Exxon Aramco?

THE WALL STREET JOURNAL: ExxonAramco?

By RIAD A. AJAMI

August 18, 2004; Page A10

Even as Western leaders proclaim growth and promise hope, recent oil-price increases continue to fuel anxieties and herald trouble in world markets. OPEC’s impractical quota system, increasing demand (especially in the U.S. and China), and the resulting inadequate oil supply are driving price increases. The political conditions in Iraq, Venezuela and Russia, as well as paranoia and the threat of terrorism, have also contributed. Such conditions will continue to influence oil markets until we enhance spare capacity and meet growing demand.

Cross-industry alliances between OPEC state-owned oil companies and multinational Western firms offer a way out of the looming crisis. By this method, each participant would be encouraged to leverage its most valuable assets. With the facilitated exchange of resources, these market-based alliances will not only bring oil prices to a more sustainable level, they will ensure a continued source of revenue for oil-producing countries and an incentive to maintain and develop production facilities and provide for needed additional spare capacity.

There is little doubt that the global economy has suffered from the grave uncertainty generated by violent fluctuations in the price of oil. In short succession, the price of crude has peaked and seemingly settled, but it will inevitably shift again, launching the market into another round of price volatility. Current price increases, if maintained, could check the emerging global economic recovery and threaten to disrupt predicated corporate cost structures. This, in turn, could lead to higher inflation and slower GDP growth. Recession is also a looming possibility — from 1960 to 2003, U.S. economic recessions have followed major increases in the price of oil.

Isn’t it time for U.S. policy makers to help create a climate for market-based solutions that can stabilize oil prices and ensure access to global supplies? Trading and encouraging market access to the largest oil-consuming market (the U.S.) in exchange for secure oil supplies from OPEC state-owned oil companies is in the best interest of U.S. consumers. In the immediate future, we should also demand that OPEC spare production capacity, particularly that of Saudi Arabia (at about three million barrels daily), be made available. At the same time, we should take the lead position to help create an oil industry “working group” to facilitate oil supply/marketing alliances between the oil producers and multinational oil companies. Such market-based alliances effectively represent a supply-chain integration which could smooth out price fluctuations and ensure adequate oil supplies. These linkages will force state-owned oil companies to behave more in tune with global markets where they are likely to have a vested financial interest and stake.

The precarious position of the U.S. is only a reflection of the oil market’s global imbalance. While the U.S. produces 8.8 million barrels of oil daily and holds around 5% of the world’s reserves, the Middle East controls over 40% of global output and two-thirds of reserves. Clearly, some degree of volatility is inherent to the industry. The global oil market is defined by two distinct, but parallel, relationships: state-owned vs. public companies and producers vs. distributors/consumers.

This division by function generally mirrors a division by ownership, with state-owned entities dominating production, and private-sector “majors” dominating distribution. The interests of each group have been characterized as inimical to the others. Of the 15 largest oil-producing companies, four of the top five are state-owned by OPEC countries. The largest, Saudi Aramco, has a daily output of 8.4 million barrels, followed by the National Iranian Oil Company and Pemex of Mexico. In contrast, the largest multinational, ExxonMobil, produces 4.5 million barrels daily, while BP Amoco produces 4 million barrels and Royal Dutch Shell only 2.2 million barrels per day. Abundant reserves and lower production costs (about $2 per barrel extracted) give state-owned companies further advantage over Western counterparts, who are competing for risk capital and adequate rates of return.

Nevertheless, the publicly traded oil companies are dominant in downstream markets. They control the majority of the necessary oil infrastructure, particularly retail outlets, and have direct access to the world’s largest consumer regions. Currently, the U.S. consumes approximately 20 million barrels a day, over half of which is supplied by imports. By 2010, world oil demand is expected to grow from 80 million to 92 million barrels daily. Such growth in consumption, especially in China — the second largest oil consuming country — should be a source of concern for the U.S. It is estimated that two-thirds of this oil will come from Middle East state-owned oil companies, and China’s competing demand could challenge our access to oil.

As the U.S. dependence on Middle Eastern oil grows, so does the dependence of state-owned oil companies on U.S. consumption. In today’s oil market, neither the state-owned oil producers nor the U.S. consumers can afford to lose what the other has to offer. This sensitive symbiosis should be supported by market-based alliances and U.S. policies, in which access to the U.S. oil-consuming market is exchanged for secure oil supplies from OPEC state-owned oil companies. Multinational oil companies can move upstream toward oil reserves, while state-owned companies move downstream toward coveted customers. This long-sought balance can thus be achieved and sustained through mutual need. These market-based alliances are in effect production/marketing ventures formed between a state-owned oil company — Saudi Aramco, to name one — and a U.S. multinational oil firm — ExxonMobil, say — which holds a large network of retail gasoline stations.

These production/marketing alliances can be transitional in nature (one to two years) while also being subject to extensions. Under such alliances, a state-owned company agrees to supply enough crude to its venture partners at a favorable, competitive and agreed-upon fixed price for the duration of such agreement. U.S.-based gasoline outlets would then add the state-owned oil company’s logo or name to their pumps. State-owned oil companies could then benefit through increased brand-name recognition as a reliable oil supplier. Brand-name recognition and a large market share would be of immense strategic benefit to such a firm, as in the case of Saudi Aramco, which coincidently holds the world’s largest oil reserves. In short, U.S. oil companies will be trading access to their network of gasoline stations in order to secure adequate oil supplies at a stable price. Under this scenario, joint-venture strategic alliances could benefit U.S. oil companies by allowing some to achieve “critical mass” — an industry commanding height whereby a firm attains global reach, scale and scope while retaining a measure of market-agility. This development is an imperative for firms wishing to achieve a high status of viability and competitiveness within the oil industry.

* * *

U.S. oil companies could also improve performance by simultaneously replenishing depleted reserves, shedding declining and unproductive oil fields and assets, reducing expenditures on redundant exploration, keeping up with consumer demand, and enhancing shareholder value. This could result in a more viable and competitive U.S. multinational corporate sector. Natural gains will encourage both entities to respond to the dictates of global markets, where they have an overwhelming interest. Price stability at a sustainable level can thus be achieved for all consumers through supply/marketing alliances. Most of all, a market-reliant system, such as the one proposed here, could effectively attenuate OPEC’s political motives. Oil will then become a commodity where market fundamentals and options could prevail.

Mr. Ajami is director of the Center for Global Business Education and Research at the University of North Carolina, Greensboro.