The IOCs in the Oil Industry - Essay Example

The IOCs in the Oil Industry - How they Started International Oil industry is the main and one of the most important industries in the world. The history of its development goes back to the previous century when the first International Corporation emerged. The history of development of various corporations, as a rule, testifies, that the level of profit is a result of successful political strategy provided by the counties. It this case, it is possible to say that International Oil market is one of those markets which are closely connected and influenced by the changes in the world politics and strategies of a particular country dominated worldwide. IOCs are dynamically evolving entities operating within a dynamically evolving environment, some means of evaluation of the way in which they interact has to be found to enable them to be better matched. Most of the International Oil Companies have been started as national corporations operating only on the domestic market. In general, the history of the IOCs goes back to 1850s when domestic oil industry development was marked by significant growth (Mohr, 1976), and many companies like Marathon Oil began to penetrate into other markets given a start to International Oil Corporations (Marathon Oil corporation History, 2005). The international expansion of International Oil Companies began at the beginning of the XX century when substantial oil fields were discovered in Asia. For instance, explorations of oil in India had been started in 1875, and after that time some International Oil companies sterted their activity in the Assam region. According to the historical data production of oil was about 0.30 million tones at the end of the XIX century. The main problem of national oil industry of many less developed countries was that the oil fields discovered by the public sector were literally gifted to the private sector without recovering the direct costs, let alone the sunk costs, written off over the years, for futile exploration activities in other parts of the country and abroad. The oil reserves were underestimated by design or ignorance about the speculative nature of oil reserves estimation. It is well known that oil reserves generally increase with time, as more and more data is made available during production from these fields. The private sector was given the international prices, which had been denied to the public sector for exploitation of these fields discovered by the public sector oil companies. Some minor explorations by national companies took place in Asia, but as experts suppose "production from these fields was uneconomical as the administered price given to the two national oil companies was very low as compared to international crude oil price" (Yeomans, 2004). National companies addressed their governments for international crude oil price for economic exploitation of these discoveries but neither of them got any response. So, it is evident that during the fist stage of global expansion IOCs received greater possibilities and opportunities than national companies in less developed countries, and for this reason the first successful steps on the international arena resulted in rapid growth of IOCs. The next stage of IOCs development was closely connected with political and legislation changes. At the beginning of the XX century the "landlord was able to lease his land with its mineral rights to a lessee who gained rights in petroleum Exploration and Production" (Mohr, 1976). So, the system of leasing supported the start and development of International Oil business. During this period of time most IOCs were represented by joint-ventures, like Anglo-Persian Oil which in 1938 was developing oil fields in Iran, and Kuwait (Kuwait: Oil Fields, Gas Fields, 1993). During this period there were a variety of arrangements for joint developments and alliances. Some were very formalised inter-organisational relationships; at the other extreme there were very loose arrangements of co-operation between organisations, with no shareholding or ownership involved. International Oil Companies were typically thought of as arrangements where organisations remain independent but set up a newly created organisation jointly owned by the partners. The joint venture was, for example, a favoured means of beginning collaborative adventures between eastern and western European firms, with eastern European firms providing labour, entry to markets and sometimes plant; and western companies providing expertise and finance. For instance, "in 1934 the Kuwait Oil Company Ltd was incorporated as a jointly-owned venture with Gulf Oil Corporation of Pennsylvania, which discovered oil in Kuwait in 1938. In 1932 the Company formed a joint UK marketing company with Shell called Shell-Mex and B.P. Ltd" (Administrative/Biographical History, 2005). The Great Depression had an influence on the IOCs. Like most companies, IOCS suffered financial losses due to the unprecedented economic downturn, forcing the company to reduce output and lay off workers. In addition to selling off poorly performing subsidiaries, IOCs weathered these hard times by introducing a range of new technologies. The First and the Second World Wars and technological innovations of this period changed understanding of the role of IOCs, including military sphere. "By 1940 about 4,000 barrels per day were being produced. World War II and its aftermath brought development to a halt between 1942 and 1947, and exports did not begin until 1949. The Dukhan field extends south from Dukhan along the west coast and has three oil reservoirs layered progressively deeper between limestone formations and a natural gas field underlying them all' (Qatar, 1991). The period before the WWII witnessed unprecedented growth and prosperity. The milestones included a multimillion dollar research program to develop exploration drilling and improve drilling technologies. Converting operations increased with the construction of new refinery platforms. The contracts of agreement played a significant role at this time. For instance, when oil was discovered in the Persian Gulf several major IOCs "were blocked from obtaining concessions there by what was known as the Red Line Agreement, which prohibited companies with part ownership of a company operating in Iraq from acting independently in a proscribed area that covered much of the Middle East" (Oil Industry, 2005). Standard Oil Company California (Socal) was one of IOCs which was allowed to continue exploration and "gained a concession and found oil in Bahrain in 1932. Socal then sought a concession in Saudi Arabia that became effective in July 1933" (Oil Industry, 2005). After the Second World War the quite new Discretionary System of Licensing was adopted. According to this law the Lessor of the petroleum (the government), granted rights for exploitation to the International Oil Companies. "Under the Discretionary System the IOC's were usually obliged to pay a rather modest cash "signature bonus " and also to assume a binding obligation to carry out certain geophysical work and to drill one or more exploratory wells within the Contract Area so awarded" (Bromley, 1991). For instance, "in 1935, after years of behind-the-scenes, British and United States oil companies was granted to the AngloPersian Oil Company, which transferred the concession to Petroleum Development, an affiliate of the Iraq Petroleum Company (IPC) (Qatar, 2005). According to the new rules came into force after WWII "if the IOC fails to carry out its contracted work then the Consideration has not been paid in full and the IOC-Lessee is in default" (Croissant, 1999). Another important stage was connected with Production Sharing Contracts stipulating the share of oil between IOC's and government of the country during cost recovery and profit sharing stages were all heavily tilted in favour of the former. The history of production of oil dates back to 1950s. As many experts suppose that extremely limited resources of some countries do not covered by production sharing contracts (Economides, Oligney, 2000). In order to protect countries' resources, the Work Obligation and Discretionary System for IOC's were introduced at 1959. This document stipulated the timing and definition of exploitation works, "contains amongst the most difficult issues to be agreed in the negotiations thereby tending to markedly increase transaction costs" (Goralski, Freeburg, 1987). In most common practice the Work Obligation is linked to a Dollar Expenditure Obligation so that if the IOC fails to carry out its commitments the government would demand the payment of the unfulfilled expenditure obligation in cash (Yergin, 1991). The early 1960s marked a watershed in the history of IOCs. The Organization of the Petroleum Exporting Countries (OPEC) was founded at the Baghdad Conference in the 1960. the main role of this organization was defined as "to co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry" (Sheikh Rustum, 1986). the first members of OPEC were Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. Later other countries as Qatar, Indonesia, Socialist Peoples Libyan Arab Jamahiriya, United Arab Emirates, Algeria, Nigeria, Ecuador and Gabon had jointed this organization. One of the major drivers towards the use of strategic alliances in IOCs development was the growth in international market development. They were looking for new countries recognized that they have skills or knowledge deficiencies where an in-depth knowledge of a foreign market is required. The need to develop local knowledge increased and innovations of drilling was being considered to meet market demands. While local knowledge could be hired, it was often quicker and more reliable to seek assistance from already established Oil Companies of the host country. It should also be noted that a legal requirement of many countries was that foreign organizations had to have host partners before they could exploit natural resources making a joint venture an essential method of development (Banuazizi, Weiner, 1994). The 1970s was marked by rapid development of IOCs. The process of their global expansion resulted in two scenarios, the purpose of which were to sensitize decision-makers in the groups to recognise signals of possible changes in the world. The propositions were that a more rapid and appropriate business response could then be effected compared with that likely to occur if such changes came as a surprise (Barro, 2000). The two strategies were "global mercantilism" and "sustainable world". The world at this time was seen in terms of three areas of potentially far-reaching change: geopolitics, international economics and the natural environment. These form a common starting point from which two different logic-flows branch towards the distinct scenarios. The branching point for these two stories is a (hypothetical) coincident economic downturn in several major countries (Yeomans, 2004). Global mercantilism was the outturn of a weak international order as a result of the end of the cold war. There was instability in the world's economic and political systems which led to a focus on building a new, more managed, regional system. The emphasis was on regional pacts and bilateral agreements rather than a global system. It encouraged internal, protectionist thinking within countries or blocs, but it also recognised that IOCs need to be competitive. The route to competitiveness was seen to lie in the free-market approach, so that deregulation and privatisation are the prescription. Environmental concerns were not high on the political agenda in this picture: although local/regional actions could be taken, international environmental issues proved too difficult to resolve. IOCs industry faced changing rules and the continuous reconfiguration of markets. Regional self-sufficiency is the emphasis and non-OPEC production is continued. Oil marketers and producers develop tight bonds and reciprocal arrangements, while volatile economic growth makes it hard to control oil prices, which are liable to large fluctuations, largely outside the influence of OPEC (Sheikh Rustum, 1986). In contrast, another strategy of sustainable world, provided by GB and France put the environment at the top of the list. Political and economic thinking converge in a world where the importance of international trade agreements is recognised and pursued. Large economic powers in particular recognise that there are limits to the burden that can be placed on the environment, so there is a shift to tighter environmental regulation and taxation. This world has a global, caring outlook, with concern for the developing countries and aid given to try and help achieve environmental improvements in these resource-scarce regions. Implications for the Oil industry are centred on increasing governmental pressure to reduce environmental impact. Pressure is exerted as regulation for lower emissions into the atmosphere and incentives to gain greater energy efficiency. The technology exists to meet the challenge, and economic conditions are made favourable so that, with time, the environmental payback is reaped. In 1970s IOCs entered a critical period. Controlling valuable and debt-free assets that had been built up over decades, they witnessed an era of an unprecedented number of mergers and acquisitions. To avert a hostile takeover and tackle diversification problem, the many IOCs increased indebtedness and acquired specialty businesses. However, like many leading corporations of the late 1960s that diversified into markets that were unrelated to their core businesses, IP found it difficult to integrate its recent acquisitions and most were sold a few years later. Over the past twenty years the global trend has been towards free-market economies, away from controlled ones. Liberalisation has occurred through acts of privatisation and deregulation by governments. This trend started in the USA in the 1970s, was followed enthusiastically in the UK during the 1980s, and is one of the fundamental principles of the EC post-1992. The main advantages of IOCs include possibilities to exploit resources outside their countries, and be direct suppliers for their refineries which helps to safe additional spending. Also, some countries have limited oil resources and IOCs operations allow them to receive cheap raw materials for their refineries (Banuazizi, Weiner, 1994; Yeomans, 2004). Nevertheless, for some countries like Saudi Arabia "the oil sector is the key domestic production sector; oil revenues constituted 73 percent of total budgetary revenues in 1991" (Oil Industry, 2005). In this case, IOCs have a positive influence on the countries economy. Inspire all advantages the main disadvantage is that IOCs empty natural resources of less developed countries in order to save their own. During the post war period IOCs found increasing demand for their crude oil but a 35% decline in the purchasing power of a barrel of crude (Banuazizi, Weiner, 1994). The influence on the countries economies could be illustrated on the basis of Algeria experience. The five-forces tool provides a useful way of understanding the nature of industries and how these might change. The international oil industry provides a good example of an industry which has traditionally been regulated to some extent by national governments. What happened in Algeria in the 1980s was typical of the sorts of change occurring more widely. Two major international companies dominated the oil industry in Algeria, and government regulation existed in order to secure supply of an important product for which Algeria had no indigenous substitute. The national fuel-oil sector (which supplied oil for electricity generation and for heating) had fewer restrictions of operations than did the retail sector (selling gasoline to the car-owning public) and was a natural entry point for new international competition to penetrate the industry, which had grown profitable in an environment of weak competitive forces: Threat of entry had been low due to lack of knowledge outside the industry about how to trade in oil products. But by the early 1980s the threat was increasing as spot-market trading developed, enabling entrepreneurs to enter. Threat of substitution was very low. Until the late 1970s oil had met over 70 per cent of the country's primary energy requirements. At the end of the decade, however, another international company entered the country. By 1984 national fuel oil had lost more than 20 per cent of its market share, and international corporation received long-term concessions on it. In three years a maximum price for oil was set by the regulator which was based on the oil companies' costs, plus an allowable margin. Price was set to meet international company costs and provide a margin to traders. Demand was high, but due to the introduction of new international companies was falling (Yergin, 1991). The result was a market with low competitive rivalry and high margins. However, entrepreneurs saw an opportunity to capitalise on the margins they could earn from entering the fuel-oil sector with lower operating costs than the established players. The effect was to undermine the government's set price and remove effective regulation at a time when market forces were changing. The final result was a significant increase in the competitiveness of the sector. It should be mentioned that many IOCs like Shell for instance, is transnational by their nature. They share the feature that they are usually large and they have direct investments in one or more foreign countries. The foreign investments may be part-shareholdings, but are more usually wholly owned subsidiaries. The difference between IOCs is in the degree to which the foreign investments are coordinated. Many Transnational Oil Companies have a high degree of coordination in its international interests. They usually have a strategic centre which manages the global operation such that all parts act in accordance with a centrally managed strategic purpose. So, during the period the development of IOCs was marked not only by global expansion, but changes occurred in their structure and organizational performance. The exploitation of the Kuwait oil resources has been started after World War II, and helped to "transform Kuwait from a largely impoverished desert sheikdom into the modern nation-state it is today" (History of Oil: Kuweit, 2005). The first attempt to find oil in North Kuwait was made in 1936, but was not successful. In two years in the area called the Al Burqan field a large field was oil was discovered. According to the recent data this field is the largest and most productive fields in the world. The first was AngloPersian Oil and the American Independent Oil Company (Aminoil) which received rights in the Neutral Zone in 1948 (Crystal, 1992). Than Arabian Oil Company also received the rights to exploit Saudi Arabia and Kuwait oil field. After a century of discoveries it is possible to say that the main oil reserves lie in the Middle East. But, IOCs faces the problem that "major oil exporters like Saudi Arabia and Kuwait (and outside the Middle East, Mexico) remain largely closed to foreign investment, while in other countries, such as Iran, complex production-sharing and buyback deals discourage IOC involvement. For their part, IOCs have contributed to the problem by showing limited understanding of the nature of the host countries' dependence on oil and their strategic objectives" (Kochhar, Ouliaris, 2005). Today, many leading IOCs suppose that a production sharing agreement should be signed between Kuwait and Iraq to insure their international operations. Economists say that "competition between Iraq and Kuwait to extract the largest amount of oil as fast as possible may lower reservoir pressure and damage the reservoir before it is depleted. This problem could be worse than expected if Iraq allows the Russian oil companies (that are notorious for their lack of technology and inefficiency that led to the premature decline of Russian oil production) to operate in Rumaila field" (Alhajji, 2003). The expansion of globalization brings benefits to developed countries: faster economic growth, higher level of the life, new opportunities. On the other hand, expansion of globalization is distributed irregularly within the countries and resulted in polarization between winners and losers grow. IOCs were faced with many difficulaties during the period of development and further growth as oil industry and market is one of the most important in the world and for this very reason is greatly influeced by world politics and strategies than by needs of the countries and IOCs' goals. Maintenance of consecutive growth means that less developed countries could use benefits of global expansion first of all. Globalization forces IOCs to extend their influence throughout the world. References Administrative/Biographical History. Available at: http://www.archiveshub.ac.uk/news/0300bp.html 1. Alhajji, A. 2003, Kuwait will not Benefit form Foreign Investment in the Northern Fields Even if an Agreement with Iraq is Reached, Available at: http://www.gasandoil.com/ogel/samples/freearticles/roundup_02.htm 2. 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