• Petroleum

• Crude oil

• Natural gas

• LNG

• Fractionation

• Oil fields

• Dissolved gas drive

• Gas-cap drive

• Water drive

OIL EXTRACTION

& PRODUCTION

• How was oil used after its discovery in western PA? What products did it replace?

• How geologists find oil now?

OIL EXTRACTION & PRODUCTION

•Regulation of drilling (“drilling mud” and other wastes) and refining (air pollution and other wastes)

OIL EXTRACTION

Common law

Rule of capture

Monogahela case (PA, 1907): “every landowner or his lessee may locate his wells wherever he pleases … He may crowd the adjoining [landowner] …”

OIL EXTRACTIONDoes the common law tend to ensure production at the maximum efficient rate of recovery? If not, how might we achieve this goal?

•“unitization” and “pooling” by regulation in U.S., solving the collective action problem. By single (government) owner most everywhere else.

•“secondary recovery”

How did the world oil business change in the 1970s?

Lower 48 Crude Oil Reserves & Production, 1945-2000

0

5

10

15

20

25

30

35

40

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Cru

de

Oil

Res

erve

s, B

illio

n B

arre

ls

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Cru

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Oil

An

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, Bill

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Lower 48Reserves

Lower 48Production

PeakProduction1970

PeakReserves1959

Economics of Oil Industry

• Shift from control by private oil companies toward state-owned companies

• Declining profitability

View of western oil companies in developing world

Nationalization

1917: Russia

1931: Mexico PEMEX

1970s: Libya, Iran

Do nations have a legal right to nationalize private assets?

“act of state” doctrine in international law

OPEC and Oil Prices:

• 10/73-3/74: OPEC embargo more than doubles world prices

• Israeli-Egypt war

• 1979-83: price more than doubles again

• Iranian revolution

• OPEC price controls

• Post 1983: declining OPEC power

What is OPEC’s goal in supply/price-setting?

What is impeding OPEC’s ability to control prices now?

Production by National Oil Companies

Source: US EIA “Hubbert’s peak”

Source:

BP

Oil Resources in Developing Countries: Political Risk

What is “political risk”?

What sort of political risks can undermine the value of a firm’s investment?

Nationalization/expropriation Policy change (regulatory; monetary) Terrorism/war/civil strife

“concessions” Lease term & lessee duty

to produceAbsolute ownership of

subsurface

How can firms contemplating investment in developing countries predict political risk?

Timeline

Early 20th c: rapid growth of international oil industry

1930s-70s: Latin American nationalizations

1960: OPEC formed

1960s-70s: Middle east nationalizations

1973: first oil crisis in US; price controls instituted

1977: second oil crisis in US

Oil Resources in Developing Countries: Political Risk

Assessing/Predicting Risk:

• “Grand Tours” approach

• “Old Hands” approach

• Quantitative analysis

• Qualitative analysis: “Delphi” technique

Do you think political risk is predictable?

Oil Resources in Developing Countries: Political Risk

“corporate managers came to view risk analysis as an ‘ivory tower exercise,’ rooted in academic theory rather than managerial practice.”

HBS Note on Political Risk

Then how do companies (or their investors or insurers) decide when political risk is too great? What characteristics do you think are correlated with political-legal stability, or negatively correlated with political risk?

Oil Resources in Developing Countries: Political Risk

What should investors look for?

1. Veto points in the policy process (e.g., divided government, separated powers, federalism)?

2. System stability, but political change?

3. Strong independent bureaucracy & judiciary?

In other words, “credible commitments against arbitrary policy changes”: e.g., “takings clause”?

How can corporate managers manage political risk?

Oil Resources in Developing Countries: Political Risk

• Insurance

• Sharing risk with host nation

Do you think something like the World Bank’s risk guarantee for investment in electric infrastructure could work for oil exploration? Is it needed? Should the World Bank be in the business of reducing investor risk?

Modern Petroleum Agreements: 3 approaches

1. Legislatively-prescribed terms

2. Delegation to national oil company

3. Hybrid system

Standardization equal treatment Rigidity (how?) Government bargaining power?

Flexibility best deal (how?) Comparison problems potential corruption or discrimination

Modern Petroleum Agreements

Selecting contractor/developer:

What are the differences between these approaches? What are the advantages/disadvantages of each?

• Discretionary licensing

• Auction

• Open Competition

Modern Petroleum Agreements

What are the important differences between these different methods of foreign participation in developing domestic oil resources?

• Licensing/concession

• Joint venture

• Production sharing agreement

• Service contract