But there were two obvious risks. One came from being in the position of being able to bet only on three or four big projects, instead of ten or fifteen. The second was the danger of being absorbed in a hostile takeover. Phillips faced the same risks. And these were not theoretical risks. After all, the reason Conoco had fallen into DuPont’s arms in 1981 was to ward off hostile bids. And later in the 1980s, Phillips had been the target of hostile tenders by both T. Boone Pickens and Carl Icahn. And, thus, Dunham and Phillips’s CEO, James Mulva, had begun discussing a possible combination in 2000. But the talks had foundered in October 2000.
Instead, the two companies went head to head as finalists in bidding for the Alaskan assets that BP and ARCO had to shed in order to consummate their merger. Phillips was the winner. That meant a strategic transformation. For the acquisition doubled its reserves and gave it a bulk that made it commensurate with Conoco in size. But how were talks to get going again?
During World War I, the state of Oklahoma had run short of money and, as a result, had left its capital’s building in an embarrassingly unfinished condition—that is, without a dome. Eighty-five years later, in June 2001, a celebration was being held in Oklahoma City for a newly built dome that was to be hoisted atop the capitol. Both Phillips and Conoco were financial contributors to this historic rectification, and the two CEOs, Dunham and Mulva, both in town for the event, ran into each other in the lobby of the Waterford Hotel.
“We need to talk again,” said Mulva.
Months of negotiations followed. In November 2001, the two companies announced their merger, creating ConocoPhillips, the third-largest oil company in the United States with, in fact, the largest downstream system in the nation. Dunham become chairman. Mulva, who was now the CEO of the combined company, was very clear as to the purpose of this merger: “ We’re going to do this so we can compete against the biggest oil companies.”16
STANDING ASIDE : SHELL
One company was notably absent from the fray, Royal Dutch Shell, which had been, prior to the mergers, the largest oil company of all. There were several reasons. An internal analysis had concluded that the long-term oil price would be determined by the cost of new non-OPEC oil, which it pegged at $14 a barrel ; and so it used a $14 oil price to screen investments. It had also concluded that size mattered, but only up to a certain threshold. But there was a still more important reason—the structure of the company itself.
When Mark Moody-Stuart would introduce himself at conferences, he would say, “I’m the chairman of Shell. I’m also the closest thing you’ll ever see to a CEO of Shell.” That was the problem. Shell had a unique structure. Although it operated as one company, it was actually owned by two separate companies with two separate boards—Royal Dutch and Shell Transport and Trading. It had no CEO; it was run by committee. This was the compromise reached to carry out a much earlier merger, in 1907, and then modified in the late 1950s. This “dual structure” had worked well for many decades, but had become increasingly inefficient. The dual ownership also made it “very difficult,” as Moody-Stuart put it, to do a stock-based merger with another large company. In fact, it had made such a merger virtually impossible. During the merger years, Moody-Stuart had tried to push through an internal restructuring , but the reaction from many of the directors was, as he said, “quite stormy.” 17 Nothing happened. After all the mergers were done, Shell was no longer the largest oil company.
What had unfolded between 1998 and 2002 was the largest and most significant remaking of the structure of the international oil industry since 1911. All the merged companies still had to go through the tumult and stress of integration, which could take years. They all came out not only bigger but also with greater efficiencies, more thoroughly globalized, and with the capacity to take on more projects—projects that were larger and more complex.
Looking back a decade later on the consolidation, on this earthquake in the industry structure, Chevron CEO David O’Reilly observed, “A lot of it has played out as was expected. The part that hasn’t quite played out relates to the national oil companies. Are these larger companies competitive with the national oil companies?”18
When a minor corner of the world economy—the overleveraged Bangkok commercial real estate market—began to convulse, and the overvalued Thai baht began to plummet from speculative attacks, no one expected that the consequences would lead to an Asian, and then a wider global, financial crisis. Certainly none of the managements of the world’s major oil companies would ever have expected that the distress of this rather obscure Southeast Asian currency would trigger a collapse in the price of oil and the massive restructuring of their own industry. Yet more was to come. For the consequences would also transform national economies and countries, including one of the world’s most important oil producers.
5
THE PETRO-STATE
For oil-importing countries, the price collapse was a boon to consumers. Low prices were like tax cuts. Paying less for gasoline and home-heating Boil meant that consumers had extra money in their pockets, which was a stimulus to economic growth. Moreover, low oil prices were an antidote to inflation, allowing these countries to grow faster, with lower interest rates and less risk of inflation.
CRISIS FOR THE EXPORTERS
What was a boon for the consumers was a disaster for the oil producers. For most of them, oil and gas exports were the major source of government revenues, and the petroleum sector was responsible for 50 or 70 or 90 percent of their economies. Thus, they experienced sudden large drops in GDP. With that came deficits, budget cuts, considerable social turmoil, and, in some cases, dramatic political change.
The most dramatic change of all would be in Venezuela. Because of the scale of its resources, Venezuela could be described as the only OPEC “Persian Gulf country” not actually in the Persian Gulf. In 1997 it was actually producing more petroleum than either Kuwait or the United Arab Emirates, and almost as much as Iran. Its position in the Gulf of Mexico and its role as a Western Hemisphere producer made it a bulwark of U.S. energy security, as it had been going back to World War II. But Venezuela had also become the very embodiment of what is called a petro-state.
The term “petro-state” is often used in an abstract way, applying to nations that differ widely in everything—political systems, social organization, economy, culture, religion, population—except for one thing: they all export oil and natural gas. Yet certain common features do make the petro-state a useful lens. The common challenge for these exporters is to ensure that the opportunities for longer-term economic development are not lost to economic distortion and the ensuing political and social pathologies. That means having the right institutions in place. It is very challenging.
Venezuela’s national saga illuminates the difficulties.
“The Venezuelan economy since 1920 can be summed up in a word: oil,” the economist Moises Naim has written. Prior to that, it had been an impoverished, underpopulated, agricultural nation—a “cocoa-state” and then a “coffeestate” and “sugar state”—highly dependent on those commodities for its national income, such as it was. Local caudillos ran their little fiefdoms as if they were their own countries. Of the 184 members of the legislature in the mid-1890s, at least 112 claimed the rank of general. Afflicted by innumerable military coups, Venezuela was ruled by a series of dictators, such as General Cipriano Castro, who after taking power in 1900, proclaimed that he was “the man raised by God to fulfill the dreams of Bolivar” and reunite Venezuela, Colombia, and Ecuador as a single country. He was soon pushed aside by another general, Vicente Gómez, who ruled the country as his “personal hacienda” from 1908 until his death in 1935.1
The decisive event for Venezuela’s fortunes came in 1922. The giant Barroso well in the Maracaibo basin blew out with an uncontrolled flow of 100,000 barrels a day. (It was discovered by the same engineer, George Reynolds, who in 1908 brought in the first oil well in Iran.) With the Barroso gusher, Venezuela’s oil age had begun. Ther
eafter, increasing wealth poured into the country as more and more oil flowed out of the ground.
Yet why did Juan Pablo Pérez Alfonso, the influential energy minister after the restoration of democracy in 1958, and one of the founders of OPEC, decry petroleum in his retirement years as “the excrement of the devil”? It was because he saw the impact of the influx of revenues on the state, the economy, and society, and the psychology and motivations of the people. The oil wealth could be wasted; it could distort the nation’s life. In his view, Venezuela was already becoming a petro-state, a victim of the alluring and malevolent “resource curse.”2
THE “REVERSED MIDAS TOUCH”
In the 1980s and 1990s, oil could generate more than 70 percent of Venezuela’s central government’s revenues. In a petro-state, the competition for these revenues and the struggle over their distribution becomes the central drama of the nation’s economy, engendering patronage and clientelism and what is called “rent-seeking behavior.” That means that the most important “business” in the country (aside from oil production itself) is focused on getting some of the “rents” from oil—that is, some share of the government’s revenues. Entrepreneurship, innovation, hard work, and the development of a competitively oriented growth economy—all these are casualties of the system. The economy becomes inflexible, losing its ability to adapt and change. Instead, as the edifice of the state-controlled economy grows, so do subsidies, controls, regulations, bureaucracy, grand projects, micromanagement—and corruption. Indeed, the vast amounts of revenues connected with oil and gas create a very rich brew for corruption and rent seeking.
A group of Venezuelan academics summed up the problem this way: “By the middle of the twentieth century, there was already a deeply rooted conviction that Venezuela was rich because of oil, because of that natural gift that does not depend on productivity or the enterprising spirit of the Venezuelan people.” They added: “Political activity revolved around the struggle to distribute the wealth, rather than the creation of a sustainable source of wealth that would depend upon the commercial initiatives and the productivity of the majority of the Venezuelan people.”3
The petro-state and its attendant resource curse have two further characteristics. One is called the Dutch disease. The term describes an ailment that the Netherlands contracted in the 1960s. Around that time, the Netherlands was becoming a major natural gas exporter. As the new gas wealth flowed into the country, the rest of the Dutch economy suffered. The national currency became overvalued and exports became relatively more expensive—and, thus, declined. Domestic businesses became less competitive in the face of the rising tide of cheaper imports and increasingly embedded inflation. Jobs were lost and businesses couldn’t survive. All of this came to be known as Dutch disease.
A partial cure for the disease is to segregate some of these earnings. The sovereign wealth funds that are now such important features of the global economy were invented, in part, as preventative medicine—to absorb this sudden and/or large flow of revenues and prevent it from flooding into the economy and thus, by so doing, insulate the country from the Dutch disease.
The second, even more debilitating ailment of the petro-state is a seemingly incurable fiscal rigidity, which leads to more and more government spending—what has been called “the reversed Midas touch.” This is the result of the variability of government revenues, owing to the volatility of oil prices. When prices soar, governments are forced by society’s rapidly–rising expectations to increase their spending as fast as they can—more subsidies to hand out, more programs to launch, more big new projects to promote. While the oil can generate a great deal of revenues, it is a capital-intensive industry. This means it creates relatively few jobs, adding further to the pressure on governments to spend on projects and welfare and entitlements.
But when world oil prices go down and the nations’ revenues fall, governments dare not cut back on spending. Budgets have been funded, programs have been launched, contracts have been let, institutions are in place, jobs have been created, people have been hired. Governments are locked into ever-increasing spending. Otherwise they face political backlash and social explosions. The governments are also locked in to providing very cheap oil and natural gas to their citizens as an entitlement for living in an energy-exporting country. (In 2008 gasoline in Venezuela went for about eight cents a gallon.) This leads to wasteful and inefficient use of energy, as well as reducing supplies for export. A government that resists the pressures to spend—and increase spending—puts its very survival at risk.
There are easier ways than cutting spending to alleviate the “reversed Midas touch.” But they work well only in the short term. One way is by printing money, which leads to high inflation. Another is by international borrowing, which keeps the money flowing. But that debt needs to be serviced and repaid, and as the debt balloons, so do the interest payments, leading of potential debt crises.
In the petro-state, no constituency is in favor of adjusting spending downward to the lower levels of income—except for a few economists who understandably become very unpopular. On the contrary, across society most hold the conviction that oil can solve all problems, that the tide of oil money will rise forever, that the spigot from the finance ministry should be kept wide open, and that the government’s job is to spend the oil revenues as fast as possible even when more and more of those revenues have become a mirage.
As Ngozi Okonjo-Iweala, former finance minister and foreign minister of Nigeria, summed it up: “If you depend on oil and gas for 80 percent of government revenues, over 90 percent of exports are one commodity, oil, if that is what drives the growth of your economy, if your economy moves up and down with the price of oil, if you have volatility of expenditures and of GDP, then you’re a petro- state. You get corruption, inflation, Dutch disease, you name it.”4
While these are the general characteristics that define a petro-state, there are wide variations. The dependence on oil and gas of a small Persian Gulf country is obvious, but its population is also small, which reduces pressures. And it can insulate itself from volatile oil prices through the diversified portfolio of its sovereign wealth fund. A large country like Nigeria that depends heavily on oil and natural gas for government revenues and for its GDP has much less flexibility. Spending is very difficult to rein in.
There is also a matter of degree. With 139 million people and a highly developed educational system, Russia possesses a large, diversified industrial economy. Yet it does depend upon oil and natural gas for 70 percent of its export revenues, almost 50 percent of government revenues, and 25 percent of GDP—all of which means that the overall performance of its economy is inordinately tied to what happens with the price of oil and gas. And while Russia is much more than a petro-state, it has some of the characteristics of a petro-state—from which it can benefit and with which it must contend—and which generates a constant debate about how to diversify the economy away from oil and gas.
“WE COULDN’T LOSE TIME”
But it is Venezuela that is as identified as any nation with the very idea of the petro-state. And it was Carlos Andrés Pérez who embodied the petro-state—at least the first time around. His first term as president of Venezuela was during the height of the oil boom in the 1970s, when revenue far greater than anyone had ever contemplated was flowing into the national treasury. As a result of the quadrupling of the oil price in 1973–74, he had gained, on an annualized basis, four times as much money to spend as his immediate predecessor. And he was determined to spend it. “We are going to change the world!” he would say to his cabinet. Venezuela’s human capital made the ambitions more credible. Even before the price increases, the government was taxing the oil companies as much as 90 percent, and as part of the policy of “sowing the oil,” a good deal of money had been spent on education, and as a result, Venezuela had an educated and growing middle class.
As much as anyone, Pérez was the architect of what became the modern Venezuelan petro-st
ate, “the kingdom of magical liquid wealth.” Some called it “Saudi Venezuela.” Pérez proclaimed his vision of Le Gran Venezuela, an increasingly industrialized, self-sufficient nation that would march doubletime, fueled by oil, to catch up with the developed countries. Oil had “given us,” he said, the opportunity to “pull Venezuela out of her underdevelopment . . . We couldn’t lose time.”
In 1976 Pérez engineered the government takeover of the oil industry, in accord with the great wave of resource nationalism that was sweeping the developing world in that decade. But Venezuela carried out its nationalization in a careful and pragmatic way. Considerable talent had been built up throughout the industry during the years that the international majors ran the sector. Prior to nationalization, 95 percent of the jobs in the industry, right up to the top management, were held by Venezuelans. So nationalization would be a change of ownership but not of personnel. The new state-owned company, Petróleos de Venezuela, S.A. (PDVSA), was generally run on professional grounds. It was the holding company, overseeing a series of cohesive, operating subsidiaries.5
“IT IS A TRAP”
When Pérez left the presidency in 1979, the money was still flowing. But in the 1980s, the oil price plummeted and so did the nation’s revenues. Yet the edifice of the new petro-state was locked in place and indeed had expanded. Pérez was out of office during the 1980s, and the ills of the petro-state now became all too evident to him. As he traveled the world, he looked at different models for economic development and the struggle for reforms, and reflected on the costs and inefficiencies and defects of the overweening, oil-fed state. “An [oil] price spike is bad for everyone but worst for developing countries that have oil,” he had concluded. “It is a trap.”
The Quest: Energy, Security, and the Remaking of the Modern World Page 13