National oil companies: The right way to go abroad

Deals with foreign partners can open the door to overseas profits.

The well-publicized efforts of the Chinese and Indian governments to secure oil and gas reserves have focused attention on the international ambitions of national oil companies. Investing abroad is nothing new for these companies, whether they are rich in resources or, in the case of those in China and India, simply attempting to secure supply. But many such foreign investments fail to create value for the national oil companies or their governments, according to our research. Often, strategies were poorly crafted, so the companies were slow off the mark or lacked the necessary resources (including technology and talent) to accomplish their goals. In other cases, value creation was plainly not a priority, as government policies, such as enhanced energy security, guided the internationalization efforts.

But all this doesn't mean that national oil companies should shun international investments. In fact, foreign deals may be the only way for some energy-rich countries to extract value from their natural resources. These players can succeed abroad but must focus on specific kinds of ventures: mainly those that stimulate demand for their products or secure market access for their reserves.

There are more than 100 national oil companies around the world—one from almost every oil-exporting country and a number from major importing countries. These companies have pursued internationalization to gain access to skills and knowledge, to leverage proprietary skills, to use diversification to reduce the cost of capital, to build operational synergies through regional expansion, and to advance national policies. But according to our analysis, the underlying economic rationale for these investments was frequently unclear, and they resulted in losses.

While using joint ventures with international petroleum corporations to fill gaps in skills (by improving the process for recovering oil from existing wells, for example) is a valid goal, such arrangements rarely deliver these capabilities. In fact, barriers within a national oil company's organization may inhibit the effective transfer of skills over the longer term. Moreover, such a company often lacks the necessary knowledge-sharing mechanisms (including the flexibility to rotate its employees in and out of the foreign ventures) to absorb the lessons from international partners. It may simply be more cost effective to hire some other concern, such as an oil services company, to do the job. Another worthy objective for an international venture is to leverage proprietary skills, but few national oil companies actually have a competitive advantage that the marketplace recognizes. In some situations, their shareholders—that is, their respective governments—require managers to undertake projects in the interests of national security, thus obligating a national oil company to pursue international ventures that aren't destined to create value.

What works

There are circumstances in which pursuing foreign deals makes great sense. We found that the primary ways a national oil company can create value abroad are either obtaining access to an overseas market that needs its products or stimulating demand for its natural resources in an existing market or both. Let's look more closely at two cases where these approaches succeeded.

Algeria's Sonatrach Petroleum was searching for a more effective way to deliver its tremendous reserves of natural gas to market. In June 2003 it joined forces with BP and Statoil (Norway's national oil company) to export liquefied natural gas to Europe. Through this project, Sonatrach is a coinvestor in the exploration, development, and commercial exploitation of its gas reserves while using a regasification terminal owned and operated by a third party to gain entry to the UK market. The project's timing was critical to the United Kingdom, which had predicted natural-gas shortages starting as soon as 2007. Algeria began production for the project in 2004, paving the way for the country to extract and deliver to market an estimated 11 trillion cubic feet of natural gas.

In the late 1980s and the 1990s, Pemex (the Mexican national oil company) faced the challenge of building demand for its heavy crude oil, which is much more difficult to produce and refine than light crude. The company encouraged refiners to invest in facilities to accommodate processing heavy crude in exchange for risk protection through special long-term supply contracts. We estimate that the deal created about $2 billion in value. Also beginning in the late 1980s, Petróleos de Venezuela stimulated demand for its heavy crude oil by upgrading three wholly or partially owned refineries in the United States. The estimated benefit: around $300 million in value.

Strategic thinking

How should national oil companies approach foreign investments? For starters, they must resist falling prey to internationalization as a business fad, even though many of them are racing to invest outside their borders. Since a national oil company's first duty is usually the care and management of its country's resources, it needs to ensure that attempts to invest abroad don't detract from its primary goals by draining local talent or by diverting the attention of top management.

For an international joint venture to be successful, its underlying ends—whether straightforward business ones or support of national policy—must be clear. If the reasons are related to business, managers must determine if internationalization will create economic value and then ensure that the project is aligned with the company's objectives. This advice may sound obvious to managers in the private sector, but national oil companies have not always been able to operate in this way. If an investment is dictated by national policy, managers must seek to minimize costs and look for ways to use national policy to achieve their business objectives.

Then a national oil company must spell out its strategy, tactics, and organizational concerns. One reason many attempts at internationalization have gone awry is that managers often underestimate the challenges and complexities involved—especially those inherent in being a national oil company.

In many cases, a big part of such efforts will involve selecting one or several foreign partners with which to pursue a venture. Some national oil companies, suspicious of multinationals, worry that a joint venture will reduce their control over valuable national assets. But the realities—maturing oil fields, tired technology, heavier crudes, and newly discovered but hard-to-exploit deposits—make acting alone tougher than ever. Thoughtful, responsible partnerships are possible, as the Sonatrach-BP-Statoil venture shows. And national oil companies aren't the only ones in need of partners. After all, the major publicly traded oil corporations control less than 10 percent of the world's oil reserves, so it's also in their interest to negotiate win-win agreements.

With notable exceptions, the efforts of national oil companies to internationalize have failed to create substantial value. As important revenue generators for their home countries, they should fully evaluate all alternatives, including joint ventures with multinationals, before committing valuable resources. Even when opportunities are identified, national oil companies must conduct rigorous economic and strategic analyses to increase their chances of creating value.

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