Hamish McRae: Government may have to step in where companies fear to tread

Economic Life: Any other company, particularly a foreign one, will now think twice about investing in technically demanding oil exploration in the US
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The Independent Online

Ten years ago, BP ran a campaign seeking to persuade us that the initials also stood for "beyond petroleum". It was a cute idea, capturing the mood of the millennium that this century would see oil gradually replaced by other sources of energy. As it turned out the sheer convenience of the stuff, coupled with the boom in Asia, progressively increased demand. The consequence of that came though in the oil price, leading to the first "oil shock" that was not caused by a cut in supply. In turn, the consequence of that was to put pressure on companies to push to the limits to get oil from yet more difficult places with yet more complex technology. BP did not go beyond petroleum at all; quite the reverse. And in so doing, it – and the entire industry – took on new and unknown risks.

The story has moved from being simply one of a disaster, through to one of corporate survival. In that sense there is a parallel with the banks. They too underestimated the risks they were taking on, and as a result their shareholders lost huge amounts of money. BP investors have only lost one-third of their money; shareholders in some of the banks have lost more than 90 per cent and in a few cases, the whole lot. So this is also a story about risk.

The energy industry will become more risky over the next couple of decades. Conventional oil production is pretty much stuck. We will get more from natural gas liquids and more from bio-fuels. We will also get more from unconventional oil sources, in particular from oil shale. But the pressure to go for offshore oil, in deeper and deeper waters, will increase. I had not realised what a pepper-pot the Mexican Gulf has become, with drilling all over the place, until I saw the map also reproduced here. But that is just one region that happens to be convenient for the US. Key point: easy oil is the past.

Markets don't mind risk but they do mind uncertainty – risk that they cannot evaluate. This leads to what will, I suggest, be a longer-term consequence of the BP shock. Why should the fall in the market value of BP be double the top-end of the estimated costs of the clean-up? Because of the uncertainties exposed.

If this is right, it is deeply worrying. Already it has proved impossible for the private sector to take on the uncertainties involved with nuclear power. Only the state can carry those. We have just in the past few days heard the Government reveal that there are several billion of nuclear decommissioning costs which have not been provided for and that the taxpayer will have to fund these.

Now we have the US authorities taking an aggressive stance towards the responsibilities of BP. That is understandable in the context of American politics, but it means that any other company, particularly a foreign one, will think twice about investing in demanding oil exploration in the US. If there is a danger you may be pilloried if things go wrong, you may be better not to go there at all. One lasting effect of the US political response will be to make all foreign investors be aware of reputational risks of operating there.

There will, however, be sources of capital for investments where the risks are unknowable. It is just that these will not, in the main, be companies quoted on the world's principal equity markets. The sources will include sovereign wealth funds, but only those where the managers are not answerable to democratic governments. They will include ultra-rich individuals, particularly those based outside the closely-scrutinised societies of Europe. And they will include some private-equity groups.



You can catch a glimpse of what will happen on equity markets in general by looking at what already has happened in finance. It was Abu Dhabi that was prepared to take a risk with Barclays Bank when the general equity markets were not prepared to stump up more capital and the only other choice would have been to go to the British government. (Interesting, isn't it, that a foreign government is a more welcome investor than your own one?) Banks everywhere are being more tightly regulated and, as a result, will be less able to lend to risky ventures.

There is a further twist. Not only will publicly-quoted companies be less able to take on risk; they will be less able to offer their staff financial incentives for taking on tough tasks. Boardroom pay has become a much more contentious issue and understandably so. The system had become corrupted. But it looks as though we will move some way back towards a world where people who want to take risks – and be appropriately rewarded – will set up their own businesses rather than work for large corporations.

Put these two forces together and what will be the result?



Well, I think we will move towards a world where large quoted companies will behave more like public utilities. To generalise, they will be more regulated and more risk-averse. Governments will find it harder to offload difficult projects on to them. Public-private partnerships will be harder to establish or at least the terms will be less favourable to government. Privately-owned companies will flourish because they will be able to operate with more freedom than quoted ones. And companies – and investors – from the emerging world will take on risks that their counterparts in the West will shun.

If this is right, it has worrying long-term implications. The greatest driving force of the developed world is the publicly-quoted company. That is where most innovation comes from – or to be more precise, where innovation is applied to commercial products and services – and it is where much of the accumulated savings of successive generations of pensioners are invested. Things don't change suddenly and it would be ridiculous to draw, from the difficulties of the banking industry and now from BP, the conclusion that the quoted-company will now go into decline. But it will be under greater pressure.

So the implicit assumption that many people in the West have made – that our system of corporate ownership and governance will continue to spread around the world, becoming the standard model for economic advance – may not be quite as solid as we suppose.

This is particularly serious in the energy business. Take oil. Western companies are the best at finding and developing oil and gas resources. Governments cannot find oil. Actually Japanese and Chinese companies have not been good at finding it either. It is at least arguable that the best company in the world for discovering new petroleum reserves is BP.

As I say, things don't change suddenly and it is important not to over-emphasise the impact of one particular disaster. But there will be one lasting effect from the events of the past few weeks. Commercial companies, however big, will be more risk averse. As a result governments will end up taking on more risk, not less.

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