2009 podcast pollitt oiling

Oiling the wheels of productivity

17 February 2009

The article at a glance

The performance and efficiency of the world’s national oil companies – i.e. those still wholly under government ownership – could be increased …

The performance and efficiency of the world’s national oil companies – i.e. those still wholly under government ownership – could be increased very dramatically by privatising them, new research finds. The results of such performance improvements would be staggering, explains Dr Michael Pollitt, Reader in Business Economics at Cambridge Judge Business School, and could see global oil and gas production in the first year alone increase by 2.7 million barrels of oil equivalent per day – which is more than all of France’s current oil and gas consumption.

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Judge Business School’s Christian Wolf and Dr Michael Pollitt have been studying what happens to national oil firms when they are privatised or partly privatised. They have found that over a period of seven years around the privatisation date, such firms – some of the most important contributors to their respective economies – not only improve their return on sales by 3.6 percentage points, but also increase total output by 40 per cent and output per employee by 30 per cent. They also increase capital expenditure by 47 per cent.

Based on these findings, say the authors, if the 18 fully state-owned firms among the world’s 50 largest oil and gas companies were to go down the privatisation path, the results would be “staggering”. These 18 firms currently have a combined oil and gas output of 47 million barrels of oil equivalent per day, 18 million barrels per day of refining capacity, and estimated revenues of one trillion US dollars (PIW 2007). If they were to experience the kinds of performance improvements that privatisation brings, “global oil and gas production in the first year alone could increase by 2.7 million barrels of oil equivalent per day – which is more than all of France’s current oil and gas consumption”.

The researchers add that the overall increase in output over the remaining six years around privatisation could amount to 19 million barrels of oil equivalent per day – that’s almost 15 per cent of current global production (and consumption) of oil and gas. Based on the improvement in return on sales, one could expect their combined annual profits to rise by US$33 billion over the period, even without taking into account the increasing volume sales. According to the researchers, this post-tax profit could be used by governments for social infrastructure projects to compensate for any changes in the companies’ objective function.

The authors say that “whilst these are hypothetical numbers, they illustrate the magnitude of the potential benefits from privatisation. Furthermore our study suggests that most of these gains might be realised by partial privatisation alone, i.e. without the selling government having to cede majority control”.

This paper is the first comprehensive study of share-issue privatisations in the global oil and gas industry and it addresses a number of important questions. Surprisingly, despite their economic and political importance, there has been limited research on the performance and efficiency of national oil companies, while questions over resource ownership have gained widespread attention in recent years. And these questions are not only to do with concerns about whether Europe is becoming too dependent on Russia for its energy, for example. The questions are also to do with the efficiency of nationally owned and run oil firms. National oil companies, such as Saudi Aramco and Petroleos de Venezuela SA, currently own about 80 percent of the world’s reserves, it is estimated, so enhancing their performance and productivity would seem to be highly desirable.

However, far from privatising such firms, there has been increasing state involvement in the Venezuelan oil industry over recent years: international oil companies have seen their equity stakes in Venezuelan oil operations forcibly cut to minority levels while the Venezuelan state oil company has been under-investing in oil production, it is reported, as the government has been using oil revenues for other purposes. And observers think that the current global economic crisis, and its impact on oil prices, makes it less rather than more likely that any of the Arab state-owned oil firms will be privatised.

But the study lays down very compelling arguments in favour of privatisation. It looks at the initial share issue privatisations of some 28 oil firms, including such names as BP, Britoil and Enterprise Oil in the UK, France’s Elf Aquitaine, Spain’s Repsol, Brazil’s Petrobras and three firms in China. The privatisations took place over a period from June 1977 (when the initial share issue privatisation of BP took place) up to 2004 when privatisation reduced state ownership of Pakistan Petroleum from 93 to 78 per cent.

“The results of our study clearly show that there are some pretty spectacular performance benefits to privatisation,” says co-author Dr Pollitt, who is assistant director of the ESRC Electricity Policy Research Group at Judge Business School and a University Reader in Business Economics. “But one problem is that national oil companies tend to be very profitable and that can mask their underlying poor performance, making it difficult to see that there could be even more benefits to be derived from the firm if it were privatised.”

And where do these benefits come from? “Output. Under private or part-private ownership, firms just get better at extracting oil. This is because the flow of oil produced by the company is directly affected by the amount of investment put in. So the Russian oil and gas sector, for example, has been badly affected by inefficient state involvement. In contrast, the private oil companies are well set up to organise efficient investment and even though national firms often go into joint ventures with these firms it is not clear that that is an efficient substitute.”

All this said, there are of course some other issues around privatisation of oil firms. Some governments are reluctant to consider privatisation because they fear losing valuable revenues, but Dr Pollitt points out that this concern can be addressed by using suitable tax instruments rather than dividends to extract revenue. And if there were to be such a significant increase in output by newly privatised firms, that would raise issues over who the buyers would be for all this extra oil, and what increased output might do to oil prices and to the quotas of OPEC nations.

But at the moment, the biggest argument against privatisation would be price. There have been some dramatic swings in oil prices in the last six months, automatically making oil company share issues less attractive to selling governments, and the timing of any future privatisation would obviously be influenced by considerations about oil prices.

Says Dr Pollitt, “Getting the timing right would be by no means straightforward given some of the extreme recent price swings. But such swings do tend to be quite rare. And then, if you are going only for part privatisation then your exposure to oil prices on any given day are limited. The firms we looked at had several tranches of privatisation. Even if a firm got the timing of the first one wrong, it could subsequently follow it up with a release of shares onto the market at more favourable times.”

Further Reading

Wolf, C. and Pollitt, M.G. (2008) “Privatising national oil companies: assessing the impact on firm performance.” Judge Business School Working Papers, No.02/2008. Cambridge: University of Cambridge. Available online at: https://www.jbs.cam.ac.uk/wp-content/uploads/2020/08/wp0802-v2.pdf