Panel 2 Investment Flows

Panel 2 Investment Flows Gulf Oil Producers Investment Flows Valerie Marcel, Chatham House

Council on Foreign Relations WORKSH OP ON OIL A ND POLITICA L RE LA TIONSHIPS Thursday, January 19 Friday, January 20, 2012 Memo on Gulf Oil Producers Investment Flows Valérie Marcel Associate Fellow, Chatham House vmarcel@chathamhouse.org Do political calculations affect the Gulf producers and their NOCs international investments and inward investments in the oil and gas sector? Determining whether politics are driving investment decisions requires bringing to light the decision-making processes and respective prerogatives of government and NOC in various types of investment decisions. For inward investments: In most cases, inward investments in the oil and gas sector are in the decisionmaking realm of governments, more precisely in the hands of the oil ministry with consultation with the leadership and often with the NOC. In Iraq, license awards have been driven by the Minister of Oil. In Saudi Arabia, in the only instance of inward investment in the upstream petroleum sector - the Saudi Gas Initiative - Saudi Aramco was sidelined and the leadership took central stage in early discussions with the oil companies, eventually letting Saudi Aramco and the Ministry take over negotiations (now the Ministry handles licensing and regulation). Where NOCs are concessionaires for upstream licenses, they select investors, subject to approval by government or the governing council for the petroleum sector. This is the case in Abu Dhabi, Kuwait, and Iran. However, in all these countries, tables have been turned on the NOCs at times: in Abu Dhabi and Iran government has increasingly stepped in to select investors and in Kuwait the National Assembly has blocked investment plans. Iraq In Iraq licensing rounds for oil and gas have clearly favored consortiums with NOCs as prominent partners. In the first round 1 out of 3 licenses were awarded to a consortium with an NOC: BP with CNPC in Rumaila. The second round had NOCs involved in every license: Shell with Petronas, Petronas and Japex, CNPC with Total and Petronas, Gazprom with TPAO, Kogas and Petronas, Lukoil with Statoil, Sonangol for 2 fields and CNOOC with TPAO. The 2010 round for gas had a cast of NOCs again with Kogas with KMG, TPAO with Kuwait Energy (private) and Kogas, Kuwait Energy with TPAO. Several of the NOCs involved in Iraq probably should not have been pre-qualified (Sonangol is not equipped to operate Najma and Qayara; and several licenses of the gas round were won on what appear to be unrealistic cost

estimates indeed KMG pulled out of a license last May.) The dominance of NOCs as investors points to a probable informal criteria in the qualification phase (the federal government has a transparent bidding process). Presumably this was done to help counter criticism of former minister of oil Shahristani s early licensing rounds, as the NOCs national status and non-western base do not elicit the same degree of nationalistic response as the supermajors. Abu Dhabi In Abu Dhabi, historic concessions are up for renewal from 2014. There is much uncertainty about which partners will be renewed and whether the terms will be changed. ADNOC has historically been given a large degree of freedom to manage the foreign oil partners and the Supreme Petroleum Council (SPC) has usually approved plans and recommendations made by ADNOC. However, since Sheikh Zayed s death in 2004, the decision-making processes have been changing, with a growing role for the political advisors of the ruler and instances in which the SPC overruled the advice of ADNOC. The Shah gas field is a good example of the change: when Conoco Philips pulled out of its 30 year old concession for the sour gas field, the SPC decided ADNOC should develop it alone (in spite of very high risks related to the high percentage of hydrogen sulfide). The SPC then changed its mind and choose Occidental to develop the field, against the advice of ADNOC which recommended traditional partner Shell (which had lobbied ADNOC for years to obtain the contract). ADNOC was sidelined in this decision-making process. The decision was said to be based on cost. Many oil executives in Abu Dhabi worry that American companies hold increasing sway in the energy sector. In the instance of the renewal for the Upper Zakum oil field in 2006, competition between the traditional oil partners was intense. ExxonMobil won an undivided 28% stake, arguing that by operating alone it would commit its best technology to the field (normally operatorship is shared among partners). Rumors circulated that diplomatic pressure was also brought to bear from the White House. While the US is clearly a crucial ally for Abu Dhabi, it has also forged a strategic relationship in the energy sector with Japan. Amidst uncertainty about concession renewal, a Japanese consortium led by Cosmo Oil received the good news that its concession for 3 small fields (due to expire in 2012) would be renewed and the emirate said it would consider favorably Tokyo s request to renew JODCO s concessions too (MEES, 17 Jan 2011). To support the claims of the Japanese companies, state-run JBIC granted ADNOC a $3bn loan to support oil production. Parallel to this, Abu Dhabi s IPIC took a 20% stake in Cosmo Oil in 2007. ADNOC also signed an agreement with Tokyo to store crude in Japan and market it to its Asian customers. South Korea has also been forging strong political and economic ties with Abu Dhabi. A Korean-led consortium is building nuclear reactors in the emirate. Leaders of both countries agreed to develop closer energy ties, including a plan for Korea to build a storage facility for Abu Dhabi crude in Korea. Abu Dhabi has also offered KNOC 3 (unnamed) minor blocks. While South Korea hopes to be awarded more upstream opportunities, Korean companies do not have the necessary experience for the

emirate s mature or sour fields and there are factions in the ruling family that do not favor a Korean presence in the oil sector (MEES, 16 May 2011). European companies are not excluded by any means. They are negotiating and lobbying with other for renewals of their concessions. There are also indications that European companies that are not current concession holders are negotiating to develop oil and gas (including Wintershall from Germany). Iran It is well known that Tehran has sought investment from companies whose governments may offer diplomatic support or protection against further sanctions and a military campaign. Repsol, Shell and Total have left Iran (ENI, Petronas and Statoil are leaving as their contracts expire), but the Indian ONGC, Sinopec and Gazprom are investing in upstream gas. Future phases of South Pars will involve (aside from numerous Iranian companies) CNPC and PDVSA (Sonangol pulled out in February 2012). CNPC is also active in the oil sector, with the North Azadegan oil field which it took over from INPEX (which left following US pressure). Sinopec has a 2007 buyback contract for Yadavaran. China is a crucial source of support and trading partner. Before the last round of sanctions hit Iranian oil exports, 20% of its oil went to China, 17% to Japan, 16% to India and 10% to Italy. Recently, its dependence on China came into focus as it was forced to concede to further price discounts for its crude exports to China. Political drivers of inward investment decisions have markedly increased since President Ahmadinejad came to power. Successive purges of the technical professionals working at NIOC initiated by the President s office have also led to increased politicization of the NOC and the Ministry (these two organizations are to a large extent symbiotic). Even in normal times, NIOC and Ministry officials have difficulty understanding political objectives because of the complex political maze and multiple checks and balances in the system. More recently, understanding these political objectives has become a necessary (but not sufficient) condition of professional survival at NIOC. Kuwait Project Kuwait has languished for years as a result of parliamentary opposition to the plan to bring in foreign oil companies to develop the heavy oil of the Northern fields. In framing the terms of investment and pre-selecting investors, KPC and the Ministry of Oil have worked in unison. They have also worked constructively with the Supreme Petroleum Council (SPC). Unlike Saudi Aramco, KPC is a strong advocate of foreign investment. It favors the supermajors (and selected these for the technical service agreements signed between 1994-1997). However, members of parliament have consistently blocked the project. Interestingly, they do not oppose the terms of the license or the investors, but rather challenge the process for approving the contracts. Members of Parliament want a say on the management of the oil sector. Outward investments:

Overall the issues of how much oil and gas is produced and who buys it are a political matter. OPEC policy is the preserve of the ministers. But this extends also to the crude feedstock for the NOCs refineries abroad. KPC (through KPI) and Saudi Aramco respond to government requests to supply these refineries with national crude, even against economic rationale. Saudi Aramco has also maintained market share in markets of strategic importance to the Saudi government by offering a discount on crude oil. This has been the case in the US in the past. This resulted in a spread in prices between crude sold to American refiners and Asian refiners (the Asia premium). However, there are signs recently that Aramco is no longer instructed to maintain its share of the American market. There is a shift to Asia. It is visible in the gradual disappearance of the Asian premium, which shows the growing importance of China (and other Asian importers) both to Riyadh and to Saudi Aramco. International expansion strategies of national oil companies in the Persian Gulf tend to be commercially driven. Their rationale is in fact often to escape government scrutiny (for fiscal purposes mostly). Once this fact is revealed to governments, they reign in foreign investments (Kuwait after 1991). That said, there are cases where a political motivation superseded the business driver. The only national oil companies with significant international activities are Saudi Aramco and Kuwait Petroleum Corporation. They have engaged in forward integration (shipping, storage, refining, retail, limited trading, marketing). NIOC has an international trading company that is listed offshore, Naft Iran Trade Company (NICO), to trade its share of oil from the buyback contracts. It also has a stake in Venezuela s Orinoco through Petropars. Adnoc s international activities are broadly limited to chemicals, crude storage and marketing. Kuwait Petroleum Corporation KPC has been a pioneer in international investments, starting in the 1980s with the upstream subsidiary KUFPEC and the downstream subsidiary KPI (Q8) and a fleet of tankers. Acquisitions were rather reckless and largely unprofitable, but they were driven by commercial and strategic objectives (e.g., outlets for its sour crude, security of demand, transfer of skills, and profit making). The upstream investments abroad have always been a marginal part of the broader business strategy of the company. Target countries are primarily in the region and outside OPEC and are not the subject of intense political consideration. In its downstream investments, KPC has turned away from Europe towards Asia over the last 15 years. This strategic shift appears to be guided above all by the shift in its customer base eastward. Recent agreements with Sinopec show the two companies are cementing a strategic alliance on the back of a major refinery and petrochemical JV in China, which is to lead to increased state-to-state relations in the short-term and cross-investments (i.e., undisclosed investments in Kuwait s energy sector) longer term. Both of the latter fallouts from the deal indicate political discussions have taken place between capitals.

Saudi Aramco Saudi Aramco s international ventures have not been in the upstream. In the downstream, it has proceeded more cautiously than KPC, primarily through JVs to reduce risk and gain experience. While initial forays abroad were in the US, the company is clearly looking more to Asia, with China as a strategic partner of growing importance. The commercial relationship between Chinese and Saudi NOCs is supported by diplomatic ties. While the selection of host countries for downstream investments is likely guided by a convergence of diplomatic and commercial (marketbased) interests, the choice of specific projects appears to follow investment methodologies common to international oil companies. Saudi Aramco in fact usually takes on oil majors as partners in the projects. Last November, Aramco CEO Khalid Falih made unusual comments indicating that unconventional oil and gas had tipped the balance and that the call on Saudi crude would not be as great. In what I would interpret as a warning to the royal family to rethink its policy of subsidizing domestic energy consumption, Falih indicated that Aramco s focus would shift away from oil to gas and the downstream in order to meet domestic energy demand growing at 8% annually. A few weeks later, Aramco was said to be competing for a 30% stake in Frach Tech International, a service company, and also in talks with the company to form a JV for fracking in the Middle East. Such investments are strategically driven; the company foresees the need to develop unconventional gas domestically to meet growing demand for energy and free crude for export and is acquiring the technology to do so. Iran and NIOC Pipeline projects of course seek to bring oil and gas to market, but there are also guided by political factors. Iran has sought to secure pipeline agreements to the UAE (which faltered primarily because of price disputes), to Pakistan and India (which faced diplomatic opposition and pricing disputes), to Europe (which, before the latest round of sanctions on Iran, imported about 19% of Iran s crude through other means), and to Syria (these plans are likely to fall apart without President Assad). Iran already has pipes to Turkey and Armenia. Investments by Petropars in Venezuela s Orinoco ultra-heavy oil JVs with PDVSA also indicate a strong political component in investment decisions. The Presidents of the two countries met in Caracas in 2007 and in Tehran in 2009, following which a number of bilateral agreements were signed, leading to cross investments in energy (PDVSA in Phase 12 South Pars, Venezuelan gasoline exports to Iran, Petropars to operate the Dobokubi Block) as well as other non energy areas. The two countries also coordinate on OPEC policy and blocked Saudi Arabia s attempt to raise volumes at the acrimonious June OPEC meeting.