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Comment & analysis

Analysis

IT IS THEIR OIL -- WESTERN ENERGY GROUPS YIELD TO STATE PRODUCERS
By Carola Hoyos

Financial Times
July 9, 2008

http://www.ft.com/cms/s/0/215e812c-4de2-11dd-820e-000077b07658.html

Paolo Scaroni swivels round on the cream-colored recliner towards his two fellow passengers on the Falcon 900 flying over the west coast of Sicily and says: “Now I will give you a short history lesson, if you don’t mind.” The chief executive of Eni, the Italian oil company, begins to summarize a century of Italy’s often fraught relationship with Libya.

He explains that among the Libyans Italy exiled to the Tremiti islands during its occupation of the North African country that began in 1911 was the grandfather of one Shokri Ghanem. Mr. Ghanem is the head of Libya’s national oil company and the man Mr. Scaroni is on his way to see.

That respectful awareness, along with the frequency with which he travels to see Mr. Ghanem -- 19 times last year alone -- illustrates how the power relationships have shifted between the two men, between their countries and between international oil groups, such as Eni, and state entities such as Libya’s National Oil Corporation. As oil prices have risen to a record $140 a barrel, 14 times what they were a decade ago, oil- and gas-rich national energy companies have taken the driver’s seat and are exploiting their new-found power.

Mr. Scaroni and Mr. Ghanem are meeting to sign perhaps the most important contract so far in Mr. Scaroni’s three-year tenure at Eni. The deal sets out the new terms under which Eni will retain access to its most important oil patch, one it clung to for 44 years despite the threat of retaliatory U.S. sanctions.

Eni is the first of a list of companies, which also include Total of France and Spain’s Repsol, to have to renegotiate its contracts in Libya in order to give Tripoli a greater share of the profits of existing projects. In return, Eni and the other international oil companies will win the right to remain in one of the world’s pre-eminent oil and gas basins at a time when other petro-states are nationalizing their fields or closing their doors to foreign oil companies.

The two men joke that during the protracted negotiations they saw each other more often than their wives. But Mr. Ghanem is a big fan of Mr. Scaroni, whom he successfully nominated to become 2008’s petroleum executive of the year, an award to be presented in October at the annual Oil and Money Conference in London. He compares him with Enrico Mattei, Eni’s charismatic but controversial founder, who shook up the industry in the first half of the 20th century. By signing more generous deals with the poorer countries of the Middle East and the Soviet bloc, Mr. Mattei broke the stranglehold the “seven sisters” -- a phrase he coined to describe the main oil companies of the time, including Standard Oil -- had over the industry.

Sitting in his dimly lit conference room in Tripoli after signing the contracts last month, Mr. Ghanem says: “Paolo has brought back the days of Enrico Mattei to Eni. Once again Eni is a major company.”

But not everyone is happy with Mr. Scaroni’s approach. Rival oil groups, many of which are descendants of the original seven sisters, are particularly concerned. In private, their executives say Mr. Scaroni’s willingness to bend to national oil company demands makes it more difficult for others to stand their ground.

In fact, Mr. Scaroni even joked as he signed the Libyan deal that Mr. Ghanem would use the new contract as a bargaining tool with other oil groups. “He is going to exploit the concessions he got from us as he negotiates with the other companies, because he plays the game to the end,” Mr. Scaroni said.

Analysts too are unsure whether Mr. Scaroni is a visionary reaping the first-mover advantage of someone who has recognized that the industry has changed for good, or is giving away too much for too little gain. Neil McMahon, analyst at Sanford Bernstein, notes that Mr. Scaroni -- not unlike Mr. Mattei -- is more willing to bend than his peers because of necessity. “Eni are more desperate than Exxon for longer-term reserves as they have a smaller legacy position,” says Mr. McMahon.

The same could be said of Repsol. Antonio Brufau, its chairman and chief executive, says his strategy is closer to that of Mr. Scaroni because those who move first have a better negotiating position than those at the end of the queue. “Being last is not going to change the picture, the fact that it will happen. Being first . . . at least you prove the will to adapt yourself.”

Mr. Scaroni simply counters his critics by saying: “I am not here to litigate with oil countries. It is their oil.”

All around the world -- from Kazakhstan to Alaska -- oil-rich governments are reasserting that ownership as they squeeze international energy groups, raising taxes and royalties and taking a bigger share of projects. In Russia, the Kremlin has forced companies such as Royal Dutch Shell, BP, and their peers to sell the majority share of their projects to Gazprom, the country’s state-controlled gas monopoly.

In Venezuela, almost every big international oil company has had to give up part or all of its oilfields. Eni took Caracas to arbitration but quickly settled, agreeing to lose its Dacion field for compensation of at least $700m (£355m, 446m euros) and a chance to become involved in Venezuela’s heavy oil deposits in the Orinoco belt. ExxonMobil -- seen as the strictest among its peers on sanctity of contract -- is sticking to its guns and has taken Caracas all the way to the courts in the U.S., the Netherlands, and the U.K., antagonizing the government of President Hugo Chávez in the process. “Eni has too few lawyers and Exxon has too many” is how one industry lawyer puts it.

Kazakhstan’s Kashagan project, which Eni operates, is perhaps the starkest illustration of just how different the Italian oil company’s approach is from that of its peers. A consortium including Exxon, Total, Shell, and ConocoPhillips has already invested $17bn in developing the Kashagan field, which, when it hits peak production of 1.5m barrels a day some time in the middle of the next decade, is projected to become one of the world’s three biggest.

But over the past two years, the Kazakh government has escalated its demands on its foreign investors, eventually forcing the companies to reduce their stake in order to give Kazmunaigas, its national oil company, a larger share. The dispute pushed already slipping deadlines back even further and revealed acrimony not only between Kazakhstan and the companies but also among the foreign partners themselves. Rivals blame Eni for badly managing the project, which is seen as one of the industry’s toughest. Their executives say Eni promised the government too much, too quickly.

Things turned so bad that Eni’s partners quietly began to lobby against the Italian company. They got their way late last year when the Kazakh government announced that Eni would lose its operatorship at the end of the primary phase of the project when the field comes on stream.

Christ­ophe de Margerie, Total’s chief executive, says Exxon and Total long saw the earlier start-up dates as too optimistic. He adds that he is pleased Eni will not be running the second phase of the project on its own.

But the tussle between oil companies and oil-rich nations has implications far wider than prompting infighting among the companies. Oil production growth is slipping as many national oil companies prove themselves ill-equipped to manage the industries of which they are increasingly in control. Often their governments use them as piggy banks rather than allowing them to reinvest their profits.

In Venezuela, oil production has fallen steeply since the populist Mr. Chávez took over. In Mexico, where politicians are again negotiating whether to give Pemex, the Mexican national oil company, more freedom to allow foreign companies to help, production is declining by more than 30 per cent a year at Cantarell, the country’s largest field. This not only threatens Mexico’s future national income but also buoys international oil prices. In Russia, the Kremlin’s power grab has also had dire consequences for what is the world’s ­second-largest oil producer: in the first quarter of this year the country suffered its first fall in production in a decade.

Combined, these factors have led to stagnating oil production growth outside the OPEC cartel. The International Energy Agency, the developed countries’ watchdog, forecasts in its latest medium-term outlook that, for the first time in the industry’s modern history, countries outside OPEC will in the next five years hardly be able to increase production at all. Nobuo Tanaka, IEA executive director, last week called on non-OPEC countries to grant companies greater access to their resources and create more transparent legal systems conducive to investment. He said: “The underground resource is still there; the problem is above ground.” [NOTE: OPEC's members are Iran, Iraq, Kuwait, Qatar, Saudi Arabia, the United Arab Emirates, Libya, Algeria, Nigeria, Angola, Venezuela, and Ecuador. --J.R.]

The lack of growth means OPEC’s share of the market is projected to rise from 40 per cent to 50-60 per cent, shifting money and influence from Western countries to oil exporters in the Middle East, Latin America, and Africa. But even national oil companies within OPEC are not investing as much as international oil companies. Exxon alone has a capital expenditure programme of $125bn over the next five years, 60 per cent of the $210bn that all 13 members of OPEC combined intend to invest in the same period. This lack of investment means oil prices are generally forecast to stay high unless a recession drastically erodes demand in large parts of the world.

In such a climate international oil companies, despite record profits, are struggling. Output will either remain flat or fall, while their reserves will probably shrink. That is a big problem for Mr. Scaroni and his peers, whose success is judged by how much they can increase production and how well they do in finding the reserves that will yield the oil on which their companies’ future revenue depends.

So it is no surprise that when asked, on the flight back from Tripoli, Mr. Scaroni names growth as his single most important objective for Eni. And he has one more historical footnote, this time on the Republic of the Congo, where -- in the quest to fulfil his ambitions for growth -- Eni in April bought the right to exploit several oilfields. They include the first extra-heavy field that will come into production outside Canada’s tar sands and Venezuela’s Orinoco belt.

Buoyed by his accomplishment in Tripoli, Mr. Scaroni takes on a more competitive tone. He asks his fellow travellers where the capital of free France was in 1944. The answer is Brazzaville, a titbit Mr. Scaroni picked up five years earlier in a biography of Charles de Gaulle. “When you have lunch with African presidents and other people you do business with, you can’t talk about oil the entire time,” he says.

In the oil world, Congo-Brazzaville may not have the cachet of Libya. Nevertheless, Mr. Scaroni is acutely aware of just how much his company, and the industry as a whole, now depend on the leaders of oil-rich nations. But whether his legacy will stand up to that of Mr. Mattei, or whether he will be remembered as the man who gave away Eni’s riches, will become clear only long after he has retired from an industry where many projects now take a decade to complete.