This blog will cover some news items related to Sustainability: Corporate Social Responsibility, Stewardship, Environmental management, etc.


Cleaning up: Power companies and shorting traders have done better than the environment

Cleaning up
May 4th 2006
From The Economist print edition

Power companies and shorting traders have done better than the environment

MARKETS are naturally volatile; but when they are new, thin and involve governments, they are especially capricious. So it is with the market for carbon-emission permits created by the establishment of the European Union Emissions Trading Scheme (ETS) in January 2005. The price of permits, which had tripled since the scheme's launch, dropped by more than half in the last week of April.

The ETS is designed to cut greenhouse-gas emissions so that European countries meet the targets set for them by the Kyoto climate-change agreement. Some 13,000 factories and power stations in five different industries may emit carbon only if they have a permit. At the start of the scheme, they were given permits worth around 2.2 billion tonnes of carbon dioxide per year. Those permits may be used up as fuel is burned and carbon generated, or they may be traded. Around €10 billion-worth ($12.4 billion-worth) of permits were traded last year. This year the figure will probably be three times that.

When the scheme was originally established, politicians expected the permit price to hover around €10 a tonne. Instead, it rose to a peak of €30. “The gas-coal spread is mostly responsible,” explains Anthony White of Climate Change Capital, a specialist investment bank. The power-generation business dominates the carbon market, because it emits so much pollution. In Europe, gas and coal are the main fuels used. When the gas price rises, power companies tend to switch to coal. Coal is dirtier than gas; so, as power companies switch to coal, they need more permits, and the price rises.

Then, in late April, several countries, including France and Spain, announced how much carbon they had emitted last year. The numbers were surprisingly small. Suddenly, the future demand for permits looked lower than expected—and the price crashed. Unfortunately, the numbers reflect not the scheme's success in cutting pollution, but industry's success in getting itself allocated more permits than actual emissions warranted when the scheme was launched. Dieter Helm, an energy economist at Oxford University, questions the way the information was sprung on the market, and the degree of competition (or lack of it) in the market. “It ought to be investigated,” he says.

So far, the ETS has done more for power-generating companies than it has for curbing pollution. Because carbon permits were handed out free, rather than auctioned (as most economists said they should be); and because the carbon price has been unexpectedly high, permit-holders found they were sitting on unexpectedly valuable property rights. IPA Energy Consulting, in a report for the British government on the scheme, says it reckons that the British power-generation sector has profited to the tune of £800m ($1.5 billion) a year.

Meanwhile, there's no sign that the permit regime has brought about a switch to cleaner fuel—indeed, the reverse has been happening. That's not just because gas has been so much more expensive than coal, but also because the first phase of the ETS lasts only three years. Beyond that, nobody has any idea how many permits will be issued, and therefore what the price might be. And since investments to reduce emissions have pay-back periods of five or more years, nobody is going to start investing on a three-year view.

The ETS's troubles do not mean markets are no use in curbing emissions—but they do mean that markets need to be part of a scheme that has been well designed. The ETS hasn't.


EPA Releases Top 10 List of Retail Green-Power Partners

EPA Releases Top 10 List of Retail Green-Power Partners

WASHINGTON, April 12, 2006 - The U.S. Environmental Protection Agency (EPA) has released the most recent national Top 10 Retail Partners list highlighting the largest retail purchases of renewable energy by members of its Green Power Partnership. The list reflects renewable energy purchases made through March 27, 2006.

Topping the list is Whole Foods Market, followed in second place by Starbucks. Rounding out the top six purchasers of green power are Safeway Inc., Staples, FedEx Kinko's, and HEB Grocery Company. A newcomer to the list is My Organic Market, reaching No. 10 on the ranking.

Whole Foods Market, Starbucks, Safeway Inc., Staples, and FedEx Kinko's also appear on EPA's most recent overall Top 25 list of the largest corporate green power purchasers in the Green Power Partnership.

The actions of the Top 10 Retail Partners help drive the development of new renewable energy sources of electricity generation. Combined, the green power purchases of the Top 10 Retail Partners amount to over 877,000 megawatt-hours (MWh) of green power annually. This is enough renewable energy to power approximately 82,000 average U.S. homes per year or is equivalent to removing the emissions of 107,000 cars from the road annually.

The Top 10 Retail Green Power Partners, listed in descending order of purchase size, are as follows:

1.        Whole Foods Market (463,128 MWh)
2.        Starbucks (150,000 MWh)
3.        Safeway Inc. (87,000 MWh)
4.        Staples (49,456 MWh)
5.        FedEx Kinko's (40,6000 MWh)
6.        HEB Grocery Company/Austin Region Operations (27,000 MWh)
7.        Liz Claiborne Inc./N.J. Corporate Headquarters (25,000 MWh)
8.        prAna (16,500 MWh)
9.        Lowe's Home Centers in N.C., N.M., S.C., Tenn., Texas (16,500 MWh)
10.        MOM’s - My Organic Market (1,488 MWh)
EPA’s Green Power Partnership is a voluntary program helping to increase the use of green power among leading U.S. organizations. The program encourages organizations to purchase green power as a way to reduce the risk of climate change and environmental impacts associated with conventional electricity generation. Currently, the Green Power Partnership has over 625 Partners voluntarily purchasing nearly 5 million MWh of green energy. Partners include a wide variety of leading organizations such as local, state, and federal governments, trade associations, universities, and Fortune 500 companies.

EPA updates both its overall and sector-specific lists of green power purchasers quarterly. The next scheduled update is set for July 2006 and will reflect information received by Partners as of June 26, 2006.

More information on EPA's Top 10 List of Retail Partners is available

GLOBE 2006: a tale of two cities

GLOBE 2006: a tale of two cities
VANCOUVER, May 1, 2006 - The ninth episode in the GLOBE series of environmental conferences wrapped up with a tale of two cities. Technically, it was a tale of a mega-city, Chicago, and a tiny village, Whistler – but their common focus on preserving natural heritage demonstrates that, in environmental terms, our world really is a global village.

Chicago Mayor Richard Daley’s account of the Herculean efforts to restore his city’s environment stood in stark contrast to Whistler Mayor Ken Melamed’s struggles to protect the British Columbia resort community’s natural heritage in the lead-up to hosting the 2010 Winter Olympics.

But the two presentations also highlighted the diversity of interests that GLOBE 2006 brought together for three days in March under the spreading sails of Vancouver’s Convention and Exhibition Centre.

More than 2,000 delegates from 77 countries, 10 per cent more than attended GLOBE 2004, gathered to share their environmental expertise and dreams of a sustainable global society. They packed meeting rooms to hear senior officials, business leaders and environmental activists debate the merits of sustainable development.

The delegates jammed the huge Trade Fair area to learn more about ground-breaking business and technology solutions offered by more than 400 exhibitors and national pavilions sponsored by Canada, Austria, Korea, Holland, France, Wales and the United States.

They wandered the Sustainable Construction Showcase to view the latest in green building design and construction and the Advanced Transportation Technologies and Solutions Showcase to view advances in the transportation field. They lined up to test drive Honda’s innovative FCX fuel cell vehicle.

Networking with like-minded executives and entrepreneurs, including at several organized breakfasts and lunches, and an opportunity to plant the seeds for future business deals (more than $500 million worth were initiated at GLOBE 2004) are a large part of what make GLOBE events a huge success.

The GLOBE Awards banquet saw conference organizer GLOBE Foundation of Canada honour five companies and institutions for their progressive approaches to sustainability – Interface Flooring Systems (Canada) Inc., Corporate Competitiveness Award for Product; Suncor Energy Inc., Corporate Competitiveness for Efficiency and Mitigation category; Ivey International, Corporate Award for Technology Innovations; Advanced Glazings Ltd., Industry Award for Export Performance; Jantzi Research Inc., Capital Markets Award for Sustainable Investment and Banking; and the Canadian War Museum, Excellence in Urban Sustainability.

But GLOBE 2006’s plenary sessions and topic-specific meetings were what sent the delegates home energized and ready to tackle day-to-day environmental challenges. Organized along four broad themes – Corporate Sustainability, Energy and the Environment, Finance and Sustainability, and Building Better Cities – the more than 50 sessions offered detailed technical information, including a series on climate change sponsored by the Canadian government’s Technology Early Action Measures program, as well as thought-provoking discussion and debate on key environmental issues.

The closing plenary offered GLOBE delegates a preview of new Canadian Prime Minister Stephen Harper’s environmental agenda. Environment Minister Rona Ambrose showcased a self-deprecating sense of humour about her new role as an environmental leader and offered insight into her approaches to key issues.

Ambrose voiced concern over Canada’s recent inability to live up to its “Boy Scout” image on environmental issues, and vowed to restore Canada’s credibility as a global environmental leader.

“Have we earned all of our badges? I, for one, do not believe that we have,” she told a hall packed with GLOBE delegates. “I am concerned. Our government is concerned. I can tell you that our Prime Minister is concerned. . . . That is why we are taking action to clean up our own back yard.”

Pointing to the billions of dollars in health care spending that can be directly linked to atmospheric pollution, Ambrose said it is unacceptable that the health of Canadians is being compromised by inaction on cleaning up air pollution. She promised a new Clean Air Act that will take major steps toward addressing broad air pollution issues, as well as contributing to Canada’s efforts to address climate change by reducing greenhouse gases emissions.

“Tangible results – this is the mark that I want to put on Environment Canada’s actions,” she said.

Ambrose’s comments provided a perfect book-end to environmental icon Maurice Strong’s comments to the opening plenary two days before, in which he cited corporate sustainability as the key to the world’s environmental future.

“The concept of sustainability is very real, and is consistent with corporate profitability,” Strong said from the stage he shared with BP chief executive Tony Hayward and Dow Chemical Canada president Ramesh Ramachandran.

Hayward agreed, noting that companies are no longer able to separate their approaches to business and the environment.

“There is only one bottom line – profit. But profit is enhanced and sustained by good social and environmental performance,” he said.

Dow’s Ramachandran stressed that corporations now understand that it is possible for a corporation to be both extremely profitable and a good social and environmental steward.

“They are not competing goals,” he said. “Tomorrow’s customers have made it very clear they will punish us severely if we ignore these goals.”

The interplay between social and environmental responsibility and corporate growth and profit was a recurring theme at GLOBE 2006. Conference organizers used a highly interactive “armchair dialogue” format to put delegates in direct contact with corporate executives and regulators, a more informal approach that generated lively debate.

Senior business executives participating in one such panel warned of the need for corporations to make a strong business case for pursuing social and environmental goals.

Tim Mohin, director of sustainability with Intel Corp., noted that companies are making significant investments in specific social and environmental programs, but will not take action on broader issues such as climate change until they offer business opportunities.

“For business to do anything, there has to be a return on that investment,” Mohin stressed. “Until we cross that hurdle where there’s a return, you’re not going to see too many business leaders out there proselytizing.”

It is also unclear whether investors are as yet willing to support corporations for their social and environmental performance through greater investment and higher share values, he said. “Are we rewarded for that? I’d say only that we’re not punished for it.”

Interface Americas Inc. executive Jim Hartzfeld took a slightly different approach, suggesting that changing corporate and public attitudes is the key to producing a sustainable global society. “There are a few minds left to change,” said Hartzfeld, the floor coverings firm’s vice-president of sustainable strategy.

But Hartzfeld cited clear business opportunities in the drive for sustainability, and noted that Wal-Mart Corp. is jumping on the corporate sustainability bandwagon in an effort to offset negative public perceptions of its operations. A switch to a more socially and environmentally responsible business model was originally perceived by Wal-Mart as a “license to operate” necessity, but is now seen by its top executives as a major opportunity to grow the company, he said.

Environmental activists involved in GLOBE 2006 sessions pointed to a greater acceptance by corporations of their involvement in setting sustainable development policies, evidence of a shift away from the purely confrontational approaches in the early days of the environmental movement.

“We are entering into an era of greater cooperation as we focus more and more on solutions on the ground,” said Cathy Wilkinson, executive director of the Canadian Boreal Initiative.

But business executives stressed that doesn’t mean the relationship will always be cooperative. Environmental non-government organizations are still entitled to criticize some aspects of the performance of they corporations they are working alongside, and conflict is a regular feature of the collaboration process, said Gord Lambert, vice-president of sustainable development with Suncor Energy Inc.

Native activists, meanwhile, pleaded with corporate chief executives in another GLOBE 2006 session to adopt a “take only what you need” approach to corporate sustainability, and the executives applauded the emotional appeal for a more holistic approach to conservation.

The activists’ pleas reflect wisdom that has been passed from generation to generation, and must be taken into consideration, said Bob Elton, president and chief executive officer of provincial utility BC Hydro.

“It’s what our grandmothers told us. It’s personal. You don’t take more than you need,” Elton said. “But I’m an optimist. I think we’re capable of having a good standard of living while ensuring that we don’t waste our natural capital.”

Jim Carter, president and chief operating officer of Syncrude Canada Ltd., suggested that industry also has a responsibility to take advantage of business opportunities and use economic development to create value for society as a whole. “A high tide lifts all boats,” Carter said.

The key is for corporations to maximize their economic performance while minimizing its negative environmental and social impacts, stressed Elyse Allan, president and chief executive officer of GE Canada.

“To us, that’s not a program. It’s a core value,” Allan said. “We want to make sure that any decision we make upholds our reputation.”

A new focus at GLOBE 2006 was the interplay between sustainable development and finance, and particularly among clean technology investment, government regulations and policies, capital markets, and responsible investment.

The climate change issue is having far-reaching financial effects, in particular for the insurance sector, and finding a way to address global warming will require strong regulatory controls, said Jacques Dubois, chairman and chief executive of Swiss Re America Holding Corp.

“We support proposals requiring U.S. corporations to embrace significant long-term restraints on emissions under federal regulation, and in return to receive limited liability for past sins of emissions,” Dubois said.

Climate change is also a major issue for large pension funds, but pension experts at the conference suggested that funds are unlikely to screen out investments in companies with a high level of exposure to carbon emissions or to sell off existing investments in those companies.

Rather, the experts suggested, large pension funds will use their investments to influence corporations to adjust their environmental, social and governance approaches. Screening of investments is viewed as increasing investment risk and reducing returns, but direct engagement is an accepted part of owning assets, said Susan Enefer, manager of corporate governance for BC Investment Management Corp.

California’s largest public pension funds – the California Public Employees’ Retirement System and California State Teachers’ Retirement System – use proxy voting, and disclosure of how they vote, to pressure corporations to improve their environmental and social performance, said Toni Symonds, chief consultant to the California State Assembly’s Committee on Jobs, Economic Development and the Economy.

“What we know is that direct engagement pays off, and I believe that’s the way forward,” she said.

After three days of intense discussion – from general issues like the need to consider climate change in corporate planning to more specific ones like profiting from the growing market for carbon trading to highly technical ones like measuring the results of projects to reduce emissions of greenhouse gases – the 2,000 GLOBE 2006 delegates headed home with an overload of information, but also with renewed hope in their ability to address and overcome environmental challenges.

They carried with them the upbeat messages of Chicago Mayor Daley and Whistler Mayor Melamed, worlds apart in the size of their challenges but united in their unfaltering dedication to sustainable development.

Melamed detailed how his very small community is coping with the pressure of hosting a major event and the accompanying economic development, including a “no new development” policy that sticks to Whistler’s original strategic plan and strict design and sustainability guidelines for any new construction.

“If we grow any more, we risk the very resource that makes us so successful,” Melamed said. “It seems a bit of a contradiction that a destination resort should talk about sustainability . . . but what choice do we have?”

Daley, meanwhile, catalogued the many steps his city has taken to transform a large industrial centre into one that co-exists with its natural environment – including restoring the Lake Michigan waterfront and the Chicago River, planting more than 500,000 trees and replacing asphalt parking lots with green spaces.

“Environmentalism makes sense economically and politically,” said Daley, whose more than 16 years as mayor demonstrate that point. “Taking pride in your city, taking pride in your home. That is the key to success.”

Power companies open dialogue to a sustainable electricity future

Power companies open dialogue to a sustainable electricity future

Geneva, 4 May 2006 - One of the most ubiquitous forms of modern energy is electricity, a highly efficient energy carrier providing an array of services to customers with a high degree of flexibility. Electricity is more than energy. Its crucial social value means that the demand for it has been and is growing faster than that for any other energy carrier.

So widespread is its use, so successful its integration into our world, that we barely give it a second thought. We take it for granted until it isn’t there. But we should be thinking about electricity, because affordable and reliable power in abundant quantities is the lifeblood of our modern society and underpins economic progress.

At the same time, power generation contributes around 40 percent of global CO2 emissions, with coal-fired generation responsible for about 70 percent of this. In addition, 1.4 billion people lack access to modern forms of energy in our world today. Predictions in business-as-usual scenarios do not reduce this number substantially in the future, even though that is crucial for meeting the Millenium Development Goals.

Simply put, electricity is at the heart of the world’s energy challenge, including security and reliability of supply, affordability and access, local pollution and climate change.

The potential of power companies to contribute to solutions to these challenges is enormous. Power companies make large investments in infrastructure that lasts 40 years or more, and they often enjoy a direct link with their customers through the electricity network This makes them a compelling agent for change in the quest for more sustainable energy supply and consumption. But they can’t do it alone.

Eight power companies have joined forces under the WBCSD’s Electricity Utilities Sector Project to highlight the urgency to act, and to clarify their role in addressing these challenges.

These companies are now engaging civil society and other stakeholders in a serious dialogue about what each can contribute to spark change, with the next dialogue taking place on 8 May during UNCSD 14 in New York (see below for details).

The companies do not pretend to have all the answers to the challenges outlined above, but have organised their position on solutions into six main objectives that need to be tackled through concerted efforts by business and a range of other stakeholders:

  • Continuously improving energy efficiency
  • Diversifying and decarbonising the fuel mix
  • Investing adequately in infrastructure and securing a reliable grid
  • Bringing to market the promising technologies that can make our long term path more sustainable
  • Providing wider access to electricity, and
  • Building partnerships and developing a dialogue with decision-makers and civil society
The New York event follows an international roundtable discussion in China in March 2006 that focused on the challenge of satisfying the rapidly growing demand for secure and affordable electricity in China, while reducing GHG emissions and other impacts. The discussion showed that the situation is far from rosy. China is currently building one coal-fired power plant roughly every two weeks. All participants agreed that China should make all possible efforts to increase energy efficiency and the diversity of its fuel mix.

However, this is easier said than done, and the rapid expansion of coal use in power plants is likely to continue for a long time, especially with gas prices as high as they are now as a result of high oil prices. This puts at centre stage the question of how to accelerate the deployment of clean coal technologies.

“The challenges that we are facing require not only the involvement of all stakeholders, but also a focus on key objectives and clarity on the role of different players”, says Simon Schmitz, who is heading the WBCSD project. “Many NGOs and policymakers who are concerned about these issues will attend UNCSD, and by scheduling a dialogue during the conference in New York, we hope to be able to engage with a global audience.”

On the same day as the side event, the project will also launch a four-week public internet consultation, for specific feedback on the current drafts for discussion.

Wall Street Concerned About Impact of Oil Prices, Energy Policies, and Climate on Auto Companies

Wall Street Concerned About Impact of Oil Prices, Energy Policies, and Climate on Auto Companies, 1 May 2006 - A new Ceres report finds that the uncertainty in the U.S. regarding the future course of energy and climate change policy is a major problem for investors and Wall Street analysts in assessing the value of auto companies, and that analysts need better disclosure from auto companies about their strategies for managing the risks and capturing the opportunities posed by new energy and climate change policies taking effect worldwide.

The report, "Climate Risk and Energy in the Auto Sector -- Guidance for Investors and Analysts on Key Off-balance Sheet Drivers," highlights key findings from an auto analyst briefing last December at JP Morgan in New York City where Wall Street analysts, institutional investors such as CalPERS and CalSTRS, and others gathered to discuss the impacts of high oil prices, fuel efficiency and foreseeable climate change regulations on the future of the auto industry. Three conclusions were widely agreed upon by the analysts at the meeting:

  • Regulatory uncertainty on climate change is a major problem for the auto sector;
  • Flexibility in manufacturing is a key factor for future profitability;
  • Investors need improved disclosure on the risks and opportunities posed by fuel prices, climate change, and other factors.
"Given that many corporate CEOs now agree that mandatory climate change regulations are inevitable, Wall Street needs more clarity from President Bush and Congress on the eventual structure of climate policy so analysts can assess the financial and competitive implications on auto companies accurately," said Mindy S. Lubber, president of Ceres and director of the Investor Network on Climate Risk, which includes over 50 institutional investors managing nearly $3 trillion in assets. "Investors are calling for policy certainty and better climate risk disclosure so analysts can better estimate the fair value of the auto companies in their portfolios."

Experts also agreed at the December meeting that U.S. automakers have less flexibility to meet changing regulatory and consumer demands. The report states that only two manufacturing facilities in the U.S. -- facilities owned by Nissan and Honda -- are capable of rapidly switching from producing SUVs to more fuel-efficient vehicles.

"Steadily rising fuel prices since January 2002 have already shifted consumer demand away from large SUVs and pickup trucks, but U.S. manufacturers responded not by shifting their future product plans but by lowering prices on the same inefficient vehicles they've been offering for years," said Dr. Walter McManus, Director of Automotive Analysis for the University of Michigan Transportation Research Institute and a keynote speaker at the December briefing. "The SUV cash cow has turned out to be a Trojan horse." The Ceres report analyzes several key trends that could affect the valuation of auto companies' securities:

  • High oil prices and unstable gas prices at the pump. Even as President Bush has called on Americans to reduce their dangerous dependence on foreign oil, new predictions from the International Energy Agency (IEA) say that 95 percent of the world's economy may come to depend on oil from five or six politically volatile Middle Eastern and North African countries. In February, the U.S. Energy Information Agency raised its predictions for future oil prices, saying that oil won't fall below $42 per barrel over the next 20 years. As gasoline prices stay high, Americans will likely increase their demand for more fuel efficient cars. The Ceres report quotes Ford Sales Analysis Manager George Pipas, who said: "If gas prices don't stabilize, I think it's going to be a very tough endeavor to sell mid-sized and full-sized SUVs."
  • New energy independence measures and climate change regulations taking effect globally. For the first time in 13 years, the United States passed a federal energy bill in 2005 that provides tax credits to consumers for purchasing fuel-efficient vehicles, and creates new mandates and incentives for the production, distribution and sale of renewable "biofuels." Canada, the European Union, China, Australia, Japan, Korea and other countries are taking steps to reduce greenhouse gas emissions and increase vehicle fuel efficiency, in part responding to the enactment of the Kyoto Protocol in February 2005. California and 10 other U.S. states have adopted or are adopting mandatory regulations to curb GHG emissions from vehicles -- actions that are being opposed by most of the world's leading automakers.
  • Alternative technologies and fuels will result in leaders and laggards. Some automakers, like Toyota and Ford, have increased their focus on hybrids and clean diesel, while others, like GM, have concentrated on deploying flex-fuel vehicles capable of operating on gasoline or ethanol. Hydrogen fuel-cell technologies are still a decade or more from commercial viability. The December auto analyst briefing was co-sponsored by Ceres, the Investor Network on Climate Risk, the Natural Resources Defense Council (NRDC), JP Morgan, Cornell University and the Office for the Study of Automotive Transportation at the University of Michigan (OSAT).


Comparing gas/petrol prices around the world, v2

Some more data, by popular demand...

And as far as the tax component of gas prices...

Here is California: (crude oil costs are in red)

The Dutch have the dubious distinction of paying the most to fill 'er up, according to the U.S. Deptatment of Energy. (There are various agencies that track gasoline prices, but these are among the most recent figures available.) As of April 10, drivers in the Netherlands were paying the equivalent of about $6.73 a gallon at the pump. The gas itself cost $2.61; the rest  — $4.12 — represented tax. That’s a 158 percent tax. By comparison, the U.S. has the lowest tax on gasoline of any industrialized country: about 15 percent at current prices.

From the US DOE (based on lower than current prices):

There is a pretty good wikipedia entry here:

And finally, for Canada:

Jean-François Barsoum                                                                                    
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Sonia Abecassis/France/IBM@IBMFR

03/05/2006 02:48

Jean-Francois Barsoum/Markham/IBM@IBMCA@IBMDE
Re: Comparing gas/petrol prices around the worldLink

Where is Paris ?

Business Controls S&D IMT France / NW Africa
IBM Corporation

Office : +33 (0)1 49 05 60 72 / tie line : 33 60 72 Mobile : +33(0)6 12 07 31 59
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Jean-Francois Barsoum/Markham/IBM@IBMCA

02/05/2006 19:12

Comparing gas/petrol prices around the world

I waas just curious about this and found this chart (to which I added Toronto, Montreal and Washington for comparison)
Global gas prices
City Effective Date Price in USD
Caracas Apr-06 $0.12
Kuwait Apr-06 $0.78
Riyadh Apr-06 $0.91
Shanghai Apr-06 $1.94
Beijing Apr-06 $2.05
Buenos Aires Feb-06 $2.09
Mexico City
Washington DC
Sydney Apr-06 $3.42
New Delhi
São Paulo Apr-06 $4.60
Tokyo Nov-05 $5.05
Rome Apr-06 $5.53
Brussels Apr-06 $6.16
Hong Kong Nov-05 $6.25
London Apr-06 $6.28
Oslo Apr-06 $6.90

Note: Self-service prices have been collected where available (usually in No. American, Europe and Japan)
Associates for International Research, Inc.

Smile, pain at the pump has pay-offs: Not only should we learn to live with high fuel prices, we should be glad of them [An Australian Viewpoint]

Thanks to Matthew for this one

Smile, pain at the pump has pay-offs
May 3, 2006

Not only should we learn to live with high fuel prices, we should be glad of them, writes Ross Gittins.


ONE good thing about next week's federal budget is that even though Peter Costello is flush with cash and likely to offer tax relief to families, he's unlikely to make any cut in the tax on petrol. That's a good thing because we must learn to live with high petrol prices, not find ways to duck them.

With prices nudging $1.40 a litre in some cities and Costello warning that worries about the Iranian nuclear stand-off could push them up to $1.60, the motoring lobbies are looking for ways to ease the pain. The Royal Automobile Club of Victoria, for instance, wants Costello to remove the GST on fuel excise, saving about 3.4 cents a litre.

But, whichever way you look at it, cutting the tax on petrol would be the wrong way to go. For a start, there's the conventional economists' argument that the best response to higher prices is higher prices.

Huh? When you think about it, it's not as meaningless as it sounds. Prices rise when the demand for something is growing faster than its supply. Although part of the rise in oil prices is based on speculation about disruption in the Middle East, and so may not last long, the underlying increase in demand is coming from the rapid growth in the economies of China, India and other developing countries. This is likely to keep upward pressure on oil prices for many years.

But in a market system, a rise in the price of such a commodity prompts a change in behaviour. It increases supply by encouraging exploration for new sources, makes formerly uneconomic oilfields profitable and encourages the development of substitute fuels. At the same time, it reduces demand by encouraging consumers to use petrol more economically and search for cheaper substitutes. Put this reduction in demand together with the increase in supply and you see that a rise in prices should lead to a fall in prices.

So allowing retail petrol prices to move in response to market forces is the best way to minimise the long-term rise in prices likely to come from the developing world's increasing demand for oil.

There's evidence that motorists really are changing their behaviour in response to the higher prices of the past year or two. Despite the continuing growth in our economy, the quantity of petrol sold in Australia last year fell by 8 per cent.

In the purchasing of new cars there's a marked swing away from four-wheel-drives and other gas-guzzlers and towards smaller cars. There are even signs of a modest switch back to travel by train and bus.

But the economists' conventional response doesn't fully capture the situation. With the evidence of global warming getting stronger, we need to be limiting our use of petrol and other fossil fuels in the interests of the environment.

So, if anything, the tax on petrol needs to be higher, not lower. The recent report on international tax comparisons showed that, in the December quarter of last year, we had the third-lowest level of taxation on unleaded petrol among the 30 members of the Organisation for Economic Co-operation and Development - 49 cents a litre compared with the average of $1.15 a litre.

That gap is likely to continue widening because of John Howard's decision to abandon the annual indexation of the excise on petrol in 2001.

The Americans are by far the lowest taxing. And, since they consume about a quarter of the world's oil, it has to be said that if only they were to levy an appropriate rate of tax, the resulting fall in consumption would significantly lower the world price of oil as well as improving the prospects for climate change.

It really is remarkable, the way we can have our regular bouts of indignation over the price of petrol without anyone thinking it relevant to mention greenhouse gases. Politicians and greenies who profess to be terribly concerned about our failure to sign the Kyoto Protocol keep their mouths firmly buttoned.

But, if you accept that the world price of oil is likely to stay high and go higher over the coming years, there's a third respect in which we need to adjust rather than duck.

It concerns the way our state governments have persistently neglected public transport while desperately seeking to accommodate our desire to drive everywhere. Whatever the truth of the claim that in their obsession with reducing debt, the states have allowed public infrastructure to run down, it can't be said of their continuing direct and indirect investment in expressways.

But it isn't working. No matter how many improvements they make, the reduction in congestion is always temporary. Why? Because congestion is the only thing restraining our deep-seated preference for driving.

So, when conditions improve, driving increases until the degree of congestion returns to about its former level. The fact that public transport keeps getting worse doesn't help, either, of course.

The point is that this pointless struggle to accommodate motoring won't be able to continue. It fits neither with our need to reduce greenhouse gas emissions nor with the likely inexorable rise in the cost of private motoring.

But when finally our state governments get the message that they need to switch their investment from expressways to public transport - when they're encouraging us off the roads rather than onto them - there'll be a bonus for you and me.

Research into happiness shows that the aspect of people's daily lives they least enjoy is commuting - with the journey to work a little worse than the journey home.

And much research by psychologists shows that people find driving through heavy commuter traffic particularly stressful. It's so bad, people never get used to it. In extreme cases it can cause gastrointestinal problems, headaches and anxiety. Elevated blood pressure is common.

But if driving through heavy traffic is so bad for us, why do so many of us want to do it? Because human nature is full of contradictions. The state pollie who wakes up to this one will do wonders for our health and happiness.


McKinsey on "Big Oil"

Capital discipline for Big Oil

The oil and gas industry has a history of overinvesting at the top of a cycle. This time it should break the habit.

Richard Dobbs, Nigel Manson, and Scott Nyquist

Web exclusive, December 2005

Cash is gushing into international oil companies after the recent jump in the price of oil and gas. According to our estimates, the five largest corporations generated more than $120 billion in cash flow before capital expenditure in 2005—equivalent to about twice their capital expenditure over each of the past few years and more than one and a half times the annual cash flow recorded during the industry's last boom, from 1979 to 1981.1 Suppliers are also benefiting: oil field service companies are expected to report increases of more than 50 percent in full-year 2005 profits over the figures for 2004.

What should companies do with the extra cash? Although executives might be expected to relish such a problem, the decisions they make will have ramifications far beyond the oil industry. On the one hand, companies face pressure to invest more in exploration, production, and refining (where margins have also risen): consumers and governments are angry about high prices, the industry's large profits, and the channeling of those profits into share buybacks and dividends rather than into investments that might bring down prices. On the other hand, with the industry outperforming the S&P 500 by almost 30 percent since 2003, the capital markets seem to be rewarding companies for the share buybacks and dividends—amounting in total to almost $120 billion—that have been announced during this period.2

The conundrum is this: has the industry entered an era of permanently higher oil and gas prices and refining margins or is it merely experiencing another market bubble? If executives believe the former hypothesis, they will focus their companies' excess cash on long-term investments, though at the risk of precipitating the kind of price collapse that would destroy the value of those investments. If they believe the latter, they will return the cash to shareholders and risk missing opportunities to create value over the long term if prices remain high.

We believe that such crucial decisions would be better informed if the industry were to reflect upon its history—in particular, its inability to return its cost of capital over four decades of boom and bust. Coupled with an understanding of the economics of new capacity and of alternative fuel technologies, the evidence suggests that dangers await companies that place too large a bet on a fundamental structural change by investing in projects that will be profitable only if the market has indeed altered for good. They would do better to exercise discipline over capital spending and to invest in opportunities to build sources of competitive advantage that they can sustain regardless of whether prices shift structurally or revert to levels closer to the long-term averages.

A familiar road

The history of the oil industry is long on boom-and-bust cycles in crude prices and refining margins and short on examples of capital discipline. In the 25 years to 1998, the industry's total return to shareholders (TRS) was below that of the S&P 500 (Exhibit 1) because the industry failed to return its cost of capital over the cycle. During booms, oil companies would behave as if the world had changed permanently, investing in projects that could make a profit only if prices stayed high.3 The exceptions were the larger, globally integrated companies, such as BP, ExxonMobil, and Royal Dutch/Shell, which delivered TRS in line with the overall market. These companies did show capital discipline: they made strategic investments in assets and technologies, including very large oil fields and deep-water drilling, that demanded specialist capabilities and large amounts of capital, as well as investments in refining portfolios that use better technologies and are located in economically attractive places. In this way, they generated returns roughly in line with the cost of capital over the cycle.

Chart: Booming now

Since 1998, the industry has enjoyed its longest boom in 40 years and consistently earned returns above its cost of capital (Exhibit 2). Recently, prices have been pushed ever upward thanks to unexpected increases in demand from the United States and China, as well as a tightening of supplies caused by delays in upstream projects, the war in Iraq, and last autumn's hurricanes in the Gulf of Mexico. Margins on refining have also risen. These external factors, combined with a fall in real interest rates,4 have enhanced the value of oil companies (Exhibit 3). Since 1998, the industry's TRS has been 13 percent, compared with less than 1 percent for the S&P 500.

Chart: A recent upturn


Chart: Higher valuations
Here we go again?

The executives who must decide which direction the industry will take see conflicting signals. Initially, the case for the idea that a structural change has occurred seems strong: most large oil fields are maturing, a significant proportion of the reserves is located in politically unstable or unsafe areas, and the need for secure oil supplies is greater than ever—in developed and developing economies alike. Indeed, it is demand, rather than constraints on supply by OPEC,5 that differentiates the recent spike in oil prices from earlier increases. In refining, the chronic overcapacity of the 1980s and 1990s has also disappeared.

At the same time, though, the messages from financial markets are decidedly mixed. The forward curve6 of prices suggests a structural shift: crude futures contracts appear to have abandoned the $20–to–$25 range of the past decade and are forecasting prices as high as $60 a barrel until 2010. To justify the stock price of oil and gas companies, you would have to believe that oil prices will be something closer to $30 to $40 a barrel. Moreover, predictions vary wildly from one analyst to another, with long-run price forecasts for crude oil ranging from as little as $30 to more than $90 a barrel—and even a few extreme forecasts of more than $200.

Executives must also factor in the macroeconomic conditions, such as global GDP growth, that influence margins. Traditionally, economic growth slows as oil prices rise, although high prices might have less effect now than they had in the past, given the combination of low worldwide interest rates7 and what by historical standards is a lower than usual global dependency on crude oil. Even so, the developing world's demand for oil is vulnerable to a setback in China's fragile banking system, for example, or to a monsoon in India.

More difficult still is the task of forecasting the behavior of other executives, national oil companies, and new industry participants and investors, such as private equity firms. Their actions—particularly in relation to capital investment and the development of alternative fuels and fuel efficiency—could swiftly change the industry's outlook.

The old enemy

With so much cash available, companies may be sorely tempted to loosen their capital discipline. Many opportunities to invest in refining and upstream assets are highly attractive at current prices and margins. Moreover, companies that in recent years have invested in projects requiring prices and margins to remain high have reaped rewards, at least so far. And evidence suggests that the level of investment is rising rapidly: capital expenditure by integrated players and by the exploration and production business has nearly doubled since 1999 (Exhibit 4).

Chart: Increasing capital investment

There are three main reasons for the increase in capital expenditure. One is inflation—the result of higher prices for commodities such as steel and of shortages in essential inputs such as engineering resources and drilling equipment. Another is incremental investments (which can have quick paybacks) in existing fields and refineries. But the third is strategic bets on high long-term oil prices and refining margins. In some cases, such bets are being placed because industry players have difficulty finding investment opportunities that are attractive at lower prices and because of pressure to replace reserves.8 In hindsight, it will be thought that these investments either reflected deep insights into a structural shift in the oil industry or represented further examples of its lack of capital discipline.

The risk is that lax discipline in pursuing investments could severely erode margins. McKinsey analysis suggests that if all private-sector and national oil companies increased their capital spending from the current level of about 75 percent of cash flow to 90 percent (in line with the industry average over the past decade), by 2010 worldwide production and refining capacity would rise by 10 to 15 percent of the current level, in addition to the growth that is already expected. Depending on how much demand grows, a significant amount of this capacity could be unused, leading to the familiar bust.

A further threat to oil and gas prices comes from the rise of alternative fuels and substitute technologies. The longer crude prices and refining margins remain high, the greater the incentive for outsiders to invest in renewable generation, in nonfossil fuels such as biodiesel, and in hybrid-car technology—and the more price-competitive these technologies become as a result of scale effects. Governments can also tilt the field toward new technologies by providing incentives for reducing carbon dioxide emissions.

Clearly, the industry faces more uncertainty than it has at any time in the past decade. This uncertainty—and the accompanying volatility—will probably continue for some time. Given these conditions, there are three possible outcomes. In the first, capital discipline could slip in the core business while investment in alternative technologies increased. The result would be excess capacity and below-cost-of-capital returns across the value chain. In the second scenario, the downturn might be limited to refining and service areas such as shipping, since it is easier to add capacity there than in exploration and production. Such an outcome might lead to a softer landing of adequate returns on capital in exploration and production, where overinvestment is less likely because exploration opportunities are limited and often found in restricted geographies, such as Iraq. In this scenario, exploration and production investments might also benefit from OPEC's support of oil prices. The longer prices remain high, however, the greater the opportunity for overinvestment—and the worse the first two scenarios become. In the third scenario, the whole industry could enjoy a soft landing if executives were to use discipline in placing their bets and if investment in alternative fuels were limited.

What will set the winners apart?

Faced with such uncertainty, how might executives plot their strategies? First, they need to move the focus of their discussions with boards and investors beyond volume-based metrics such as market share and reserves replaced. A preoccupation with these measures increases the likelihood of an indiscriminate capital expenditure to meet a target. Instead, the emphasis should be on the conditions needed for new reserves to create value. Next, since the industry's immediate outlook is sound, the logical move would be to pursue investment opportunities that benefit from high current and likely near-term margins but do not depend on permanent structural price shifts.

In an uncertain climate, executives should also keep the following principles in mind:

  • Think for the long term. In current conditions, oil companies should be able to build positions that are competitive under most market conditions. They can invest, for example, in new technologies and capabilities, in new territories (as ExxonMobil has done in Qatar and Schlumberger in Russia), and in the booming markets of China and India. To give themselves options down the road, they should also invest enough in less common types of oil, such as heavy crude and tar sands, and in alternatives to oil and gas, such as wind power, solar power, and biofuels.9 These options, which could be attractive if costs came down significantly or higher prices and margins were sustained, must be balanced against their longer-term strategic positioning.
  • Sell high. With so much money available, now is a good time to dispose of disadvantaged assets at attractive prices to buyers who might also be better placed to exploit them. Sellers can then redeploy their human and financial capital to other investments.
  • Focus M&A. Companies should avoid deals whose value relies on the sustainability of high margins. Mergers of equals, asset swaps, and the purchase of capabilities are all relatively independent of future market prices. In addition, if companies understand the margin assumptions embedded in their own share price, they can selectively use their shares for acquisitions when prices are in line with these assumptions. Companies might be able to pay high prices by using the futures market, hedging near-term production to justify the acquisitions, and then keeping the assets as a long-term play. They might also undertake strategic acquisitions, including assets or capabilities to support future business building, to enter new geographies, or to acquire expertise in alternative fuels.
  • Maintain capital discipline. Rather than spend excess cash on projects that require high prices and margins, executives should use them to increase dividends or buy back shares—even if this approach affects the company's ability to replenish reserves or to bolster market share—and resist pressure from governments and consumers to invest more. When deciding between share buybacks and increased or special dividends, executives must take into account the valuation of their companies instead of considering only the boost in earnings per share. They should also develop a deep understanding of the way cash flows evolve over the economic cycle, so that they have the flexibility to seize opportunities both when cash is plentiful and when it is not (see "Making capital structure support strategy," coming in early February).
During all oil price booms, it becomes possible to imagine that the industry's economics have changed forever. But history shows that the point when industry observers start to say that things are really different this time around usually marks the top of the cycle. By then, the seeds of the crash to come have germinated. In the current boom, companies at all stages of the value chain need to maintain investment discipline. Executives should use excess cash to build sources of competitive advantage while shifting the focus to measures of true value creation. They will then be equipped to generate value in a highly uncertain environment and to break the pattern of the past 40 years.

About the Authors

Richard Dobbs and Nigel Manson are partners in McKinsey's London office, and Scott Nyquist is a partner in the Houston office.

The authors wish to acknowledge the contributions to this article of Andre Annema, John Bookout, Jiri Maly, Matt Rogers, and Jeneiv Shah.

This article was first published in the Winter 2006 issue of McKinsey on Finance. Visit McKinsey's corporate finance site to view the full issue.


1 Adjusted for inflation.

2 This sum is based on the figures for 2004 and estimates for 2005.

3 The industry has wrestled with this problem for more than 150 years: in the early 1860s, for example, overinvestment in Oil Creek, Pennsylvania, pushed down the price of crude oil from $10 a barrel to 50 cents in less than six months and to 10 cents within a year. See Daniel Yergin, The Prize: The Epic Quest for Oil, Money & Power, reissue edition, New York: Free Press, 1993.

4 A fall in real interest rates lowers the discount rate, thereby increasing the value of future cash flows and thus share prices.

5 Organization of Petroleum Exporting Countries.

6 The forward curve may not be a reliable indicator—it lacks real liquidity and has been consistently wrong in the past.

7 In the previous oil price spikes, countries tightened monetary policy to offset inflation, but this approach also exacerbated the economic shock of higher oil prices.

8 Ivo J. H. Bozon, Stephen J. D. Hall, and Svein Harald Øygard, "What's next for Big Oil?" The McKinsey Quarterly, 2005 Number 2, pp. 94-105.

9 Ivo J. H. Bozon, Stephen J. D. Hall, and Svein Harald Øygard, "What's next for Big Oil?" The McKinsey Quarterly, 2005 Number 2, pp. 94-105.

What's next for Big Oil?

The major oil companies are struggling to replenish their reserves amid increased competition for new sources of petroleum. Innovative approaches are needed to ensure these companies' long-term viability.

Ivo J. H. Bozon, Stephen J. D. Hall, and Svein Harald Øygard

2005 Number 2

On the surface, times could hardly be better for the petroleum industry. Surging demand and a tight global supply have pushed oil prices to record heights, with no downturn in sight. The major oil companies, even while investing at record levels in renewed exploration and development efforts, still have enough cash left over to return huge sums to shareholders. And projects now in development will keep production growing for the next five to eight years.

Yet all is not as it seems: Big Oil confronts its most far-reaching test in decades. The top five companies—Exxon Mobil, BP, Royal Dutch/Shell, ChevronTexaco, and Total—face increasingly tough challenges finding new sources of oil and natural gas to replace existing reserves. Access to the Middle East, which holds half the world's known petroleum reserves, has been difficult—especially for oil—since the 1960s and 1970s, when governments there nationalized the assets of Western oil companies. Many of the world's remaining potential new sources of oil and natural gas are in countries with relatively high political and legal instability, such as Nigeria and Russia, or technically challenging regions such as the Arctic and Asia-Pacific. The complex refineries needed to process the world's vast reserves of heavy, sulphur-laden crude represent a large and risky new investment.

Moreover, competition for untapped energy deposits is fiercer than ever. China and India, anxious to secure sufficient fuel for their growing economies, are investing large sums in oil and natural-gas sources as far afield as Angola and Venezuela. Government-owned national oil companies, such as Malaysia's Petroliam Nasional Berhad (Petronas), are expanding internationally, while small to midsize companies such as Apache and BHP Billiton are flush with profits and scrambling to build their own reserves. In the past, major international oil companies—with their leading-edge technology, unrivaled expertise in managing complex projects, and, last but not least, deep pockets—had a clear edge in negotiations with the national governments in control of energy resources. But those advantages have become less pronounced as resource-rich countries have increased their technical and managerial capabilities, thus strengthening their position at the negotiating table.

All this might amount to no more than a footnote in the long history of the big international oil companies' preeminence, but as more players compete for new reserves, there is a growing risk that Big Oil could face a difficult choice between shrinking volumes and shrinking margins. To keep that from happening, the oil majors will have to take big gambles on hard-to-reach energy sources. More important, they must make tough decisions about how to become more attractive partners to the national governments that control the reserves. The key will be building capabilities that give these companies a clear advantage over their rivals. Four areas provide the biggest opportunities: developing unique technologies, providing a market for difficult-to-exploit energy sources, using diplomatic savoir faire to surmount political obstacles, and addressing the broad social needs of the resource-rich countries where the majors do business.

Big Oil's challenge

Historically, the industry's winners have been large oil companies, which have created at least twice as much shareholder value as midsize and independent ones. As a group, the five major companies represent more than 50 percent of the market capitalization of all publicly traded oil stocks, and during the past 20 years these corporations have generated returns 10 percent higher than the industry average. Even though the major oil companies account for just 15 percent of global energy production, they have the largest acreage and the most infrastructure across a majority of the significant hydrocarbon basins outside of the Middle East. And thanks to their lead in technology and their willingness to take on risk, they have captured the largest and most profitable energy deposits.

Chart: Sinking

Today, however, many of the major companies' oil and natural-gas basins are aging and generate less than they did in their prime. That is particularly true in North America and northwestern Europe, which account for about 60 percent of the majors' current oil and natural-gas production and where more than 50 percent of the reserves have been extracted. In those areas, production costs continue to climb, and every new investment to extend the life of the reservoirs becomes more marginal, as fixed costs are covered by shrinking volumes. In the North Sea, for instance, the average extraction cost for a barrel of oil rose 42 percent from 2000 to 2005. The efforts of oil companies to replenish their reserves through traditional exploration have been increasingly unfruitful (Exhibit 1). Since the late 1990s, when several large finds in deep-water locations raised reserves, the average size of new discoveries around the world has declined threefold, to about 22 million barrels of oil. In 2004, for instance, Shell replaced just 15 to 25 percent of the oil and natural gas it pulled out of the ground, as measured by conservative accounting rules used by the US Securities and Exchange Commission.

Limited access

To maximize returns from investments in exploration and extraction, the big oil companies depend on their ability to secure an equity stake in a country's potential oil and natural-gas reserves, with no limit on the returns they can earn. In exchange, they invest significant amounts of capital, provide expertise, and pay tax on every unit of energy they extract. In recent years, however, many governments have curtailed the role of international oil companies and capped their returns, making these investments less attractive.

State-owned oil companies are expanding rapidly beyond their borders and becoming direct competitors to the oil majors

State-owned oil companies are expanding rapidly beyond their borders and becoming direct competitors to the oil majors (Exhibit 2). State-owned companies typically have less financial discipline than do corporations beholden to the stock market and so often settle for lower returns. Indeed, some have lost large sums of money: by the time the Japan National Oil Corporation was disbanded, in April 2005, it had destroyed an estimated $7 billion in shareholder value during its 40 years of operation. Nonetheless, the growing technical and commercial capabilities of these homegrown companies, which frequently use technology from oil industry service providers such as Halliburton and Schlumberger, provide governments with a viable alternative to working with Big Oil.

Chart: Beyond the borders

In addition, competition from smaller Western oil companies has increased. In the past decade or so, North American producers such as Apache and Talisman Energy have expanded, and they now extract significant amounts of oil from international sources (Exhibit 3). These midsize players have joined the big leagues and are capable of competing with rivals in a number of regions. The mature oil fields of countries such as Iran, Iraq, and Kuwait, where oil production can be handled with mainstream technology, represent an attractive opportunity for these companies.

Chart: More global players
Volatile prices

Most analysts expect oil prices to remain high over the next few years, partly because the world's excess production capacity has shrunk to three million to five million barrels of crude oil a day (compared with as much as ten million in the 1970s and 1980s). Yet experienced oil companies know that a multibillion-dollar investment calculated to break even at $35 a barrel can quickly become an expensive liability if prices fall to $25 or below. To be safe and to reassure shareholders, most companies are therefore making investments with the assumption that long-term prices will range from $25 to $30 a barrel. Such conservative estimates allowed the five majors to return $184 billion to their shareholders from 2000 to 2004, but this strategy also explains why they lose out to competitors willing to bet that higher prices are here to stay.

Of course, Big Oil has surmounted challenges in the past. BP, Exxon Mobil, and Shell all had to rebuild after the wave of nationalizations in the Middle East and South America. Indeed, BP's 2004 production of four million barrels of oil a day only now equals the level it achieved in 1975. A series of mergers and acquisitions has helped the major companies regain their global scale and scope in operations from exploration to retailing. Further marriages of industry giants are certainly possible. However, such mergers are unlikely to offer a long-term solution, since everyone faces roughly the same challenges in securing potential reserves. And while big companies will continue to buy small and midsize competitors when the price is right, in the long term that strategy likely won't be as successful as it was in the past, since there simply aren't enough takeover targets to sustain those companies with annual revenues of $200 billion or more.

Standing out from the crowd

The big oil companies must find new ways to distinguish themselves from the competition in order to continue thriving. Governments are likely to offer the most attractive terms to partners that possess rare and valuable skills. To avoid competing directly with rivals in auctions for acreage and production licenses, major oil companies must make tough choices instead of simply trying to keep pace with the pack. Four broad areas offer potential opportunities for a company to differentiate itself from its rivals.

Seize the technology high ground

Big Oil's technical leadership has been its main edge. Historically, the ability of the oil majors to develop and field-test customized technologies has allowed them to trump small companies and state-owned enterprises. Over the past 10 to 15 years, however, the majors have let this advantage slip by increasingly relying on technologies developed by oil service companies. Governments now question why they should buy technology from the majors when it can be acquired more cheaply from national oil companies, midsize Western players, and service companies.

In the future, companies that are able to exploit hard-to-reach energy reserves located outside the Middle East will be distinctive. Key areas to focus on include developing efficient extraction equipment that can withstand the stress of year-round ice and designing reliable technology to separate oil, natural gas, and water at the bottom of the sea (or, in the case of wells located far from land, equipment to carry material hundreds of miles to a shore-based separation facility). A company's corporate goals and its geographic portfolio will define its investments in technology over the long haul. In the 1980s, Shell bet on deep-water exploration in the Gulf of Mexico, for example, and became an early leader there by developing the necessary techniques and equipment for extraction.

Major oil companies need to increase their spending on research and development to levels well above the industry average—about 1 percent of revenues—in order to regain their edge. Industrial-equipment companies, for example, spend 4.5 percent of revenues on R&D. More important, the oil majors must manage their technology investments more effectively. A system that uses a series of stage gates to winnow out the duds from a portfolio would allow companies to start with an array of options and to make big investments in only the most promising opportunities. These techniques are widely used in venture capital firms and should be adopted by the oil giants.

For more about applying the venture capital model to technology development, see "Can big companies become successful venture capitalists?"

They also need to forge closer partnerships with suppliers and small service companies, which have initiated many of the industry's big innovations over the past 20 years. Just as the drug industry has done, Big Oil needs to do more to share the risks and benefits of R&D with innovative companies—for instance, by offering them test beds for emerging technologies. In exchange, the oil company could negotiate exclusive rights to the new technology for a certain period of time.

Provide custom routes to market

In many cases, finding hydrocarbons and extracting them are not enough to create a profitable business. While the global market for light crude oil (which can be easily refined into gasoline and other products) is well developed, that isn't true for the natural gas stranded in the world's remote corners or for heavy, sulfur-laden oil requiring special equipment to extract and refine. Around the world, there are an estimated 700 billion barrels of recoverable heavy oil and 5,800 trillion cubic feet of stranded natural gas—enough to meet US demand for 96 and 260 years, respectively. Countries rich in these resources need a custom-designed route to market in order to generate attractive returns. The oil majors—thanks to their refineries, retail networks, and relationships with major customers in important markets—can offer unique solutions.

Exploiting new sources of natural gas will be one of the industry's big battlegrounds over the next decade. This relatively clean fuel is increasingly used to generate electricity in Europe and North America. The world's proven reserves are in places such as the Middle East and Siberia that are far from customers. Countries need guaranteed markets to justify the multibillion-dollar investments required to build long-distance pipelines or the plants that liquefy natural gas for shipment. The companies that control important facilities (such as regasification plants) or provide access to a large market are attractive partners for these projects. Another opportunity is to invest in the specialized coking1 and hydrocracking2 facilities needed to convert heavy oil (from countries such as Canada and Venezuela) into marketable products. Today there is insufficient capacity to exploit these vast reserves, and companies offering ready-made solutions will be the most attractive partners for governments.

To take advantage of these opportunities, oil companies will need to upgrade their refineries and invest in other forms of infrastructure before securing customers—a break from the past. Big Oil's scale and scope lower the risk of making such infrastructure bets (which can cost as much as $5 billion), since these investments represent a smaller proportion of overall capital spending than they do at smaller companies. And because the majors have a vast number of oil and natural-gas sources around the globe, the likelihood is greater that new facilities will be utilized quickly. Such a strategy carries real risks, but the company that moves first stands to gain handsomely.

Play a diplomatic role

In some cases, the technology and the market are in place, but politics remains a barrier, especially when an oil or natural-gas pipeline crosses national borders or when the project requires long-term commitments from the buyer and the seller. Eastern Siberia's gas reserves will remain undeveloped, for example, until China and Russia can agree on price and delivery terms for the estimated 30-year lives of these reservoirs. This type of cooperation requires a willingness on each side to honor the bargain.

Major oil companies can play a unique role in such projects as a diplomatic go-between and financial guarantor. Their substantial balance sheets allow them to be partners in huge infrastructure projects without undue risk. By taking an equity stake, oil companies can ensure that a deal goes through while they gain access to energy reserves. Their strong relationships with governments mean that they can also facilitate complex, cross-border deals. BP's role as a significant coinvestor in Azerbaijan, for instance, helped seal a pipeline deal with Georgia and Turkey that will allow oil to flow from the Caspian Sea to the Mediterranean in the near future.

In some places, there is growing distrust of Big Oil's political ties with Europe and North America

In some parts of the world, growing distrust of Big Oil's political ties with Europe and North America makes it all the more urgent for companies that want to succeed in the political arena to build small teams of specialists adept at negotiations and shuttle diplomacy. Ex-politicians and former senior civil servants with both the standing and the experience to deal with top government ministers are natural candidates. Chief executives must also become more involved in building long-term relationships with heads of state and other government officials. Whereas in the past CEOs typically showed up just to sign important deals, now they must play aninstrumental role in laying the groundwork.

Make a positive economic impact

Paradoxically, petroleum-rich countries often suffer as a result of their energy wealth. In many cases, the influx of foreign funds raises the value of the local currency. As a result, the country's other exports can't compete on the world market, so that whole sectors of the economy are decimated. Indeed, such problems prompted Juan Pablo Perez Alfonso, a founder of the Organization of Petroleum Exporting Countries (OPEC), to describe oil as "the devil's excrement." Nigeria is often cited as an example of what can go wrong: it remains one of the world's poorest countries, despite having earned some $300 billion from oil exports since the late 1950s.

International oil companies can capture an important competitive advantage and improve their chances of gaining access to important new reserves by demonstrating the broad positive economic impact their presence can have. At best, the record of oil companies in this respect is mixed, and clearly there are limits to what they can achieve. Nonetheless, a key initial step for companies is to develop and train local employees so that they can fill key roles traditionally held by expatriate managers. Companies need to help local employees break through the glass ceiling—a task that is harder than it sounds. Mentoring often fails because many expatriates are poorly equipped, both technically and culturally, to nurture their local colleagues. Companies must first train the mentors and then give them incentives to further the careers of local workers. Organizations must also cope with high turnover, since local employees with management experience at multinational corporations are often highly sought after in developing economies.

The oil majors could also do far more to enhance the positive economic and social impact of their investments. Too often, energy projects create pockets of wealth for a privileged few but fail to lift the economy. One potentially positive measure companies can take would be to help develop the technical and management know-how of local contractors and service companies. Most oil companies outsource low-skilled work such as cleaning and security to local organizations, in part to meet government-imposed hiring quotas. To broaden a country's economic base, oil companies should also nurture local companies that provide higher-skilled services, such as information technology and equipment maintenance. The Japanese carmakers Honda Motor and Toyota Motor assign engineers or other professionals (such as accountants) to local purchasing organizations; these specialists can spend months improving the capabilities of individual suppliers by working on the factory floor and in the front office. Similarly, oil companies can partner with governments and international organizations to improve standards of governance, thus reducing the risk that oil revenues will be wasted by public bodies. Anticorruption efforts—for example, the Extractive Industries Transparency Initiative—offer companies other ways to engage with governments.

In practice, none of these propositions is easy to act upon. Moreover, companies cannot single-handedly solve the deep-rooted problems of poverty and underdevelopment. During the course of a 30- to 50-year relationship between an oil company and a country, however, even partial successes can have a significant impact. Companies that are astute enough to navigate these complex and politically sensitive issues are likely to have an edge over their rivals.

Major international oil companies face an era of unprecedented change and new threats to their long-term viability. To avoid becoming irrelevant, they must expand their capabilities and increase their distinctiveness. Doing so will require bold strategic choices and new investments at a time when profits and the risk of complacency are high. Future winners will become true front-runners in the eyes of their customers: the governments controlling access to the world's hydrocarbons.

About the Authors

Ivo Bozon is a director in McKinsey's Amsterdam office, Stephen Hall is a director in the London office, and Svein Harald Øygard is a principal in the Oslo office.

The authors wish to acknowledge the contributions of Greg Lalicker, Chris Laurens, Franco Magnani, Scott Nyquist, and Paul Sheng to this article.


1A refining process that thermally converts denser, heavier petroleum residue into more valuable products.

2A refining process that converts heavier petroleum products into lighter, more valuable ones through the application of heat, high pressure, catalysts, and hydrogen.

National oil companies: The right way to go abroad

Deals with foreign partners can open the door to overseas profits.

Vicente F. Assis, Bernard Minkow, and André Olinto

Web exclusive, November 2005

The well-publicized efforts of the Chinese and Indian governments to secure oil and gas reserves have focused attention on the international ambitions of national oil companies. Investing abroad is nothing new for these companies, whether they are rich in resources or, in the case of those in China and India, simply attempting to secure supply. But many such foreign investments fail to create value for the national oil companies or their governments, according to our research. Often, strategies were poorly crafted, so the companies were slow off the mark or lacked the necessary resources (including technology and talent) to accomplish their goals. In other cases, value creation was plainly not a priority, as government policies, such as enhanced energy security, guided the internationalization efforts.1

But all this doesn't mean that national oil companies should shun international investments. In fact, foreign deals may be the only way for some energy-rich countries to extract value from their natural resources. These players can succeed abroad but must focus on specific kinds of ventures: mainly those that stimulate demand for their products or secure market access for their reserves.

There are more than 100 national oil companies around the world—one from almost every oil-exporting country and a number from major importing countries.2 These companies have pursued internationalization to gain access to skills and knowledge, to leverage proprietary skills, to use diversification to reduce the cost of capital, to build operational synergies through regional expansion, and to advance national policies. But according to our analysis, the underlying economic rationale for these investments was frequently unclear, and they resulted in losses.

While using joint ventures with international petroleum corporations to fill gaps in skills (by improving the process for recovering oil from existing wells, for example) is a valid goal, such arrangements rarely deliver these capabilities. In fact, barriers within a national oil company's organization may inhibit the effective transfer of skills over the longer term. Moreover, such a company often lacks the necessary knowledge-sharing mechanisms (including the flexibility to rotate its employees in and out of the foreign ventures) to absorb the lessons from international partners. It may simply be more cost effective to hire some other concern, such as an oil services company, to do the job. Another worthy objective for an international venture is to leverage proprietary skills, but few national oil companies actually have a competitive advantage that the marketplace recognizes. In some situations, their shareholders—that is, their respective governments—require managers to undertake projects in the interests of national security, thus obligating a national oil company to pursue international ventures that aren't destined to create value.

What works

There are circumstances in which pursuing foreign deals makes great sense. We found that the primary ways a national oil company can create value abroad are either obtaining access to an overseas market that needs its products or stimulating demand for its natural resources in an existing market or both. Let's look more closely at two cases where these approaches succeeded.

Algeria's Sonatrach Petroleum was searching for a more effective way to deliver its tremendous reserves of natural gas to market. In June 2003 it joined forces with BP and Statoil (Norway's national oil company) to export liquefied natural gas to Europe. Through this project, Sonatrach is a coinvestor in the exploration, development, and commercial exploitation of its gas reserves while using a regasification terminal owned and operated by a third party to gain entry to the UK market. The project's timing was critical to the United Kingdom, which had predicted natural-gas shortages starting as soon as 2007. Algeria began production for the project in 2004, paving the way for the country to extract and deliver to market an estimated 11 trillion cubic feet of natural gas.

In the late 1980s and the 1990s, Pemex (the Mexican national oil company) faced the challenge of building demand for its heavy crude oil, which is much more difficult to produce and refine than light crude. The company encouraged refiners to invest in facilities to accommodate processing heavy crude in exchange for risk protection through special long-term supply contracts. We estimate that the deal created about $2 billion in value. Also beginning in the late 1980s, Petróleos de Venezuela stimulated demand for its heavy crude oil by upgrading three wholly or partially owned refineries in the United States. The estimated benefit: around $300 million in value.

Strategic thinking

How should national oil companies approach foreign investments? For starters, they must resist falling prey to internationalization as a business fad, even though many of them are racing to invest outside their borders. Since a national oil company's first duty is usually the care and management of its country's resources, it needs to ensure that attempts to invest abroad don't detract from its primary goals by draining local talent or by diverting the attention of top management.

For an international joint venture to be successful, its underlying ends—whether straightforward business ones or support of national policy—must be clear. If the reasons are related to business, managers must determine if internationalization will create economic value and then ensure that the project is aligned with the company's objectives. This advice may sound obvious to managers in the private sector, but national oil companies have not always been able to operate in this way. If an investment is dictated by national policy, managers must seek to minimize costs and look for ways to use national policy to achieve their business objectives.

Then a national oil company must spell out its strategy, tactics, and organizational concerns. One reason many attempts at internationalization have gone awry is that managers often underestimate the challenges and complexities involved—especially those inherent in being a national oil company.

In many cases, a big part of such efforts will involve selecting one or several foreign partners with which to pursue a venture. Some national oil companies, suspicious of multinationals, worry that a joint venture will reduce their control over valuable national assets. But the realities—maturing oil fields, tired technology, heavier crudes, and newly discovered but hard-to-exploit deposits—make acting alone tougher than ever. Thoughtful, responsible partnerships are possible, as the Sonatrach-BP-Statoil venture shows. And national oil companies aren't the only ones in need of partners. After all, the major publicly traded oil corporations control less than 10 percent of the world's oil reserves, so it's also in their interest to negotiate win-win agreements.

With notable exceptions, the efforts of national oil companies to internationalize have failed to create substantial value. As important revenue generators for their home countries, they should fully evaluate all alternatives, including joint ventures with multinationals, before committing valuable resources. Even when opportunities are identified, national oil companies must conduct rigorous economic and strategic analyses to increase their chances of creating value.

About the Authors

Vicente Assis is a principal in McKinsey's São Paulo office, Bernard Minkow is an alumnus of the London office, and André Olinto is a principal in the Rio de Janeiro office.


1In this article, we define internationalization as either investing abroad—including exploration and production, refineries, pipelines, or gas stations—or partnering with international agents (such as oil companies or contractors) to gain access to skills, knowledge, or capabilities. We do not include simply selling oil and gas outside the home country or opening commercial and trading offices abroad.

2The history of national oil companies in the developing world dates back to the 1920s, with the founding of Argentina's Yacimientos Petrolíferos Fiscales.

Think of it as a kind of TiVo for electricity: A device lets you buy energy when it's cheapest and store it for later use.

A new way to cut your %!@# power bill
Think of it as a kind of TiVo for electricity: A device lets you buy energy when it's cheapest and store it for later use.
FORTUNE Small Business Magazine
Justin Martin, FSB contributor
April 27, 2006: 2:29 PM EDT

NEW YORK (FORTUNE Small Business) - In an age of flextime, when workers increasingly commute outside peak traffic flows, the delivery of electricity seems a bit, well, static. When you need it most, so does everyone else, imposing big costs and occasional brownouts on utilities and their customers. But a Washington, D.C., startup called GridPoint has a better idea. Starting this spring, GridPoint is selling a "smart box," priced from $15,000 to $20,000, that will allow business owners to manage their electricity more intelligently - and cut down on power bills.

The system works thanks to "dynamic pricing" - a payment arrangement in which utilities charge customers more during periods of peak usage, such as dinnertime, and less when demand is low - say, 3 A.M. Though this option has been around for decades in some areas, it's still available to only about 10% of U.S. customers - but that's about to change. An energy law enacted last year requires that all utilities offer customers some form of dynamic pricing by February 2007.

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How it works
Dynamic pricing
Electric utilities will soon start adjusting their prices based on demand, meaning expensive rates during peak use and cheap rates late at night.
Gridpoint protect
A sort of TiVo for electricity, the system, which costs $10,000 for homes and $15,000 to $20,000 for small businesses, automatically buys power when rates are cheapest and stores it.
Backup power
Users will save about 15% on electric bills and can even use GridPoint as a backup generator during blackouts.

Most utilities have been dragging their feet, because it's expensive to fit homes and businesses with smart meters capable of registering the time electricity is used. But once those new meters are in place, prepare for a shock as utilities raise prices whenever demand rises. That is where GridPoint comes in.

"Our product will allow customers to trim their bills painlessly," says CEO Peter Corsell. "Think of it as a kind of TiVo for electricity."

The device, called GridPoint Protect, is the size of a small file cabinet and connects to the circuitbreaker panel. (The company also offers a lower-capacity version designed for homes, which costs $10,000.) A built-in computer powered by a Pentium chip will make intelligent purchase decisions, buying when prices are low, then storing the electricity for later use. That will make it possible to run your company during the workday with cheaper electricity that you purchased at 3 A.M.

Corsell, 28, estimates that his device will shave a business's electric bill by about 15%. Assuming monthly charges of $2,500, the system would pay for itself in less than four years.

GridPoint Protect offers a second function: Because it stores electricity, it can double as a backup generator that is safer and faster than many models currently available. Standard generators run on gas or diesel, and their carbon-monoxide exhaust fumes can be dangerous. By contrast, GridPoint Protect uses safer gel-style batteries, similar to those that back up cellphone towers. Standard generators also take a few seconds to power up, but GridPoint Protect kicks in within about 30 milliseconds, fast enough to prevent a company's computers or other sensitive devices from crashing.

Founded in 2003, GridPoint has raised $18 million from venture capital firms and private investors and now employs a staff of 50, with no revenues until it sold its first units this spring. The company features an all-star board of advisors, including tech guru Esther Dyson and Bill Bradley, the former presidential candidate and longtime member of the Senate Energy Committee.

"It's a smart company, focused on a couple of regions where there's a real need in the marketplace," says Daniel Violette, a Boulder energy consultant.

Picture it - one day soon you might be at a cocktail party and encounter someone bragging not about his hot stock picks but about how much he saved on his electric bill.

Comparing gas/petrol prices around the world

I waas just curious abour this and found this chart (to which I added Toronto, Montreal and Washington for comparison)
Global gas prices
City Effective Date Price in USD
Caracas Apr-06 $0.12
Kuwait Apr-06 $0.78
Riyadh Apr-06 $0.91
Shanghai Apr-06 $1.94
Beijing Apr-06 $2.05
Buenos Aires Feb-06 $2.09
Mexico City
Washington DC
Sydney Apr-06 $3.42
New Delhi
São Paulo Apr-06 $4.60
Tokyo Nov-05 $5.05
Rome Apr-06 $5.53
Brussels Apr-06 $6.16
Hong Kong Nov-05 $6.25
London Apr-06 $6.28
Oslo Apr-06 $6.90

Note: Self-service prices have been collected where available (usually in No. American, Europe and Japan)
Associates for International Research, Inc.