Thursday, August 19, 2004

Yesterday’s Wall Street Journal carried a guest editorial by Riad Ajami, proposing that the time was right for grand alliances between the state oil companies of the OPEC countries, which own the bulk of the world’s crude oil reserves, and the Supermajors of the international energy industry, which have access to the world’s most important downstream markets and much of the infrastructure linking the two. He suggested a linkup between ExxonMobil and Saudi Aramco, as an example. This is not exactly a new idea. However, it suffers from a fatal flaw: alliances work best when the interests of the parties are well-aligned, and the interests of the majors and OPEC may be contrary, at least in the short term.

Oil producers worry most about their ability to access downstream markets when oil is seen as abundant, and prices are soft. In such a buyers’ market, refiners can be choosy and drive a hard bargain with suppliers, who need to dispose of their production somewhere, or see it shut in. In contrast, refiners and marketers worry most about access to oil when markets are tight and even lower quality oil—heavy or high in sulfur—commands premium prices. Then, they risk having their expensive facilities underutilized, at a point in the cycle at which maximum throughput and efficiency are key. But at that point suppliers have a host of buyers competing for their output. Thus, the appetite for producers to enter into this kind of arrangement peaks precisely when that of the refiner/marketers hits its nadir, and vice versa.

Another problem relates to the main engine of earnings for the international majors. Except in rare years, they earn the lion’s share of their profits from discovering and exploiting oil and gas reservoirs. They do best when they can capture part of the economic rent associated with the resource, and that implies the need to own it, or at least have attractive, long-term access to it. The refining and marketing parts of these companies have typically been regarded as either an economic hedge or a legacy means of disposing of crude, or in industry parlance, “making it go away.” So in their most important line of business, the majors act as customers, service providers, and even competitors to the state oil companies. This is not exactly complementary, in the way you’d want for a natural alliance.

There’s also some history here. The last time this idea was tried was in the late 1980s, when Texaco formed a downstream alliance with Saudi Aramco for its US refining and marketing assets east of the Mississippi River. The stated rationale was exactly as described by Mr. Ajami. An additional alliance and a merger later, Shell now sits in Texaco’s chair in this alliance, called Motiva Enterprises. Without speaking out of school, it should be instructive that in the nearly 20 years since this alliance was formed, the industry hasn’t rushed to copy it.

As I’ve suggested in previous blogs, I believe the real opportunity here is not matching resources to downstream markets, but rather matching the majors’ technology and capital to OPEC’s underexploited resources. That could result in alliances, too, but they might look a bit different than the proposed ExxonAramco. On the other hand, an OPEC country, flush with cash generated by sustained $45 oil, might find one of these companies an attractive acquisition target. That has also happened before.

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