Research shows that the majority of national oil companies (NOCs) and the largest oil majors are planning
to maintain or increase their level of capital investment through the down cycle, though this could change quickly if there is a fundamental reassessment of future demand.

Adversity brings opportunity

The global economic downturn and instability in financial markets have created new challenges and opportunities for oil and gas companies. However, the effect on different components of the sector is highly variable.

There are opportunities for well-capitalized companies to position for the upturn. Corporate oil and gas valuations have been hit hard by the sharp fall in oil prices and the wider sell-off in equities. The market turmoil has opened up new acquisition opportunities for cash-rich players. Reserve-seeking NOCs have become more active again in the mergers and acquisitions (M&A) market now that targets are more affordable. Typically, NOCs are not reliant on debt-to-finance acquisitions, which is likely to give them a competitive advantage in the M&A market while the debt markets remain dysfunctional.

Oil price volatility and uncertain demand are making it difficult for NOCs to plan forward investments — resource-holding NOCs want security of demand.

However, research shows that the majority of NOCs and the largest oil majors are planning to maintain or increase their level of capital investment in real terms through the down cycle.

Based on publicly announced data, in 2009 the largest NOCs collectively plan to invest more than US $275 billion in the development of their businesses at home and abroad. By 2015, based on current estimates, these NOCs will have invested more than $598 billion in their hydrocarbon sectors. The planned and actual level of investment by NOCs is likely to be higher as many state-owned oil companies do not make their investment intentions public. And it is not only NOCs that are maintaining investment levels through the downturn; the supermajors between them plan to invest up to $100 billion in oil and gas activities in 2009.

This is comparable to the $122 billion they invested in 2008, but with better terms now available for equipment and services, oil companies may find they get more for their investment in the current environment. And it should be remembered that 2008 was a record year for oil and gas investment.

Differences in opportunities

There are some noticeable differences in both the scale and scope of oil companies’ planned investments in 2009. China’s CNPC has the most ambitious investment program, totaling $42 billion, although it is accompanied by a package of cost-cutting measures. Petrobras and the two largest publicly traded oil and gas companies, ExxonMobil and Royal Dutch Shell, announced sizeable capital investment budgets for 2009.

In contrast, Russian oil and gas companies have been more adversely impacted by the fall in oil prices, reduced availability of credit, and investors’ flight from risk. Rosneft is the only major Russian oil firm that has indicated that it still plans to increase spending this year.

Some companies have more compelling and unique reasons to raise investment levels. The presalt discoveries by Petrobras and its foreign partners promise to propel Brazil into the major league of oil producers. Petrobras plans to invest $28 billion in presalt areas as part of a $174 billion business plan for the period 2009-13. Around 90% of the total investment will be targeted at projects in Brazil. The investment allocated by Petrobras for 2009 represents 38% of the planned $91 billion expenditure by South American NOCs this year. Asian NOCs collectively plan to invest more than $98 billion in the oil and gas sector in 2009. Acquisitive reserves seeking NOCs will be evaluating opportunities to acquire foreign oil and gas reserves now that targets are more affordable.

Many resource-holding NOCs may defer international expansion plans in the short term to finance prioritized domestic projects. CNOOC plans to diversify into domestic downstream activities while also furthering its international expansion. In China, some domestic spending has been mandated by the state as part of the economic stimulus plan for the sector. The NOCs of the Commonwealth of Independent States (CIS) countries have announced plans to invest $36 billion in total in oil and gas activities in 2009. Middle East NOCs have announced $29 billion of investment, and African NOCs $21 billion.

Uncommitted spend is being reviewed by most companies, not only in light of lower oil prices, but also in expectation of getting a better deal in terms of material prices and service company rates in 12 to 18 months’ time. The price of oil has fallen rapidly, but costs are moving down much more slowly. As a result, many NOCs are reassessing their operating practices, investment and capital plans, and potential sources of finance. Oilfield services companies are responding to the lower margin outlook and reduced activity levels by reducing headcount, deferring new equipment orders, and being more selective in bidding for projects.

New partnerships

The seemingly relentless rise in oil prices in the first half of 2008 helped NOCs cement their position of power in the sector. Enjoying easy access to capital, NOCs have been in a position to dictate terms, forming partnerships with IOCs principally for access to the latest technology to get the most out of their own reserves. A combination of high-quality technology and ample capital has enabled NOCs to initiate a number of capital-intensive projects.

However, the economic slowdown and the fall in oil prices have left many state-owned oil and gas companies unable to finance projects with surplus cash flows. In a number of countries, higher oil revenues have helped fund social development projects. Many government budgets for 2009 are based on oil prices at higher levels than have been seen this year to date. The new economic environment may therefore lead to renewed government interest in foreign involvement and possibly investment in their hydrocarbons sectors.

This provides a fresh opportunity for International Oil Companies (IOCs) to partner with NOCs on a long-term sustainable basis. IOCs, particularly those with sufficient liquidity, will now be able to offer potential partners not only technological and operational expertise, but also access to much-needed capital.

Planning for the upswing

For any arrangements made in the current downturn to be sustainable through the cycle, it is important that they are transparent, comply with the regulatory environment, and are seen as fair to all stakeholders involved at any point in the oil price cycle. This means that it is essential for IOCs partnering with NOCs to develop a thorough understanding of the stakeholder environment in which their partnering NOC operates and how this environment is likely to develop in the future.

In the long term, the overall structural issues surrounding location of reserves and achievable levels of production have not changed. When the global economy recovers, the same pressures evident earlier last year will resume. Any renewed appetite from NOCs for IOC participation, therefore, represents a great opportunity for the IOCs to work toward addressing their longer term access to reserves and replacement issues.

The views reflected in this article are the views of the author and do not necessarily reflect the views of the global Ernst & Young organization or its member firms.