Value Creation and its Antecedents
–
A Glance at the World’s Top 100 International
and National Oil Companies
MASTER OF SCIENCE
International Business & Management by
Lennard Liebig
University of Groningen
Faculty of Economics and Business
Student Number: S1976451
Supervisor: Dr. M. Astarlioglu Co-Assessor: Drs. A. Visscher
Submission Date: Monday, January 23rd, 2017
ABSTRACT
The present research falls in the broad realm of value chain and network analysis by investigating value creation and its antecedents in the rapidly changing, dynamic petroleum and gas industry. The study sets out to quantify International Oil Companies (IOCs) and National Oil Companies (NOCs) value creation by proposing a comprehensive Value Creation Index (VCI), capturing tangible operational, financial and intangible social performance. The VCI is applied to a rare sample of 81 IOCs and NOCs from the “Energy Intelligence Top 100: Ranking the World’s Oil Companies.” The study further empirically and theoretically identifies five endogenous and exogenous antecedent value drivers, as they inherently determine which aspects to focus on in order to maximize value creation. In search of significant empirical evidence, the aforementioned value drivers are hypothesised to affect and drive IOCs and NOCs value creation. The analysis reveals that (1) state-owned NOCs, (2) fully integrated IOCs and NOCs, (3) IOCs and NOCs that are located in resource munificent environments, and (4) IOCs and NOCs that are located in institutional environments with low regulatory quality exhibit a higher degree of value creation. The study is also one of the first to quantitatively examine the role of “Control of Corruption”, which is found to have a twofold moderating effect and highly context-dependent with regards to IOCs and NOCs ability to create value.
Keywords: Value Creation Index, VCI, Value Creation, International Oil Company, National Oil
ACKNOWLEDGEMENTS
TABLE OF CONTENTS
1. INTRODUCTION ... 7
2. THEORY AND LITERATURE REVIEW ... 10
2.1. A Modern History of Petroleum & Gas ... 10
2.2. A Petroleum & Gas Value Chain Analysis ... 12
2.3. Value Creation ... 16
2.4. The Antecedents & Drivers of Value Creation ... 17
2.4.1. Ownership ... 17 2.4.2. Integration ... 19 2.4.3. Strategy ... 20 2.4.4. Resource Munificence ... 22 2.4.5. Institutional Environment ... 24 2.4.6. Conceptual Model ... 26
3. METHODOLOGY AND RESEARCH METHODS ... 27
3.1. Research Paradigm ... 27
3.2. Data & Sample ... 27
3.3. Dependent Variable ... 29
3.3.1. The Value Creation Index (VCI) ... 29
3.3.2. Proxy Measures for the Value Creation Index (VCI) ... 30
3.3.2.1. Operational Performance ... 30
3.3.2.2. Financial Performance ... 32
3.3.2.3. Social Performance ... 34
3.3.3. Determination of the Value Creation Index (VCI) ... 36
3.4. Independent Variables, Moderator & Control Variables ... 37
3.5. Multiple Linear Regression Analysis ... 39
3.5.1. Evaluation of Method Assumptions ... 39
3.5.1.1. Normality ... 40
3.5.1.2. Linearity ... 40
3.5.1.3. Multicollinearity ... 40
3.5.1.4. Homoscedasticity ... 41
4. EMPIRICAL RESULTS ... 42
4.1. Value Creation Index (VCI) - Results ... 42
4.2. Descriptive Statistics ... 43
4.3. Regression Results ... 44
4.4. Discussion ... 48
5. CONCLUSION ... 53
5.1. Limitations ... 54
5.2. Recommendations for Future Research ... 55
5.3. Managerial Implications ... 56
6. REFERENCES ... 57
LIST OF FIGURES, TABLES & APPENDICES
Figure 1. Porter’s Generic Value Chain Framework Figure 2. Petroleum & Gas Value Chain
Figure 3. Value Creation Model of IOCs and NOCs Figure 4. Conceptual Model
Figure 5. Determination of the Value Creation Index (VCI) Table 1. Energy Intelligence Top 100 (By The Numbers) Table 2. Main Variables, Description & Measures Table 3. Variance Inflation Factors (VIFs)
Table 4. Value Creation Index (VCI) – Results Table 5. Descriptive Statistics
Table 6. Table of Correlations
Table 7. Results of Multiple Linear Regression Analysis Table 8. Results of Hypotheses
Appendix A. Global Value Chain Framework Appendix B. Petroleum & Gas Value Chain Appendix C. Petroleum Sector Value Chain Model
Appendix D. Imbalances in the Integration of the Major Private Oil Companies (2001) Appendix E. Capital Expenditure Rotation (1990 – 2001)
Appendix F. Research Pyramid
Appendix G. Energy Intelligence Top 100: Ranking the World’s Oil Companies (2009) Appendix H. VCI Index - (1) Operational, (2) Financial and (3) Social Performance
Appendix I. Key metrics for Multiple Linear Regression Analysis & Method Assumptions Appendix J. SPSS Normal Probability Plot of Regression Standardized Residual
ABBREVIATIONS AND ACRONYMS
BBL Oil Barrel
BCF Billion Cubic Feet of Natural Gas BOE Barrel of Oil Equivalent
BP British Petroleum
CAPEX Capital Expenditure
CNOOC China National Offshore Oil Corporation CNPC China National Petroleum Corporation CSR Corporate Social Responsibility
DV Dependent Variable
E&P Exploration & Production IEA International Energy Agency
IFRS International Financial Reporting Standards IOC International Oil Company
IOCs International Oil Companies
IVs Independent Variables
KPC Kuwait Petroleum Corporation MMBOE Millions of Barrels of Oil Equivalent
MV Moderator Variable
NIOC National Iranian Oil Company
NNPC Nigerian National Petroleum Corporation
NOC National Oil Company
NOCs National Oil Companies
OPEC Organization of the Petroleum Exporting Countries
QP Qatar Petroleum
RDS Royal Dutch Shell
ROA Return on Assets
RPR Reserves-to-Production Ratio US$ United States Dollars
VC Value Chain
VCI Value Creation Index
VIF Variance Inflation Factor
WGI Worldwide Governance Indicators
1. INTRODUCTION
In the 20th century, the oil and gas industry became the world’s largest business. Approximately “two billion” dollars a day of petroleum and gas are currently traded worldwide, which makes it the single largest items in the balance of payments and exchanges between nations (Tordo, Tracy & Arfaa, 2011). Unlike most commodities, petroleum and gas represent the largest share in total energy use and are subject to international politics and socio-economic development. As Economides (2000) states “Oil is not just black, it affects all shades of life and industry. In fact, it colours everything.”
In 2008, the world has seen one of the most severe global economic and financial crisis, decimating oil and gas demand and sending oil prices to multiyear lows from record highs. At the crisis’s nadir oil and gas companies could only watch in what amounted to a state of shock. Most oil and gas companies tallied their “cash, assessed their credit, evaluated oil and gas markets, weighed their next moves and wondered if the post-crisis oil industry would resemble its pre-crisis self – a process made all the more complicated by growing social responsibility, environmental consciousness and the Deepwater Horizon1 disaster in the Gulf of Mexico in April 2010” (Energy Intelligence, 2011).
The world is still “experiencing residual recessionary effects as economic, market, political and regulatory uncertainties continue to engender some vacillation” (Energy Intelligence, 2011). Economic recovery in the developed markets is evident, if still underwhelming, while the developing world is proving somewhat more resilient. Oil prices have stabilized at a “comfortable” level, and corporate and asset-based deal making has picked up considerably. Yet recent developments in the Western hemisphere, particularly in the US, signal a move towards protectionist trade policies that vow to lead a “fossil-fuel revival to underpin job growth” (Dahan, Gamal, Zhdannikov, 2016). Oil historian Daniel Yergin2 warned to "Buckle up your seatbelts for a more turbulent and uncertain global economy that is ahead” (Dahan, Gamal, Zhdannikov, 2016).
1 On April 20, 2010, the Deepwater Horizon drilling platform exploded in the Gulf of Mexico near Louisiana, killing eleven people and causing the largest offshore oil spill in US history (Victor, Hults, and Thurber, 2012).
Today’s “Top 100” group is dominated by two dichotomous organizational forms - namely International Oil Companies (IOCs)3 and National Oil Companies (NOCs)4 which represent a total share of “87% of the world’s oil reserves and 72% of its gas reserves” and account for more than “80% of world’s oil and gas production (Energy Intelligence, 2011). As such, relatively few large IOCs and NOCs exert control and are of great consequence to their country’s economy, to importing countries’ energy security, and to the stability of the oil and gas market.
A comparative assessment of IOC and NOC performance and value creation is far from trivial and generally not useful given the deviations in organizational goals and objectives (Wolf, 2009). However, IOCs and NOCs goals and objectives are converging in recent years. On the one hand, NOCs are becoming increasingly commercial entities highly interested in being benchmarked against its competitive peers. On the other hand, IOCs are increasingly pressured to broaden their social and economic participation as the “oil curse” imposes “significant costs on society” (Spence, 2011). Therefore, today's oil and gas companies work within an ever-broader and more complex set of social institutions, norms and expectations that co-exist alongside market forces. In light of the aforementioned structural changes that are undulating throughout the industry, long-held assumptions about corporate shape, size and value creation are re-evaluated and altered. Particularly, since it has become evident that neither “operational size nor profit maximization has proven to be the formula for value creation” (Victor, 2007).
The present study falls in the broad realm of value chain and network analysis seeking to “understand the systemic factors and complex conditions through which a value framework and its firms can achieve a higher level of performance” (Allee, 2003). A large body of research focused so far either on the performance of IOCs, NOCs (Victor, 2007; Tordo et al., 2011) or the systematic performance differentials between IOCs and NOCs (Wolf, 2009; Eller, Hartley & Medlock, 2011). Given the converging goals and objectives of IOCs and NOCs the present study attempts to define a single, comparative and comprehensive measure in order to quantitatively assess IOCs and NOCs value
3 The abbreviation “IOC” can have different meanings: “(1) International Oil Companies: the non state-owned (normally publicly floated) oil and gas companies that have operations spanning the globe; (2) Integrated Oil Companies: the companies engaged in the exploration and production of oil and gas, as well as least one other significant activity in oil refining, marketing or transportation; (3) Independent Oil Companies: oil and gas companies that are usually relatively small in size compared to companies that integrate these activities with transportation, refining and marketing. In this study IOC is referred first and foremost as “oil companies that are not owned by governments and operate in the international economy” (Victor, 2007).
creation. Accordingly, the present study draws on the evolving “Value Creation Index” (VCI) model, as its application has proven to “precisely capture the dynamics unique to the oil and gas industry” (Low, 2000; Cohen Kalafut, Low, 2001; Freudenberg, 2003; Tordo et al., 2011).
The study ultimately seeks out to answer the following two consecutive research questions:
(1) How and to what extent do IOCs and NOCs contribute to overall value creation in the petroleum and gas industry?
(2) Which antecedent value drivers enable and explain the variance in IOCs and NOCs value creation and what is their relative importance?
2. THEORY AND LITERATURE REVIEW 2.1. A Modern History of Petroleum & Gas
In July 1913, as Europe was sliding towards war, Winston Churchill set out the importance of oil postulating “If we cannot get oil, we cannot get corn, we cannot get cotton and we cannot get a thousand and one commodities necessary for preservation of the economic energies”5 (Yergin, 1991).
Yet a century later, oil and gas are still among the most important energy sources in the world despite conflicting forecasts about the potential reserves and resources. While oil is usually associated with “gasoline, diesel fuel and the transport industries, in truth it is used in a whole range of everyday products” (Markus, 2014). The petroleum and gas industry is here to stay and prosper as “energy demand will increase, and the use of petroleum will be emphasized and expanded” (Economides, 2000).
Most of the oil and gas consumed in today’s world has moved from one country to another. Natural resources such as oil and gas are by far the largest commodities in international trade, and the “oil industry is one of the largest and most international worldwide” (Parra, 2004). Despite the early recognition of the distinctive usefulness, those hydrocarbons are relatively young traded commodities6 and remained merely local before the 19th century due to underdeveloped “exploration and extraction techniques (E&P)” (Markus, 2014).
From the beginning of “industrial activities in the 1850s till the First World War (WW), petroleum and gas extraction had been 100% privately owned” (Yergin, 1991). After the Second WW the oil industry expanded and internationalized quickly, largely due to “low-cost resource reserves discovered” by a handful of US and European companies in developing countries such as the Middle East or Latin America. Enrico Mattei, head of Italy’s NOC “AGIP” branded the largest of the aforementioned IOCs as the “Seven Sisters”7 (Parra, 2004). The “Seven Sisters” were fully integrated
5 Churchill considered security and diversity of oil supply to be of utmost importance. In 1914, the British government therefore acquired a controlling stake in the Anglo-Persian Oil Company, later renamed BP, setting a precedent for the many other state-owned or ‘National Oil Companies’ (NOCs) to follow (Wolf, 2009).
6 The history of the petroleum industry is well documented in a number of publications (e.g., Giddens, 1938; Anderson, 1987; Linde, 1991; Yergin, 1991; Mommer, 2002; Mabro, 2005; Marcel, 2006). Any historical account of the industry is bound to focus on oil rather than natural gas. Crude oil has been a globally traded commodity from the early days of the industry, “gas has been somewhat of a late starter, albeit a very successful one” (Tordo et al., 2011).
“oil companies, active in the extraction and transportation of oil as well as in the production and marketing of petroleum products” that dominated and developed the international petroleum and gas industry until the 1970s (Parra, 2004; UNCTAD, 2007).
Nonetheless, natural resources were massively concentrated in a “small number of backward (soon to be developing) countries in the Middle East, Latin America and Asia” and were owned first and foremost by the government (Parra, 2004). This made for a strange kind of relationship between investor and host country, and “one imbued moreover with colonialist overtones, since some of the countries had been colonies or protectorates” (Parra, 2004). The relationship was embodied in so-called concession agreements of “extraordinary longevity”, which were one-sided contracts giving an oil company “exclusive rights to explore, develop, sell, and export oil or minerals extracted from a specific area or country” (Parra, 2004; Radon, 2005). The explosive mixture was accompanied by the fact that “crude oil” in those resource rich dependencies was incomparably cheaper than other sources and “whoever” exerted output control was in an advantageous position to “cash in on the huge economic rents” (Parra, 2004).
“Years of this uneasy relationship and intermingled strategic interests were punctuated by localized breakdowns” starting with the early cancellations of concessions and “nationalizations8 in Bolivia (1937), Mexico (1938) and Iran (1951)” (Parra, 2004). Since then, the government has continually increased the level of control in the oil and gas industry, which was merely motivated by two major forces namely (1) “an increase in the share of ownership of oil and gas resources” and (2) “the strategic and economic importance of these resources” (UNCTAD, 2007).
The tide ultimately turned in the 1960s, “when the developing countries that were home to most of the world’s oil and natural gas supplies took on a more assertive role” (Victor, et al., 2012). In the 1970s, the OPEC9 emerged, who promptly converted from “a common-front” created to balance the
8 Outright nationalization of oil and gas firms, defined as the “compulsory transfer of the ownership of the whole industry to the state”, first unreeled in the context of the “Russian Revolution in 1917” followed by nationalizations in “Bolivia (1937), Mexico (1938), Venezuela (1943), Iran (1951), and Argentina, Burma, Egypt, Indonesia and Peru in the 1960s” (UNCTAD, 2007). In the 1970s nationalizations occurred in “Algeria, Iraq, Kuwait, Libya and Nigeria” whereas in Saudi Arabia’s ownership in Aramco was gradually increased (Yergin, 1991). More recent examples of moves towards nationalization is the “Russian Government’s attempt to increase shares in petroleum companies” and “Venezuela’s push to reduce IOCs shares in different joint-venture projects” (UNCTAD, 2007).
international industry, into a cartel (Parra, 2004). Fuelled by resource nationalism10, popular state-led
economic development and the hope for cartelization, a disruptive wave in developing countries radically changed the “ownership picture in the oil and gas industry” (Tordo et al., 2011; UNCTAD, 2007; Victor, et al., 2012). Cheon (2015) notes that the primary beneficiaries of the resource nationalism wave and the associated expropriations of foreign owned resources have been state-owned11 entities - known as NOCs. NOCs are conventionally defined as “state controlled oil and gas entities entrusted with managing the national resource endowment” that carry out at least some commercial operations (Victor et al., 2012). NOCs radically upended the structure of the energy markets. In the early 21st century, for the first time three NOCs topped the world’s list of the largest oil and gas producers namely “Saudi Aramco (Saudi Arabia), Gazprom (Russian Federation) and the NIOC (Iran)”, while other partly or fully state-owned NOCs increasingly matured such as CNOOC and CNPC (China), Pertamina (Indonesia) or Petrobas (Brazil) (UNCTAD, 2007). As a result, the reigning era of IOCs from developed countries, solely controlling the world’s oil and gas reserves, ended by giving way to NOCs evolving beyond vestiges of an era of resource nationalism (Leis, McCreery, Gay, 2012).12
2.2. A Petroleum & Gas Value Chain Analysis
There are few industries as foundational to modern life as the petroleum and gas industry. As outlined above, within the last century the face of the oil and gas industry has altered tremendously, witnessing an astounding degree of change. Given the industry’s seditious history and contemporary structural changes, it is critical to reassess and review how value is created along the petroleum and gas value chain (VC).
VC analysis was first popularized and theorized by Porter (1985) as a decision support tool that was based on the “process view” of organizations and added onto the competitive strategies paradigm. Initially, the framework was developed for a better understanding of the particular activities by which a firm develops its competitive advantage and creates value. Porter’s (1985) generic VC (depicted in Figure 1.) parts a business system into a series of value generating activities and “investigates a full
10 Resource nationalism has since reduced their “share of the world’s oil and natural gas base to less than 10%” (Lewis, 2007). Thus, crude oil production of IOCs has “plummeted from 94% in 1970 to only 45% in 1979” (UNCTC, 1983). 11 “State-owned” refers to a sovereign political unit. A “government” is the political leadership within a state. Thus, governments can come and go; states tend to endure (Victor, Hults, and Thurber, 2012).
range of activities which are required to bring a product or service from conception, through the different phases of production (involving a combination of physical transformation and the input of various producer services) and delivery to final consumers.” The VC framework quickly made its way to the forefront of management, thought of as a powerful analysis tool for strategic planning and systemic competitiveness (Kaplinsky, Morris, 2001). Numerous studies on value chain analysis and value networks have been published since (e.g. Allee, 2003).
Figure 1. Porter’s Generic Value Chain Framework
Source: Porter (1985)
In the real world VCs are much more complex. Therefore, the VC concept has been extended beyond individual firms and can be applied to whole industry supply chains and distribution networks which Porter refers to as “value systems” (Kaplinsky, Morris, 2001). A value system or network analysis perspective is beneficial as it “identifies key areas in the value network where constraints occur and opportunities for improvement arise” (Weijermars, 2010).
While the VC should be viewed from a holistic point of view, an in-depth and detailed review of the petroleum and gas industry VC13 is outside the scope of this study. In short, the oil and gas industry value system encompasses a range of different “activities and processes that jointly contribute to the
transformation of underlying petroleum and gas resources into useable end-products” (Tordo et al., 2011). In line with Porter’s (1985) framework, the petroleum and gas value system encompasses “E&P, transportation and storage, refining and marketing of oil, processing and marketing of gas, as well as related activities such as oilfield services and equipment and petrochemicals” and is depicted in Figure 2. and described in detail in Appendix B. (Tordo et al., 2011). As such, the aforementioned value chains are highly interlinked and typically involve a wide range of individual “suppliers, distributors/sellers, and customers” (Tordo et al., 2011).
Figure 2. Petroleum & Gas Value Chain
Source: Adopted from Wolf (2009)
has “enabled important advances to be made in the analytical and normative usage of the VC concept, particularly because of its focus on the power relations which are embedded in VC analysis” (Kaplinsky, Morris, 2001). Gereffi explicitly focused on the “coordination of globally dispersed, but linked, production systems” and revealed that a lot of VCs are characterised by a dominant organizational form “which determines the overall character of the chain” (Kaplinsky, Morris, 2001). As outlined earlier, the contemporary oil and gas playing field is made up of a wide array of large, integrated and diversified IOCs next to “fully or partly state-owned NOCs from emerging economies” that exert control over most of the world’s oil and gas reserves (Austin, 2009). In line with Porter’s (1985) and Gereffi’s (2005) frameworks and the overall focus on value creation, the present study will focus on the two aforementioned key institutions that are assumed to generate and contribute the “vast majority of direct value in the petroleum sector” – namely IOCs and NOCs as illustrated in Figure 3. below (Wolf, 2009).
Figure 3. Value Creation Model of IOCs and NOCs
Source: Adopted from Wolf (2009)
2.3. Value Creation
As proposed, IOCs and NOCs generate the vast majority of direct value in any national petroleum and gas sector. “Value” is a widely used term, however no single universally accepted definition or meaning exists.
Generally, IOCs and NOCs create “value as operators of petroleum and gas installations” (Wolf, 2009). From a financial perspective value creation is often narrowly defined as performance in terms of financial accounts such as “net income, return on assets or share price performance” (Wolf, 2009). Performance is thereby measured solely by a firm’s financial performance and its return to the shareholders. This perspective falls in line with Friedman’s subversive doctrine stating that “there is one and only one social responsibility of business – to use it resources and engage in activities designed to increase its profits” (Friedman, 1962). The concept has been widely used and applied by private organizations such as IOCs since the late 1980s. However, this perspective fails to fully capture the broad “mandate” of today’s organizations. Others widely acknowledge and understand value creation in a much broader sense as “operations and finances, whether focused on inputs, processes or outcomes” (Wolf, 2009). Tordo et al. (2011) note that in an economic sense to “create value along the chain, the value of aggregate outputs must exceed the value of aggregate inputs on a sustainable basis.” Aggregate inputs hereby span all economic costs such as “production costs, cost of funding, cost of resource depletion and opportunity cost” (Heal, 2007). Consequently, value creation is a relative concept that can only be meaningful in relation to a given objective.
2.4. The Antecedents & Drivers of Value Creation
Although a quantitative measure of value creation in the form of the proposed VCI is informative, it does not reveal which antecedent factors referred to as “value drivers” influence IOCs and NOCs value creation. Identifying value drivers could “inherently determine which aspects IOCs and NOCs need to focus on in order to maximize or facilitate value creation” (Tordo et al., 2011). Value drivers in the present study will be classified into “endogenous and exogenous.” Endogenous drivers refer to firm-specific organizational factors (or operational, strategic set-up, priorities and capabilities), whereas exogenous factors are dependent on the country specific context and fall into a broader set of geopolitics, economy and state.
The subsequent section sets out to empirically identify and theoretically define the potential endogenous organizational, managerial and exogenous socio-political, economic variables that are most likely to affect IOCs and NOCs value creation.
2.4.1. Ownership
Most of the existing literature on the theoretical basis for state intervention in the economy and “its comparative advantage vis-á-vis private ownership was produced from the 1960s onwards” (Tordo et al., 2011). Various studies drawn mostly from political science, explain the rationales for forming a state-owned organization. According to Victor et al. (2012) one of the most prevailing explanations for state-owned organizations is that “left-leaning governments worldwide adopted statist ideologies” which reflected the “belief that state ownership would better allow governments to promote and control economic development, redistribute income, and advance national pride.” This view is contrasted with the rather capitalist perspective of private ownership and redistribution of wealth through taxation which largely applies to IOCs.
extraction away from future toward the present. Additionally, NOCs might be “forced to sell oil products at subsidized prices” and thus appear to be “inefficient relative to private IOCs, especially at generating revenue from given inputs of labour and reserves” (Eller, Hartley & Medlock, 2011). Al-Obaidan and Scully (1991) were one of the first to empirically investigate the efficiency differences in question and found that NOCs are only “61% to 65% as technically efficient” as IOCs. Victor (2007) also finds that NOCs under tight state control “do not only develop their reserves to a lesser extent, but also do not generate revenue from their output with the same efficiency as IOCs” resulting in dead revenue.
Overall, NOCs were criticized for becoming too powerful in the context of domestic politics especially when there were few countervailing powers. “Information asymmetries and principle-agent issues in the technically complex oil industries allowed the NOC to pursue rent for their own purposes”14 (Wainberg, Foss, 2007). Thus, a substantial body of research suggests that “state-owned” firms are less efficiently managed than their private sector counterparts, which is clearly related to the aspect of ownership. As the present study seeks to find out what variables are likely to affect the value creation of IOCs and NOCs, the following is presumed:
H1. A higher degree of state-ownership will likely yield in a lower degree of value creation.
Moreover, McPherson & MacSearraigh (2007) argue that the so-called “resource curse and specific petroleum industry dynamics make the oil and gas sector particularly prone to corruption.” Corruption refers here to the “exercise of public power for private gain” reflecting a “lack of respect for rules and regulations that govern economic interactions in a given society” (Cuervo-Cazurra, 2006). Corruption is affecting all parts of the oil and gas industry, however NOCs in particular have enjoyed a “notorious reputation for corruption and waste” (McPherson & MacSearraigh, 2007). Past audits, especially of state-owned NOCs, such as Nigeria’s NNPC or Indonesia’s Pertamina estimated annual losses of “more than $1 billion” and thereby on a macroeconomic scale cannot be ignored as they have a tremendous impact (McPherson & MacSearraigh, 2007). Consequently, corruption is seen as “sand in the wheels” expected to hinder especially state-owned NOCs ability to create value. As such effective measures in terms of “control of corruption” shall be tested:
H1a. Control of corruption moderates the effect of state-ownership on the degree of value creation,
such that a higher degree of state-ownership will likely yield in a higher degree of value creation when control of corruption is high.
2.4.2. Integration
According to Tordo et al. (2011) the benefit and potential of integration15 for value creation has long been subject to controversial discourse among scholars and industry practitioners. Generally, IOCs and NOCs that engage in E&P activity and moreover “refine, transport and/or market their petroleum products” are referred to as fully integrated (Tordo et al., 2011). The degree of integration with regards to IOCs and NOCs varies to a certain extent depending on their “economic and political systems, reserve base, domestic infrastructure, consumption needs or other factors” (Kaiser & Yu, 2012).
Integration can take two distinctive forms namely horizontal and vertical integration. Regarding “horizontal integration”, the benefits of economies of scale, in most of activities along the VC, are widely acknowledged due to the fact that “petroleum projects are highly capital intensive, have long lead times and are inherently risky” (Stevens, 2005)16. Thus, plenty of IOCs and NOCs partner in E&P projects due to high financial and operational risks.
The present study focuses on the more prevalent “vertical integration”, which can take two principal forms namely “(1) financial integration occurring when one holding company owns subsequent stages of the VC and controls their cash flows; and (2) operational vertical integration occurring when there is a physical exchange of crude and products between subsequent stages of the VC” (Luciani & Salustri, 1998; Stevens, 2005; Tordo et al., 2011; Antill & Arnott, 2002).
IOCs have started early to integrate both financially and operationally before the area of resource nationalism. Key motivations were to “secure sources of supply, secure off-take markets, create entry barriers, circumvent taxes, eliminate the profit margins of intermediaries, and practice price discrimination” (Bindemann, 1999; Tordo et al., 2011). Looking at the operational level, NOCs were “heavily weighted towards production, whereas IOCs were weighted towards refining capacity” (Antill & Arnott, 2002) (Appendix D.). Over the last decade there has been “some convergence between the two groups, with IOCs reducing their refining capacity in contrast to major NOCs who are still trying to increase their downstream presence” (Antill & Arnott, 2002). A rationale for integration is that it is known for significantly reducing transaction and information costs by
15 It should be noted that an IOCs or NOCs decision to vertically or horizontally integrate might be affected by country-level industrial policies and the related legal and regulatory framework. Tordo et al. (2011) state that countries such as South Africa prohibit vertical integration in the petroleum sector.
facilitating logistical operations (Stevens, 2005). Today, financial vertical integration is a prerequisite for operational vertical integration, but the opposite is not true, as “intermediate markets can substitute for operational vertical integration” (Tordo et al., 2011).
Given the prominence and longevity of the major integrated IOCs, financial and operational integration are often assumed to be inherently advantageous in creating value. Accordingly, many NOCs from emerging markets have adopted integration as a business model. In contrast, Antill & Arnott (2002) argue that value creation is better “unlocked if they were reconstituted as independently focused entities.” This would explain why it has become fashionable to question the vertically integrated structure of IOCs such as BP, RDS or Exxon-Mobil. Nonetheless, benefits at the corporate level have proven difficult to quantitatively “pin down in empirical studies” (Bindemann, 1999; Antill & Arnott, 2002) giving reason to test the following hypothesis:
H2. IOCs and NOCs that are (vertically) integrated are likely to exhibit a higher degree of value
creation.
2.4.3. Strategy
Despite the fact that most IOCs and NOCs are fully integrated entities, it can be argued that most of them make strategic and operational choices to sustain their business. Throughout the recent decade the “ongoing consolidation trend within the private petroleum sector (increasingly also involving NOCs as acquirers of petroleum assets) is testament” to an increased need to strategically focus on certain upstream or downstream core areas (Tordo et. al., 2011). “Natural resource limits and issues of appropriate depletion strategy” have lead to increased capital investments aimed at building a broader E&P footprint in the upstream petroleum sector (Tordo et. al., 2011). Other segments of the value chain such as refining, storage, and oil trading on the other hand have attracted “substantial investment” as well (Tordo et. al., 2011). Accordingly, it is claimed that those strategic organizational choices and investments directly translate into “value creation” (Tordo et al., 2011).
whereas a downstream one would seek strategic assets.”17 Obviously, for a firm focusing mainly on
upstream activities (E&P of oil and gas), it makes economic sense for it to acquire mostly oil and gas resources. On the other hand, for an IOC or NOC that is more specialized in downstream activities (i.e. refined oil products), it will naturally seek to invest in strategic assets such as “refinery technology, brand names or market accesses” because these assets will help it to produce and sell downstream products (Lai et al., 2015).
A bulk of literature centres around the proposition that one of many key drivers “is the need to access natural resources” (De Beule, Duanmu, 2012; Dunning, 1979; Dunning, 1992). The upstream sector (E&P) can be argued to be one of the most valuable and critical to all subsequent oil and gas VC components and typically is the most “politically sensitive part of the industry” (Wainberg, Foss, 2007). The ability to find and develop hydrocarbons in a cost effective manner is therefore of crucial importance for overall value creation. Hence, IOCs and NOCs sustainability is threatened if they cannot replace production cost-effectively (Wainberg, Foss, 2007). In order for an IOC or NOC to survive it “must reinvest substantial capital consistently and successfully over a long period of time to find new reserves and replace and grow its production” (Wainberg, Foss, 2007). Since the 1990s, IOCs and NOCs have systematically shifted their capital away from refining and marketing operations towards E&P (Appendix E.). Between 2000 and 2011 the global scale of E&P capital expenditure has increased “from $130 to almost $545 billion in nominal terms”, undermining the significance of the upstream business and capital expenditure (Mitchell, Marcel, Mitchell, 2012; Arnott & Antill, 2003).
The apparent alternative hypothesis affirms that IOCs and NOCs located in the downstream chain are rather strategic asset seeking. The downstream sector has been struggling to “cut costs in the refining and marketing business” for almost twenty years and reached its limit, in terms of “cost-cutting measures” by the “mid 1990s” (Arnott & Antill, 2003). Many IOCs and NOCs realised that it was “impossible to maintain a competitive advantage by following the strategy of being the lowest cost provider” (Arnott & Antill, 2003). Resulting from the increasing pressure, IOCs and NOCs financial performance is proven to be dragged down by poor downstream returns, leading to the question whether strategic downstream investments will eventually lead to a higher degree of value creation.
The previous discussion about an upstream and downstream strategic focus and proven relevance for value creation gives cause to test the following proposition:
H3. IOCs and NOCs that strategically focus on upstream investments (i.e. upstream capital
expenditure) rather than on downstream investments are likely to exhibit a higher degree of value creation.
2.4.4. Resource Munificence
A first exogenous value driver is the nature of resources underground which is referred to as “resource munificence” (Victor et al., 2012; Hoskisson, Wan, 2003). Some countries are blessed with “easy” oil and gas while others face much larger geological challenges. “The composition (oil/gas), quality (sour heavy oil vs. sweet light oil), quantity (size of proved reserves), diversification (number of geographic areas and geological basins), location (onshore/offshore, deep/shallow, remote/near markets) and maturity (proved undeveloped vs. proved developed reserves)” is proven to directly affect IOCs and NOCs performance and value creation (Wainberg, Foss, 2007).
A large body of theoretical and empirical literature has addressed the role of resources in economic development and value creation. Naturally, one would assume resources to be a tremendous source of income and prosperity and thus positively affect overall value creation. Wainberg & Foss (2007) find that large resource endowments “that are not overly complex for production” generally translate into greater “financial resources, liquidity and economies of scale.”
Others claim that resource abundance does not automatically translate into a higher degree of value creation. The aforementioned phenomenon is referred to as the “resource curse”18 and describes the apparent failure of many states to “translate a wealth of natural resources into sustainable economic development” (Stiglitz, 2005; UNCTAD, 2007; Victor et al., 2012; Tordo et al., 2011). Historically, “abundant developing countries have underperformed when compared with the resource-deficient developed countries” (Ranis, 1991; Sachs, Warner, 1999; Auty, 2001).
The aforementioned “resource curse” is not limited to the economy or the institutional framework but also has tremendous spill over effects on a microeconomic or firm level. Generally, IOCs are said to be more efficient in using their reserves or “one-third better at converting reserves into actual output.”
Current production by NOCs can likely be achieved by IOCs with a reserve base that is about “700 billion barrels smaller – suggesting that in the hands of NOCs 700 billion barrels of reserves is so-called dead oil” (Victor, 2007). The “performance and commercial efficiency” of NOCs has not lived up to expectations yet (Tordo et al., 2011). Successful value creation in developed and relative resource-scarce countries such as “Australia, Norway or the US” on the other hand, has not been merely a matter of resource endowment; rather, it has resulted from the existence and continuous development of “human resources, skills, learning and innovation” around E&P activities (UNCTAD, 2007).
The size of the resource endowment may matter, however the manner in which it is exploited seems to matter more. Large resource endowments “only lead to higher value creation if the resources are extracted efficiently” (Tordo et al., 2011). Therefore, it can be argued that IOCs and NOCs that belong to countries with large resource endowments find it more difficult to create value than their counterparts in countries with smaller resource endowments. Given the theoretical controversy about the relationship between resource munificence and value creation, following hypothesis shall be put to test:
H4. IOCs and NOCs that are located in resource munificent environments are likely to exhibit a higher
degree of value creation.
In line with the reasoning above, it shall be tested whether control of corruption has a moderating effect on the preceding hypothesis:
H4a. Control of corruption moderates the effect of resource munificence on the degree of value
creation, such that IOCs and NOCs located in resource munificent environments are likely to exhibit a higher degree of value creation when control of corruption is high.
2.4.5. Institutional Environment
Primarily drawing upon arguments developed in “institutional economics” (North, 1990), the relationship between firm performance and dissimilar home country environments seems to matter. North (1990) emphasizes the importance of the larger environment arguing that “without the institutions, or the rules of the game that prescribe a country’s incentive structure and economic specialization, complex inter-firm transactions would become too costly to complete and business dealings would be restricted” (Hoskisson, Wan, 2003). Any company’s ability and willingness to perform and create value is therefore strongly embedded within, and affected by, matters of institutions, governance and regulations. Institutions in a broad sense refer to political and legal institutions. Political institutions are primarily related “to the credibility and effectiveness of a country’s bureaucratic infrastructure and are the foundation for business transaction” (Hoskisson, Wan, 2003). “The effectiveness of legal enforcement, indicated, for instance, by the existence of an efficient judiciary system, is equally important” according to Hoskisson & Wan (2003). Arguably, institutions enable firms to engage in complex transactions thus facilitating the overall creation of value.
With regards to the oil and gas industry, it is expected that a stable, predictable and efficient environment in terms of legal and political institutions contributes positively to IOCs and NOCs ability to create value. In reality, as oil-rich regions have asserted authority over petroleum resources (through nationalizations, the reservation of production rights to NOCs or the imposition of unfavourable concession terms), resources are located in places where “laws are few, governments are relatively corrupt or inefficient, and violent conflict is endemic” (Spence, 2011). In these difficult environments, modern IOCs and even NOCs are concerned about protecting their operations, assets and reputations beyond the pure goal of maximizing profit and shareholders value (Spence, 2011).
as some “sought greater role for state ownership in the newly lucrative sector, many added new social obligations for their NOCs, such as procurement requirements or domestic gasoline subsidies” (Victor et al., 2012). Moreover, weak institutional environments often incentivise government as a whole, or certain interest groups within or outside, to direct funds from petroleum production to inappropriate or even illegal purposes, if no appropriate checks and balances exist. In such cases “the ground just might be the safest place for the asset” (Humphreys, Sachs, Stiglitz, 2007). Hence, it shall be tested whether the institutional environment is a potential value driver by hypothesising the following:
H5. IOCs and NOCs that are located in a home-country environment with high regulatory quality (e.g.
effective government) are likely to exhibit a higher degree of value creation.
As noted earlier, no country is “immune to the malign dynamics of corruption” (McPherson & MacSearraigh, 2007). In sectors with unusual high rents, “corruption can lead to a gradual weakening of institutions originally designed to regulate these sectors” (McPherson & MacSearraigh, 2007). On the other hand, a “well functioning regulatory institution limits corruption by standing in the way of potentially big money” and fraudulence (McPherson & MacSearraigh, 2007). Institutional environments that demonstrate a high level of bureaucracy with high integrity and a political culture that frowns on illicit practices is thus expected to limit corruption effectively and in turn enable value creation. Again control of corruption is expected to moderate the relationship between the institutional environment and the degree of value creation proposed as follows:
H5a. Control of corruption moderates the effect of the institutional environment on the degree of value
2.4.6. Conceptual Model
The previous literature review and hypotheses laid the foundation for developing a conceptual model, which is visualized in Figure 4. below.
Figure 4. Conceptual Model
3. METHODOLOGY AND RESEARCH METHODS
The following section will elaborate on the research paradigm and set of methods that will be employed throughout the study in order to give a concise overview about how the research is conducted and how relevant data will be collected and analysed. Additionally, the section sets out to describe how the dependent variable (DV), independent variables (IVs) and moderator variable (MV) are operationalized. Conclusively, the chapter will provide a short assessment of whether the methodological assumptions, for the chosen statistical research method are satisfied.
3.1. Research Paradigm
The choice for the following research methods is based upon certain assumptions of reality and the world in general (ontology), and how to best research this (epistemology) (Jonker & Pennink, 2010).
The present study and theoretical framework draws first and foremost on a positivist research paradigm19 that seeks out scientific explanation in an organized matter for “combining deductive logic with precise empirical observations” (Antwi & Hamza, 2015). The positivist research paradigm underpins the use of quantitative methodology and statistical analysis (Velez, 2008). Thereby, positivism clearly focuses on “measuring variables and testing hypotheses that are linked to general causal explanations” (Marczyk, DeMatteo & Festinger, 2005; Jonker & Pennink, 2010). For the sake of clarity, the research process that will be employed can be found in Appendix F. and is in accordance with the “Research Pyramid” model established by Jonker & Pennink (2010).
3.2. Data & Sample
The purpose of the following chapter is to provide a more complete outline of the chosen cross-sectional secondary data, which is somewhat more complex than it first appears. The dataset that will be used throughout the present study draws first and foremost on the 2011 edition of the “Energy Intelligence Top 100: Ranking the World’s Oil Companies” (Energy Intelligence, 2011) (Appendix G.). The unique study ranks and compares the biggest oil companies, both IOCs and NOCs, respectively. The 2011 edition reports the 2009 fiscal year results and contains observations about 59 IOCs and 41 NOCs.
The “Top 100” group of oil companies included in the ranking represent a total share of “87% of the world’s oil reserves and 72% of its gas reserves” (Energy Intelligence, 2011) (Table 1.). The “Top 100” ranking looks at more than 100 operational, financial and CSR metrics and provides an in-depth insight for a precise measurement of the performance of oil companies across a wide range of criteria.20
Table 1. Energy Intelligence Top 100 (By The Numbers)
No. of Companies 2010 2011
National Oil Companies 40 41
International Oil Companies 60 59 No. of Countries Represented 47 47
Share of Global Operations (%)
Oil Production 87 88 Gas Production 81 81 Oil Reserves 86 87 Gas Reserves 71 72 Product Sales 86 87 Distillation Capacity 74 76
Source: Energy Intelligence (2011)
Energy Intelligence (2011) notes that the “absence of some company data means that many of the individual ranking tables have fewer than the 100 companies listed” which is particularly true for several “financial criteria which are covered as accurately as possible, but for which data are lacking or not comparable for many state-owned oil companies.” Despite financial challenges regarding the absence of internationally accepted accounting standards (IFRS) or varying exchange rates, Energy Intelligence (2011) provides a “wide, universal coverage while adhering to definitional consistency.”21
In a few cases, missing financial data and accounts have been manually added for a handful of NOCs such as KPC, QP or Petrovietnam. Most missing financials were derived from the company’s 2009 annual report or estimates based on 2008 fiscal year accounts.
20 According to Energy Intelligence (2011), the ranking is based on considerable resources since the 1980s that “monitor industry development closely, constantly collect data and analyse activity and performance of the world’s leading oil companies” in order to track the main structural changes in the international oil business.
In 19 cases data was plagued by problems of missing values, which would render the subsequent composite indicator less reliable and distort the relative standing of the sample as a whole. Therefore, 19 companies were omitted from the sample due to unsubstantial data, which is methodologically in line with Freudenberg (2003). The final VCI sample covers a total of 81 IOCs and NOCs from the initial “Energy Intelligence Top 100.”
3.3. Dependent Variable
The following section proceeds by constructing a comprehensive composite indicator, namely the VCI, to measure IOCs and NOCs performance, efficiency and degree of value creation. The VCI theorized by Stevens (2008) was first applied by Tordo et al. (2011) to solely measure NOCs value creation, however, the authors state in an earlier study that the VCI can easily be adjusted and applied to IOCs which “allows a direct, comprehensive measurement and comparison of IOC and NOC performance” (Wolf, 2009).
3.3.1. The Value Creation Index (VCI)
The composite VCI is a synthetic index of individual indicators, where an indicator can be defined as a “quantitative or qualitative measure derived from a series of observed facts that can reveal relative positions in a given area” (Freudenberg, 2003). Composite indicators are useful and popular for a wide range of applications due to “(1) their ability to condense large amounts of information into easy-to-understand formats; (2) their ease of application; and (3) their convenience as a communication and benchmarking tool” (Wolf, 2009). The VCI presented in this section is not meant to capture all intricacies and aspects of value creation but provides a useful measure of key aspects of value creation and represents a convenient tool to benchmark IOCs and NOCs performance on an individual level. The VCI will be calculated on an annual basis as the data is cross-sectional. Thus, “long-term sustainability considerations and long-term growth potential” such as the “future flow of revenue from the extraction of existing reserves” are not captured by the index (Tordo et al., 2011).
partnership” (Tordo et al., 2011). However, those key measures are more drivers and enablers of value creation rather than pure indicators.
The three categorical dimensions that will be used to quantitatively capture IOCs and NOCs value creation are in line with Stevens (2008) theoretical framework namely (1) operational performance, (2) financial performance and (3) social performance. If each of these categories could be observed and measured directly, the summation of the observed values would provide the desired measure of value creation. However, “categorical measures do not exist” (Stevens, 2008). Therefore, various proxy variables will be estimated to capture certain aspects of value creation that are believed to be important for each category (Tordo et al., 2011). Additionally, it is worth noting that data availability directly affects the selection of proxy variables.
3.3.2. Proxy Measures for the Value Creation Index (VCI)
The following section will discuss the proxy measures for each of the three sub-indices respectively. In general, the underlying indicators should be chosen based on their “analytical soundness, measurability, data quality, relevance to the phenomenon being measured, and relationship to each other” (Wolf, 2009). Therefore, the definitive set of indicators, measuring performance and value creation of IOCs and NOCs, needs to be properly justified. A maximum of five indicators has been set for each of the three sub-indices in order to keep the amount of variables limited to the conceptual core. Adding or including as many variables as possible could result in “double-counting and bias, and make the composite index harder to audit” (Wolf, 2009).
3.3.2.1. Operational Performance
Stevens (2008) states that operational measures of performance can include “physical and financial measures and can be used to consider the growth of the firm.” Commonly used physical measures relate to upstream and downstream activities.
levels without adding reserves22 expressed in time. The ratio signals the remaining lifespan of natural
resources. The RPR ratio will be calculated for “Total Liquid and Gas”23, “Total Liquid”24 and “Total Gas”25. According to Energy Intelligence (2011) it should be taken into account that “particularly high ratios resulting from limited production relative to large resources tend to overstate the longevity or significance of the reserves” whereas “particularly low ratios may overstate a low reserve situation.” The formula for calculating the three distinct RPR ratios looks as follows:
𝑻𝒐𝒕𝒂𝒍 𝑳𝒊𝒒𝒖𝒊𝒅 & 𝑮𝒂𝒔 𝑹𝑷𝑹 = 𝑻𝒐𝒕𝒂𝒍 𝑳𝒊𝒒𝒖𝒊𝒅 & 𝑮𝒂𝒔 𝑹𝒆𝒔𝒆𝒓𝒗𝒆𝒔 (𝒎𝒎𝒃𝒐𝒆) 𝑻𝒐𝒕𝒂𝒍 𝑨𝒏𝒏𝒖𝒂𝒍 𝑳𝒊𝒒𝒖𝒊𝒅 & 𝑮𝒂𝒔 𝑷𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒐𝒏 (𝒎𝒎𝒃𝒐𝒆) 𝑻𝒐𝒕𝒂𝒍 𝑳𝒊𝒒𝒖𝒊𝒅 𝑹𝑷𝑹 = 𝑻𝒐𝒕𝒂𝒍 𝑳𝒊𝒒𝒖𝒊𝒅 𝑹𝒆𝒔𝒆𝒓𝒗𝒆𝒔 (𝒎𝒊𝒍𝒍𝒊𝒐𝒏 𝒃𝒃𝒍) 𝑻𝒐𝒕𝒂𝒍 𝑨𝒏𝒏𝒖𝒂𝒍 𝑳𝒊𝒒𝒖𝒊𝒅 𝑷𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒐𝒏 (𝒎𝒊𝒍𝒍𝒊𝒐𝒏 𝒃𝒃𝒍) 𝑻𝒐𝒕𝒂𝒍 𝑮𝒂𝒔 𝑹𝑷𝑹 = 𝑻𝒐𝒕𝒂𝒍 𝑮𝒂𝒔 𝑹𝒆𝒔𝒆𝒓𝒗𝒆𝒔 𝒃𝒄𝒇 𝑻𝒐𝒕𝒂𝒍 𝑨𝒏𝒏𝒖𝒂𝒍 𝑮𝒂𝒔 𝑷𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒐𝒏 𝒎𝒎𝒄𝒇
In addition, the ratio of “Total Liquid & Gas Output” to “Total Assets” will be used, which in short reflects capital efficiency and complements the operational effectiveness measures above.26
𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑬𝒇𝒇𝒊𝒄𝒊𝒆𝒏𝒄𝒚 = 𝑻𝒐𝒕𝒂𝒍 𝑳𝒊𝒒𝒖𝒊𝒅 & 𝑮𝒂𝒔 𝑶𝒖𝒕𝒑𝒖𝒕 (𝒎𝒎𝒃𝒐𝒆) 𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔 (𝑼𝑺$)
Lastly, to reflect labour efficiency “Total Liquid & Gas Output” to “Employees” will be calculated (Tordo et al., 2011).27
𝑳𝒂𝒃𝒐𝒖𝒓 𝑬𝒇𝒇𝒊𝒄𝒊𝒆𝒏𝒄𝒚 = 𝑻𝒐𝒕𝒂𝒍 𝑳𝒊𝒒𝒖𝒊𝒅 & 𝑮𝒂𝒔 𝑶𝒖𝒕𝒑𝒖𝒕 (𝒎𝒎𝒃𝒐𝒆) 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒆𝒔
22 Reserves as a stand-alone measure should not be part of a performance assessment, as many “reserve numbers are based upon estimates and simply reflect mathematical extrapolation” rather than any operational effort (Stevens, 2008).
23 The sum of “oil and gas reserves” as well as the sum of “oil and gas production” are reported in barrels of oil equivalent per day (with gas converted to crude oil equivalent at a standard Btu basis of 6,000 cubic feet per barrel).
24 “Total Annual Liquid Production” spans the production of crude oil, natural gas liquids and condensates (Energy Intelligence, 2011).
25 “Total Annual Gas Production” includes net or marketable gas production, not including natural gas liquids. In most cases this excludes “flard gas, gas used for reinjection and, in some cases, gas used in other aspects of production operations” (Energy Intelligence, 2011).
26 “Total liquid & gas output” is defined here as the sum of upstream production, expressed in millions of barrels of oil equivalent (mmboe).
3.3.2.2. Financial Performance
The second sub-index attempts to measure the financial performance of oil companies. Commonly, accountancy makes use of a “variety of financial ratios to assess the performance of companies drawn from the annual accounts”28 (Stevens, 2008). Arguably, all of the financial performance measures fall widely within the concept of “value based management”, whereby the performance of the company is measured solely by the return to the shareholders.
It is argued that IOCs and NOCs differ largely “in terms of lower revenue or lower profitability” (Wolf, 2009). Those efficiency gaps are attributed partly to the complexity of objectives pursued by NOCs. Ideally, a direct comparison of IOCs and NOCs should account for those structural differences29, however will be disregarded in the present study. Chen & Jaffe (2007) argue that most NOCs see themselves as pure commercial business”, indistinguishable from private operators. Therefore, both IOCs and NOCs will be treated along this dimension as pure commercial entities.
A number of financial indicators were considered, however due to a lack of transparency, missing data and potential inaccuracy30 the following proxy indicators were chosen to measure financial performance, profitability and financial efficiency: (1) “Revenue/Total Assets”, (2) “Net Income/Total Assets” and (3) “Revenue/Employee.” In order to ensure uniformity, all accounts used to assess the “operational, financial or social performance” have been converted and are denoted in U.S. Dollars (US$).
28 According to Tordo et al. (2011), when using financial accounting data, the following aspects need to be taken into account amongst others: (1) previous accounting literature has shown that companies can manipulate their disclosure, even in developed capital markets and jurisdictions; (2) differences in accounting standards between countries (and within countries) can reduce the comparability of data; (3) irrespective of accounting standards, the detail and quality of the accounts and the auditing process might vary significantly especially between IOCs and NOCs.
29 With regards to financial performance it should be noted that one of the structural differences in the oil and gas industry is taxation. IOCs and NOCs financial viewpoints differ tremendously, as IOCs are merely interested in tax reduction or avoidance in order to increase private shareholders value. IOCs are flexible with regards to “portfolio management or related tax implication” (Wolf, 2009). Therefore, to benchmark IOC performance should ideally be based on after-tax profits. In contrast, to assess NOCs performance Tordo et al. (2011) argue that “after tax measures are not appropriate because taxes are not a loss of value as viewed by the government.”
As a first indicator, “Asset Turnover” measured as “Revenue31/Total Assets32” will be used to evaluate
the efficiency of a company’s use of its asset base in generating revenue. Generally speaking, a higher asset turnover ratio indicates better performance in terms of generating more revenue per dollar of assets.
𝑨𝒔𝒔𝒆𝒕 𝑻𝒖𝒓𝒏𝒐𝒗𝒆𝒓 = 𝑹𝒆𝒗𝒆𝒏𝒖𝒆 (𝑼𝑺$) 𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔 (𝑼𝑺$)
Secondly, the “Return on Assets” (ROA) ratio will be employed to assess financial performance. ROA is a company’s “Net Income”33 divided by its “Total Assets” and is a key profitability ratio which measures the amount of profit made by a company per dollar of its assets. The ROA ratio will be calculated as follows:
𝑹𝑶𝑨 = 𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆 (𝑼𝑺$) 𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔 (𝑼𝑺$)
The distinct difference between Asset Turnover and ROA is that ROA considers net income whereas the Asset Turnover considers revenues. By using net income, the ROA formula factors a company’s expenses that occurred in the given accounting period.
The third variable “Revenue per Employee” is a ratio that is calculated as a company’s “Revenue” divided by the current number of employees and is foremost useful when comparing it to companies in the same industry (Victor, 2007). A higher ratio suggests higher productivity and better use of IOCs and NOCs resources. Moreover, a higher productivity ratio is said to be a “key objective for both public and private firms” (Eller, Hartley & Medlock, 2011).
𝑹𝒆𝒗𝒆𝒏𝒖𝒆 𝒑𝒆𝒓 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒆 = 𝑹𝒆𝒗𝒆𝒏𝒖𝒆 (𝑼𝑺$) 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒆𝒔
31 “Revenue” is defined as “total net revenue, however in cases where estimates are used or full details are unavailable, the revenue figure listed could either include or exclude other sources of funds” (Energy Intelligence, 2011).
32 “Total Assets” is the sum of current and fixed assets (Energy Intelligence, 2011).
3.3.2.3. Social Performance
Tordo et al. (2011) define aspects such as “creating employment opportunities, promoting economic growth and contributing to energy self-sufficiency and security of supplies” as typical NOC mission statement objectives. However, not just NOCs are responsible to contribute to the domestic economy. In recent years, local content policies increasingly started to affect both IOCs and NOCs. Moreover, as Stevens (2008) argues the “reputation of a company” relates to the public perception of “their record on a number of issues, ranging from managerial style and environmental issues, to human rights.” Thus, a shift and growing interest towards ethical standards and corporate social responsibility can be observed in recent years, emphasizing the importance of what is called here the “social performance.” The chosen variables to reflect social performance are (1) “Employment Share of Country Workforce”, (2) “Domestic Output Use” and (3) “CSR Reporting” which will be discussed hereafter.
The first social performance indicator is the contribution of IOCs and NOCs to local employment and the creation of a skilled local work force which is measured by the company’s “share of its country’s employment” (Tordo et al., 2011). Simply put, if an IOC or NOC accounts for a large share of its country employment, disposable incomes are likely to have noticeable multiplier effects on the national economy yielding in a higher degree of value creation.
𝑺𝒉𝒂𝒓𝒆 𝒐𝒇 𝑪𝒐𝒖𝒏𝒕𝒓𝒚H𝒔 𝑬𝒎𝒑𝒍𝒐𝒚𝒎𝒆𝒏𝒕 = 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒆𝒔
𝑪𝒐𝒖𝒏𝒕𝒓𝒚 𝑾𝒐𝒓𝒌𝒇𝒐𝒓𝒄𝒆
The second variable to be assessed is “Domestic Output Use” which measures an oil company’s contribution to “energy self sufficiency and security of supplies, as well as domestic value-added processing of crude oil (either in refineries or in industries further downstream)” (Tordo et al., 2011). “Domestic Output Use” is measured by the ratio of an IOCs or NOCs “Annual World Liquids Production” supply to the total domestic “Country Oil Consumption.” Domestic supply often comes at a financial cost, as exports would most likely maximize rents on oil, however the ratio indicates a stronger “forward linkage to the domestic economy” and hence indicates which oil companies create more value from a national perspective (Wolf, 2009).
Finally, initiatives and attempts to measure corporate social responsibility (CSR) have received growing attention accompanied by an intensive discourse on how to best assess CSR. Tordo et al. (2009) stated that so-called “health, safety and environment (HSE)” indicators such as the reporting on oil spills or flared gas are tremendously “useful indicators” but not available for a wide range of oil companies. The “Energy Intelligence Top 100: Ranking the World’s Oil Companies Corporate Social Responsibility Reporting 2008-09”, however debuted a section that summarised the CSR reporting by the “Top 100” oil companies that will be employed as a proxy. The Energy Intelligence’s CSR ranking is designed to analyse the degree to which the Top 100 firms report data on their social and environmental performance. The five criteria and dimensions which are reported and analysed in the years 2008 and 2009 include “(1) hydrocarbons spilled, (2) greenhouse gas emissions, (3) hydrocarbon flaring, (4) total recordable incident rate and (5) energy consumption” (Energy Intelligence, 2011). The CSR Reporting Index is calculated as follows:
𝑪𝑺𝑹 𝑹𝒆𝒑𝒐𝒓𝒕𝒊𝒏𝒈 𝑰𝒏𝒅𝒆𝒙 = 𝒊𝟏+ 𝒊𝟐+ 𝒊𝟑+ . . . +𝒊𝒏 𝒎S𝟏𝟎
𝒊S𝟏
Many NOCs and US-based IOCs fail to fully report data for the selected categories, which is not a surprise “given their lack of transparency and accountability” (Energy Intelligence, 2011). The CSR activities of IOCs are widely regarded as an activity outside of their “normal” mission, which are naturally “aimed at creating and strengthening their license and public authorization to operate” (Stevens, 2009). Generally, it should be noted that ranking and drawing comparisons between the reported CSR data is subject to a lack of uniformity34 with regards to reporting these data. Nonetheless, the Energy Intelligence (2011) ranking is a good first cut and significant indicator of how IOCs and NOCs respond publicly towards corporate responsibility, environmental protection and sustainability.
3.3.3. Determination of the Value Creation Index (VCI) Figure 5. Determination of the Value Creation Index (VCI)
Source: Adapted from Wolf (2009).
For the selected IOCs and NOCs, the VCI is calculated on an annual basis as the weighted average of the three sub-indices depicted in Figure 5. (the respective formulas are summarised in Appendix H.):
𝑽𝑪𝑰 = 𝟏 𝒎 𝟏 𝒏 𝑵𝒋 𝒏 𝒋S𝟏 𝒎 𝒊S𝟏
where “VCI is the composite index, Nj is a normalized variable and j indicates the number of
sub-components in each sub-group i” (Freudenberg, 2003; Tordo et al., 2011).
The different individual indicators are normalized, as all of them are measured on different unites, different ranges and distributions. Moreover, normalization has the benefit of avoiding the dominance of extreme values (Wolf, 2009). With respect to the present VCI, the distance from the “best and worst performers” will be used, “where positioning is in relation to the global maximum and minimum and the index takes values between 0 (laggard) and 1 (leader)” (Freudenberg, 2003):
𝑵𝒋=
𝑿𝒋 − 𝑿𝒋𝒎𝒊𝒏
