What role for NOCs?

Alex Kemp, University of Aberdeen

May 1, 2016

In 1975, the UK’s national oil company (NOC), BNOC, was formed. It didn’t last long, while others are still going strong. Alex Kemp takes a look at the whys and wherefores of NOCs.

National oil companies have been in existence for many years, but their roles and indeed their very existence, have been, and continue to be, the subject of much controversy.

Their current importance is enormous. According to some estimates, collectively they control over 80% of the world’s remaining oil reserves. Several different motives explain their formation and continued existence.

In many cases, national ownership of a perceived valuable resource has been a main reason. A national oil company can reduce what is felt to be excessive reliance on foreign ownership and/or extraction of a key national resource (or treasure as it is described in some countries). National ownership in whole or in part is thus a device to reduce this dependence.

This should be distinguished from the motive of procuring state ownership as a manifestation of socialist principles. This thinking was prevalent in the UK in the second half of the 1970s, for example, when the notion that the state should have ownership of the “commanding heights of the economy” was promoted.

Fashions change. Only a few years later the view that the state should not be directly involved in the production of oil and gas was promoted, and the British National Oil Corp. was privatized.

In other cases the key motive has been to use a national oil company as an instrument of state control rather than for any socialist principle. This reflects a dirigisme view of the role of the state. Examples are in some Middle East countries.

A national oil company can also be an instrument whose main purpose is to collect an (equity) share of the associated revenues to the state. In other respects, the company may play a passive role. An example is Petoro in Norway, which is the custodian of the state’s direct financial interest. Such state participation in licenses and contracts is common.

Private sector companies obviously prefer to choose their own partners. Having a state company as a compulsory partner can sometimes increase the investor’s perceived political risk, but in other cases it can reduce these risks. Thus a state company partner may have insightful and helpful relationships with the host government.

But, preferential participation terms such as carried interest obligations can cause problems, particularly in circumstances (such as the present) where capital rationing is acute.

Thus, the expected returns to a private sector explorationist can be turned form positive to negative by carried interest terms where the state company is not a full risk-sharing investor, particularly where there is no reimbursement of the state company’s share of exploration costs.

Worldwide, the oil and gas sector requires regulation. In some countries the national oil company is given this duty (such as oversight of the performance of petroleum contracts) by the host government. The fact that the state oil company has expert knowledge of the industry is often cited as a reason for this. Unfortunately, when this duty is combined with that of acting as a conventional oil company, conflicts of interest can readily arise.

These can adversely affect working relationships with private sector partners who generally do not appreciate the situation where one organization in effect sits at both sides of a negotiating table. There is a clear virtue in the separation of regulatory and conventional oil company activities.

The duty of fostering security of oil or gas supply for the domestic market is sometimes bestowed on a national oil company. Where this involves the purchase of oil or gas at prices below the full market value conflicts with private sector partners can readily arise.

In sum, petroleum contracts are likely to be most successful when they can accommodate unambiguously the aspirations of both host governments and private sector investors. This is most readily achieved when the roles of national oil companies are clearly designed to prevent the emergence of conflicts of interest.

Alex Kemp
is professor of Petroleum Economics and director of Aberdeen Centre for Research in Energy Economics and Finance at the University of Aberdeen. He has published more than 200 papers on petroleum economics and was a specialist adviser to the UK House of Commons Select Committee on Energy in 1980-1992, and in 2004, and 2009. He was awarded the OBE in 2006, for services to the oil and gas industries and wrote The Official History of North Sea Oil and Gas, published in 2011.