A century after the breakup of John D. Rockefeller's Standard Oil empire gave birth to the modern oil industry, Rockefeller's heirs are being eclipsed by nimbler rivals with less to lose -- as well as less nimble but powerful state-owned companies around the world. Meanwhile, Big Oil has mostly turned inward over the past 25 years, pursuing a strategy of ever-greater industry consolidation without either producing new significant sources of oil and gas or addressing the need for alternative energy sources.
To understand their current position, the oil majors would do well to look at the history of a very different industry: information technology. There is a reason why IBM could not create Microsoft, Microsoft could not create Google, and Google could not create Facebook. While a company's performance may require economies of scale, innovation often benefits from the opposite, since it necessarily comes at the expense of the existing business -- and therein lies Big Oil's problem. Big Oil either must reinvent itself -- and quickly -- or become obsolete. . . .
Rising oil prices over the past dozen years have largely masked any problems the companies have in terms of financial performance; the considerable increase in the value of the majors' underlying assets has been enough to keep share prices steadily climbing. Yet the companies' ability to find new oil reserves to replace current production remains anemic, and they lag far behind independent oil and gas producers in net profit margin.
Most tellingly, the supermajors, despite vast exploration resources and technical expertise, missed the shale gas revolution altogether. Recent breakthroughs in the exploitation of these previously untapped natural gas resources were spearheaded by independent producers and oil field service companies who were small and spry enough to experiment with new techniques. The major oil companies, by contrast, had long since outsourced core skills -- geophysical surveying, seismic data processing, drilling, well-logging, engineering, and construction -- in a fit of cost-cutting and manpower reduction. Their comparative advantage now lies in mobilizing and managing these essential oil-field services supplied by contractors rather than possessing them themselves.
Arriving late to the party, the supermajors have been buying up the independent producers that led the shale gas revolution -- part of a longer-term trend in which the companies, lacking new major discoveries to replace their existing production, aggressively acquire other enterprises to make up the difference. But it is an open question whether this Pac-Man strategy is sustainable. Every time a major acquires an independent at a premium to market share price, it dilutes the value of its own shareholders by overpaying, unless it can generate more income in the process. In the past, dubious acquisition deals were papered over by higher oil prices -- but there's no guarantee that Big Oil will always be so lucky. The supermajors have also taken to using their ample cash flows to repurchase their own shares in hopes of enhancing remaining shareholder value. This, plus their acquisitions-led growth at a time of high oil prices, suggests that these businesses have run out of ideas.
It's not all Big Oil's fault, of course. Eighty percent of oil and gas reserves are in the hands of national governments and their national oil companies. The supermajors are fighting over a much smaller share of existing assets and future opportunities. And growth in worldwide oil and gas demand no longer resides in the industrialized world but rather in emerging economies, especially China, Southeast Asia, India, Brazil, and the Middle East, where the multinationals have no natural advantage in the retail market -- and where consuming countries such as China and India are expanding their own national oil companies' international activities in order to ensure supply. Meanwhile, demand in North America and Europe -- Big Oil's home turf -- is declining in relative terms due to slower economic growth and (in Europe, at least) climate-change policy decisions. The growth of spot markets -- markets in which purchases are made on short notice rather than on long-term contracts -- in crude oil, petroleum products, and liquefied natural gas (LNG) means vertical integration no longer brings the business advantages it once did; refiners and end-users can simply buy oil when they need it.
The supermajors would argue that even in this dramatically changing environment, their unique skills and resources are still valuable -- and that they alone have the organization and proven track record to pull together complex business deals and manage the high risks of technologically advanced projects. And it is true that Big Oil can still boast unparalleled financial resources, ability to attract capital, and some proprietary technologies -- it is hard to imagine, for example, large LNG projects proceeding without the multinationals' participation. But the biggest failures -- both operational and financial -- of recent years have also belonged to Big Oil. The massive oil spill in the Gulf of Mexico last year was the work of BP and its contractors. The partners in the much-delayed Kashagan project -- an oil field in Kazakhstan where $30 billion has been spent on the largest oil discovery in 30 years without a drop of commercial oil production to show for it -- include a veritable who's who of Big Oil heavy-hitters: ExxonMobil, Shell, Total, Eni, and ConocoPhillips.
Big Oil needs a new corporate narrative. Without one, it faces the danger of becoming obsolete in energy markets dominated by national oil companies on one hand and oil-services companies or more agile and risk-happy independents on the other. . . .