The_Global_Oil_Industry

The global oil industry is a very complex industry. It is one of the oldest in the world as well as one that affects tremendously all aspects of business. Oil is a precious energy source that fulfills 40% of the global energy needs. The products of oil companies revolutionized daily life and the way we do things. Upstream and downstream are two major sectors in the oil industry. In between, there is another sector namely the midstream. The midstream sector processes, stores, markets and transports commodities such as crude oil, natural gas liquids as ethane, propane and butane. . The upstream sector involves the processes of oil exploration and drilling. Over the years, because of technological advancement, oil producers have been able to access more deposits which resulted in an increase in reserves. The downstream sector involves refining, transporting and marketing of oil and oil products. At the production unit, it is processed and refined into different products that include gasoline, kerosene, residual fuel oil and asphalts. Summary of the Case The case presented an overview of the history of the Oil industry from its early beginnings to the late 1990’s. Oil was found initially in Pennsylvania in 1859 and it initiated the first oil boom, replacing whale oil as the main source of fuel. The first oil company was Standard Oil in Ohio in 1865. When it was broken up in 1911 by the Supreme Court, 10 separate oil companies were formed. In the early 1900s, Gulf came on stream, then Texaco, followed by Royal Dutch/Shell Group and later British Petroleum. The early demand for oil spurred from World War I as it was vital to the war effort for military power. During the period between that first War and the Second World War, oil fields were discovered in Venezuela, Iraq, Saudia Arabia, Kuwait and Bahrain. There were technological advancements in exploration, production and refining. From inception, there was political conflict between oil producing countries and oil consuming countries. Mexico which was a large producer had its oil companies nationalized in 1938. Then came the Cold War where control of oil was at the center of the struggle. During this period, there was also increase in demand for oil. But, it would not be filled by the five early oil companies, but there was the emergence of OPEC in 1960. OPEC consisted of twelve oil producing nations including Iran and Venezuela. The dominance of OPEC has resulted in historical fluctuations in oil prises, oil crisis where oil supply was curtailed, for example, the Iran-Iraq War in 1990 and contrasts in oil market stock valuations. Alliances and joint ventures among oil companies, refineries and pipelines were very popular. In the 1990s, as world oil production continue to increase exponentially, the oil companies involved into large oil conglomerates, dominating revenue earnings and profits, to become “petropreneurs”. Major changes in the Oil Industry The oil industry generates the largest amount of revenues compared to any other industry in the world. According to the Fortune 500 magazine (2009), three out of the top five most profitable companies were large oil conglomerates. At the top was Exxon-Mobil with revenues of over 440 million dollars, followed in third place by Chevron with over 260 million dollars and in fourth by Conocco Phillips with 230 million dollars. This trend has been consistent over the past 5 years. Five companies, Exxon-Mobil, Royal Dutch Shell, BP, Chevron, and ConocoPhillips had revenues increased by 51% from 2003 to 2007, whilst net income increased by 85%. Net income came from upstream activities, downstream, chemicals and “non-oil” products (Lazzari, 2008). This has been driven primarily by the fact that there is an increase in the amount of persons worldwide who demand energy. The world's oil consumers, joined today by an increasingly oil-hungry India and China, purchase 80 million barrels a day (Koppel, 2006). The Organization of Petroleum-Exporting Countries (OPEC) has been one of the primary influences in oil prices. In the past, their influence has fuelled oil price hikes including one in 2000 across Europe. However, their influence has diminished because member countries control a much less significant share of the world's total oil supplies than they had in the past. Instead, non-OPEC countries such as Russia, Norway and Mexico have expanded up production capacity as well as new flows of oil fields have been discovered in Africa and South America (BBC Report, 2002). While OPEC still controls more than half of the world's crude oil exports, only three of their members are among the top 10 oil production areas. Hence, it was no surprise when oil prices fell in 2001 although OPEC had taken measures to avoid such a situation. This is important to note because since its inception in 1960, OPEC has the bargaining power in its hands. Although the oil industry is highly profitable, this does not signify it is without difficulties. The most significant threat to the industry is the depletion of resources since oil is a non- renewable resource. Oil fields have a natural lifecycle. When they are discovered, oil is pumped out of them, and they reach the end of their lifecycle. Giant fields, like Ghawar in Saudia Arabia and Cantarell in Mexico have gone into sharp decline or are being kept at their current levels through extreme, unsustainable rescue efforts. The current estimate is that for every four barrels used only one barrel is discovered. Thus, there is the creation of oil vulnerability (Hopkins, 2009). The major cause of depletion is the increasing utilization of oil as a source of energy by large countries such as the United States and China. The United States, with only 5% of the world population and 2% of proven oil reserves, consumes 26% of total world oil (Reda, 2008). China is an emerging market and already imports two thirds of its oil from the Middle East. This puts a strain on the oil reserves in oil producing areas such as the Middle East. According to William Hutton (2006), the proportion of oil supplied from the Middle East will rise from around two-thirds today to more than 80 per cent by 2020. However, depletion is no simple issue. Depletion of oil reserves can threaten national security for countries dependent upon petroleum. For instance, American military power is totally dependent on petroleum. According to Professor Michael Cox (2008), the average American soldier in Iraq consumes 16 gallons of oil per day. Moreover, it can change military power and control because without the presence and dominance of oil, the United States would be unable to fight simultaneously wars in Iraq and Afghanistan. Hence, oil is essential for the military might of the U.S. These wars have created a greater need to find new oil fields and to control areas of peak oil production such as the Middle East. This is the justification for the military intervention of Iraq in 2002 by the United States. Saddam Hussein was removed from power in order for the U.S to secure their supply of oil under their terms. In fact, such a policy is embedded in the Carter Doctrine from 1890, “any attempt by a hostile power to threaten the flow of oil from the Persian Gulf will be viewed as an assault on the vital interests of the United States of America and, as such, will be repelled by any means necessary including military force”(Koppel, 2006). Also, the world oil supplies would have been totally in the hands of Islamic fundamentalists, Shia in Iraq and Iran and Wahhabis in Saudi Arabia. The Americans believe that terrorists from places in the Middle East (Osama Bin Laden in Afghanistan) were responsible for the World Trade Center bombings in 2001 which threatened national security. It has sparked a war on terrorism drive by the United States to protect their country and “interests” which have included military intervention in Iraq and Afghanistan. The outcome was a “safer” America and greater control of the long term petroleum supply sources but with increasing political instabilities from groups within the country. Hence, oil output from Iraq, which account for the fourth largest reserves on the world has remained problematic. Failure to bring about security, economic progress and political stability in Iraq will have a direct impact on near-term oil production and exports and prevent Iraq from reaching its technical potential for many years to come. Thus, the oil industry has engendered geopolitics. Oil is significantly impacting world politics. There is a struggle between the United States and China over the control of oil supply. Both are heavily dependent upon oil, and they both each want to control the oil producing regions. This is the biggest geopolitical threats in the oil industry since the Cold War between the United States and the Soviet Union. This fight is under the competitive arms diplomacy in which there is the utilization of military assistance, intelligence sharing, and military training to gain geopolitical advantage in areas of interest to both the United States and China in Africa, the Middle East and Central Asia (Reda, 2008). In the last few years, both the United States and China have substantially enlarged their supply of all forms of military aid and arms in a competitive struggle to win the loyalty of important oil-producing countries in those areas. In Africa, for instance, which is the fastest growing source of new oil for both the United States and China; the United States has increased its arms deliveries to Nigeria, Angola, and Kenya. On the other hand, China has increased its arms deliveries to Sudan in places like Darfur and in southern Sudan to crush rebel forces, Algeria, and Zimbabwe. China is also making its presence known in Nigeria and Angola. Another new area for sourcing oil is the Caspian Sea and Central Asia. The Caspian Sea is situated along the line of the largest series of existing oil and gas reserves extending from the Caucasus to the Middle East. Furthermore, the existence of additional oil fields in other Central Asian countries such as Uzbekistan, Tajikistan and Kyrgyzstan are part of the new oil emirates in terms of potential wealth in the 21st century. Due to this, both the U.S and China are intensely competing for dominance by providing arms, technical assistance and training to the Central Asian Republics of Kazakhstan, Kyrgyzstan, Uzbekistan, Tajikistan and Republic of Georgia (Reda, 2008). Furthermore in 2005, U.S. Congress blocked the takeover of energy company Unocal (United Oil Corporation of California) by one of China's two state-owned oil companies (CNOOC) who bided $18.5 million (Cox, 2008). The main reason for the rejection of the deal was that some oil reserves would have passed from US ownership to the Chinese Communist party. This has augmented the level of competitiveness between the two nations for oil control. But not only is the struggle over the control of oil fields, there is also conflict over access to the oil reserves through pipelines. The pipelines needed to transport the oil are mainly under the control of Russia in the Caspian region and Central Asia. Hence, the pipelines are not owned by the oil companies, but by countries, thus is subject to geopolitical controversy by nations about which country has the control of the pipelines. In fact, China is now funding the construction of new pipelines in oil-rich areas as a means of curtailing the supremacy of Russia. For example, China has begun to invest heavily on the construction of onshore oil and gas import channels transiting through Kazakhstan, Turkmenistan and Uzbekistan (Reda, 2008). Originally, the only access to their oil was through pipelines under Russian influence. On the other hand, the United States is also busy trying to acquire its own pipeline routes to the Caspian region through its alliances with Turkey and Israel. The Ceyhan-Tblisi-Baku (BTC) oil pipeline is funded by the U.S and is projected to bypass the Russian pipeline routes to transport oil from the Caspian area to the Eastern Mediterranean. However, one of the biggest problems for the United States is Iran whose geographic location overlaps into the Caspian region. Iran is a political ally of Russia, and together they want to ensure that the United States obtains no access to Caspian oil. Therefore, the oil industry lack of control over the pipelines independently of politics is a potentially serious threat to the supply of oil. Other conflicts which have affected the oil industry include corruption and nationalization in Venezuela while in Nigeria there has been civil unrest. Additionally, Saudi Arabia is the most important oil producer and exporter in the world. It is the only country with significant spare capacity, which has saved world oil markets from steeper price spikes during the Iraq-Iran war, the Gulf War and again recently during the war on Iraq. However, demographic trends, inability to diversify the economy away from the capital-intensive petroleum industry, declining per capita income, rising unemployment among Saudis, an educational system which has failed the private sector, lack of popular participation in government all point in the direction of rising tension within Saudi society (Vidal, 2005). While Islamic radicals have turned against both expatriates and Saudi officials, it is not impossible to exclude the possibility that petroleum infrastructure could become a target in the future. SWOT Analysis Strengths 1. The oil industry generates the largest amount of revenues compared to any other industry. 2. Most of the oil global companies in upstream and downstream activities have vertically integrated operations. The level of vertical integration of the larger companies gives them a big advantage over other small companies. This enables oil majors to exert monopoly power. Also large income is generated through taxation including tax subsidies, primarily for upstream activities such as exploration and development, and extraction and production. 3. Alliances play a very important role in the industry. The majority of oil, gas fields and pipelines are handled through joint ventures. Certainly, the fact those joint ventures which are used as a mechanism to rationalize downstream activities will assist in cost cutting measures. The big exploration projects collaborate because of the huge capital requirements and the need to spread the risk among many partners. Thus, alliances are the best solution. 4. The oil industry provides a large number of jobs through both upstream and downstream activities. For example, the U.S. oil and natural gas industry supports millions of jobs throughout the economy, directly employing more than 2.1 million people. The industry supports a grand total of 9.2 million jobs. (AP1, 2009) 5. Technological improvements enable further oil exploration and production. The industry has invested in the development of more environmental friendly equipment such as safety valves on drilling equipment to make them more resilient. There has been upgrading and expansion done on refineries. 6. Crude oil accounts for the manufacture of other products such as chemicals, plastics, petrochemicals, lubricants, jet fuels and fuel oil. 7. The emergence of oil as a major source of energy has contributed tremendously to economic prosperity of oil-rich nations in the Middle East and other countries. The taxes paid by this industry go back into the economy for social development and further capital investment. In addition, for oil consuming nations, it has improved the quality of life for persons in many developing countries and has been responsible for economic growth in emerging markets such as China and India. Weaknesses 1. Oil exploration results in destruction of the natural environment during the drilling and transportation processes. Oil spills are examples of disasters which not only wastes oil, but also devastate areas through water and land pollution. For instance, the continual movement of fleets of large ships carrying up to 2 million barrels of oil across the world's oceans to refining destinations along U.S. coastlines is extremely dangerous. The 456,000 gallons of oil that was spilled in Port Arthur came from Mexico (Larrabee, 2010). Oil spills also endanger wildlife. Drilling activities attract birds to the oil rigs which can be harmful. 2. The process of oil extraction if not properly managed can result in a large portion of oil being left in the ground, and this cannot be recovered. Thus, resources are wasted at a high cost to the oil companies and the environment. 3. The technique of flaring and burning gas from oil extracting sites is considered to be environmentally unfriendly. 4. The cost of exploration is high and having to search for replacing supplies as a result is costly. For instance, exploring a deepwater well can cost up to $100 million and there is only a 30-50 % chance of oil being found (Mouawad, 2009).Thus, exploration is also risky. 5. Constant inflations in the price of oil continue to have a negative impact on the pockets of oil consumers. In addition, there is no sign of that issue being resolved in the future. For example, in June 2008, the market price reached a high of $147 per barrel which is vastly different from the price of $30.75 per barrel in 2003 (API, 2009, refer to graph).The Industry Taskforce for Peak Oil and Energy Security warns that demand for oil could outstrip supply as early as 2015 which would make oil prices higher and even more volatile. 6. Variations in the ownership of oil in the world. In places like Venezuela, the oil industry is nationalized whereas large multinationals such as British Petroleum, Shell, Chevron and Exxon are private companies. Thus for oil consuming countries, depending on whether private or state run, oil negotiations differ. With private oil companies, negotiations are direct. However with nationalized oil companies, there is heavy government intervention which compromises the deal. Hence, ownership of oil is not standardized globally. In other instances, some countries want to lay claim to other nations such as the British wants to claim the Falkland Islands which have new reserves of oil. 7. The majority of the oil fields are located in politically volatile areas such as the Middle East and Africa. Thus, political conflicts can disrupt oil supply to the world. This is major because many industries would be adversely affected. It would mimic the situation in 1990 with the Iraqi invasion of Kuwait resulting in the interruption of the supply of oil to consuming nations. Opportunities 1. There is the potential for industry diversification through an increase in non-conventional petroleum supplies, Canadian tar sands, Venezuelan extra heavy oil, and a certain amount of liquids from corn, ethanol and other alternatives. For instance, the Canadian oil sands located in Alberta produces a maximum of one billion and provided 13% of Canada’s needs for petroleum. A new process to pump oil can further open up 80% of the remaining oil sand deposits below the surface. (Stier, 2010). 2. New technology discovered such as “cable free land acquisition” uses radio transmission and can lessen the cost of seismic collection on land. 3. The discovery of new oil fields can increase the supply of oil to meet world demand. New oil fields have been discovered in Northern Iraq in the Kurdistan region holding two billion barrels of oil, Australia, Israel, Norway, Russia and Ghana. British petroleum has found a region in the Gulf of Mexico known as the Tiber Field which holds 4-6 billion barrels of oil and gas (Mouawad, 2009). 4. Oil producing nations are increasing their capacity to produce more oil such as Saudi Arabia. The country has invested in a $100 billion programme to strengthen its production capacity from 9 million barrels per day to 12.5 million barrels per day (Mouawad, 2009). Threats 1. There is a sharp decline in output of current oil fields. 2. The supply of oil is depleting at an increasing rate. The Middle East has the largest supply of oil whereas the United States is the largest consumer of oil followed closely by China and India. 3. Globalization has affected the oil industry and causes a new challenge to arise. The suddenly expanding new markets in countries meeting current and future global demands have become a greater test. In recent times, the surfacing of instant communication and on time supply chains have allowed inhabitants of developing nations to raise their standard of living and their expectations for the future. As a result demands are on the providers to increase energy sources needed to fuel this growth. 4. OPEC consists of Arab oil producers plus Iran and Venezuela. Their main objective was to unify and coordinate the petroleum policies of the twelve major oil producing and exporting countries. OPEC sets production quotas for each of its member states and as a result it was able to regulate the supply of oil which ultimately led to the manipulation of the global oil price. Although their control is not as strong as in the past, they still have some power over oil prices. 5. Geopolitical conflicts over new oil reserves found in the Caspian region and Central Asia. 6. Pipelines are independently owned by the oil companies, but are under the dominance of mostly Russia in major oil producing areas. 7. The rise in the call for environmental protection by environmental activists due to global warming has severely impacted the image of the oil industry. According to the world Economic Forum, automotive transport fueled by gasoline accounts for 8% of CO2 emissions. Additionally, Rob Hopkins (2009) purports that one car produces 4 tonnes of CO2 per year. Hence, there is an urgent call for energy sources which are more eco-friendly, helping to reduce global warming and its effects on climate change. This has fueled many debates and given rise to proposals for sustainable sources of energy using alternatives. 8. The search for alternative sources of energy as a substitute to oil has become rampant over the past five years. It has been mainly due to increase in environmental awareness so that there is a drive towards eco-friendly products. Additionally, there is a great need for cost efficiency as a means out of the economic recession and one of the ways to do so is to replace oil with cheaper alternative sources of energy such as wind, solar, water and electrical power. Actually, it has become more than a suggestion, there are already initiatives being undertaken which can replace petroleum as the source of energy for cars. A perfect example is the project led by Shai Agassi to mass produce electric cars operated using lithium polymer batteries, rechargeable utilizing an electrical plug. The first site of production is in Israel through collaboration with Renault-Nissan to develop cars starting in 2011 at a cost of $1 billion. The cars would have an electric range of 20 to 40 miles before they need to be energized. The major attraction to these cars is that they would be cheaper than petroleum fueled cars. For instance, the projection is that a 12,000 power battery pack would be able to run over 250, 000 miles using renewable sources at a cost of 7 cents per mile. Secondly, there would be a reduction of CO2 emissions by 50%, thus they would be more eco-friendly. Shai Agassi says he aims to set an example for the rest of the world to replace gasoline transmission cars with electric cars by 2020. He has already gotten places like Denmark, France and Australia to accept his model and in the near future begin production. (Agassi, 2009) 9. There is a prediction of a tremendous increase in the demand for energy. According to the US Department of Energy, world energy consumption is expected to rise by 57% between now and 2030. This would put an unprecedented amount of pressure on the current oil reserves, thus creating anxiety about a possible energy crisis. It would severely hamper transportation especially in the United States where the entire transportation infrastructure runs on petroleum. According to the World Economic Forum, worldwide automotive transport is 99% dependent on petrol. When indirect industries such as tourism, manufacturing and mechanized agriculture are taken into consideration, this poses a huge problem identical to a catastrophe. 10. Depletion of oil reserves can threaten national security for countries dependent upon petroleum such as the United States. Recommendations From all indications there will be a need for more sources of energy in the next 10 years. The current situation of the oil industry is unable to provide the necessary energy unless certain actions are adopted. These include the discovery of more oil fields, more cost efficiency in oil production, reduced carbon emissions and less geopolitics over oil. Because of the high uncertainty of these changes, it is imperative that alternatives to oil be seriously sought as sustainable sources of energy. In light of this reality, the future would see the oil industry being threatened by better sources of energy. Based on the Copenhagen Summit Agreement 2009, there is a rapid movement and adoption of green growth as an essential part of the economic climate globally. Therefore, by the next ten years, oil would have to compete aggressively with electric and hydrogen cars along with ultra light hybrid cars which utilize carbon composite crush instead of steel, which saves more fuel. The model used by Shai Agassi for electric cars would be duplicated by most major players in the automotive industry to replace gasoline fuel cars by 2020. In fact, more consumers would be demanding cars which are powered by other sources of energy besides oil for several reasons. Electric cars are a viable solution to gasoline fueled vehicles. They are more affordable, convenient, eco-friendly and cost efficient for the industry. Firstly, Shai Agassi estimates that the price of electric miles would be 2 cents per mile by 2020 which is a sharp contrast to the rising cost of oil currently at about $1.60 per gallon. Secondly, electric cars are powered by batteries which can be recharged at homes. Thirdly, they have zero CO2 emissions which mean a reduction in air pollution and a safer environment. Lastly, efficient mass production of these cars can reduce total costs to companies. Moreover, governments would be given incentives to consumers to buy hybrid cars. For example, Denmark has already decided to place a 180% tax on the purchase of gasoline fuelled cars whereas electric cars would have no taxes on them. In fact, based on the Copenhagen Summit Accord 2009, the European Union hopes to have renewable energy of 20% for all electricity generation by the year 2020. Therefore, the oil industry would have to: · Invest into research to drill oil using safer methods to avoid oil spills. · They can further explore to find new oil reserves. For example, they just recently discovered the Bakken Shale reserve which contains 4.3 billion barrels of oil. · There is a need to develop new technology using computer base models to help in the location of new oil reserves so that capital would not be wasted searching in areas which are not viable. · Encourage auto manufacturers of gasoline fuelled cars to generate ways to reduce carbon emissions to promote a clean environment. This too is in line with the Copenhagen Accord 2009 for low carbon economic plans. · Remove present tax subsidiaries until oil companies create a more efficient method to cut their carbon emissions. This will increase the cost of production for oil companies, thus they would have to innovate. Conclusion The oil industry is indeed very powerful and will continue to play a role in the supply of energy across the globe in the future. However, from all indications, its role will significantly decline from the early years. This is fuelled mostly by the large number of external threats and internal weaknesses as highlighted in the SWOT analysis. If it wants to continue to remain a dominant force, there must be a move towards generating more clean energy in accordance with the Copenhagen Agreement of 2009 which set the way forward for both developed and developing economies. Green growth is the future and the oil industry is being forced to adapt.