WIXLIB

Executive SummaryApproximately two billion dollars a day of petroleum are traded worldwide, whichmakes petroleum the largest single item in the balance of payments and exchangesbetween nations. Petroleum represents the larger share in total energy use for most netexporters and net importers. While petroleum taxes are a major source of income formore than 90 countries in the world, poor countries net importers are more vulnerableto price increases than most industrialized economies. Unlike most commodities, petroleum is a major factor in international politics and socio-economic development. Thesecharacteristics of the petroleum sector largely explain why many producing and importing countries have, at least at some point during the course of history, opted for directstate intervention rather than more liberal governance regimes.Today national oil companies (NOCs) control approximately 90 percent of theworld’s oil reserves and 75 percent of production (similar numbers apply to gas), as wellas many of the major oil and gas infrastructure systems. This can be directly as producers or as the “gatekeepers” for exploitation by private oil companies (POCs). PetroleumIntelligence Weekly ranks 18 NOCs among the top 25 oil and gas reserves holders andproducers. In addition, an estimated 60 percent of the world’s undiscovered reserves liein countries where NOCs have privileged access to reserves. As such, NOCs are of greatconsequence to their country’s economy, to importing countries’ energy security, and tothe stability of oil and gas markets.Governments’ petroleum sector policies often pursue a variety of development andsocioeconomic objectives, including the maximization of the net present value of theeconomic rent derived from the exploitation of petroleum, inter-temporal equity, thepromotion of backward and forward linkages, the promotion of bilateral trade, energyself sufficiency, and security of supplies. NOCs are often used to achieve a wide arrayof these objectives, as primary tool or in combination with other policy tools. The choiceof policy tools—NOC, regulation, or a combination of both—depends on the type ofobjectives that policy makers wish to achieve and their relative priorities. These in turndepend on the country specific context. Exogenous factors, including oil and gas prices,economic cycles, and the existence of international sanctions, also affect government policies. This helps to explain the diversity of policies pursued by governments over time.Whatever the objectives and their mix, governments’ primary concern should be tomaximize economic efficiency and the generation of social welfare. Although there areestablished criteria to guide policy formulation in cases that involve a certain level ofvalue judgment, in practice deciding whether or not establishing the NOC maximizessocial welfare is a matter of political choice. Indeed economic considerations, such as thedesire to address market deficiencies or inefficiency or to maximize rent capture, maynot be the primary reason for establishing the NOC. Hence, any attempt to compare therelative contribution to social value creation of direct state intervention and regulationwould inevitably imply a considerable level of subjectivity. This is not attempted in thispaper. Rather we analyze the available evidence on the objectives, governance and performance of 20 NOCs from both net importing and net exporting countries, and drawconclusions about the design of policies and measures that are more likely to lead tosocial value creation by NOCs. In this paper, social value creation refers to the creationxi

xiiWorld Bank Working Paperof benefits or reductions of costs for society in ways that go beyond the maximization ofthe financial return on investment derived from the exploitation of the resource.The first step towards measuring NOCs performance is to establish their objectivefunction. But NOCs differ on a number of very important variables, including the levelof competition in the market in which they operate, their business profile along the sector value chain, and their degree of commercial orientation and internationalization.One thus needs to be mindful of possible over-generalizations. On the other hand, mostNOCs share at least some core characteristics: they are usually tied to the “national purpose” and serve political and economic goals other than maximizing the firm’s profits.Perhaps this is the most relevant single factor that explains their existence and resiliencein very different political, social and economic environments. These core characteristicsneed to be taken into account in defining what constitutes NOC value creation and analyzing NOCs behavior and strategy.A quantitative measure, the “value creation index”, is proposed to capture theNOC’s capacity to fulfill its mission and objectives (that is, its contribution to valuecreation). The index, which includes operational, financial and national mission performance indicators, is not designed to measure all aspects of value creation; it focuses onkey aspects of short-term value creation by NOCs, and is used to reveal the relative position (and direction of changes over time) of the NOCs in the study sample with respectto the observed value creation measures. This in turn provides an indication of relativepolicy success.Although informative, the value creation index does not reveal which factors“drive” value creation. We refer to them as “value drivers”. If we were able to identify these factors, we could determine which policies and tools should be used to affectNOC value creation. To this end, a conceptual model of value creation is proposed thatidentifies five classes of value drivers: geology and geography, state context, petroleumsector governance and organization, NOC strategy, and NOC corporate governance.An exploratory regression analysis is applied to understand the relationship betweenvalue drivers and NOC value creation. The analysis confirms the importance of geology,petroleum sector governance and NOC corporate governance to value creation. However, caution should be applied in interpreting these results. One of the main difficultiesthat we faced in this attempt to statistically measure the relative importance of valuedrivers was the uneven quantity and quality of data across the NOC sample. Althoughsome general observations can be drawn from this analysis, overall the result cannot beviewed as offering substantial understanding on how the various drivers affect valuecreation. More research is warranted.On the other hand the low explanatory power of the statistical model may indicatethe uniqueness of each NOC, underlying the importance to value creation of countryspecific and NOC specific factors. To test this hypothesis, the experience of 12 NOCsis analyzed in detail to establish whether discernible patterns with respect to valuecreation can be observed for NOCs with similar strategy and corporate governancearrangements, and whether certain country specific context variables lead to particularNOC corporate governance arrangements and strategies. In particular, our analysis aimsto answer the following questions: Are certain corporate governance arrangements moresuited than others to promote value creation? Is good geology a pre-condition for NOCvalue creation? Are there benefits from exposing the NOC to competition from POCs?Does the development of forward and backward linkages hamper NOC value creation?Overall, country specific objectives, constraints, and concerns have a substantial effect

National Oil Companies and Value Creationxiiion NOC value creation. Therefore, it is difficult to identify general principles that applyto all countries in all circumstances. Our findings are summarized below.Internal governance mechanisms are more critical to NOC value creation thanthe ownership structure. Particularly in the petroleum sector where prices, technology,competition, and management techniques are continuously changing, nimble decisionmaking processes and budgetary and financial autonomy are crucial to value creation,regardless of the NOC’s ownership structure. These features are associated with thelevel of technical and managerial competence of the NOC. Government interference inthe NOC’s decision-making processes seems to be more closely related to the degree ofeconomic or strategic relevance of the petroleum sector to the specific country, ratherthan to the percentage of independent BOD members. This may have something to dowith the difficulty in assessing the true level of independence of BOD in companiesthat exhibit a high concentration of ownership, even when nomination committees areestablished. Cultural differences across countries help to explain why similar corporategovernance arrangements may function in a very dissimilar way.NOCs that belong to countries with large resource endowments may find it moredifficult to create value than their counterparts in countries with smaller resourceendowments. The size of the resource endowment matters to value creation, but themanner in which it is exploited matters more. Large resource endowments lead to highervalue creation if the resource is extracted efficiently and revenues from its sale are reinvested to support production levels and replace reserves. Given the complex networkof often conflicting interests between efficiency of exploitation and state needs, following this approach is often harder for NOCs that belong to countries with large resourceendowments, than it is for their peers in less endowed countries. Ultimately, the political,institutional, and societal qualities of a country—more than the actions of its NOC—arecritical to determining to what extent the gift of nature will translate into value creation.Temporary restrictions on access to petroleum activities can be effective policytools to enhance value creation by the NOC. Among the countries surveyed in thispaper, many impose, or have imposed, some form of restriction on the participationof POCs in petroleum exploration and production activities by granting special rightsto the NOC. These privileges have generally taken the form of mandated associationbetween the NOC and POCs, with minimum levels of state participation. This formulais often used by countries and NOCs that are new to the petroleum sector with several objectives: (i) fast-tracking the learning curve through the association with experienced industry participants; (ii) reducing information asymmetries between industryparticipants and the state; (iii) increasing rent capture; (iv) reducing exploration risk;and (v) accelerating the exploration and production of the country’s resources whilemaintaining control over sector activities. Full exclusion of industry participation inpetroleum exploration and production activities is rare. Well-designed restrictions onaccess that take into consideration the characteristic of the resource, domestic capacity,the fiscal regime, and market structure can be very effective tools to address information and capacity asymmetries. Sheltering the NOC from competition allows it to focuson developing the necessary competence and economies of scale. However, this policyhas decreasing effects on value creation over time and may discourage the NOC fromdeveloping efficient and competitive processes.The pursuit of national mission objectives does not necessarily hamper the creation of value by the NOC. National mission objectives hamper value creation whentheir pursuit is in conflict with other key value-added functions of the NOC, such as the

xivWorld Bank Working Paperefficient and sustainable exploration and exploitation of petroleum resources. Definingproper national mission objectives for the NOC is thus critical to value creation. Thisis particularly important in countries where the NOC is the only company authorizedto carry out petroleum activities, with limited possibilities for sharing exploration anddevelopment risk with other parties, since this approach requires, inter alia, a superiorlevel of operational efficiency and the ability to prioritize core-business investments.For example, creating a skilled workforce, developing technology, and supporting thelocal supply industry allow the NOC to lower the cost of operations while fulfilling itsnational mission objectives. If the NOC’s national mission objectives include the development of industries that make direct use of the oil and gas sector’s output (forwardlinkages), the pursuit of these objectives may hamper value creation since it requireslarge scale operations and technology that may not be available in the country. Whenconditions are in place, forward linkages can enhance value creation by capturing theadvantages of vertical integration.Organization of the PaperThis paper has five chapters. Chapter 1 describes the key features of upstream, midstream, and downstream petroleum operations and how these may impact value creation and policy options. Chapter 2 draws on ample literature and discusses how changes in the geopolitical and global economic environment and in the host governments’political and economic priorities have affected the rationale for and behavior of NOCs.Rather than providing an in-depth analysis of the philosophical reasons for creating aNOC, this chapter seeks to highlight the special nature of NOCs and how it may affecttheir existence, objectives, regulation, and behavior. Chapter 3 proposes a value creationindex to measure the contribution of NOCs to social value creation. A conceptual modelis also proposed to identify the factors that affect value creation. Chapter 4 presents theresult of an exploratory statistical analysis aimed to determine the relative importanceof the drivers of value creation. In addition, the experience of a selected sample of NOCsis analyzed in detail, and lessons of general applicability are derived. Finally, Chapter 5summarizes the conclusions.

1The Petroleum Sector Value Chain“The weakest link in a chain is the strongest because it can break it.”(Stanislaw Lec)The oil and gas indu

Today national oil companies (NOCs) control approximately 90 percent of the world’s oil reserves and 75 percent of production (similar numbers apply to gas), as well as many of the major oil and gas infrastructure systems. This can be directly as produc-ers or as the “gatekeepers” for exploitation by