By Mark Finley
Fellow in Energy and Global Oil
The number one question I get asked these days is, “what’s the future of the IOC business model”?
International Oil Companies (IOCs) have been under tremendous pressure since the global COVID-19 pandemic emerged. Oil prices have collapsed (along with their share prices). Not only has global oil demand fallen sharply as COVID-related shutdowns impacted transportation, but fears of long-term decline have gained traction in the face of renewed focus on sustainability. Industry analysts are now racing to reduce their future oil demand forecasts and accelerate the timing of “peak oil” demand.
So when the question comes, it’s always about the “O” in IOC…what will falling oil demand mean for these companies?
It’s a great question, and a fair one. But I find myself increasingly worried about the “I” and the “C” as well.
First the “O”.
Concerns about “peak oil” aren’t new. From the time Colonel Drake drilled his well at Titusville, Pennsylvania in 1859, oil watchers have worried about running out of oil supply. Oil industry historian Dan Yergin has noted at least five periods when there was widespread fear that the world was on the verge of running out of oil. Yet global production was at an all-time record before US shale growth forced OPEC and other producers to cut output last year – and would have hit a record this year without the pandemic’s forcing producers to cut supply.
What’s new this time around is the notion that the “peak” may be driven by a lack of demand rather than a lack of supply. The prospect of more aggressive action to address climate change – including “green stimulus” as governments try to boost economies hurt by the pandemic – is real. And declining demand would indeed have severe implications for companies that produce, refine and market oil, not just through a shrinking market but also lower prices as producers compete for a smaller pie.
Of course, the future is uncertain. Will more aggressive climate policies be adopted? Will EVs become more competitive? Alternatively, will countries put climate policy on the back burner while they struggle to raise living standards? Will consumers shun mass transit post-COVID and actually drive MORE? BP’s recent outlook sees declining oil demand in all its scenarios; the International Energy Agency sees a range of outcomes from flat-to-declining; while OPEC sees continued growth. Investors have clearly voted with their funds: ExxonMobil (XOM -1.6%), Chevron (CVX -1.5%), Royal Dutch Shell, and BP have seen their shares fall by an average of over 50% this year, while the S&P 500 has registered a small increase.
SO the “O” concern seems to be a valid one—but not the only one.
What about the “I”?
International companies thrive in a globalized marketplace…which is under threat. A backlash against globalization has been building for years—see the protests at WTO meetings in Seattle twenty years ago. And those forces seem to have accelerated in recent years: according to the WTO, global merchandise trade grew by nearly 8% yearly for the 20 years leading up to 2014, but by nothing since. (And with a large pandemic-driven decline projected this year…) Dollar-denominated oil trade has also reversed course in the past five years (using a proxy based on BP’s oil trade and inflation-adjusted price data), though this is a reflection of lower oil prices rather than volumes.
If anything, concerns about supply-chain vulnerability/robustness stemming from the COVID-pandemic threaten to accelerate this process of de-globalization. Growing disparity in the strength of environmental policies may also slow global trade in the future—see recent EU statements about placing a border tax on carbon. Populist governments around the world are focused on ‘make it here’ policies. And at times both environmental and security considerations are used as a rationale for protectionist policies.
The bottom line is that the global business that many of these companies depend upon (and are built around) may also be under threat.
…and that brings me to the “C”.
A company is a social construct; it doesn’t exist in a vacuum. The Western-style multinational corporate business model that we take for granted is a product of a very specific political and economic culture: It is not the only business model. The oil & gas industry lived through a wave of nationalizations in the mid-twentieth century. More recently, we’ve seen the rise of State Capitalism and national champions. With a rise of populist governments, the temptation to seek advantage through political access grows: We need only to look back a few months to recall a host of independent oil & gas companies beseeching the Federal Governmentas well as the Texas Railroad Commission for protection from global competitors. Each of these alternatives would represent a fundamental shift from the current IOC business model.
Finally, IOCs face growing challenges from NOCs and national champions in accessing global hydrocarbon resources as well as rapidly-growing demand markets in emerging countries—pressures exacerbated by the forces discussed here. Only two IOCs based in the OECD rank in the top 10 oil producing companies worldwide. Moreover, IOCs are under much more pressure from ESG investors than non-OECD companies—especially NOCs and national champions.
I’m not writing this to alarm you…well, actually I am. But only as a motivational tool!
The idea that international trade based on comparative advantage is a win-win, is the rare concept that almost all economists agree on. The efficiency and reach of modern corporations have reduced costs and expanded consumer choice.
But by this point I hope I’ve convinced you that we can’t take this rules-based, international system of free enterprise for granted. Public trust in the benefits of this system has eroded, sometimes fed by the industry’s own short-sighted behavior, fueling the obstacles I’ve described above.
We frequently describe business with sports analogies. While business leaders rightly focus on winning the game, we can’t ignore the condition of the playing field. As a Buffalo Bills fan, let me run with a football theme: Josh Allen is a great QB, but if he blows out his knee because of a poorly-maintained field, the Bills don’t win. A football field doesn’t mow itself.[*] (And now you see how the title connects Big Oil with mowing a football field!)
And so: If you believe in this model, make the case for it: To the public, to policymakers, to investors, and to competing systems around the world.
How to make the case? Recognize that the playing field needs to be well-maintained in addition to building your own winning team. Don’t oppose reasonable environmental policies, like efforts to reduce methane flaring. Make sure you demonstrate benefits for consumers as well as shareholders. Support efforts to establish and enforce global ESG standards. Be transparent.
Working to rebuild public trust may not help manage the industry’s “O” risk…but it can certainly help with the “I” and “C”. And those are (equally) important considerations for the industry!
[*] And yes, I know the Bills play on artificial turf. Please permit me some creative license!
This post originally appeared in Forbes on October 27, 2020.