I love reading about the oil business in the press. You know, “Big Oil,” popularly portrayed as a monolithic behemoth run by fat American men that rule the world and screw consumers while gleefully counting their vast supplies of money? Well, that’s the Hollywood version of the world that defines what a typical American thinks. I have spent my entire adult life working in this industry, several years of it with “Big Oil,” and have never seen anything that even remotely resembles this cartoon ‒ except for the fat American man part, but that’s just me.
So, truth seekers, here is “Big Oil” from a puny insider American Producer of American Energy point of view. Be patient.
The REAL BIG International Oil Business
The Big Picture is that over 70% of the world’s reserves are produced by National Oil Companies (NOCs). These are companies with reserves and production that dwarf those of ExxonMobil or Shell, and with names you have probably never heard unless you are in the bidness. These are companies like PDVSA, Aramco, PetroBras, CNOOC, Gazprom, Yukos, and Pemex.
Some of these companies are owned by countries that enjoy membership in the Organization of the Petroleum Exporting Countries (OPEC), some by those that don’t. Of course, being “National Oil Companies,” i.e., those owned ostensibly by “the people,” but controlled by the “people’s representatives” who are generally either politicians or despots, profitability and sustainability aren’t necessarily the rule of the day. Whereas many are well run and have fantastically smart employees and management, others are so laughably inept they couldn’t run in any other way than as Wards of the State.
“The people” as shareholders have a very different ethic from “the people” as “owners” of something nebulous that they cannot sell or control. This leads the politicos to often view these NOCs as golden geese to provide noble things, like infrastructure and food, and sometimes less noble things, ranging from vote-buying as a “Friend of the Poor” from the more flamboyant or self-involved leaders, to the more mundane efforts of the less visionary leaders, like stuffing Swiss Bank Accounts to the bursting point with “the people’s” cash flow. Another popular practice is to use NOCs to “provide employment,” an especially enticing carrot to the command and control types, which, ironically, actually minimizes the value of labor. Unfortunately, these latter foci result in the long term squandering of the wealth provided by the oil in the ground… companies large in reserves but low in production or the capacity to produce in the future. If you don’t do the maintenance, the house eventually collapses. It is far more fun to buy handguns and candy than to fix your septic system.
Out of the Mouths of Babes
A quick example of the inverse reasoning of jobs before productivity… I was vacationing in Central America last year. An old man was sweeping the street with a stick with three twigs nailed to it. I suggested to my friend I was visiting, a Wharton grad and part-time resident of the picturesque village we were visiting, that a village investment in a whisk broom might provide much higher productivity.
“Oh, no, no,” replied my friend smilingly. “If he had a whisk broom, then the village couldn’t provide jobs for the other 8 old men it has hired to sweep streets.”
“But isn’t there a more productive use for them,” I asked?
“Welcome to the third world, amigo! Jobs are what is important, not what they produce with the jobs. This is what you get with that mindset… a country where people pay to become cops and villages provide toothbrushes to old men to clean the sidewalks,” he replied.
Wow. Paying people to do something, anything, as an end and not the means, without any thought to productivity. This is why the Soviet Union had the dubious distinction of selling a loaf of bread for less than the component cost of the grain. Value destruction all along the production chain. In the words of my environmentalist brethren, “This isn’t ‘sustainable.’”
In any case, it is these nation-owned companies that provide the vast bulk of the world’s hydrocarbons and together dictate the raw commodity price of oil.
“But, but … third worlders, those ‘live off the land’ victims of Western imperialism wouldn’t manipulate prices for economic gain … like, like … filthy business men, would they?” One might ask with quivering chin.
Holding the Purse Strings
Oil price manipulation isn’t a huge secret. There is a little cartel that was created to do just that. Its name is OPEC and its official publicly-stated mandate is to “Manipulate world oil prices.” Last I checked, none of the hated major oil companies were members. They were buyers of that oil.
Saudi Arabia, being the world’s supposed swing producer, meaning it can single handedly raise or drop the price of oil by merely by turning a valve (ok, maybe 3,000 valves) is even rumored to have hedged a significant portion of its production before it tanked oil prices in the early 1990′s. Ahhh, to make no-risk money in high price and low price environments! The sweet perquisite of being the swing producer.
Why would anyone in their right mind take a futures contract position opposite Saudi Arabia? Basically, because Saudi Arabians, not being stupid, supposedly made those contracts through hundreds of intermediaries with shadowy ownerships. In other words, no one knew they were betting against the bank!
So why would Saudi Arabia lower the price of oil? Well, as I just pointed out, they can do so with only minor revenue repercussion to themselves. In the early 1990′s, OPEC was watching its pricing power deteriorate due to significant North Sea production being brought online, and many OPEC members were cheating on their production quotas, as is their wont. Saudi Arabia, in addition to being the world’s swing producer, has by far the lowest lifting costs per barrel of oil. Production costs them maybe $0.25 per barrel compared to $10 per barrel or higher for the Western world (this does not count finding costs). Therefore, once their hedges were in place, they announced they would increase production by 2-4 million more barrels per day. The price dropped to $10 dollars per barrel, OPEC cheaters were chastised and financially hurt, worldwide capital projects for new oil came to a screeching halt because no one wanted to invest in money-losing capital projects, the bankers of the world were reminded once again of the risk endemic to oil investment, and Saudi Arabia was banking close to the old price per barrel of oil. The world was brought to heel once again and all was well again in the Kingdom of Heaven. Some analysts believe a reprise of this may be in the making ‒ the threat being Unconventional Hydrocarbons.
When Matt Simmons questioned Saudi reserves and deliverability in the early naughts (00′s), the Saudis responded by sending their Oil Minister and the head of Aramco to discretely meet with oil producers, bankers, and engineers to talk up their 300-year plus reserve life. I attended one of those meetings at the Dallas Petroleum Club, all the while choosing which fellow husky white man I was going to dive under to provide me with a human shield if some sort of Jihadist burst in given the minimal security. “Business card, please. Ok, yes, you are on the list.” Such was the mood in those paranoid days following 9/11.
There is huge political value in the Saudis preserving at least the illusion of swing producer status, whether they actually are or not. I mean, how satisfying to have the leaders of the free world bow to you on command? An interesting aside, the Texas Railroad Commission was the most powerful political entity on earth until 1973 because, up until then, it was regarded as the world’s Swing Producer based on its control of Texas production allowables. Remember those days? When we shut in portions of our production? Some are saying that Unconventional Liquids are today’s Swing Production. Interesting.
So, why would Saudi ever let the price get higher? Well, you can’t hedge forever. You want to maximize your cash flow, but you don’t want to let it get so high that alternatives are given much financial traction.
We Have Met BIG OIL and He is NOT Us
So when I think “Big Oil,” I think of a couple of Middle Eastern countries and one or two South American ones. Fat Not White Men, so to speak, with NOCs that are NOT necessarily run for a long-term, sustainable production regime, but for reasons that don’t necessarily engender confidence in future supply.
What I DON’T think about is ExxonMobil or Shell or the like. Maybe at the turn of the Century, and maybe as late as the early 1970′s, but for the last 40 to 50 years, these companies have been stripped via “nationalization” of the contractually-secured product of their investment and intellect, often without compensation, and nearly all without fair compensation, because armed robbery is perfectly legal once your assets are big enough and you are a government.
All of this reminds me of a couple of stories, one true and the other possibly true. The possibly true story was when Lee Raymond, then CEO of Exxon, was introduced to the head of the Soviet Oil and Gas Ministry. Raymond introduced himself as CEO of the “largest oil company on Earth.” His Soviet counterpart countered by introducing himself as “head of the largest oil company on Earth.”
The second story, absolutely true, was the rage expressed by the Saudi oil minister at an OPEC meeting after several Western European countries instituted gasoline taxes greater than the price of the raw commodity. “Britain and France make more off of a barrel of Saudi oil than we do,” he exclaimed. Given that fact, and the fact that, say, ExxonMobil pays twice as much in taxes, duties, and tarriffs than they have in profit, I would characterize Governments of all sorts as BIG OIL much more than ExxonMobil. How would you like to get taxed or “fee’d” at 90%, then get back 40% of that as some sort of deduction or credit, and have that 40% derided as “Corporate Welfare”? If you appreciate the irony of that sort of thing, welcome to the Oil Bidness!
What about you? What do you think when you hear the term “Big Oil”? Please leave your thoughts in the comments below.
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