| Canterbury, UK, 8 April 2013 MEETING THE CHALLENGES OF LOCAL CONTENT John Westwood Chairman, Douglas-Westwood Taming the Demon "The black and cruel demon……an Evil Power which roams the earth, crippling the bodies of men and women, and luring nations to destruction by visions of unearned wealth and the opportunity to enslave and exploit labour." These dramatic words were penned by Upton Sinclair in his book 'Oil'1 a commentary on the social conditions of the Californian oilfields of the 1920s and the inspiration for the film 'There Will Be Blood'. But as we know, oil & gas can also be a miracle worker and bring great economic and social benefits. The difference is how fairly the prize is shared amongst all the stakeholders and in this process development of true local content has a major role to play. The Starting Point "You must have a good system of governance in place …and use the revenues in a manner that will create a lasting benefit to society." 2 So commented Farouk Al-Kasim on the Norwegian experience. Al-Kasim was the individual tasked with planning how Norway would exploit its newly discovered resources, working as director of petroleum resource management in the Norwegian Petroleum Directorate from 1972 to 1990. Biographers have noted that he did a remarkable job of marrying private-sector and government ambitions, and indeed Norway seems to have avoided "the Dutch disease" that has dragged down the economies of many nations exploiting huge hydrocarbon reserves. Local Content Objectives A major challenge for local content programmes is in meeting the requirements of multiple stakeholders: Governments, State Oil Companies, E&P Companies and their Contractors, Workers and Local Communities. Most simply put, local content objectives are usually to "create jobs, promote enterprise development and accelerate the transfer of skills and technologies".3 Objectives can include: - Workforce development including employment and training.
- Supplier development to enable E&P companies to achieve a required level of local content (an ambition of 70% is usual).
- Technology development, often initially by transfer, then local R&D and ultimately exports of goods and services to third markets.
The Challenges Many, if not most states require oil & gas industry companies to develop local content and in this some have been more successful than others. Governments' policy focus has to be dynamic and change during the industry life cycle. In the initial stages there is a need to attract E&P companies, but as oil & gas production grows the desire to develop the local supply chain often emerges as a government objective. As production reaches a plateau and new discoveries become smaller and of little interest to IOCs, policy again has to shift to focus on attracting on a new group of smaller E&P players and encourage the supply chain to develop export markets. During production decline these drivers become even stronger as ultimately long-term success demands a long-term view to deliver benefits after the oil & gas has depleted. For the E&P companies the challenges include maintaining global standards and managing inflation as meeting local content can dramatically increase costs short term, particularly in lesser-developed countries as there is often no significant industrial base from which to develop suppliers. In the case of technologically demanding sectors (such as deepwater) there is often no practical alternative to importing both equipment and services. Corruption In some countries perhaps the greatest challenge to delivering real long-term benefits to local people is corruption – as the Transparency International4 surveys show, many of the developing world's oil producers operate the least transparent (most corrupt) regimes. Also as recent events in the defence sector proves, the problem is not exclusive to oil, but anything that involves large sums of money. In reality, what the western world regards as corrupt is in many other locations merely normal business practice and very difficult to circumvent, as many have found to their cost. The UK, the US, Norway and many other developed economies are fortunate in now having laws that outlaw corrupt practice in foreign countries and deliver harsh penalties to those who flout them. Lessons from the Past The North Sea Experience: In the case of both Norway and the UK there was a focus on achieving high local content and ownership based on strong support by governments of local oilfield services (OFS) companies. This was in reality aided by the major challenges of what was the most operationally difficult environment yet experienced which in its turn drove the development of new technologies and resulted in a major focus on R&D. Yet the each North Sea sector was different. Norway: Oil was discovered by Phillips Petroleum in Ekofisk in December 1969. Norway benefited from a small population and a major oil & gas resource with the result that a there was a real danger of oil wealth overheating the economy. The state oil company Statoil was formed in 1972 and in 2007 it merged with Norsk Hydro's oil and gas division reaching a size and strength suitable for international expansion. But significantly, over the years Statoil became a major force in developing Norway's local content. A state wealth fund was established which is today worth some NOK 4.176bn. The 'Government Pension Fund Global' was set up in 1990 as a fiscal policy tool to support long-term management of Norway's petroleum revenue. The Ministry of Finance owns the fund on behalf of the Norwegian people. The ministry regularly transfers petroleum revenue to the fund and the capital is invested abroad, to avoid overheating the Norwegian economy and to shield it from the effects of oil price fluctuations. (Despite its name, the fund has no formal pension liabilities and no political decision has been made as to when the fund may be used to cover future pension costs.)5 As both production and local capability grew a goods & services export initiative was initiated in the form of the 'INTSOK' trade body. Today Norway has both a high local content and annual OFS exports of $20bn. By this measure Norway has, without doubt, out-performed the UK. The UK: Oil was discovered in the Forties field in 1970. In 1973 the Offshore Supplies Office was formed as a division of the Department of Energy and tasked with local content development by means of a 'Full & Fair Opportunity' policy. The economy was already in a fragile state when oil production began in 1975, and the decade's oil price shocks, rampant inflation and industrial unrest caused further devastation and limited the net economic benefit. A requirement was put in place for E&P companies to conduct R&D in the UK and include a statement to that effect in their licence application – in effect a 'non-cash' element of their bid for acreage. Very soon virtually all the players had dedicated R&D managers and were investing in UK oil & gas R&D and a whole new business sector emerged. However, this scheme eventually fell foul of European competition law with disastrous consequences for companies set up to absorb this flow of funds. The UK local content situation was further undermined by the demise of the state oil company Britoil. Then in the 1980s the oil majors changed their business models and cast off much of their own R&D capability. Without doubt offshore oil & gas rescued the UK economy but many doubt whether the claimed 70% local content was actually realised. However, as the UK faces a future of falling production from rapidly depleting fields it is clear that a major and increasingly export-based OFS activity has been achieved (over $12bn in 2011 in Scotland). But concerns have been raised that few British-owned world-class players have emerged. It is of note that former OSO director general Dr Norman Smith titles his book on the early years "The Sea of Lost Opportunity".6 Brazil: The state oil company Petrobras which has achieved remarkable success in pushing the frontier of deepwater production is also tasked with developing local content. Like many other countries Brazil aims for aims 70% and indeed it has been very successful in encouraging international suppliers to establish local operations and in developing its own indigenous companies. However, Brazil now faces the challenge of exploiting its pre-salt reserves which requires massive expenditure on hardware, including big-ticket high-tech items such as drilling rigs and floating production systems. As a result there is now an increasing focus on Brazil's shipbuilding industry with players such as Singapore's Keppel setting up joint ventures. But as noted by a recent study, Brazilian companies can charge 55% more and Brazilian engineers cost 15% more than foreign workers.7 At Douglas-Westwood we have been long concerned over the challenge Petrobras faces and note this study also states "Brazil is in a challenging position - higher costs than emerging countries and lower productivity than developed countries. Limited to domestic suppliers, Petrobras forecasts no production growth in the next three years …… causing speculation that the government may relax local content requirements." There are of course many other examples of local content achievement and ambitions including: Angola: It is reported by the Angolan Chamber of Commerce (CAE) that between 2005-2010, 302 contracts oil industry were won by 124 Angolan businesses, with a value of US$ 212M, generating 2,700 Angolan jobs. Yemen: Total's US$4.5bn Yemen LNG project aims for a 90% local staff by 2015. Significance of National Oil Companies NOCs are usually tasked with building local content and growing a knowledge base, often by facilitating R&D. Examples include Petrobras's massive long-term drive to develop the Brazilian OFS industry and Statoil which has also assisted companies to cross the R&D 'valley of death' by facilitating access for new technology to offshore installations. Norway has resultantly grown a number of high technology companies. But ultimately local oil & gas production declines and NOCs may need to access other countries' reserves. Local OFS companies then have to leave behind the patronage of their state oil company to compete for business in world markets – it is at this point that the value of their offerings is really tested. Practicalities The challenges of growing local content are many and varied. In some developing economies a lack of basic industrial infrastructure makes local manufacturing impractical. Once a local capability does exist there becomes a de facto purchasing obligation, often resulting in cost inflation – 10-55% has been seen. Project delays are another possibility and there are concerns regarding a potential increase to HSE risk from using less experienced and unproven suppliers. Furthermore, local content policies often create excessive bureaucracy in government agencies, oil companies and suppliers alike. When the above factors are combined with intrusive regulations and high taxes, OFS companies may not be able to be internationally competitive so choose to leave when fields deplete and local business opportunities reduce. One of the major constraining factors is the shortage of skilled and experienced personnel – a global people problem that impacts local content ambitions. Brazil, for example, has a shortage of engineers with just 1.95 per 10,000 inhabitants, less than the other 35 countries studied in the OECD8. In Australia skills shortages and associated higher labour costs are partly to blame for a 21% increase in the $53bn Gorgon LNG project, and that is despite the major modules being built in Korea. What Works for Companies It is most important to realise there is no real quick fix to developing a local content strategy. Companies need to avoid becoming focused on meeting reporting requirements. Knowing that a reliable local supply chain can in the longer term offer better overall value and accepting the associated short-term cost premium, together with internally communicating the business benefits are key success factors. What Works for Governments Developing clear objectives and realistic expectations are vital, providing single points of contact for information & support of local companies and interaction with E&P companies. Avoidance of multiple initiatives and a large bureaucracy for managing the programme and reporting are also key factors. In some countries governments have actively supported the establishment of trade bodies, sometimes to great effect. In other situations supply chain development has been greatly aided by provision of infrastructure (e.g. port & supply base facilities) and in some cases establishment & management of technology and science parks. In general the 'scatter gun' approach to support is not usually the best approach and a policy of supporting the most capable of local companies is usually more productive. At later stages, assistance with R&D of key technologies can be fruitful, together with advice and support for local company internationalisation. Conclusions The demon can be tamed and the potential prize for a country that successfully implements local content is huge, bringing benefits for all stakeholders by reducing imports and creating jobs. Effective local suppliers do reduce E&P costs. Goods and services can be provided to the oil company end user at competitive prices but to achieve this all must recognise the value of real partnership. Governments must have realistic expectations as, for example, the transfer of total responsibility for major projects from an IOC's international headquarters will remain rare. There is a great temptation for governments to focus on initiatives on sectors that create the maximum number of jobs. However, many of these may be low quality jobs and transient in nature – the focus must be on delivering long -term benefits. Oil & gas reserves are finite so the ideal should be to build an OFS export industry. Each country, each city, each O&G centre is unique. We can learn from each other but initiatives must be specific to local needs – there is no 'one size fits all solution'. Most importantly, our work for governments has shown that growing business is about more than demanding a local presence from operators and their contractors. In the long run, providing a business-friendly environment is probably more important. [1] Sinclair, Upton. 1927: 'Oil' [2] Sandbu, Martin. August 29, 2009 Financial Times Magazine. ' The Iraqi who saved Norway from oil' [3] IPIECA 2011: 'Local Content Strategy: A Guidance Document for the Oil and Gas Industry' [4] http://www.transparency.org/cpi2012/results [5] http://www.nbim.no/en/About-us/Government-Pension-Fund-Global/ [6] Smith N.J. 2012: 'The Sea of Lost Opportunity. North Sea Oil and Gas, British Industry and the Offshore Supplies Office' [7] July 2012, Booz & Co study for ONIP, Brazil [8] Pearson, Samantha April 8, 2012: Financial Times 'Skills shortage in Brazil's oil industry' ______________________ | 
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