China Changes Calculus for Petro-Rulers

Much has been written on how low oil prices will help to reverse the fortunes of resource-strapped Big Oil – if not precisely jolly over their new penury, closed-armed petro-powers, it's said, will now allow western oil companies at least to make a case why they should be permitted to conduct exploration and production. Atop the list of this ostensible new state of affairs have been Venezuela, Libya, and Russia.

But so far, the opposite appears to be happening -- resource-rich countries are not opening up to new deals with western oil companies. One reason is that the analyses appear to have played down two factors – the depth of discomfort among the petro-powers with Big Oil; and the deep-pocketed willingness of China to step in.

The implications of China's entry as cash savior include not only trouble for non- state oil companies; it also could exaggerate an expected resumption of relatively high oil prices once the global economy recovers.

In the last week, we have seen China lending Russia's Transneft and Rosneft $25 billion in exchange for a guaranteed oil supply of 300,000 barrels a day for 20 years. The price of the oil wasn't disclosed. Look next for Gazprom to borrow from the Chinese to finance its ongoing operations.

Even more conspicuous was last Thursday's announcement that China is lending Brazil up to $10 billion to help develop its oil company Petrobras's deepwater oilfields. The deal is in exchange for up to 160,000 barrels a day of oil. Again, the price of the oil wasn’t disclosed.

The Brazilian case is perhaps more important because it appears on the cusp of the country becoming a huge petro-power on the backs of an estimated 12 billion barrels of offshore oil; Brazil itself says it may possess an additional 100 billion barrels of oil.

Because the oil has been found in extremely deep water, analysts have forecast that Petrobras will need Big Oil’s cash and capabilities in order to develop it. Indeed already Exxon Mobil, Amerada Hess and BG are among companies working offshore in Brazil. But if China remains open-walleted, there will probably be less need for more cooperation with multi-nationals.

Interestingly, both Russia and Brazil were willing to be on the hook to China for guaranteed reserves while at least for now remaining closed to new cooperation with Big Oil.

The ramifications for future oil prices stems from the nature of the deals. The price of oil is set to a large degree on the availability of supply during moments of man-made or natural crises, such as war or hurricanes. To the degree that the available supply is already tied up in long-term contracts, there’s less wiggle room during these crises, and thus more of a chance of a price spike.

Already, oil companies are significantly reducing new exploration projects, and shutting in uneconomic oilfields in the U.S. and elsewhere. This means that, once the economy and oil demand recover, there will be less supplies of oil and natural gas. China's new oil deals will exacerbate the supply tightness. And any geopolitical or weather-caused crisis will more likely drive oil and ultimately gasoline prices higher.

Is Exxon Right This Time?

I've written the cover story for BusinessWeek, which hit the stands today. The topic is Exxon. The premise of the story is to take a reading of Big Oil by examining the most successful by far of all the companies; if Exxon has got problems, the rest definitely do. The story points out that Exxon retains superlative cash flow, but has numerous weaknesses built in to its system.

Ultimately, Exxon has successfully navigated the real and supposed crises of the last several decades by sticking steadfastly -- some say rigidly -- to much the same highly cautionary formula devised in the 1870s by John D. Rockefeller, the founder of Exxon predecessor Standard Oil.

So where are we today? At the cusp of a fundamental shift in global energy, as many argue? Or, as Exxon asserts in continuing to adhere to its orthodoxy, are we in just another cycle?