The factors restraining investment in the oil and gas industry - Dissertation Example

Investments The Factors restraining investments in the oil industry THIS DISSERTATION DEALS WITH THE FACTORS RESTRANING INVESTMENT IN THE OIL INDUSTURY. THE DISSERATION IS BEEN SUBMITTED IN THE PARTIAL REQUIREMENT FOR THE AWARD OF M.SC (ENERGY STUDIES) AT THE CENTER OF ENERGY MINERAL PETROLEUM LAW AND POLICY, CEMPLP, UNIVERSITY OF DUNDEE. SHAMMAS HABIB MUHAMMED AUGUST 2006. Contents CHAPTER 1 1. Introduction____________________________________________________3-5 CHAPTER 2 2.1 Determination of Investments in upstream Industry__________5-7 2.2 Downstream Investments________________________________7-10 CHAPTER 3 Issues Affecting Rate of Investment 3.1 Price and Demand Volatility_____________________________10 3.1.1 OPEC: Guilty or Not Guilty____________________________________10-11 3.1.2 Speculation by Industry Observers_______________________________11-12 3.1.3 Other Factors________________________________________________12-13 3.1.4 Poor Data___________________________________________________13 CHAPTER 4 Peculiarities of Oil Exporting Countries 4.1 Underdevelopment_____________________________________13-14 4.2 Investments___________________________________________14-15 4.3 Monopoly by National Oil companies______________________15-16 4.4 Political Instability_____________________________________16-17 4.4.1 To understand the Political Instability of the countries which are developing and the countries that have the resources but not a good political environment (Nigeria and Angola).__________________________________________17-19 CHAPTER 5 Environmental Issues 5.1 The United States______________________________________19 5.2 Europe_______________________________________________19-20 5.3 The Developing World__________________________________20-21 5.4 Financial Implications__________________________________21 CHAPTER 6 Factors Effecting Investments 6.1 Factors That Influenced Past Investments___________________21 6.2 Non-OPEC Producers__________________________________22 6.2.1 Uncertain Surrounding Reserves______________________________22 6.2.2 Organizational Uncertainty___________________________________22-23 6.2.3 The Volume of Financing from Foreign Investors________________23 6.3 OPEC Countries_______________________________________23-25 CHAPTER 7 7. Conclusion____________________________________________25-27 CHAPTER ONE Introduction Investment is an important source of capital for growth in the developing countries. It provides a package of new technologies, management techniques, finance and market access for the production of goods and services; and thus contributes significantly to raise the productivity in the host countries in attaining their overall economic growth. An investment is been determined by balance, opportunity, and risk, which are relative concepts, especially with respect to Exploration activities. Opportunity involved in finding commercial quantities of oil and gas, the intensive capital required for undertaking exploration and production result in significant business risks. In many developing countries, the transformation from an agricultural and resource based economy to the export-led economy has contributed to higher energy consumption. Although they are oil & gas reserves located in those countries; very few had sufficient financial resources for the upstream investments, especially for the development of oil & gas exploration and production. Government can promote investment opportunity by adopting a proactive approach to selecting foreign partner towards improving entry procedure moreover, reducing red tape in oil and gas sector operation. However, many countries had granted development rights to foreign Companies, which have adequate capital, technology, and expertise; still some foreign Companies are not investing in those countries for many reasons. The influx of foreign capital to developing countries investors has made foreign investors become an important financier and long- term operator of infrastructure activities, especially in the water, transport, telecommunication, and energy sector. Due to difficulties in gaining capital and lack of expertise needed for resource exploration and development, for many years most of the oil & gas projects in developing countries were been Financed by IOCS, but the situation changed during earlier 1970s, when government involved in the petroleum sector to ensure better control of their reserves. Now the projects were been Financed by government, official borrowing and as well as from IOCS. Again, in the earlier 1990s, emphasis again shifted towards private sector, as the governments and IOCS began limiting their involvement in the oil & gas sector, but the IOCS have begun to include a wide range of partners in the projects for a variety of reasons, including a political need for local participation and a desire to share project risks. This resulted in funding of oil and gas projects quite complex, involving public as well as private investors and financers. In many developing countries, there is another dimension of political risk, which is more difficult to handle. In countries where government have taken steps to establish a stable framework and clarify policies, project sponsors and financiers may not have full confident that the new business Environment will remain unchanged and thus, they do not take a proposal seriously until they, Receive some assurance that political risks are manageable The biggest deterrent to foreign investor participation in the upstream sector in the developing Countries is the lack of well-established legal, regulatory system and policies makes it difficult for government to predictable action that could affect cost moreover, revenue stream, particularly towards prices, taxes, and royalties. A part for effectively managing the balance between perceived opportunity and risk, another Challenge for the host countries is how they settle their relation with the IOCS (Khadduri, 2002). The relationship between host government and IOCS is critical in facilitating or obstruction Investment. Their relationship can be friendly if either both have mutual benefits in expanding the industry, or tense if both have different objectives, agendas and timetables. The purpose of this research is to discuss and identify conditions that are militating against Investments in the oil industry, in light of the current fears that are been expressed by industry Observers. This paper begins with a review of the factors that determine investment inflows, including the general setting of the upstream business environment. This is been followed in Chapter 3 by an analysis of the factor affecting the rate of investment in the industry, with an emphasis on price and demand volatility. Chapter 3 starts an attempt at forecasting what issues/ factors might influence future investments and ends with chapter 6. Finally, chapter 7 closes with a conclusion of the study. CHAPTER TWO 2.1 Determination of Investments in upstream Industry Investment or Foreign Direct Investment (FDI) refers to the investment undertaking of a form in an oversea enterprise in which the investor has a long-term interest as well as substantial control (Brenton, 1999). FDI is been viewed as a major stimulus to economic growth in developing Countries. UNCTAD’S (United Nation conference on Trade and Development) report (2003) revealed that in 2002 China, Honk Kong, Singapore, Malaysia, Indonesia, Korea, Taiwan, Thailand, India, and Vietnam were top 10 recipients of FDI inflow amongst the countries in Asia, accounting for over 97% of total FDI region. In addition to these socioeconomic and Political variables, another factor is the presence of natural resources such as mineral ores, Petroleum and natural gas, coal and other raw material, the availability of which may also act As location specific, advantage in attracting FDI to host counties (Akinkugbe, 2003). Dunning (1998) also noted that FDI inflows to the oil and gas industry is of the resources seeking kind, which means that one of the key reasons for the IOCS investing in such country is because of its Natural resources. Another distinctive characteristic is that while large investment capital investment is required, it takes a long time to explore and develop oil and gas deposits, thus requiring more time for accruing benefits of such development. Many developing governments have identified the upstream oil and gas industry as a priority development sector with considerable potential and are now working hard to improve the legal moreover, fiscal framework to provide the long-term clarity, stability, and consistency needed to fulfill the requirement of foreign investments. As the developing governments are working hard in every sector for improving their legal and fiscal framework, they are undergoing operations in which they are identifying many issues, which can be helpful in their progress. Removing Restriction and providing good business Operation conditions are been generally believed to have a positive effect on FDI (ODI, 1997). As mentioned in the report of ODI, 1997 that if good Business conditions are provided, it will be easier for the foreign investors to invest in the Projects for development. The most important change in the upstream oil and gas industries has been adoption of Production-sharing legislation. This form of legislation, which is an effective and speedy method of jump-starting the upstream oil and gas sector, is been adopted in many countries. However, the lack of transparency in investment approval procedure and an extensive bureaucratic system in some countries are still deterring FDI. Many developing governments are providing investor- Friendly environment for the foreign investors in order to encourage them to increase FDI flows (UNCTAD, 2003). These include fiscal incentives, financial incentives, and market preferences. Fiscal inventiveness includes tax reduction, acceleration deprecation, investment and Reinvestment allowances and exemptions from import and export duties. Financial incentives include subsides, grant and loan guarantees. Market preferences include monopoly rights, protection from import competition and preferential government contracts. 2.2 Downward stream Investment The past few years have witnessed serious capacity tightness and considerable challenges for the refining industry in the face of the seemingly endless march of demand—even in light of a growing catalog of new projects under development. For many years, the focus of the oil market has been on crude production and production capacity, but due to several years of lagging in investments for many years in capacity and made worse by swelling products demand in 2004. The IEA (International Energy Agency) 2004 estimate that the global oil demand in 2010 will be about 90 million barrels pre day, an increase of nearly 8 million barrels pre day over the 2004 number. This increase is about 30-40 world scale refineries, and the net impact on the marketplace, even in that much refinery capacity could be made operational by 2010, would simply be maintaining today’s high margins and volatility. Clearly, even in a future setting where growth reduces somewhat from the levels seen in 2004, the tight refinery capacity situation is been expected to persist until at least 2007 or 2008, but is expected to ease gradually thereafter as additional refinery capacity is been added in most worlds regions. In addition, to meet the increases in demand growth expected in the coming years, refiners must also face up to • A changing product demand mix: Demand is shifting toward the middle of the barrel, with middle distillate products like diesel and jet fuel growing the fastest of any major products. • Concentration of demand: Demand growth in the years ahead will be concentrated in the emerging nations, particularly in Asia Pacific region, versus more sluggish growth in the Mature markets of North America, Western Europe, and OECD Asia Pacific. • Price controls: Many of the highest demand growth markets remain under some level of regulation, where prices below international market parity tend to stimulate demand and reduce margin incentives for new capacity investment. • Product quality specifications: The pressure to comply with tighter product quality specifications will continue to drive required refinery investment in all major markets. The American Petroleum Institute estimates that the refining sector spent $47.7 billion on meeting Environmental regulations in 1995–2004. Product demand mix In every region of the world, demand for middle distillates (Diesel, Heating oil, and Jet fuel) is growing faster than for any other major refined product. In addition, in some regions, such as Western Europe and China, there is a strong push for diesel-fuel passenger vehicles where fuel price and taxes enhance appeal of diesel-fuel for economic reason. Finally, when economies are growing rapidly and run into bottlenecks on electricity supply, diesel fuel is often been used for on-site or portable generators. While middle distillates currently account for about 36% of global product demand, no less than 50% of every barrel of incremental demand over the next 10 years will be diesel fuel, heating oil, or jet fuel. Shift in Regions of Demand The recent patterns of refined product demand growth indicate that it is increasingly concentrated in the emerging markets, particularly in the Asia Pacific region. The rapid pace of Economic expansion in emerging markets in Asia Pacific and elsewhere will continue to be the main driver underlying global refined product demand growth. Demand increase in Asia Pacific alone are been expected to account 50% of the increase in Global oil demand today over the next ten years, compared to less than 29% of global demand today. The oil demand is not limited to Asia, oil demand in other regions, including the Middle East, Africa, and Latin America, is on track to grow rapidly, with each region clamming a large share of global oil demand than at present. North America, Western Europe, and OECD Asia Pacific account for a combined 59% of Global oil demand today, but only 20% of the increase in demand over the next 10 years. Therefore, the developed regions of the world are been expected to make a lower contribution to the oil demand in the coming years. Product Quality Standards In addition to the cost of building new plants, some refiners will need to invest to meet stricter product standards, principally affecting gasoline and diesel fuel quality. Refiners planning to supply markets where gasoline and diesel fuel specifications are becoming tighter will have to do Whatever is necessary to meet compulsory Sulfur limits in these products over the next few Years. Price Control People tend to assume that the oil market is a homogeneous international market, as if all National markets are fully been integrated into one single free market where common price Signals are providing incentives (or disincentives) to supply and demand equally across the National markets. Although this can be relevant, as long as governmental, control of domestic a price is a negligible factor in international oil fundamentals. As international light products price have sharply raised since mid-2004, regulated prices in these growth markets tend to be substantially lower than import parity, preventing international price signals from fully reaching consumers and suppliers and thus creating a cut off. CHAPTER THREE Issues Effecting Rate of Investments 3.1 Price and Demand Volatility In the past few years, the world seems to have entered into an era of higher crude oil price volatility. In December 1998, the WTI spot price (FBO at Cushing) stood at a historic low barely $10/B. In March 2000, it increased to over $31/B, after reaching a peak of about $37/B in September 2000, the WTI price declined to less than $18/B in November 2001induced by fear of Worldwide economic downturn as the result of the 11 September 2001 attack. Since then there has been an upward trend in crude oil price with WTI price reaching an unprecedented level of above $70/B in June 2006. In a study, Adelman (1999) noted that crude oil prices have been more volatile than other has commodity prices. On the demand side, oil consumption has been stable relative to GDP while on the supply side, it is easier and faster to adjust output to demand conditions than in other Industries. From these observations, he hypothesizes that oil prices must be more volatile for a special reason and that reason is OPEC output control. He therefore argues that high oil price volatility is because “the thermostat of a competitive market has been turned off” and then predicts, “Price volatility will continue higher than in other markets so long as price is fixed high by collusion in the cartel.” 3.1.1 OPEC Guilty or Not Guilty Although OPEC might be or might not be the culprit for the oil price volatility because of its Strategic importance as a major supplier of crude oil, laying the blame solely on the organization in addition, explaining volatility in terms of OPEC’s ‘price fixing’ is not been warranted. OPEC Abandoned fixing the reference price in 1987, favoring a system in which OPEC sets production Quotas based on its assessment of the market’s call on OPEC supply. OPEC has done some Adjustments accordingly to its calculation, but these adjustments process can prove to be quite Problematic, at times including undesired price volatility. Due to lack of reliable and timely data about consumption, production, and inventory levels, and the unreliability of short-term forecast, it is difficult for the OPEC to Control the market. This is because OPEC comprises different Countries with distinct economics, social and political challenges and with no incentive to share information. Furthermore, OPEC has no monitoring system to oversee production and shipments in addition, more importantly no punishments mechanism to deter cheaters. In this respect, it is a problem for OPEC to implement output adjustment and quote restraint, in the face of falling or growing global oil demand through for different reasons, i.e. OPEC’s response is asymmetric to global demand condition. In the case where global demand for oil rises, although agreement to increase quota are easier to reach and implement, OPEC may not respond quickly to this upward stream tend, especially in an environment of imperfect information. The slowness of the response to an upward trend can contribute further to volatility by undersupplying the market. 3.1.2 Speculation by Industry Observers This brings us to a related way through which OPEC can bring about volatility: the extent of speculation surrounding OPEC meeting. The list of factors that OPEC has used to explain its decisions since 1999 expanded to include the level of oil and product stocks, market speculation, basket price range, geopolitical factors, supply demand situation and US$ exchange rate (Garcia, 2005). The increase in the frequency of OPEC meetings and the increase in the frequency of quota adjustment in recent years have also contributed to an increase in speculative activity (Weston and Christiansen, 2003). During the late 1980s and mid-1990s, the market did not witness any major increase in price instability except for few hikes in oil prices caused by Political shocks beyond the control of OPEC. In fact, at time of such disruptions, the main OPEC Producer, Saudi Arabia, played a significant role as swing producer filling the oil gap and Moderating oil prices. The economist points that Saudi Arabia has done this many times during the period of wars, when the supply of output from those countries was not sufficient. 3.1.3 Other Factors It is clear that in order to understand the current episodes of higher volatility one must move beyond the exclusive focus on OPEC policies and widen the investigation to include some features that have emerged in the oil market and the oil industry the past few years. Four such features are important: the gradual erosion of OPEC spare capacity the shift in the strategy of inventory management by international oil companies; the increasing importance of the oil futures market in the current oil pricing system; and the worsening (or no improvement) in the quality and correctness of data on oil-related factors. Saudi Arabia has gone to unusual length to provide assurances to markets and analysts that it can increase production to meet growing global demand. These assurances however were not able to calm oil markets. This has led The Economist to comment that, “Ali Naimi, the Saudi Oil Minister, usually moves markets when he speaks. Some other important factors that contributed to heightened volatility are the changes in practice of inventory management. The relationship between levels of inventory and volatility, however, is not straightforward and can run in the Opposite direction, i.e. volatility of oil prices can affect inventory levels. Another important development in the past two decades has been the emergence and growing importance of futures market in setting oil prices. OPEC’s oil pricing regime since 1987 is been based on a price formula, which uses crude markers such as WTI or Brent as a benchmark. Since the price of these markers are determined in the interrelated spot, future and derivative markets, daily oil Price movements are been affected not only by current fundamentals of the market but also by Market participants’ expectations about future supply and demand of crude oil in the futures market. 3.1.4 Poor Data Although oil prices have become more transparent over the years, information about crude oil consumption and production has not improved both in quality and in timelessness. This problem is becoming worse with the increasing importance of some developing countries such as India In addition, China as major oil consumers with even less reliable data. Furthermore, the advent of many small oil producers on the oil scene increases further difficulties of collecting reliable in addition, timely information. The quality of inventory data is also subject to uncertainties and revisions. Since in a tight market scenario every barrel is important, uncertainties about supply and demand contribute to the volatility of oil markets both through magnifying the oil gap and through increasing speculation. CHAPTER 4 Peculiarities of Oil Exporting Countries 4.1 Underdevelopment Douglas North (1981) highlighted the importance of intellectual property rights and the ability to enforce existing agreement in modern economic growth this implies that any negative effect of Natural resources on institution will indirectly frustrate economic growth. Many scholars have claimed that resources rents tend to erode the sound institutional base of the economy. In most cases, there is a limited access to resources usage rights due to their limited physical availability, granted to a few public or private companies or even individuals. The larger the amount of resource rents, the fiercer is been expected to be the rent-seeking competition. There has been empirical evidence that resource-dependence hinders democratic reforms. Ross (2001) argues that oil and mineral revenues make governments less accountable to the society by increasing public spending and overall satisfaction and relieving social pressure. Torvik (2002) argue that rents have to channel into “white elephant” projects of low social return as a politically appealing way of canvassing. Collier and Hoeffler (1998) argue that resource abundance is also harmful to Political stability. Since resource wealth is often geographically concentrated, it may trigger Ethnic or regional conflicts or worsen existing tensions. They also find, for instance, that Resource wealth increases statistically the probability of a civil war. 4.2 Investments The positive role of investment in economic development is been well documented in recent literature. It is been found that investment is one of the few strong determinants of economic growth, which independent of the conditioning is set of other variables. Several explanations justify the negative relationship between resource abundance and investment. World price for primary commodities tend to be more volatile than world prices for other goods. This argument may provide substance to the strong negative connection between resources abundance and Foreign investment rates over the last three decades. Last, even if the level of investment in physical capital is of similar magnitude between resources Abundant and scarce regions, there are differences in its quality and the efficiency of the investments use. Investments often fail to reach the productive base of the economy. Resource transfers often provide protection to many infant manufacturing industries that simply failed to mature. 4.3 Monopoly by National oil Companies Since the 1980s when Britain spearheaded privatization up to today, economic liberalization, Market economy reforms and corporate management reorganizations have characterized the oil and gas industries of major energy producing countries such as Russia, Norway, Canada, and Malaysia, as well as the energy industries of major consuming countries in the developing world such as China, Brazil, Japan and India. These emerging integrated firms, together with remaining traditional oil and gas state monopolies, control the vast majority of proven resources remaining for exploitation and development. State monopolies represent the top 10 reserve holders internationally. By comparison, Exxon Mobil and the Royal Dutch Shell Group are ranked 12th in addition, 13th while BP and Chevron Texaco are ranked 16th and 19th respectively. In terms of world oil production, however, only six of the top firms are national oil companies, while Exxon Mobil, Royal Dutch Shell, BP, and Chevron Texaco represent among the largest oil in addition, gas producers worldwide. Of the top 20 oil and gas producers worldwide, 16 are national oil companies or newly privatized National oil companies and the ranking shows that Saudi Armco, Gazprom, NIOC, Pemex, Sonatrach, INOC (Iraq), PetroChina, KPC, Petrobras, Petronas, Yukos, Lukoil, PDV (Venezuela) and NNPC are among the most important oil and gas companies in the world. EIA Ranking on all measures ranks Saudi Armco, PDV, NIOC, Pemex, and PetroChina in the top 10 Oil companies in the world. The Western international companies are now interested in strengthening ties with emerging National oil companies to diversify their operations and enhance supply security but strategic Alliances have been difficult to form. The gap between the high ranking of national oil companies’ resource holdings and the ranking of the world’s largest oil and gas, production-operating companies highlights a potential source of supply instability in world energy markets. The fate of emerging national oil companies, their strategies and policies will have a substantial, long-term impact on the pace of resource development in the coming years. Firms such as India’s ONGC and IOC; China’s Sinopec, Cnpc, and Malaysia’s Petronas have been successful in Africa and Iran, with eyes now on Investments in Saudi Arabia, Kuwait, and Iran. Strategic investments and trade alliances for emerging national oil companies are been sought based on geopolitical rather than economic considerations. CNPC now studying forming investment alliances with Petronas, and continues to desire a strategic investment in a Russian oil company. Russia, on the other hand, has shown reluctance for its oil companies to connect with Western or Chinese firms but has announced interest in forming alliances with Saudi companies. 4.4 Political Instability Investment, including FDI, is a forward-looking activity based on investors expectations regarding future returns and the confident that they can place on these return. Thus, by its very nature, the FDI decision requires some assessment of the political future of the host country. The other consequences of the Political instability stems from the fact that it is likely to affect invested the value of the host country’s currency, thus reducing the value of the assets invested in the host country as well as of the future profits generated by the investment. Alesina and Perotti (1996) found that an increase in the intensity of political instability decreases investment, hence slowing down economic growth. Using a political instability index based on political assassinations, revolutions and successful coups, Campos and Nugent (2002, 2003) investigated the causal link between the index and growth and investment, respectively, using pooled panel data. 4.4.1 To understand the Political Instability of the countries which are developing and the Countries that have the resources but not a good political environment (Nigeria and Angola). Nigeria and Angola are deeply troubled countries. Political problems have proven, extremely disruptive to oil production in Nigeria. With or with out oil, Nigeria would be a very troubled, difficult to govern country, but oil has created additional complication, at the root of all problems is the extreme ethnic diversity of the country. There are over three hundred ethnic groups, but most importantly three dominant blocs. Northerners have historically dominated the military, the Yoruba’s from the west have been prominent in the business sector, and Ibos from the east have provided disproportionate numbers to the civil service and business. The tensions among the three major blocs exploded in the civil war of 1967-69, which started when the Ibos of the Eastern region seceded from Nigeria and set up their own state of Biafra. Biafra was eventually Defeated and Nigeria was been reunited, but the underlying problem of achieving stability in such diverse country remains. In fact, the political picture has become even more complicated recently. The division between Muslims, that dominate the north, and Christians, more numerous in the rest of the country, has become politicized, as Muslims in Nigeria follow the worldwide trend toward greater assertiveness. Oil producing areas, which have little political influence, were short-changed. An additional source of instability in Nigeria is the ever-present threat that the military, which has governed the country through most of its existence, will seek to seize power again. Even this shortened overview should make it clear that many of Nigeria’s problems are not been caused by the misuse of its oil riches, and would not go away completely even if oil revenue was used better and more equitably and if oil companies implemented more effective remedies for the ills, their operations produce. The Angola situation is somewhat less complicated. In Angola, the oil industry has been somewhat insulated from the civil war that raged in that country since it attained independence in 1975 because most oil deposits are offshore. Indeed, Angola became an important oil producer in the midst of war. After the death of UNITA leader Jonas Savimbi in early 2002, the war has Largely ended and the country is struggling toward stability. Paradoxically, oil may well become a new source of domestic strife, as Angolans turn their attention from wartime survival to the present socio-economic problems and discover how much of the oil revenue has been misused Alternatively, worse, has disappeared without a trace. Although the country has experienced Almost thirty years if civil war, the conflict was a bilateral one between the ruling MPLA and the insurgent UNITA, and did not have complexity of Nigeria’s multiple layers of conflicts. The Civil war ended after the death of UNITA’S leader Jonas Savimbi in February 2002. Angola has moved toward democratic governance and relative peace which might likely result in a more favorable investment climate. This does not mean that Angola will soon be a democratic Country because subsequent elections are unlikely to be truly free and fair, given UNITA’S present weakness, the MPLA’S strong grip over the country and the oil revenue, and the virtual absence of any other viable political party. Nevertheless, elections will at least be a step in the right direction. With the return of peace, however, the enormity of the socio-economic problems the country faces is becoming more evident and it is more urgent to address them, lest they become source of new conflicts. Many of these problems are been related to oil and the misuse of oil revenue. Thus, oil production in the future will be at the centre of political conflict in Angola, while during the civil war, it was not. CHAPTER 5 Environmental Issues 5.1 The United States The United States has only a few remaining oil and gas frontiers: areas of Alaska, including the Arctic National Wildlife Refuge; the deepwater Gulf of Mexico; off the western Florida coast; in addition, offshore California’s Outer Continental Shelf. Additional resources, including up to half of the remaining untapped natural gas resource base lies under federally owned lands, mainly in the Rockies. Questions exist about industry access to many of these areas. Prohibition of drilling off the California and Florida coasts has rendered many long-held leases worthless 5.2 Europe In Europe, access to the Wadden Zee inlet off the coast of Holland is subject to similar obstacles, moreover, public concern for environmental protection has effectively put the area off-limits. In addition to informal pressures, an important regulatory force in the EU is the Habitats Directive, Established in 1992 to provide a network of protected areas called Natura 2000, across EU member countries. The United Kingdom has introduced the Habitats Directive into the offshore Oil and gas licensing system, which is likely to increase pressures to ban some exploration or subject the industry to more stringent conditions in sensitive areas. 5.3 The Developing World Operations in developing countries are been exposed to a number of different costs and pressures, including project delays, sabotage of equipment and pipelines, loss of access to reserves or partnerships, and negative publicity that has incited consumer opposition in developed countries. Occidental’s withdrawal from Colombia are been attributed in part to opposition from both the indigenous community and international NGOs, though the company maintains that the decision was been based purely on economic considerations. In 1999, oil companies operating in Nigeria announced that losses from disruptions caused by these incidents exceeded $1 billion. Shell’s Nigerian operations were able to produce at only 25 percent of capacity in 1999 and 220,000 barrels less total capacity as at January 2006 or almost 10 percent Nigeria is output.1 Social pressures have had repercussions for other companies as well, as protest movements are been organized against Chevron and other corporations producing in the region. The search for new reserves is been impeded by environmental and social concerns. Access to too many U.S. reserves have already been restricted or is in question. Access constraints also exist in Europe. Access in developing countries is at risk from both international and local opposition. 5.4 Financial Implication The ability to secure access to reserves are been made more difficult by accompanying Environmental and social concerns and the ease with which controversial activities can be communicated to distant consumers and shareholders. These risks may affect companies in various ways. The cost of developing new fields may increase if community-focused projects become an indispensable part of the development price, or if pressure builds to meet more Stringent environmental standards than those set by government. CHAPTER 6 Factors Effecting Investment 6.1 Factors That Influenced Past Investments Factors, which effected the past investments, were, the First World War, the Second World War, the communication gaps between the countries, due to unreliability between the countries, communication gap between the investors and the country, lack of confidence on each other, Transportation problem, and lack of support to each other. Due to the world wars, the developed countries and the undeveloped countries were in not contact with each other, which was a big problem at that time, and when the war was finished, it took a lot of time to understand each other, which was the unreliability between the countries. After that, it was the transportation problem, as the underdevelopment countries were not having sufficient and required machinery, skilled labor and many things that were required for the Development. These few important factors influenced the past investments. 6.2 Factors Likely To Influence Future Investment 6.2.1 Non-OPEC Producer Non-OPEC producer, less OECD, experienced a negative growth of 1.1% in 2005, while in the OECD region it was reduction of 4.7% in crude production when compared with 2004. Therefore what is likely to affect oil industry in Russia could help shed more light and give an insight into what could shape oil investment and production in non-OPEC countries and the likely future Scenario. 6.2.2 Uncertainties Surrounding Reserves One of the greatest unknowns affecting the development of Russian oil production concerns reserves. While they are been known to be substantial, there is considerable debate as to their estimated volume. Figures range from 48 billion to 140 billions barrels, depending on to the source of information. Problems of management and conservation of deposits must have to addressed, as mentioned above. These problems are a result of the policy of maximum Exploitation practiced by production association during the soviet era and in all likelihood still pursued today. Indeed, this could explain the sometimes alarmist declarations of certain Russian Official experts. According to the IEA, 60% of proven reserves are difficult to recover. 6.2.3 Organizational Uncertainty Recent developments suggest there is hesitation between several possibilities. The first possibility would be to put in a number of state-owners that would dominate the sector and sever as a means of extending a centralized policy. The second would involve pursuing the structuring of the sector by developing companies with public, private, and foreign capital an option that would not exclude the possibility of the state keeping some shares in the main firms. So far, priva­tisation has taken place in an environment characterised by the weakness and opacity of market institutions, opening up little prospects of a model that can described as an “International Oil Company”. In particular, private groups that acquired state-owned companies sold off under the Loans for Shares programme in 1995 reacted by practising cash stripping (a Way of rapidly increasing the value of their assets) and asset stripping, behaviors that are not at all compatible with strategies to renew oil resources. 6.2.4 The volume of Financing from Foreign Investors The spectacular rise in pric­es is boosting revenues and thus opening up greater possibilities of Self-financing for Russia. However, given that the government’s goals to diversify the economy Imply using this extra revenue for other activities, this should nevertheless prompt the au­thorities to seek more financing from outside the country to develop the hydrocar­bons sector, considered by foreign investors to be a more attractive investment option. In fact, the financing needed for Oil industry investments is considerable, estimated by the IEA at $328 billion for the period 2001. The new international oil context in which supply will be subject to constraints in the coming years has changed the terms of the equation as far as capital from foreign investors is concerned. Although international oil companies generally prefer to be the opera­tors, they could be satisfied with substantial, though minority, in­terests, provided they had to give more sound Guarantees than those in force previously. This is particularly true in view of the fact that they saw their profits and cash flow increase with the increase in prices. Moreover, it is becoming vital for them to boost their own reserves, even though for the time being not all OPEC Countries has yet fully opened their upstream sectors to foreign investment. 6.3 OPEC Countries In trying to understand and project the future of investment among OPEC countries, we are going to adopt an analysis of disparate sub groups within the dominant or larger group. Gately (2003) termed these sub groups as “core” and “Non-core”, with Saudi, Kuwait, and UAE among the core, while Nigeria, Venezuela, and Iran Iraq Libya etc in the “Non-core” group. Members of the Saudi group share common similar traits such as smaller population, almost homogeneous Cultures and plentiful oil reserves. On the other hand, the other sub groups are been characterized by large population with huge demands on social infrastructure, smaller oil reserves. A likely analysis of these two groups would show that these two groups within OPEC are engaged in a constant-sum game. Total OPEC payoffs will be virtually unchanged whether Both groups increase output slower or faster or whether one expands faster and the other expands Slower. Each faction has some reason to expand its own output faster if the other group would expand Output slowly. Nevertheless, if each group expects the other to match its output growth Increases – With neither benefiting from faster output growth – then faster output growth from both are unlikely. The issue is whether OPEC countries would have sufficient incentive to increase their production as rapidly as projected, by IEA not whether the demand for OPEC oil will rise so rapidly. With assumptions made in this paper, if OPEC acts collectively then it has no incentive to increase its output as rapidly as IEA project, because faster increase in output would be more than offset by lower prices. The faster it increases its market share above its current level (37%) the lower will be its likely payoff. OPEC’s production will increase substantially only if one or more countries within OPEC, believe that they can achieve a sustainable increase in their share of OPEC production. The obstacles to aggressive expansion of Capacities within OPEC are substantial. More likely would be a cautious approach to capacity expansion, with only moderate growth, at most 2% annually – much less, than the 3.5% to 3.7%-annual growth assumed by DOE and IEA. Such decisions are been motivated by various political and economic arguments: competing claims on government budgets that compete with investments in capacity expansion; unwillingness to allow participation by foreign oil companies; and conservation concerns about too-rapid exhaustion of oil reserves. One could even imagine statements of concern about global warming, and the willingness of the oil producing countries “to do their part” – especially if they believe, there would be no profit penalty from slower output growth. CHAPTER 7 Conclusion Implication in the International Oil Market The oil production situations as well as plans and problems are to solve in four countries are been mentioned above. These matters are been considered to bring the following impact And/or uncertainties to the international oil market. First, for OPEC, it is a grave challenge that these four countries are trying to almost double crude oil production capacity from 7.55 million B/D in total at present to 13 million B/D by 2010. In fact, Venezuela and Nigeria have problems difficult to solve in the short term, and thus their current plans for increased production are not been considered achievable as they are. However, they have ample resource potential and are been almost certainly expected to expand the production capacity by 2010 as with Libya and Algeria. If the OPEC plans are been achieved, the production capacity of 10 OPEC members, excluding Iraq, will exceed 38 Million B/D. at the same time, OPEC estimate that demands for OPEC Crude oil will reach around 35.9 million B/D by average annual growth of 1.8% from 2000 to 2010. Even if OPEC carries out drastic production reduction, OPEC members overproduce due to dissatisfaction with allowing non-OPEC oil-producing countries to increase production and get a Free ride. Thereby confidence in OPEC’s production adjustment will be impaired. At the same time, OPEC members will increase demand for the reallocation of the quota due to dissatisfaction with unbalance between the production capacity and the allocated production quota. In fact, Nigeria, Algeria, and Libya have demanded the rise of the production quota since 2001, although their demand has not come to the surface because they virtually produce for the production quota due to a sharp rise in crude oil prices. On the other hand, Venezuela, which makes it a principle to comply with the OPEC production quota, is also not fully satisfied with OPEC’s current pricing policy, as is clear in the fact that it recently requested an upward adjustment of the target price range. The reallocation of the production quota is an issue that may develop into political confrontation among OPEC members, but OPEC is destined to deal with this issue in the long and medium terms. Secondly, there is the issue of uncertainty in how long Saudi Arabia, which has played a role in final Supply-demand adjustment. On the other hand, although production in the North Sea is on a declining trend in Europe that is the natural market for African crude oil, Europe has ample sources of supply, including Middle East, Africa, Russia, and the Caspian Sea area. Due to the maturation of economy and the strengthening of environmental measures, there is little possibility that oil demand in Europe largely will increase in the future. At the same time, supply from Russia and the Caspian Sea area is been expected to increase in the future since the expansion of production and the increase of export capacity are now in progress in these areas. In such circumstances, production increase in African oil-producing countries, including Nigeria, Libya, and Algeria, will further intensify competition among oil-producing countries in the European market. If oil prices in the European market declines because of the competition, African oil-producing countries will have more incentive for export to the United States and Asian countries. The oversupply of oil expected in the European market will change the flow of African crude oil. In the Asian oil market, demand will further increase in the future, especially in China and India, nevertheless, production in Asia is on a decreasing trend, and dependence on the Middle East is increasing. All Asian oil-consuming countries are promoting attempts to reduce dependence on the Middle East, and import from Africa may be one of the options for such attempts. There is already a trend of increase in supply from Nigeria to China and Japan. Now, African crude oil is to purchase mainly when price difference between Brent crude oil and Dubai crude oil decreases In addition, African oil thus becomes highly economical. However, Asia-Africa oil trade is been expected to expand if oil prices starts to decline in the European oil market due to oversupply and intensifying competition among oil-producing companies as mentioned above. Read More