The Petroleum Economics Monthly

Transcription

1 The Petroleum Economics Monthly Philip K. Verleger, Jr. Volume XXXII, No. 12 December 2015 Big Oil: Nightfall Is Coming Publication Date: 1/24/ , PKVerleger LLC. All rights reserved. ISSN Reproduction of The Petroleum Economics Monthly in any form (photostatically, electronically, or via facsimile), including via local- and wide-area networks, is strictly forbidden without direct licensed permission from PKVerleger LLC. Contact Dr. Verleger at 540 Fox Run Dr, Carbondale, CO or

2 (This page left blank intentionally.)

3 Big Oil: Nightfall Is Coming Philip K. Verleger, Jr. PKVerleger LLC Disclaimer: Although the statements of fact in this report have been obtained from and are based upon sources that PKVerleger LLC believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions and estimates included in this report constitute the judgment of PKVerleger LLC as of the date of this report and are subject to change without notice.

4 (This page left blank intentionally.)

5 Table of Contents Summary... 1 The Coming Nightfall for Big Oil: Lessons from History... 5 A History Lesson... 5 Will Big Energy Be Railroaded?... 9 Conclusion Glossary Statistical Appendix List of Figures Figure 1. Oil Industry Global Upstream Capital Expenditures, 1986 to Figure 2. Spot Natural Gas Prices at Henry Hub, Monthly Average, 2005 to Figure 3. Number of Wireline and Wireless Phones in India, 2004 to Figure 4. Monthly Freight Car Loads in the United States, Seasonally Adjusted, January 2000 to October List of Tables Table 1. Factors that Brought Down the New York Central Railroad vs. Factors that May Bring Down Big Oil i

6 (This page left blank intentionally.) ii

7 Summary In the popular HBO series Game of Thrones, the major characters repeatedly say winter is coming, meaning they realize the world as they know it is coming to an end. In similar fashion, nightfall is coming for Big Oil. To illustrate this, our cover graphic shows a corporate logo moving slowly but inevitably toward its sunset. When we first created this image, we used the logo for Gulf Oil, which vanished in 1985 into the Chevron system. One could just as well have used logos for Kodak, Univac, Baldwin Locomotive, or thousands of other companies that have vanished into the night after flourishing. But Shell, or to be more formal, Royal Dutch Shell? Many will ask how we can even think one of the world s largest oil producers could disappear from the corporate field of play. The answer is simple. Many companies that dominate in one period of history are gone in the next. We chose Shell to make the point. At this time, we think it very likely that Shell will not exist in twenty years. We may be wrong. Shell could survive. If it does, though, it will be very different from what it is today. Furthermore, if Shell continues, it will operate in a world where most major investor-owned multinational oil companies no longer exist. Today, one can include at least eleven firms in this group. 1 Twenty years from now, their number may be down to three and the survivors will be but shadows of their former selves. History, in other words, will repeat. Nearly five years ago, IBM celebrated its centennial with a four-page advertisement placed in The Wall Street Journal and other major newspapers. It begins with this sentence: And then continues: Nearly all the companies our grandparents Admired have disappeared. Of the top 25 industrial corporations in the United States in 1900, only two remained on that list at the start of the 1960s. And of the top 25 companies on the Fortune 500 in 1961, only six remain there today. Some of the leaders of those companies that vanished were dealt a hand of bad luck. Others made poor choices. But the demise of most came about because they were unable simultaneously to manage their business of the day and to build their business of tomorrow. 2 IBM was justified in celebrating its one hundred years. Today, though, one wonders if it will still number among the world s leading firms in It may. In contrast, no traditional members of the international oil community will likely be among the elite then as they are today. Big Oil will be gone, replaced by irrelevant oil. The IBM ad provides a clue as to why Big Oil will shrink: The technology field is cruel to those who fail to make the leap from era to era, but tech companies are hardly alone. The hand of commoditization spares few. The question becomes, as leaders, what do you do about that. 1 For reference, these firms include BP, Chevron, ConocoPhillips, ENI, ExxonMobil, Marathon, Petrobras, Rosneft, Shell, Statoil, and Total. 2 IBM advertisement celebrating the beginning of its one hundred first year, The Wall Street Journal, June 16, 2011, pp. a10-a13. 1

8 Our lesson learned: You have to keep going to the future. Partly, it s about creating new spaces to move into investing in good times and bad. This requires a kind of institutional patience; upside benefits rarely come this quarter, or even next year. Sometimes, they never come. But it s not about what you create. It s also about what you choose to leave behind. Every institution, by its nature, favors the ideas, products, and services that made it successful. Leadership often requires shedding emotional attachment to that heritage. The IBM authors were likely thinking about successes and failures in the computer industry. For example, they pointed to the Prodigy online service, noting that it may have been a good idea but was ahead of its time, as an example of firms where expected returns sometimes, never come. The concise advice offered by IBM applies to the oil industry. Many firms today face a grim future or no future at all because they have failed to leap from era to era, that is, they continue to favor the strategies and practices that brought them success in the past but will not in the future. The large multinational companies are also encumbered by investments and institutions that cannot be easily abandoned. Historically, projects in the fossil-fuel industry have been hugely expensive, taken years to complete, and then operated for decades if not centuries. Some of the earliest oil fields developed in California still produce almost a century later. Some working coal mines go back even further. Some pipelines and infrastructure are also more than a century old. The long-lived nature of the fossil-fuel industry, particularly the oil sector, differentiates it from the computer industry, where a product or project s lifespan is often less than ten years. The principles expressed by IBM, though, continue to be valid because external changes can have the same impact on an industry where expansion and innovation require decades (oil, for example) as those where rapid change is the norm. To see how, one need only examine another capital-intensive industry, one where projects also take decades to complete. This industry railroads has already undergone a transition that could portend the future of large multinational oil companies. Railroads and the oil industry share several characteristics. Railroads were once considered essential to national economic development. They played key roles in the US Civil War, the Franco-Prussian War, World War I, and World War II. Railroads were key to the United States development, although economic research by Nobel-winning economist Robert Fogel suggests the industry s publicists overstated their contribution. 3 Politicians showed enormous deference to railroad magnates for decades. In the end, though, firms collapsed, brought down by disruptive technologies, institutional barriers, and changes in consumer preferences and lifestyles, regulation, and taxpayer support for competitive transportation modes. In the United States, railroads were revived by government intervention but only after bankruptcies and restructurings that greatly diminished their role in the economy. A review of the collapse of key railroads reveals that many of the industry s problems occurred because, as the IBM copywriters noted, the industry stayed wedded to the old way of doing things. The decline of the US railroad industry carries a warning for multinational oil companies. Like the railroads, these firms have been essential to the development of national economies. 3 See Robert William Fogel, The Union Pacific Railroad: A Case in Premature Enterprise (Baltimore: Johns Hopkins Press, 1960) [ 2

9 Like the railroads, the oil industry has played a key role in the major global conflicts of the twentieth century. And like the railroads, oil has played an important role in the development of the United States. Executives from the largest oil companies, too, have enjoyed deference from politicians and the public. Their credibility has been enhanced by the many tomes praising their work and lauding their history, books such as The Prize. 4 However, as Proverbs 16:18 reminds us, Pride goes before destruction, a haughty spirit before a fall. Here we argue that the investor-owned multinational oil business today confronts threats similar to those that brought the railroad industry to its knees fifty years ago. Among the forces threatening oil are disruptive technologies, institutional barriers within the industry, the arrogant belief that its approach is best, and competition from taxpayer-supported alternatives despised by Big Oil. Ultimately, the industry may be doomed because, to paraphrase the IBM copywriters, it stubbornly continued to favor the ideas, products, and services that made it successful. In the years to come, historians will probably write that like railroads, mainframe computer manufacturers, and photographic film makers the oil industry s demise resulted from unanticipated external forces. Highways were a key contributor to the problems experienced by railroads. Personal computers undermined mainframe computer firms. Digital imaging technology ended the domination of the silver-halide film industry. In the case of oil, nightfall will come due to the introduction of renewable fuels, fracking, alternative energy sources (wind and solar), changes in consumer preferences, and, most significantly, the realization that a successful fight against global warming requires much of the world s oil resources to remain unburned. 4 See Daniel Yergin, The Prize: The Epic Quest for Oil, Money, and Power (New York: Simon & Schuster, 1991) [ 3