Remember the giant companies that once dominated the world oil market as the Seven Sisters? Of course, they have long since been expelled as owners from the Middle East to Mexico, and must now beg and barter for access to oil. The majority stake in world oil reserves that they held is now in the hands of nation-states. The result is a critically important anomaly: a vast global free market for oil, in which all the power players are nationalized, often highly inefficient state monopolies. One might call them the Seven (Or So) Sovereigns.
These new giants are far less controversial than the old ones. As oil prices continue to hover around record highs of $75 a barrel or more, the heated public discussion in the West still is focused on oil states and multinationals: Saudi Arabia and ExxonMobil, not Saudi Aramco. Yet, shielded from market forces, the state oil companies have a very clear impact on prices. In comparison with private companies like ExxonMobil, they pump a smaller share of their reserves, using less modern technology, with much more erratic management, and spend much less on finding new wells. All of this works to tighten supply, raise uncertainty and push up prices.
From the market viewpoint, the problem with state oil companies comes down to "inefficiency," says Jean-François Seznec, an oil expert at Columbia University. "The market fears that there will not be enough oil in the future, that production will decline because of these inefficiencies, and prices react."
From the largest (Aramco) to the smallest (the Libya National Oil Co.) the Seven Sovereigns face no shareholder pressure to maximize short-term profit and are husbanding their oil-pumping 4 percent of their proven reserves each year, half as much as the big multinationals. The stifling impact on supply is growing, as state oil companies are now often the winning bidders in the hunt for new reserves worldwide. Newly aggressive Russian and Chinese buyers are active from America to Africa, and even smaller state oil companies like Norway's Statoil are now regular players. As more reserves end up in the hands of state firms that are in no rush to deliver them to market, supply will be increasingly restrained.
The Seven Sovereigns are also increasingly reluctant to open up at home. This is true for all of them from Russia, which has been blunt about its intention to protect oil as a national strategic asset, to Saudi Arabia, which in 1998 had signaled (under Western pressure) plans to release Aramco's grip on oil and gas reserves. Instead, they played the major bidders off one another and "dragged their feet until the big boys were no longer interested," says Edward Chow, an oil consultant and former Chevron executive who has worked closely with Aramco.
Many big state oil companies are equally slow to adopt the latest technologies, designed to suck crude out of the cracks and folds of aging shafts. Those in Libya, Venezuela and Russia are badly in need of foreign help to rebuild dilapidated infrastructure and upgrade technology. The result is that while private companies typically recover 50 percent of the oil in a well, national companies recover only 20 percent.
"They had no reason to use advanced technology because they were blessed with such ample supplies," says Leonardo Maugeri, a senior vice president for the Italian energy company ENI.
For example, the second largest oil well in the Persian Gulf-Kuwait's Burgan-is plumbed by derricks that were first erected by the original Seven Sisters in the 1950s. Often state oil companies confront nationalist opposition to modernizing, particularly if it means more foreign influence. The Kuwait Petroleum Co. has for years been promoting a $7 billion, 25-year plan to nearly double its capacity but has met resistance from politicians who fear foreigners out to "steal" Kuwaiti oil. So many skilled oilmen have left Iran since the 1979 revolution that President Mahmoud Ahmadinejad was hard pressed to find even one clearly acceptable candidate to become Energy minister last year.
National oil companies are also far more opaque than private companies, adding to uncertainty about future supplies. Few divulge detailed accounts of the size of their oil reserves, as publicly traded companies are required to do by stock-market regulations. Even Saudi Aramco, widely regarded as the most transparent of state-owned oil firms, is not entirely forthcoming about the size of its wells, fueling speculation about the sustainability of the world's oil supplies.
Often the Seven Sovereigns are used as cash cows to bankroll social programs, not to reinvest in oil supply. Most state oil companies are obliged to send their revenue directly to the Finance Ministry. Venezuelan President Hugo Chávez, for example, is famous for using oil money to fund his socialist agenda, but the practice is now quite common, from Iran to Russia. With much of their revenue diverted to political ends, state oil companies spent about a third less on exploration in 2003 than the big multinationals did.
Consider Pemex of Mexico. The world's fourth largest oil and gas producer must transfer nearly two thirds of its $66 billion in yearly revenue to the government in royalties and taxes, supporting a third of the federal budget. Its total debt is four times that of ExxonMobil Corp., and output from its biggest oilfield will begin to taper off this year-by as much as 14 percent annually, according to some estimates. Fitch Ratings has warned that the company, threatened by debt and declining reserves, needs greater corporate autonomy and freedom to enter into joint ventures and partnerships globally.
"Pemex's job is to provide oil cheaply, not make money off it," says Manouchehr Takin, an analyst at the London-based Centre for Global Energy Studies. "It's more a civil-service organization. That's what happens when governments interfere beyond their regulatory responsibility."
Get used to it. In the global oil market, the state-for better or worse-is the guiding hand. And it's going to cost you.