The management of oil & gas revenue in Norway - Essay Example

The Management of Oil & Gas Revenue in Norway Abstract The petroleum industry contributes to the economy of Norway to the extent that it accounts for 21 percent of the value creation in the country. With the motivation to explore the concept of Oil and Gas Industry in Norway in a holistic context, this study proposes to gain deeper insights into the management of petroleum industry in Norway and its relation with management of oil revenue in the Norway. The research proposes to analyze many aspects of independent variables and would attempt to gauge its effect on oil revenue in Norway. The proposal describes various factors which are responsible for the fluctuation in the oil revenues and tries to describe the overall effect of oil revenue in Norway petroleum industry. Chapter One Introduction Background The oil and gas industry comprises of exploration, development, production, refining, storage, transportation and marketing of oil and gas (Datamonitor, 2009). The Norwegian oil & gas market generated total revenues of $12.1 billion in 2008. The sale of crude oil was the most lucrative for the industry in 2008. Large, diversified, multinational companies have a presence in the Norwegian oil and gas industry. These firms have highly vertically integrated operations throughout the different operations within the industry. Thus, a firm can appear both as a buyer and a player within different segments. Some of these large companies include Exxon Mobile, Shell, Statoil Hydro or BP, who by sheer scale of their production and distribution networks can reduce costs and enhance profitability. Purpose of the study The purpose of the study is to analyze the petroleum industry (oil & gas) and its marketing pattern in the Norway. Also, we will examine the various independent variables that affect the revenue of the oil industry in Norway. Research Question Is there any association between the distance from monitoring headquarters and related contractual form? Is there any relationship between population density and type of oil retail contract? Are there any hierarchies which would most likely be located in non-repeated business locations (petroleum industry)? Is there any relationship between the level of revenues and oil & gas contractual form? Significance of the study This study is significant in many contexts. Huge potential lies within the petroleum sector in Norway. Its resource base and the technology and competence in the industry are its most important assets. Petroleum activities have contributed significantly to economic growth in Norway and to the financing of the Norwegian welfare state. Through more than 30 years of operation, the industry has created values in excess of NOK 4,000 billion in current terms; it is today Norway's largest industry. In 2004, the petroleum sector accounted for 21 percent of the value creation in the country. This equates to twice the value creation of the manufacturing industry and around 15 times the total value creation of the primary industries. Through direct and indirect taxes and direct ownership, the state is ensured a high proportion of the values created from the petroleum activities. In 2004, the state's net cash flow from the petroleum sector amounted to 28 percent of total revenues. After more than 30 years of production, the business has generated net revenues to the state in the order of NOK 2,000 billion in current terms. Beyond the resources used to cover the non-oil budget deficit, the state's revenues from petroleum activities are allocated to a separate fund, the Petroleum Fund. By the end of 2004, the value of this fund was NOK 1,016 billion. Scope of the study This study highlights many issues related to management of oil & gas industry (petroleum) in Norway and gives a broad analysis of the independent variables that affects the oil revenue in Norway’s Petroleum sector. Summary Petroleum is the biggest sector in the Norway Economy. The use of petroleum revenues has an impact on competitiveness in Norwegian business and industry. A high level and substantial variations in the use of petroleum revenues would have a negative impact on internationally exposed industries. The methodology includes various aspects regarding management of oil revenue in Norway. Chapter Two Literature Review The development of Norwegian and Norwegian based petroleum expertise has been an important factor in Norwegian petroleum policy. (Karl 1997) Initially, there was a strong element of knowledge transfer from foreign oil companies and supply/service companies, but today Norway has a highly developed and internationally competitive petroleum industry. This applies to oil companies, the supply industry and research institutions alike. The industry provides a powerful boost for innovation and technology development to other sectors of the Norwegian economy. (Smith 2004: 234) Supply companies in Norway are active along most of the supply chain - from exploration and development to production and disposal. (Smith 2004: 234) In a number of areas, Norwegian suppliers are among the world leaders, in particular in seismic surveying, subsea installations and floating production systems. They are present in all of the country's counties. Local and regional economies have petroleum activities that extend to a relatively high degree even to areas of the country not normally associated with petroleum activities. The Norwegian Directorate of Labour's latest survey, from 2003, showed that more than 75,000 people are employed in the petroleum industry in Norway. (Smith 2004: 234) Al-Moneef (1998) examines the vertical integration strategies of the national oil companies (NOC). With the changes in the market structure from an oligopolistic (international oil majors in control) to a cartel (the governments of OPEC in control) ultimately led to a separation in the upstream and the down stream sectors. The NOCs controlled the upstream while the major oil companies controlled the downstream. The author contends that this affected the horizontal and vertical characteristics of the multi-national oil companies. This paper examines the benefits and disadvantages of vertical and horizontal integration strategies of the oil companies. International downstream investments can lead to efficiency and future growth. The benefits of downstream integration by the international companies have been highlighted which suggests that there is a relation between the distance from monitoring headquarters and the agreement that they have. Vertical integration can reap benefits both for the oil producers and the marketers but the study finds that investment in downstream can affect the investment in crude production. Karamushko (2006) also found that the Norwegian market for gasoline is oligopolistic since gasoline is sold exclusively through very few vertically integrated chains. The five major brands are not present in all local geographical markets but they have a very dense retail network. The study examined the nature of competition that affects the price setting in the Norwegian local markets. The oil retail contracts would be impacted by the local market competition, the input prices and the common strategies of the Norwegian oil companies. The study discusses the tacit collusion model and the competitive model but has not studied whether population density impacts the type of retail contract. This study was limited to two geographical areas and a few gas stations. Wiig (2001) studied the organisation of the supply chain in the offshore oil industry. Incentives have to be offered to the suppliers and the right alliances with the suppliers can lead to reduction of the life cycle costs. The study also found that cultural aspects such as trust can influence the organisation of the supply chain. The study also discusses the key tasks in the upstream oil sector, the downstream supply chain and the role played by producer services. The supply chain helps to understand which market segments to penetrate and take a decision whether to outsource certain functions or integrate them into the supply chain streams. This study is based on Angola as the Norwegian oil companies have a stronghold there. The study found that contracts are mainly based on market transactions between the supply industry and the oil companies. As far as outsourcing in the sector is concerned, the study found that technically advanced tasks are kept in-house and the low-skill intensive tasks are outsourced. An integrated approach helps the oil companies to deal with limited number of suppliers which in turn reduces the transaction costs. The risks are also spread and the firm is able to concentrate on core activities. This study found that at each level of supplier, it is the personal relationships that are built, hold importance and influence the contracts. The supplier must hold a good reputation and price is not always the factor for awarding contracts in this sector. Nygaard and Dahlstrom (2002) examine the organizational challenges that emerge in the wake of horizontal alliance. They contend that horizontal alliances can lead to role stress and ultimately impact the performance. Data was collected from 218 managers of dual-branded retail oil outlets and concluded that role stress and role ambiguity can affect the sales, customer satisfaction and competence. The study concludes that stress influences organizational outcomes but it does not suggest factors that mitigate the influence of stress. Empowerment and autonomy are essential to fight competition. This study also focuses or organizational relationships and its consequences. Contractual forms in the oil and gas industry can impact the service innovation. This has been discussed and studied by Panesar and Markeset (2008) with special reference to improve operation and maintenance process. The authors adopted the sae study approach to understand the influence of contractual relationships on industrial service innovation. The focus of the study was the contractual relationships between service companies that sell operation and maintenance services to production facility operators in the Norwegian oil and gas industry. Service innovation is a form of revenue generation but the study does not discuss the increase in revenue due to service innovation. The study found that the existing contractual relationships do not support innovation. The cooperation and collaboration during contract execution can influence the contract duration, the contract type and the control mechanisms. This no doubt can influence the efficiency, the effectiveness and the maintenance process in the capital intensive industries such as the oil and gas sector. Finally the revenues are impacted but the study does not bring up the issue of revenues being influenced by contracts. Thus, the literature reviews suggests that while a lot of studies have been conducted on the supply chain and the integration with the upstream and the down stream suppliers, there have been no studies on the influence of the contracts. Literature review highlights several factors that influence the contracts between the oil companies and the suppliers but no study has found relationship between the level of revenues and the oil & gas contractual form. No study has also focused on the supplier contract related to population density or even on monitoring by the headquarters. This proposal intends to address these issues which are pertinent to the Norwegian oil and gas sector, as the economy is to a large extent. dependent on this sector. Chapter Three Methodology Model Formulation Distance from Monitoring Sites The principal monitors the agents to safeguard its interests. When it is difficult to monitor the agent efforts, the franchiser devises retail contracts that give the franchisee motivation to perform efficiently (Rubin 1978; Slade 1993). These contracts often emphasize the franchisee’s share in the profits of the operations. Sharing in the profits of an outlet should entice the manager to focus on the provision of quality products and services. Where agent activity is relatively easy to observe the franchiser will employ contracts that utilize fixed wages (cf. Bergen et al. 1992; Eisenhardt 1989). The difficulty associated with monitoring agents is reflected in the distance between monitoring offices and retail sites. As the distance from the franchiser increases, the costs to supervise the agent should also increase. Rather than incur these costs, the franchiser will devise control systems that give the retailer incentive (i.e., profits) to be efficient. Thus, franchising is preferred in locations physically removed from the franchiser while corporately held facilities are developed near corporate offices (Brickley and Dark 1987; Rubin 1978). This relationship between distance and contract type should be manifest in Scandinavian oil contracts. Market contracts should be used in locations well removed from monitoring sites. In these locations control is facilitated by the franchisee’s profit incentives rather than franchiser monitoring efforts. Hybrids will tend to be used in locations intermediately dispersed from the Oslo headquarters. These contracts feature lower incentives than their market-counterparts, but the franchiser can supervise these locations more easily. Finally, it is hypothesized that hierarchies will be used in locations near corporate offices. Under these conditions the franchiser can employ managers and oversee their operations at relatively low costs. Hl: Markets will be used for outlets that are farthest from monitoring headquarters, hybrids for outlets that are moderately far, and hierarchies for outlets that are relatively close to monitoring sites. Population Density The distribution of population plays an important role in determining the efficacy of alternative contractual arrangements. Where retail outlets are geographically dispersed, the franchiser is likely to spend a great deal of time traveling from store to store (Rubin 1978). The costs incurred to control distant units motivate the company to externalize units located in scarcely populated areas (Norton 1988). Population density should be particularly germane to ownership decisions in Norway. Oslo, for example, comprises 10.8 percent of the Norwegian population but is roughly 0.1 percent of the country’s land mass (Enderud 1987). There should be economies of scale in the management of hierarchical outlets in these locations. Where the population density is lowest, market-based outlets are more efficient. In these low-population areas, the franchiser is able to obtain an acceptable rate of return with a minimal investment. Hybrids will be preferred in intermediate levels of population density. These settings have greater potential for return than in the low population areas but do not offer the opportunity available in the densely populated regions. The franchiser invests in land and capital but contracts for human resources. In this intermediate arrangement the franchiser gains a higher share of the revenues than in the market outlets, but does not have the personnel overhead associated with the corporately-held outlets. H2: Markets will be used where population densities are lowest, hybrids will be used with intermediate densities, and hierarchies will be used where population density is highest. Purchasing Environment The likelihood that an individual will neglect contractual responsibilities is related to the type of purchasing situation. In repeat selling situations the owner of a specific outlet is interested in maintaining quality. In a non-repeat selling environment the dealer will neglect obligations when there is profit potential from doing so (Brickley, Dark and Weisbach 199 1). The dealer limits the services rendered to the customer and curtails general maintenance at the retail outlet. The welfare loss is carried by the franchising system rather than the independent outlet. In order to secure the compliance of the agent the franchiser may retain ownership of operations in a non-repeat purchase setting. The proximity of retail outlets to freeways should influence ownership decisions (Brickley and Dark 1987). In locations far from freeways customers are assumed to be more likely to engage in repeat purchasing. Managers of market-based outlets are not prompted to act opportunistically in this setting because they rely upon loyal customers. Hybrids have revenue-based incentives to service repeat customers but do not have as much at stake as their market counterparts. Managers in hierarchies have the least to gain from repeat business because their contracts have minimal financial incentives. Thus, hierarchies are less likely to be utilized in repeat purchase settings. H3: Markets will be used more often when repeat purchases are important, namely when the outlets are far from free ways. Hierarchies should be used when repeat purchases are rare, and hybrids should be preferred for intermediate levels of repeat purchases. Revenues Agency theory suggests that incentives increase the supply of non-shirking managers, and franchise contracts that offer greater incentives should yield greater revenues. Because outlets with higher revenues are likely to be more difficult to manage, and more important to the retail system, the contracts for these outlets emphasize incentives. Thus Norton (1988) reported a positive relationship between establishment size and franchising in restaurants and motels. This relationship between incentives and revenues should be manifest in Norwegian oil retailing. Market-based contracts have the greatest retailer incentives and should yield the highest revenues. Hybrids have intermediate incentives that are associated with intermediate returns. Because hierarchies have the lowest motivation to increase sales, one can expect them to post the lowest revenues. While higher sales are likely to be related to incentive contracting, this relationship should be tempered by the level of market demand. Indeed, population density, per capita income, and location should influence the revenue potential for an outlet. Where the influence of these covariates is reduced, the following is proposed: H4: Hierarchies have the lowest, hybrids an intermediate level, and markets the highest level of annual revenues. Research Methodology In the analytical part of methodology of the real purсhasing power of oil prices (revenues), variables like the swing of the dollar’s value vis-à-vis other сurrenсies, the effects of dollar swings on oil demand and, in turn, oil priсes should be taken into account. One cannot simply use a currency deflator and an inflation deflator separately to calсulate the real purсhasing power of oil prices (revenues) if there is a dependency between the dollar swing and the nominal oil priсe. If this is the case, one has to remove the effeсts of the dollar swing on the nominal oil priсe (revenue) and then calсulate the effects of the dollar swing on the real purchasing power of oil prices (revenues). However, this is beyond the sсope of this study. In order to respond to these questions, a test of the hypothesis that changes in the dollar exchange rate cause changes in the dollar priсe of oil should be evaluated. One could сome up with a result by сalсulating the correlation coefficient between the two. Since the dollar’s movement сould be сonsidered vis-à-vis many other hard сurrenсies, the correlation should be сalсulated for major сurrenсies. The сorrelation between oil prices in different denominations, including the dollar, gives the same results, denoting that the dollar does not affeсt the nominal oil price. Estimation of correlation сoeffiсients between Group of Seven oil prices (i.e. oil priсes denominated in national сurrenсies) and dollar oil prices for the first quarter of 1972 to the fourth quarter of 1992 gives a correlation of more than 93%, depicting a сlose movement of oil priсes in different denominations (Cooper, 1996). This, in turn, proves the hypothesis that the oil priсe is not affeсted by the movement in the value of the dollar. Results of the causality test and the high correlation of oil prices are expressed in different currencies and it is concluded that the priсe of oil in the long term has been largely independent of any particular сurreny or group of currencies (Cooper, 1996). Quantitative method of research While there are arguments on how a study can be conducted, this study would use the quantitative method of research. In the quantitative method, the focus is on numbers that represent opinions and concepts. In the quantitative method the hypotheses have to be formulated in advance and they enable testing deductive generalizations. Quantitative data enables comparative analysis, statistical analysis, and repeatability of data collection in order to verify reliability. This study requires statistical analysis and hence the quantitative method is justified. Participants and Instrumentation This research proposes to study about 300 Norwegian oil retailers operating service stations for a major international oil company. The questionnaires will be sent out by this oil company, which would ensure maximum cooperation by the retailers. The form of principal-agent contract, location, population, proximity to highway, and the revenues would be collected from the dealers. Contracts would be segregated into hierarchy, hybrid, and market categories. Data Model and Analysis The distance from monitoring sites will be estimated as the kilometric air travel distance from Oslo. The proximity to freeways will operationalize as a dichotomous variable: highway location (i.e., non-repeat business) or local market (i.e., repeat customers) coded as a dummy variable: 0 (highway) and 1 (not highway) (cf. Minkler 1990). Population density will be assessed through reports of the conventional community classification scheme utilized in Norway. According to the Norwegian Central Bureau of Statistics, a community is defined as that area in which the distance between dwellings does not exceed fifty meters (Statistisk Sentralbyri 1991). This definition classifies communities into one of three mutually exclusive categories: 1. Rural areas: communities with less than 200 persons, 2. Villages or small towns: communities with 200 to 2000 persons, and 3. Urban areas: communities with over 2000 persons. In order to control for the demand effects associated with station revenues, per capita income, county income, population density, and proximity to highways would be treated as predictor variables for revenues. The residual values by using regression will serve as the predictor variable in H4. Multinomial logit regression will be employed to assess the relationship between contractual form and location, population density, repeat business, and residual revenues. The likelihood that hierarchies will be employed versus other contracts is estimated as follows: In [pr (markets)/ pr (hierarchies)] = 11 + 22 ( distance) + 23 (population density)+ 24 (highway location) + 25 (residual revenues) In [pr (hybrids)/pr (hierarchies)] = 21 + 22 (distance) + 23 (population density)+ 24 (highway location) + 25 (residual revenues) The probability of hybrids with respect to markets is: In [pr (hybrids)/ pr (markets)] = (21 - 11) + (22 - 12) (distance) + (23 - 13) (population density)+ (24 - 14) (highway location) + (25 -15) (residual revenues) The model results would be summarizing by likelihood ratio test which will be indicating that the model captures a significant portion of the variance in contractual form or not. H1 will maintain that the distance from monitoring headquarters will relate to contractual form. H2 will suggest that population density will relate to the type of retail contract. H3 will suggest that hierarchies would most likely be located in non-repeat business locations. H4 will maintain that the level of revenues would be associating with the contractual form. Ethical concerns All precautions would be taken to ensure that no coercion or incentives are offered to make the respondents answer the questionnaire. Prior permission will be obtained from the organization and the purpose of the research would be informed to all. This would avoid any misunderstandings and ensure a smooth research process. The respondents would be assured of anonymity and their identity would not be disclosed to the press. No names would be disclosed in the final report. It is important to maintain secrecy and hence all documents would be destroyed once the data is tabulated. Privacy and confidentiality concerns would be addressed in way acceptable to the oil company. The researcher would ensure that all participants have taken an informed decision and not under obligation or coercion from the oil company or even from the researcher. All efforts would be made to ensure independence of the observer from the subject. Limitations No research process can be perfect and can have limitations. It is likely that the retailers do not respond accurately to the questionnaire. They may be barred by the top management from disclosing the details. Moreover, the executives present at the time of signing the contract may not be in service with the company at the time of this study. This could possibly influence the responses. Since the questionnaire would be initially sent out by the oil company, the chances of cooperation by the dealers in the research process, is high. All efforts would be made to ensure the validity and the reliability of the data collected. The questionnaire itself would be prepared in consultation with the oil company. 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