As oil prices push toward $100 a barrel amid turmoil in the Middle East, investors may be looking for ways to profit from the turbulent energy sector. Trading on price changes up and down is one way to do it. But there are other ways to get on the oil bandwagon without the heart palpations that come with trading volatile futures contracts.
Multinational oil companies radically changing the way they strike contracts to share what they discover with countries where they drill. Four partners at Booz & Co. recently wrote about how Middle Eastern countries are reassessing these production-sharing agreements. Countries like Iraq and the Gulf states are driven by the fact that the crude they pump out of the ground is worth a lot more when it’s refined in plants nearby into chemicals and plastics rather than put in a tanker and shipped abroad. It seems that the man who gave Benjamin career advice in “The Graduate,” was correct all along.
Because a small Gulf state would like to keep more of its oil in nearby chemical refineries, these nations are becoming more aggressive about how much they hold onto when the oil is discovered. Part of their desire to use more oil for higher-margin chemicals stems from concerns that worldwide demand for oil will drop in the coming year. The National Bank of Kuwait expects demand to decline between 1.2 and 1.6 million barrels per day (or 1.4 to 1.8 percent) as governments seek to reduce their own budget deficits and central banks move to raise interest rates to more normal levels, says NBK.
Until recently, the classic production-sharing agreement common in oil-rich Middle East countries allowed a foreign oil company to receive a percentage of whatever oil it helped produce. According to the Booz & Co. report, Iraq, for one, now favors service contracts with international oil companies that call for production thresholds.
When the wells have extracted oil up to the predefined limit, the companies get a fee for each barrel of oil produced above and beyond that limit. Unlike what was typical in the past, however, the company doesn’t own the oil extracted above the threshold – Iraq does. “The contract also stipulates a plateau production target that the consortium must achieve within seven years and then maintain for an additional seven years,” according to the Booz report.
Chemicals and plastics are the future of the Middle East refineries. Because this new type of service contract is an attempt at increasing the domestic country’s share, it’s a boon for companies that provide equipment and services needed to drill deeper and for longer periods of time. The new way to expose an investment portfolio to the unpredictable energy sector: buy stocks of oilfield-service firms that provide the big multinationals with drilling equipment, rigs, and even geological surveys.