How are National Oil Companies changing the face of the industry?

February 27, 2018 Stephen George, Chief Economist EMEA and APAC and Mark Routt, Chief Economist Americas

The in-house battle

As NOCs expand their export-oriented capacity, they will increasingly be looking commercially for markets for their own surplus refined products. India and China are Asia’s two most important product markets, but strategically both are looking to maintain domestic oil refining capacity in balance with growing demand. NOC product exporters are therefore increasingly likely to find themselves competing with IOC majors, traders and eventually themselves as they look to carve out routes to market for their growing surplus of products. Importantly too, Middle East exporters will soon find that their own crude exports to refiners in Asia will put them in competition with their own refined product exports.

Successful transition from an NOC to an IOC-style model is not only dependent upon the downstream entity, but also on the state ceding control. When these transitions occur, then NOCs like Pemex and Petrobras should be able to ‘up their game’ and increase their access to regional markets. But, and it is a large caveat, this depends upon a cultural change in the state regulatory environment.

Redefining the competition

As NOCs spread their wings in the competitive space, the potential for NOC-on-NOC competition grows more likely. Signs are starting to emerge as multiple Middle Eastern NOCs target the same Asian oil product demand. Not only are Middle Eastern NOCs going head to head against one another for Asian market share, they are also starting to compete against their own joint venture interests in those same Asian markets. The more commercial NOCs become, the more they must face the realities of competition, even amongst their own stable-mates. With more new projects launching between now and 2022, the market will only become more competitive, and more exports from NOCs means more imports elsewhere.

The transformative development of NOCs from national champions to global competitors reflects a strong desire on the part of the national governments to be the ‘last man standing’ as forecast demand for refined oil products – especially transport fuels – starts to plateau in the 2030s. So as refined product demand dwindles due to increased electrification and use of other fuel alternatives, even while there is adequate global supply of petroleum products, it is not enough to have the resources in the ground. It will be necessary to survive and thrive on thinning refining margins, a higher regulatory burden and a shifting product demand barrel. The long-term income stream from hydrocarbons will remain critical to OPEC and other oil-exporting economies and their competitive repositioning is designed to move them from their role as national champions to a global base load.

Operational Excellence is crucial for future success

The implications of this transition are profound both for NOCs and non-state oil refiners. A more globalized oil products market signals tighter margins, which in turn should drive investments in Operational Excellence and discipline in capital allocation. NOCs, and even IOCs, that don’t respond to these signals will lag their counterparts and limit their options in an increasingly global commodity market. Narrower margins will then constrain new capital investment, and in turn give preference to companies operating either on more commercial lines or that have a private source of capital.

Markets aren’t standing still. Scale and efficiency will become more important in the refining sector after 2020, and oil refiners will have to respond to new challenges including carbon emissions reduction, marine fuel sulphur reductions, and the evolving refined product demand barrel moving away from transport fuels in favor of petrochemicals and renewable alternatives. As an oil refiner, your market environment will determine your best response to the challenges ahead. NOCs evolve, they will need to focus on full scale business transformation programs to maintain cost competitiveness and optimise capital employed to achieve higher net margins in competition against your peers and highly efficient export refiners. By setting out a program of continuous improvement, operational excellence focuses on the areas of your organization where improvement is required and delivers sustainable performance improvements that deliver real value to your bottom line.

All oil companies looking to future-proof their current investments will need to adjust to a new reality where NOCs will effectively enter markets traditionally dominated by IOCs and traders. Smaller independent oil refiners will need to become more agile, take advantage of a wider slate of opportunity crudes, and develop product flexibility that includes new markets only available through trade and enhanced commercial operations. IOCs must focus on value chain optimization opportunities, including widening feedstock and product slates, integrating refining with petrochemical production, and potentially producing additional desirable unfinished intermediates at a low total cost to increase overall net profits. As new forces emerge, all oil refiners need to plan their unique response to the changing shape of more global competition.

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