Historically, despite industry evolution, companies have been reluctant to undertake change in operating models on an enterprisewide basis, although there have been cases where operators have implemented major change, such as the BP North Sea case of two divisions, with one focused on mature field operations. Other exceptions to the rule are typically event‐driven cases of operating model redesign, such as post‐merger integrations (PMI) and financial restructurings—for example, the many divestments of downstream refining and retail operations and corporate unbundling, like the disaggregation of Fletcher Challenge (which included Fletcher Challenge Energy, subsequently acquired by Apache and Shell) and Canadian Pacific Limited (which included PanCanadian, subsequently merged with Alberta Energy to form EnCana). The split of EnCana was also a financial restructuring that afforded enterprise‐wide changes to operating models, splitting the company into two more focused businesses—Cenovus, an integrated oil company, and EnCana, a pure‐play natural gas company. An initial public offering can also trigger event‐driven operating model redesign.

The role and ownership of NOCs has been a point of debate since their creation nearly 100 years ago. This debate is critical—not only to the economic wellbeing of the citizens of oil‐exporting nations but to the prosperity and security of people around the world. NOCs account for the majority of the world's conventional oil production and proven reserves and are playing an increasingly active and important role. They are leading domestic efforts toward economic development and diversification, as well as increasingly investing beyond their own national borders. Moreover, as renewable energy gains a greater share of the world's primary energy mix, we might expect NOC charters to be expanded, or that new entities will be created, to foster similar leadership roles in this emerging but vital energy segment.

The lens of a publicly traded company makes Saudi actions regarding low oil prices for the past two years look not only rational but even predictable. It may represent relatively straightforward economic decisions rather than retailesque strategies about market share. Aramco recognized its advantaged cost position on the world's evolving supply curve, expanded by US tight oil and CDN oil sands, and waited for classic economic theory to restore a supply–demand balance instead of fighting market forces and risking not only lower prices but also lower volumes. Nor does talking about production cuts, when a seasonal reduction is already underway and an extra $5 per barrel provides $50MM per day (i.e., $1.5bn per month), represent a reversal of this position.

THE SEARCH FOR A PERFECT OWNERSHIP MODEL

The ownership of NOCs continues to be fluid, with no ownership model emerging as an ideal form. There have been many cases of change, and even reversals, such as in the cases of BP, YPF, and Petro‐Canada.

British Petroleum (BP) began in 1908 as the Anglo‐Persian Oil Company (APOC), but in 1913, the British government acquired a 50 percent controlling interest. The company expanded rapidly over the next several decades, with the help of Winston Churchill, with upstream development in Iran, Iraq, and Scotland, plus investment in shipping, pipelines, and refineries. In the 1970s, the company's oil assets were nationalized in Iran, Iraq, Libya, Kuwait, and Nigeria, representing a loss of direct access to OPEC country resources. After flirting with diversification into coal, minerals, and even nutrition, the British government sold a 5 percent stake in 1979 and its remaining ownership in 1987.

Argentina's YPF S.A. was established in 1922 as a state enterprise to promote economic independence and the domestic ownership and control of resources. In 1930, YPF was the target of military coup backed by foreign oil trusts. It was then privatized in 1993, bought by Spanish Repsol S.A. in 1999, and renationalized (51 percent) in 2012—its history highlights the challenge of reconciling the needs of a publicly traded company with a domestic mission premised on the state control of natural resources and the unwieldy expectations that this often brings.

Petro‐Canada was founded in 1975 as a state oil company as an element of Prime Minister Pierre Trudeau's economic nationalism with hopes to more directly benefit from high world oil prices. It was initially capitalized with the government's stakes in Panarctic Oils (45 percent) and Syncrude (12 percent), plus C$1.5 billion in cash. As an energy policy tool under the National Energy Program, it acquired Atlantic Richfield Canada (1976), Pacific Petroleums (1978), Petrofina (1981), and BP Canada's (1983) downstream refineries and retail network. It became one of the largest operators in the Canadian oil sands and offshore Hibernia. But in 1991, a new Tory government began to privatize Petro‐Canada—the state kept a 19 percent stake and no other shareholder was allowed to own more than 10 percent, with foreign control capped at 25 percent. This was a difficult era for the industry, characterized by low oil prices, and the company reduced its staff from 11,000 to about 5000, sold down assets, booked large losses on the revaluation of assets, and saw the value of its shares decline. In 2004, the government sold its remaining 19 percent stake.

Analysts tend to be very cautious about recommending investment in any type of state‐run company, and despite its preeminent position, Aramco is no exception. State‐run oil companies have a checkered history that has included political interference, corruption, poor investments, and underinvestment. Investors in Brazil's Petrobras (NYSE:PBR) have seen shares decline almost 90 percent over the past 10 years, amidst a major scandal at this once iconic company. But there have also been successful long‐term returns on state owned companies—Warren Buffett's investment in Petro China (NYSE:PTR) returned more than 600 percent in the early 2000s as the price of oil rose from $30 to $75 per barrel.

PREPARING TO GO PUBLIC

In preparing for the successful transition to a public company, there is much to be learned from those who have already made the journey—both successfully and unsuccessfully. But there is also much to learn from cases of state‐owned enterprises that successfully completed a “commercialization journey” without the benefit of a change‐in‐control to help force through necessary but difficult change. Without the catalyst of an IPO, any organizational transformation must be that much more planned and purposeful.

In the 1990s, Postmaster General Marvin Runyon successfully led a broad commercialization transformation of the US Postal Service. And a decade later, CEO Moya Greene led Canada Post (and more recently the Royal Mail) on a comprehensive transformation program toward commercialization. While there were marked differences in their scope and emphasis, in both cases service levels were improved, employees engaged, costs cut, and capital efficiency enhanced, through sweeping changes in both business strategy and operating model.

However, the E&P sector is quite unique, and so appropriate operating models must be designed accordingly. For example, in E&P we make great use of joint ventures (i.e., JVs) and nonoperated ventures (i.e., NOVs but also known as OBO or operated‐by‐others). JVs tend to be used to syndicate subsurface risk and/or capital needs—both of which can be extremely large and daunting in upstream projects. NOVs may be used to lower operating costs in regions or in resource types where the company doesn't have the scale for an efficient critical mass. They are also used as a safe, low‐cost way for early‐stage exploration and exploitation in a new region or resource type.

And so their use by an IOC tends to mirror its regional strengths and weaknesses in different parts of the world—greater use in regions of the world where the company has less of an operational footprint, and less use in regions of the world where the company has more of an operational footprint. Recognizing the growing importance of NOV production and reserves in upstream O&G, super majors tend to have a separate NOV organization and operating model to coordinate and share best practices. In some cases, an asset moves out of the NOV group when it goes into production.

KEY SUCCESS FACTORS

The optimal corporate ownership and operating model isn't only elusive in the case of NOCs—many companies struggle with these. We can infer many useful key success factors for IPOs from the literature:

1. Don't forecast earnings. CEOs must focus on long‐term performance, not Wall Street analysts. As discussed earlier, prominent investors, leading academics and governance experts, and progressive CEOs argue against providing earnings forecasts or guidance.
2. Don't let your investor relations pitch become your business strategy. Managers up and down the hierarchy work hard on strategies, plans, and their execution, but when the figures are tabulated, they may fall short. All too often, executives react by “encouraging” middle and lower‐level managers to “redo” forecasts. Ultimately, constructive dialogue about strategy and execution is supplanted by the investor relations pitch and Wall‐Street‐speak, characterized by GAAP accounting and endless metrics, promising outcomes unrelated to a plan of specific actions. Lost is any constructive debate about industry direction and needs, requisite organizational capabilities and talent development, or vision for the company's “right‐to‐win.” Discussion of actionable inputs is replaced by a discussion of outcomes. CEOs must reclaim the conversation about strategy and execution.
3. Align the interests of managers with owners. CEOs must resolve the conflict between the owners and managers of company resources. Industries such as E&P, where business decisions are confounded by technical considerations, are exceptionally difficult places to get things done (IT departments suffer the same challenges). For example, whether farming down portfolio assets that lack the critical mass for low‐cost (i.e., per bbl) operation or moving assets of certain resource type/geography into NOVs because the enterprise lacks the relevant organizational capabilities for efficient exploitation, it's all too easy for technical experts to raise internal barriers against change or action, unless these outcomes are in their own self‐interest.

   Furthermore, a traditional twentieth‐century model of corporate governance—dispersed public ownership, professional managers without substantial ownership, and a large board of directors dominated by management‐appointed outsiders—is more suited to high‐growth sectors where profitable investment opportunities exceed the cash they generate internally. These businesses are unlikely to systematically invest in marginal or unprofitable projects, especially when they must regularly return to the capital markets for more money. Alternative corporate organizations (e.g., Private Equity portfolio companies) and operating models have emerged where agents with a shared interest make remarkable gains in operating efficiency, employee productivity, and economic performance.

4. Reward your stars. As my former business partner, Bennett Stewart would remark, “A world without As, praise, gold stars, or incentives?” The Soviet economy collapsed, despite vast natural resources, in part because people did not see or feel benefit from their collective efforts: “They pretend to pay us, and we pretend to work.” With entrepreneurial efforts stifled by bureaucracy, and the gains of personal initiative harvested as a public good, innovation ceased and productivity froze. The modern approach to operating model design is more enabling and aligns workforce interests with the organizational mission. It also ensures that outcomes are rewarded and success is celebrated. In economic terms, the best incentive is “a piece of the action.” When the context is conducive, people act in unison to carry out their organization's mission. However, company stock is not an effective incentive at the shop floor—it offers a poor linkage between pay and performance because it is both too intangible and beyond the “line‐of‐sight” of all but a handful of staff. A better approach is to share in the economic contribution of a business unit (i.e., economic profit contribution). This can provide three clear and actionable incentives: to improve profitability, to grow profitability, and to withdraw from uneconomic activities.
5. Keep the stay/go private option. CEOs may wish to stay private or go private, to enable greater focus on long‐term success. In the face of the rise of predatory hedge funds, mainstream 24/7 business media coverage, equity analyst influence, and rapid turnover in the C‐suite, corporate executives increasingly sacrifice the long‐term prospects of their companies to meet the short‐term expectations of the stock market. Moreover, the burden of being a public company has also grown, in terms of the rising costs and complexity of disclosure, regulatory compliance, and unwelcome public scrutiny. In his Harvard Business Review article, “Eclipse of the Public Corporation,” Michael Jensen called for new models to employ pay‐for‐performance compensation systems, substantial equity ownership by the board and leadership, and governance mechanisms to limit cross‐subsidization between business units and wasted free cash flow.¹ Institutional investors have widely adopted private ownership as a strategy. Berkshire Hathaway took Burlington Northern private in 2009 in a $44 billion deal and privatized HJ Heinz ($28 billion) in 2013. Founder, Michael Dell, took his company private in a $25 billion deal. Though many deals involved private equity partners, a return to the public markets has not been part of their logic.

EVENT‐DRIVEN REDESIGN

With oil prices so low, it may seem an odd time to sell shares in the world's largest oil company. But IPOs are not always about market timing, nor principally a financial transaction. Some deals serve as a catalyst for change—cultural change, economic evolution and development, and organizational transformation that includes changes to the operating model. These have more to do with change management than any financial calculations. NOCs and other state‐led enterprises face an enormous challenge in balancing the needs of their public mission with the demands of commercial and economic success.