The role and influence of national oil companies (NOCs) is rapidly transforming along with the relationships they are forming among themselves and with international oil companies (IOCs).

The days of NOCs focusing exclusively on domestic activities are over. The new approach is a globalized strategy focused on international expansion, technology exchange, and industry engagement. This has created major link-ups between NOCs and IOCs in the form of strategic partnerships, alliances, and areas of mutual cooperation down all avenues of the energy pipeline.

Although not all state-owned oil and gas entities are following in the steps of leading energy conglomerates like Petrobras, Statoil, Petronas, and China's CNPC and CNOOC, the trend is catching on – and fast.

As E&P continues to expand into new frontiers such as ultra-deep water, the Arctic, and unconventional resources like shale gas, the inherently different strengths of IOCs will enable them to maintain relationships with the NOCs in a changing energy landscape. But the relationships going forward will be very different from those of the past.

NOC spending power

Rising global activity and spending power of NOCs is shrinking the pool of opportunities for IOCs. Many IOCs have reacted to this situation by adjusting their operating models and capitalizing on strengths such as technological and operational know-how, securing access to capital markets, and the ability to better manage risk or fast-track projects.

The key appears to be how IOCs can leverage their technology, know-how, and value to assist an NOC in better developing its resources. This is the path ahead for many western majors and independents as they seek to access new hydrocarbon resources, often in areas previously inaccessible.

As much as 80% of global oil reserves today are controlled by NOCs, up from less than 15% in the 1960s. NOCs also control 75% of oil production. The story is similar for gas.

As NOCs look to develop these vast resources, they recognize that they need the IOCs as much as IOCs need them – at least for now. Petrobras, CNPC, Rosneft, and many others openly acknowledge these relationships are the best way to acquire or transfer the techno-

Topsides on the FPSO Cidade de S?o Vicente on Petrobras' pioneering Lula Field. The Brazilian NOC has become "IOC-like" in terms of its in-house technical expertise and is a world-leader in the deepwater and presalt frontier. (Photo courtesy of Petrobras) logical and commercial expertise needed in new energy frontiers.

It is no surprise, therefore, that companies like BP, ExxonMobil, Shell, and Chevron have been able to cement and expand their established relationships with state energy companies around the world.

Instruments of government

According to John Westwood, chairman of international advisors for Douglas-Westwood, as state-owned bodies, NOCS operate as an instrument of the government and, as such, tend to act in the best interest of their sovereign nation. And many of them still have huge oil reserves.

Meanwhile, "there is significant evidence to suggest that the majority of IOCs have passed peak production and are now in decline," Westwood said.

When Westwood entered the energy industry in the 1970s, IOCs controlled 80% of the world's oil reserves. Today that position has switched, and NOCs directly control 78%. He believes this has major implications for IOCs.

In the 1980s, some IOCs had "really shot themselves in their corporate feet" by changing their business model, Westwood said. The "What business are we in?" approach caused many of them to abandon upstream R&D – believing this was the role of their suppliers – and cast off much of their in-house technical expertise.

This greatly boosted some of the major oilfield technology suppliers. In many instances, NOCs can easily buy all the expertise they need from the service companies and have less need for the skills, route-to-market, and finance of the IOCs, according to Westwood.

"Some NOCs are not willing to cooperate with IOCs on an equity-sharing basis," he said. "As a result, a large proportion of the global oil reserves –conventional onshore resources that are relatively cheap to produce – are difficult for the IOCs to access."

Meanwhile, reduced opportunity has forced IOCs into higher cost areas where they still have the internal expertise to overcome technological challenges. These areas include deep water, horizontal drilling, subsea completions, or enhanced recovery, Westwood said. Accordingly, deep water, for example, will be a primary means of reserve replacement for IOCs.

But in some cases the NOCs need to cooperate with the IOCs, Westwood said. "This has been particularly true for tackling complex multibillion-dollar gas processing projects such as LNG liquefaction plants."

Forming new alliances

BP is one major that has recognized the need to form new partnerships with resource holders, characterized by its ongoing ambition to strategically align with Russia's Rosneft.

BP’s Northstar field, 8 km (5 miles) northwest of Prudhoe Bay, came online in 2001 and was the first Arctic offshore field connected to shore by subsea pipeline only. IOCs like BP can offer vital experience on such projects when negotiating partnerships with NOCs to enter previously inaccessible areas such as the Russian Arctic shelf. (Photo courtesy of BP)

While this proposed alliance is still the subject of delicate negotiations with TNK-BP, the reason behind it is simple – it offers huge upside in terms of enabling potential access to Russia's Arctic Continental Shelf.

The agreement would create the first major equity-linked partnership between an NOC and IOC. The terms would see Rosneft hold 5% of BP's ordinary voting shares in exchange for approximately 9.5% of Rosneft's shares, bringing BP's total shareholding in Rosneft to 10.8%. The proposal demonstrates a major step-change in the thinking behind a relationship between an NOC and IOC.

BP CEO Bob Dudley commented in a recent investor presentation that the company is stepping outside the traditional IOC model.

"We're focusing on long-term value by investing in the key inputs – namely, safety, capability, technology, and relationships," Dudley said. "But we're also evolving the model of what an IOC does. Clearly, project scale and complexity, requiring access to financing, technology, and capability, continue to enable IOCs to uniquely invest in our industry's challenges – deepwater projects are a prime example, and we remain deeply committed to this important resource."

Dudley said BP also is pursuing new kinds of relationships with NOCs and major resource holders. "We don't see them only as competitors but increasingly as partners when our capabilities are suited to their needs," he said.

According to Dudley, potential deals such as the Rosneft alliance – which would also see the company establish an Arctic technology center in Russia – provide a platform from which BP can "seek additional opportunities for international collaboration."This typifies the way BP is mirroring global trends.

"Growth in energy demand and economic activity is coming almost entirely from the emerging economies," Dudley said, pointing to Brazil, Russia, India, and China as the most significant players.

Rosneft clearly sees the advantage of increasing its partnerships. The company also signed an agreement with ExxonMobil to collaborate in the potential development of resources in the Black Sea. The companies plan to form a joint operating company, with Rosneft holding a 66.7% stake and ExxonMobil holding the remainder. They expect to begin exploration in the Tuapse Trough area next year.

Both companies will evaluate joint E&P opportunities elsewhere and will invest in deepwater technology R&D.

Changing roles

Jay R. Pryor, vice president of business development at Chevron, underscored the need for NOC/IOC partnerships in a keynote address at the World National Oil Companies Congress 2011, highlighting two critical trends – the long-term energy investment challenge and increasingly difficult resource areas available for development.

Building out the energy infrastructure to meet future demand will be an enormous undertaking, with the International Energy Agency estimating that US $33 trillion in investment will be needed to meet global demand by 2035. And with several major energy-consuming countries now abandoning nuclear power, the demands on fossil fuels could take on still greater urgency. The world will need the equivalent of at least three new "Saudi Arabias" by 2020 to make up for declines in existing oil fields, he said.

At the same time, the development prospects available are growing increasingly difficult to pursue. The industry is facing deeper reservoirs, heavier crudes, tight gas formations, and ever-more-remote locations that are subject to harsher weather conditions.

"Needs bring national oil companies and international oil companies together, and transformative technologies are often crucial to addressing these needs," Pryor said. "NOCs and resource holders look to IOCs to unlock the value of stranded resources. They do so by applying ingenuity to pair new technologies and practical know-how.

He used Chevron's Tengiz field as an example. "In Kazakhstan, we more than doubled production from the Tengiz field," he said. "This is the deepest known supergiant reservoir. And it has some of the most daunting challenges in the world.

"Innovative systems return produced sour gas into the field at extreme pressures. This helps preserve the Tengiz field's high current reservoir pressures."

It is important, he added, to keep in mind the changing roles of NOCs and IOCs. "NOCs include highly successful companies – which have advanced management and technology greatly," he said. "(But) more and more, we need to identify particular projects where specific NOC-IOC partnerships will bring greater value than either can provide individually. By definition, NOCs must proceed in a manner consistent with and supportive of national policy. For that reason, it's even more incumbent on IOCs to approach new projects not only in terms of the business proposition but in the framework of the countries and the communities in which they operate."

Acknowledging that "there will be gaps" for both NOCs and IOCs, he said this creates an opportunity for both partners to step in and fill those gaps with capital, resources management, or technology.

Using historical links

Royal Dutch Shell spent much of 2010 firming up agreements with NOCs in China, Qatar, and Saudi Arabia covering new natural gas potential.

That momentum continued, with Shell and CNPC signing a Global Alliance Agreement in June emphasizing their intent to pursue mutually beneficial cooperation opportunities internationally and in China.

The two parties also signed a Shareholders Agreement to establish a well manufacturing joint venture (50% each). The intent is to develop an innovative, highly automated well manufacturing system (WMS) that could significantly improve the efficiency of drilling and completing new wells onshore, specifically with tight gas, shale gas, and coalbed methane in mind.

Shell also signed a protocol with Russia's Gazprom last year for strategic global cooperation. Among the opportunities the companies will consider are further development of bilateral cooperation in hydrocarbon E&P in western Siberia and the Russian Far East, cooperation in the downstream oil products business in Russia and Europe, and Gazprom participation in Shell upstream projects outside Russia.

Asian NOCs most active

Some of the most active NOCs are in Southeast Asia, where there is a growing interest in unconventional resources, particularly shale gas.

According to Ernst & Young's NOC monitor report, estimates from the US Energy Information Administra- tion (EIA) show that 14 regions outside the US contain 5,760 Tcf of technically recoverable shale gas resources. Almost a quarter of these are in Asia, which holds the largest estimated shale gas resources of any region.

NOCs have raised their E&P spending budgets this year more than the IOCs and above the industry average. This is also understood to be a conservative estimate. (Data courtesy of Pareto)

China's as yet unqualified shale resources could rival those of the US. With gas demand in China forecast to more than double by 2020, there is an impetus to develop supplies locked up in substantial coal and shale deposits.

According to the Ernst & Young report, the Chinese government will need to be open to more foreign investment if the country's shale gas potential is to be properly exploited.

Several Asian NOCs have signed agreements to acquire international shale gas assets, with a number of these agreements requiring the NOC to fund all or part of the drilling costs, according to the report.

In January, Italy's Eni and PetroChina entered a memorandum of understanding (MoU) to collaborate on upstream oil and gas projects, especially unconventional sources such as shale gas in China and other parts of the world.

"The future of shale gas development in China shows potential, but it is likely that it will be at least a decade and probably closer to two decades before production will reach material levels," the Ernst & Young report contends.

The key for many of these deals is their expansive nature. The Eni/PetroChina agreement also entails jointly studying and researching "common opportunities to expand their operations in Africa's conventional and unconventional oil and gas industry," the report states.

PetroChina will evaluate certain assets of Eni for a stake purchase, and the Italian NOC will evaluate opportunities in unconventional resources provided by the Chinese NOC.

While the MoU is in line with Eni's strategy to increase its presence in Asia, it also enables PetroChina to significantly benefit from Eni's experience in unconventional resources and jointly explore favorable opportunities.

Another example of expanding NOC/IOC cooperation is the acquisition of a 33.33% stake in Chesapeake Energy's shale oil and gas assets in the Denver-Julesburg and Powder River basins in the US by CNOOC's subsidiary, CNOOC International Ltd. As a part of the deal, state-funded CNOOC has agreed to bankroll 66.7% of Chesapeake's share of drilling and completion costs, up to $697 million, by the end of 2014.

Korea National Oil Corporation (KNOC), meanwhile, has a planned acquisition of one-third of Anadarko Petroleum's assets in the Maverick basin in Texas's Eagle Ford shale play. KNOC will fund 100% of Anadarko's drilling costs in the area this year and 90% annually thereafter in return for acreage in the oil-rich Eagle Ford and in the underlying Pearsall shale that mostly produces gas.

Privileged access

NOCs are in the driver's seat, controlling a large percentage of the world's oil and gas as well as much of its major infrastructure systems.

Of the top 25 oil and gas reserves holders and producers, 18 are NOCs, according to the World Bank. In addition, it is estimated that 60% of the world's undiscovered reserves lie in countries where state companies have privileged access.

Due to different priorities, NOCs often generate lower revenue, are less profitable, and produce a significantly lower percentage of their upstream reserves than their IOC counterparts. They have widely varying structures, functions, and complex mandates compared to the relatively simple IOC mantra of maximizing shareholder returns. And they must be seen to deliver a wide range of socioeconomic and political objectives for their sovereign governments in the national interest, often while under political pressure.

With their profit focus, IOCs do not operate under such restrictive guidelines and have developed a skill set that enables them to manage risk better than some of their state counterparts.

These fundamental differences between the NOCs and IOCs are why the proliferation of strategic alliances and partnerships is taking place – different needs bring them together.

With frontiers no longer based on geography but increasingly represented by high-risk challenges, the vast majority of the world's NOCs are signaling their wish to continue a mutually beneficial relationship with IOCs to unlock stranded reserves and mitigate risks.