Big Oil Facing Crisis Despite Huge Profit Influence of State-Owned Companies Has Made Western Firms ‘Small Players’

By Jad Mouawad

Oil companies may be awash in profits, but in a disturbing sign for future energy supplies, production has begun to fall at all seven of the major Western oil companies at a time when they are discovering few new fields to exploit.

Part of the reason is political. From the Caspian Sea to South America, Western oil companies are being squeezed out of resource- rich provinces. They are being forced to renegotiate contracts on less favorable terms, while frequently finding themselves losing battles with assertive, state-owned oil companies.

The companies are often blamed for surging prices, which have been wrenching for the economy, with consumers struggling to cope with record gasoline costs, and carmakers and airlines posting billions in losses. And the oil majors are frequently accused of holding back on their investments as a way to restrict supplies and maximize their profits.

There may be some truth to that, but experts say the unpleasant reality is that the giants that once dominated the global oil scene have lost much of their influence – and with it, their ability to increase supplies from traditional sources.

“This is an industry in crisis,” Amy Myers Jaffe, the associate director of Rice University’s energy program in Houston, said. “They are like a deer caught in headlights. They know they have to move, but they can’t decide where to go.”

The industry’s shrinking role is one reason why oil production has failed to catch up with surging energy consumption in recent years, a disparity that propelled oil prices to records this year. While prices have fallen lately, they remain above $100 a barrel, unimaginable a few years ago.

The production shortfall was evident in the latest quarter when the seven biggest publicly traded oil companies, including Exxon Mobil, said their oil output had declined by a total of 650,000 barrels a day, even as they posted $57 billion in profits.

While that drop might not sound like much in a world that consumes 86 million barrels of oil each day, today’s markets are so tight that the slightest shortfalls push up prices.

Part of the decline in production was due to contracts between oil companies and producing countries where governments allocate fewer barrels to companies as prices rise. A bigger reason is that much of their production is in mature regions that are declining, like the North Sea or Alaska.

“It has become really, really difficult to grow production,” Paul Horsnell, an analyst at Barclays Capital, said. “International companies have a portfolio of assets in areas of significant decline and no frontier discoveries to make up for that.”

As a result of the industry’s troubles, energy experts do not expect to see oil supplies increase this year in countries outside the Organization of Petroleum Exporting Countries. Global oil demand is harder to predict, given that growth is slowing around the world, but industry analysts are still talking about an increase of as much as 800,000 barrels a day, mostly in China and the Middle East.

The global oil industry has changed substantially in recent decades.

As late as the 1970s, Western corporations controlled well over half of the world’s oil production. Today, these companies – Exxon Mobil, BP, Royal Dutch Shell, Chevron, Total, ConocoPhillips, and Eni – produce just 13 percent.

Meanwhile, 10 largest holders of petroleum reserves today are state-owned companies, like Russia’s Gazprom and Iran’s national oil company.

The international companies control less than 10 percent of global reserves. “They have become small players,” Henry Lee, an energy expert at Harvard’s Kennedy School of Government, said.

Experts say the new oil order has unsettling implications for the future of global supply because the private Western companies are far better than most national oil companies at finding and extracting petroleum. They have developed the world’s most advanced exploration technologies, and can muster huge financial resources to develop new fields. Yet instead of drawing on this expertise, many of the world’s exporting states have decided to spurn it in favor of keeping full control of their oil.

To make up for disappointing oil supplies, the Western companies have turned to natural gas as a profitable source of growth. In addition, they have sought to diversify their reach to tap challenging hydrocarbon resources, like deep-water reserves, heavy oil, or tar sands. And some companies, like Shell and BP, are investing in renewable fuels.

Oil-company executives prefer a straightforward explanation for their problems: a trend known as resource nationalism. They contend that rising assertiveness in the Middle East, in Russia, in South America and elsewhere by governments determined not to share profits has essentially shut them out of promising regions.

“The problem with the supply side of the equation is a problem of accessing the resources in the ground so they can be explored and developed,” Rex Tillerson, the chairman of Exxon, said during a recent interview. “That’s a political question where governments have made choices.”

Without question, some of the world’s major fields are off limits to foreign companies. Saudi Arabia, the top holder of oil reserves, does not allow foreign exploration. Mexico will not relax a constitutional ban on outsiders, even as production from its biggest field is plunging. In Kuwait, domestic politics have kept many majors out.

The conviction that a growing part of the world is now off limits also helps explain why oil companies are pushing for expanded offshore drilling in the United States – increasingly, they see it as one of their few options.

Even in places where the majors are allowed to operate, they face growing problems. Countries like Russia, Algeria, Nigeria, and Angola have recently sought to renegotiate their contracts with foreign investors to capture a bigger share of the profits.

Sluggish supplies have sparked a cottage industry of doomsday predictions that the world’s oil production has reached a peak. But most energy experts say these “peak oil” theories are misplaced. They say the world is not running out of oil- rather, the companies that know the most about how to produce oil are running out of places to drill.

“There is still a lot of oil to develop out there, which is why we don’t call this geological peak oil, especially in places like Venezuela, Russia, Iran, and Iraq,” Arjun Murti, an energy analyst at Goldman Sachs, said. “What we have now is geopolitical peak oil.”

Yet, some energy experts argue that the oil companies’ explanation for their problems is incomplete. They contend that the companies share the blame after failing to invest enough in exploration and production following the oil-price collapse of the mid-1980s that lasted through the 1990s. When they finally reacted a few years ago, it was too late, these experts said.

“The oil companies have dragged their feet like molasses,” Fadel Geith, a long-time oil analyst at Oppenheimer, said.

In 1994, the top five oil companies spent 3 percent of their free cash on share buybacks and 15 percent on exploration. By 2007, they were spending 34 percent of their free cash on buybacks – in effect, propping up their share prices – and a mere 6 percent on exploration, according to figures compiled by a team led by Jaffe and Ronald Soligo of Rice University. As a result of insufficient investment, some experts warn that supplies are likely to fall short of the projected growth in demand over the next decade, a scenario that could send prices well above current levels.

At a recent conference in Madrid, Christophe de Margerie, chief executive of Total of France, said the world would be hard-pressed to increase supplies beyond 95 million barrels a day by 2020. A few years ago, forecasters expected 120 million barrels a day by 2030, a level many analysts now view as unrealistic.

The majors have picked up their capital spending since around 2005, although much of that increase has been wiped out by the soaring cost of development. Exxon, for example, expects to spend about $25 billion a year for the next three years to expand its business, compared with $15 billion a year between 2002 and 2006.

“It’s amazing the difference from the 1970s, where a lot of money went into exploration, development and production of new resources,” said Paul Stevens, a senior research fellow at Chatham House, a London research firm. “It is happening a little bit now, but it is not going to be enough.”

As the power and clout of Western companies erode, many experts predict that the role of national oil companies will keep growing, making the world increasingly dependent on these government- controlled entities.

“We are going to depend on the Venezuelan, the Nigerian, or the Iranian oil companies for the future of our oil supplies,” said Bruce Bullock, the director of the energy institute at Southern Methodist University. “This is a troubling trend.”

Originally published by The New York Times Media Group.

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