From volume to value: the transformation of National Oil Companies 0 1 0 2 H ydrocarbon-driven economies R ole of the NOC — the “ contract Co n t e n t s in emerging markets with the S tate”
0 1
Hydrocarbon- d r i v e n e c o n o m i e s in em erging m a r k e t s
The unfortunate convergence of increasing incentives, and critically, on subsidy W eak oil prices have led to a decline oil supply and weakening global demand support and social welfare programs. in current account balances and, for has created an oversupplied market and This is increasing the pressure on the maj ority of emerging economies caused a sharp and sustained decline in the National Oil Companies ( NOCs) dependent on oil revenues, have caused international crude oil prices. F rom its and changing the very nature of the a significant slowdown in their ability to last peak in J une 2 0 1 4 , crude oil prices relationship with the S tate ( their key fund economic activity. Despite putting have declined by over 5 5 % 1 during the stakeholder) . in place some austerity measures, and an last thirty months. The recent agreement overall decline in spending from previous between OPE C and non-OPE C producers H ow is changing the nature of this years level s , the fiscal break-even prices to cut output has provided much needed “ contract with the S tate” impacting the for the maj ority of M iddle E astern and reprieve to the oil market by setting a floor NOC, and what ensuing repercussions may North A frican countries is still higher than price. H owever, we do not see that this this have on the oil and gas industry? the prevailing oil price, causing deficits development will change our outlook of for many national budgets. W hile some S econdly, what changes in the contract longer-term low prices. countries have used the cushion available would the NOC need from the S tate to from the government reserve surplus set in place an equation that enables F or many emerging economies heavily accumulated during the boom years, this a sustainable return to equilibrium for dependent on oil revenue, the dramatic option becomes ever more challenging national finances, in what is generally fall in prices has unleashed a chain when the oil price outlook remains weak agreed to be the twilight era for the reaction with far-reaching consequences for the nex t few years. on government budgets, sovereign oil economy? investment, economic development
1 E Y A nalysis of data from Thomson R euters Datastream
1 | From volume to value: the transformation of N ational Oil Companies 0 3 0 4 0 5 NOCs and future fiscal edefining the NOC strategy S etting the path for the NOC responsibility moving from “ volume to value” transformation j ourney
The OPE C member countries’ Figure 1 : Drop in OPEC’ s revenue
annual oil ex port revenues OPE C’s oil ex port revenue trend are estimated to decline for the third consecutive year to 8 0 0 U S $ 7 5 3 b Decline of % in 5 5 revenue U S $ 3 4 1 billion ( not adj usted 7 0 0
for inflation in This 6 0 0 is 3 4 % lower than the 2 0 1 5 5 0 0 revenues, and nearly one- U S $ 4 0 4 b U S $ 3 4 1 b fourth of the 2 0 1 2 levels, and 4 0 0 ( E I A estimate) notably the lowest in the past 3 0 0 1 0 years. This constituency 2 0 0 has recorded a j oint current account deficit of nearly 1 0 0 U S $ 1 0 0 billion in 2 0 1 5 0 the first time in nearly two 2 0 1 4 2 0 1 5 2 0 1 6 P
decades) , down from a U S $ 2 3 8 ource I , analysis billion surplus in 2 0 1 4 .
F igure 2 depicts the vulnerability of certain i e e a e t fi cal deficit f acc lated pl e countries deficit coverage, several of whom are actively ex ploring options to iscal deficit billion and surplus position in sovereign wealth funds to access loans from the I M F and the W orld cover deficit in years B ank. I t also brings to attention the 8 0 .0 3 5 .0 possible fragility of other countries, which 7 0 .0 will become significantly more exposed 3 0 .0 the longer it takes for oil markets to regain 6 0 .0 2 5 .0 U S $ 7 0 + levels. 5 0 .0 2 0 .0 A s a result, a more ex pansive strategy is 4 0 .0 required, bringing into play the national 1 5 .0 Y ears
illion 3 0 .0 budget itself, maj or changes to costly 1 0 .0 subsidy programs, and potentially also the 2 0 .0 core function of the NOC. 1 0 .0 5 .0 A good ex ample of the ex tent of change 0 0 impacting NOCs and hydrocarbon- A ngola K uwait Nigeria S audi UAE M ex ico M alaysia R ussia dependent economies is highlighted in A rabia S audi A rabia’s V ision 2 0 3 0 . The country’s iscal deficit illions S overeign F und Coverage No. of Y ears fiscal reserves are estimated to provide cover for over six years and the ongoing ource analysis of various sources shortfall in revenue has resulted in S audi A rabia actively, and successfully, tapping There is an urgent need for NOCs around the w orld — particularly in heavily into the international bond market to raise dependent hydrocarbon economies to formulate a long term plan to fulfill debt to cover part of the deficit their obligations to the State, over and beyond short-term tactical responses. The m anner in w hich these NOCs are operating, their structures, and their contributions to the State, are sim ultaneously changing; a transform ation so profound that it stands next to the nationalizations of decades past as the m ost defining moments of their respective histories
From volume to value: the transformation of N ational Oil Companies | 2 0 2
R ole of the NOC — t h e “contract w ith t h e S t a t e ”
NOCs are maj or players in the global oil Figure 3 : Evolving role of N OCs and gas industry, accounting for 5 8 % of global reserves and of production Country N OC % of revenue ey d i e and c an e in c nt act it t e tate They often play a leading role in emerging f il and gas to market economies, and are normally t e fi cal called to be the custodians of a nation’s d et resource development and energy security. S audi A rabia A ramco 8 0 % • M ax imiz ation of value in company listing y definition, the hydrocarbon-driven • L ocal content program to drive suppliers to have localiz ed economy prospers by the efficiency with manufacturing in kingdom which the country’s oil and gas assets are • Double natural gas production monetiz ed, and the proceeds of which • I ncrease of downstream value capture contribute significant proportions of the K uwait K PC 9 4 % • I ncrease output to 4 mb/ d by 2 0 2 0 S tate’s revenue. H owever, the NOCs role • Delivery of natural gas for industrial growth and energy mix rarely stops there, and depending on their • I ncrease of downstream value capture • E mployment and development of Nationals home country, they may also be policy makers, regulators, trading commercial UAE A DNOC • I ncrease output by 3 .5 mb/ d entities or a combination of such functions. • M aintain competitive edge by being commercially driven • I mprove productivity across group businesses They fulfill their government mandates, • I ncrease of downstream value capture through a diversified group of structures along the entire hydrocarbon value chain, Nigeria NNPC N/A • I ncrease output • educe import of refined products in various manners, including partnerships • Increase efficiency and reducing bureaucracy by splitting with foreign oil and gas companies, local NNPC to into seven independent units partners or in government-to-government • S uccessful implementation of Nigeria Content A ct ( G2 G) cooperation agreements. A ngola S onangol 7 0 % • estructuring of onangol to drive efficiency • Two new entities — the A gency and the S uperior Council — M oreover, in many hydrocarbon- will be responsible for regulation and administration. driven emerging markets, NOCs also act as engines of economic and social ource analysis of media reports development and have ex plicit or implicit duties such as national infrastructure There is no standard role or function to optimiz e around sustainable economic development and social welfare programs. for NOCs, and their political, social value. B ut for NOCs whose governments K az M unayGas ( K M G) , the NOC of and economic importance as a maj or have very high reliance on oil revenue, K az akhstan for instance, has been tasked revenue generator, employer and the situation is very different. These with integrating the country into the innovator has stretched their “ contract governments face a more ex istential level world economy and making sure that with the S tate” over time beyond pure of threat, firstly from the continuation of the company’s growth and development extractive efficiency an oil price that yields less than half of translates into more general economic its 2 0 1 4 revenue, and secondly from the growth for the country. A t the lower dependency end of the oil tangible growth of energy alternatives revenue continuum, NOCs will be looking
3 | From volume to value: the transformation of N ational Oil Companies demand that are starting to pull the era of make longer term sense to satisfy more A framework that takes into account both peak oil to within a horiz on of 2 5 years. domestic energy demand through gas NOC obligations and critical elements I n this contex t, it is likely to be necessary imports ( or even solar) and to ex port for discussion/ re-negotiation as the to adopt a more ex pansive policy and to more crude. The additional revenue can “ new contract with the S tate” is set out redefine the role and function of the NOC then be reinvested in related, but non-oil, in F igure 4 . commercial ventures that are then spun- F urther along the continuum between low off once established in order to grow gross The immediate focus is on the ex pectations and high levels of dependency, it may be domestic product ( GDP) . faced by the NOC, to sustain and grow necessary to start thinking of NOCs less in this new era of oil price environment. as a ‘ National Oil Company’, and more in The aim for a ‘ National Company’ would W e identify this ( critical) ex pectation on terms of them being a ‘ National Company’. be to max imiz e the multiplier effect of its the NOC as the new fiscal responsibility domestic investments and contracting regime, which places a clear emphasis on I n such a role, a National Company’s strategy In this way, it help to fulfil the profitability and quality of earnings investment strategy needs to be pushing contract with the state in a different way, greater economic diversity alongside by actively growing the wider economy maintaining or increasing production. ( and resulting tax revenues) . A t this F or ex ample, some NOCs are actively end of the continuum, debt or equity investing in solar power to generate steam financing is unlikely to represent a path to for injection into the oilfields instead a sustainable new budget equilibrium in of burning valuable natural gas which what may prove to be the twilight era the can be channelled for manufacture of oil economy. higher value added products. I t may also
i e ne c nt act it t e tate
e ne tiatin n te al c itical ele ent S trategies it t e tate
M aximize state revenue M anage and grow output p e a in and f c n p fita ility ef e lat y inancin t ct e apital penin e t environment pp t tate ind t iali ati n ec n ic di e ificati n cal c ntent de el p ent nc atin ne ine a ea and ec y te M anage taxes and tariffs ed ce idie t incentivize investment pand al e c ain t capt e Foreign investment eate p fit int ent e e ta li ent in c nt y Increase private and ainin and de el p ent f ei n ne ip pl y and ed cate citi en and cal c ntent e pl y ent d cati nal ect pa tne ip inc ea e t ei ill Reduce imports and inc ea e al e f l cal n e t ent in content requirement i e inn ati n it aidin t ei Partnering on innovation centers nati nal de el p ent
From volume to value: the transformation of N ational Oil Companies | 4 0 3
NOCs a n d future fiscal responsibility
ow oil prices have triggered fiscal i e p in p ice it n n di e ified ea nin a de t tightening measures in many emerging Change in revenues ( % ) and net margin ( bps) : 2 0 1 5 vs. 2 0 1 4 markets. E qually, prolonged low oil prices may further weaken the fiscal balances of 0 % 2 0 -4 .4 1 .0 1 .3 0 these S tates despite such efforts. M any are -6 .0 -1 .5 0 -2 1 .3 responding by taking difficult yet fiscally -1 0 % -5 % -6 % -2 0 responsible measures such as -4 0 -1 6 % -6 0 • R educing ( sometimes eliminating) -2 0 % -2 1 % -8 0 subsidies on fuel and energy prices -2 5 % -1 0 0 -3 0 % -2 6 % -2 6 % -1 2 0 • Cutting salaries for government -1 4 0 employees across all levels -4 0 % -1 6 0 -4 0 % • Cutting capex programs -1 8 0 -1 6 9 .0 -1 7 6 .0 -5 0 % -2 0 0 • M ax imiz ing oil and gas production volumes in the short term to partially CNPC R epsol Pemex R osneft
compensate for lower prices Petronas E copetrol Petrobras Pertamina The sharp decline in global oil prices has shattered direct revenues and tax receipts Change in revenues ( % ) Change in net margin ( bps) and created significant budget tensions for oil-dependent emerging economies. The ource Capital I less diversified NOCs have experienced a much bigger impact from the drop in W e are witnessing an unprecedented and project financing The level of oil price. number of governments considering economic diversification, and thus relative partial privatiz ation or listing of their contribution of the oil and gas sector to the NOCs to raise capital, ex ploring alternative country’s GDP, is pivotal on the urgency of means of funding capital requirements action required.
5 | From volume to value: the transformation of N ational Oil Companies i e nitiati e y e n ent and t ed ce deficit ai e capital att act ne in e t ent
Restructuring of oil sector and IPO of state- ow ned Opening up sector for planned IPO of N OC entities in oil and gas foreign investors Introducing Ni g e r i a E g y p t p ect financin I r a n Privatization
K u w a i t R u s s i a
Saudi A rabia
M e x i c o IPO of S audi Aramco implementation of Opening up of Vision 2 0 3 0 oil and gas sector for foreign investors Om a n
Restructuring of Oman Oil Co. B r a z i l A n g o l a Reforms to increase foreign investment. N OC Restructuring announced plans for maj or of N OC UAE I n d o n e s i a divestment and IPO T a n z a n i a of subsidiary. N ew regulatory Restructuring IPO of non- core business regime for of ADN OC ow ned by N OC oil and gas
Privatization/efforts to reform sector
ource analysis of media reports
From volume to value: the transformation of N ational Oil Companies | 6 0 4
Redefining the NOC s t r a t e g y : m oving from “volum e to v a l u e ”
W ith revenues per boe at less than half E nterprise value is only one part of the etc. F or ex ample, S audi A ramco is likely to of their 2 0 1 4 peak, NOCs are quickly equation. The increase in in-country value be a maj or new adopter of this principle becoming aware of the need to shift away an NOC can bring to their respective as a result of its desire to complete an I PO from a focus on volumes towards the country and how that value is used and max imiz e the earnings that should be realiz ation of value. and reinvested for the nation’s wealth generated from its listing. redistribution, j ob creation, infrastructure NOCs are largely volume- and budget- focused organiz ations, while the ex tent of capital employed — and the effectiveness i e t an f ati n nde tandin t e le f capital of that capital — have generally been secondary considerations. I n this capital- A ll of these roles will change the NOC primary accountabilities and responsibilities due constrained environment, the focus to the core focus on capital efficiency needs to be on ex tracting the max imum sustainable value from capital assets or, in other words, doing more with less. W hile moving from volume to value is not a new concept for I OCs, the concept has only CE O been more recently embraced by NOCs. • Responsible for delivering “quality earnings” to the The NOCs enterprise value can be shareholders • Holds the business considered in different ways, but with a accountable for earnings constant financial point of view one that and capital efficiency represents the quality of the free cash flow CF O COO it generates and the return on capital it is • Drive commerciality • Driving a P/L mindset in able to deliver. in the business operations • Value management • Operating margin becomes the norm becomes the norm • Focus is on • Focusing on capex/ ROCE/ROI/EBIT opex/reliability Ca p i t a l
Allocation based on maximization of ROCE/ROI/EBIT at the key activity level ource
7 | From volume to value: the transformation of N ational Oil Companies hile each NOC will have their own specific ex cellence and operational ex cellence and issues, the constant thread is the reality of by breaking down traditional silos across The NOCs who will succeed in capital constraints, and the urgent need for the value chain, will the NOCs be able to max imiz ing their potential enterprise NOCs to “ commercializ e” their business. I n achieve their goal of max imiz ing return in value, and thus max imiz e their this contex t, NOCs will have to develop new the most efficient manner contribution to the nation, will be operational models that those who succeed at building capital To begin addressing this, NOCs — ex cellence and operational ex cellence • F ocus on building commercial acumen particularly in M iddle E ast and North into their culture. throughout their organiz ation across A frica – are establishing new investment the entire value chain of operations committees, tasked with allocating capital across the portfolio of business activities in • E nsuring decisions are made which a significantly more efficient manner One fully max imiz e and sustain commercial of the more impactful outcomes of this returns from the entire eco-system approach will be focusing on the CA PE X portfolio by; The roles of finance, championed by the CF O, as well as operations, championed • S eeking to eliminate uneconomic by the COO ( or A sset L eaders) , are also proj ects undergoing significant change s depicted in F igure 7 , the ex pectation of the CF O is • R epositioning and re-grouping proj ects to drive commerciality in the business. The seeking to leverage synergies C O, and finance at large, need to actively partner with the business to ensure that • M inimiz ing potential overlaps across the the allocation of capital is optimiz ed to portfolio. drive key performance indicators such as W ith capital budgets falling, tighter R OCE and R OI . There is increased need to choices are required between and within embed the impact of core operations to categories, and a strong, consistent basis E B I T throughout the business. for value evaluation is required. S ymbiotically, the COO, and the core asset S imply stated, for NOCs, the common operations, will need to embed a P/ L mind- value denominator will always remain the set across the asset teams — alongside net government cash flow it is able to operational reliability, to complete the generate — however, the quality of earnings operations value equation. will define its real value Only by having a fully coordinated effort, i.e., by establishing a culture of capital
From volume to value: the transformation of N ational Oil Companies | 8 0 5
Setting the path f o r t h e NOC transform ation j o u r n e y
To conclude, the case for NOC I ndustry transformations are never simple. NOCs must change the way they relate to transformation is clear. The coming years F or an NOC to be able to max imiz e the their government in order to maintain their will be defining for the NOCs as they quality of its earnings and contribution critical roles within the global oil and gas progress to become “ commercial NOCs” , to the S tate, many aspects critical for the market and within their governments. B y fully embracing the need to embark on the successful NOC of the future will need to implementing changes that max imiz e their capital transformation. be understood and addressed, which are margins and increase capital efficiency, included in F igure 8 . NOCs will position themselves for survival and growth through this new era of abundance. i e t an f ati n nde tandin t e le f capital
Revenue streams and diversification Balancing national versus commercial objectives The NOC has multiple revenue The evolution of the NOC serves as a key contributor of the country’s GDP while streams from a diversified fulfilling both national objectives and the profitability expectations of key core business portfolio stakeholders of the entity. of investments. Internationalization The NOC creates a significant international presence with investments in major high-growth-potential markets. Autonomy The NOC has a well-structured contract with the state and the oil and gas regulator, which enables the entity to allocate NOC capital that will enhance its Funding long-term value and produce transformation It has a combination of external quality of earnings. commercial finance, equity investors and free cash flow from operations.
Vertical integration People, capabilities and The NOC is fully integrated to capture skills development and maximize income in the entire Enabling technology The transformed NOC has oil and gas value chain. well-developed centers of excellence in The NOC uses cutting-edge technology key locations, and its staff are able to and digital solutions to improve conduct market-leading training efficiency and productivity that helps it programs. retain status as one of the low-cost producers.
9 | From volume to value: the transformation of N ational Oil Companies EY contacts
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From volume to value: the transformation of National Oil Companies | 10 EY | Assurance | Tax | Transactions | Advisory
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