Professor Jeffrey A. Born
The sell-off of common stocks the past several weeks has cut more than a trillion dollars off shareholder wealth globally and has re-ignited concerns over a double-dip recession taking hold in the US and/or Europe. Fear of slower growth for developed economies has helped drive the spot price of oil well off of its high for the year and as of this writing leaves it nearly half of its July 2008 all-time high, but still well above the lows recorded in December of 2008. With all of the dark clouds over global stock markets and oil’s spot market, one wonders if the spending spigot of NOCs is next in line for a downward adjustment. I think that there are three good reasons to believe that NOC spending, particularly in the BRIC countries (Brazil, Russia, India and China), will not be significantly curtailed.
First, the fundamental forces that set off the BRIC NOC spending spree of the past few years have not changed. BRIC oil consumption increased almost 2M barrels per day from 2007 to 2009 (14.5M to 16.4M) and maybe up another 1M barrels per day since 2009. Much of this growth is being driven by exceptionally strong economic performance which is reducing the income gap between BRIC and OECD countries. Demographic studies point to continuing population growth compared with stagnation and decline inside the 34 countries that compose the OECD (Organization for Economic Co-operation and Development). The political desire in countries outside the OECD to make real gains in per capita income gains during the next decade translates into a continuing need for secure significant new energy sources – whether from successful exploration programs or acquisitions.
Second, CEO’s of publically-owned energy corporations’ answer to their shareholders and the financial marketplace, whereas NOCs are controlled by their governments and politicians answer to a much larger set of constituents. Falling spot prices put pressures on profits and profit margins for many publically-owned energy companies and it is not uncommon for them to scale back spending plans in these conditions. Falling stock prices raise the opportunity cost of equity capital, which reduces the expected returns from exploration programs and it raises the cost of stock mergers and acquisitions for publically-owned companies. While the same pressures bear on NCOs, they are muted by the number and size of other voices driving the behavior of NCOs – and many of those voices are calling for increased supplies.
Third, there are almost no reasonable long-term global economic scenarios that suggest oil prices below the levels that they are right now. Faced with no end in sight to the growth of domestic demand inside NCO countries, particularly the BRIC countries, the managers of NCOs almost certainly view the recent developments in global market conditions as an opportunity to ‘buy (long-term supply sources) on weakness.’ Many of the NCOs are flush with cash from their trading profits, so they have the wherewithal to continue their growth plans. Others used their trading profits to de-lever their balance sheets and they are sitting on top of uncommitted debt capacity, which will them to continue their growth plans (unless debt markets seize up as they did in 2008).
While a massive curtailment of NCO spending plans seems unlikely, these companies are not entirely immune to events of the past several weeks either. As capital costs rise as the result of falling security prices, some NOCs might be expected to change their financing mix. Since most of the NOCs have diversified their asset holdings well beyond the energy industry, we can expect some to sell off non-energy assets to help finance their energy growth plans. A few of the financially weaker NCOs might cut back on spending plans, but on the whole and in the main, there are very strong reasons to expect BRIC NCOs and others to continue their quest to secure safe and secure supplies of oil for the foreseeable future.