Petroleum and Oil

LUKoil was one of several firms created in 1991 out of Russia’s state-owned petroleum monopoly. While both Russia and LUKoil must export to meet their economic objectives, political relations within and outside of Russia could impair LUKoil’s future ability to export. Thus, foreign investment and ties to Western oil companies are very important to the firm’s ultimate success. Controlling 19 percent of Russia’s oil production and refining capacity and employing more than 120,000 people in its operations worldwide, LUKoil has become Russia’s largest oil company. It is also the first Russian oil company to integrate from “oil wells to filling stations.”

High market prices have enabled LUKoil to amass sufficient capital to make substantial foreign investments. While much of its FDI has been directed to nearby countries, LUKoil has also acquired 100 percent of Getty Petroleum in the United States, as well as 800 U.S. stations from ConocoPhillips. Forward integration into filling stations will guarantee LUKoil market access and enable the company to sell its crude oil during times of global oversupply. Further, LUKoil sees its foreign acquisitions as a means of gaining experienced personnel, technology, and competitive know-how to help it compete more efficiently and effectively both at home and abroad.

Questions

What theories of trade help to explain Russia’s position as an oil exporter? Which ones do not, and why? Both the theories of absolute and competitive advantage help to explain Russia’s position as an oil exporter. Prices in the global oil market are driven by the laws of supply and demand. Given the fact that Russia now has 15 more proven reserves than Saudi Arabia and its oil companies have become major global competitors, the country enjoys both natural and acquired advantages with respect to oil. Thus, factor proportions theory is applicable. The fact that a preponderance of its foreign expansion has been to countries of the former Soviet Union supports the country similarity theory.

The Porter Diamond of national competitive advantage also helps to explain Russia’s position as an oil exporter. Global demand conditions are favorable; and Russian oil companies are making significant strides in the areas of factors conditions, related and supporting industries, and firm strategy, structure, and rivalry. Neither the interventionist theory of mercantilism nor the theories of country size apply. Further, product life cycle theory does not apply because petroleum is not an appropriate type of product for that model.

1. How do global political and economic conditions affect world markets and prices of oil? Global political and economic conditions affect world markets and prices because of their real and perceived effects on global supply. In spite of their general upward trend, oil prices have fluctuated widely in response to events during the twenty-first century. OPEC’s supply quotas, general economic uncertainty, China’s economic expansion, political unrest in Venezuela, and the war in Iraq have all contributed to the favorable market conditions that have led to record-setting prices and profits in the global oil industry.

2. Discuss the following statement as it applies to Russia and LUKoil. “Regardless of the advantages a country may gain by trading, international trade will begin only if companies within that country have competitive advantages that enable them to be viable traders—and they must foresee profits in exporting and importing.”

Given the globalization of the world’s oil industry on the one hand, and the massive capacity of Russia’s oil producers on the other, it is vital that Russia’s domestic companies have competitive advantages that enable them to operate profitably in global markets. Otherwise, foreign competitors that can do so would be in a position not just to serve the world’s markets, but to enter the Russian market via foreign direct investment, if such action were permissible.

Thus, it is critical that both LUKoil and other Russian oil companies become as efficient as the major global competitors, either by developing or acquiring the latest petroleum technology, marketing skills, and operating efficiencies that will yield the efficiencies required to effectively compete at both the global and local levels.

3. In LUKoil’s situation, what is the relationship between factor mobility and exports? Capital, technology, and skilled employees are all critical factors in the global oil industry. Even in Russia oil production and processing are capital-intensive activities that require massive amounts of highly valuable and highly specialized capital equipment manned by skilled laborers. Investment naturally flows to those sites where oil is abundant and production activities are the most efficient.

Because oil is a limited resource and demand exists the world over, competitors such as LUKoil serve their global customers via production sites that are scattered across the world. Whereas LUKoil’s European customers will likely be served from its European reserves, other customers are more likely to be served by oil sourced from its holdings in other parts of the world.

4. Compare the role of the Costa Rican government in the chapter’s opening case with the role of the Russian government in their use of trade to meet national economic objectives. The roles of the two governments are quite different in the sense that Costa Rica set about developing acquired advantages in targeted industries, while Russia chose to exploit its given natural resources in order to compete in global export markets as it transitioned to a market-based economy.

Although exports of coffee and bananas are still important to Costa Rica, high-tech manufactured products (electronics, software, and medical devices) are now the backbone of that country’s economy and export earnings. On the other hand, as Russia moved through the transition from a centrally-planned to a market-based economy, it fashioned competitive enterprises such as LUKoil from its state-owned assets. Those firms have since had to rely on their earnings in order to develop or acquire needed products, processes, facilities, and/or employees.