by Tom Bower
As well as having to smooth local sensitivities to retain access to the oil, Chevron was faced with unprecedented hurdles. The company’s fortunes were threatened by the technical superiority of state-funded corporations, especially Petrobras and Statoil of Norway. Statoil had become the world leader in drilling in the Arctic seas, deploying unique subsea production technology to convert natural gas into LNG on the seabed, while Petrobras had proven its expertise finding oil in deep water under a mile of salt. In 1992 the Brazilian company, founded in 1953 as a government monopoly, had been categorized as among the least efficient in the world, and was even prosecuted for impugning the national honor. Over the following 10 years, as the state reduced its stake to 32 percent, new managers transformed Petrobras into a world-class operator, drilling 200 miles off Brazil’s coast to similar depths as in the Gulf of Mexico. Encouraged to plan over the long term, with global aspirations, access to domestic oilfields and unique technology, Petrobras and Statoil could, over the next 20 years, cripple Chevron and every other second-division player.
In March 2003, Chevron was directly challenged by two Chinese oil companies, Sinopec (the China Petroleum and Chemical Corporation) and CNOOC (the China National Offshore Oil Corporation), both of which had negotiated to buy stakes in Kashagan from BG, the British oil and natural gas corporation. After these attempted purchases were blocked by other shareholders exercising their right to buy the stakes, Sinopec successfully bid $2.2 billion for two fields in Angola, accompanied by promises of loans in the future. Soon after, Chinese planes and ships arrived with men and materials to build an airport and workers’ accommodation as a preliminary to wrenching control of Angola’s deep-sea oil wells from Chevron and the other Western companies when their licenses expired. The pattern repeated itself in Kazakhstan, where dozens of Chinese transport planes delivered men and equipment to build an oil pipeline to the Chinese border. In both countries, corrupt local politicians were common. Unlike Western corporations, which were subject to laws and scrutiny, the Chinese companies’ largesse was sanctioned by their government. “China’s doing now what we did one hundred years ago,” admitted a Chevron executive. The Chinese even followed Chevron into the Sudan, despite the civil war.
But there was a limit to tolerating competition, especially in America itself. In March 2005, CNOOC indicated its intention to bid for Unocal, America’s ninth-largest oil and natural gas company, operating in the Gulf of Mexico, Southeast Asia and Azerbaijan. With a market value of $14 billion, Unocal’s principal attraction was 1.8 billion barrels of proven reserves, especially in Burma and Thailand. CNOOC’s bid prompted counterproposals from ENI and Chevron. Chevron appeared to be vulnerable. At the end of an 11-year streak, the company had not sanctioned a single large-scale project during 2004, and had only replaced 18 percent of the previous year’s production. Having made a $13.3 billion profit in 2004 and increased its cash deposits during 2005 by $1 billion every quarter, it had spent nearly $2 billion buying back shares, but had failed to restore its reserves. O’Reilly’s solution in April 2005 was a $16.8 billion bid for Unocal. Financially the bid could only be justified because oil had risen to $65 a barrel, a price O’Reilly said was too high. Two months later, CNOOC offered $18.5 billion for Unocal, an apparently knockout bid.
The Chinese had not anticipated the xenophobic outcry their bid would trigger. Although Unocal was small and lacked any strategic importance, officials in the Bush administration were persuaded of the danger of foreign ownership. Ignoring the hypocrisy that American oil companies, supported by Washington, demanded the right to invest in Russia and along the Caspian on their own terms, O’Reilly urged politicians in Washington to block CNOOC’s bid. The national oil companies, he said, were competing on unfair terms against the privately owned oil majors. CNOOC’s higher bid for Unocal, claimed O’Reilly, was only feasible because the Chinese government had provided interest-free loans. State companies like Petrobras and CNOOC, Chevron’s spokesmen complained, were untroubled by low profits, and their purpose was clear. CNPC, a third state-owned Chinese corporation, had bought oil assets in 30 countries including Sudan, Angola, Russia, Kazakhstan, Australia and Saudi Arabia, and planned to invest a further $18 billion by 2020. Sinopec had signed a 25-year contract worth $100 billion to buy LNG from Iran’s reserves in South Pars, although America’s embargo had rendered that agreement useless: without Western expertise, Iran’s oil and gas industry was crippled. Chevron painted a scenario of oil shortages in the future and the national oil companies exploiting their advantages if Washington’s politicians did not favor American corporations. CNOOC’s bid was rejected, and O’Reilly improved Chevron’s offer to $18.3 billion in cash and stock. On the first day of its ownership, Chevron obliterated Unocal’s culture. The company’s name disappeared and the employees who remained were absorbed into Chevron’s organization.
Chevron’s victory intensified competition between the national oil companies and the oil majors — with an unexpected twist. Higher oil prices gave an incentive to all the producers to earn more profits by increasing production; or, as the national companies discovered, they could enjoy the same income by producing less oil. Russia and the socialist countries, increasingly influenced by political rather than commercial criteria, challenged the oil majors to defy their command over access and prices.
Producing sufficient quantities of oil at Tengiz to make the field profitable had never been in doubt until rising prices encouraged President Nazarbayev to demand that the 1993 PSA agreement, which was tilted in Chevron’s favor, be rewritten. Nazarbayev wanted a $2 billion low-cost loan, and more income — immediately. In theory, he could impose higher taxes, demand a bigger share of the royalties or insist that Chevron and ExxonMobil, the junior partner, produce more oil. The obstacle was the terms of the original contract, which stipulated that Kazakhstan would receive only 2 percent of the revenue for 10 years, about $120 million, until the oil companies’ costs had been repaid. Under Chevron’s plan, those costs would increase if the company decided that production should rise from 270,000 barrels a day to 430,000. That expansion, said Chevron, would cost $3.6 billion and would delay Nazarbayev’s receipt of royalties. To persuade Chevron to pay royalties immediately, Nazarbayev fined the company $73 million for allegedly storing sulphur in a manner contravening Kazakhstan’s environmental laws. Surprised by the existence of these laws, especially since its storage method was common in America and Canada, and fearing that Nazarbayev would also seek to rewrite the Kashagan agreement, Chevron announced on November 15, 2002, what was called “a lesson in oil politics.” Expansion of production was halted until Nazarbayev agreed to withdraw his request to rewrite the 1993 agreement. “It’s about time someone drew the line,” said a Chevron executive, buttressed by ExxonMobil’s traditional resistance to changing contracts. Nazarbayev surrendered. He would be less amenable in Kashagan.
The discovery of oil in Kashagan had been a relief for the majors. Earlier, Total’s directors had despaired after drilling dry holes around the Caspian, and were on the verge of quitting the region, while ExxonMobil had accepted the loss of millions of dollars on unsuccessful trials. Both corporations had looked on enviously at BP’s successful production of 100,000 barrels a day from the Azeri field, due to be pumped in 2005 through the Baku–Tbilisi–Ceyhan (BTC) pipeline, and hailed as an American triumph because it bypassed Russia, while Azeri natural gas flowed 1,100 miles from Deniz to Turkey through the South Caucasus pipeline. By contrast, the consortium in Kashagan, which included ExxonMobil and Total, originally estimated that $29 billion would have to be invested before production could begin. After five years, the estimated cost of developing the oilfields had risen to $136 billion and the production of oil had been delayed from 2005 to 2015 at the earliest. The blame was heaped on ENI, which had demanded the right to manage the project.
Paolo Scaroni, ENI’s ebullient chief since 2005, had similar ambitions to David O’Reilly, but inherited a tradition of taking bigger risks.
He committed $3 billion to produce oil in a violent offshore area in Nigeria, paid $6 billion to purchase Yukos assets, signed a long-term supply deal with Gazprom, and bid a record $902 million to search for oil in one block in Angola. “At the time it seemed crazy,” he conceded, but ENI’s ambitions demanded risks. Scaroni’s predecessors had aggressively insisted on taking the lead in developing the Kashagan field, probably the most complicated project in the oil industry’s history. ENI, the Italians insisted, possessed the technical expertise to develop the world’s biggest discovery in 40 years. Capitalizing on the dislike between the executives of ExxonMobil and Shell, another major investor, ENI’s bid to become the operator slipped through as a reluctant compromise. ENI’s initial $10 billion investment required its engineers to work in temperatures ranging between 55°C in the summer and −40°C in winter. The principal contracts had not been awarded to specialists, but to inept Italian companies favored by ENI, and in every task the engineers blundered. They encountered innumerable difficulties, not least while navigating with special icebreakers through the shallow waters during the winter. The wind, tinged with poisonous hydrogen sulphide, exacerbated the perils of extracting the crude oil, trapped under huge pressure and liable to explode. Drilling safely down to 20,000 feet proved to be a near-insuperable challenge, and $2 billion spent building accommodation on an artificial island was wasted after jet vapors of lethal hydrogen sulfide sprayed over the new buildings. The original plan to produce 100,000 barrels a day by 2005 was abandoned, and the ultimate ambition to produce 1.2 million barrels a day was indefinitely postponed.
The Baku—Tbilisi—Ceyhan (BTC) pipeline
Frustrated, Nazarbayev successfully demanded that the original contracts be rewritten, tilting the advantage away from the oil companies. Unusually, ExxonMobil’s objections to this demand were defeated. Kazakhstan was given a bigger stake in the oilfields, the oil companies agreed to pay compensation for the delays, and ENI was stripped of operating control. Nazarbayev’s victory was a blow to the oil companies. Without their expertise, Kazakhstan’s oil would have remained unobtainable, yet rather than gratitude, the country’s dictator had voiced anger. The relationship between the oil-producing nations and the private oil corporations, especially the smaller companies like Chevron and ENI, was jeopardized. Rising oil prices were creating an arrogant conviction among all the oil-producing nations about their permanent indispensability.
Chapter Nineteen
The Survivor
ENI’S INCOMPETENCE made Lee Raymond impatient. In his opinion, the free market in oil was diminishing. Instinctively, he asked himself of every proposition, “Is this serving the interests of Exxon’s shareholders?” Exxon, he needed to remind outsiders, was not a government agency. The corporation’s prosperity, he believed, depended on producing huge volumes of oil. He dismissed those who argued that Exxon’s long-term survival depended on focusing more on the value of a project than on pure profit. In the hostile business environment of high taxes, overbearing regulations and growing nationalism, he would opt to stay out if the returns for Exxon’s shareholders were not guaranteed. In an earlier era, Raymond could comfortably have identified himself as a professional imperialist. His virtuous cause was to enrich ExxonMobil’s shareholders by any legitimate means. He made no pretense about himself or the corporation. The values of the chairman and of ExxonMobil were interchangeable: impervious to criticism, neither sought love, and both assumed admiration. Aloof and awkward in the limelight, Raymond cultivated an image of inflexibility and irrefutable success. “We are gigantic,” his ambassadors would tell new recruits, listing ExxonMobil’s unchallenged superiority as the biggest oil major. “Exxon owns 2 percent of the world’s reserves. We understand the molecular structure of oil better than our competitors, and how to get more oil per barrel than our competitors.” Since America’s fate depended in part on Exxon’s continued success, those doubting that oil was a religion as much as a science were methodically excommunicated from the ranks. While extolling the purity of exploration and production, Raymond mocked BP and his smaller rivals as grubby for trading oil. ExxonMobil was in a race, he preached, not only to rank first, but to last the longest.
After 1998, as his exploration engineers failed to find sufficient large reserves, Raymond began limiting the investment budgets and used the company’s profits to buy back shares and pay high dividends to sustain its rising stock market value. Even Exxon, the champion of the long-term view, occasionally switched to short-term performance. Raymond was reassured that besides steadily accumulating billions of dollars in cash — about $40 billion would be deposited in the bank by the end of 2008 — ExxonMobil’s reserves of around 72 billion barrels of oil guaranteed its survival. Some would criticize his “inordinate emphasis on reserves” as a mistake, embodying a complacency that would threaten the corporation’s ultimate fate, but they were ignored. The chairman paraded his realism as a badge of pride.
In the hunt for more oil, the prime target for Raymond had been the Middle East. Following the meeting at the Saudi Arabian embassy in Washington in December 1998, he had been encouraged to extract oil and natural gas in the Kingdom’s “empty quarter,” which required expertise the Saudis lacked. But by 2000, Raymond was dissatisfied. Exxon was being asked to undertake the exploration in a $600 billion project, but was denied ownership of the oil and natural gas. During a year’s negotiations, the relationship between the corporation and the Saudi rulers became acrimonious. “This is a bad deal,” Crown Prince Saud al Faisal, the foreign minister, reported Raymond saying. Exxon, complained Raymond, was not a contractor providing services like Schlumberger, but an oil major, and was only prepared to take a risk in return for some ownership of the reserves, and profits. Nothing less than 12 percent, and preferably up to 20 percent. Exxon’s resources and equipment were too costly to be employed merely to provide services, especially if there was no certainty that oil and natural gas would be found in the area. After Shell and Lukoil had been awarded the rights in the region, they would discover that Raymond’s doubts were well-founded. That would be little satisfaction for Raymond.
Exxon’s failure to reenter the Middle East at the end of the 1990s had coincided with problems in Russia. Ten years earlier, the corporation’s executives had arrived as Cold War victors to take the spoils. Famed for remaining impervious to pressure, Harry Longwell, the tough and reliable head of Exxon International, was taking no prisoners. Neither Raymond nor Tillerson had appreciated the history of Russia’s oil industry, and when they saw its dilapidated state, they were unimpressed. To some Russians, the two Exxon executives appeared unable to decide whether they were visiting an eastern country like China or India, or a former colony like Nigeria. Some concluded that neither man cared. Uninterested in obliging the Russians’ request for money and assistance, Exxon’s representatives insisted on buying stakes in virgin sites.
Avoiding ENI’s and Total’s loss-making investments, Raymond refused to develop Sakhalin 1 unless Exxon’s shareholders profited. The risks were considerable. Amid drifting ice packs, snow, fog and earthquakes, a $1 billion platform would be constructed to extract two billion barrels of oil and 15 trillion cubic feet of natural gas. Tillerson approached the negotiations according to the Exxon rulebook. Since no Russian official or engineer properly understood the complications, and since only after 15 to 25 years would the project’s profitability be certain, Exxon could only be protected by the sanctity of the contract. Its principles had been developed from the experience of the previous hundred years. Every agreement was influenced by different circumstances, but as an Exxon senior executive maintained, “There’s nothing new in oil — only the players and the country are different. And you don’t negotiate your principles. If something is unknown, you must negotiate it according to principles.” During the negotiations in Moscow, Tillerson and Longwell expressed no sentiment. Their task was not to help Russia — although the country would benefit from Exxon’s expertise — but, after crunch
ing the detail, to impose a contract ensuring Exxon’s profit, and to abide by it. They had no doubts that a familiar cycle — as in Venezuela and the Middle East — would recur: “Mega-projects are lumpy, so there’s no easy way to show continual progress. There’ll be the thrill of agony, victory and defeat.”
Success at Sakhalin encouraged Raymond’s optimism. Exxon’s most experienced teams had assembled 40,000 tons of equipment to drill nearly two miles down and over six miles horizontally into the Pacific Ocean. Over 10 years, Exxon was committed to invest nearly $4 billion and employ 70 Russian design institutes to construct two thirds of the infrastructure in Russia itself. That commitment, Raymond reckoned, would surely persuade the Russian government to grant the company more licenses. But to Raymond’s disappointment, despite US vice president Al Gore’s representations, the Kremlin declined to oblige.
A $1.5 billion agreement to develop oil production in Timan-Pechora province in the far north was rescinded in August 1997 by Viktor Orlov, the natural resources minister, blaming “legal irregularities” and Exxon’s “unacceptable conditions” for Rosneft’s participation. The Exxon executives’ zest for “business with integrity,” combined with their passion for secrecy, was regarded by the Russians as dogma. Soon after, another agreement for Exxon’s development of two more blocks in Sakhalin and the Nenets oilfield was canceled. “We don’t need Russia,” Raymond declared, surprised that the Russians’ need for Exxon’s expertise did not override their irritation about the inflexible contract. “If we drill a dry hole we can’t go back and ask for a contribution to the cost,” was his reasoning. The Exxon contract protected the company’s investment. Exclusion from Russia did not make Raymond fear that other countries might also reject Exxon. He would not, as a Chevron vice president would describe it, attempt to “seduce and innovate by offering solutions to the local government’s problems.” The Kremlin would accept Exxon’s way or no way. To his critics, who believed that Raymond’s intransigence would “break the Exxon model,” a senior executive replied, “What’s happening in Russia is nothing new. The same happened in Venezuela and Africa. It’s always the same cycle and balance of risk that you win some and lose some.”
