Petroleum Industry Overview

Overview
The oil and gas industry is currently going through a transition. Signs of this
include the entry into force of the 2015 Paris Agreement, an international
effort to tackle climate change, the increasing deployment of wind and solar
technologies and the fall of oil prices in recent years by over 50%. These
factors have caused energy companies to seek to survive in the short run by
large-scale lay-offs, mergers and acquisitions, project deferrals and
divestments. Investments in new oil and gas projects have slowed.

However, transition also means a new industry picture is evolving, both as a

result of the above factors and fast-changing technological advances. New
opportunities are likely to arise to meet the future demand for energy due
to population growth, urbanisation, mobility and connectivity. This topic
material explains the traditional stages and elements of oil and gas industry;
the upstream, midstream and downstream sectors, from a contemporary
perspective, including an overview of the current and future challenges for
the petroleum sector and recommendations for the policy makers.

It contains the following chapters:

1. Context
2. Upstream
3. Midstream
4. Downstream
5. Key considerations for policy makers

1. Context – industry value chain

An overview of the oil and gas industry is best provided with reference to
the industry value chain. The value chain is used to identify each distinct
segment of oil and gas activities that create value and includes upstream,
mid-stream and downstream activities, as shown in the diagram below.

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Context – industry players

Activities within the value chain can be undertaken by one or a consortium

of different companies, who can be classified as follows:

Petroleum industry players: Quick facts

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Context - Global economy

Traditionally there has been a direct proportion between a country’s gross

domestic product (GDP) and its energy consumption. The International
Energy Agency (IEA) however notes in its 2016 World Energy Outlook that
among the OECD group of economies, higher GDP translated to lower energy
consumption. Despite this, when the world-wide GDP and energy
consumption is concerned, the predicted rise in world population from 7.3
billion in 2015 to 9.2 billion in 2040 and increase in GDP at a rate of 3.4% per
year will translate into higher demand for energy.

According to the 2016 World Energy Outlook, the future growth of GDP, will
have a higher impact on petroleum consumption, taking into consideration
the forecast expansion of industrial output, especially in energy-intensive
sectors, such as iron and steel, cement or petrochemicals.

The following sections cover the upstream, midstream and downstream

components of the sector value chain.

2. Upstream

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Upstream activities are composed of exploration, appraisal, determination of
commerciality or relinquishment and development/production stages. Once
the lease is obtained, exploration takes place to search for oil and gas. If it
is found, the discovery necessitates development. The drilling and extraction
activities make up the production in the long term. Each petroleum-rich
country has their own regime for the bidding and contracting process and
rules and regulations to govern exploration, development and production.

A well is only developed if the resources can be commercially produced

given current technological advances that allow the recovery of the cost of
production and guarantees investor profit. While the companies will strive
for profit maximisation, the host state will want to ensure that the
maximum revenue is generated from its resources. Usually, there is
therefore tension in balancing profitability for the companies and
revenue/royalties/taxes for the host states. The profitability of the resources
will differ depending on the geology and available technology, as well as the
commodity price.

Process of bidding and tendering

The greater the perceived or proved hydrocarbon endowment of a host

country, the more likely that a process of bidding and tendering will be
followed. This process varies among host countries but typically includes:

 Opening for tenders

 International competitive bidding
 Bidding factors and award procedures, pre-qualification of bidders
 Data purchase
 Negotiable bid factors/terms, seismic option
 Invitation to bid, direct negotiations, and possible re-tender

The lower the perception of host country proceptivity, the more likely it is
that the country will elect to invite tenderers to bid and then follow a
process of direct negotiations.

Time-frame

The exploration period can last five to seven years. Development and
appraisal process can be up to two years, sometimes overlapping the
exploration phase. Production periods can be 20-30 years, with possibilities
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of 5-10 years’ extensions if commercial production remains possible. Finally,
the best practice in abandonment is to have contractor create an ongoing
reserve during commercial production to cover its ultimate costs, noting
that offshore operations are far more expensive to abandon than onshore
operations.

Conventional vs. unconventional resources

It is important to highlight the difference between conventional and

unconventional oil resources. Shale oil and gas is the greatest technological
advance in over a century. It bypasses traditional drilling for oil in deposits
and traps and goes directly to the source of the petroleum's generation, in
what the Industry calls "the kitchen". While shale oil and gas are both cost
and resource (water) intensive, they have the potential to increase the
world's petroleum resources exponentially. Indeed, countries with no
discovered conventional oil resources may yet have significant shale oil and
gas resources.

Shale oil and gas production can be a game changer. However, it also has its
risks, such as that of early failure, need for continuous drilling, multi stage
hydraulic fracturing (making the cost of finding oil significantly higher than
conventional reserve exploration and exploitation), greater risk of
environmental damage and pollution of potable aquifer water and expensive
production methods that drive up the base cost of finding and producing.
Shale production is much more subject to 'boom or bust" conditions as the
volatile price of crude oil varies.

Exploration

Exploration of oil and gas is led by petroleum geologists and geophysicists,

usually in companies operating internationally. It is a high-risk and high-cost
activity. The key decision for the oil companies is where to search for oil and
gas: in which continent, whether onshore or offshore, and using which
technology (assuming that government content and data can be obtained).

Rapid and thorough exploration is important for a host country to achieve

maximum benefits from petroleum development. It is therefore usual for
host states to impose time limits and minimum performance guarantees in
petroleum contracts. These would include having: minimum obligatory
exploration work programmes; performance guarantees during exploration
(usually corporate guarantees or bank letters of credit) and relinquishment
or surrender of contract areas after a set number of years. Petroleum

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agreements will also provide for terms for appraisal of a discovery, and
determination of commerciality.

The exploration process can be divided into various stages, including the
declaration of commerciality, for example from seismic studies, and the
establishment of rigs and types of exploration wells. Most governments in
emerging petroleum producing states generally opt for carried interest at
the exploration stage due to the probability of success given exploration is a
high-risk activity which increases with water depth. This means that the
State does not pay anything when it comes to costs at exploration (and
development) but pays for its share of the costs when oil production starts.

A summary of exploration methods

Development: appraisal and determination of commerciality

This stage of upstream sector activity in the petroleum value chain concerns
the project development process. The risks and gains are evaluated and
valued so that the producer can make an informed decision on whether to
develop the discovered reserves. Qualitative and quantitative assessments
to measure project feasibility are commonly undertaken during the
development stage and these include:

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Key elements of a successful project development

A successful project development would require these assessments and

checks to be carried out and managed throughout the entire project life
cycle. Key elements for a successful project development include:

 Having formalised and achievable project phases and checkpoints in

place;
 Identifying accountabilities within the project implementation team;
 Continuous control of costs;
 Risk monitoring.

The objectives of the development strategy for the host state should also
focus on maximisation of commercial discoveries; meeting national demand
for petroleum sector to stimulate industry and employment; and maximising
reservoir recovery.

For efficiency in gains and the environment, gas flaring should be prevented
and where associated gas is recovered this should be processed to replace
oil use (where possible –such as in heating) and used to help oil recovery.

The issues at stake may be different when it comes to offshore production.

Considerations such as environmental concerns and local settlement are
more prevalent in onshore development.

See, for example the case study, Niger delta issues in Nigeria.

Production

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The production stage, following successful discovery of petroleum
resources, can last up to 40 years or beyond, and is often 20-30 years with
up to two mutually agreed extensions of five years each. But it can also be
indefinite, expressed as, “for as long as commercial production remains
possible". However, states do not favour this later formulation, as it creates
the perception among citizens that they have given away their national
petroleum patrimony completely and for too long.

All of this is circumscribed, though, by the requirement that the contractor

always uses best available oilfield practices and adheres to Maximum
Efficient Production protocols. The producer would have to take a decision
between fast production within a shorter productivity timeline or
sustainability of production and lengthening the producing life of the field.
The urge to cut dependence on oil and gas imports, often a huge burden on
the state budget, may lead a newly resource developing country to conclude
a deal in which they do not have control of operations.

The decision determining the preferred pace of extraction is important

particularly to avoid a resource curse scenario. For instance, following the
discovery of commercial reserves in Norway the government’s policy
adopted a cautious approach to the speed of drilling operations. They
concluded that a moderate pace of production would allow the host country
to gain expertise and adopt appropriate policies and legislation to govern the
sector in a way most beneficial to its citizens.

Reservoir management

Once the production has begun, the next challenge is to enhance

production. There are a number of activities that can be performed to fulfil
this task.

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Cost management

As the price of oil and gas commodities is driven by global market forces
outside the control of the producers, productions costs define the
competitive edge of industry players in the sector. Depending on the size of
the project, there are many factors which have an impact of cost of
production and efficient management of each of these items has a potential
for cost reduction.

Additional information relating to production processes and costs is

contained in the topic material: Petroleum Engineering and Standards.

3. Midstream

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The midstream segment of the value chain comprises transportation,
trading, gathering, storing of oil and gas and processing of natural gas.

Transportation

Depending on the distances the petroleum to be carried there are three

alternative methods for transportation of oil. Oil can be transported by
trucks over short distances, and by barge or rail for medium distances.
Tankers and pipelines are the only method for the long-distance
transportation of oil.

The usual mode of transport for natural gas is pipelines or tankers,

irrespective of the distance between the wellhead and the market. For land-
locked producers, pipeline transport is their only access to international
energy trade.

Pipelines

The petroleum pipeline is a distinct means of transportation, belonging to

the category of the so-called “network-bound” or “grid-bound”
transportation. Its essential quality is the use of fixed installations, which
are extremely capital intensive but involve relatively low operating costs.
These capital costs are sunk costs and their payback period is extremely
long.

From a technical point of view, there is a distinction between pipelines used

for the transportation of oil and those used for gas, the latter being more
complex. Both types can be on-land as well as submarine and from the
international legal perspective, cross-border oil and gas infrastructures have
much in common.

Significant numbers of pipeline projects are proposed and in-progress

across North Africa and the Middle East. There are projections of large

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volumes of pipeline flows into China from both Russia and Central Asia, with
possible extensions to northern Asia. For example, in 2013 a service
agreement on a Turkmenistan-Afghanistan-Pakistan-India gas pipeline (TAPI)
project was signed in Turkmenistan's capital Ashgabat.

Examples of pipeline agreements and arrangements

A range of bilateral and multilateral agreements dealing specifically with

cross-border and transit petroleum infrastructure. These instruments are
becoming significantly more elaborate and sophisticated, due to the
complexity of the legal and jurisdictional issues involved. Some examples of
agreements formulated to manage this complexity are provided below:

1. The North Sea Pipelines cross only one border at the edge of the
territorial sea; the jurisdiction is divided at the delimitation of each
State at the continental shelf. International agreements related to
cross-border oil and gas pipelines in the North Sea are mostly bilateral,
involving States-producers of hydrocarbons (mostly Norway and the
United Kingdom) and States-consumers (such as Germany, Belgium,
France). These agreements often regulate similar issues such as
jurisdiction, pipeline ownership and operations. They may also contain
specific rules addressing construction and safety standards, mutual
inspection, abandonment, environmental protection and metering
issues.
2. The Baku-Tbilisi-Ceyhan pipeline project, which consists of a
trilateral governmental agreement between Azerbaijan, Turkey and
Georgia, and individual host government agreements (HGAs) between
the project company and respective governments.

Further examples of pipeline agreements

3. The Caspian Pipeline Consortium (CPC) is an integrated trans-boundary

pipeline system. The CPC is a consortium that represents the interested
parties in a unitary structure. It was created in June 1992 by an
intergovernmental agreement (IGA) signed between Kazakhstan and Oman to
build an export pipeline. Russia signed a protocol the following month,
entering into the IGA. However, due to difficulties in obtaining sufficient
funds for the project, a protocol between eight IOCs and the participating
governments was signed for the reorganisation of the CPC in 1996. The
protocol accorded certain control of the pipeline to the International Oil
Companies through transfer of a 50% share in the project.

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4. The development of the Chad-Cameroon pipeline, akin to that of BTC, is
based on an IGA between the Republic of Chad and Cameroon and the
respective HGAs of the project signed between Chad and Chad Oil
Transportation Company, and Cameroon and Cameroon Oil Transportation
Company.

The design and setup of transportation and processing tariffs differ in each
jurisdiction. Some governments, such as in the UK, allow companies to
negotiate these tariffs independently, whereas others have government
mandated prices or quasi-nationalised midstream pipeline networks, as is
the case for Gassco in Norway.

Oil tankers

Crude oil tankers

are the most used
method for
transport of crude
oil from the
wellhead to
refineries
worldwide. Oil
tanker sizes range
from general
purpose to ultra-
large crude carriers
on Average Freight
Rate Assessment
(AFRA) scale. The
approximate
capacity of a ship
in barrels is
determined by
using an estimated
90% of a ship's deadweight tonnage (see the diagram below), and
multiplying that by a barrel per metric ton conversion factor specific to each
type of petroleum product and crude oil, as liquid fuel densities vary by type
and grade.

Oil tanker spills

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While more common than pipeline transport in carriage of oil, tanker
carriage has higher environmental risks. According to data provided by The
International Tanker Owners Pollution Federation Limited (ITOPF):

 In the 1990s there were 358 spills of 7 tonnes and over, resulting in
1,133,000 tonnes of oil lost; 73% of this amount was spilt in just 10
incidents.
 In the 2000s there were 181 spills of 7 tonnes and over, resulting in
196,000 tonnes of oil lost; 75% of this amount was spilt in just 10
incidents.
 In the six-year period 2010-2015 there have been 42 spills of 7 tonnes
and over, resulting in 33,000 tonnes of oil lost; 86% of this amount was
spilt in just 10 incidents.

Mitigation methods

After a major well control incident in the Gulf of Mexico in 2010, the IPIECA
(The global oil and gas industry association for environmental and social
issues)-IOGP Oil Spill Response JIP (OSR-JIP) was established to implement
learning opportunities in respect of oil spill preparedness and response. The

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OSR-JIP produced around 20 guidelines which cover topics relevant to both
Exploration and Production activities as well as shipping and transportation.

LNG tankers

Because of the physical properties of natural gas, it was initially transported

and supplied domestically or regionally via pipelines. The development of
liquefaction of natural gas to LNG aimed to make gas international and
enable bigger volumes of gas to be transferred as liquids, which take less
space than gas. With LNG, natural gas produced is piped to a liquefaction
plant, turned to LNG, and transported by tankers to be regasified at its
destination for supply to the market. LNG tankers are essentially
massive thermos bottles that keep the gas cold and liquid.

LNG export capacity

There is an ever-growing LNG global export capacity. Since 2006, Norway,

Russia, Yemen, Peru, Angola and Equatorial Guinea all have started making
LNG, while Qatar, Nigeria, Australia, Oman and Indonesia have expanded
production. The United States, Australia, and potentially Canada and
Mozambique, are likely to be among the main contributors to an increase in
LNG.

With new major players emerging in the global energy market, the world
production capacity of LNG can at least double by 2020. However, newly
discovered huge gas resources in different parts of the world are unlikely to
turn into LNG exports before 2020. In general terms, most of them are still
awaiting actual development plans and/or final investment decisions. The
current change in market conditions will further delay their materialization.
Mozambique for instance still lacks clearly defined development plans with
associated costs. Among others, the country’s geography, its lack of both
basic infrastructure and technically skilled personnel, will make overall LNG

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development cost a challenging factor in the current market scenario for the
companies holding the major portion of the gas resources in the country.

Rail cars

The cost of transporting crude oil by rail is higher than transport by pipeline.
While both railroad tankers and pipelines pose a detrimental risk to
communities and public health in the case of an explosion and/or spill, it is
reported that in the US, far more oil was spilled from rail accidents – more
than 1.15 million gallons – than in the previous four decades combined.
Modern railroad tankers have evolved significantly today with an increased
load capability. However, most petroleum products are transported via
marine tankers and pipelines today.

Trading

Petroleum is the world's most actively traded commodity. The global oil
market comprises thousands of participants who help facilitate the
movement of oil from where it is produced, to where it is refined into
products, and from there to where those products are ultimately sold to
consumers.

When it comes to crude oil pricing:

1. Brent is generally accepted to be the world benchmark of petroleum

pricing, and is used to price two thirds of the world's internationally
traded crude oil supplies.
2. In the United States, the benchmark is West Texas Intermediate
(WTI).
3. In the Gulf, Dubai crude is used as a benchmark to price sales of
other regional crudes into Asia.
4. The OPEC Basket price is an average of 15 different crudes which
include Saharan Blend from Algeria, Girassol from Angola, Oriente from
Ecuador, Minas from Indonesia, Iran Heavy, Basra Light from Iraq,
Kuwait Export, Es Sider from Libya, Bonny Light from Nigeria, Qatar
Marine, Saudi Arabia's Arab Light, Murban from the Emirates and BCF
17 from Venezuela.

Oil price

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In principle, while the difference in price of Brent, WTI and the Opec Basket
price is not significant, they are priced differently due to significant
differences in the compositional characteristics of the crudes and their
product yields.

Petroleum (crude oil) and petroleum products are traded on organised

exchanges. Crude oil products are traded via futures contracts or spot
markets.

A futures contract, in contrast to a spot transaction, concerns the future

purchase or sale of crude oil or petroleum products. They are a promise by
the seller of a determined amount of oil in a defined location and the
exchanges are paid daily based on the market value.

“Spot” contracts typically involve delivery of crude over the coming month.
Spot markets are often referred to as the “physical market” since they entail
the buying and selling of physical volumes.

Oil trade

Traditionally, oil markets have been made up of long-term and rigid

contractual relationships but this has changed to a market with participants
now including producers, refiners, marketers, traders, consumers,
investment banks and hedge funds.

Natural gas trade

Natural gas on the other hand is still not a fully liberalised market when it
comes to trade. There is no generally accepted reference price for natural
gas, and it has traditionally been the only commodity not priced by demand,
but by substitute indexation. Oil-linked prices have been seen as the only
remedy for market failure in natural gas.

In terms of natural gas liberalised markets, the hub model was first rolled
out in the US – with its Henry Hub – and in the UK - with the creation of the
National Balancing Point or NBP (a virtual trading location for UK gas). NBP in
the UK followed an interest model by creating a virtual rather than physical
hub. This model was copied by Belgium (Zeebrugge), the Netherlands (TTF),
France (PEG’s), Germany (NCG and GPL), Italy (PSV) and others. Today, in
most European countries, gas is bought based on hub pricing. Natural gas
prices in Asia are mainly linked to crude oil, but also make use of spot
indexes increases.

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Global natural gas trade trends

Global natural gas trade rebounded in 2015, rising 3.3% mainly as a result of
pipeline exports. There had also been a significant growth of LNG exports.
The diagram below presents globally traded natural gas volumes in 2015 in
billion cubic meters. The bulk of this gas is used in electricity production.

Globally traded volumes of LNG are shown in the diagram below.

Storage

Another stage before oil and gas is transported to the downstream market is
storage. Storage levels matter globally because they have an impact on oil
price. Storage is also importance in terms of ensuring energy security and
for avoidance of supply disruptions to the industry, commercial and
residential users.

There is no international rule that require national oil and gas storage levels
to be revealed, and in fact some of the major consumer and producer states
such as Russia and China choose not to report their oil-storage levels.
Traders and oil companies that park supertankers have no obligation to
make public their supply.

International Energy Agency (IEA) members however are required under the
1974 Agreement on an International Energy Program (I.E.P. Agreement) to
hold oil stocks equivalent to at least 90 days of net oil imports and – in the
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event of a major oil supply disruption – to release stocks, restrain demand,
switch to other fuels, increase domestic production or share available oil, as
necessary.

Some countries also have detailed regulations on oil storage. Scotland for
instance set regulations for above ground oil storage devices including fixed
tanks, intermediate bulk containers, drums and mobile bowsers.

As gas has a much lower energy density than oil, gas storage costs are
higher. However, due to limited methods of transport options (LNG and
pipelines), natural gas storage has a far higher importance in terms of
energy security, particularly in winter for residential users. Natural gas is
stored in underground salt formations, aquifer reservoirs and depleted
reservoirs. It can also be stored as LNG in tankers.

4. Downstream
Refining

The refining of crude oil means its transformation into petroleum products
by breaking them down into their components. Petroleum products include:

Refined products

These products are selectively reconfigured into new products such as fuels
and lubricants for automotive, ship, and aircraft engines. Refined by-
products can also be used in petrochemical processes to form materials
such as plastics and foams.

The largest producer of petroleum products in the world is the US, followed
by the European Union, China, Russia and India. The global crude refining
capacity is forecasted to grow significantly towards 2020, led by China,
Southeast Asia, Latin America and the Middle East.

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Whereas no new green field refineries have recently been built in the US,
existing refineries are being expanded. Most new projects today are
announced in Africa, including for example:

 In Egypt, the expansion of the MIDOR refinery announced in 2015

 In Uganda, where Total intend to take stake in greenfield refinery at
Kaabale according to 2016 media report
 In Nigeria, where a Nigerian investor plans $12m private crude oil
refinery in Nigeria by 2019

Africa’s richest man to invest in greenfield refining to end Nigeria’s fuel

deficiency

There are also new and expansion projects in Asia.

 Malaysia – EPC contracts signed for the RAPID greenfield refinery in

2014
 Taiwan – expansion of Ta-Lin refinery in Taiwan (to replace the
Kaohsiung refinery) in 2016

Marketing

Petroleum products include: Motor fuels, aviation fuel, lubricants, fuel oil for
heating, and fuel oil for power generation, asphalt and propane. These are
sold to the end users at the end of the value chain. The motor fuels used to
power transportation hold the majority of the market share. The end price
of these products in the market usually varies according to the price of
crude oil but can also be subsidised by governments through taxes.

Natural gas

Natural gas is an essential component of "petroleum" generally, but it is

significantly different in its properties, treatment and development. It is
more abundant than oil worldwide and is the preferred hydrocarbon
resource today from an environmental standpoint.

Most IOC and major independent companies’ contractors are seeking

exportable crude oil. Natural gas discoveries are often relinquished back to
the state as "exploration failures". To encourage contractors to develop
natural gas discoveries, states often allow them longer retention periods (up
to 10 years) before mandatory relinquishment. This allows the domestic
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market to develop, export options by pipeline or through conversion to LNG
to be explored and in some cases aggregation of smaller, non-commercial
discoveries into a pooled commercial discovery. As a minimum, the state
may require contractors to appraise natural gas discoveries at the State's
expense and then relinquish them in condition for the state to develop.

Natural gas produced at the wellhead must first be processed to be of an

accepted quality to be taken to market. The processing of wellhead natural
gas can be complex and involves several processes.

Common contaminants contained in natural gas include non-hydrocarbon

gases such as water vapour, carbon dioxide, hydrogen sulphide, nitrogen,
oxygen, and helium. Natural gas liquids which must also be cleaned out
include ethane, propane, and butane (which are the primary heavy
hydrocarbons extracted) and other petroleum gases, such as isobutane,
pentanes, and normal gasoline. Natural gas that is not within certain specific
gravities, pressures, British Thermal Unit (Btu) or water content ranges is
likely to cause pipeline deterioration, pipeline rupture and other operational
problems.

Natural gas processing

In addition, it is often necessary to install scrubbers and heaters at or near

the wellhead. Scrubbers serve primarily to remove sand and other large-
particle impurities. The heaters ensure that the temperature of the natural
gas does not drop too low and form a hydrate with the water vapour
content of the gas stream. These natural gas hydrates are crystalline ice-like
solids or semi-solids that can impede the passage of natural gas through
valves and pipes.

The figure below shows the typical natural gas processing stages required to
achieve pipeline-quality gas.

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The changing role of International Oil companies (IOCs)

International oil companies (IOCs) include the oil & gas “majors”, being the
original “seven sisters” of the 1970s: Exxon, Mobil, Gulf Oil, Texaco, British
Petroleum (BP), Shell and Total S.A. Over time, smaller and medium sized oil
companies have emerged, with a majority being listed on stock exchanges
and alternative markets, and having widespread operations especially in
emerging markets. A good example is UK’s Tullow Oil, which has extensive
operations in Africa: founded in 1985, it is listed on the London Stock
Exchange and had operations in 22 countries as at the end of the 2015
financial year.

Experiments within the oil industry over decades showed that a specialised
enterprise with its shareholdings and profit making requirement in a
competitive market has provided efficiency among the industry participants.

In today’s sector the state and IOCs have complementary decision making
powers. From the early days of oil till 1970s, for about a period of 70 years,
IOCs maintained a privileged position vis-à-vis many resource rich states,
which frequently lacked the expertise and experience to negotiate
effectively with IOCs. However, with the establishment on NOCs and of
OPEC as a response to the limitation of states’ rights and powers to
influence their own natural resources, the role of IOC in the global markets
has changed.
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The IOCs: Business model

The IOCs’ typical business model is premised upon 3 pillars: maximising

shareholder value; maximising bookable reserves; and minimising costs.
However, this business model is widely perceived as failing, caused by
various factors, including:

(a) the rise of NOCs since the 1970s, resource nationalisation and the 2nd
nationalisation wave of the 2000s (NOCs, especially from OPEC countries,
now control majority of the oil & gas reserves and production globally);

(b) industry consensus thinking which led to destructive behaviour, such as

multi-billion dollar investment in heavy crude oil refineries, in a market with
an increasing light crude slate;

(c) adoption of capital asset pricing model in management strategy, which

undervalued risks;

(d) losing IOCs technical and technology edge to service companies through
outsourcing. While this was adopted as a strategy to minimise costs, it also
meant that NOCs could outsource to service companies, and were not
dependent on IOCs. Indeed, the shale gas revolution in the US was led by
small and medium sized companies and IOC majors have been late to the
party;

(e) global decline in crude oil prices both historically, and post-2014; and

(f) more recently, challenges posed by the green revolution and emissions
reductions, which will continue to be seen as a result of emission reduction
commitments under the Paris Agreement on Climate Change of 2015, which
is likely to lead to stranded assets and unexploited reserves.

IOCs control of global oil

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Problems faced by IOCs

All these challenges have been reflected in the stagnation of IOC share
values, causing concern for investors.

Possible solutions

To weather these challenges in the future, IOCs will need to re-think their
business models. Several options have been suggested, including:

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1. Mega mergers: such as BP’s acquisition of AMOCO and Arco in 1999, which
was intended to increase bookable reserves and minimise costs by reducing
duplication. However, mega-mergers are likely to face competition authority
scrutiny and should be carefully considered;

2. Diversification away from oil and gas: especially in light of climate change
focused emission reduction commitments. IOCs such as BP and Shell are
investing in renewables;

3. Investment in the US shale gas revolution: although they would be coming

in late, IOCs can take advantage of the rate of bankruptcies being seen in
small shale gas companies who were heavily leveraged and are suffering
from the rise in interest rates;

4. Reshuffling portfolios: such as reduction of refinery capacity or

ConocoPhillips example of splitting upstream and downstream operations;

5. Re-focusing on development of in-house technology: instead of being

over-reliant on outsourcing; and

6. Reducing operation in risky locations, and investing in large, long-life, low-

cost, expandable, upstream assets in less-risky developed (OECD) countries.

5. Key considerations for policy makers

This section provides an overview of some of the key challenges facing
policy makers today, including:

 Dutch disease
 Climate change concerns and low-carbon technologies
 Revenue volatility
 Resource exhaustion
 Public support

Dutch disease

Dutch disease is used to describe a situation where, due to the rapid

increase in welfare in a country after discovery of natural resources, and a
heavy inflow of foreign currency to the country, other non-extractive sectors
becomes too expensive in the export markets and hence fail to compete
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with internationally traded goods. For example, in the 2000s, Indonesia was
heading towards competitive industrial diversification of its economy.
However, the commodity boom which began in 2004 eroded its
manufacturing competitiveness, and caused further increased
unemployment.

The possible creation of a national sovereign wealth or emergency fund, as

was undertaken in Norway, has been the traditional cure for the Dutch
disease. Chad’s sovereign wealth fund experiment, discussed in the resource
listed below is also a useful case study of the failure of this kind of
instrument, in addition to the more hopeful initiative now being undertaken
in Timor-Leste.

See the African Development Bank Group working paper no 142: Africa’s
Quest for Development: Can Sovereign Wealth Funds help? Thouraya Triki
and Issa Fay. This resource is available in the topic library

Climate change concerns and low-carbon technologies

The Paris Agreement on Climate Change, was signed by 195 countries and
the EU in December 2015, and ratified by 115 countries in October 2016.
Member countries have committed to the goals of keeping global
temperature rise at below 2 degrees Celsius above pre-industrial levels, and
to pursuing efforts to limit increases even further to 1.5 degrees Celsius
above pre-industrial levels. This will be achieved through an ambitious
reduction of greenhouse gas (GHG) emissions.

Countries commit to have a more robust transparency networks, encourage

new technology and improve capacity building and support for developing
countries. Countries are required to put forward nationally determined
contributions (NDCs) and to have a stock-take every five years, the first one
being in 2023. Emission reduction commitments have led governments to
make ambitious country-specific regulatory and policy changes. For
instance, the UK has committed to a 57% emission reduction from 1990
levels by 2030 (the EU has committed a 40% reduction), and Scotland aims
to have 100% renewable energy by 2030. This is likely to lead to a reduction
in new oil & gas discoveries and an increase in stranded assets.

Energy efficiency and carbon capture and storage

Largely due to climate change concerns and the need for greater energy
efficiency, there has been a surge in:

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 1. Renewable energy (such as wind and solar), buoyed by subsidies by
governments; and
2. Electric cars, and low carbon technology, causing a reduction in oil
demand.

Energy security of supply in the future is likely to still require deployment of

coal and oil energy sources, due to the intermittency of renewable energy
sources like wind and solar. There is potential for coal and oil power
projects to continue to be deployed in the Paris Agreement era, utilising
carbon capture and storage (CCS) technology. Some countries, such as the
UK, are developing robust CCS strategies within their energy policies.
However, more research and development is required for efficiency and cost
management.

All the above factors would need to be carefully considered by policy

makers.

Revenue volatility

The price of oil has fluctuated greatly in the last decade, and together with
the unpredictability of oil price and discovery of unexpected reserves caused
volatility in revenues for the states.

Resource exhaustion

Due to the exhaustible nature of oil, gas and minerals, host governments are
required to develop a long-term strategy with a ‘resource horizon’ to extract
maximum value from development of the sector, otherwise it may
experience destabilised economy.

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Public support

Due to its very nature, the extractives sector has in the past faced, and will
continue to face public scrutiny and tension related to:

1. Environmental Concerns: Examples of past public and NGO action

include the public protests and 2002 class action suit against BHP
Billiton in Papua New Guinea concerning the annual dumping of 90
million tonnes of mine tailings and waste rock into a local river system.
BHP withdrew its stake in the mine in 2002 and converted it into a
fund to support local development. More recently, public protests
against shale technology in the UK, Germany, Poland, France and
Bulgaria have led to the halting of projects, bans, moratoria and the
revocation of permits;
2. Human Rights: Human rights in the extractives sector have gained
even more prominence with the development of the UN Guiding
Principles for Business and Human Rights, commonly known as the
Ruggie Principles, in 2008. The Ruggie Principles are based on three
pillars: the state’s duty to protect against human rights abuses by third
parties including business; the social responsibility of business to
respect human rights; and the need for greater access by victims to
effective remedies against human rights abuses, both judicial and non-
judicial.

Other elements of public support

3. Labour, local content and local community participation: most

extractives sector projects are large scale, technically complex and
capital intensive, and require foreign investment. However, a balance
needs to be struck between foreign resources and local content, as
this can sometimes lead to protests, as noted in countries like: Ghana
- where tension between artisanal miners and AngloGold Ashanti were
a contributing factor to latter’s closure of the Obuasi mine in 2016; and
South Africa, where labour union riots calling for increased wages in
the Marikana platinum mine operated by UK listed Lonmin, led to the
death of 34 miners, and major losses for the world’s third largest
platinum producer; and

4. Revenue transparency and corruption: greater public participation

and NGO engagement is likely to be seen with transparency initiatives
like Publish What You Pay (PWYP) and with more countries becoming
members of the Extractive Industries Transparency Initiative (EITI).
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 Aside from states’ “peer pressure”, public protests have led to some
states joining transparency initiatives. For instance, Tunisia joined the
EITI in February 2016, after having had a history of protests calling for
greater transparency, and most notably, violent protests in 2013. The
US’ Dodd-Frank Legislation, which requires extractives resources
issuers listed in the US stock exchanges to disclose payments made to
governments, is also likely to encourage public engagement. There is
an increasing realisation of the importance of the “social licence to
operate”, especially in the present digital information age where
information is widely disseminated and accessible. Policy makers will
need to consider more transparent and inclusive public participation
through stakeholder groups and NGOs.

Extractives Sector Development: Curse or Blessing?

Non-governmental organisations and other sector stakeholders have warned

that oil, gas and mining projects in developing countries may have adverse
effects on a country’s development process and that newly producing
countries tend to experience high rates of corruption, civil war and/or
undemocratic governments.

However, there are also several countries that have avoided the resource
curse. In the academic literature, the resource curse is not perceived as
inevitable. Paul Steven’s recent literature review on this, for example,
supported the perspective that recent literature does not accept the
resource curse phenomenon as an “iron law”.

An earlier study by Paul Stevens found that some countries such as

Botswana, Chile, Indonesia, Malaysia and Norway had not suffered from the
resource curse at all and others, namely Colombia, Suriname, Trinidad and
Tobago, and Tunisia had suffered less from it.

See the Chatham House paper:

Paul Stevens, The Resource Curse Revisited, Appendix: A Literature Review,

Research Paper Appendix, Energy, Environment and Resources, August 2015.
This paper can be viewed in the topic library.

Resource curse

It is important for the literature to identify the measures needed to be

adopted to avoid the resource curse. There are various international

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voluntary mechanisms and frameworks, as well as examples of mandatory
regulations that promote inclusiveness’ in decision-making by governments,
so that the government involves stakeholders from civil societies, NGOs and
companies, decisions are transparent, and government is accountable.

One way of mitigating the adverse effects of the resource curse is to link
foreign extractive industry investments to domestic non-oil sectors of the
economy to build capacity, enhance skills, and ensure long-term
diversification. These development linkages may take many forms – forward,
horizontal and backward linkages.

Developmental linkages are well explained in Columbia Center on

Sustainable Investment (CCSI)’s report Linkages to the Resource Sector: The
Role of Companies, Government and International Development Cooperation.
The report is contained in the topic library.

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