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The Internationalization of Energy firms

A literature review

Bachelor Thesis 2011 43 Pages

Economics - International Economic Relations

Excerpt

Table of Contents

Table of figures

Abbreviations

1 Background / Introduction
1.1 Academic relevance - Research Gap
1.2 Objective of the thesis
1.3 Structure of the thesis

2 Development of the energy sector in the past
2.1 Early activities, early organization. Energy firms start to internationalize
2.2 Energy market liberalization
2.2.1 Benefits of and barriers to the liberalization of the market
2.2.2 Consequences for European energy companies as well as for global big-players
2.3 Managing governmental energy policy - the role of the state in the energy sector

3 The global, liberalized energy industry of today

4 Identification of current trends in the energy sector
4.1 The wave of M&A and strategic alliances
4.2 The evolution of “National Champions”

5 Analysis of the expansion strategy of global players in the energy sector
5.1 British Petroleum
5.2 Royal Dutch Shell plc
5.3 Gazprom
5.4 To what extent do companies follow theoretic Internationalization Theories?

6 The energy industry as one part of the extractive industry
6.1 Extractive Industries - Definition and Characteristics
6.1.1 The obsolescing bargain in the extractive industry
6.1.2 Foreign-Investor host-country bargaining
6.2 Motives for Internationalization in extractive Industries
6.3 The global mining industry with regard to the Expansion Strategy of the MNC BHP Billiton
6.3.1 Definition
6.3.2 Structure of the global mining industry
6.3.3 Business Strategies in the global mining industry
6.3.4 FDI in the global mining industry
6.3.5 BHP Billiton - The Internationalization Strategy of a Small-country firm
6.3.6 The Internationalization Model - A suitable underlying theoretical framework for

Expansion Strategies in the mining Industry?

Conclusion

Sources

Table of figures

Largest oil companies, ranked by revenues in 2002

Gazproms JV in Western and Central Europe

Internationalization Theory

II and GSI of the top 20 mining companies in 2007

Abbreviations

illustration not visible in this excerpt

1 Background / Introduction

The process of globalization, the constant search for economies of scale and the more efficient allocation of scarce resources are some of the commonly identified drivers of internationalization. The opening of more and more economies worldwide to foreign capital and international trade leads us to the question if any economy could still exist as an autarkic market without sacrificing prosperity. Expanding into foreign markets does not simply mean for a firm to benefit from growth opportunities, it also implies accepting the challenge to compete with firms in a completely diverse country.

As regards the specific case of Energy firms, we have to consider that these kinds of industries differ significantly from other sectors of the economy. Taking this into consideration, it is crucial for us to analyze the differing corporate strategies of these firms in order to figure out the decisive underlying values, processes and aims.

Despite the fact that the choice of the suitable entry mode is one of the most frequent empirically analyzed topics in International Business, it is often not possible to follow exactly a theoretical Internationalization theory. Firms rather combine different approaches in order to figure out an individual strategy - most suitable for the corporation.[1] This thesis will analyze how Energy companies find out this perfect approach, which criteria they take into account, how these criteria are ranked according to the individual importance and in general, what motives exist for expanding abroad.

Furthermore, the author will analyze the development of energy firms in the past as well as current and future trends by drawing comparisons with other companies in the extractive industry.

1.1 Academic relevance - Research Gap

In spite of its central practical relevance, little has been published on the internationalization behaviors of energy firms and hardly any data is available in this field. We can explore that there is a research gap regarding the profound internationalization processes of companies in the extractive industries in general and of energy firms in particular due to the fact that mainly whole countries and markets are analyzed instead of focusing on specific companies.

The aim of this thesis will be to fill this gap.

1.2 Objective of the thesis

The objective of this thesis will be the classification and analysis of already existing literature related to the internationalization strategies of Energy firms in order to figure out which similarities and differences exist and by which motives and drivers these strategies are backed. By having the theoretical knowledge of internationalization theories on the back of its mind, the author will accomplish a final summary of the empirical preliminary findings.

1.3 Structure of the thesis

First of all, the author will give a brief overview of the past development of the energy sector followed chronologically by the characteristics and determinants of the sector nowadays. Afterwards, current trends in the energy industry will be identified. The analysis of the expansion strategy of global players is crucial in order to see if these companies act according to the Internationalization theory. To conclude, the author will draw comparisons with other firms in the extractive industry, by focusing on the mining industry in particular.

2 Development of the energy sector in the past

2.1 Early activities, early organization. Energy firms start to internationalize.

Today, most of the oil consumed has moved from one country to another. The international oil industry is one of the largest and most international of all industries in the world and it is crucial to mention that oil is the largest single commodity in international trade.[2] Therefore we are able to stress the importance of analyzing the evolution of this kind of industry by focusing on incisive events and how these affected the industry in general and its players in particular.

The examination of the two sides of the industry is a suitable approach for studying the evolution of the global oil market: Since the end of the Second World War, demand for oil products in Western Europe has risen substantially. Due to its undeniable advantage over coal, oil was fundamentally important in the economies of Western Europe, as its contribution to energy needs has risen from 32% in 1960 to 63% in 1972. Obviously, the world economic crisis of 1973-1974 has dramatically changed the development of demand, both quantitatively and qualitatively. Firstly, the decrease in economic growth has caused a reduction of overall energy demand in general and secondly, the economic crisis has altered the structure of energy demand, which was mainly due to the substitution of indigenous energy sources, as for instance coal or gas in the domestic and industrial sectors and nuclear energy in generating electricity.

As world demand for oil was growing for a fast rate, sustained over a period of more than 20 years (despite of negligible, short periods), oil companies were until 1973 never under pressure from stagnating volume. However, the considerable change in demand evoked by the economic crisis caused very serious problems for oil companies. Due to the fact that they had based their development and investments on long term plans and that they could not foresee the sharp economic decline of 1974, they suffered from a huge surplus of refining capacity and an overlarge fleet of oil tankers. In order to meet the new market, a complete modification of a whole industrial sector has become necessary, in transport and refining as well as in distribution. As this modification has not yet been implemented satisfactorily, fundamental problems of the European oil companies were the consequence. Because of the fact that companies were forced to sell their surpluses at a price that corresponds only to the marginal cost of production, they were consequently going to be in deficit.[3]

As already mentioned above, the oil surplus constitutes the main problem in the petroleum’s history. According to Chevalier (1973), the creation and appropriation of oil surplus constitutes the main stake between the various actors in the petroleum industry. The extent to which this surplus affects the energy business depends largely on the existing type of market organization. During the last 30 years, the world oil industry has gone through three successive stages, corresponding to three different organizations of the market. These orders all differ in terms of competition or the conditions of oil surplus distribution:

1. The majors order (1929-1973): The international petroleum industry was developed almost entirely by seven large companies (“majors”). During this period the industry was dominated by the objectives of these multinationals, the individual profit maximization being obviously the most important one. Therefore this period was characterized by an integrated oligopolistic type of organization of the market.

2. The OPEC order (1974-1986): After the energy crisis in 1973 control over oil production passed to the government who promptly converted OPEC from a common-front organization designed to balance the common front presented by the seven major oil companies, into a cartel, which resulted in profound structural changes in the market.[4] (It went from being a vertically integrated market into a disintegrated one: The producers controlled the oil industry upstream while the majors controlled it downstream). This period ended with the evolution in a change in

the production costs’ trend, which brought about a break with OPEC’s organization of the market - the 1986 price war.

3. The consumer-countries order (1986 to the present): This order differs from the other ones because of its invisible, but efficient organization of the world oil market. In this period, consumer countries appropriate the greater part of oil surplus. The shift towards a consumer-oriented point of view limited the leeway of other actors in the market. Consequently producer countries and their firms had from now on not only to cope with their share of oil surplus but also with modernizing their industry at the risk of being eliminated from the market.[5]

Obviously, these successive stages with differing market organizations affect the corporate strategies of firms acting in the energy industry. When the first energy firms started expanding abroad, they were watching and following prospectors and buying up land where the latter had made discoveries. The European-led outward expansion started already at the end of the 19th century when oil was discovered in Baku in 1871 and in Atjeh, Sumatra in 1885. The kerosene that was manufactured from this oil was exported to Europe and China and created the beginning of an international market outside the US (European companies had to stay outside the US which was the acknowledged domain of the US oil companies). After that, energy companies implemented a new expansion strategy by including the prospecting and exploration function in their own business thus integrating all activities related with petroleum, a so-called “vertical integration”. New applications and uses of oil products were found and following this new demand, the petroleum industry moved to new areas worldwide, as for instance Iraq, Mexico or Venezuela.

As a considerable part of the global expansion took place in the Middle East, major US and European oil companies formed alliances to cover the risks of and share the investments needed for undertaking exploration and production operations in this unknown area. Shortly before the First World War, in London, a new company was established, its goal was to acquire exploration acreage in Iraq. TPC (Turkish Petroleum Company) included amongst others shareholdings of Anglo-Saxon-Oil Company (Royal Dutch/Shell) and Anglo-Persian- Oil Company. In 1928, a group of US companies was permitted to participate in TPC, namely Standard Oil Company and Socony-Vacuum Oil Company (Mobil). After that, the name TPC was renamed into IPC (Iraq Petroleum Company). Subsequently, after the Second World War, other US shareholders, as for instance Arabian American Oil Company (Aramco) joined the venture. Due to the heightened demand for oil products and the wish of the Western States to mitigate their dependence on oil from the Middle East, the geographical expansion of the petroleum industry continued. Major oil discoveries in Canada, Alaska, Africa and

Scandinavia were founded, followed by the enormous oil potential of the Soviet Union and the Russian Federation.

Due to the Internationalization and at the same time Integration of their activities, the oil companies became gradually structured as an International Oil Group (IOG) consisting of a series of companies owned through shareholdings by a parent company positioned at the top of the corporate structure. Furthermore, following the example of the companies of the former Middle East, it has become standard practice among IOGs to form joint ventures between their respective operating companies. The exploitation of new oil provinces has not yet came to an end as discoveries are still being made albeit in technically challenging areas, as for instance Brazil.[6]

2.2 Energy market liberalization

Since 2004, when the first EU directive entered into force, industries and private households are in theory able to choose their energy and gas supplier freely in a competitive market place. The second directive was adopted in 2007. However, many obstacles remained, with a single European energy market still far from reality. Consequently, corrective action was promised by the European Commission, which made further legislative proposals:

- The Commission obliged companies, which control both energy generation and transmission, to sell parts of their assets. Shareholders would be able to keep their participation in the group via a system of “share-splitting”, whereby two shares are offered for each existing share.
- The ISO (Independent System Operator) option was a kind of compromise introduced from the Commission, which states that companies involved in energy production and supply would be allowed to retain their network assets, but would lose control over the management of these assets. Important decisions would be left to an independent company (ISO), to be designated by national governments with the Commission’s prior approval.
- The ITO (Independent Transmission Operator) reflects basically the same idea of the ISO option: In order to retain ownership of their gas and electricity grids, companies have to give up daily management to an independent transmission operator. However, by setting up a framework for ensuring the independent operation of the transmission network, they are able to retain important decision-making. (For
instance, by setting up a supervisory body, made up of company representatives, third-party shareholders and representatives of the transmission system).[7]

2.2.1 Benefits of and barriers to the liberalization of the market

Obviously, liberalization of energy markets can yield important benefits but at the same time it may also entail some drawbacks for the firms due to the fact that domestic regulations often make it difficult for energy firms to engage in cross-border trade. Being aware of the benefits and drawbacks associated with liberalization of this market is crucial in order to understand the value of stronger international trade and investment principles.

Despite the fact that liberalization of energy markets has lagged behind other sectors such as airlines, telecommunications and banking, there exist a sufficient number of cases to suggest that removing restrictive price regulations, market entry barriers, and other restrictive practices can generate significant economic benefits, as for instance:[8]

- Prices (as the fundamental justification for market liberalization) under liberalization will be lower due to more efficient management and resource allocation.
- Europe is likely to see more Mergers & Acquisition opportunities due to the restructuring of the industry in anticipation of a more competitive market.
- Better investment in infrastructure and management
- Energy liberalization creates opportunities for distribution companies.[9]

2.2.2 Consequences for European energy companies as well as for global big-players

The European Commission has made clear that it favors splitting up energy’s production and distribution activities in order to ensure fair competition and lower prices for consumers. This “full-ownership unbundling” would solve the conflict of interest that occurs when incumbents are told to grant access to their network to new competitors entering the market.[10]

Research has shown that 63% of Europe’s 19 largest gas utilities focus their operations exclusively on their domestic markets. In spite of the liberalized energy market, most energy companies are operating solely in their home country. Less than half of 27 major European energy companies record significant sales outside their local regions. Due to the fact that liberalization of the market encourages the threat of new market entrants, most firms do not venture out of their domestic sphere. As a result, even once the European energy market became fully liberalized in 2007, consumers will still not be able to take full advantage of pan- European competition.

Furthermore we can unveil the phenomenon that the liberalization of energy markets led to lower profits and - implicating this - a decline in a company’s level of profitability. It is important to mention that it is not the level of market share that determines a company’s profitability. It turned out that a much more relevant factor is the presence of other major utilities that firms have to compete with in their domestic market. While energy market liberalization is intended to benefit energy consumers across Europe, the profitability of energy firms tends to decline and, contrary to the initial intention, a pan-European energy sector still remains a distant prospect.[11]

For the incumbent European energy companies, market liberalization is both an opportunity and a threat. On the one hand, the opening of markets offers them the possibility to be present in foreign markets. Liberalization implies amongst others exploiting trading arbitrage and benefiting from economies of scale and synergies. Moreover, several companies have managed to build up very successful trading units in order to manage their risks in the market and generate additional business from trading. While on the other hand, new competitors as for instance banks, hedge funds, independent trading houses or energy resellers have now access to all segments of the energy value chain. Consequently, energy firms have to face huge challenges and these circumstances effect of course the opportunities and strategies to expand internationally.[12]

To what extend the corporate strategy is affected by the market liberalization depends obviously on several factors, as for instance the country/environment in which the firm operates.

This becomes clear by taking for instance the Russian state-run gas monopoly, Gazprom as an example: Gazprom is the leading energy-exporter for the European markets. Therefore the direction into a liberalized market influenced considerably its strategy: The European Union’s goal is to increase competition in order to lower electric gas prices for consumers. The primary means to achieve this are ensuring free access for gas producers directly to consumers and developing a system of retail contracts (spot deals). The EU directive requires that all signed, long-term contracts be revised to remove restrictions on gas-resale by the buying nation. Each of Gazprom’s contracts is based on such terms. It included in each contract a special clause banning re-sale of the supplied gas to third nations. Therefore the EU directive runs counter to Gazprom’s interests as understood by both the former and current company management. Furthermore, the energy market liberalization forced Gazprom to modify its export strategy: It is just about to retain its position as the region’s leading wholesale supplier (especially by acquiring assets of gas transport companies) and to become more integrated in the retail trade. It is crucial to mention that the spot market is the weakest link in Gazprom’s European activities, as it supplies mainly to large importer companies, which subsequently resell the gas to the consumer. Consequently Gazprom had to adopt a completely new export strategy by shifting a substantial part of its export shipments to the spot market. Moreover, increased competition on the European market as well as unclear consequences of its liberalization forced the firm to redirect its target markets and pay attention to alternative markets, mainly on the southern and eastern routes, as for instance Turkey and the Asian regions.[13]

2.3 Managing governmental energy policy - the role of the state in the energy sector

As regards the right or wish for governing their own affairs, companies in the energy market are always constraint by frequent intervention of government and regulators. In fact, intervention in energy markets is inevitable and no company is immune. It is important to mention that most of the firms consider market intervention as a threat and regard it solely as a risk whose effects should be minimized. This is not quite correct though. A substantial part of the energy firms would not have been successful without the opportunities created by government support mechanisms. Consequently, managing energy policy risks and simultaneously exploiting opportunities are indispensable to winning in the energy business.

Whatever will be the goal of the market intervention, there is a considerable number of levers that government and regulators can pull to steer the market towards their desired goals. They can stimulate demand through obligations, establish a high market price or decrease costs by granting direct subsidies or limiting the regulatory burden, thus offering benefits for the concerned firm. By contrast, they are easily able to suppress demand through regulatory constraints, reduce prices or increase costs through direct taxation or implementing regulatory obstacles. Therefore, it is crucial for a company to understand the energy policy landscape in which it operates and to know on which issues this policy is mainly focused. So, when considering any major investment or strategic move into a foreign country it turns out to be vital to understand how these steps affect the energy policy goals of the country and therefore where the risks and opportunities may arise.[14]

This issue gets clear when we look for instance at the relationship between energy companies in Russia and the European Union. Russia is the major energy supplier to the European Union, whereas the latter is the biggest purchaser or Russian energy products. It is not surprising that European standards of liberalization are often contradictory with Russia’s energy policy, which is relatively centralized by the state. Russian energy strategy is complex as it adopts a realistic perspective of international relations while on the other hand the strategy is primarily based on the priorities of the state.[15] Gazprom clearly benefits from the Russian energy strategy: By having the background of being a monopolist in Russia and at the same time benefiting from the investment environment in Europe, it attained a very strong market position, leading to the biggest market share supported by increasing subsidiaries and affiliates in European countries. Therefore we can see that Russia benefits from liberal markets abroad (consequently facilitates corporate expansion of Gazprom in Europe), yet strictly adheres to state centric policies.[16]

3 The global, liberalized energy industry of today

All kind of industries are subject to some key drivers, which influence the structure and the strategy of the concerned firms, so also the international energy industry. Although most of the commonly identified drivers are identical in all industries, their precise weighting, manifestation and interaction vary from industry to industry. As regards companies in the energy sector of today, the following determinants are the most decisive ones:

- Globalization: The present-day energy sector consists of sectors that demonstrate varying degrees of internationalization and international integration. The oil industry, as a truly international industry encompasses some of the world’s biggest companies. This can be seen by the fact that oil and gas companies comprise six out of ten of the biggest companies by revenue worldwide and seven out of ten in terms of profitability. By contrast, the electricity supply industry has traditionally operated along regional or national monopoly lines. However, as a consequence of privatization and regulation efforts in many countries, also this sector is more and more directed into an international one.

- Technology: The continuous improvement of technology is a key influence of the development of the world’s energy sector. In the oil sector, for instance, new technology has made the exploitation of previously unprofitable fields profitable and made previously inaccessible fields accessible. Moreover, the implication of more energy- efficient features helped to break the link between economic growth and energy consumption and the solely importance of scale economies is declining.

- The Environment: In the last decades, environmental issues played a crucial role in government policies as well as corporate strategies of energy firms. The way how companies handled the link between their business and the environment came under intense scrutiny, whereas the approach to the climate change plays a crucial role. Therefore, energy companies have to face the challenge to focus their business strategy on initiatives that both increase their environmental credentials and enable them to retain their long-term profitability.

- Supply and Demand: The world’s energy crisis so far have mainly been a crisis of supply arising from political unrests. However, this key influence does not only relate to past events. There is rising potential for more long-term crisis in the future resulting from a mismatch between supply and demand. Therefore the energy sector is extremely subject to the vagaries of these two economic fundamentals.

- Politics: As already mentioned above, government - energy links can be particularly strong. This can be explicitly illustrated by the US government, as many of President George W. Bush’s senior appointments came originally from the ranks of the oil industry. Furthermore, substantial donations from Bush election campaigns derived from the energy industry, encouraged the perception that US energy policy was determined by the energy industry in its own interests rather than by broader national ones. Similar relations can be observed in the Russian energy market as the Russian prime minister from 1992-1998 was a former head of Gazprom, which still continues to maintain close links with the government.[17]

4 Identification of current trends in the energy sector

4.1 The wave of M&A and strategic alliances

In recent decades, the energy sector has shown an increasing activism concerning M&A in all its variations, be it national, cross-border, horizontal or vertical mergers. Obviously, this behavior changed the shape and the whole structure of the European energy market. Before going more into detail of this merger wave phenomenon particularly related to the energy industry, we try to analyze initial rationales for this behavior: A first explanation of the phenomenon for the whole wave of M&A is found on the increase in cash liquidity of energy firms. European companies invested this additional liquidity rather in M&A than in generation, transmission or even exploration activities.

[...]


[1] Cf. N. Hashai et al. 2010, p.660

[2] Cf. F. Parra 2004, p. 1

[3] Cf. M. Pacchetta 1978, p 97ff

[4] Cf. F. Parra 2004, p. 3

[5] Cf. J.W. Baddour 1997, p.143ff

[6] cf. B. Taverne 2008, p.21ff

[7] Cf. Euractiv: Liberalising the EU energy sector

[8] Cf. P.Evans 2002, p. 15

[9] Cf. The Economist 2003, p.2

[10] Cf. Euractiv: Liberalising the EU energy sector

[11] Cf. Anonymous 2007, p.131f

[12] Cf. M.Obert 2009, p.1.

[13] Cf. G.Fellers 2004, p. 45ff

[14] Cf. S.Skillings 2008, p.27

[15] Cf. M. Bilgin 2011, p.1f

[16] Cf. M.Bilgin 2011, p. 3ff

[17] Cf. D. Johnson et al. 2010, p. 461ff

Details

Pages
43
Year
2011
ISBN (eBook)
9783656101833
ISBN (Book)
9783656101345
File size
1004 KB
Language
English
Catalog Number
v186865
Institution / College
Vienna University of Economics and Business – Institute for International Business
Grade
1
Tags
internationalization energy

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Title: The Internationalization of Energy firms