Industrial Effects of the Petroleum Activities

Presentation for a Venezuelan government delegation at a Ministry of Petroleum and Energy seminar 18 June 2001

1. While focus in the beginning was almost only on finding rich petroleum reserves and making money from sales of oil and gas, we are now talking much more of the petroleum industry as a large and varied industrial cluster consisting of petroleum companies, the supply industry, the maritime sector and parts of related businesses like energy production, process industry, finance, transportation and not least information technology. As the NCS matures and the industry develops, we are probably in a mid-phase between being mainly a resource rent producing sector and mainly a technology and knowledge based sector.

2. The cluster has developed and grown from almost nothing through some 30-35 years, although we had a good basis in the shipping and ship-building businesses. There has been a lot of discussion whether the petroleum industry would drain investment from and crowd out other industries, and it has not ended yet, but we are learning to understand that the total cluster, including firms that only deliver parts of their produce to the petroleum industry, today in fact represent a major part of all industries exposed to international competition, and that it is a technological backbone and a source of activity that benefits all economic life.

3. A recent study in fact found that the petroleum industry is Norway's largest and most powerful cluster in the way economists now define the concept. It is characterised by a high level of diverse technology and a multitude of individual companies that both compete and co-operate. It has very much become a knowledge industry that has reached a level of maturity where advances in one company spread to the others to enhance everybody's knowledge base. We think we are internationally pretty good, in particular within subsea construction and equipment, exploration and production drilling, seismic surveys and interpretation, floating production and offshore loading and transportation. The petroleum sector has proven to be a very potent market for modern information and communication technology, which benefits technologically by developing specialised applications. In spite of periodic cost control problems, we think we also have become pretty good in major project management, with spill-over for example to companies specialising in taking on project leadership for large construction projects in the third world. There are also many examples of technology spin-offs into pretty remote industries like fish-farming and even the space industry.

4. So far the fairy tale, which, in my best opinion is true. But it becomes less magic when I now shall turn to how we came this far and some problems facing the industry today.

5. When oil and gas was discovered, the risk was of course that foreign interests, using their own suppliers and developing and benefiting from their own technology, would dominate the new industry. In the very beginning, very little attention was paid by Norwegian industry to the potential offshore market, with one major exception, and that was the shipping community. Foresighted ship-owners were quick to take contact with oil companies, assisting their establishment in Norway and offering their services. Pretty soon, we had an industry of semi-submersible drilling rigs, supply ships and so on. Manufacturing industry was slower, but there were some early highlights, such as Aker's H-3 rig concept.

6. The traditional challenge when you want to create a new industry in competition with foreign suppliers is how much and how long to give it protection - the "infant industry" dilemma. If you do not give birth help at all, you might achieve very little, or at least it would be too late. If you assist and protect too much and too long, your industry gets complacent and fails to develop efficiency, and you end up with a choice between letting it all go anyway or continue with Stalinist import restrictions, with the corresponding growing cost problem, which in the end would have killed it anyway. Hence, some might tell you that Norwegian authorities and/or the industry community have been very advanced and clever to find the right balance between the extremes. I am afraid I do not share that opinion.

7. The shipping industry was already an established international industry and highly committed to free trade. It insisted from the beginning that it would have no part in any public goods and services policy that could even remotely be associated with protection. I think this set some kind of ideal standard for everybody, though for a long time not very operational.

8. The first step was to get into the primary upstream industry. The first to move was Norsk Hydro, Norway's largest enterprise, already well established internationally. It got quickly started with the help of French interests and mostly retained a competitive and dominantly commercial attitude, although it certainly didn't mind the early Norwegian policy of favouring Norwegian oil companies with concessions and later operatorships. Next came Saga, now gone, and then, in 1972, Statoil.

8. We approached the birth help issue from many directions. Statoil was clearly given the task of helping along Norwegian industry. It took the job very seriously. It developed close and very proactive contacts with potential Norwegian suppliers and was very generous with development contracts, early information and so on, but of course also by keeping international competitors out and preferring Norwegian suppliers even though they could be significantly more expensive and less experienced. Of course, this cost a lot of money.

9. As opposed to the UK, the authorities played a less conspicuous role. While the UK established its Offshore Supplies Office with several hundred employees, openly boasting about its overt protectionism, the MPE established a small goods and services offices with less than ten people to administer a rule in the Petroleum Act requiring that Norwegian companies be included in the bidders' lists and chosen if competitive. Clearly and truly exempting the maritime sector, oil companies had to file advance reports, sometimes resulting in open or covert reactions, but rarely stretching protection above say a 10% price difference. When it still occasionally happened, it was usually because of political intervention, or in the case of minor contracts with major technology content.

10. The main power of that office was however its close relationship to the sister office that had responsibility for licensing. Oil companies were told that their goods and services practises would influence their opportunities to get new licenses. This "brownie point system" was a very powerful weapon that no doubt made the companies make a strong extra effort. Sometimes also international companies did some pretty heavy favouring of their own volition.

11. The "brownie point system" was also extended to cover onshore industry and R&D. The "industry co-operation program" was initiated and run by the Ministry of Industry. Oil companies were required to make investment in onshore industry unrelated to the petroleum industry. In theory, they would use their own side competence in relevant sectors, but this turned out mostly an illusion, and the program really was about pure and simple cash gifts. Some of the projects ended as industrial disasters. Ironically, oil companies managed to secure immediate tax deduction, writing their "investment" immediately off and claiming it to be "expenses to gain income". Hence, we paid 70-80% of the program ourselves, of course much more including the cost of making suboptimal choices between oil companies. Fortunately, the MPE mostly succeeded in making the other Ministry and the industry believe this mattered, when actually it ignored most of it, and gradually it boiled away.

12. The R&D part was different. In the beginning, it started as a similar "brownie point" system, but later it was mostly changed into a requirement that oil companies must spend at least 50% of their R&D related to projects in Norway by employing Norwegian research institutions. The oil companies didn't mind, since R&D isn't very expensive in Norway (lower span between low and high wages), since they would deduct it against petroleum tax anyway, and since the R&D institutions actually are pretty good. This program was very successful and no doubt contributed significantly to technology advances for the supply industry.

13. Politicians even tried a similar scheme related to the export of oil and gas. It was (we are now in the late seventies) believed that those countries that were "allowed" to purchase oil and gas from the assumed politically stable Norway should be willing to pay extra for this, and several countries, notably Germany, Sweden and France, were invited to join in "industrial development agreements" where the foreign governments would pay into funds designed to transfer technology to Norway. The only surprise was that it worked for a short time and produced some small money, mostly from the Germans, who no doubt - erroneously - believed this to be some kind of bribery among nations for forthcoming benefits, but in fact these programs were total failures.

14. Finally, nature came to the assistance of the industry. After the introduction of the Condeep concrete platform project (a true creation of Norwegian industry), it turned out that these giant structures could only be constructed and towed out from Norwegian fjords. There simply were no possible sites in the UK. The concrete structure was an engineering feat by itself, and it was seen as advantageous to integrate the engineering with the topsides as well, hence there were good arguments for choosing Norwegian engineering companies. Next, it was argued that there were synergy effects between engineering and construction, so construction should take place in Norway as well. I guess you will find all kinds of opinions about how much of this argument was real and how much was a convenient cover for protectionism, also about whether the Condeep project sometimes might have been chosen partly for this reason. The truth is as always somewhere in the middle, I guess.

15. The combination of all this created a very powerful system of "infant industry" assistance. Norway got, justly, a reputation of being a very protectionist country, but so was of course the UK. We had frequent arguments across the North Sea about who was the worst. It remains unresolved to this day, when almost all of it is history on both sides.

16. So how come we managed to get out? Some would say it is because of the EU, and it is true that EU directives and competition policies today create efficiently supervised safeguards against most discrimination. I won't speak for the UK, but in Norway's case it is my opinion that the driving factors were more related to industry itself.

17. We did, of course, experience all of the negative effects of protectionism. The supply industry was for most of that period pretty unable to compete outside Norway. We developed a very serious cost problem. The main tool, Statoil, developed a very unhealthy paternalistic attitude to its suppliers. As Statoil grew, suppliers became very dependent on Statoil's likes and dislikes. Statoil was perceived as unpredictable and erratic. You will find both suppliers who describe Statoil as a trusted and loyal ally and those who say Statoil took a dislike to them and disregarded any effort. Far into the eighties there was real fear among suppliers that any word of criticism was dangerous. Some felt that Statoil thought it owned its suppliers and had little regard even for proprietary technology and that there was a risk that Statoil used one company's knowledge to assist a competitor. As a state oil company, Statoil wasn't too efficient itself, and likely to transfer inefficiency to its suppliers by pushing over costs, in particular for more or less necessary ideas about changes and improvements down the road, pushed by sector interests within Statoil.

18. It is my opinion that in particular Statoil, which overall did a very fine job according to its mandate, but also the successful parts of the other strategies, were instrumental in the development of a powerful industrial cluster. Some of it would have come anyway, but it is unlikely that the rest would have come in time to have a firmly rooted technology-based cluster before international investment and trade had become too internationalised to make its creation possible. On the other side, we would surely have ended in the protectionist ditch, never developing beyond the "infant industry" stage and gradually destroying what had been created, if this had been the full story.

19. Fortunately, it wasn't. The rest of the story is about diversity. Statoil was from the beginning a traditional state oil company, and it did dominate a lot for a long time, but it was never alone or in total control. While the "brownie point" system did influence the international oil companies, there were limits to how far they were willing to go, but, more important, it did not cover the two other Norwegian companies Hydro and Saga. They, too, had a favourable attitude to Norwegian industry, but they rarely accepted outright favouritism. After all, they had few privileges and had to mind their bottom lines. They did not fear repercussions in licensing rounds, since there was a separate policy of making sure all three Norwegian oil companies got good opportunities, and they had sufficient political resources to fend for their own interests. Therefore, in particular Hydro, then Saga, then to varying degrees the international oil companies, came to represent a counter-weight that maintained a pressure for efficiency on the suppliers. And those who felt left out by Statoil had few alternatives.

20. It was just as important that again in particular Hydro, then Saga, represented a moderating influence on Statoil. The relationship between the three was a very hot debate from the very beginning. Hydro and Saga rightly found it unfair that Statoil - because it was considered an instrument for the state and a vehicle for collecting state revenue - was given the lion's share of field equity, majority voting rights and many other privileged positions. The traditional idea of having a state oil company conflicted severely with the just as traditional idea of having commercial companies competing on a level playing field. After Norway reached its nationalistic peak in the mid-seventies, there was a continuous and politically very controversial process of reducing the differences between the three Norwegian companies. One effect of this was that the three companies were compared on performance, and Statoil could not allow costs to grow without limits. Thus, Statoil itself became gradually less eager to choose more expensive solutions just because they were Norwegian. Another, more important, result was that Statoil's fundamental role changed. Through the Statoil reform of 1985, the instrument role was significantly reduced as voting rights in licenses changed and the state isolated "its own" part of the cash flow to bypass Statoil's commercial economy, directly into the Treasury, through the establishment of the so-called SDFI (now Petoro). The new Statoil leadership that was appointed after the Mongstad cost overrun scandal in the late eighties took its new role very seriously and built a new, commercial and bottom-line oriented company culture.

21. Also in the late eighties, leading suppliers like Aker and Kværner decided that they relied too much on the NCS. In particular, it was troublesome that activity came in cycles because of oil price variations. They needed to internationalise, and told the authorities that they were in favour of reducing remaining protectionist elements. True, they were not always loyal to this policy in later crunches, but it contributed to the general development towards more commerciality, more focus on cost control and international competitiveness and less protection. I am not saying it went completely away, nor that no investment or purchase decisions even today are taken with industrial activities in Norway at least partly in mind, but the main picture through the nineties and today is one without government intervention and with open international competition in all parts of the activity. Of course, proximity to markets is an advantage everywhere and still helps to offset cost problems, but the fact is that the Norwegian supply industry today does have significant and growing exports and mostly is considered internationally competitive.

22. The conclusion is therefore that our success - so far - is not a result of any balanced plan or any single or unified will. It is due to the work of conflicting industrial interests and political paradigms, often very controversial. Without the existence and early strength of an interventionist, even socialist, paradigm, it is doubtful that so much would have been created. Without the early balancing and today stronger paradigm of diversity, free market and capitalism, much of it would have died in adolescence. The competition between the paradigms has been both on the industrial and the political level, and in interaction between the two. In one manner of speaking, Norway's ability to balance between the two ditches has been accidental; in another, more philosophical manner, one could say it was made possible because we have a democratic and pluralist society.

23. It has also been important for the development of the supply industry that it gradually has taken over more responsibility for planning and design of facilities. Originally, there was clear separation between conceptual choice, engineering, procurement and construction, with the operator inviting to separate bidding for a large number of contracts for goods and services. The operators, allowing the suppliers very little creativity on their own, normally specified each component in great detail. Industry felt that it simply gave away its ideas and technology to the oil companies that then made it available to everybody. This, of course, destroyed incentives for industry's own technology development. Hence, industry wanted the opportunity to bid for larger packages, based as much as possible on functional specifications. Ideally, they wanted the operator simply to say, "Here is where the petroleum is, here is where we want it, please come up with a total proposal about how to get it there."

With few and small exceptions, it never got that far. But gradually, oil companies responded, as they decided that changes along these lines would be more cost efficient. Later, the development was boosted by the new international trend of outsourcing, as oil companies globally decided to concentrate on their core competence. Today operators work initially with several suppliers about the overall conceptual choice. When one is chosen, the rest of the job is normally put up for bidding as a so-called EPC contract (engineering, procurement and construction), often adding the "I" for installation. This has made it possible for operators to slim their organisations considerably, and allowed suppliers to compete much more on their own creativity and technology.

24. Therefore, the EPC contracts represented a large improvement, but they also meant new problems. The suppliers' autonomy after contract award was far from total. The operator still had the right to order amendments and additions down the road, and the scope of work was only sketchily defined at the time of bidding. Because of tight schedules, variation orders had to be implemented before it could be decided whether the costs were inside or outside the bidding package, leaving the supplier very much at the mercy of the operator at the end of the day. The oil companies have generally had strong incentives to transfer costs to the suppliers, partly because of increasing international rate of return requirements, conflicting with the high Norwegian petroleum tax level, and partly because of cost pressure from other parts of Norwegian society, assisted by the oil companies' own belief that they have to be politically correct. Statoil, still fairly dominating, still has serious remaining efficiency problems and has - though not alone - occasionally ran into drastic cost overruns, giving it an extra push to take back whatever it can from suppliers. Recently, operators and suppliers agreed about a new contractual model designed to increase predictability and create fair procedures for cost allocation, but it still remains to be seen how it will work.

25. The effects of a history of "infant industry" and the more recent problems described above are among the main reasons for the dominating problem today faced by the supply industry and therefore the total cluster: We have an impressive base of knowledge and technology, and we are very aggressive in implementing new technology, but we are unable to get much profitability from it. Value creation is very impressive, but too much is siphoned off because of gold-plating, concessions to sector interests and other cost drivers, and the state takes the lion's share of what is left, forcing oil companies to behave as smaller lions towards suppliers at the end of the day.

26. It is my opinion that authorities have failed to adjust the petroleum tax system, as the character of the offshore activities have changed. Value is to a lesser degree created from resource rent realisation and more from technology, knowledge and human effort. The old, rich fields are still spectacular, but the future is less visible. Whatever resource rent remaining should of course be taxed as such, but the system is not designed to protect returns from knowledge capital, which is pretty difficult to separate from resource rent both in classic social economic theory and in practical accounting. It is, nonetheless, terribly real.

27. This is not a problem for nations that have their main industrial clusters in industries not based on natural resources. Without the presence of special resource taxation, the normal business cycle of investment, profits, savings, new investment and growth works for knowledge capital as well. In a resource based industry, the shift from resource rent to value creation from knowledge pushes the latter into super-high tax brackets so a much too large part of this cycle is broken, putting a disproportionate large share of ordinary social growth into the government's coffers. Norway has become a super-capitalist, but most of the capital is owned by the state. In the US, and, closer to Norway, Finland, Sweden and Ireland, the values created by growing technology levels and knowledge based clusters are naturally recycled back to new knowledge building and new growth. Structural problems within the cluster allows for the hardship to be pushed over from oil companies to the suppliers.

28. Many believe that this is not so much of a problem since suppliers still normally are left with a reasonable return allowing them to survive. Politicians generally do not react before jobs are threatened. And on the surface it doesn't look too bad. But we are forgetting that a knowledge based industry needs to keep reinvesting and restructuring to remain ahead, and we still have not understood that knowledge building is beneficial far beyond the individual company, because of the mutual exchange within a cluster and between clusters. Our own petroleum cluster, into which Norway has put enormous amounts of financial and human capital, therefore risks falling behind its competitors.

29. This is now becoming visible, as foreign interests have purchased several key carriers of technology and more are likely to follow. Generally it does not seem to lead to slaughter or loss of physical activities, as almost all acquisitions have been motivated by synergy effects, and Norway is still an attractive place to be, because of the strong competence on the community. A known feature of a dynamic industry cluster is that it prefers to stay together, no matter ownership. Clusters are therefore hard to create, but remain loyal to their host country until conditions become truly bad. Full ownership flexibility is also beneficial, since each firm needs to restructure all the time by finding the partner with highest synergy effects. Restrictions on ownership changes are therefore counter-productive. But a systematic drain of ownership may in the long run lead to a drain of technology and leadership functions and should definitely be avoided.

30. The loss of ownership seems to be due to the weak financial muscles of Norwegian firms. One reason is the poor profitability that means low book value and low market value. But market values are low even compared to book value and real assets. It is believed that this is due to the weak Norwegian private equity market and the small size of the Oslo Stock Exchange. This is turn has to do with the government's policy to invest its savings in the Petroleum Fund abroad, by refusing its agents to reinvest in Norwegian companies. Critics therefore say that the state efficiently removes what should have been reinvested in the cluster and channels it abroad. The argument depends on certain assumptions about the behaviour of investors and the view that proximity between the investor and the industry is important, in short that a viable industrial cluster needs to include a just as viable investor community with relevant knowledge. This is definitely a novel idea, but I believe it is true. This debate is just starting.

31. While we learn more about value creation, growth factors and restructuring in a modern hi-tech petroleum industry cluster, many improvements are made through other processes. All parts of industry, as well as authorities, have a strong focus on cost control and efficiency enhancement. Parliament has decided on many regulative changes that will have positive effects, and there are more to come. This year's SDFI and Statoil reform are of course of utmost importance also in the perspectives discussed here. SDFI sales will facilitate restructuring of field ownership with important efficiency improvement. Statoil privatisation is a completing element in the company's long road from a classic instrument for the state to a professional, commercial company, and is expected to make the company more effective, to the benefit also of its partners and suppliers. Further, the privatisation will increase the traded volumes at Oslo Stock Exchange and make it more attractive, which as shown above also should benefit others.

32. It is also an asset for the cluster that it has developed several co-operation institutions where also the authorities are part, in particular NORSOK and its successor KON-KRAFT that have focused on cost control and improved efficiency, initiating adjustments both in framework conditions and internal relations. Such bodies are vital to facilitate communication and improved rules of conduct while maintaining and enhancing normal commercial competition.

33. To conclude, we have a strong and highly competent petroleum industry cluster that certainly is able to take on very challenging projects at home and abroad. There is no crisis in the short term. But we have quite a job to do to maintain the cluster and ensure its role as a locomotive for technology and growth in the future, for all of Norwegian society. This has to do with fiscal and regulative framework conditions, but also with many internal relations within the cluster.

Ramm Energy Partner, PO Box 104 Stovner, N-0913 Oslo, Norway.
Tel +47 21902000 or +47 92805015.
(Former name Ramm Kommunikasjon)

This page last updated 17 October, 2010.