PETROLEUM ECONOMICS & LAW

MSc in PETROLEUM ENGINEERING

“Critically assess the economic effects of national oil

companies and their links to the government.”

Professor: Stella Tsani Student: Eirini Pafra

July 2021
Abstract
This assignment is written under the effect of the Covid-19 pandemic and an already
tough more that one year period on which the oil and gas sector was undertaken by
a wide shock. However, under most scenarios and given its role in supplying “easy”
energy, it is too important to fail and will most probably remain a multi-dollar
market for the next decades.

National oil companies (NOCs) are a point of controversy. To politicians from oil
producing countries they often are the ace in their sleeve, a strategic asset capable
of giving out long-term benefits to the state. To many analysts though, they seem
like an outdated model that encourages corruption and delivers fewer benefits to
citizens. Truth lies somewhere in between. Many NOCs have managed to make their
governments key players in the market by gaining control over their oil and gas
sector. But the total reliance on them, comes with a risk; both with the volatility of
the sector itself and with the government's allocation strength.
Part 1
National Oil Companies (NOCs) are oil and gas companies which are fully or
primarily owned and controlled by a state (state owned companies)
Key points
● National oil companies (NOCs) are the main players in the oil and gas sector,
dominating the production in some of the world's most oil-rich countries,
from Saudi Arabia and Iran to Mexico and Venezuela. Assets of more than $3
trillion have been published on 2019.
● A big percentage on all the revenues of more than 25 countries, heavily rely
on their NOC, which actually means that they rely on how well the according
companies are run, how is the quality of its spending and how much revenue
it is required to transfer to the state at the end of the day.

Figure 2- Global map of national oil companies.

In a number of oil-dependent countries the NOCs are playing a fundamental role in

all aspects of the country's governance. In the best case scenario, they can be the
source of all kind of national goods, but at the worst, they can be the the most
corrupted part within the public sector.
NOCs offer an estimate of 90 million barrels of oil/day globally. Many of these
companies, manage a huge amount portfolio of public money, employ numerous of
locals and perform a pallet of services from providing energy to building
infrastructure and much more. Most NOCs were giving an approximate of 25% of
their gross revenues to their governments with the number kept decreasing,
reaching a 17% on 2015. The companies spent the rest on their operation and
investments, leaving a very small (or no) amount to be spent by the state on health,
education or any other needs.

Figure 2- Rankings of NOCs based on total assets, 2019

Part 2
However as important as they might be, NOCs are not easy to be read through,
since the absence of solid information on their activity is something that
characterizes them, causing a big headache on all the other market players. With
transparency being a main issue that comes along with a bold NOC, we get a failure
in reporting severe information needed for a proper oversight. Companies in the
Middle East and Northern Africa take the lead on this one, being the most quiet
when it comes to company reporting issues.
This opacity has of course many consequences for the government's ability to
maintain a healthy relationship with the NOC. The data exported is partial, usually
company related, and addressed mainly to investors which raises another issue.
The reliability of it. If it comes from an uncontrolled environment, how trustworthy
can it actually be?
A big amount of money is gathered within these companies, mostly by selling their
oil and gas. Then, the decisions that need to be made by the state on how these
revenues will be used, despite their big importance, they end up going through a
questionable procedure and not through the typical public sector budgeting
process.
 Figure 3- NOCs reporting on specific sections

High-profile scandals with NOCs in Brazil, Mexico and Nigeria have helped draw
significant public attention to these topics. Several core elements of NOC
management in many countries leave them prone to corruption risks, especially
where public oversight and corporate governance checks are weak.

Part 3
For many reasons either operational or political, NOCs have to borrow money. That
can lead to a substantial amount of debt, which of course is inevitably linked to the
state itself, risking the country's overall sustainability. For example, Kazakhstan’s
KazMunayGas was unable to service its debt and required state support in 2015 and
Russia’s Rosneft, which borrowed heavily in recent years. Both the Russian
government and Rosneft are under international sanctions, but the company was
able to acquire credit from abroad using intermediaries.

Figure 4- Debt to equity leverage ratios of selected NOCs

There are numerous countries where the government did not consolidate NOC debt
into government accounts and debt statistics for several years, but then had to,
when the details of the debt was uncovered. For example, in Bolivia the IMF notes:
“More than half of the investment by the national hydrocarbon (YPFB) and electricity
(ENDE) companies is carried out by their subsidiaries which are not included in the
consolidated fiscal accounts. To manage associated risks, the financial operations
of all state-owned enterprises (SOEs) should be included in the fiscal accounts of
the NFPS and subjected to public audits.” In Chad, it was revealed that the Société
des Hydrocarbures du Tchad had accumulated large debt, which was not on the
government’s books. It was only in requesting financial assistance from donors that
the company unveiled its debt.

Part 4

It is crucial to study how the NOCs transfer money to the state, since the the
companies have a large impact on the fiscal affairs and the national wealth. There
are several mechanisms that are used to serve the purpose:

● Royalties, which are paid by the NOC to the state in exchange for the right to
extract resources from the subsoil. Royalties are often structured as a
percentage of the value of gross production, sometimes after deduction of
transportation fees or other delineated charges.

● Dividends, which are paid by the NOC to the state shareholder out of
company earnings or reserves.

● Income taxes, which are payments to the state made as a percentage of the
company’s income, once NOCs have deducted allowable expenses.

● Proceeds of state profit or equity petroleum: NOCs are often responsible for
selling portions of oil and gas production, either via their ownership of equity
in joint ventures with private partners or as recipients of the state’s share of
oil/gas in production-sharing contracts. Some NOCs transfer the proceeds of
these sales directly to the state, sometimes after deducting a fee

Part 5
As noted earlier, many NOCs spend most of the money they collect. This approach
has always come with opportunity costs. The company spends significant amounts
of revenue instead of transferring it to the treasury for public sector investments,
with the goal of accumulating assets and capturing a bigger share of the country’s
petroleum revenues.
Specific problems that come along with the bond between the NOCs and the state
include the following:
● Blur orders: While trying to earn profits, NOCs pursue other targets that deal
with their extra commercial activities, leading to unclear strategy,
unmonitored performance and maybe distorted markets

● Political affect on the decisions: Bureaucrats without experience on the

sector can play an unfortunate significant role in decision making that comes
along with their social and political status.
 ● Limited competition: By being the monopolies in their field, they can continue
their operation even when totally damaging to the state.
Nonetheless, these companies have been playing a very important role in the
management of national oil and gas sector since the wave of nationalization came
along in the 1970s. NOCs were established as the governments’ replacement of
International Oil Companies (IOCs) in resource projects or privately held companies
were nationalized into NOCs and IOCs got excluded from operations. This was the
case with, for instance, Saudi Aramco and Venezuela’s PDVSA. NOCs in many
developing countries work as partners with IOCs. This is especially in developing
countries where the government and NOCs still lack sufficient capacity, technical
competence and funding, to carry out oil and gas projects exclusively.

Conclusion
The governments need to engage a solid analysis as they build and manage their
NOCs, by promoting the country's best interest and creating the right incentives for
performance
They should decide how to allow the companies to finance itself- huge amount of
public money can pass through their hands, which leads to the risk of the gains not
being handed back to where it was initially planned by the state. So a better control
on the strategy, on the levels of the oil revenues and the quality of its institutions
could lead to a better fiscal management. As some good examples have been set by
some countries (eg. Norway, Malaysia), we can derive that there are certain
mechanisms that can promote an effective NOC performance:

• Corporate governance tools within the NOC for an effective, accountable and
ethical management, non-corruptible environment, employee- friendly with
independent authorities to perform audits.
• Intra- government checks, such that all the above mentioned management
stands accountable for their performance.
• Public reporting system that gives the full picture of how the people's money
is spent. Detailed, clear and easy to follow reports need to be submitted at
least yearly.

References

1-National oil companies as instruments of risk and reward- Patrick R.P. Heller
2-National Oil Companies (NOCs)- Extractives Hub
3-National Oil Companies and Value Creation Silvana Tordo, Brandon S. Tracy, Noora Arfaa
4-Massive and MisunderstoodData-Driven Insights into National Oil CompaniesPatrick R. P. Heller
and David Mihalyi
5-The Role of National Oil Companies in the International Oil Market- Robert Pirog