrangements between international oil companies and governments around the world these days, there is provision for the oil companies to recover the costs they sunk, their investment, before the project is considered to have achieved profit, where a pre-agreed division of spoils kicks in, either through splitting the oil that comes out of the ground, or the country paying the oil company a fee per barrel, or whatever. Cost oil and profit oil. Cost oil is where the company is allocated all the oil, or the money which came from selling it, up to a certain cap to recover their costs. What counts as costs are agreed as part of the agreement the company signs with the government – and often includes interest payments on loans taken to pay for the investment. But here’s the nub – and the reason Samir has a bee in his bonnet. By the time oil companies bill the government, this interest is not from the low-cost bond the parent company put out into the market but a higher cost loan that the affiliate company in-country has taken from some other part of the oil major’s empire, at a higher rate of interest. This is all quite workable when you consider that BP, for example, has at least 1,500 subsidiaries in over 80 jurisdictions around the world. To get technical, by one measure it would seem there is only the chance to arbitrage a few percentage points – the difference between the bond’s interest rate and the loan charged onto the government might be only two or three percent. But there are two aspects to that. First, even 3% of a project absorbing a billion dollars a year is a tidy $30 million. Secondly, the effective rate of return to the company could be considerably higher, depending on what collateral it needed to issue the bond in the first place.
When is an international oil company (IOC) not an IOC? When it’s a security firm, a trader, or a bank. Collectively, these add up to tidy proportion of oil company profits, and that’s before we get to finance-related gains to be had from transfer pricing and switching profits to tax havens, as so ably outlined in Nick Shaxson’s Treasure Islands .
What about national oil companies in producing countries from Nigeria to Mexico, Russia to Indonesia? One stereotype which immediately comes to mind, of course, are the Five Per Cent companies, the operations with no pretensions to any useful skills or knowledge other than the signature of the president’s cousin, number of the president’s hotline or blackmailable information about the oil minister. The history, and present, of oil is littered with these which give ideological fantasies about privatisation of the oil industries a bad name among the billion people who live in resource-dependent economies, whatever the grandees of free market economics in the World Bank or the IMF think about it.
But all of this frames the other kind of national oil company, the state-owned erstwhile monopolist who disinherited Big Oil from their throne of owning most of the world’s reserves in the waves of nationalisation from the 1960s through the 1990s, in a new light. If anyone can be anything as long as they stand close enough to Pure Rent, then why can an oil company not be a health or social welfare service, as in Venezuela or many of the Arab countries? Why not a national institution of excellence driving talent across the industry, the role of NOCs in perhaps 30 countries around the world, including an increasing presence in international markets such as Malaysia’s Petronas and Brazil’s Petrobras? Why not the overt representation of their country’s foreign policies, including energy security, as with the Chinese and Indian companies? Valerie Marcel’s Oil Titans, btw, is an excellent and much needed close-up examination of how NOCs see themselves, which, surprise surprise, is as complex but largely positive players adapted to their own country environments.
The usual arguments against such mission creep remain convincing. Oil companies, whether national or international, aren’t set up to do that kind of thing well. Although the scary thought comes to mind that in many countries they may be better set up than core government ministries and institutions. The bigger picture is, though, the oil majors are hardly less focused on the business of getting oil out of the ground and supplying global energy needs than the nationals, they just get sidetracked into different kinds of diversion.
A senior Shell executive told me a couple of weeks ago that Shell was an engineering company, and should not therefore be considered as political. What a closer look at profit centres in most oil companies tells us is it aint so and wishing’s not going to make it so. So what’s next?