Oil and Petroleum Industry in UK - Essay Example

? Oil and petroleum industry in UK Table of contents Introduction 3 2. Oil and Petroleum industry in UK 3 2 Current supply and demand conditions3 2.2 Collusive behaviour in the industry 4 2.3 Price leader(s) 5 2.4 Abnormal profits 5 2.5 Barriers to entry and exit 6 2.6 Competitive behaviour and theoretical models 7 3. Conclusion and Recommendations 8 References 9 Appendix 11 1. Introduction The performance of industries in the global market is commonly based on their ability to keep their profitability at standard levels in the long term. In highly turbulent periods, like the current one, the ability of industries to support national economies is usually decreased. However, there are industries, like the oil and petroleum industry, which have managed to keep their competitiveness and remain intact from global market pressures. Current paper focuses on the oil and petroleum industry of the UK. The specific industry is considered as highly profitable, as analysed further below. Still, the industry has been related to anti-competitive behaviour, supporting the development of oligopolies. The characteristics and the competitive behaviour of the above industry are explored in this paper. Emphasis is given on the industry’s potentials to control anti-competitive behaviour and promote the equal development of its members. 2. Oil and Petroleum industry in UK 2.1 Current supply and demand conditions The oil and petroleum industry of UK is highly developed, a fact related to the country’s high efficiency in terms of oil and gas. Indeed, it has been proved that a percentage of 99% of oil and gas produced in UK is extracted from ‘the seabed surrounding the country’ (Oil & Gas UK 2012). The producing fields of the oil and petroleum industry of UK have been estimated to 383 (Oil & Gas 2012). Of course, the amount of money invested on the relevant projects is also quite high; in 2008, ‘the funds spent on drilling projects were estimated to ?1.4 billion’ (Oil & Gas 2012). It should be noted that the last five years the continuous changes in oil price worldwide have caused turbulences in oil supply and demand in all countries (Bloomberg 2007). UK is also affected every time such phenomena appear. According to the Department of Energy and Climate Change the oil and gas production of UK highly supports the local needs in terms of energy (Department of Energy and Climate Change 2012). For example, the country’s oil and gas production of 2009 reached high levels, covering ‘the two-thirds of the local energy needs’ (Department of Energy and Climate Change 2012). The particular industry also supports that UK economy; the contribution of the industry in the UK economy has been estimated to ‘an average of ?8 billion annually’ (Department of Energy and Climate Change 2012). In the context of the global market, the performance of the oil and petroleum industry of UK can be characterized as quite satisfactory, leading to the classification of UK as one of the most powerful oil and gas producers worldwide. Indeed, ‘in 2008 UK ranked 14th’ (Department of Energy and Climate Change 2012) in terms of its oil and gas production. It should be noted that the industry’s key firms have been estimated to 30 (see Table 1, Appendix); however, among these only 3 are those that share the key part of the oil and petroleum industry of UK (see those firms highlighted in Table 1, Appendix). 2.2 Collusive behaviour in the industry Collusive behaviour reflects the use of practices that are opposed to market ethics or to the law. In the oil and petroleum industry of UK such practices may have occurred but have not clearly reported or identified. However, there are signs that indicate the existence of such practices. For example, in a report published by the Department of Energy and Climate Change of UK (2012) it is explained that the production of oil in UK has reached up to now ‘the 40 billion barrels even if the potential for 20 more billion barrels existed’ (Department of Energy and Climate Change UK 2012). Tisdell (2008) notes that the arrangement between firms operating in an industry to keep the level of production low can be considered as a collusive behaviour. In the specific case, by keeping the production low, the firm’s major competitors had the chance to keep the price of crude high, a fact that has led to the significant increase of their profits (Mason 2011). Moreover, Lundgren (2012) notes that currently the level of oil and gas production has limited at about 50%, reaching ‘the 2.2 million barrels/ daily, compared to the 4.5 million barrels/ daily in 1999’ (Lundgren 2012). The above practice has led to the development of renewable energy, as an alternative to cover the energy needs of UK and avoid further increase in the oil and gas price (Lundgren 2012). 2.3 Price leader(s) As noted above, in section 2.1, three firms dominate the oil and petroleum industry of UK: BP, BG Group and Royal Dutch Shell (see also Table 1, Appendix). In the first three moths of 2011, the profits of these three firms reached the ?9.2bn (Mason 2011). These firms have developed a common practice in regard to the price of crude: the price ‘of crude per barrel has been kept at $100’ (Mason 2011), leading the price of petrol across UK at extremely high levels, about ‘140p/litre’ (Mason 2011). The control of oligopoly, which has been developed in the oil and petroleum industry of UK, could lead to the decrease of the oil and gas prices across the country. 2.4 Abnormal profits In order to evaluate whether there is a case of abnormal profits of firms operating in the oil and petroleum industry of UK, it would be necessary to evaluate the profits of certain of these firms, meaning especially the industry’s key competitors, in comparison with the industry’s profitability. It has been noted above the three key competitors of the oil and petroleum industry of UK, i.e. the BP, the BG Group and the Royal Dutch Shell have achieved a significant profit in 2011 reaching the ?9.2bn for the year’s first three months (Mason 2011). However, as it is made clear in Graph 1 (Appendix) the crude oil production, import and export in UK seem to be continuously decreased from 2000 onwards (Graph 1, Appendix). For gas also, a similar trend has been reported (Graph 1a, Appendix). How these three firms have managed to achieve record profits within such turbulent market conditions? 2.5 Barriers to entry and exit The term ‘barriers to entry’ is used for describing not only the difficulties in entering a particular economic area but it also incorporates the challenges that a firm has to face when trying ‘to develop its brand name, to improve its ‘know how’ and to identify investments for realizing its plans’ (Smith 2011, p.81-82). In the oil and petroleum industry of UK such issues have appeared, meaning that firms that have tried to enter the industry have faced barriers, in regard to one or more of the sectors described above. According to Smith (2011), the development of barriers to entry in the particular industry has been related to the severe problems and delays appeared during ‘the exploration of North sea oil and gas’ (Smith 2011, p.82). Also, the oil and petroleum industry of UK is characterized as highly risky; as a result only firms of high financial status and with appropriately skilled staff have managed to face effectively the industry’s challenges and risks, which can be also considered as barriers to entry (Smith 2011, p.82). In 2003, the UK government introduced two new licences, aiming to attract foreign investors: ‘a) the ‘promote UK’ licence and b) the frontier licence’ (OECD 2005, p.76). These licences, being available at quite low cost compared to the traditional licences, could possibly attract foreign investors; still, this plan targeted only small investors. This means that the UK energy industries, to which these licences were related, could not be particularly benefited (OECD 2005, p.76). This differentiation in regard to the policies targeted the small investors, compared to those related to other investors, can be also characterized as a barrier to entry. Since then, the UK governments have not made important efforts for eliminating barriers to entry in the oil and petroleum industry of UK. On the other hand, no barriers to exit have been identified in the particular industry. After increasing the difficulty for firms to enter the specific industry there is no need for the British governments to establish barriers to exit the above industry. 2.6 Competitive behaviour and theoretical models In the context of European Union, the limitation of competition in all industries is related to the following fact: in order to achieve European integration countries-members of the Union have promoted strategies that favoured the development of common practices by organizations of different size (Jolly 2009). The specific problem has also appeared in the oil and petroleum industry despite the efforts of the international community to control the phenomenon. An example of these efforts is the establishment of OPEC, an organization aiming to join the countries that have the higher oil reserves globally (Lawler and Seddighi 2001). As noted above, competition in the oil and petroleum industry of UK is rather problematic. The status of the industry in terms of competition could be made clear by referring to the existing theories of competitive behaviour. For example, the competitive rivalry theory has been used for explaining the competitive behaviour of organizations. In the context of this theory, organizations are likely to develop competitive practices not for establishing their own policies but rather as ‘a response to the practices of their competitors’ (Hitt, Ireland and Hoskisson 2012, p.134). In the case of the oil and petroleum industry of UK the most appropriate competitive behaviour model seems to be the oligopoly. The specific model has certain requirements, such as: ‘the existence of few suppliers and many buyers, homogenous products, barriers to entry in the industry’ (Nellis and Parker 2006, p.188). Moreover, the industry’s firms tend to cooperate and develop common policies, another phenomenon of oligopoly (Nechyba 2010, p.618). McEachern (2010) also notes that the key characteristic of oligopoly is the existence of ‘few sellers’ (McEachern 2010, p.233). The oil and petroleum industry in UK meets these requirements, as explained above, and can be characterized as an oligopoly. The increase of competition in the particular industry would allow new entrants but it could possibly threaten the industry’s profits, especially since the industry’s key players could not make arrangements for promoting common practices and keep prices high. 3. Conclusion and Recommendations One of the key characteristics of the oil and petroleum industry of UK has been its rapid development. According to the issues discussed above, the offshore activities of the particular industry have had a key role in the industry’s high performance. Still, competitiveness across the industry is not effective, at least not fully. As a result, oligopolies have appeared, a phenomenon that it is quite common in developed markets internationally. On the other hand, the particular industry is a key part of the British economy. The introduction of strict measures for changing industry’s characteristics, including the level of prices and the terms of competition, could lead to severe turbulences in regard to its profitability. Under these terms, turbulences in the UK economy would be unavoidable. It would be necessary for the British government to introduce laws that would reduce barriers to entry in the specific industry, taking into consideration the fact that a key part of the industry should be controlled by UK firms. The foreign investment on the oil and petroleum industry would be welcomed but it should be kept up to a specific level. Also, the ability of the industry’s competitors to develop common practices should be controlled, possibly through the update of existing legislation. The review of the industry’s characteristics and its competitive status leads to the following assumption: the chances for the industry to achieve a high growth in the future are increased. However, it would be necessary for the industry’s firms to keep their strategies aligned with relevant legal rules and to avoid developing common policies, so that competition is not threatened. References Bloomberg (2007). Oil: it’s back to supply and demand. [Online] Available at http://www.businessweek.com/magazine/content/07_06/b4020055.htm [Accessed at 25 June 2012] Boyes, W., & Melvin, M. (2007). Economics. Belmont: Cengage Learning. Department of Energy and Climate Change, UK (2012). Oil and gas. [Online] Available at http://www.decc.gov.uk/en/content/cms/meeting_energy/oil_gas/oil_gas.aspx [Accessed at 25 June 2012] Hitt, M., Ireland, D., & Hoskisson, R. (2012). Strategic Management: Concepts and Cases: Competitiveness and Globalization. Belmont: Cengage Learning. Jolly, A. (2009). Business Insights: Europe: A Practical Guide to Company Formation, Employment Law and Taxation Across the EU. London: Kogan Page Publishers. Lawler, K., & Seddighi, H. (2001). International Economics: Theories, Themes, and Debates. Essex: Pearson Education. Lundgren, K. (2012). Wind’s $168 Billion North Sea Boom Lures Oil Industry. [Online] Available at http://www.bloomberg.com/news/2012-04-30/wind-s-168-billion-north-sea-boom-lures-oil-industry-energy.html [Accessed at 25 June 2012] Mason, R. (2011). Oil companies poised to unveil huge profits. [Online] Available at http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/8657075/Oil-companies-poised-to-unveil-huge-profits.html [Accessed at 25 June 2012] McEachern, W. (2010). Microeconomics: A Contemporary Introduction. Belmont: Cengage Learning. Nechyba, T. (2010). Microeconomics: An Intuitive Approach. Belmont: Cengage Learning. Nellis, J., & Parker, D. (2006). Principles of Business Economics. Essex: Pearson Education. OECD (2005). Energy Policies of IEA Countries: 2005 Review. Paris: OECD Publishing. Oil and Gas UK (2012). The voice of the Offshore Industry. [Online] Available at http://www.oilandgasuk.co.uk/knowledgecentre/weblinks.cfm [Accessed at 25 June 2012] Parliament UK (2011). The UK’s Energy Supply: security or independence? [Online] Available at http://www.publications.parliament.uk/pa/cm201012/cmselect/cmenergy/writev/supply/m30.htm [Accessed at 25 June 2012] Smith, N. (2011). The Sea of Lost Opportunity: North Sea Oil and Gas, British Industry and the Offshore Supplies Office. Oxford: Elsevier. Statistics UK (2012). Energy production and consumption. [Online] Available at http://www.statistics.gov.uk/hub/business-energy/energy/energy-production-and-consumption [Accessed at 25 June 2012] Appendix Firms operating in the oil and petroleum industry of UK Anadarko Marubeni BG Group Nexen Petroleum BHP Billiton Noble Energy BP OMV Chevron Perenco CNR International Petro-Canada ConocoPhillips Premier Oil Dana Petroleum RWE DEA Dyon UK Shell Eni Group Star Energy ExxonMobil Statoil Gaz de France Talisman Hess (aka Amerada Hess) Total Lundin Petroleum Tullow Oil Marathon Oil Venture Table 1 – Firms operating in the oil and petroleum industry of UK (Source: http://www.acorn-ps.com/web/page/oilgas/oilcom.htm) Graph 1 – Production, import and export of oil in UK (Source: http://chartingprogress.defra.gov.uk/feeder/Section_3.9_Oil_and_Gas.pdf p.254) Graph 1a - Production, import and export of gas in UK (Source: http://chartingprogress.defra.gov.uk/feeder/Section_3.9_Oil_and_Gas.pdf p.254) Read More