Energy Information Administration

Privatization and Globalization of Energy Markets

6. The Privatization of State Energy Companies

This chapter reviews the range of investment opportunities presented to FRS companies that have arisen as a result of privatization of various state energy companies. In part, the roots of these privatizations lay in the globalization of the world economy and the growth in international trade and investment. Also, in part, these privatizations evolved due to the receding of communism in Eastern Europe and the Former Soviet Union (FSU) in recent years and to the growing conviction that free enterprise advances the wealth of nations better than nationalized industries and planned economies. Recent efforts by different countries to privatize state-owned industries have varied considerably. Consequently, in this chapter privatization is defined as any movement towards a market-driven economy that replaces public ownership and control with private ownership and control.

For the FRS companies, privatization may turn out to be one of the most important developments in world petroleum markets in recent times. Upstream, privatization offers opportunities to add crude oil and gas reserves of a magnitude unseen since the discovery of the North Sea and Prudhoe Bay. Downstream, FRS company investment opportunities have also grown considerably as a result of recent privatizations. In addition, opportunities in natural gas pipelines, electric power generation, and in non-petroleum energy investments have also grown considerably. To the extent that privatization and other economic reform promotes greater economic growth and with it greater energy demand, FRS companies stand to benefit from increased sales.

Recent privatization efforts have been global phenomena occurring in countries as different as China and Colombia. However, for the FRS companies, privatization efforts in the countries of the FSU, in China, and in Latin America may prove most consequential and are discussed more extensively in this chapter. The sheer size of these regions' national petroleum industries accounts for this emphasis. Together, the FSU, China, and Latin America account for 29 percent of world crude oil production. Although the potential of these regions for the FRS companies remains enormous, China and the FSU comprise relatively newly-opened areas of exploration and development activity while in Latin America the FRS companies have been active to some degree for decades. In 1994, the FRS companies produced little crude oil in China and the FSU, while FRS companies produced 236,000 barrels per day in Latin America.

For these regions to continue to develop their petroleum resources, foreign capital will play a critical role. In part, this is due to the vast expenditures needed to meet energy development plans in coming years. For example, between now and 2000, China alone has energy investment needs that have been estimated at $300 billion {see Endnote 154}. Several nations have thus far raised billions of dollars through privatization. For instance, since 1989, Argentina has raised at least $20 billion in revenue through privatization {see Endnote 155}. Mexico has raised a similar amount through privatization of state-owned industries {see Endnote 156}. For state petroleum companies being privatized, the FRS companies have much to offer. In addition to being sources of highly needed capital investment, FRS companies offer technological and managerial expertise, as well as access to crude oil and refined product outlets. FRS companies also offer newly-privatized companies a means of quickly adapting to the business practices of the global market economy.

Progress in privatizing state petroleum companies has been uneven across and within regions. On more than one occasion, previous progress at privatization has suffered severe setbacks. The risks attendant to forming joint ventures have been mostly political in nature. For example, billions of dollars of planned FRS investment activity in the FSU are currently on hold pending passage of a property rights law. As another instance, in August 1995, one of the state governments in India decided to pull out of a deal recently negotiated with Enron to build and operate a $3-billion electricity generating plant {see Endnote 157}.

Opportunity in the Former Soviet Union

The breakup of the FSU and its move toward a market-driven economy offer new exploration and production opportunities in one of the world's largest petroleum-producing areas. In no other region does the successful transformation of state-run petroleum companies into privately-owned enterprises hold out more promise for the FRS companies. In areas of the FSU where privatization's progress has been slight, the lifting of restrictions on foreign investment in petroleum has still resulted in attracting FRS company investment dollars. However, foreign investment in petroleum operations also entails greater risks in these regions. So far, FRS companies have expressed a willingness to invest several billions of dollars to develop FSU petroleum resources {see Endnote 158}. However, until the FSU achieves a much greater degree of political stability and economic reform, these investments will largely be deferred.

The breakup of the Soviet Union resulted in the creation of three substantial crude-oil-producing political entities, the Russian Federation, Kazakhstan, and Azerbaijan. In 1994, the three areas produced over 95 percent of the 7.4 million barrels per day of crude oil produced in the FSU countries {see Endnote 159}. At 6.4 million barrels per day of crude oil production, the Russian Federation was the largest of the three producers, followed by Kazakhstan (435,000 barrels per day) and Azerbaijan (195,000 barrels per day).

Privatization in these regions holds many potential benefits for both the FSU and the FRS companies. For the FSU, privatization provides a means of obtaining badly needed foreign technology, investment capital, managerial and technical expertise, and access to global petroleum markets. The FRS companies could also become instrumental in reversing the precipitous decline in FSU crude oil production. The FSU reached its peak in 1988, when crude oil production averaged 12 million barrels per day (or 20 percent of total world production), and the FSU was the world's largest producer of crude oil. However, several years of underinvestment, artificially low prices, outdated technology and equipment, poor management, and, most recently, political turmoil, have been responsible for a five-year slide in FSU crude oil production. By 1994, FSU production of crude oil had fallen by over 4 million barrels per day.

For the FRS companies, privatization means access to a new source of reserves and new markets for equipment and technology sales. FRS companies and other foreign investors are currently negotiating over the development of an estimated 11 billion barrels in reserves in Russia alone {see Endnote 160}. Ironically, the 1990's are not the first time U.S. oil companies have looked to this region as a major source of future petroleum reserves. Both Standard Oil (which in one way or another was a precursor to the FRS companies Amoco, BP America, Chevron, Conoco, Exxon, Mobil, and Sun) and Royal/Dutch Shell (corporate parent of Shell Oil) had struggled for control of Russia's vast oil riches late in the last century. As Daniel Yergin noted in The Prize, "Time after time in years past, the fortunes of Russian oil have had significant global impact, beginning in the nineteenth century, when the development of an oil industry in Azerbaijan around Baku broke the global grip of Standard Oil and indeed the virtual monopoly of western Pennsylvania" {see Endnote 161}.

At present, ambitious plans to develop FSU resources have faltered largely due to uncertainties surrounding oil and gas laws, changing tax regimes, and the ability (both physically and legally) to export crude oil to international markets. Although only two FRS companies reported petroleum production in FSU countries in 1994, at least nine of the FRS companies reported exploration and development spending in FSU countries, while several more FRS companies have reported ongoing or planned projects. If economic reforms continue and political stability improves in FSU regions, the FSU could eventually rival the North Sea in its importance to the FRS companies as a source of petroleum investment, production, revenue, and income. To entice foreign capital and investment, the FSU must offer investors the opportunity to earn acceptable returns on their investments. To do so, the FSU must respect private property rights, permit access to markets, liberalize prices, and offer fair taxation. Reliable transportation and access to foreign markets are other hurdles faced by both Russian and foreign companies. Exasperation with such difficulties has led some western companies to withdraw from their FSU investments entirely {see Endnote 162}. Others are putting existing and future projects on hold, choosing to wait until an adequate legal structure that allows for protection of private property rights through enforcement of contracts and protection of property is in force.

The Russian Federation

Production by joint ventures has been increasing, but still they contribute only a fraction to overall FSU production. One frequently cited problem with investing in Russia is the slow progress in enacting legislation, particularly the Oil and Gas Law (which establishes the authority for production-sharing agreements) designed to clarify the uncertainty surrounding jurisdiction over resources, licensing, and taxation. Foreign companies want a stable legal framework in place to protect them from the many risks associated with investing in the region. Currently, production sharing agreements are not recognized by Russian law. What started out three years ago as promising legislation is still going through the bureaucratic process where it is currently being redrafted.

In Russia, reform of the market economy has been undergoing mass privatization under President Yeltsin's broad Presidential powers. Yeltsin's November 1992 decree set the stage to establish 10 to 12 vertically integrated oil companies from former oil producing associations of the FSU. So far, nine vertically integrated regional companies have combined production associations with refineries and marketing associations. Lukoil is the largest and it has been ranked in the top 20 largest world oil producers for the last two years.

To attract direct foreign investment, the Russian government will allow foreign acquisition of up to fifteen percent of the major Russian oil-producing companies during the second phase of privatization {see Endnote 163}. So far, Atlantic Richfield (ARCO) is the first and only western company who announced its intention to acquire an equity stake in a Russian petroleum company. For $250 million, it intends to secure a 6.3-percent interest in the largest vertically integrated Russian oil firm, Lukoil {see Endnote 164}. The difficulty of maneuvering around the many legal and bureaucratic obstacles in Russia may be the incentive for ARCO to make the investment, whereby Lukoil will help guide ARCO through the maze of developing Russia's large reserves in its effort to increase its oil reserves in exchange for ARCO's capital and technology.

There are five major areas of production in the Russian Federation, three of which have attracted the interests of the FRS companies: The Arctic Region, The Russian Far East, and Western Siberia.

• The Arctic Region
• The Russian Far East
• Western Siberia
• The Caspian Basin
• Kazakhstan
• Azerbaijan

  Latin American Petroleum Privatization

  As in the FSU, privatization in Latin American countries has occurred in an atmosphere of rapid economic transformation. In the early 1990's, most Latin American countries embarked on a series of market-based economic reforms. These reforms have in some cases been universal, covering virtually the entire range of economic activities fiscal, monetary, commercial, trade, and industrial policy. Central to Latin American economic reforms has been the privatization of a range of formerly state-owned industries, from phone companies to electric utilities to petroleum companies. Legal reform also has been key to privatization, particularly with regard to treating foreign companies and domestic companies equally.
  
  Although amounting to only 6 percent of total FRS foreign exploration and development spending in 1994, FRS company Latin American exploration and development spending has grown twice as fast as FRS exploration and development expenditures in other foreign locales (Table B34) and nearly doubled between 1987 and 1994 (Figure 26). Current FRS activity in Latin America is far flung, involving several countries and several types of activities. The following section highlights some of the more important recent FRS company developments in several nations.

• Argentina
• Mexico
• Venezuela
• Brazil
• Colombia
• Ecuador
• Peru

  China's Energy Privatization

  Efforts In recent years, China has also attempted to partially open its doors to foreign investment in domestic energy ventures. In many ways, China offers an alternative to the FSU and Latin America as a future source of petroleum reserves. China's state oil companies currently produce nearly 3 million barrels of crude oil per day, making China the world's sixth largest producer (See the box entitled "The Chinese Petroleum Industry"). China is the world's largest producer of coal, which accounts for nearly three-quarters of all energy consumed in China. By contrast, coal accounts for less than a quarter of energy consumption in the United States.
  
  
  
  In sharp contrast to the FSU, part of China's enormous potential stems from the strength of the Chinese economy, which has realized double-digit growth rates in recent years. Although both China and the FSU have been emerging from state-planned economies, China's current positive economic predicament is substantially different from that of the FSU. China's energy "problem" lies in the inability of its domestic energy industries to produce enough crude oil, petroleum products, coal, and electricity to keep pace with the rapid growth in domestic demand. Despite China's vast energy resources, China finds its current economic upswing jeopardized by energy shortages. Price controls and underinvestment have also hampered China's crude oil productive capacity. By the year 2000, crude oil consumption in China is expected to exceed domestic production by over a half million barrels per day. However, petroleum production is not the only energy industry facing difficulties in China. The rapidly growing Chinese industries continue to be hampered by periodic refined product and electricity shortages.
  
  As with the FSU, China's attraction to foreign petroleum companies is enormous. However, China's potential for foreign investment has been hamstrung thus far by many of the same shortcomings found in the FSU. The erratic pace of China's petroleum industry privatization efforts is in part due to such difficulties as uncertainty over government policies, uncertainty over obtaining foreign exchange and materials, bureaucratic inertia, the absence of clearly defined property rights, and other legal issues. Recent FRS company investments have been directed at all aspects of China's energy industry from oil and gas production, to petroleum transportation and refining. Electricity generation and coal mining have also been targets of FRS company investment (Table 28, PDF format).

  Chinese Energy and FRS Companies

  In the past, upstream investments of western energy companies were restricted to offshore regions developed jointly with the China National Offshore Oil Corporation (CNOOC), as China's government wished to obtain sorely needed foreign technology without having to surrender control over resource bases. Earlier efforts to invite foreign participation were also hindered by confiscatory royalties and tax rates. Since 1982, there have been four rounds of bidding on offshore contract--two-thirds of which were eventually awarded to U.S. companies {see Endnote 210}. By 1993, U.S. companies had spent $1.2 billion in offshore exploration and $300 million on offshore development. In early 1993, China opened the potentially promising--and largely unexplored--Tarim Basin to foreign companies. The Tarim Basin is located in a desolate and underdeveloped region in western China and is expected to have substantial crude oil reserves. Although encouraging joint ventures, the central government still wields a great deal of control over allocating investment, supply, and price in the domestic petroleum industry. For instance, in March 1994, the Chinese government placed severe restrictions on the importation of crude oi and refined products. For the FRS companies, most investments have been limited to joint ventures with Chinese firms, although in 1994 ARCO acquired a 9.9-percent interest in China's Zhenahl Refining and Chemical Company Limited. This opening is in part due to the previously discussed inability of China to generate the enormous capital needed to expand an energy sector which has failed to keep pace with the rapid pace of Chinese economic growth in recent years. China is also sorely in need of foreign energy technology and equipment as much of China's energy industry is much less developed relative to world standards.