A Reconceptualization of Asset Specificity in the Regionalization Literature

A RECONCEPTUALIZATION OF ASSET SPECIFICITY IN THE REGIONALIZATION LITERATURE

A PERSPECTIVE ON THE OIL MAJORS

Master Thesis

MSc. Business Administration – International Management University of Amsterdam Supervisor: Dr Johan Lindeque Second reader: Dr Michelle Westermann-Behaylo Student: Martin Poodt Student ID: 10663541 Date: 30 January 2015

Statement of originality

This document is written by Student Martin Poodt who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

Abstract

This study applies Williamson’s four dimensional typology of asset specificity as a theoretical framework for appraising the nature of inter-regional liability of foreignness of five leading oil majors as listed in the Fortune 500. The thesis begins by addressing how asset specificity is reflected in an unsophisticated and rather ad hoc operationalization of the construct in the regionalization literature. Following a review of the multifaceted nature of asset specificity from a mainstream strategy perspective, the role of asset specificity on the internationalization process of the oil majors is analyzed by using a qualitative multiple case study design. Site specificity and physical specificity appear to be the most pertinent dimensions of asset specificity in the sample of MNEs investigated. The two dimensions’ interaction with high institutional distance contexts resulted in a high degree of inter-regional liability of foreignness. Because of the high potential gain from expropriation of quasi- rents, opportunistic host-country actors used all available cost-effective means to seize that return. By implication, this directly affects the way the regional presence of these MNEs is measured.

Keywords: regionalization; transaction cost economics; asset specificity; oil and gas industry

Acknowledgements

First and foremost, I wish to thank my supervisor Johan Lindeque for his support and excellent guidance during the execution of this research. Our regular discussions, your positive attitude, and patience had been invaluable for completing my thesis. Also, I would like to express my gratitude to Michelle Westermann-Behaylo for taking the time to read my thesis. Last but not least, I would like to say the following words to my American friend Ryan Donovan: Gracias por tu apoyo, sos un gran amigo!

Table of contents 1. Introduction ...... 8 2. Literature review ...... 11 2.1 Regionalization debate ...... 11 2.2 A reconceptualization of asset specificity in the regionalization literature ...... 13 2.2.1 Conceptualization of asset specificity in the regionalization literature ...... 13 2.2.2 Conceptualization of asset specificity in the strategy literature ...... 16 2.3. Asset specificity and inter-and intra-regional liability of foreignness ...... 19 2.4 Disaggregated measure of asset specificity in the oil and gas industry ...... 23 3. Methodology ...... 26 3.1 Research Philosophy ...... 26 3.2 Qualitative multiple-case study design...... 26 3.3 Quality criteria ...... 27 3.4 Theoretical sampling strategy and case selection ...... 28 3.4.1 Cases and studies TCE asset specificity ...... 28 3.4.2 Case selection – the oil and gas industry ...... 30 3.5 Data collection ...... 31 3.6 Data analysis ...... 33 4. Results ...... 34 4.1 Within-case analysis ...... 34 4.1.1 Case study 1: Royal Dutch Shell...... 34 4.1.2 Case study 2: ConocoPhillips ...... 41 4.1.3 Case study 3: BP ...... 46 4.1.4 Case study 4: ENI ...... 51 4.1.5 Case study 5: Chevron ...... 55 4.2 Cross-case analysis ...... 58 5. Discussion...... 65 6. Conclusion ...... 69 6.1. Limitations and future research ...... 69 6.2. Implications ...... 70 7. References ...... 72

Index of Tables

Table 1: exemplary studies that acknowledge asset specificity in the regionalization literature ...... 14 Table 2: operationalization of the asset specificity construct ...... 18 Table 3: prior empirical work that draws on asset specificity ...... 29 Table 4: cases of indirect and direct expropriation of oil and gas assets...... 31 Table 5: sample and collection of newspaper articles ...... 32 Table 6: codebook ...... 33 Table 7: within-case analysis Royal Dutch Shell ...... 36 Table 8: impact appropriation quasi-rents on regional profile ...... 39 Table 9: within-case analysis ConocoPhillips ...... 42 Table 10: within-case analysis BP ...... 47 Table 11: within-case analysis ENI ...... 52 Table 12: within-case analysis Chevron...... 56 Table 13: cross-case analysis ...... 59 Table 14: incremental improve in the expropriation of quasi-rents ...... 62 Table 15: working propositions and their level of support ...... 66 Table 16: oil spend on R&D in 2013 ...... 67

Acronyms

CSA Country Specific Advantage

FSA Firm Specific Advantage

FDI Foreign Direct Investment

IOC International Oil Company

LoF Liability of Foreignness

MNE Multinational Enterprise

NOC National Oil Company

OFSC Oilfield Service Companies

PSA Production Sharing Agreement

TCE Transaction Cost Economics

1. Introduction

Transaction cost theory (Coase, 1937; Williamson, 1975, 1979, 1985, 1991, 1996) has received extensive attention from a variety of disciplines, but it holds a particularly central place in strategic management (Mayer, 2009). Williamson’s work in the 1970’s and 1980’s has been instrumental in the rise to prominence of this theory and provided a strong foundation for analyzing governance decisions resulting in hundreds of empirical papers in a wide variety of research streams (Macher and Richman, 2008). Williamson (1996) identified asset specificity as the main source of exchange hazards in transaction cost economics (TCE), where asset specificity refers to the degree to which one or both parties are tied to a transaction because the assets required for the transaction have less value in the second-best use. This key construct has recently emerged in regionalization theory as well and has been defined as “the substantial ‘linking’ or ‘melding’ investments in order to integrate a multinational enterprise’s (MNE) existing firm specific advantages and exogenous country specific advantages” (Rugman, 2005. P. 225), which is argued to differ between business units (Proff, 2002, Rugman and Verbeke, 2008; Kolk et al., 2013). In spite of the potential that lies in the cross-fertilization of this construct between the TCE and the regionalization framework, the concept of asset specificity – as originally intended by Williamson (1975) – does not travel well between these two theoretical perspectives. Despite the acknowledgement of the construct’s importance in the regionalization literature, it has been poorly developed. Asset specificity has been conceptualized in the form of additional, location-specific linking investment (e.g. the development of location-bound FSAs to complement non-location bound FSAs), implying that such transactions come at costs in comparison to conventional deployment of FSAs in locations where these location-specific linking investments are not necessary (Rugman, 2004). However, the original TCE notion of asset specificity should not play a role in the FSA transferability evaluation in the pre-investment period, but is expected to be most pertinent in explaining changes in regional presence after transaction parties contracted and investment has occurred. In the post-investment period the interaction of asset specificity with high institutional distance locations results in significant additional transaction cost to the MNE because their quasi- rents are appropriated. Therefore, this construct might not drive the initial perception of the potential for internationalization based on the degree to which existing FSAs are transferable, but where misappreciation does occur, asset specificity explains why MNE’s regional presence is reduced in the post investment period. Secondly, asset specificity framed in the regionalization theory has been treated as a clear and homogenous construct. Scholars in the strategy literature, however, have acknowledged the multidimensional property of asset specificity (Williamson, 1983; Malone et al.,

1987; Joskow, 1987) and identified four dimensions of asset specificity; site asset specificity, physical asset specificity, human asset specificity, and dedicated asset specificity. Williamson’s (1983) discussion of the four distinct types of relationship-specific investments is very helpful for identifying variations in the importance of asset specificity (Joskow, 1987). It is likely that by giving asset specificity in the regionalization literature this multi-dimensional property, it can provide greater explanatory power of the drivers of inter- and intra-regional liability of foreignness (LoF) in sectors featured by foreign direct investment (FDI) with high degrees of asset specificity. In other words, the use of asset specificity as a multidimensional construct potentially refines the regionalization literature’s arguments, especially in industries featured by a high degree of asset specificity. The relatively uncommon occurrence of truly global firms (Rugman and Verbeke, 2004), with a balanced distribution of their sales and asset across the extended triad of North America, Europe, and Asia, has been addressed in a variety of industries and (sub)sectors, by an increasing number of scholars (Filippaios and Rama, 2008; Gardner and McGowan, 2010; Grosse, 2005; Kolk and Margineantu, 2009; Oh and Rugman, 2006; Rugman and Collinson, 2004; Rugman and Girod, 2003; Rugman and Verbeke, 2008b). Most of these sectors do not exhibit characteristics that one would associate with the classic conceptualization of asset specificity. This thesis argues that the concept of asset specificity is at the forefront for companies operating in industries such as oil and gas extraction (Barham et al., 1998) and it should therefore play a much more pivotal role in regionalization theory than it does at present for such firms. The oil and gas production chain is characterized by high degree of investment specificity. Firstly, assets have a fixed location and cannot be moved; secondly, equipment is engineered for a specific project; thirdly, the infrastructure is constructed in order to connect a fixed set of participants (Mironova, 2013). Through drawing clear examples of TCE theory driven asset specificity, one can directly analyze how MNE’s regionalization is affected through this construct. There is reason to predict that internationalization strategies in these industries are influenced by the combinative effect between institutional factors and transaction cost economics dimensions (e.g. asset specificity) (Demirbag, et al., 2010), because formal and informal institutions that shape interactions, provide the structure in which transactions occur (North, 1990). Specifically, it can be argued that asset specificity enhances the effect of institutional distance because it causes MNEs to be concerned more about their specific assets. Facing high institutional distance, MNEs may be more likely to be exposed to local partners with a higher tendency of opportunism. In addition to the fundamental role of asset specificity, natural resource seeking firms are often constrained in selecting the most efficient location from a supply side perspective. The locus of available reserves dictates the location of capital intensive upstream projects, limiting the potential locations in which these MNEs can operate. Note, oil and gas reserves distribution is highly skewed as the Middle East’s oil accounts for 48,4% of total proved oil and gas

9 reserves (BP, 2013). The cumulative effect between institutional factors and asset specificity, and the unequal distribution of reserves are likely to be a strong underlying force driving the LoF. This thesis aims to contribute by answering the following question:

How does the institutional environment effect the internationalization of MNEs with firm specific advantages (FSAs) of differing types and degrees of asset specificity?

In exploring firm strategies and developing a theoretical representation of asset specificity within the regionalization literature, this study concentrates on a sample of the leading oil and gas firms (as listed in the 2013 Fortune Global 500) over the period 2009 to 2013. This sample consists of the firms that emerged out of the original seven sisters – Chevron of the US, Europe’s BP (UK), and Royal Dutch Shell (The Netherlands) – accompanied by two comparative newcomers to the ranks of international majors: ConocoPhillips (US) and ENI (Italy). The geographic dispersion of assets, sales, as well as proved developed and undeveloped reserves, are tracked from their annual reports over the period 2009 to 2013 for analyzing their international presence. To obtain further insights into the oil major’s strategies, Financial Times publications on the seven firms were scrutinized. The remainder of this paper is structured as follows. The literature review opens with the regionalization debate and a review of the existing conceptualization of asset specificity in this stream of research. This is followed by an examination of the occurrence of asset specificity in the stream of strategy research, employing earlier references by Williamson (1979). The subsequent section seeks to identify, discuss and integrate Williamson’s (1979) perspectives on the nature of asset specificity into more recent contributions to regionalization theory. Research propositions will also be developed by combining the TCE determinant and institutional theory. The research methodology will then be detailed in the following sections, as well. Chapter 4 presents the analysis and results of the research. In chapter 5, the study outcomes and their implications for academics and practitioners will be discussed. Ultimately, limitations of the study are presented and directions for future research are provided.

2. Literature review

The first section of this literature review discusses the regionalization versus globalization debate. Section 2.2 starts by analyzing the current conceptualization of asset specificity in the regionalization literature. Subsequently asset specificity will be discussed from a mainstream strategy perspective addressing the necessity to treat asset specificity as more than a composite construct. These sections seek to identify, discuss, and integrate perspectives on the nature of asset specificity into more recent contributions to regionalization theory. This will be done in section 2.3 by developing research propositions that combine asset specificity and institutional theory in the international context.

2.1 Regionalization debate

“As a global company that operates in more than 90 countries worldwide, Royal Dutch Shell is, by its nature, a diverse organization.”

– Peter Voser, Former CEO Royal Dutch Shell

Globalization is widely viewed as one of the dominant imperatives driving business strategy in the twenty-first century (Douglas et al., 2011). As markets become increasingly integrated, more firms from all parts of the world are expanding operations on a global scale (Gupta et al., 2008; Peng, 2009). Some have suggested that globalization has become so pervasive that multinational enterprises (MNEs) that do not think and act globally will be at a competitive disadvantage to firms that have global orientations (Levitt, 1983; Ohmae, 1989). By the mid-1980’s, a growing number of academics started to question the appropriateness of this view on ‘global strategy’, resulting in considerable scholarly attention on regional strategy as opposed to global strategy for MNEs (Birkinshaw et al., 1995; Morrison et al., 1991). Studies have shown that pressures for global integration are often misinterpreted and that competitors frequently adopt strategies that are either too global or not global enough (Douglas and Wind, 1987; Morrison, 1990; Yip, 1992). Hamel and Prahalad (1985) argued that the perspective on globalization of markets and global competition was incomplete and misleading. The integration responsiveness framework (Bartlett and Ghoshal 1989; Prahalad and Doz, 1987) identified the increase in pressures for global integration coupled with pressures for local responsiveness as key forces influencing the MNE’s organizational design. However, the debate on the tension between regional and global strategies did not gain its full momentum until the publication by Alan Rugman (2001) of ‘The End of Globalization’, where he

11 takes the position that global business is dominated by a relatively small number of MNEs, and the majority of operations for these MNEs occur regionally rather than globally. This assertion is based on the observation that a vast majority of MNE activities of a sample of the largest 500 global MNEs (i.e. by sales, assets, and employment) are concentrated in their home regions (Rugman & Verbeke 2004). In other words, the data clearly refutes the view that most MNEs undertake activities globally on a significant scale. The reason of this regional concentration is the economic significance of triadism (Li et al., 2010), where no complete economic integration can be observed, but, by shifting towards regionalization, the world is in a state of semi-globalization (Ghemawat, 2003). Regionalization is a firm-level manifestation of semi-globalization (Kolk, 2010). Countries within a region are argued to be more homogeneous in terms of institutions, culture, and economic development than countries in other regions (Rugman and Verbeke, 2005; Ghemawat, 2005). Regional strategy theory suggest that the LoF for intra-regional expansion appears to be much lower than the LoF for inter-regional expansion: the additional costs of doing business abroad are often much higher when moving into other regions of the world than when expanding intra-regionally, in the home triad region (Rugman & Verbeke, 2007). The regionalization literature here builds on Zaheer’s (1995) conceptualization of liability of foreignness defined as the differential costs arising from spatial distance, unfamiliarity with the host country environment, and home and host country restrictions. Following Rugman and Verbeke (2004), there is a growing body of work that seeks to understand how this regional orientation prevails in specific sectors, with sectors that have been studied including food and beverages (Filippaios and Rama, 2008), soft drinks (Gardner and McGowan, 2010), accounting services (Kolk and Margineantu, 2009), cosmetics (Oh and Rugman, 2006), automotive (Rugman and Collinson, 2004), retail (Rugman and Girod, 2003). Different industries tend to vary in terms of their internationalization motives due to differences of technological intensity, capital intensity, economies of scale, etc. (Shan & Song 1997; Sarkar et al., 1999). These motives create differences in the potential of value creation by adopting a specific international strategy (Li and Li, 2007). While scholars in the field of regionalization theory have showed the prevalence of regional focus of MNEs, they have not fully addressed the interaction of asset specificity and geographic scope choices. Interestingly, mainstream internalization theory, i.e., the TCE framework developed to address MNE expansion patterns, Buckley and Casson (1976), Rugman (1981) and Hennart (1982), has not fully addressed this issue either. Internalization theory does address MNEs entry mode choice, and acknowledges that the LoF is not necessarily identical in nature to every host country, but, to date, it has not fully incorporated geographic scope as a key determinant driving managerial decision making on internationalization (Rugman and Verbeke, 2005). The lacking criteria with conventional Williamsonian (Williamson, 1975, 1979, 1985, 1991,

1996) TCE reasoning is that it does not fully address the impact of geographic scope choices to solve the bounded rationality problems critical to MNE decision-making (Rugman and Verbeke, 2005). TCE and institutional theory adopted in regionalization theory to explain the degree of intra- and inter- regional LoF can be complementary to cope with internationalization strategy in providing a full-scale explanation of organizational behavior of firms operating in resource seeking sectors. Though, it can be argued that conventional drivers of contractual hazards are amplified by the presence of nation- state border and institutional differences (Rugman and Verbeke, 2005).

2.2 A reconceptualization of asset specificity in the regionalization literature

The task of understanding the impact of asset specificity on geographic scope options can be facilitated through an examination of the research into its dimensions. This section starts by analyzing the current conceptualization of asset specificity in the regionalization literature, in which it is used for explaining the degree to which FSAs are internationally transferable. Asset specificity will then be discussed from a mainstream strategy perspective (Williamson, 1979; Teece, 1988; Saussier, 1997). It is illustrated how the concept of asset specificity – as originally intended by Williamson (1975) – increases the hazards of opportunism, and how relationship performance responds differently to the different dimensions of asset specificity.

2.2.1 Conceptualization of asset specificity in the regionalization literature

Despite the centrality of asset specificity to the strategy literature, it is surprising that the concept of asset specificity has not received more attention in regionalization theory. It has only recently been the case that any regionalization studies highlighted asset specificity and those that did have failed to unravel these “linking” investments into its various elements or dimensions to explain intra- and inter-regional LoF. Table 1 summarizes regionalization studies that conceptualized asset specificity, underlining the limited empirical research into the topic. Rugman (2009) argues that the scope of geographic expansion is determined by the MNE’s ability to link its firm specific advantages (FSAs) with location specific advantages (CSAs) in host countries. He emphasizes that each MNE commands an idiosyncratic set of FSAs, which gives a firm a competitive advantage relative to other firms (Rugman, 1981). These FSAs arise when the MNE has developed special knowhow or a capability that is unavailable to others and cannot be duplicated by them, except in the long run at high costs (Rugman et al., 2011). Two types of FSAs can be

TABLE 1: Exemplary studies that acknowledge asset specificity in the regionalization literature Total Studies in Regionalization Literature with Asset Specificity as a Central Issue: 2

Exemplary Studies and their Approaches to Including Asset Specificity in the Regionalization Literature Article Definition

Rugman (2005: 13) A form of asset specificity: host regions require substantial “linking” or “melding”

investments.

Kolk, et al. (2013:1) Distinct regionalization patterns for business units and different firm-specific

advantages.

Li and Rugman Irreversibility of initial investment in a foreign market. Irreversibility may result from

(2007: 696) asset specificity that characterizes the MNE’s investments in a foreign country.

Rugman and Linked to human asset specificity (meaning here, the specific, cost increasing or Verbeke (2008:399) service-provision delaying requirements to satisfy potential purchasers in terms of

desired features of the individuals providing the service).

Arregle, Beamish, Each foreign location requires location-specific linking investments to meld existing and Hébert (2009: FSAs with CSAs (Rugman & Verbeke, 2005: 13), which creates asset specificity. 90)

Collinson and This guided the quality control and process improvement efforts that underpinned its Rugman (2008: FSAs in manufacturing relative to British Steel, tailoring innovation efforts towards 226) particular customers. Other studies have termed this "contingent knowledge" to refer to the context specificity of expertise, where familiarity with the idiosyncrasies of the

equipment, people, processes and client requirements helps in perform.

distinguished; non-location bound (NLB-FSAs) and location-bound ones (LB-FSAs) (Rugman and Verbeke, 1992). The former are defined as company strengths that can easily be transferred across locations at low cost and globally exploited, leading to benefits of scale, scope, or exploitation of national differences. The NLB-FSA can be used effectively in foreign operations with only limited need for adaptation. In contrast, LB FSAs (a resource-based expression of host country national responsiveness), reflects company strengths deployable and exploitable only in particular locations (or set of locations, such as a country or region), but cannot be profitably exploited outside of this area without significant adaptation (Rugman et al., 2011). Rugman (1980, 1981) notes that possessing FSAs is a necessary, but not a sufficient condition for FDI to take place. There are country factors, unique to the business in each country which can lead to country-specific advantages (CSAs). The CSAs can be based on natural resource endowments (minerals, energy, forests) or on the labor force, physical infrastructure, the innovatory system or educational facilities, and associated cultural factors, which may be unique to a country (Rugman, 2008). These CSAs are reflected in Dunning’s (1998) broadly adopted FDI motives; natural resource seeking, market seeking, efficiency seeking, and strategic asset seeking. A successful expansion does not follow from proprietary knowledge in R&D and marketing, but from a MNE’s ability to adapt successfully, the deployment of its existing FSAs to the specific circumstances of foreign markets (i.e. aligning FSAs and CSAs). Rugman (2005) gives a simple TCE

14 explanation to explain geographic expansion. He refers to the requirement of substantial “linking” or “melding” investments in host country regions, which he considers as a form of asset specificity, in order to integrate the MNEs’ existing FSA and exogenous CSAs. Rugman (2005) argues that such “linking” or “melding” investments are much lower in the home region than in host regions as a result of Ghemawat’s (2001) cultural, administrative, geographic, and economic distances. In other words, entry and exit barrier may be higher or lower, depending upon the adaptation investments required in the host environment and the potential for redeployability of the resources invested (Rugman and Verbeke, 2008). It is the extent of adaptation costs, taking into account the redeployability of the resulting additional knowledge in the relevant locations, which explains why most MNEs expand first in their host region, and may face severe constraints as their expansion leads to other regions (Rugman, 2004). The problem of the additional investments is multiplied by the fact that the MNE’s commitment of resources to meld its existing collection of FSAs with foreign location advantages (for example the presence of a large market) through crafting location-bound FSAs in foreign markets, is no way to ensure success for market induced geographic expansion (Rugman, 2004). The resource commitments made to entice budding foreign customers and to raise sales are fully one-sided. Rugman (2004) argues that this differs for example for resources-seeking or strategic asset-seeking FDI. Foreign locations may again need location-specific melding investments from the MNE, but whereby all relevant parties, such as foreign suppliers, themselves engage in reciprocal commitments to make these investments worthwhile. However, Vernon’s (1971) obsolescing bargain model might challenge this view. This model suggest that with time and increasing resource commitment into fixed assets, bargaining power shifts from the MNE into the host country government authorities. This leads to an obsolescing bargain that is likely to be renegotiated at the initiative of the host government (Vernon, 1971). Investments with a high degree of asset specificity weaken the stance of the foreign firm relative to the host country authorities and decrease the reciprocal commitments of related parties. More recently, scholars have argued that the firm’s redeployability of resources invested may differ along the value chain, establishing the importance of asset specificity in explaining degrees of MNE regionalization (Oh & Rugman, 2012). In general, manufacturing MNEs are able to decouple upstream and downstream activities, and to adapt those two activity types separately to host environment requirement (Rugman & Verbeke, 2008) and many of the regionalization studies reflect this argument (Proff, 2002, Kolk et al., 2013). R&D-based intangible assets seem to reflect a firm’s central capability of performing upstream activities (e.g., product development and manufacturing), while marketing-based intangible assets indicate the firm’s capability of managing downstream activities (e.g., branding, packaging, distribution) (Li, 2008). MNEs are often not capable

15 of effectively coping with LoF outside the home region at the downstream end of the value chain (Rugman and Verbeke, 2008a). While some MNEs have global spread of upstream activities, especially to take advantage of market imperfections in markets of raw materials and labor, the downstream end has a regional distribution (Rugman and Verbeke, 2008a). The above argument is consistent with Porter’s (1986) insight that downstream activities create competitive advantages that are largely country-specific: a firm’s reputation, brand name, and service network in a country grow largely out of a firm’s activities in that country and create entry/mobility barriers in that country alone. Competitive advantage in upstream and support activities often grows more out of the entire system of countries in which a firm competes than from its position in any one country (Porter, 1986).

2.2.2 Conceptualization of asset specificity in the strategy literature

Transaction cost economics (Coase, 1937; Williamson, 1975, 1979, 1985, 1991, 1996) has received extensive attention in strategic management for over the last three decades. Williamson’s work in the 1970s and 1980s has been instrumental in providing a strong foundation for analyzing governance decisions resulting in a significant number of empirical papers in a wide variety of disciplines (Macher and Richman, 2008). Williamson’s TCE theory relies on two main behavioral assumptions, namely bounded rationality and opportunism (Crook, 2005). First, TCE theory expects that economic actors are boundedly rational (Simon, 1945; Williamson, 1975), which means that the transacting parties cannot anticipate and specify all exchange contingencies before they surface. Second, TCE theory assumes that economic actors are opportunistic (Williamson, 1975), which means that transacting parties will seek advantages at each other’s expense (Crook, 2005). As a result, bounded rationality and the threat of opportunism create exchange hazards for transacting parties. Klein (1980) defines exchange hazards as situations wherein one party has the ability to take advantage of contractual agreements by capitalizing on unwritten or unenforceable parts of the contract (Klein, 1980). Exchange hazards give rise to adaptation problems. These problems refer to a firm’s inability to respond to disturbances in the environment. To protect against potential exchange hazards and adaptation problems, transacting parties can either form more complete agreements that protect each party’s long-term interests, which increase transaction costs, or hierarchical governance structure can be used (Crook, 2005). Williamson (1975, 1979) depicts three main transaction attributes: uncertainty, frequency, and asset specificity. The uncertainty determinant deals with an inability of a firm to predict future events (Williamson, 1985), and often depends on the unpredictability of environmental conditions of

16 the host country market (Hill and Kim, 1988). In volatile environments, external partners will have several opportunities to renegotiate to their advantage. Frequency refers to how often a transaction occurs (Williamson, 1981), and provides an incentive for firms to employ hierarchical governance, because ‘the costs of specialized governance structures will be easier to recover for a large transactions of a recurring kind’ (Williamson, 1985 p. 60). To date, frequency has only received limited attention in the TCE literature (Geyskens et al., 2006), therefore this thesis will not address this part of the TCE framework. Asset specificity refers to the degree of investment required or that is uniquely dedicated to support a transaction (Klein et al., 1978; Williamson, 1979). Asset specificity is of special interest for the purpose of this thesis. Attention will hereafter be focused on this attribute, uncertainty will be marginally discussed. When ‘the degree to which an asset can be redeployed to alternative uses and by alternative users without sacrifice of productive value’ (Williamson, 1996: 59) is limited, the MNE faces a risk of ex-post opportunistic recontracting from their partners in trade in the amount of the quasi-rents at stake (Murtha, 1991). Quasi-rent is the profit an investor in a specific asset expects for using the asset if he has to turn to the next best alternative. The potentially appropriable specialized portion of the quasi-rent is that amount, if any, in excess of its value to the second highest-valuing user (Klein et al., 1978). If the supplier's transaction-specific investments are high and those of his transacting partner are low, the opportunism risk is high because his partner may appropriate the supplier's quasi-rents under asymmetric dependency (Anderson and Weitz, 1992, Buvik and John, 2000). If asymmetric specific investments exist, the quasi-rents of the more dependent party create a hold-up situation for the less dependent, therefore transaction costs rise with transaction-specificity (e.g., Anderson, 1988). Scholars have acknowledged the multidimensional property of asset specificity (Williamson, 1983; Malone et al., 1987; Joskow, 1987) and in order to operationalize the analysis of asset specificity, four dimensions of asset specificity were identified, see table 2. Site specificity, pertains to the decision of the buyer and the seller to locate their operations within physical proximity of each other (Joskow, 1987). Previous studies suggest that site-specific investments can substantially reduce inventory and transportation costs and can lower the costs of coordinating activities (Dyer, 1996a), but once sited, the assets in place are highly immobile (Joskow, 1987). Physical asset specialization has been found to allow for product differentiation and may improve quality by increasing product integrity or fit (Clark & Fuji-moto, 1991). Human asset specificity pertains to transaction-specific know-how accumulated by transactions through long- standing relationships. Dedicated assets refer to general investment by the seller which is made with the expectation of a considerable amount of trade with one particular buyer. Should the relationship expire, excess capacity will result (Lamminmaki, 2005). Joskow (1987) acknowledges that these four categories point to essentially the same phenomenon, but the differentiation between dimensions

TABLE 2: Operationalization of the asset specificity construct

Type of asset specificity Definition (i) Site specificity The situation whereby successive production stages are located close to one another. Once in place, the assets involved are highly immobile and, thus, the cost of their relocation is very high (Joskow, 1987). (ii) Physical asset Physical asset specificity regards investments in equipment with low value specificity outside of the transaction relationship (Joskow, 1987). (iii) Human asset Investments in knowledge specific assets, which often arise through a learning- specificity by-doing process (Williamson 1996). These intangible assets are not easily transferable, owing to their limited application in other work settings (Lamminmaki 2005). (iv) Dedicated asset Large discrete investment made in expectation of continuing business. Should specificity this relationship end prematurely, excess capacity will, however, be created (Joskow, 1987). is highly valuable when it comes to empirical applications. According to TCE theory, these types of asset specificities give rise to a problem because of the of long-term contract specification. Hart (1988) and Sassier (1997) argue that a complete contract includes stipulations regarding every possible circumstance, and as such, these contracts will never (need to) be adjusted. For Williamson (1985, 1996) and Hart (1988), a contract is incomplete if it cannot anticipate all appropriate actions for all future events. Thus, incomplete contracts only define appropriate behaviors for a limited list of situations. For this reason, Williamson (1985, 1996) asserts that contracts must explain not only the devices ex ante but also the governance structure required to establish desired implementation of contracts ex post. In most transactions, incomplete contracts are sufficient to induce cooperation among individuals. In other words, for transactions with a low degree of asset specificity and a high transaction frequency, cooperation between economic agents can be restored easily (Quinn, 2010). For example, for an activity with a low degree of asset specificity in competitive market, if the supplier reduces ex post the quality of the product to increase its profit, the buyer can easily cancel the contract and switch to an alternative suppliers without incurring significant costs (Walker & Weber, 1984). Thus, when switching costs are low, the threat of competition can deter the supplier from attempting to hold up the MNE. However, in sectors featured by high transaction costs, the incompleteness of contracts impedes their functioning as a coordination mechanism (Nicita and Vatiero, 2009), and in this situation transaction costs are associated with the establishment of a new cooperative relationship. The greater the asset specificity and lower the frequency of relations means that actors will have larger difficulties in redefining a cooperative relationship. In such cases, coordination mechanisms should be crafted to induce the transacting parties to coordinate their

18 actions and will make noticeable effort to design an exchange relation that has good continuity properties (Williamson, 1981). Relating to asset specificity and external uncertainty, under the header of internalization theory (e.g. Buckley and Casson, 1976; Rugman, 1981; Hennart, 1982), these two transaction cost- based parameters have been dominant in explanations of MNEs’ selection of foreign market entry modes (Madhok, 1995). In volatile environments, external partners will have several opportunities to renegotiate to their advantage and therefore entrants are better off accepting low control entry modes to retain their flexibility (Anderson and Gatignon, 1986). Though low control provides MNEs flexibility, in the case of high specificity this has already been given up (Anderson and Gatignon, 1986; Teece, 1986). Since investments are specific to a transaction, firms are confronted by high exit barriers and lower flexibility due to switching cost (Spanjer, 2009) and they are thus confronted with a lock-in situation (Williamson, 1985). In case of renegotiation of an arrangement with a local (contractual) partner, a MNE can exert less influence because of this loss of flexibility. Johanson and Vahlne (1977) argue that firms start internationalizing using low-commitment entry modes, e.g. exporting, sales agents, and contractual agreements. Teece (1986) asserts that in the presence of specialized assets, firms tend to adopt high degree of integration and control, making equity entry modes more advantageous. Market expansion through equity modes advocate for internalization of foreign activities in order to have greater control over the use of high asset specific investments. While the TCE explanation for governance decisions has been widely investigated (e.g. Anderson and Schmittlein, 1984; Klein et al. 1990; Levy, 1985; Masten 1984; Monteverde and Teece 1982), the TCE’s implication for the performance of inter-firm relationships in the presence of asset- specific investments has only received limited attention (De Vita, 2010). As noted by De Vita et al. (2010), this is particularly striking because it is maybe even of greater importance to know what happens to those firms that do choose to enter market transactions under conditions of high asset specificity, especially when one considers that TCE theory posits that this relationship is ‘subject to costly haggling and maladaptiveness’ (Williamson, 1985, p. 89). The next section will address this relationship, and illustrates which impact asset specificity is expected to exert on MNEs internationalization by merging TCE and regionalization theory.

2.3 Asset specificity and inter-and intra-regional liability of foreignness

Countries vary in the level of their institutional development, which has consequences for different aspects of business activities (North, 1990). The institutional environment itself operates at two levels: an informal level - sanctions, taboos, customers, traditions, norms - and a formal level -

19 constitutions, laws, and property rights - (North, 1991). Regulatory distance, including the political environment or any other regulatory difference between two countries, captures the similarity or dissimilarity between the host and home countries in terms of rules, laws and regulations which can ensure the stability of a society, and almost becomes the foremost concern of a firm when entering a foreign market (Xu and Shenkar, 2002; Yiu and Makino, 2002). In presence of high institutional distance, a firm faces a greater level of LoF (Eden and Miller, 2004), a phenomenon referring to MNEs experiencing additional costs that are not experienced by local firms (Hymer, 1976), resulting from sources such as market ambiguity (Martinez & Dacin, 1999) and discrimination hazards (Kostova and Zaheer, 1999). Using the TCE interpretation, the presence of nation-state borders and institutional differences amplifies the threat of opportunism and bounded rationality constraints (Rugman, 2005; Henisz and Williamson, 1999). It is likely that asset specificity may strengthen the effect of LoF on internationalization strategies because the broader geographic scope choices create additional costs, in the sense that it increases MNEs' concerns about appropriation of quasi-rents through bounded rationality and opportunism. There will be more or less quasi-rents available to the local partner as a result of institutional distance which is driven by either opportunism through the presence of discriminatory LoF or bounded rationality through the presence of incidental LoF. The institutional environment influences the direct relationship between asset specificity and intra- and inter-regional LoF. The positive effect of contractual hazards created by asset specificity on MNEs inter-regional LoF is either magnified or reduced in the presence of high or low institutional distance respectively. Discriminatory LoF may strengthen the effect of asset specificity on internationalization strategies because it increases MNEs' concerns about local partners' opportunism. Discriminatory LoF comprises explicit regulations exclusively targeting MNE subsidiaries, in order to benefit indigenous firms and also includes costs due to implicit prejudices and nationalism (Sethi and Judge, 2009). Discriminatory LoF affects the MNEs’ relationships with host country stakeholders (the host country government, consumers, and other firms) (Eden, 2004), as discriminatory hazards might encourage a host country partner to become more opportunistic in its dealings with the multinational (Henisz and Williamson, 1999). Where quasi-rents are large, an opportunistic host-country actor will use all available cost-effective means to seize that return (Henisz and Williamson, 1999) and the result is often a costly ex-post process of haggling, renegotiating and bargaining between the parties (Williamson, 1985). A low level institutional distance implies a low probability of partners achieving a change in the current regulations and local partners will not find lobbying host-country political actors for a policy intervention that would alter the distribution of returns between the local partner and the MNE to have a positive expected value (Henisz and Williamson, 1999). In other words, the level of contractual hazard through asset specificity is not independent from the level of political

20 hazards, in reality the two hazards are closely intertwined (Gatignon and Anderson, 1988; Henisz and Williamson, 1999; Henisz, 2000). The host-country partner may opportunistically approach the government with a request to take actions that have the effect of favoring them at the expense of the MNE or the MNE may be affected directly by state-sector opportunism (Henisz and Williamson, 1999). In a less developed regulatory setting, legal protection and enforcement are fragile (Peng and Heath, 1996; Zhou and Poppo, 2010) and conflict resolutions still rely heavily on ties with governmental officers (Child, et al., 2003; Peng and Luo, 2000). Property rights of assets are more sensitive to regulatory distance because they are anchored in legal provisions, as property protection law (Xu and Shenkar, 2002). In host countries with high political hazards, one mechanism through which expropriations of quasi-rents may occur is through manipulation of the political system, which means that the MNE will participate more political gaming and more frequent appeals to arbitration or courts (Henisz, 2000). Whereas opportunistic use of the state are a general concern, they are a special concern in cross-national contracting and investment (Williamson and Henisz, 1999). Once the quasi-rents are appropriated, MNEs can do nothing to salvage the damage done since local partners may conspire with governmental officers (Luo, 2006). In these cases of opportunistic behavior the MNE faces added hazards relative to the host-country firm due to the differential access to the political process that arises from discriminatory LoF (Henisz and Williamson, 1999). MNEs seek credible commitments from governments in the form of regulations to uphold a stable environment that eliminates the costs of repeated bargaining, which is expected to be lower intra-regional than inter-regional since the political relations with the home government are generally much better than with host country governments (Baron, 1995). Incidental LoF may strengthen the effect of asset specificity on internationalization strategies because it results from MNE managers’ bounded rationality problems. Incidental LoF reflects a foreign MNE’s lack of host country knowledge or experience compared to domestic firms in the host country (Sethi and Judge, 2009). It contains non-discriminatory costs of learning and adaptation to cope with the unfamiliarity and lack of roots in the host-country environment. Following TCE argumentation, a broader geographic scope leads to additional costs, in the sense of more severe bounded rationality (Rugman, 2005). Distance creates challenges for an MNE, which must accustom itself to different subsidiary environments (Verbeke and Greidanus, 2009). The lack of reliable business information systems and established institutions to support business activities creates uncertainty in the sense that it limits the MNE’s ability to absorb, process, and purposefully act upon complex and often insufficient information (Khanna and Palepu, 1997; Verbeke, 2009; Verbeke and Kenworthy, 2008). In a less developed regulatory setting, MNEs lack sufficient support from market monitoring mechanisms (Boisot and Child, 1996; Keister, 2009). Incidental LoF leads to more

21 bounded rationality because the MNE can neither imagine all of the possible contingencies that should go into the contract nor articulate them.

Proposition 1: A high degree of asset specificity of FDI will result in greater inter-regional LoF in high institutional distance host country contexts for internationalizing MNEs.

In presence of contractual hazards caused by discriminatory and incidental liabilities, MNEs may design ownership with a lower level of control (Dacin, et al., 2007; Eden and Miller, 2004; Yiu and Makino, 2002). Though low control provides MNEs flexibility, in the case of high specificity this has already been given up (Teece, 1986). Teece (1986) asserts that in presence of specialized assets, firms tend to adopt high degree of integration and control, making equity entry modes more advantageous. Conceptually, the optimal decision given a high degree of asset specificity would therefore be internalization. However, the formal institutional environment in the host country might shape the contracting options available to the MNE. A wide body of empirical evidence support the proposition that, ceteris paribus, local partners will be more likely to receive a share of equity ownership in host countries with high political hazards (Aggarwal and Ramaswami, 1992; Brouthers, 1995; Gatignon and Anderson, 1988; Goodnow and Hansz, 1972; Kogut and Singh, 1988; Oxley, 1999; Philips-Patrick, 1991; Scholhammer and Nigh, 1984; Shane, 1992). Note that from the perspective of the MNE this involves a less hierarchical governance structure.

Proposition 2: A high degree of institutional distance will result in sub-optimal entry modes for the given degree of asset specificity.

LoF not only relates to additional costs that are not experienced by local firms, but it also reduces the usefulness of accumulated knowledge and hinders the transfer of managerial practices to the local subsidiaries (Brouthers, et al., 2008; Xu and Shenkar, 2002). The effectiveness of an international strategy is contingent upon the transferability of firm specific intangible assets developed through strong CSAs (e.g., Severn and Laurence, 1974; Kotabe et al., 2002; Li, 2003; Lu & Beamish, 2004). A major problem with deriving benefits from leveraging global firm-specific intangible assets is that certain intangible assets (e.g., experiential knowledge) are sticky and do not move easily across countries (Kogut & Zander, 1993; Szulanski, 1996; Rugman & Verbeke, 2001). Vernon (1971) used the product life cycle to explain the foreign activities of MNEs, taking into account the role of innovation and the diffusion of knowledge, arguing that the technology transfer through FDI will mainly take place where the products that the technologies are associated with are in mature stages of the product cycle. Today, Vernon’s (1971) analysis of stages in product

22 development, with relation to international expansion, might be interpreted as supporting the proposition that early innovation is better sustained by locating close to headquarters and home- country markets (Hedge & Hicks, 2005). In the case of the oil and gas industry, it is expected to find that the transferability of intangible FSAs is a less of a meaningful explanation for the relative degree of inter-regional LoF because of the sectors’ mature technology. It is more standardized, widely known and easily duplicated (Jones et al., 1978), and therefore expected to be more internationally transferable. However, when knowledge-based assets are explicit and therefore highly transferable, but significantly featured by asset specificity once the investment is made, MNEs may still face a high level of inter-regional LoF. Facing high institutional distance, MNEs may be more likely to be exposed to local partners with a higher tendency of opportunism to appropriate quasi-rent. The very nature of specialized knowledge makes it subject to maladaptation and opportunism, which in turn constitutes a risk for the owner (Hennart, 1988). The further importance of this dynamic by type of asset specificity and context will be addressed in greater detail throughout section 2.4.

2.4 Disaggregated measure of asset specificity in the oil and gas industry

Studies grounded in the regionalization theory draw little distinction between different dimensions of asset specificity related to specific investments. Even with TCE literature, a large number of studies have computed an aggregated measure of asset specificity (De Vita et al., 2010). However, according to Joskow (1987, p. 17) the differentiation between dimensions is highly valuable when it comes to empirical applications. The economic organization of the international oil industry may serve as a good example of investment in specific assets to examine this multifaceted nature and its effect on MNE’s internationalization. The oil and gas production chain is characterized by high degree of investment specificity. Firstly, assets have a fixed location and cannot be moved; secondly, equipment is engineered for a specific project; thirdly, the infrastructure is constructed in order to connect a fixed set of participants (Mironova, 2013). Under conditions of high institutional distance as described in proposition 2, each of the sub-dimensions of asset specificity can be expected to be more significant in terms of effecting inter-regional LoF than under low institutional distance. The following propositions will each deal with the effect of each asset specificity dimension with respect to upstream business units, starting with the notion of the effect of upstream segment’s physical asset specificity on the MNE’s experienced level of inter-regional LoF.

Physical asset specificity

Because of the specific nature of tangible assets of the upstream segment, the investing MNE is vulnerable to ex post opportunism by the owner of the oil or gas field to which the particular tangible assets are dedicated. This is because assets are often custom built to handle a particular type of crude oil mix and they are fairly dependent on it, as switching costs can be very high (Meijknecht, et al., 2012; Al-Obaidan & Scully, 1993; Kearney, 2012). Therefore, asset specificity in terms of the extent of the actual investments in physical assets made by the transaction partner specifically for the purpose of the relationship is considerably high. The contention would be that as physical asset specificity increases, so does the pressure for predictable and stable institutional arrangements (Guthrie, 2002). It is expected that discriminatory LoF will encourage a host country partner to become more opportunistic in its interaction with the MNE (Henisz and Williamson, 1999), which is likely to be lower for intra-regional expansion than for inter-regional expansion.

Proposition 3: Oil and gas MNEs are expected to experience high inter-regional LoF as a result of a high physical asset specificity of their investments.

Human asset specificity

To recall, human asset specificity could be characterized as unique technical skills and experience required in carrying out the activity being transacted (John and Weitz, 1988; Walker and Poppo, 1991). It has also been described as knowledge specific assets (Dibbern et al., 2005) that arise from learning-by-doing (Williamson 1996), and which are not easily transferable, owing to their limited application in other work settings (Lamminmaki, 2005). In case of human asset specificity, IOCs heavily lean on service providers for complementary FSAs of specialized nature (Rowlands, 2000). In this sense, IOCs do not have to provide an extremely specific training to their employees carrying out the activity being transacted. Moreover, skills, knowledge and experience of MNE’s employees cannot be considered being specific to the requirements of dealing with another firm; it is rather industry specific. Therefore, employees obtain knowledge which has applicability for other transactions, as well. Conclusively, the level of human asset specificity in the oil and gas sector is at least quite low and consequently this is not be expected to lead to high inter-regional LoF.

Proposition 4: Oil and gas MNEs are not expected to experience high inter-regional LoF as a result of human asset specificity of their investments.

Site asset specificity

Site specificity is prevalent in the upstream industry. Building facilities requires a vast amount of investments which are sunk and the incurred capital costs are fixed (Barham, 2005; Correljé et al. 2011; Frankel, 1969; Kesicki, 2010). This is accompanied by the fact that facilities once built to a certain location cannot be relocated (Joskow, 1987). As the plants are immobile, the users and the suppliers are locked into bilateral relationships that are subject to potential hold-up problems. Additionally, facilities need to gain access to crude oil and other feedstock to process, and then they should have the ability to distribute their output in the marketplace. This makes oil and gas facilities highly site-specific for another reason, minding their locations are a high priority when considering accessibility to major transportation channels and open sea, as well as their logistic assets infrastructure, such as pipelines (Meijknecht et al. 2012; Kearney, 2012; Cuthbert, et al. 2011). Consequently, the institutional factors interacting with site asset specificity are of importance in explaining oil and gas MNEs’ inter-regional LoF.

Proposition 5: Oil and gas MNEs are expected to experience high inter-regional LoF as a result of site asset specificity of their investments.

Dedicated asset specificity

As noted earlier, dedicated assets are those that are put in place contingent upon particular supply agreements and, in cases of premature termination of these contracts, a supplier would be left with significant excess capacity (Williamson, 1983; Joskow, 1985). Investments for these assets are discrete and would not take place but for the prospect of selling a significant amount of product to a particular customer. For upstream segments, the difficulty of rearranging the infrastructure for other uses and the importance of scale economies imply that in ‘immature’ markets, the remuneration of the transport investment is frequently dependent on a small number of players (Ferraro, 2014). This means that upstream segments will have more difficulties to redefine a cooperative relationship once the original relationship concludes. Should the relationship expire, excess capacity will result.

Proposition 6: Oil and gas MNEs are expected to experience high inter-regional LoF as a result of dedicated asset specificity of their investments.

3. Methodology

This chapter will focus on the research methodology and research design. The first section describes the ontological and epistemological foundations in this research design. The following section focuses on the multiple case study design in light of Yin (1981;2009) and Eisenhardt’s (1989) work. Subsequently, the quality criteria associated with multiple case study designs are presented, followed by the case selection. Ultimately, the proceeding section includes data collection methods and the analytical approach.

3.1 Research Philosophy

The foundation of this research is objectivist ontology and post-positivist epistemology. Epistemology fits with an objectivist world view. By adopting an objectivistic world view the author argues that the world is external and independent of the researcher and the effort at studying it will not influence the outcome of the study (Brannick and Coghlan, 2007; Saunders and Lewis, 2012). By adopting a post positivist epistemology, the external objective world is not affected by the researcher’s personal beliefs and values (Gephart, 2004). However, it is not claimed that social phenomenon like organizations can be known to the same degree that science may claim and as such the post positivist position argues that the world can only be partially known through an individual study (Gephart, 2004). By using a multiple case study design, each case study highlights a slightly different perspective. This creates an accumulation of knowledge which helps to interpret the external world in a more objective manner.

3.2 Qualitative multiple-case study design

This study will use a multiple-case study design, in the same vein as adopted by Rugman and Collison (2004) and Kolk, et al. (2013), framed around Eisenhardt’s (1989) and Yin’s (2009) approach to multiple-case study design, as it allows the questions what, why, and how to be answered with a relatively full understanding of the nature and complexity of the complete phenomenon (Yin, 2003). The advantage of this design is that it assures richness of context and can lead to novel and testable theories (Eisenhardt, 1989). This method lends itself to incremental development (Eisenhardt, 1989) of the regionalization theory and has the benefit of replication across cases (Saunders et al. 2009). Moreover, through developing propositions important to allow generalization to theory, a strong theoretical foundation is pursued (Yin, 2009). The approaches of Eisenhardt (1989) and Yin (1994) are

26 aligned with the objectivist ontology and post-positivist epistemology foundation as mentioned in the previous section. Although this research is theoretically driven, it combines the inductive bottom- up techniques advocated by Eisenhardt (1989) with the more deductive approach of Yin (2009). Weick (1996) proposes that theorizing is enhanced by combining inductive with deductive approaches, or vice versa. The main strength of such deductive bottom-up theorizing (Shepherd and Sutcliffe, 2011) is that it allows openness to new insights for theory extension, while having predetermined set of constructs to guide a study through a large amount of data. In line with Hyde’s (2000) and Yin’s (2009) approach to multiple case studies, working propositions were thus developed prior to carrying out the case study research, but the research was conducted broad-minded, allowing the data to provide unexpected insights. The strength of a multiple case study design is that strategic decisions or events of each firm can be addressed and explained in detail. Furthermore, the use of multiple methods makes the arguments and findings more convincing (Yin, 2009). On the other hand, case-study methodology is perceived as exhibiting a lack of statistical generalizability and this could result in a lack of rigor (Yin, 2009). In order to improve this, it is good practice to ensure research is done on the basis of certain specified criteria, which will be addressed in the next section.

3.3 Quality criteria

Yin (1998) recommends that researchers continually judge the quality of their case study design. Four principles are commonly used to certify the quality of a study, more specifically construct validity, internal validity, external validity, and reliability. Construct validity is related to the accurate measurement of the objects in study. This is realized by using triangulation to extend and validate the data collection through the use of multiple sources of evidence (Eisenhardt, 1989; Yin, 2003) and through the use of proven measures (Yin, 2009). In the present study, the IBV and TCE are used as the overreaching theoretical foundations between the regionalization and location literature, hereby, the case study establishes a solid base for further analysis. This research uses both quantitative and qualitative data in order to triangulate results (Patton, 1990; Brannick and Roche, 1997). Annual reports are used for quantitative data about the dispersion of sales, assets, and proved reserves for establishing MNEs regional profiles and Financial Times newspaper articles for qualitative data about the recorded rationale for transactions. The internal validity test will evaluate the evidence for pattern matching and establishing causality. This is secured through detailed explanations of relationships under examination, including

27 contrasting explanations. All within-case analyses are conducted following the theoretical framework and the results are analyzed in the cross-case analysis (Yin, 2009). The test for external validity will ensure that the research findings are applicable outside the confines of the selected case study. This is achieved through the use of multiple cases and through the use of deductive and inductive principles (Eisenhardt, 1989). The case study sample is theoretically sampled, extending and excluding particular determinants in the constructs that are examined (Eisenhardt 1989). This allows an empirical context which is of theoretical interest, showing the applicability of using a more specific conceptualization of assets specificity and how this relates to concepts of inter-regional LoF. Subsequently, external validity will be enhanced through performing a cross-case analysis (Gibbert et al., 2008). The test for reliability verifies that the research procedures and findings can be replicated by other parties (Yin, 2009). This is done by increasing replication and transparency (Yin, 2009). By following a rigorous data collection process in which all information is stored in a case study database and a case study protocol is followed which clarifies the taken steps (Gibbert et al. 2008; Hyde, 2000). Furthermore, transparency is created by a detailed description of each case.

3.4 Theoretical sampling strategy and case selection

The next section provides a brief overview of research designs adopted by TCE related research. Section 3.4.2 outlines the methodology employed in this research.

3.4.1 Cases and studies TCE asset specificity

Most of the theoretical and empirical studies within the TCE framework have traditionally been concerned with examining a single industry. Examples include studies that analyses of cable television franchising (Williamson, 1976); organizational arrangements in the aluminum industry (Stuckey, 1983), between rail operators and freight (Palay, 1984), between tuna harvesters and processors (Gallick, 1984), and between coal mines and electric utilities (Joskow, 1985); contracts in the shoe (Masten and Snyder, 1993) and petroleum coke (Goldberg and Erickson, 1987) industries. As can be seen from the empirical studies summarized in Table 2, TCE related research focuses primarily on single transactions, including studies examining specificity such as the development of automotive components for a vehicle assembler (Monteverde and Teece, 1982a; 1982b) and the wing producing facility investments made by a Boeing supplier (Milgrom and Roberts ,1992).

TABLE 3: Prior empirical work that draws on asset specificity

Studies Examination Unit of analysis Lamminmaki,D. (2005) Appraising the nature of outsourcing 11 large Southeast activities in hotels. An examination using Queensland (Australia) hotels. asset specificity. Walker and Weber (1984) Examining make-or-buy decisions for US automobile company. analyzing transaction costs. Stuckey (1983) Analysis of organizational arrangements in Aluminum and Bauxite the aluminum industry. industry, focusing on 6 major firms. Coase (2000) Analysis of the inter-firm relation between Fisher Body and General Klein (2000) Fisher Body and General Motors. Fisher Motors. Body invested large amounts in presses used to stamp parts for General Motors. Once it had committed itself to such specialized equipment, GM was able to opportunistically renegotiate a better contract. Azarian (2012) Analysis of the impact of asset specificity on Transaction between a plastic Inter-firm transaction structure. producer firm and its supplier of steel injection. Milgrom and Roberts (1992) Analysis of supplier’s investments made to Relationship between Boeing customize the wings of a specific Boeing supplier and Boeing. plane. Williamson (1976) Analysis of governance mechanisms to Oakland cable TV franchise. allocating cable TV services rights. Once idiosyncratic investments were in place, a large number of bargaining situation during the bidding process transformed into a bilateral monopoly.

According to Masten and Saussier (2000), TCE case studies examining these transactions are necessary and complement econometric analysis, as it often provides a richer description and perspective than statistical analysis offered (Macher, 2008). These case studies often represent the stimulus to refinements of TCE theory or future quantitative examinations. According to Masten (2000), a good case study will encompass a complete range of details, in addition to exploring variations which might exist over time and across transactions. In some cases, transactions are important enough in their own right to warrant intensive analysis (Masten, 2000). Following this argumentation, the methodology adopted in TCE-related research is reflected in the research design of this thesis, in which oil and gas projects are selected to reflect ´specific transactions´ that the sampled MNEs are doing. To date, studies in the regionalization framework have not considered the use of single transaction as the basic unit of analysis.

3.4.2 Case selection – the oil and gas industry

Reflecting the emphasis on sectorial specificity in both the regionalization literature (Filippaios and Rama, 2008; Gardner and McGowan, 2010; Grosse, 2005; Kolk and Margineantu, 2009; Oh and Rugman, 2006; Rugman and Collinson, 2004; Rugman and Girod, 2003; Rugman and Verbeke, 2008b) as well as TCE related research (Anderson 1985; Anderson and Schmittlein 1984; Espino-Rodríguez and Gil-Padilla, 2005), this study concentrates on the oil and gas industry. The companies operating in this industry can be grouped into three categories, namely International Oil Companies (IOCs), National Oil Companies (NOCs), and Oilfield Service Companies (OFSCs) (Al-fattah, 2013). The major IOCs are vertically integrated firms in which all stages from exploration to retailing take place within the structure of the firm. Oil and gas companies are highly capital intensive (Al-Obaidan & Scully, 1995). There are a number of factors in oil and gas production which require a significant amount of R&D support. Expansion into foreign markets enables them to spread the high initial investment in fixed assets R&D expenses over a large market and allow further exploitation of non-location bound FSAs (Scully, 1995). However, the domination of natural resource seeking motives in this sector, companies’ strategic maneuvering room is limited in terms of host country location selection (Dunning and Narula, 2000; Nachum and Zaheer, 2005). IOC’s investments in infrastructure are characterized by high degrees of assets specificity (Mironova, 2013) and IOCs are therefore confronted by high exit barriers and lower flexibility due to switching costs (Spanjar, 2009). The geographical profiles of the major IOCs, in terms of distribution of reserves and markets are quite comparable, and they all access the services of OFSCs (Rowlands, 2000). NOCs are organizations that have the largest shares of their value held by their parent governments. Given the central role of oil for a nation’s economy, NOCs are chartered to work toward the interest of their home countries (Morse, 1999; Al-fattah, 2013). Oilfield Service Companies (OFSCs) provide services and outsourcing needs for both IOCs and NOCs. Their services cover practically all areas of E&P and a variety of technical performance and financial contracts (Al-fattah, 2013). In exploring firm strategies and developing theoretical representation of asset specificity within the regionalization literature, this study concentrates on a sample of the leading IOCs (as listed in the 2013 Fortune Global 500). This sample consist of the firms that emerged out of the original seven sisters – Chevron of the US, and Europe’s BP (UK), and Royal Dutch Shell (The Netherlands) – accompanied by two comparative newcomers to the ranks of international majors: ConocoPhillips (US) and ENI (Italy). The sample of IOCs is theoretically sampled, as the choices fit with extending and excluding particular variables in the constructs that are investigated (Eisenhardt 1989b; Eisenhardt & Graebner, 2007). It allows an empirical context which is of theoretical interest,

30 showing the applicability of using a more specific conceptualization of assets specificity and its relationship with the concept of inter-regional LoF. Within a case, a project is selected to reflect

‘specific transactions’ that the IOC is executing, for an overview of the selected projects see Table 4.

TABLE 4: Cases of indirect and direct expropriation of oil and gas assets

Country Project Firm (consortium) partners Key event(s) Russia Sakhalin-ll Royal Dutch - In 2006, Russia put pressure on project. Shell Royal Dutch Shell to sell its share to Gazprom. Venezuela Orinoco Oil ConocoPhillips ExxonMobil, Chevron, and ConocoPhillips exited Venezuela Belt project BP in 2007; sought remedy in international courts. Russia Kovykta gas BP TNK-BP Joint venture Gazprom did not give BP access project to the local pipeline infrastructure. Kazakhstan Kashagan Eni (operator). Shell, ExxonMobil, Total, Renegotiation of the entire PSA in project ConocoPhillips, Japan's 2008; ENI’s shares were diluted. Inpex and the Kazakh state oil company, KazMunaiGaz Kazakhstan Tengiz Chevron - Kazakhstan accused Chevron of project failing to meet its obligations under the PSA and threatened to nationalize the project in 2007.

As noted earlier, using transactions as a unit of analysis is a well-established strategy in the TCE literature, especially with respect to different kinds of asset specificity to study inter-firm relationships. The selected transactions in this thesis reflect large capital intensive projects in institutionally distant locations (Al-Obaidan & Scully, 1993). The IOCs geographical profiles in terms of distribution of reserves and markets are quite comparable (Rowlands, 2000). As these projects and MNEs have similar profile and institutional context, the use of embedded unit of analysis is therefore not adopted as a common strategy, as it does not add value in terms of credibility of the findings. All cases are inter-regional, which is most common for the sampled firms, as no intra-regional projects are available or the intra-regional projects are not susceptible to the expropriation of quasi-rent since political relations with the home government are generally much better than with host country governments (Baron, 1995).

3.5 Data collection

This study has both quantitative and qualitative foundations to analyze the internationalization patterns of business activities and the drivers of these patterns. The combination of quantitative and qualitative method increases the breadth and depth of the understanding of regionalization (Hussein, 2009).

The first round of data collection pointed to the need to classify international strategies according to Rugman’s classification scheme. The geographic dispersion of assets, sales and proved developed and undeveloped reserves are tracked from their annual reports over the period 2009 to 2013 for analyzing their international presence. Proved reserves is a sector-specific measure of MNE presence related to those reserves that geological and engineering information indicates with reasonable certainty can be recovered in the future from known reservoirs under existing economic and operating conditions. This is in a similar vein as the sector specific measures which are used by Rugman and Collison (2004) for the study of automotive sector and by Kolk et al. (2013) for the study of electric utilities. The data is centralized in a database in which it is assessed against Rugman and Verbeke’s (2004) initial benchmarks. According to their set of criteria, the regional orientations of the sampled MNEs are established. Through the longitudinal character of this measurement, support for the oil majors’ regional nature not only captures a snapshot in time hereby addressing Osegowitsch and Sammartino’s (2008) critique. In the second round of the data collection process, the LexisNexis database was used to find newspaper articles from the Financial Times London to select projects suitable for analysis, using the firm’s name as key search term as a first step. For some companies it was necessary to use additional keywords; using only the company name rendered too many results. The time frame of all cases needed to be similar to facilitate a cross-case analysis. To accommodate this, without having an unreasonably long time period, the 10 years spanning 2003 to 2013 have been chosen for the initial search for finding reporting on projects. This resulted in a broad range of articles being retrieved, which were then systematically reviewed to identify articles providing significant commentary on

projects and the strategies of the focal firms. A search in LexisNexis yielded the results in Table 5.

TABLE 5: Sample and collection of newspaper articles Company name Search term Total FT articles found Used FT articles Royal Dutch Shell Shell AND Russia 1487 88 ConocoPhillips ConocoPhillips AND Venezuela 101 44 BP BP AND Russia 2123 76 ENI ENI AND Kazakhstan 158 51 Chevron Chevron AND Kazakhstan 252 38

A broad and thorough search was undertaken to ensure that no relevant newspaper articles were excluded. For example, a search with the term ‘Shell AND coercion’ might have excluded newspaper articles solely describing the dispute between Shell and Russian authorities as a failed negotiation, downplaying the regulatory pressure exerted by the Russian authorities. When necessary the newspaper data was enhanced using annual accounts from the companies under investigation. The timeframe that will be examined are the years surrounding the life cycle of the project, which is similar across cases and accommodates the cross-case analysis.

3.6 Data analysis

The aim of the analysis of the qualitative data is to understand the working propositions, which is achieved through the process of thematic coding. This thesis uses a technique of deductive formulation of an “a priori template of codes” (Fereday and Muir-Cochrane, 2006, p. 83), as well as inductive approach in which themes arise during the data collection process. The deductive categories were created related to the key themes in the literature review of the current research. The categories were translated into codes to which relevant and useful clippings were assigned, which allows later analysis and interpretation of outcomes (Payne, 2004). The data were managed and analyzed using software for qualitative data analysis (NVivo) as it facilitates accurate and

transparent data process which provides a reliable, general picture of the data (Welsh, 2002).

TABLE 6: Codebook WP Code Description 1&2 Institutional distance Captures the dissimilarity between the host and home countries in terms of rules, laws and regulations. 1 LoF Hazards MNEs face when doing business abroad. 1 Bounded rationality Transacting parties cannot anticipate and specify all exchange contingencies before they surface. 1 Uncertainty Inability of a firm to predict future events. 2 Entry modes Determination of the choice of governance, namely hierarchy or market transactions. 3 Physical asset specificity Investments in physical assets that are tailored to a specific transaction and have few alternative uses. 4 Human asset specificity Significant investments in knowledge and routines that the firm has invested in to deal with a specific firm. 5 Site asset specificity Building the plant next to the buyer making it hard to serve other buyers. 6 Dedicated asset A product contract with one large customer may cause a firm to expand specificity its capacity to meet demand, which would ultimately result in significant over-capacity and important financial disruption if the customer in question chooses not to renew the contract.

Using the information in the relevant clippings, a narrative of the key events for each firm could be developed which provided a history of key events of the whole project cycle. The time frame that will be examined are the years surrounding the life cycle of the project, in which actions were taken in the same period across the cases. This also facilitates the examination of different forms of expropriation over time. The analysis was completed through a within-case analysis of the firm’s project independently and then cross-case analysis in which all cases are compared and contrasted to find patterns that could support the working propositions (Eisenhardt, 1989).

4. Results

The following chapter presents the findings that have resulted from the analysis of the data as described in section 3.4. The section starts the within-case analyses. All cases are individually analyzed and subsequently compared to complete the within-case analysis.

4.1 Within-case analysis

This chapter will present the key events that the IOCs faced regarding the development of major oil and gas projects. The projects function as an embedded unit of analysis which reflects specific transactions. The cases illustrated in the next chapter consist of quote materials from Financial Times articles and annual reports. Each of these cases represents an instance of post contracting time period in which asset specificity emerges within the context of the investment and affects the MNE’s regional presence.

4.1.1 Case study 1: Royal Dutch Shell

This case focuses on Royal Dutch Shell, the majority owner of company Sakhalin Energy, and their dispute with the Russian government which used environmental regulations to coerce Shell and other members of the PSA in Sakhalin-ll to sell 50% of their stakes. Shell experienced bounded rationality constraints related to complexity of environmental regulations which shaped the Russian government’s opportunistic behavior by exploiting unenforceable parts of the PSA. The Sakhalin-ll project also has a high degree of site and physical asset specificity, including the construction of Russia’s first LNG plant, the installation of Russia’s first Arctic-specific drilling and production rigs (Bradshaw, 2010), creating quasi-rents that were subject to expropriation by Russian authorities. The Sakhalin-II PSA1 governs the license for the exploration, development and exploitation of the two fields, Piltun-Astokhskoye and Lunskoye. The aim was to develop and produce oil and gas from these offshore fields for delivery to the Asia-Pacific market and North America. Sakhalin Energy is the operator of the Sakhalin-II project, and was until December 2006 controlled by Shell with a 55

1 A PSA is a commercial contract between the IOC and the government that allows the IOC to undertake large scale investments, long term and high risk, while the government retains ownership of the natural resources (Goes, 2013). The purpose of this contract is to define the legal and fiscal terms in relation to the development of an individual oil or gas project. The IOC acquires an entitlement to a stipulated share of the oil produced as a reward for the risk taken and services rendered (Bindeman, 2010). 34 percent equity share and later by the Russian state company Gazprom. Sakhalin is a remote, little developed region in the Russian Far East. The remoteness of this Sakhalin region contributed to raising sunk costs of the development of this field in two ways. The actual costs of the original investment were higher; the notion of ‘remote’ reflects access costs (Barham, 2005). Secondly, remoteness also reduced the salvage value of investments, thereby increasing the associated sunk costs, a reflection of a specific transaction’s attribute (Williamson, 1996). As Klein and Leffler (1981, p. 619) put it, the irreversible, non-salvageable part of an advance commitment is sunk. The conflict between Shell, on behalf of its operator Sakhalin Energy, and the Russian governmental authorities, began when Shell raised the development costs for the Sakhalin-II project which were caused by underestimation of the project’s complexity. Apparently, Shell did face some location boundedness of its FSAs in transferring them for the project’s development, as reflected in cost overruns, but they successfully set up one of the most remote oil exploration projects in the world through the transfer of FSAs which were recombined with local CSAs. The external uncertainty surrounding the Sakhalin-ll transaction – as opposed to the behavioral uncertainty stemming from the opportunist behavior of the actors (Sutcliffe and Zaheer, 1998) – created a need for adaptation in the contract terms defined ex ante. The external uncertainty had both a geological aspect – the problem of determining the volume of reserves (i.e. additional seismic studies were required) – and an economic one, namely the difficulty of estimating future production costs and variations in the market value of oil (Rossiaud, 2014). According to Shell, the cost rises were caused by higher oil prices resulting in increased demand for oilfield services (Goes, 2013). Due to the project’s complexity, Shell needed to access complementary FSAs provided by oil field service companies whose business model is based on developing specialized FSAs (Rowlands, 2000). Consequently, the level of human asset specificity of Shell’s intangible assets is at least quite low. In underestimating the complexity of the project, the instability of the Russian ruble added further unpredictability (Shell Sustainability Report, 2005). This made the PSA incomplete because contingencies increased due to these factors of uncertainty. Hence, without regional uncertainty, a more perfect PSA covering full contingencies could be written (Fan, 2000). Projects of Sakhalin-ll’s size are not immune to unexpected construction costs, especially given the complexity and remoteness of location, but these cost run-ups caused by the environment’s unpredictability gave the Russian authorities another incentive to force Shell into opportunistic renegotiation. Shell’s presence in Eurasia was less shaped by their FSA transferability. The company was more influenced by the institutional environment and asset specificity, therein framing Gazprom’s opportunistic behavior.

TABLE 7: Within-case analysis Royal Dutch Shell

Regional profile Shell

2009 2010 2011 2012 2013 Region NA EU AP NA EU AP NA EU AP NA EU AP NA EU AP % of total revenue 17,1 22 12,9 21,1 37,3 30,1 19,6 39,9 31,35 34,9 20,1 33,64 16 38,91 34,94 Regional orientation - Global Bi-regional Global Bi-regional % of total assets 19 19,9 40,3 22 15,8 42,26 22,73 14,14 42,9 24,11 14,5 42,6 NA NA NA Regional orientation - Bi-regional Bi-regional Bi-regional NA % of total reserves 17,7 13,1 45,6 13,7 10 33,9 13,9 12,5 27,5 14,6 12,8 27,5 15 12,1 26 Regional orientation - - - - -

Key Events 2002 2005 2006 2006 (second half) October 2006 Early December 2006 December 2006 Start construction Cost overruns in Memorandum of Accused of violating Construction of two on- Suspension of crucial Gazprom becomes major the Sakhalin-II understanding with Shell environmental shore pipelines had been licenses shareholder of Sakhalin Energy project in July expected Shell to make requirements in the suspended. prevented Shell from (formally signed in April 2007). 2005. concessions in the construction of the completing pipelines. negotiations on future pipeline. development. Supporting Materials Implications Illustrative quotes Institutional distance High institutional distance implies a high “Foreign investment should not be at the expense of the environment and, if Shell has broken the rules, it probability of achieving a change in the should be fined or told to make good the damage. But the rules must be applied consistently and with due current regulations, Gazprom finds process: suddenly withdrawing permits is no way to treat a corner shop, let alone a Dollars 2 billion lobbying host-country political actors for investor. Russia signed a contract with Shell for Sakhalin. It should honour that contract: letter and spirit.” a policy intervention that would alter the “The terms of the PSAs kept the projects outside Russia's then opaque tax regime, instead giving the distribution of quasi-rents. government a share of the oil and gas produced once investors had recouped their investment costs. But they have increasingly begun to look like anomalies as oil prices have soared - bringing petrodollars flooding into Russia - and the administration of Vladimir Putin has sought to retake state control of strategic oil and gas assets.” “Russia’s tightening of the screws on Shell’s Sakhalin-ll project may be partly motivated by pride. Sakhalin-ll is operated under a long-standing production sharing agreement (PSA), typically used to shield foreign operators in less-stable regimes.”

Supporting Materials Implications Illustrative quotes Bounded rationality Shell experienced bounded rationality “In 2005, we noted that it did not provide automatic legal updates and there was no mechanism in Russia problems as distance created challenges to subscribe directly with federal/local legislators. In the absence of a mechanism to provide automatic for the MNE to understand Russian updates and to guarantee 100 per cent coverage of relevant Health, Safety and Environmental and Social environmental regulations. legislation, updates depend upon working relationships with appropriate authorities (Environmental Report 2007:31).” “The transition to democracy and a market-oriented economy has been a complex one that is still evolving. The legal and regulatory framework continues to be difficult for companies developing large-scale projects in Russia.” Site specificity Shell is confronted with a lock-in “Sakhalin Energy representatives said the company suspended construction of two ground-surface pipelines situation (Williamson, 1985). Shell could in the dangerous landslide area of Makarovsky uplift of the Sakhalin Island, as the recent inspection exert less influence on Gazprom in revealed some cases of technical provisions’ violation by the subcontractor.” renegotiation of the PSA because of this loss of flexibility. Physical asset specificity Drilling and production rigs were “The Sakhalin-ll project also boasts numerous technological innovations, including the construction of purpose built, creating quasi-rents that Russia’s first LNG plant, the installation of Russia’s first purpose-built Arctic drilling and production rigs, and were subject to expropriation by Russian the equipping of offshore rigs with special bearings to cope with seismic activity” (Bradshaw, 2010; 354). authorities. Environmental uncertainty This made the PSA incomplete because “The higher costs reflect higher energy and raw materials, and wage inflation in Russia. They also reflect contingencies increased due to these the complexity and the frontier nature of the project, which were originally underestimated (Shell

factors of uncertainty (Williamson, Sustainability Report 2005:24).” 1985). Entry modes The formal institutional environment “The Ministry of Natural Resources has accused Royal Dutch/Shell, which owns a 55 per cent stake in shapes the contracting options available Sakhalin-ll, of causing enormous environmental damage and threatened to suspend an environmental to the Shell. Gazprom receives a share of permit issued three years ago. But the real reason for the attack on Shell, Russian politicians admit, has equity ownership (Aggarwal and more to do with the rising cost of the project which is being developed under a production-sharing Ramaswami, 1992; Brouthers, 1995; agreement. The increase has already soured a deal between Shell and Gazprom to swap assets so that Gatignon and Anderson, 19988) Note, Russia's gas monopoly would get a 25 per cent share of Sakhalin-ll in exchange for giving Shell a 50 per cent that from the perspective of Shell, this stake in a Siberian field.” results in a suboptimal governance “Yet senior ministers readily concede that the crackdown on Sakhalin Energy – the holding company that is mechanism as hierarchical governance 55 per cent owned by Shell – was ‘detonated’ by matters that had little to do with the environment.” mode is preferable.

In 2005, Gazprom signed a memorandum of understanding with Shell. The intended common line of action would provide Gazprom a 25 percent stake in the project and expected Shell to make concessions in the negotiations on future development of the Sakhalin-II field (Op Het Veld, 2009). However, the Russian government refused to approve the cost updates announced by Shell. The negotiations between Shell and Gazprom were in a sense nullified. The proposal by Shell which stuck to a 25 percent share for Gazprom was insufficient, given the larger share demanded by the Russian government (Op Het Veld, 2009). Subsequently, as a response to the unfruitful memorandum of understanding, opportunistic actions were taken at the expense of Shell. Inspections by Rosprirodnadzor, the Russian environmental regulator, were conducted in 2006. As a result, Sakhalin Energy – and indirectly Shell as the major stakeholder – was accused of violating environmental requirements in the construction of the Sakhalin-ll project pipeline. Following TCE argumentation, Shell experienced severe bounded rationality problems as institutional distance created challenges for the MNE understanding Russian environmental regulations. The bounded rationality problems handed an opportunity to the Russian government to put pressure on Sakhalin Energy by accusing Shell of violating environmental regulations and license agreements. The lack of reliable business information systems created severe difficulties for Shell in navigating through Russia’s complex formal regulatory framework. Russian use of administrative hurdles made it more difficult for Shell to develop and operate the Sakhalin-II project. This created incidental LoF, the phenomenon referring to the cost of adaptation to cope with the unfamiliarity and lack of roots in the host-country environment (Sethi and Judge, 2009). The lack of reliable institutions to support Shell’s activities created uncertainty in the sense that it limited the ability to absorb, process and purposefully act upon complex and insufficient information environmental regulations. Using environmental regulations to pressure Shell was an easy and achievable opportunistic action (Goes, 2013). Enforcement was based on other criteria than those related to the actual dispute as Sakhalin Energy’s written assessments and plans fully met the large majority of the individual requirements against which the project has been assessed. Moreover, the project provides examples of laudable best practice (Shell Sustainability Report, 2007:33). The accusation of violation created exchange hazards as the Russian government took the ability to take advantage of contractual agreements by exploiting unwritten or unenforceable parts of the contract (Klein, 1980). This exploitation resulted in the suspension of crucial licenses from one of Sakhalin Energy’s main contractors citing violations of environmental rules. This prevented Shell from completing pipelines connecting gas fields in the north with the LNG plant in the southern part of the island. By virtue of being a physical asset – having no value except as part of the Sakhalin-ll project – the return on Shell’s investment in the LNG plant was dependent on the cooperation of

Gazprom. The pipeline exhibits characteristics of site and physical asset specificity. First, it needed to be built at least in conjunction with the development of the oil well. Second, the pipeline was located in a particular place, between the well-head and the LNG plant; it has a single, highly specialized use, transporting gas from the well-head to the LNG plant (Kearney, 2012; Cuthbert et al., 2011). Earlier in October 2006, construction of two on-shore pipelines had been suspended by the Ministry of Natural Resources as well. The result was a process where Shell was put under pressure by the Russian authorities to renegotiate the PSA, for instance by providing Gazprom access to the Sakhalin-II project on more favorable terms. In December 2006, the Russian government resolved some concern by wresting a controlling interest in Sakhalin-ll from Shell. Gazprom acquired 50 percent plus one share, for which it paid a below market $7.45 billion (Kramer, 2004). Gazprom now owns the controlling stake – the deal reduced Shell's interest from 55 to 27.5 percent, Mitsubishi's from 20 to 10 percent, and Mitsui's from 25 to 12.5 percent. The companies involved in Sakhalin-ll and the Russian government then settled the alleged environmental infractions. Not only is understanding asset specificity important in terms of the constraints Shell faced in Russia, it is also a driver of changes in actual presence, and by implication it directly affected the way Shell’s regional presence was measured (especially when one considers that this specific project is equivalent in size to five world-scale projects (Shell annual report, 2007)). IOCs have limited locations options in terms of unequal distribution of reserves, in general. The divestment’s main impact on the consolidated Balance Sheet was a reduction of $15,7 billion in physical assets (i.e. property, plant, and equipment), out of combined physical assets totaling $101.252 million (Shell annual report, 2007). The physical assets of Sakhalin-ll accounted for 15,46% of the total assets in 2007. Table 7 shows the importance of the project to shell in 2007.

TABLE 8: Impact appropriation quasi-rents on regional profile Physical assets ($ million) Year 2005 2006 2007 2008 2009 2010 2011 Total Physical Assets 87.558 100.988 101.521 112.038 131.619 142.705 152.081 Regional distribution of physical assets in 2007 ($ million) Region Europe Other Eastern USA Other Western Hemisphere Hemisphere Physical assets 36,673 49,911 27,606 21,85 % of total 27 37 21 16 Regional distribution of proved reserves in 2007 (million barrels of oil equivalent) Country North America Europe Asia Africa Middle east/Russia Total BOE 851 1,565 1,102 1,135 3,424 8,077 % of total 10,5 19,4 13,64 14,1 42,4 100

The break in the trend of total physical asset growth in 2007 reflects the effect of the appropriation on the Shell’s total amount of physical assets. The elimination of physical assets reduced Shell’s regional presence in the Eastern Hemisphere by 31,5%. The transaction had a significant effect on Shell’s distribution of proved reserves, as well. It eliminated the portion of the reserves that was attributable to Russia, and by implication the Eastern Hemisphere. This resulted in a net reduction of 1.1 billion barrels of oil equivalent (boe), from its consolidated reserves in 2007 (Annual report, 2007; The Guardian, 2008). Replicating the effect of the asset reduction, this sector specific measure reduced their presence in Russia by 32,1%. By implication, their presence in Middle East/Russia is reduced from 42,4% to 28,8%. The effect of value expropriation on earnings cannot be classified due to absent data. Shell had also reported that revenues were significantly lower as Shell’s share of earnings in the Sakhalin-II project were reduced (Annual report, 2007).

4.1.2 Case study 2: ConocoPhillips

This chapter will focus on the development of the Orinoco Oil Belt, a huge reservoir of extra-heavy oil in Venezuela, by ConocoPhillips. The assets employed by ConocoPhillips in the development of this field are characterized by high physical and site asset specificity. The processing facilities in the Orinoco Oil Belt are custom-built to handle a particular type of crude oil mix and are fairly dependent on it, as switching costs are very high (Meijknecht, et al., 2012). Apart from the physical specificity related to the configuration and complexity of assets, site asset specificity is another important type of specificity and in regards to describing this transaction, the assets involved are highly site-specific. The specificity of the assets involved gave rise to significant ex-post renegotiation. The way the renegotiations were conducted during 2004-2008, had a significant component of opportunistic expropriation (Hogan, 2010). Due to the lack of an effective progressive tax system and a weak institutional framework, price contingencies were not taken into account. In other words, when oil prices increased, the Venezuelan government had a strong incentive for contract renegotiation. The sudden increase in price volatility created pressures for price adjustments in PSAs. Venezuela became increasingly open to foreign investment in the energy sector during the 1990’s. In order to attract foreign investments in its heavy oil projects in the Orinoco Belt, Venezuela created a new fiscal framework that applied specifically to these projects and created joint ventures with IOCs that could provide capital, know how, and technology. Relying on these terms, ConocoPhillips helped Venezuela develop the projects in the Orinoco Belt with its FSAs in heavy oil extraction. In order to develop the Orinoco Oil Belt, ConocoPhillips needed to make substantial investments featured by high degrees of physical asset specificity. The characteristics of this Orinoco oil (low gravity, high viscosity and high sulfur content) required a costly upgrading process (Marsh, 2008). In order to upgrade this crude into marketable heavy or synthetic oil, “specialized highly capital intensive oil refineries had to be constructed” (Manzano and Monaldi, 2012, p. 26). These assets are fairly dependent on a crude oil mix of a specific composition (Meijknecht et al., 2012). The equipment is designed to conform precisely to the material properties of the particular raw material, which has low value outside of the transaction relationship. The proportion of site specific assets in this Orinoco Oil Belt project was significantly higher than in other oil projects, with each project requiring initial investments of between $2-4 billion (Manzano and Monaldi, 2008). Given the characteristics of the Orinoco Belt projects it was impossible to grant short-term rents to ConocoPhillips. Credible commitment by the government became of particular importance (Marsh,

TABLE 9: Within-case analysis ConocoPhillips

Regional profile ConocoPhillips

2009 2010 2011 2012 2013 Region NA EU AP NA EU AP NA EU AP NA EU AP NA EU AP % of total revenue NA NA NA 61,7 22,8 12,8 59,5 26,7 13,5 57,8 25,3 13,3 60,1 22,2 15,5 Regional orientation NA Home-region Home-region Home-region Home-region % of total assets NA NA NA 48,3 12,4 23,9 46,3 13,3 23,9 43,3 16 23,6 42,3 16 23,6 Regional orientation NA Bi-regional Bi-regional Bi-regional Bi-regional % of total reserves 81,4 6,9 7,3 82,1 6,5 6,8 82,9 6,6 6,1 83,6 6,2 5,5 84,2 5,9 5 Regional orientation Home region Home region Home region Home region Home region

Key events 1990’s 2002-2004 2004 February 2007 June 2007 ConocoPhillips started to Projects in Orinoco Belt Changes in the tax rate. Presidential decree: contracts would ExxonMobil and ConocoPhillips refused to develop projects in the completed by ConocoPhillips. be replaced by joint ventures in accept minority positions. The Orinoco Belt. which PDVSA or any of its government expropriated ConocoPhillips’ subsidiaries would have at least a investments in their entirety without fair 60% ownership. compensation. Supporting Materials Implications Illustrative quotes Institutional distance Expropriations of quasi-rents “Much is at stake as the government speeds up its plans to roughly double overall tax rates on - and to take occurred through manipulation of majority equity control of - the four so-called "strategic association" projects set up in the Orinoco Belt in the Venezuela’s political system. 1990’s.” “Venezuela's privatization of oil has come to an end," Mr Chavez said recently, promising to hoist the national ConocoPhillips is affected directly flag over installations in the area that boasts the largest heavy oil deposits in the world. But in spite of the by state-sector opportunism. bombast, this "nationalization" is in fact the start of a renegotiation of contractual terms that will more than likely leave PDVSA with a majority stake.” “Worries about the sanctity of contracts are deepened by the fact that tax rates for oil companies have been increased four times since 2004, while PDVSA, the Venezuelan state oil company, has been negligent at paying dividends to partners in existing joint ventures.“

Supporting Materials Implications Illustrative quotes Physical asset specificity The equipment is designed to “On top of that the projects require high start-up costs, in particular because of the need for complex and conform precisely to the material expensive refineries known as upgraders necessary to process the tar-like "extra-heavy" oil found in the properties of the particular raw Orinoco.” material, which has low value “Conoco recently signed two agreements worth over US Dollars 1.8bn with subsidiaries of Venezuela's national outside of the transaction oil company, Petroleos de Venezuela (PDVSA). In the first, Conoco and PDVSA operating unit Maraven plan to relationship. invest a total of Dollars 1.5bn to produce 120,000 barrels a day of heavy crude oil from Zuata, in central Venezuela, and ship it north through a 210 km pipeline to an upgrading plant at Jose, on the Caribbean coast.” Entry mode In presence of asset specificity, the “Hugo Chavez, Venezuela's president, announced the state takeover of majority control of operations in the potential for maladaptation arises Orinoco Belt this year, along with the nationalization of Venezuela's largest electricity and telephone due to contractual incompleteness companies.” in a minority-owned JV (Henisz, “Now it has also completed the process of obliging all foreign companies to accept minority shares in joint 2000). ventures with PDVSA.” “However, analysts said that both ExxonMobil and ConocoPhillips, which was the most exposed of the private companies in the Orinoco, refused to accept minority positions in the ventures for compensation that they considered to be below market value.” Uncertainty The difficulty of estimating “The rise to power of Hugo Chavez was the tipping point back towards resource nationalism, as he abrogated variations in the market value of contracts and increased taxes and ownership of foreign companies’ operations. Others, like Bolivia and oil. The volatility refers to the rate Ecuador, followed suit but even nations like Angola and Kazakhstan sought contract revisions, as contracts had and unpredictability of change in not been written in anticipation of the levels of prices seen in the past decade.” an environment over time and creates a need for adaptation in the contract terms defined ex ante.

2008), as the capital recovery takes longer to complete (i.e. all 30 to 35 year projects) (Manzano and Monaldi, 2012). The Venezuelan government required the oil majors to build these refineries and processing facilities in Venezuela. Once built, they were highly immobile because the set up and relocation costs were great, which constitutes high site asset specificity. The FDI’s high degree of site and physical asset specificity made ConocoPhillips particularly susceptible to political risks, most notably rent seeking behavior through the revision of contracts or expropriation of assets, which started to take place in 2004. The PSA was respected during the first six years of the Chavez administration mainly because the Orinoco Belt project was not completed until 2002, therefore the site and physical specific assets were not yet sunk investments, and expropriation was less attractive (Manzano and Monaldi, 2008). By 2004, conditions had dramatically changed, the oil prices were distinctly above the levels of the previous decade, and the investment cycle of the projects had run its course, with assets specific investments in place (Manazono and Monaldi, 2010). As Klein and Leffler (1981, p. 619) put it, costs that are highly specific to a transaction are “the irreversible, non- salvageable part of an advance commitment is sunk”. The volatility of rents made it challenging for fiscal systems to capture the oil rents under different price scenarios, which in turn affected contractual frameworks in a sense that it created contract contingencies (Hogan, 2010). The Venezuelan contractual and fiscal systems did not take into account price changes of future oil values and lacked the appropriate institutional framework for managing such a changing environment. An increasing share of oil rents would be retained by ConocoPhillips. Consequently, the Venezuelan government had a powerful incentive for contract renegotiation. The high price uncertainty implied a high possibility that a market price would fall outside the contract’s realm of control, resulting in costly renegotiation, if at all pursued (Fan, 2000). Hence, in volatile environments, external partners will have several opportunities to renegotiatiate to their advantage (Williamson, 1985; Hill and Kim, 1988). Relating to Venezuelan reputational capital, weak institutional frameworks and spouts of economic or political instability induce high discount rates (i.e. authorities shorten their horizon), which make the reputational costs of opportunistic behavior less relevant (Hogan, 2010). The discriminatory LoF was directed to ConocoPhillips because the Venezuelan government was highly sensitive to foreign control over natural resources due to its central role for nation’s economy. Venezuela’s oil revenues account for about 95 percent of export earnings (OPEC, 2014). The way renegotiation was implemented and the conditions under which the government acquired ownership of the assets have a significant component of opportunistic expropriation. When negotiating the tax platform for future business, the government also asked for back taxes for the previous three years (Hogan, 2010). Moreover, in the forced renegotiation of a government majority stake in all the contracts, ConocoPhillips was offered well below the market price of the Orinoco Belt project. President Chavez issued a presidential decree, which ordered the adjustment of all contracts

44 relating to associations operating in the Orinoco Belt and all PSAs. This decree replaced all such contracts with joint ventures in which Petroleos de Venezuela, S.A. (PDVSA), Venezuela's national oil company, or its subsidiaries would have at least a 60% ownership. This finding is aligned with the general assumptions presented by a wide body of literature (Aggarwal and Ramaswami, 1992; Brouthers, 1995; Gatignon and Anderson, 1988), supporting the proposition that under the presence of institutional distance, local partners like PDVSA will be more likely to receive a more adequate share of equity ownership. Note that from the perspective of the ConocoPhillips, this involved a less hierarchical governance structure, though the optimal decision given high degree of assets specificity would be internalization. The explicit regulations exclusively targeted ConocoPhillips to benefit indigenous firms, thereby comprising discriminatory LoF (Sethi and Judge, 2009). Companies that were party to these agreements had four months to consider and agree on the terms of the new joint ventures. In this renegotiation of arrangement, ConocoPhillips could exert less influence since physical and site asset specificity resulted in lower flexibility due to switching costs. The assets were geographically fixed and had less value out of the specific transaction. In 2007, the government expropriated ConocoPhillips’ investments in their entirety without fair compensation. ConocoPhillips has filed for arbitration to obtain compensation for its stake in Orinoco Belt projects with an estimated market value of US$7.2 billion (Hogan, 2010). Do to absent data, the effect of this expropriation on ConocoPhillips’ regional profile cannot be calculated. However, ConocoPhillips’ operations in the Orinoco Belt accounted for about 10 percent of the company's reserve base and 4 percent of its worldwide production (Financial Times, 2007).

4.1.3 Case study 3: BP

This chapter will present the issues BP faced regarding the development of their joint venture with TNK in general and the development of the Kovykta field in particular. In Russia, BP experienced site asset specificity, because Gazprom did not give them access to the pipeline infrastructure. By controlling the transportation networks for oil and gas, the Russian state was able to undermine the economics of TNK-BP’s Kovykta project in the interest of rent-seeking and in the end increasing direct Russian state control of resources, seeking a renegotiation of the contract terms and the sale of BP’s assets at a discount. Because of TNK-BP’s unilateral dependency as a result of the high degree of physical and site asset specificity, the Russian government could leverage control of its energy transportation network to achieve external manipulation of energy flows—a revolutionary form of opportunistic behavior that goes beyond the coercive renegotiation of contracts for fiscal gain (Domjan & Stone, 2009). In February 2003, BP invested $6.8 billion in a 50-50 joint venture company with Russia’s fourth-largest oil company, TNK, pooling the assets of both TNK and Sidanco and giving BP access to the Kovykta gas field (Annual report, 2003; Grace, 2005). The partnership had seemed successful for several years: from fiscal years 2006 to 2007, TNK-BP saw 9% growth, to revenues of $38.7 billion in 2007. However, from 2008 the partnership began to show signs of strain as the joint venture faced pressure from the Russian authorities, resulting in selling control of the Kovytka field to state owned company Gazprom. The Kovykta gas field is located in southeastern Russia. The site specific assets of TNK-BP needed to extract oil and gas are subject to the local market circumstances, which include local environmental legislation and local regulatory and political environment (Meijknecht et al., 2012; Cuthbert, et al. 2011). TNK-BP’s site specificity also played a crucial role in terms of accessibility to major transportation channels (Meijknecht, et al., 2012). In Russia, the transportation infrastructure is controlled by state giant Gazprom, which is the only actor authorized to export gas (Moe 2010:283). TNK-BP was dependent on Gazprom for constructing pipelines between Kovykta and potential foreign customers (Goes, 2013). Hence, this interdependence is a significant factor for understanding the opportunistic behavior of the Russian state faced by BP in developing the Kovykta field. TNK-BP was not authorized to export natural gas to Korea or China without the participation of Gazprom or any other state actor in the Kovykta project. When BP acquired the field in a cooperative deal with their Russian investors in 2003, the company hoped to gain approval for the

TABLE 10: Within-case analysis BP

Regional profile

2009 2010 2011 2012 2013 Region NA EU AP NA EU AP NA EU AP NA EU AP NA EU AP % of total revenue NA NA NA 34,3 21,1 NA 35 20,2 NA 34,9 20,1 NA NA NA NA Rugman Categorization NA Bi-regional Bi-regional Bi-regional NA % of total reserves 32,3 7,8 28,8 30,3 8,6 30 30,3 8,6 32,3 26,9 7,6 35,7 22,8 5,6 45 Rugman Categorization Bi-regional Bi-regional Bi-regional Bi-regional Bi-regional

Key Events 2003 2006 2006 November 2006 Early 2007 January 2007 June 2007 2008

Established the Technical BP-TNK was not Russian Russian authorities Investigate TNK-BP Lost control Kovykta Law on foreign joint venture upgrade to able to produce the prosecutors charged TNK-BP with for violating field TNK-BP until investment prescribed TNK-BP with a export natural target volumes opened a criminal a failure to meet environmental June 2007. that oil and gas were to be gas to China Russian private specified in the investigation into production targets. regulations at the reserved for Russian state completed. oil company. license. TNK-BP. Kovykta field. companies. Supporting Materials Implication Illustrative quotes Institutional distance In these cases of opportunistic behavior, “But BP’s Russian business has been plagued by friction with its partners, a group of feisty oligarchs known TNK-BP faced added hazards relative to as AAR. Life in TNK-BP has been a white knuckle ride, marked by endless legal tussles, power plays and the host-country firms like Gazprom due regulatory problems that peaked in 2008 when its chief executive Bob Dudley – now chief executive of BP – to the differential access to the political was forced to leave Russia.” process that arises by discriminatory “A recent crackdown on the Shell-led Sakhalni-ll project and a threat to revoke a TNK-BP licence to develop LoF. the giant Kovykta gas field in eastern Siberia are the latest examples of Russia's cavalier attitude to the rights of foreign investors.” Site asset specificity The location of TNK-BP’s oil wells and “The development of TNK-BP’s vast east Siberian Kovykta field, which contains 2,000 billion cubic meters in facilities in Kovykta field had a crucial gas reserves, has been stalled for years because Gazprom has blocked access to its main export pipeline. role to play in accessibility to major TNK-BP argues it has been unable to produce the 9 billion cubic meters of gas stipulated in its license transportation channels. The highly agreement without access to export markets.” specific nature of the assets created a “Crucially, it was at Gazproms mercy: while Sakhalin oil and gas can be marketed by tanker globally, unilateral dependency between TNK-BP Kovykta is thousands of kilometres inland and its operators are utterly reliant on Gazprom to provide export and Gazprom. infrastructure.”

Supporting Materials Implication Illustrative quotes Site asset specificity “However, constraints imposed by the existing regulatory framework and limited access to Gazprom’s (continued) transportation, storage, and processing capacities often mean that independent producers encounter difficulties monetizing these reserves. Further evolution of Russia’s gas industry will depend upon the pace of liberalization of the sector and opening access to Gazprom’s transportation facilities (TNK-BP Today 2007:5).” Physical asset specificity A new technological approach for “To comply with the production rates established in the license agreements as well as the environmental drilling this particular field. This safety requirements of the license permit, the company introduced a new technological approach for idiosyncratic investment relates to the drilling in the field (Insight TNK-BP, autumn 2006:8).” transaction in question.

Dedicated asset specificity The company refused to produce the “Under the terms of its Kovykta license signed in 1992, TNK-BP was due to produce 9 billion cubic meters of amount of gas stipulated in the license gas this year. It will actually produce about 1.5 billion, rising to perhaps 2.5 billion by the end of the decade. because the domestic market would be TNK-BP says producing that much would mean it would have to flare off most of the gas because there is unable to absorb the quantity of gas. not enough local demand to make use of it.” “Russian authorities have already stepped up pressure on TNK-BP, accusing it of breaking a license agreement on production levels. The prospect of losing the license for Kovykta is likely to soften TNK-BP’s negotiation position.” Entry mode High Asset specificity in combination “TNK-BP’s 50/50 structure stuck out as an anomaly as Russia later limited foreign investors to minority with external uncertainty creates a stakes in strategic oil companies.” greater propensity for oil and gas firms toward entry through equity modes in order to reduce transaction costs. However, the institutional environment restricted the adoption of this governance mechanism.

48 export of gas to the Asian market (Goes, 2013). However, upstream markets are under strict state control and legislative restraints blocked that option by prohibiting BP taking ownership of 50% plus one share for strategic resources, such as the Kovykta gas field (Ahn and Jones, 2008), supporting the proposition that in presence of institutional distance local partners will be more likely to receive a share of equity ownership (Aggarwal and Ramaswami, 1992; Brouthers, 1995; Gatignon and Anderson, 1988). Hence, from BP’s perspective this involves a suboptimal governance structure given the FDI’s degree of asset specificity. Moreover, the legislation on foreign investment outlined that oil and gas projects on the continental shelf were to be exclusively for companies of the Russian state (Gazprom and Rosneft) and that private companies must gain authorization before acquiring more than a 50% equity stake in a strategic sector (Moe 2010; Moe and Rowe, 2008). This observation refers to discriminatory LoF, the explicit regulations exclusively targeting MNE subsidiaries, in order to benefit indigenous firms (Sethi and Judge, 2009). A large proportion of the investments made at the Kovykta gas field can be considered as assets that are immobile even before revenues start being collected (Manzano and Monaldi, 2008). For example, seismic studies, exploration, and production wells, and pipelines, are site specific investments. Additionally, to comply with the production rates established in the license agreements of the Kovykta project as well as the environmental safety requirements of the license permit, TNK- BP developed a new technological approach for drilling in the field (Insight TNK-BP, autumn 2006). The idiosyncratic investment (i.e. technology developed) was attached to the transaction in question to ensure the export of natural gas to China and South Korea, thus maximizing the profitability of the Kovykta field. The export permit created ex post bilateral bargaining situation which gave the Russian state power over TNK-BP, resulting in the potential to exploit this dependence through opportunistic rent-seeking behavior and hold-up (Fan, 2005). In 2004, Gazprom declared that TNK-BP would not get an approval to export Kovykta gas to foreign markets, arguing that the gas should be sold on the Russian domestic market instead (Ahn and Jones, 2008). TNK-BP would do better by continuing to operate as long as they could recover operational and non-sunken assets, even if TNK-BP cannot recover the sunk costs (Manzano and Monaldi, 2008). In other words, with BP already having a large stake in the costs, accepting the coercion to sell low-priced gas on the domestic market was an unavoidable choice. As a result, the Russian government expropriated the quasi-rents by opportunistically changing the conditions of investment. The Russian government could leverage control of its energy transportation networks to achieve external manipulation of energy flows—a form of rent seeking behavior that goes beyond the coercive renegotiation of contracts for fiscal gain. Through monopolistic behavior, the Russian government could extract these rents without direct expropriating sunk/assets or deterring investment.

According to the license agreements, TNK-BP was obliged to produce 9 billion m³ of natural gas a year, whereas annual gas consumption in the region was estimated at only 2 billion m³ annually (Insight TNK-BP, autumn 2006:8). Evidently, the domestic market would not be able absorb the quantity of gas that TNK-BP was required to produce (Ahn and Jones, 2008). Therefore, without other customers or export right to the Asian market, TNK-BP would be unlikely to be able to produce the amount of gas stipulated by the license permit. However, as previously mentioned, in 2004 Gazprom declared that TNK-BP would not get an approval to export Kovykta gas to foreign markets. The fact that BP-TNK was not able to produce the target volumes specified in the license provided legal grounds for the Russian authorities to charge the license operator due to falling short of fulfilling the production quotas. Thus TNK–BP was caught between government complaints of underproduction and a state unwilling to provide the transport infrastructure that would allow the company to produce at full capacity (Domjan & Stone, 2010). In early 2007, the governmental environment regulator underlined TNK-BP’s failure to meet production targets (Ahn and Jones 2008:120). Moreover, it announced that it would investigate TNK- BP for violating environmental regulations at the Kovykta field. BP experienced severe incidental LoF associated with the unfamiliar political environment and institutional environment of Russia. Obscuring the violations of environmental rules and license agreements violations were therefore offering an opportunity for the Russian authorities to pressure BP-TNK to renegotiate PSAs or to provide the state giant Gazprom with access to the project. In June 2007, under this pressure, BP agreed to sell its stake in the field to Gazprom for what analyst said was a price so low it bordered on nationalization, for an estimated price of USD 1 billion (Financial Times, 2007). The deal, however, was never finalized as both parties could not agree on the final price. The global financial crisis in 2008 contributed to delays in the negotiation process which continued until RUSIA Petroleum, the license operator at the Kovykta field in which TNK-BP had a 62,9% stake, filed for bankruptcy in June 2010. TNK-BP failed to recover some of its investments in RUSIA Petroleum. In March 2011, Gazprom acquired the physical assets (e.g. development infrastructure, infield pipelines, wells) of RUSIA Petroleum at an auction, at a price estimated to be around USD 770 million (Goes, 2013). Due to absent data, the effect on BP’s regional profile cannot be calculated. However, the Kovykta was a small part of TNK-BP’s current production at that time, but was important for its future prospects, having the potential to supply large volumes of gas (Financial Times, 22 June, 2007). Estimated annual production in the long term was estimated at 40 billion m³ (Insight TNK-BP 2003:10).

4.1.4 Case study 4: ENI

In Kazakhstan, the Italian company ENI (Ente Nazionale Idrocarburi) was forced by authorities in 2008 to renegotiate earlier established oil deals. The aim of the state has been to improve economic terms and long-term economic benefit for the country by increasing the state share of ownership in the Kashagan oil projects and by placing more of the burden of cost overruns and delays on ENI (Domjan & Stone 2010). Kazakhstan’s government is highly sensitive to foreign control over natural resources due to its central role for its nation’s economy, therefore directing discriminatory LoF to ENI and by implication shaping authorities’ opportunistic behavior. The consortium charged with developing the Kashagan fields was formed in 1997, with ENI chosen as project operator by consortium partners (Shell, ExxonMobil, Total, ConocoPhillips, Japan's Inpex and the Kazakh state oil company, KazMunaiGaz) in 2001, and oil production slated to begin in 2005. Due to the complexity of the project, the consortium heavily relied on complementary FSAs of a specific nature, provided by oil service providers such as CB&I. The project was exceedingly difficult because it was featured by high degree of external uncertainty, such as the unpredictability of the environment and technological uncertainty (Rindfleisch & Heide, 1997). The oil is 2.6 miles below the seabed in a highly pressurized reservoir with a high concentration of poisonous, sour gas. This resulted in unpredictable changes in the standards or specifications of components (Geyskens et al., 2006). Further, the environment of project was unpredictable as it is constantly fighting the natural elements as the Caspian Sea is frozen 5 months of the year. The environmental uncertainties became so numerous that it was impossible to fully consider all of them; these uncertainties exceeded the data processing capabilities of parties with bounded rationality. Hence, TCE theory suggests that the level of market and technological uncertainty or complexity of developing the Kashagan field can be significant factor affecting the likelihood of opportunistic behavior (Williamson, 1975; Williamson, 1973; Rindfleisch & Heide, 1997). Uncertain environments ease subsequent contractual renegotiation, thus it can be hazardous if there have been investments in specific assets (Leiblein and Miller, 2003). These physical and site specific assets are located on 10 man-made islands, Kashagan, 44 miles off the Kazakhstan coast. The ice that freezes to the Shallow North Caspian’s sea bed prevented the consortium from using conventional drill rigs. They built islands of rubble and concrete that house workers, drilling equipment and production facilities. To date, the sunk cost in Phase 1 is $50 billion. These assets are tailored to this specific project and have few alternative uses, owing to their specific (design) characteristics. Additionally, the man-made islands are highly immobile and, thus, the cost of their relocation is very high.

TABLE 11: Within-case analysis ENI Regional Profile ENI 2009 2010 2011 2012 2013 Region NA EU AP NA EU AP NA EU AP NA EU AP NA EU AP % of total revenues 8,5 69 9,9 6,5 73,7 6 8,9 69,6 9,5 12,9 62,5 12,9 6,8 65,5 16,2 Regional orientation Home-region Home-region Home-region Home-region Home-region % of total assets 6,2 58,7 11 6 58,1 10,9 6 57 11,3 6,4 50,8 13,3 7,9 46,4 15,8 Regional orientation Home-region Home-region Home-region Home-region - % of total reserves 4,5 17,3 27,9 3,9 17,5 27,1 4,2 20,1 24,2 5 18,7 24,4 4,8 17,9 26,2 Regional orientation - - Bi-regional - -

Key Events 1990’s 2005 2005 2007 2008 2008 Consortium charged Fine of $300 million for Around 2005, authorities decided ENI Kazakhstan orders Renegotiation of entire No less than 264 with developing the project overruns. had planned to build worker housing ENI to halt work on PSA. ENI lost its operator KazMunaiGaz (Kazakh) Kashagan fields was too near operations that could expose field. role and its stake in the employees will work at the formed in 1997. workers to toxic gas leaks. project was reduced to project. 16.81%. Supporting Materials Implication Illustrative quotes Institutional distance Due to institutional distance, “Kazakh officials accused the group of a host of violations, including environmental issues and fire safety, but analysts ENI is involved in political said the key impetus was Kazakhstan's pursuit of higher revenues from the project.” gaming and more frequent “Laurent Paris, an Oddo-Pinatton analyst, said the move by the Kazakh government was part of its efforts to put appeals to arbitration. ENI is "maximum pressure" on the Eni-led consortium. They are doing everything they can to renegotiate to get better thereby required to undertake costly (due to unfamiliarity with terms," he said.” local laws and customs) “Finally, Kazakhstan this week threatened to revoke the licence held by Italy's Eni for the Kashagan offshore oil field, preparation for these appeals among the world's largest new developments. The authorities cited environmental concerns - an argument and disputes. reminiscent of that used by Moscow in its recent attack on western energy groups in Russia. Like Mr Putin, Kazakh leader Nursultan Nazarbayev wants a bigger share of the revenues.” Site asset specificity ENI is confronted with a lock-in “The government also halted construction of a refinery that Eni's Agip KCO unit is building to process Kashagan oil. situation. Once in place, the Analysts said they believe the work stoppage at Kashagan was aimed at strengthening Astana's hand in upcoming assets involved are highly talks with Eni over the project.” immobile and, thus, the cost of

their relocation is very high.

Supporting Materials Implication Illustrative quotes Site asset specificity “Eni and its partners – ExxonMobil, Royal Dutch Shell, Total, and Inpex of Japan - also face losses from the late start of (continued) the project where much of the Dollars 19bn of investment required for the first phase has already been sunk.” Physical asset specificity Investments in physical assets “The oil far below is under high pressure from natural gas high in toxic, corrosive hydrogen sulfide. That meant were tailored to the specific building a sulfur-removal system onshore, reached by a pipeline, for the portion of the gas to be recovered.” transaction and had few “Sea ice that freezes to the shallow North Caspian's sea bed prevented oil companies from using traditional drill rigs. alternative uses, owing to So they built islands of rubble and concrete that house workers, drilling equipment and production facilities.” their specific (design) characteristics. “There were also the challenges of the Kashagan deposit itself. It's buried about 2 1/2 miles beneath the seabed, under pressures of roughly 500 times that of the atmosphere at sea level. Extracting the oil requires costly stress- resistant pipes, as well powerful compressors to pump the noxious gases back below the sea.” Uncertainty In volatile environments, “Lukashov said Eni had created an opening for the government to raise pressure on the "extraordinarily difficult" external partners will have project by accepting contract terms that were tough to fulfill.” numerous occasions to “The development of Kashagan, in the harsh offshore environment of the northern part of the Caspian Sea, renegotiate their own represents a unique combination of technical and supply chain complexity. The combined safety, engineering, advantage (i.e. act opportunistically and adopt an logistical and environmental challenges make it one of the largest and most complex industrial projects currently inflexible behavior). being developed anywhere in the world.” “Kazakhstan is trying to wrest better terms from foreign investors that negotiated favorable oil contracts in the 1990’s when oil prices were low.”Adil Abylkasymov of Kazakhstan's financial police said Eni was under investigation for over- representing the construction cost of an oil installation while it was operator of a foreign group developing the giant Kashagan field in the Caspian Sea.”

ENI’s presence in Kazakhstan would seem to be less driven by FSA transferability. The FSAs were sufficiently transferable to develop the Kashagan project. The firm did face some location boundedness of its FSAs in transferring them there, evidenced when ENI doubled its budget estimates for the project and pushed back predictions for the start of oil production to 2013. After initial entry, the institutions began interacting with the physical and site asset specificities, driving different forms and expropriating value through the acquisition of quasi-rents. First, Kazakhstan’s government fined the consortium $300 million for project overruns and environmental problems in 2005 (Roberts et al., 2007). Next, citing environmental distresses, it pressured ENI by halting work at the oil field for three months (Reuters, 2007), while simultaneously initiating criminal litigations against ENI’s executives for alleged tax evasion regarding the importation of oil-related equipment (Campaner and Yenikeyeff, 2008). Kazakh officials also suspended construction of an ENI processing facility onshore for allegedly violating safety rules and opened a criminal probe into alleged customs violations by an ENI unit. Analysts said they believe the work stoppage at Kashagan was aimed at strengthening Kazakh authorities hand in upcoming talks with ENI over the project (Reuters, 2007). The process facility was needed for the stabilization and purification of oil, reflecting Joskow’s (1987) example of site specificity, which considers the deliberate location of some electric generating plants next to particular mines. Kashagan crude contains high levels of sulphide impurities, which must be removed before oil can be exported. As a result, the Kazakh government, knowing that ENI has little recourse against its ex post opportunism, has an incentive to appropriate ENI’s profits from the project (e.g. fines); illustrating the hold-up (e.g. suspension) problem explained by TCE theory. In January 2008, Kazakh authorities called for renegotiation of the entire PSA. The site and physical assets exposed ENI to Kazakhstan’s opportunistic behavior in the contract renegotiation. The outcome of these negotiations included the concession that ENI would eventually lose its role as operator of the project, and that KazMunaiGaz, Kazakh’s NOC, would double its stake in the field, becoming an equal partner with other consortium members (Exxon- Mobil, Shell, Total and ENI). The parenthesized companies would each receive 16,8% stake in the field. Before the agreement they held a 18,5% stake. Additionally, Kazakhstan will take 5 percent of profit even before the foreign partners recoup their costs. Under the original contract, the state would have received nothing until the companies had recovered their initial investment. Moves against the Eni-led group echoed Russia's row with a Royal Dutch Shell-led consortium illustrated in case study 1, which was solved only after the partners ceded control in Sakhalin-ll to Gazprom. The renegotiation of the PSA happened before the consortium started production, which happened in 2013. However, a large proportion of the investments made at Kashagan can be considered as assets that are site and physical specific even before revenues start being collected.

4.1.5 Case study 5: Chevron

This chapter focuses on the development agreements surrounding Kazakhstan’s oil field, Tengiz, which alone accounts for more than a quarter of the country’s total oil production. It provides evidence of how Kazakhstan learns to renegotiate contracts with Chevron and shows the interplay between the specificity of the assets concerned, the uncertainty surrounding the transaction, the opportunistic behavior of the Kazakhstan’s government, and their bounded rationality. Located on the northeastern shore of the Caspian Sea, the Tengiz oil field was discovered in 1979, while Kazakhstan was still under Soviet rule. Development of this important underground field proved difficult for NOCs which lacked FSAs related to the technology needed to extract this oil (Hosman, 2009). The field posed a number of technical difficulties related to its depth, the high pressure at which the scalding hot oil emerges from the ground and with the oil itself which is laden with poisonous hydrogen sulfide, which must be removed from and disposed of. Chevron believed it possessed the FSAs to develop this oil. It required specific investment in fixed assets to meld its FSAs with the country specific advantage. The initial processing required technologies designed to conform to the chemical characteristics of the extracted oil. The processing equipment was highly specific to the material at hand, which increased the sunk costs in the activity. Chevron successfully established operations and managed the Tengiz oil field project for about 10 years. After this period asset specificity started to interact with high institutional distance, resulting in additional transaction cost to the MNE because their quasi-rents were appropriated. As oil prices rose from the end of the 1990’s, the government became gradually more assertive, most notably in 2002 when it alleged environmental damages at Chevron’s Tengiz field- nearly a decade after the contract initially had been signed. The PSA was respected during the first period of the project’s life cycle mainly because the project was not yet completed, therefore the site and physical specific assets were not sunk investments, and rent seeking behavior was less attractive. By 2002, conditions had altered, the oil prices were distinctly above the levels of the previous decade, and the investment cycle of the projects had run its course, with specific assets in place (Hosman, 2009). The oil was beginning to turn a profit for Chevron and the government claimed that the terms of the original contract had been too favorable to investors (OECD, 2012). Kazakh officials argued that agreements could be "reviewed" as the circumstances under which they were signed have changed. The high price uncertainty implied a high possibility that a market price would fall outside the contract’s realm of control, resulting in Kazakhstan’s call for renegotiation. The fact that Chevron was already heavily committed, with site and physical specific assets in place, affected the

TABLE 12: Within-case analysis Chevron Regional profile Chevron Year 2009 2010 2011 2012 2013 Region NA EU AP NA EU AP NA EU AP NA EU AP NA EU AP % of total Revenues NA NA NA 31,3 7,6 22,6 32,9 5,5 26,3 28,3 4 27,5 NA NA NA Regional orientation NA Bi-regional Bi-reginoal Bi-regional NA % of total reserves NA NA NA 40,7 3,5 23,7 42,7 3,7 20,8 43 3,6 19,23 NA NA NA Regional orientation NA Bi-regional Bi-regional - NA

Key events 1997 2001 2006 2007 2007 $5.8 million fine on The state obtained a concession from $609 million fine for Spend $2 billion creating additional Relocation of an entire Village. Chevron. Chevron that mandated more responsible environmental damage. oil-cleaning facilities. disposal of the oil’s sulfur by-product. Supporting Materials Implication Illustrative quotes Institutional In a host country with high political “The decision is taken amid mounting resource nationalism in Kazakhstan as the government seeks to seize more of the distance hazards, one avenue through which revenue from vast oil fields operated by foreign groups led by Chevron, Eni and BG, and to shore up its economy against expropriations of quasi-rents may recession.” occur is through manipulation of the “It has taken several steps in recent years to revise terms of production sharing agreements (PSAs) won by foreign oil political system. Chevron is affected majors in the 1990’ s that gave them access to vast oil fields - including Chevron's Tengiz oil field and Eni and BG's directly by state-sector opportunism. Karachaganak.”

Site asset It refers to investments in physical “Analysts said the suspension of work on a second-generation oil refinery and a project to re-inject gas into the oil field was specificity assets that are tailored to a specific most likely being used as a bargaining tool in the negotiations with consortium partners” transaction and have few alternative “Part of the problem is the changing nature of the majors' investments and in particular their big push into huge, long-life uses, owing to their specific (design) assets such as liquefied natural gas (LNG) projects. These involve years of spending on infrastructure.” characteristics.

Entry mode Maladaptation arises due to “When it ratified a new production sharing agreement law in 2005 requiring the national oil and gas company contractual incompleteness in a KazMunaiGaz (KMG), created in 2002, to hold a 50 percent stake in all new deals, Kazakhstan adopted state ownership minority-owned JV. without control by retaining a large role for direct foreign investment in its petroleum sector.” (Luong, 2010) Uncertainty Changes in the environment created “The disagreement between ChevronTexaco and the Kazakh government is the most sensational example to date of an need for adaptation in the contract ongoing dispute with western oil companies over the terms of oil contracts signed in the early 1990’s. Kazakh officials terms defined ex ante. maintain that agreements can be "reviewed" as the circumstances under which they were signed have changed.”

56 parties’ bargaining power. The Kazakh authorities counted on their reluctance to exit (Dellecker, 2011). Opportunistic behavior came to its peak in 2007 when the Kazakh government accused Chevron of failing to meet their obligations under the PSA and threatened to nationalize the project. Kazakhstan was highly sensitive to foreign control over natural resources due to its central role for a nation’s economy. The government needed the revenues from vast oil fields to shore up its economy against the global financial recession, therefore directing discriminatory LoF to the company. Before 2007, Kazakhstan had already negotiated some improvements over a period of time from the company, but not on a contractual basis (Dicken, 2011). First, the government had pushed a $5.8 million fine on Chevron for undue air pollution in 1997. The state also obtained a concession from Chevron in 2001 that mandated more equitable and accountable disposal of the oil’s sulfur by- product (Peck, 2004). Chevron initially terminated its operations in opposition to proposed renegotiations, which is explained as the result of Chevron’s following on its threat, and being taken by surprise that Kazakhstan indeed pursued renegotiations (Hosman, 2009). The state had a strategy that became clear, and after Chevron recalculated their costs, they reversed their decision after two months. Another rendezvous involved the government mandating Chevron to subsidize moving of an entire village, due to the company’s imposition of environmental ills on the villagers. The interactions caused Kazakhstan to reconsider both its reputational position as well as the perceived likelihood that Chevron would comply to the renegotiations and concessions. Chevron’s operations were resumed in January of 2003, with the company agreeing to some revisions in the PSA’s terms. Given the durability and idiosyncrasy of assets, TCE theory points to an almost inevitable desire on the part of Chevron to integrate rather than deal with the cost of contracting and opportunism. However, Kazakhstan’s institutional environment constrained Chevron in selecting the optimal entry mode. In 2002, the state established its own NOC, KazMunaiGaz, to ensure a more active role in its extractive sector (Dicken, 2011). At its outset, this new company was given a mandate to control no less than 50% of the ownership shares in the future oil project to be developed with foreign companies. This observation comprises discriminatory LoF, a phenomenon referring to the explicit regulations exclusively targeting MNE subsidiaries, in order to benefit indigenous firms (Sethi and Judge, 2009). In 2004-2005, Parliament made this mandate into a law and therefore prohibited foreign subsidiaries from entering into its sensitive sectors under majority ownership.

4.2 Cross-case analysis

This section presents the results of the cross-case analysis. The aim of the cross-case analysis is to identify patterns of consistency and differences for all sampled MNEs’ internationalization strategies. The within case analysis illustrates that IOCs are involved outside their national boundaries because they have FSA advantages over host country enterprises (e.g. NOCs). Such advantages lie in knowledge related to the technology used in production and distribution of oil products. The transferability of these FSAs seems to be less of a meaningful explanation for the experienced relative degree of inter-regional LoF. Shell, BP, and ENI did face some location boundedness of their FSAs in transferring them to host country locations. This explains costs overruns which occurred in the Sakhalin-ll project, Kovykta project, and Kazakhstan project, but it was not a significant constraint for the companies’ ability to be present in their regions for developing projects. While these firms do not seem to face boundaries to internationalization in terms of FSA transferability, the institutional factors interacting with asset specificity are of importance in explaining their internationalization patterns. Resource-seeking FDI requires vast amounts of location specific investments to meld FSAs with country specific advantages. All cases illustrate that IOCs needed to build facilities requiring investments in assets which have a fixed location. This observation highlights the presence of site asset specificity, due to the considerable proportion of installation costs that would be sacrificed if the equipment had to be dismantled. The remoteness of projects like Sakhalin-ll and Kovykta also contributed to rising sunk costs and reduced the salvage value of investment. Site asset specificity is also evident in connection with the accessibility to transportation infrastructure. All firms needed to gain access to crude oil and other feedstocks to be able to process and distribute their output in the marketplace. In the case of ENI, BP, and Shell, the institutional environment constrained these companies with terms of access. As with ENI, government authorities denied the construction of a processing facility required for the exportation of oil. BP experienced site asset specificity because Gazprom did not give them access to the pipeline infrastructure for transporting gas to the Asian market. The suspension of a crucial license prevented Shell from completing pipelines between the Sakhalin-ll gas field and its LNG plant. Physical asset specificity is also apparent with respect to the investments made, especially in case of ConocoPhilips. ConocoPhillips built specialized processing facilities required to upgrade crude oil into marketable heavy oil which was designed to conform precisely to the material properties and therefore had low value outside of the transaction relationship. Shell had a similar installation case, with a purpose-built Arctic drilling and production rig, as well as with Arctic-specific bearings being

TABLE 13: Cross-case analysis

Shell (Sakhalin-ll) ConocoPhilips (Orinoco belt) BP (Kovykta) ENI (Kashagan) Chevron (Tengiz) P1: A high degree of asset The interplay between Shell’s Due to the lack of an effective Because of TNK-BP’s Kazakh’s institutions began The fact that Chevron was specificity of FDI will result asset specificity and bounded progressive tax system and a unilateral dependency as a interacting with the physical heavily committed affected in greater inter-regional rationality constraints related weak institutional framework, result of the high degree of and site asset specificities, the firm’s bargaining power. liability of foreignness in to complexity of price contingencies were not site asset specificity, the driving different forms and The Kazakh authorities high institutional distance environmental regulations taken into account. By 2004, Russian government could expropriating value through counted on their reluctance host country contexts for shaped the Russian site and physical specific assets leverage control of its energy the acquisition of quasi- to exit and therefore used MNEs internationalization government’s opportunistic were in place shaping the host transportation network to rents (e.g. fines and halting all available cost-effective strategies. behavior by exploiting country’s opportunistic achieve external manipulation work at the oil field). means to seize quasi-rents. unenforceable parts of the behavior. of energy flows. PSA. P2: Institutional distance The Sakhalin-II PSA governs All contracts were replaced by Legislative restraints Production sharing The establishment of will result in sub-optimal the license for the joint ventures in which prohibited BP taking agreement. Before the KazMunaiGaz meant that no entry modes for the given exploration. Shell had a 55 Venezuela's NOC has at least a ownership of 50% plus one change in ownership, ENI more than 50% of foreign degree of asset specificity. percent equity share. 60% ownership. share for Russia’s strategic held a 18,5% stake. ownership shares in the resources, such as the future oil project would be Kovykta gas field. developed. P3: MNEs are expected to Purpose-built Arctic drilling Specialized highly capital To comply with the The ice that freezes to the The Tengiz field posed a experience high inter- and production rig, as well as intensive oil refineries had to be production rates established Shallow North Capsian’s sea number of technical regional LoF as a result of with Arctic-specific bearings constructed. Refineries were in the license agreements of bed prevented the firm from difficulties related to its physical asset specificity of being needed to cope with fairly dependent on the crude the Kovykta project as well as using conventional oil rigs. depth. It required specific their investments. seismic activity. oil compositions. the environmental safety investment in sophisticated requirements of the license technology. permit, TNK-BP developed a new technological approach for drilling in the field. P4: Oil and gas MNEs are Due to the project’s Limited evidence. Limited evidence. ENI leaned on service Limited evidence. not expected to experience complexity, Shell needed to providers for high inter-regional LoF as access complementary FSAs complementary FSAs of a result of low human provided by oil field service specialized nature. asset specificity of their companies. investments.

Shell (Sakhalin-ll) ConocoPhilips (Orinoco belt) BP (Kovykta) ENI (Kashagan) Chevron (Tengiz) P5: MNEs are expected to The remoteness of this The Venezuelan government TNK-BP’s site specificity ENI built islands of rubble Limited evidence. experience high inter-regional Sakhalin region required ConocoPhillips to build played a crucial role in terms and concrete that house LoF as a result of a high site contributed to raising sunk these refineries and processing of accessibility to major workers, drilling equipment asset specificity of their costs of the development facilities in Venezuela. transportation channels. and production facilities. investments. of this field. The sunk cost in Phase 1 are $50 billion. P6: Oil and gas MNEs are Limited evidence. Limited evidence. Limited evidence. Limited evidence. Limited evidence. expected to experience high inter-regional LoF as a result of high dedicated asset specificity of their investments.

60 needed to cope with seismic activity. ENI’s assets were tailored to the specific project because the ice that freezes to the Shallow North Capsian’s sea bed prevented the firm from using conventional oil rigs. The specialized equipment for the purpose of the projects, laid itself open for subsequent opportunistic actions by host countries. Two observations were noted that relate to human asset specificity. Due to Sakhalin’s complexity, Shell needed to access complementary intangible FSAs provided by oil field service companies. In case of the Kasaghan project, ENI heavily leaned on service providers as well. The reason for these two observations might be driven by the projects’ nature. Both were mega projects - Shell’s project was equivalent to 5 five world-scale projects - making them very complex, needing highly skilled workers. Conclusively, this observation implies that Shell’s and ENI’s level of human asset specificity is reduced by using oil field service companies for technical specialized work. It is noteworthy that no observations signifying the existence of dedicated asset specificity have been made. The significance of the institutional environment for cases under examination aligns with Oliver’s (1991) argumentation, as she asserts that the institutional pressures are of greater importance for firms operating in industries with high uncertainty profiles. All projects had high risks, including factors as geological viability, oil price volatility, economic conditions, and the institutional environment, which increased contingencies. The uncertain environments, be it in different manners, surrounding projects, eased subsequent contractual renegotiations which were hazardous because of firm’s asset-specific investments. As evidenced by Shell and BP with their bounded rationality constraints, the complexity of environmental regulations permitted the Russian government’s opportunistic behavior. The lack of a clear tax system and weak institutional framework in Venezuela created price contingencies which shaped the government’s opportunistic behavior against ConocoPhillips. For ENI, the project was exceedingly difficult because it was featured by high degree of external uncertainty, illustrated through constructs as the unpredictability of the environment and technological uncertainty (Grover & Malhotra, 2003; Rindfleisch & Heide, 1997). The within case analysis illustrates that different projects, with at first glance a similar degree and nature of asset specificity, have different constellations in which quasi-rents were expropriated. While having different constellations, all host country actors incrementally improved their outcomes through bargaining and strategic interaction. Table 13 illustrates that because of the high potential gain from expropriation of quasi-rents, opportunistic host-country actors used all available cost- effective means to seize that return (Henisz and Williamson, 1999).

TABLE 14: Incremental improve in the expropriation of quasi-rents

1997 2005 2007 2008 2008 2008 ENI Fine of $300 Pressured ENI Renegotiation Loses its No less than Kashagan million for by halting of the entire operator role 264 project project work at the oil Production Sharing and reduction KazMunaiGaz overruns. field together Agreement in 2008. of its stake in (Kazakh) with alleged the project to employees tax evasion 16.81%. will work at regarding the project. imported equipment. 1993 1997 2006 2007 2007 2007 Chevron $5.8 million $609 million Dispose of the sulfuric Spend $2 Relocation of Tengiz oil field fine on fine for by-product from the billion creating an entire project Chevron for environmental Tengiz field in a additional oil- Village. excessive air damage. more environmentally cleaning pollution in secure manner. facilities. 1997. 2002 2006 2006 2006 2006 2007 Shell Memorandum Accusation of Construction of two Additional Gazprom Shakalin ll of environmental on-shore pipelines suspension of becomes project understanding requirements had been suspended. crucial licenses major (expected and threat of prevented shareholder Shell to make fines. Shell from of Sakhalin concessions in completing Energy. project’s pipelines. future development). 1990’s 2004 2007 2007 2007 - ConocoPhillips Negotiation Back taxes for Presidential decree: The - Orinoco Oil for new tax the previous contracts would be government Belt project platform three years. replaced by joint expropriated (increase ventures ConocoPhillips’ taxes). in which PDVSA investments in would have at least a their entirety 60% share. without fair compensation. 2003 2006 2006 2007 2007 2008 BP Coerced to Russian Russians investigated TNK-BP Loses Law on Kovytka sell low-priced prosecutors TNK-BP for violating control of foreign project gas on the opened a environmental Kovykta field investment domestic criminal regulations at the until June prescribed market (as a investigation Kovykta field. 2007. that oil and result, TNK-BP into TNK-BP. gas were to was not able be reserved to produce for Russian the target state volumes companies. specified in the license).

Opportunistic behavior shifted away from focusing solely on fiscal benefits toward a more complex schedule of desiderata designed to capture quasi-rents. The cases demonstrate that host countries started with fines and an increase of tax rates, as evidenced by ENI, Chevron, and ConocoPhillips. Russia negotiated for an increased share of the final product, forcing BP to sell its gas on the subsidized domestic market. Subsequently, pressure was exerted on firms like Shell, BP, and ENI by halting work at the oil field on environmental grounds. Subsequently, in all cases host countries called for renegotiation of the entire production sharing agreement and negotiated for an increased level of equity in the PSA itself. ENI’s shares were diluted and the Kazakhstan government took 5 percent of profit even before the company recouped its costs. Shell’s deal with Gazprom reduced its interest from 55 to 27,5 percent. ConocoPhillips’ shares were expropriated without compensation. Furthermore, in case of Kazakhstan, a national oil company was established to eventually operate some or all of its own industry. Each host country across every case had decided what worked best for its individual path. Yet each of these issues represents incremental modification through opportunistic renegotiation by host country’s governments. According to Rugman (2002), a MNE’s bargaining position of the firms is also conditioned by the host country’s acquisitions of skills. As with the case of Chevron – Kazakhstan established its own NOC. This implies that the project management and production competences of Chevron are less indispensable and therefore Kazakhstan’s bargaining power increases. In this situation, the firm’s threat to withdraw or not to make further investment could be expected to have less force. Chevron initially would terminate its operations in objection to the renegotiations, which was purported as more of a threat. Although, the company had been astonished when Kazakhstan indeed demanded renegotiations (Hosman, 2009). Chevron retracted from their decision after two months. The success of the interactions between the host country and the firms under examination — all evidence of learning. According to Moran’s (1974) theory, learning is defined as the increase in government’s confidence in its ability to negotiate for further concessions from the IOCs. Each of the cases under examination show a cumulative shift toward the relative strength of bargaining with the host country. The process of learning and the acquisitions of skills include learning about the oil industry in general, but also what its cohorts have been able to achieve (Hosman, 2009). For example, the Kazakh government had seen that Russia revised PSA rules and succeeded (Financial times, 2010). Not only is understanding asset specificity important in terms of the constraints firms might face with going international, it is also a driver of changes in actual presence shown by the effect of the host countries complex schedule of desiderata designed to capture quasi-rents as illustrated in table 13. By implication, the expropriation of quasi-rents directly affects the way MNEs regional

63 presence is measured. This is especially evident in cases where opportunistic host countries directly took over the IOC’s rights and control over oil production, by forcing the firms to relinquish their privileges regardless of any ex ante signed PSA terms. In the Shell case, it is clearly exemplified that the divestment in the Sakhalin-ll directly resulted in a reduction of 15,7 billion in physical assets, which implicated the assets and proved reserves the firm could claim on its consolidated balance sheet. Especially when one considers that this specific project was equivalent in size to five world- scale projects (Shell annual report, 2007). ConocoPhillips’ shares were expropriated without compensation. Its operations in the Orinoco Oil Belt accounted for about 10 percent of the company's reserve base and 4 percent of its worldwide production (Financial Times, 2007). Due to absent data (arbitration still proceeds), it is not possible to examine the effect on it regional profile. In the case of BP, assets were not expropriated, but quasi-rents were expropriated by way of external manipulation toward energy flows, resulting in a lower revenue stream. It did not affect BP’s regional presence in terms of assets. This observation also highlights the dynamics in MNEs internationalization as the MNEs host country presence and, by implication, region, is not fixed and evolves over time, reflecting regionalization argumentation (e.g. Osegowitsch and Sammartino, 2008).

5. Discussion

This chapter discusses to what extent the working propositions derived in Chapter 2 are supported by the outcome of the analysis that was generated in Chapter 4. IOCs do not seem to face boundaries to internationalization in terms of FSA transferability as they were able to successfully set up oil exploration and extraction projects in remote locations through the transfer of FSAs which were recombined with local CSAs. The concept of asset specificity – as originally intended by Williamson (1975) – should therefore not play a role in the FSA transferability evaluation in the pre-investment period, as it did not drive the MNE’s initial perception of the potential for internationalization. However, the construct has significant explanatory power in explaining changes in regional presence after IOCs and host country governments contracted and investments occurred. The institutional environment affected the degree of asset specificity on inter-regional LoF through its ability to shape possibilities for opportunisms and bounded rationality. Where many countries have eased regulations explicitly targeting MNEs in recent years (Sethi and Judge, 2009), it still appears an important issue for firms operating in the oil and gas industry. Host country governments are highly sensitive to foreign control over natural resources due to its central role for a nation’s economy (Ghemawat, 2001; Penrose, 1968; Morse, 1999). As a result of upstream segments being viewed as having strategic significance, host countries were particularly likely to direct discriminatory LoF at MNEs. As a result of high institutional distance, IOCs experienced incidental LoF especially related to complexity of host country environmental regulations which leaded to more bounded rationality constraints. Discriminatory LoF encouraged host country actors to become more opportunistic in its dealings with the IOCs. MNE‘s site specific assets and physical investments were needed to link their existing pool of FSAs with foreign-location advantages, but it was no guarantee for success in the long term. Assets had been deployed which could not be withdrawn or had less value in a second use, permitting host countries to bear pressure through renegotiation. The MNEs found itself confronted by ‘renegotiations’, ‘adjustments’, ‘back-taxes’, and the like – all manifestations of ex post re-contracting. The ‘obsolescing bargain’ (Vernon, 1971:46) refers to the same phenomenon: once foreign investors have invested large sums in finding resources and establishing extractive operations, the bargaining power shifts to the oil-producing states, especially when the price of the commodity in question is high (Vernon, 1971:51–55). As explained by Vernon (1971:46) and Stevens (2008:5). ‘A poor deal today is a renegotiation of unilateral change tomorrow’ (Stevens, 2008:27). Expropriations of quasi-rents occurred through the manipulation of regulations as well,

65 which meant that the IOCs participated more in political gaming and more frequent appeals to arbitration. In presence of asset specificity, IOCs seek credible commitments from governments in the form of regulations to uphold a stable environment that eliminate the costs of repeated bargaining, which is argued to be lower intra-regional than inter-regional since the political relations with the home government are generally much better than with host country governments (Baron, 1995). The cases support the proposition that, ceteris paribus, local partners will be more likely to receive a share of equity ownership in host countries with high institutional distance. The explicit regulations exclusively targeted the MNEs to benefit indigenous firms, thereby referring to discriminatory LoF (Sethi and Judge, 2009). Findings show that upstream markets are under strict state control and that legislative restraints block options to acquire majority ownership. These findings are aligned with the general assumptions presented by a wide body of empirical literature (Aggarwal and Ramaswami, 1992; Brouthers, 1995; Gatignon and Anderson, 1988; Goodnow and Hansz, 1972). From the perspective of IOCs this involves a less hierarchical governance structure which would be preferable and necessary to overcome higher transactions costs. In presence of asset specificity, the potential for maladaptation arises due to contractual incompleteness in a minority- owned JV (Henisz, 2000). Because IOCs enter the market based on PSAs in presence of site and physical asset specificity, this inter-firm relationship was ‘subject to costly haggling and maladaptiveness’ (Williamson 1985, p. 89).

Table 15: Working propositions and their level of support

WP Description Results 1 A high degree of asset specificity of FDI will result in greater inter-regional Supported LoF in high institutional distance host country contexts for internationalizing MNEs. 2 High institutional distance will result in sub-optimal entry modes for the Supported given degree of asset specificity. 3 Oil and gas MNEs are expected to experience high inter-regional LoF as a Supported result of a high physical asset specific of their investments. 4 Oil and gas MNEs are not expected to experience high inter-regional LoF as Partially supported a result of low human asset specificity of their investments. 5 Oil and gas MNEs are expected to experience high inter-regional LoF as a Supported result of site asset specificity of their investments. 6 Oil and gas MNEs are expected to experience high inter-regional LoF as a Not supported result of high dedicated asset specificity of their investments.

The results underline that the explanatory power of each asset specificity dimension is dependent upon the nature of the transactional activity involved and the industry in which the MNE operates. Site appears to be a particularly useful construct for sharpening the appreciation of factors

66 affecting the IOCs’ internationalization process. The significance of this dimension is unsurprising given the fact that site asset specificity is by its very nature the most sizeable in terms of economic value and non-redeployability content, and therefore the one most likely to give rise to lock-in or hold-up scenarios (De Vita, 2011). Hence, the greater degree of site-specificity embedded in the transactional relationship in the oil and gas industry, the greater the quasi-rent stream. Several observations related to physical asset specificity were made as well, with plants destined for the production of qualities which may not be used for other transactions. As expected, human asset specificity proved useful at times, in the context of oil and gas transactions. IOCs lean on service providers for highly specialized FSAs. This is also reflected in the service companies’ proportion of their revenue on R&D expenditure for the development of specialized FSAs, which is significantly higher than that of the IOCs (Table 14). Schlumberger and Halliburton seem to be spending between four and ten times as much on R&D compared to the oil majors as a percentage of their total sales. From the perspective of the IOC, it is unlikely that specific knowledge is going to be outsourced because it is a sensitive aspect of business that raises confidentiality issues. Outsourcing (e.g. using service providers) appears to counter the TCE prescription on human asset specificity (Lamminmaki, 2005). By implication of using complementary FSAs, the level of human asset specificity of IOCs’ upstream investments is reduced and consequently, resulting in a lower quasi-rent stream, therefore improbable to give rise to hold-up scenarios.

TABLE 16: Oil spend on R&D in 2013 (source: Financial Times) Segment IOCs IOSCs

Company Royal Dutch Total ExxonMobil Schlumberger Halliburton Shell As % of sales 0.3% 0.6% 0.2% 2.6% 2.0%

It is noteworthy that no observations signifying the existence of dedicated asset specificity have been made. It appears that dedicated asset specificity is not one of the most suitable construct for understanding the nature of the oil and gas transactions and for explaining IOCs inter-regional LoF. The explanation for this finding might be driven by the sector’s nature. The oil and gas industry is a capital intensive sector which requires large MNEs to be able to generate the investments funds necessary for capital intensive projects (Al-Obaidan & Scully, 1993). These businesses require large capital layouts and involve long lead times and thus payback times, making decisions to invest challenging. Consequently, IOCs decide positively upon investing in host countries driven by the business opportunities on a country basis, or a more generally at a market-level, and not on a particular transaction (e.g. specific customer). This is also illustrated in the TNK-BP case. The company refused to produce the amount of gas stipulated in the license because the domestic

67 market would be unable to absorb the quantity of gas that TNK-BP. Furthermore, even if there will be cases where IOCs proceed to investment with the prospect of serving a specific transaction, these investments could be seen under the prism of physical asset specificity. The distinction between these two dimensions is notably difficult to articulate (De Vita, 2011). In general, this study implies that different types of transactions or industries will have varying degrees of asset specificity. While site specificity is vital to the oil and gas industry, and transactions such as outsourcing of restaurant services by hotels (Lamminmaki 2005), it may have limited applicability in the context of information technology (IT) outsourcing. Similarly, physical asset specificity may have less relevance in service industries (Zaheer and Venkatraman, 1995), as investments in physical components and tools are unlikely. Asset specificity in the services sector is likely to be primarily of a human asset specificity nature, implying that any appropriation of quasi- rents is going to mostly affect the revenue measure of regional presence of firms in that sector. Basically, in this case there are different constellations of asset specificity, which does not result in changes of ownership, but will constitute changes in revenues. For a different transaction or industry, the constellation of asset specificity actually changes how the regional presence of the firm is measured.

6. Conclusion

In exploring firm strategies and developing theoretical representation of asset specificity within the regionalization literature, this study concentrated on sample of leading firms in the oil and gas industry. The over-riding conclusion of this study is that asset specificity is useful when attempting to understand internationalization of oil and gas companies. Results underline that the explanatory power of each asset specificity dimension is dependent upon the nature of the transactional activity involved and the industry in which the MNE operates. Upstream value-chain activities entail transactions whereby oil and gas firms make considerable commitments. Each foreign location required a significant amount of investments in specific assets to meld existing FSAs with CSAs. In this industry, site and physical asset specificity are the only two types of Williamson’s four dimensional typology with explanatory power. The sectors’ high degree of site and physical asset specificity of FDI interacting with high institutional distance contexts resulted in greater inter- regional LoF for the IOCs internationalization strategies. Under these inter-firm relationship conditions of high asset specificity, the higher transaction cost to be incurred to safeguard against costly opportunism make internalization, rather than market-based transactional, more efficient, and hence preferred, governance structure. Results however showed that the institutional context blocks that option and this eventually makes the inter-firm relationships susceptible to costly haggling and maladaptiveness. Discriminatory hazards encouraged host country actors to become more opportunistic in its dealings with the IOCs. They used all available cost-effective means to seize quasi-rents, from a focus solely on fiscal benefits toward a more complex schedule of desiderata designed to capture direct and indirect benefits. By implication, the expropriation of quasi-rents directly affects the way MNEs regional presence is measured. This was especially evident in cases where opportunistic host countries directly took over the IOC’s rights to and control over oil production and by forcing the IOC to relinquish their rights regardless of any ex ante signed PSA terms.

6.1. Limitations and future research

Whilst this study has added to the current state of knowledge, it must also be accepted that there are several limitations to the research. This study suffers from the normal shortcomings associated with case studies based on a limited sample of observations. Despite this, its findings provide insight into an industry type that has not received much attention in the regionalization literature.

Moreover, it provides an exploration of the ways that asset specificity might manifest itself in oil and gas industry. The availability of the quantitative data for this study did not allow for a full exploration of asset specificity dimension as a driver of changes in actual presence caused by the host countries’ opportunistic behavior to capture quasi-rents. Related to qualitative data, interviews may provide more in-depth insights in the difficulties these firms experience in their foreign operations and how the specific asset specificity constructs impedes or enables internationalization. This research contributes to regionalization theory by investigating an underexplored industry in this stream of research. Evidently, more research is needed to compare and contrast the effects of different asset specificity dimensions on inter-firm relationship performance across different industries and with reference to different transactional activities. Having discussed the upstream focused work, it would also be worthwhile to explore possible differences between MNEs’ upstream and downstream internationalization patterns as well. The economic organization of the international oil industry could well serve as a fair example, considering that its production chain is conventionally divided into upstream (exploration and production), midstream (processing and transportation) and downstream (refining, marketing, and retailing) segments. This industry may serve as a possible case for examining variations in importance of asset specificity along the value chain for explaining MNEs inter-regional LoF. In this study, asset specificity has been investigated in an attempt to provide a rich consideration of this construct in the oil and gas industry. However, no statistical tests have been performed on the data. This case study may represent the stimulus for future quantitative examinations of the effect of asset specificity on MNEs internationalization process, thereby improving and refining the theory.

6.2. Implications

Present research not only contributes to the current theoretical debate in the regionalization literatures but also provides valuable insights to practitioners. The resurgence of resource nationalism, makes it important for IOCs to have the right balance between numbers of projects. Investments would more wisely be staggered across different locations and initialize different projects in variating time periods. These elements need to be considered in portfolio management as it enables IOCs to mitigate the myriad forms of uncertainty associated with institutional distance. Moreover, the evaluation of institutional distance needs to have a pertinent standing in discounted cash flow calculations, thereby taking into account the whole project life cycle. Additionally,

70 investment in oil and gas infrastructure can be accompanied by investment in social programs and transport infrastructure. This may reduce the potential for outcry against IOCs when oil prices rise and their profit increase. IOCs might need to redefine their strategy as their future holds greater sharing of revenue and operational control with the host countries as resource holders. This changes the nature of their portfolios as they might become involved with projects on a fee for service basis rather than owning a stream of future oil and gas production.

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