By John Kemp
LONDON, Aug 9 (Reuters) - The balance of power between host countries and petroleum companies has shifted decisively as a result of the shale revolution and the push into deepwater oil and gas fields off the coast of Latin America and Africa.
The first decade of the 21st century was dominated by talk about increasing “resource nationalism” as governments demanded a greater share of the revenues from natural resources located on their territory.
But in the past three years, resource nationalism has disappeared from the agenda. Rather than trying to impose tougher terms on oil and gas companies, most countries are now competing to attract investment by offering reductions in royalties and lower tax rates.
Countries as diverse as the United Kingdom, Argentina, Ukraine and Poland want to attract explorers and developers to exploit shale deposits. And countries along the east and west coasts of Africa, as well as Latin America, are all vying to attract spending on offshore oil and gas discoveries.
Faced with so many competing opportunities, oil and gas companies are pushing for a better bargain.
“We are not an opportunity-constrained company, we are a capital-constrained company,” Shell Chief Executive Peter Voser told Reuters in an interview, a position he has stressed to investors several times over the course of this year.
The underlying message from Shell and other oil companies to resource owners is clear: if you want us to invest time, money and technology developing your resource rather than somewhere else, you must offer us competitive and attractive terms.
Under the traditional model in the oil and gas industry, producers paid semi-fixed fees in the form of royalty payments and bonuses to the resource owner, normally the government. In return they got to keep any residual revenue from selling the oil and paid taxes on the profits in the normal way.
By the late 1990s, however, that model had been replaced in most emerging markets by production-sharing arrangements and service contracts, under which the oil and gas company received a largely fixed fee for investment in exploration and development, and the host government kept the residual revenue.
Service companies such as Halliburton and Schlumberger were happy to work as contractors on fixed fees. But most international oil and gas majors such as Shell , BP, Total and Exxon Mobil resisted and continued to press for access to oil and gas as equity owners.
In the 1990s and through the 2000s as China boomed and the commodity super-cycle pushed prices for oil and other commodities to record highs, resource owners pushed for even tougher deals, and for the most part they were successful.
Resource owners such as Iraq insisted on service contracts with exceptionally tough terms, and the international oil companies eventually agreed, mostly to get a foot in the door and hope the terms could be renegotiated to something more favourable later.
Even countries such as the United Kingdom, which continued to offer traditional royalty-and-tax terms, hiked tax rates, in many cases retrospectively to capture the “windfall profits” from higher oil and gas prices.
By 2008 as commodity prices were peaking, governments appeared to have won. Whether oil was produced under a royalty-and-tax system or some form of production-sharing or service contract, host governments had succeeded in capturing most of the upside from oil and gas prices.
Oil and gas companies were left to accept defeat and whatever terms were offered to them.
Petroleum leases are complicated, but most of the seemingly arcane disputes boil to down to a simple question of who gets to keep the benefits from periods of high prices.
For the oil majors, exceptional profits produced from some fields during periods of high prices are needed to compensate for the enormous risks they undertake in exploration and production and making long-term capital investments. The extraordinary profits pay for all the wells that come up dry and for the poor returns in years of low prices.
For resource owners, however, exceptional profits can look like an unearned windfall, a gift of nature, which should be kept by the people of the host country.
It is mostly a matter of perspective. Resource owners evaluate profits on a well-by-well, field-by-field or at most country-wide level and usually at only one point in time.
Exploration and production companies evaluate profits on a portfolio basis across the whole set of their assets and over the entire price cycle.
So what to a resource owner appears to be unjustified windfall profits may appear to an operator to be merely a high-performing element in an average-performing portfolio.
The last three years have seen a remarkable shift. References to resource nationalism have declined markedly, and instead a race is on to offer better terms and attract investment.
The United Kingdom has eased taxes to reverse declining investment and production of offshore oil and gas and is offering generous terms for onshore shale exploration. Russia is seeking foreign technology and companies to help develop its Siberian and Arctic fields. Even hyper-nationalist Argentina is offering more generous pricing and taxation to attract investment in its giant Vaca Muerta shale formation.
In the late 1990s and 2000s, numerous oil companies were chasing a handful of new opportunities. Now thanks to the shale revolution as well as advances in offshore drilling, the set of potential investments has widened dramatically, outpacing the number of international companies pursuing them and the amount of capital available to be employed. The result is a noticeable shift in the balance of negotiating power.
Fiscal terms and resource nationalism tend to follow a fairly well defined cycle.
In the early phases of the development of a new oil field or province, host countries are keen to attract investment and offer attractive terms, especially if a field requires very large amounts of capital and complex technology to exploit.
Later once a province is more mature, the infrastructure is built and the technology problems have been solved, the bargaining position of operating companies weakens, and governments impose tougher terms as well as revising existing contracts.
Nationalism and fiscal terms tend to be stiffer when prices are high and rising and governments are confident they can capture future revenue windfalls. They fade when prices are low or falling and governments become anxious about the need to attract investment to maintain production and revenues.
Both shale and deepwater exploration have changed industry dynamics, although in different ways.
Shale is a low-cost, low risk and relatively straightforward technology, so it should favour resource owners. But it remains untested in most countries, needs a large number of new wells to be drilled, and the gas which is often produced needs expensive liquefaction facilities to make it transportable and realise the value.
Shale production has also lowered oil and gas prices and threatens to push them down further. Resource owners need to be able to offer favourable terms to attract investment in an environment where rising prices are no longer guaranteed.
By contrast, deepwater is a complex and enormously expensive technology that most host governments cannot hope to master on their own, leaving them dependent on the international majors if they want the resource developed at all.
Little wonder petroleum companies can now afford to be much more choosy in which projects they pursue and drive a far harder bargain with resource owners.