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The Future of National Oil Companies

Copyright © 2021 Energy Intelligence Group
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State-owned energy companies dominate the global oil industry, controlling the vast majority of reserves and production. They are big business by any measure, but they also combine a strange mix of profits, politics and economics that tends to produce some unexpected outcomes. These companies have been created by governments in most cases to cure a market failure, but they often develop into organizations that operate beyond direct government controls, with their own distinct objectives. Over time, the state-owned energy company tends to set its own terms and performance criteria, reversing the control relationship with its government owners. These distinctive qualities of state-owned oil companies have created new problems of governance and control for the world’s economic and political systems. Given their dominance of the global oil and gas business, these companies pose important and unique challenges for climate policies going forward.

State-owned energy companies operate in a context as much political as economic. Even if they are companies that produce and sell in a market, they generally have their origins and their rationale in explicit political considerations. For their owners they also represent potential risks because any aspect of their operations may become politicized. Thus, for governments, there is an eternal dilemma between control through direct involvement and an arm's-length relationship. There is also the question of incentives and sanctions in order to make the state-owned energy companies move in a desirable direction. Complicating the picture further, in both oil-exporting and oil-importing countries they play a predominant role.

In oil-exporting countries, such as Iran, Mexico, Nigeria, Norway, Russia or Saudi Arabia, the national oil company is usually the largest company in the country. In oil-importing countries, such as France, Italy or Spain, the state-owned energy companies traditionally have had a privileged position as importers of fuels. Their success can further national economic development, whereas their failure can have dire financial repercussions for the whole country.

Since the early 1970s, state-owned energy companies show several industrial successes and many failures. Some of the failures, such as the bankruptcies of Indonesia’s Pertamina in 1962 and Mexico’s Pemex in 1982, strongly contributed to national financial crises. Therefore, they are politically important, contributing to the success or failure of their government-owners. This economic position gives them political influence and by extension they are usually the most influential advisers to the government agencies to which they are supposedly accountable.

More than their private counterparts, state-owned energy companies operate in a politicized environment, in the sense that they are often used by politicians for particular purposes. Their operations are linked with the political power play between different interests in their home countries. As important instruments for national policy, state-owned energy companies have a wide array of objectives that generally go beyond profits. It is an open question to what extent the instrumental and economic objectives are contradictory or complementary, but often the array of objectives complicates performance criteria and accountability. Ultimately, this range of objectives usually enhances managerial discretion and autonomy. Contradictory and diffuse objectives lead to political horse-trading. In practice, the national oil company ends up with a multitude of performance criteria, which effectively gives it freedom of choice and autonomy. The risk then becomes that managerial independence, preferential access to funds and a privileged market position, combine to allow state-owned energy companies to pursue objectives that are inconsistent with longer run public policy.

From an economic perspective state-owned energy companies usually are in a privileged position in their access to capital, profits and markets. If they are not in a monopoly position, they usually enjoy some privileges as government instruments and advisers. Normally governments use a lower discount rate than private companies, and they expect less of a return on capital, if any. At the same time, government-owners usually follow up their interests with less perseverance than do private investors.

State-owned petroleum companies are both political instruments and economic actors. Their relations with the government-owner and the market vary, but they all must balance a range of political objectives against narrower economic goals, handling both short-term commercial interests and longer-term political considerations.

Since state-owned energy companies are neither corporations nor government agencies, neither economic theory nor theories of government can fully explain their performance. State-owned companies are often incorrectly considered to be “normal” companies, operating on the model of private-sector companies. But governments handle their assets in ways that are fundamentally different from private investors, making state-owned energy companies inherently different from their private counterparts. Remarkably, some of the government-owned companies, such as Equinor in Norway and Petrobras in Brazil, emerge literally as states within the state, more powerful than any private company.

Contrary to private companies, national energy companies have been created as an instrument of public policy to accomplish tasks that market forces would not carry out. They have become strategic actors. They are neither part of the public administration nor do they operate on the same premises as private businesses. They have been established by governments, usually with public money and a political mandate for specified tasks, but they operate independently in competition with privately owned companies. They are managed by professionals with objectives and values distinct from the government, often with more in common with their private competitors. Their mandates often give them preferential treatment and dominant positions in their home markets, which are useful for expansion abroad. Usually, initial government funding is not followed up by financial performance targets. Return on capital invested is but one of several goals. For state-owned enterprises, a lower cost of capital provides strategic advantages such as longer time-horizons and lower return targets. Consequently, large state-owned enterprises make up independent entities, with their own interests and strategies, distinct from those of the government-owners, and with advantages over private competitors.

Climate Change

The politicization of climate-related issues is now increasingly driving government intervention, regulation and investment in all energy markets, from production to transportation, trading and consumption. Consequently, energy is becoming less subject to markets and more dependent on political bargaining. Competition involves not just simple economic criteria such as costs and prices but other factors such as environmental and social acceptability, which are much harder to define in economic terms, creating the potential for market failures. For example, so far the supply of renewable energy, especially electricity, is to a large extent subsidized through intracompany transfers, direct government grants, guaranteed prices and preferential market access.

In this context, national oil companies might seem to have an advantage with their inherent political bent. But governments need to be clear about the purposes of their policies and market interventions. For the sake of transparency and accountability, establishing separate companies for renewables is preferable. When oil companies, to improve their public image, finance renewable energy from their oil earnings, the risk is a distortion of the economics of the renewable energy business, For the oil companies, whether government-owned, like Equinor, or privately owned, like BP, such commitments add to the overall risk exposure. By contrast, China and Saudi Arabia have separate companies for renewables.

Demand prospects for oil and gas are uncertain. One view is that “peak oil demand” will occur worldwide in a few years’ time, making the oil industry redundant and giving governments reasons to divest. A contrary view is that regardless of inconvenience and climate risk, oil will remain competitive and in demand for a long time. In that case, worldwide oil consumption will continue to grow for some time, and, in the longer term, oil will retain economic and strategic importance. But in the future, this oil industry will increasingly be anchored in Asia, including Russia’s Siberia. The outlook is that the oil industry will become more global and less North American or West European. The question for the future is how the remaining predominantly state-owned oil companies will score on efficiency and competitiveness as well as on social and environmental accounts. Technical and managerial shortcomings would seem to make cooperation with better managed international oil companies desirable, but the terms of such cooperation are in doubt as well as their consistency with the changing business models of the international oil companies.

The dominance of government-owned oil companies is likely to expand, with their share of world oil and gas trade likely to rise. Consequently, non-economic factors will probably be even more important in conditioning oil investment and output decisions going forward. But national oil companies will also probably remain problematic and inconsistent stewards of government policy. Their lack of precise objectives will continue to complicate accountability and control, with government methods of control insufficient and actual controls often carried out by incompetent organizations.

Øystein Noreng is professor emeritus in Petroleum Economics and Management at BI Norwegian Business School in Oslo, Norway. This article draws upon his forthcoming book, “The Oil Business and the State: National Energy Companies and Government Ownership,” published by Routledge.

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