January 18, 2017

Abu Dhabi Share-Swap Deal with BP Forges New Contract Model

Abu Dhabi National Oil Company Director General Sultan Al Jaber, right, and BP Group Chief Executive Bob Dudley pose for a picture following a deal in Abu Dhabi, United Arab Emirates, Dec. 17, 2016. (WAM via AP)

Abu Dhabi capped a year of unprecedented change at state oil company Abu Dhabi National Oil Com­pany (ADNOC) with a landmark $2.2 billion share-swap with legacy partner BP. The unique model for a joint venture gives Abu Dhabi a 2 percent stake in BP in exchange for a 10 percent share in the country’s main onshore oil concession. The deal, announced on December 17, 2016, makes the emirate one of BP’s largest single stock holders and at the same time gives BP access to significant long-term onshore oil reserves, production, and cash flows. Abu Dhabi’s stake in BP will be held by Mubadala, the government’s strategic investment company. ADNOC Director General Sultan Al Jaber remarked that “the agreement marks a milestone in our efforts to forge new partnership models that bring technology, expertise and financing aimed at maximizing the value of our resources and supporting the transfer of knowledge.”

Following his appointment as head of ADNOC in February 2016, Jaber immediately embarked on an aggressive restructuring of the state oil company in a bid to transform it into a more commercial, profit-oriented business, and resumed negotiations for the long-delayed award of onshore oil concessions. In the past year, Jaber initiated extensive changes to the management and operational structures of the company, including replacing the top tier of executives at operating units with a new generation of technocratic leaders, streamlining functions among operating companies to reduce costs and improve efficiencies and merging business lines at its two offshore operating subsidies and at its shipping and ports firms. ADNOC also cut almost 10 percent of its 55,000 strong workforce in 2016.

Implementation of new technology and computer systems for business management has been key to the company’s restructuring efforts. Critically, ADNOC lacked standard computer operating systems, let alone state of the art technology used by international oil companies, to manage its business operations. Jaber made upgrading internal technology a key priority and fast tracked the installation of the first companywide computer software system at its new headquarters in 2016. The SAP (Systems, Applications, and Products) Enterprise Resource Planning software and data management tools have significantly improved how the company manages its operations and have led to lower costs, new procedures and policies for procurement and inventory strategies, and a downsizing of the company’s organizational structure, Jaber said in an interview with The National.

Cash Constraints Largely Behind New Share-Swap Model

ADNOC has struggled for the past few years to find partners for its onshore concessions, given contract terms calling for a steep $2.2 billion signature bonus. The concession, operated by ADNOC subsidiary Abu Dhabi Company for Onshore Petroleum Operations (ADCO), includes 15 onshore fields with production of around 1.65 million barrels per day (mb/d) representing more than half of the emirate’s total 3 mb/d production. The previous 40-year-old contracts expired at the end of 2013 but major legacy partners, including BP, Shell, Total, and Exxon, initially rejected the upfront payment terms, widely considered the most expensive for an oil concession in the industry’s history. In January 2015, France’s Total took the market by surprise by agreeing to pay the unprecedented asking price for a 10 percent stake in the ADCO onshore concession. Previously smaller stakes were awarded to Inpex of Japan and GS Energy of South Korea, at 5 percent and 3 percent, respectively. The concession contracts expire at the end of 2054.

adnoc_blogThe collapse in oil prices in mid-2014 made the contract terms even more untenable for oil companies as they slashed costs and cancelled projects. At the same time, cash-strapped ADNOC was also forced to scale back or delay development projects at the onshore fields, which are critical to plans to raise total production to 3.5 mb/d.

The new share-swap partnership model evolved after years of a standoff between ADCO and BP. Progress was only made following the appointment of Jaber but negotiations were nonetheless tense and difficult. A more flexible negotiating posture by ADNOC combined with cash constraints by both parties led to the adoption of the new model and enabled BP to avoid paying the $2.2 billion cash signature bonus with share stake in the international major. BP’s history in Abu Dhabi goes back more than 75 years, when the group of sheikhdoms known as the Trucial States was a British protectorate. In addition to its ADCO concession, BP holds a 14.67 interest in the 685,000 b/d offshore concession operated by the Abu Dhabi Marine Operating Company.

ADCO holds 60 percent of the onshore concession with the remaining 40 percent reserved for foreign partners. Following the agreement with BP, 12 percent of the concession remains open to bidders. ADNOC may now look for partners that provide secure market outlets, with Chinese companies favored to take some or all of the remaining stake avail­able.

A New Blueprint for National Oil Companies

Abu Dhabi’s model of engagement with joint venture partners may provide a new blueprint for other national oil companies in the region. Government spending on oil development projects has been severely constrained in the lower oil price environment, with Gulf Arab producers planning only small increases in production to 2020. Many national oil companies are also beset with chronic project delays, in part due to a bloated bureaucratic operating and management structure and in part due to a lack of technological expertise needed for mature oil field assets. Indeed, a number of producers are at maximum production levels now and capacity is likely to remain flat or decline by 2020, leaving some countries marginalized when the market does strengthen. In the current era of lower government oil revenue, other state oil companies may want to look at Abu Dhabi’s new model to attract joint venture partnerships with international oil companies to sustain future growth levels.

The significant and far-reaching changes implemented to date are only just the beginning of a broad restructuring of ADNOC aimed at transforming the heavily bureaucratic and inefficient state oil company into a more commercial-oriented business model in line with international oil companies. ADNOC is expected to continue to adopt new approaches with joint ventures across the energy sector, from gas development to refining projects to expansion of the petrochemical industry, which will help reduce the government’s dependency on oil revenue. “We are going to be more open for more business partnerships and more investors. We are only looking for strategic, value-add investors and partners,” according to Jaber.

Jaber’s rapid transformation of the state oil company and bold initiatives appear to have the full political support of Crown Prince Sheikh Mohamed bin Zayed al-Nahyan and the Supreme Petroleum Council, which oversees oil policy. In November 2016, the council approved ADNOC’s 2030 strategy, five-year business plan, and operational budget, which are designed to generate sustainable, strategic growth in the upstream, midstream, and downstream sectors; enhance technical capacity; foster a new corporate culture of accountability; and improve financial returns to the state. ADNOC’s achievements over the past year suggest these goals are well within reach.

Diane Munro is a non-resident fellow at the Arab Gulf States Institute in Washington.