In the popular mind, the oil industry has rarely looked bigger or more intimidating than it did in 2006, as high prices brought record profits and a great political clamor to rein in the multinationals' "windfall." Cyclical price swings aside, however, the fact is that the largest private oil companies have been losing power in global markets for a generation and are destined to shrink further. If they were car companies, their future would probably look something like that of Mercedes: a famous label holding its own in a high-end but small niche.
The structure of the major private oil companies dates back 50 years, to a time when seven companies supplied almost all the world's gasoline, heating oil and aviation fuel. The seven sisters--BP, Chevron, Exxon, Gulf, Mobil, Shell and Texaco--along with the French firm Total controlled the world oil market. These companies dictated prices to Saudi Arabia and other exporting countries. They also set prices for many consuming countries. They managed the market by developing reserves at a rate that kept crude production in pace with demand. These firms also invested in refining capacity and other services?from tankers to service stations?at rates that ensured stable, guaranteed supplies to consumers.
This "integrated model" of the oil industry is today no more viable than the Detroit model for building automobiles. Over a period of 30 years the major oil companies lost access to much of the crude supply they once controlled. To survive they restructured, cutting employment, selling refineries and abandoning markets. Whereas General Motors, Ford and Chrysler fought to maintain market share, the big oil companies conceded markets, often to foreign governments, rather than running up huge losses to try to protect an indefensible position. Thirty years ago Exxon and Mobil supplied 15 percent of world consumption; today the merged ExxonMobil supplies 10 percent.
As a result, the major oil companies are transforming themselves from generalists like GM to providers of more specialized, high-end products. Consider refining. Since 1985 the share of U.S. refining capacity controlled by big oil companies has fallen from 65 percent to 36 percent, as newcomers like Valero took over the business. To the extent the majors stayed in refining, they tried to keep hold of the higher-priced, higher-profit regional markets.
The transformation of Big Oil carries an implicit threat for the consumer. As new specialty firms arise or expand to fill gaps left by the departure of major oil companies, temporary market disruptions are likely. That's what happened last summer, when independent refiners abruptly stopped using the additive MTBE. That cut supply by 3 percent and helped drive gas prices up 40 percent. Price increases would have been smaller had the majors still dominated refining. Majors were more likely than independents to invest in anticipation of demand growth, smoothing price swings. Independents are more likely to attempt to capture revenue from price increases caused by limited supply.
The greatest impact of oil-industry downsizing is on human capital. The majors historically offered the best advanced "degrees" to oil engineers and scientists, training hundreds of thousands of individuals who pushed the frontiers of oil into new regions and deeper waters with minimal environmental impact. This flow of talent and innovation has now become a trickle. Research at downsized major companies has become more focused, and hiring more selective. We began to see the effect in 2006 when energy companies rushed to announce new projects, only to find them delayed by months, if not years, by labor shortages. Capacity growth has slowed, and infrastructure breakdowns have become more common. The full impact will not be felt for years. But one day, when fuel supplies are as irregular in the United States as they are now in Iraq, industry critics will recall that such problems rarely occurred when Big Oil ran the show. Those who despise Big Oil may learn to miss it, the hard way.