Reserve judgement

The oil industry has seen shifts in recent decades, with control over development largely in the hands of national governments and their oil companies. Global economic growth means that project development will continue apace by or with these national oil companies. Dennis Flannery, Executive Vice-President and COO, and Daniel Blanchard, Consultant, at projects advisory firm Taylor-DeJongh, look at the role of developing country national oil companies and the risks to look out for.


During the past 30 years, the global oil and gas industry has come increasingly under the control of a small number of developing country governments, spanning regions across the Middle East, Africa, Central and Southeast Asia, and Latin America.

In sharp contrast to the period before the mid 1970s, when major international oil companies (IOCs) had access to over 85% of global hydrocarbon reserves, these companies now have access to an estimated 10% of reserves. This shift, accompanied by a tripling in world oil prices over the past four years, has placed significant clout in the hands of national oil companies (NOCs) and the governments controlling them.

Control over the pace of development of reserves by sovereign governments is of growing concern to oil-importing nations, as stable economic growth requires a secure supply of affordable energy resources. A key concern is whether resource owners will invest the necessary levels of capital and develop sufficient capacity to keep pace with growing demand.

The issue has been brought to the fore in recent months due to a number of high profile energy sector asset claw-backs and renationalisations in places like Russia, Venezuela, and Bolivia. Given the double threat of high and volatile energy prices and a resurgence of resource nationalism, the control of reserves has come to have increasingly important strategic, geopolitical, and economic and financial implications.

There is, however, a strong pipeline of global scale energy sector projects being developed by and in partnership with NOCs. How will financiers – equity investors, commercial lenders, development agencies, export credit lenders, and risk insurance providers – involved in developing country energy project investments respond and adapt to perceived and actual risk elements in this changing environment

  • Some distinct trends are emerging. We highlight some of these through a review of some of the financing means being employed in various large-scale NOC sponsored projects. 

    Historical backdrop

    In the years during and following the Second World War, oil became recognised as the critical strategic commodity for maintaining US domestic and international strength. Domestic reserves were already seen to be depleting and it was determined that the control and development of foreign oil resources would be required in order to maintain the nation’s post-war position of international dominance.

    US and European companies quickly established long-term ownership concessions with oil rich countries in the Middle East – where significant reserves had been discovered earlier in the century – as well as in North Africa, South Asia, and Latin America, and began rapidly expanding their production activities.

    By the early 1970s, however, host countries began pushing to regain ownership of their resources. A series of nationalisations took place, followed by the creation of a slate of new ‘national oil companies” to manage the newly-independent oil sectors.

    Algeria, Iran, Iraq, Qatar, Saudi Arabia, and Venezuela fully nationalised their industries. Kuwait and Libya allowed the IOCs to remain, though at significantly reduced ownership levels and fiscal terms. The UAE, Nigeria, and Indonesia, on the other hand, allowed the IOCs to remain, but dramatically increased their government takes through various fiscal modifications.

    In the early 1990s, another shift occurred. Many of the nations that had previously expelled the IOCs began initiating programmes aimed at reopening their oil sectors to foreign participation. Some of these efforts have been more fruitful than others.

    Qatar provides perhaps the best example of successful cooperation between a national oil company – Qatar Petroleum – and its IOC partners in the development of a world-scale LNG export sector.

    Venezuela and Algeria successfully encouraged the return of the IOCs only to see these efforts rolled back (though by very different means) in more recent years. Programmes in Saudi Arabia and Kuwait to solicit the assistance of foreign companies in the development of oil and gas projects have faltered and Iran’s oil buy-back programme has had only limited success.

    Demand growth and the new price paradigm

    The historic average oil price of US$20 per barrel that persisted for nearly two decades vanished in 2003. The tripling of prices since then has altered the perspective, behaviours, and bargaining positions of resource rich NOCs and the nations they represent western governments were generally able to encourage producing countries to open their reserves to IOCs. NOCs recognised the benefits of working with IOCs; namely gaining access to project development technical skills and financial capabilities that the IOCs possess.

    In the new US$60 per barrel world, however, NOCs are able to purchase or contract required technology, and are able to finance projects from their own cashflows. The influence of western governments has waned, and their priorities, notably the security of supply, are being subordinated to the objectives of newly empowered resource owners.

    The International Energy Agency (IEA), which speaks for industrialised oil importing nations, predicts that by 2030 global oil and gas demand will grow by 38% to 116mn barrels per day (mmbpd) from around 84 mmbpd at present. Further, it believes that US$5.3tn (roughly US$200bn per annum for the next 25 years) needs to be spent in order to explore for and produce volumes required to meet the demand.

    A key concern raised by the IEA is that the necessary investment may not be readily forthcoming. It fears that rising resource nationalism, political instability, growing social spending requirements placed on NOCs, and rising construction and engineering costs could slow the pace of investment.

    The concern is that without adequate investment, the rate of ‘reserves replacement’s will likely decline. In other words, if reserve additions, either via discoveries or through continued development of existing fields, do not fully replace past production, then reserves will be depleted. Accordingly, production capacity and hence supplies would decline, creating upward price pressure, which would in turn stifle demand and global economic growth.

    The view from above

    More than three quarters of global oil and gas reserves are held by 10 countries. The holdings grow to 90% of all reserves when you consider the top 20 countries. The owner group includes all of the Opec nations (except Angola), which account for 63% of volumes.


    The Middle East, which holds 56% of reported global reserves, is the most restrictive region for IOC upstream participation. Access, estimated at roughly 15%, is mainly attributable to investments in Qatar, the UAE, and Oman. In part, these include ExxonMobil’s interests in Qatar and Abu Dhabi, and the interests of European producers in Iran, Oman, and Syria. Access in the CIS region, including Russia, is also highly restricted.

    Most of the largest NOCs are 100% government held, while some have been partially privatised. Among those that are fully government-owned are:

    • All of the major Middle Eastern NOCs
    • African NOCs in Nigeria, Angola, and Algeria
    • Asian producers Pertamina and Petronas
    • Russia’s Rosneft
    • KazMunaiGaz of Kazakhstan
    • Latin America’s PDVSA, Pemex, and YPFB

    China’s three NOCs, ONGC of India, Russia’s Gazprom, and Brazil’s Petrobras are all partially privatised with public share listings, though remain majority government-owned.

    NOC attributes, obligations, capabilities

    The one attribute that all NOCs have in common is that of government ownership. Beyond this, generalisations become difficult. The group shows great diversity along a range of defining traits, including the geopolitical and strategic objectives of the host government, the level of government control and influence in business decision making, and government budgetary funding obligations (including the extent and value of required fuel subsidies).

    In most cases, revenues from NOCs in developing countries make up substantial portions of national export earnings and GDP, and thus serve as the effective financing arm of government.

    NOCs also vary in terms of their technical capabilities and operational orientation. The attached chart categorises the world’s largest NOCs on the basis of two distinguishing variables: technical capabilities and the degree to which their production base is in growth or decline.

    Some key observations that emerge are that:

    • The two largest resource owners, Saudi Arabia and Russia are technologically capable of developing projects on their own, and are expanding their reserves and production levels.
    • West Africa has a rapidly growing reserves and production base, however is technologically reliant on IOCs for project development.
    • PDVSA, given the decline in the strength of its in-house technical skills, may be putting itself at risk if it forces IOCs out of the country.
    • China and India, with their large and rapidly growing populations, have improved their technical capabilities, but are facing declining asset bases at home; hence the push to acquire overseas.

    The types of projects that resource-rich developing country NOCs are generally involved in include upstream reserves development, and projects directly downstream from field development including pipeline transportation and LNG liquefaction projects. A number of NOCs have also begun to pursue downstream opportunities in LNG regasification terminals and gas marketing ventures, while others have established or bought into both domestic and overseas refining and product distribution projects in order to capture additional opportunities further down the energy value chain.

    Stable legal and regulatory frameworks

    The rising tide of capital availability in recent years, together with improved investment environments in many developing countries, has benefited project investments across some of the worlds’s higher risk geographies. The increased interaction of global financial markets in NOC projects has also helped to improve the operational and financial outcomes of projects.

    Several success stories help to illustrate the potential benefits to developing countries of an attractive investment environment. Qatar is one such example. Some 20 years ago, Qatar was a relatively poor country lacking the resources and expertise to develop its huge natural gas resource base. That began to change in 1995 when the government established new policies, including revised fiscal terms for exploration and production, and tax holiday incentives for foreign investment.

    The country’s aim was to attract investment toward the development of an LNG export industry. An attractive set of investment incentives together with the establishment of a stable legal and regulatory framework has enabled the country attract over US$40bn of investment capital into large scale Qatar Petroleum sponsored LNG projects including RasGas and Qatargas over the past five years.

    Both of these projects have been developed under the sponsorship of NOC Qatar Petroleum. These developments have helped to drive a sharp increase in the standard of living for the people of Qatar, where GDP per capita is now on par with that of many Western European nations.

    Risks of opaque financing methods

    In the new oil price environment, cash-rich NOCs and governments can often finance investments from internal sources, or by borrowing on the basis of proved oil reserves or sovereign guarantees. In this way, they avoid the demands of international financial markets for commercial transparency and operational and financial efficiency.

    There are numerous examples of significant fundraisings by developing country NOCs via reserve-based loans in recent years. For example, Angola’s Sonangol has raised numerous rounds and billions of dollars worth of oil-backed loans over the past decade.

    The most recent of these packages included a US$2.35bn loan in 2004 through a syndicate of nine European banks, and another US$2.25bn financing in late 2005 (US$1.45bn of which was used to refinance pre-existing debt and US$800mn of which was new funding).

    PDVSA of Venezuela earlier this year closed on a US$3.5bn 15-year reserve-based credit facility with a Japanese syndicate of two trading groups and a number of commercial banks. These agreements are in effect crude oil supply contracts with advance payments that allow, in this case, the two trading houses to offtake crude oil and petroleum products from PDVSA during the loan period.

    These types of financing mechanisms, while innovative and sophisticated in their structuring, are at odds with goals related to national economic development. Additionally, the risk of using these means to raise funds for equity investments in large-scale projects includes increased opportunities for a lack of commercial transparency, which may result in increased project costs, and reduced overall quality of project development. Furthermore, these types of borrowings are typically more costly than multilateral and ECA based lending.

    The landscape has shifted and control over the development of hydrocarbon reserves is largely in the hands of governments that possess them. Robust global economic growth means that energy project development by or in partnership with NOCs will continue apace. The interaction with global financial markets will remain critical in providing the financing needs for this expected growth. This presents new challenges for financiers as well for NOCs and their IOC partners.

    If projects are to be undertaken in a cost efficient and profitable manner, then increasingly detailed levels of due diligence will be required in the identification and delineation of both country specific and market related risks.

    Project finance or otherwise market-based financing will always yield better financial and economic results than lending backed by sovereign guarantees or booked oil reserves. Project costs will be reduced by comparison, operational and financial results will improve, and the costs of borrowing will be reduced, as transparency and commercial standardisation and governance improve.