An alternative perspective

01 February 2010

After the Fall: The Ongoing Challenge of Resource Nationalism

IAN BREMMER, PRESIDENT, EURASIA GROUP

Resource nationalism can be applied to many commodities, but for reasons both historical and practical, governments use it most aggressively in the oil sector and many of them subsidise national oil companies (NOCs) to help tighten their control. This strategy has paid bigger dividends for some governments than for others, but the broader trend has never mattered more for the global economy. Today, state-owned energy companies control more than 75 per cent of the world’s crude oil reserves.

As global economic activity accelerates, demand for oil, gas, metals, and minerals will resume its climb. In the oil sector, multinationals will work to gain new footholds where they can, bargaining with foreign governments whose intentions are often unclear. Depending on the political and economic circumstances, some will aggressively pursue agreements. Some will hang back and wait for more favourable terms. Others will avoid contracts with particular governments and exit increasingly inhospitable markets. Still others will try to renegotiate existing deals, seek out local partners to win political cover and new contacts or look to support from home governments to increase their bargaining leverage. In the end, many of these companies know they must enter these markets without help, competing at their own risk.

To understand the balance of bargaining power between these companies and countries, we have to appraise the particular strengths and limitations of the governments involved. The financial meltdown has complicated this process, because it remains unclear which countries will emerge most and least stable.

KEY QUESTIONS

That said, the financial crisis and subsequent oil price correction have helped clarify which factors sustain a government’s commitment to a policy of resource nationalism. In the oil and gas sector, leverage depends on the answers to four questions:

In the country in question, does the state-owned oil company have the financial and technological capacity to (profitably and efficiently) find and produce available energy deposits?

Is the government in question politically stable enough to withstand financial pressure and economic shocks?

Is the country fiscally stable?

How much will production of available resources cost and how much energy is accessible for development?

HOW STRONG IS THE STATE-OWNED COMPETITION?

Not all countries that practice resource nationalism have created a NOC, though those that have pose the most complicated challenges for foreign investors since the state enters negotiations with foreign companies armed with a ready-to-deploy state-owned competitor. In the past, greater technical capacity has offered multinationals valuable leverage, particularly for the most technically demanding projects like those that involve deep-water production.

That advantage is not what it used to be. State-owned companies like Petrobras (Brazil), Petronas (Malaysia) and Statoil (Norway), which account for the vast majority of oil production in their respective countries and have developed a portfolio of global operations, have sharply increased their technological sophistication in recent years, particularly for deep-water production. Petrobras, in particular, has enhanced its ability to manage risks from complex projects. This shift will matter for those who hope to participate in development of the enormous deep-water reserves believed to lie beneath the pre-salt Santos Basin off Brazil’s coast – and for the entire global economy, since this discovery will be crucial if supply is to keep rough pace with demand over the next quarter century.

China’s national companies have not yet developed the technical capacity to push multinationals from the oil business. Other NOCs – like PDVSA (Venezuela), PEMEX (Mexico), NIOC (Iran) and NNPC (Nigeria)―have yet to develop the managerial, technological or risk management expertise needed to compete successfully with either the best of the multinationals or with the state-owned companies listed above. These shortcomings have not prevented governments like Venezuela’s and Mexico’s from periodic indulgence in resource nationalism, but they weaken their governments’ hand considerably at the commercial bargaining table. Nigeria’s government is now experimenting with resource nationalism, in the form of a bill now winding its way through the country’s congress. But NNPC does not have the technical and financial capacity to manage all of Nigeria’s oil production and international companies operating in the country know it.

HOW POLITICALLY STABLE IS THE GOVERNMENT?

Some governments pursue resource nationalism because national control of national wealth appeals to national pride – and because it provides political officials with revenue they can spend in ways that make them more popular. This trend is especially obvious in Vladimir Putin’s Russia following renationalisation of the oil and gas industries that had been privatised during the economically and socially turbulent Yeltsin era of the 1990s. Hugo Chavez consolidated his grasp on political power in Venezuela in 2001 and 2002 precisely by ousting the elites that controlled the country’s oil sector. But if a government cannot continue to develop its domestic resources, economic fallout will have political implications.

Chavez’s resource nationalism was most aggressive at the height of his public popularity in 2007. By arbitrarily amending pre-existing contracts, he harassed ExxonMobil and ConocoPhillips out of the country. But with the oil price collapse that followed the onset of the financial crisis, Chavez has had to recalculate his interests. He has preserved relatively good relations with firms like Chevron, BP and Statoil – companies that offer a level of technical expertise that state-owned Chinese companies cannot match – to diminish the threat of a collapse in oil production. These ongoing relationships with foreign companies have been more crucial to the management of the Venezuelan oil sector under Chavez than have the much-hyped emerging relationships with Chinese NOCs.

Brazil, on the other hand, has weathered the financial crisis well, and outgoing President Luiz Inacio Lula da Silva remains popular. The government’s use of Petrobras’ capital investments to stimulate the economy during the slowdown has strengthened statist views within the administration. Both Lula and his preferred successor, Chief of Staff Dilma Rousseff, argue for a state-centric approach to developing Brazil’s deep-water oil reserves.

Some autocratic governments have tight enough domestic control to limit their exposure to risk of domestic unrest when things go badly. Kazakhstan, Libya and Algeria, for example, will only become more vulnerable (and easier to negotiate with) if mismanagement of oil and gas reserves empties the pockets of powerful members of the political elite.

HOW ECONOMICALLY STABLE IS THE GOVERNMENT?

A government’s political and economic strength are obviously intimately related, but they are not the same. It is entirely possible for a government’s popularity to survive a temporary bout of economic trouble – though this popularity will always come with an expiration date. Some states navigated the financial crisis with a minimum of trouble. The Arab OPEC producers have generated sizable fiscal surpluses and national budgets with relatively conservative oil price assumptions. Countries like Libya and Algeria do not have liberalised capital markets and did not experience the kind of capital flight faced by many other resource-rich countries. Venezuela and Russia are a different story. Hugo Chavez remains politically secure for the moment, but the country’s overwhelming dependence on oil exports as a source of foreign exchange and state revenue leaves the country enormously vulnerable.

As PDVSA’s available capital is squeezed, the company and government become ever more dependent on investment from foreign companies. Russia and its NOCs face similar capital budget pressures. In fact, both the Russian government and its NOCs face fiscal shortfalls that could worsen the trend toward oil production decline. In 2008, Russian production fell year-on-year for the first time since 1996. Oil firm Rosneft and state pipeline operator Transneft accepted an “oil for loans” agreement with China in early 2009 – both to fund export infrastructure in eastern Siberia and to help them repay outstanding debt. During the financial crisis, Russia badly needed the revenue that its resource champions could provide. Over the longer-term, the Kremlin appears to recognise that foreign investment – with carefully crafted terms – will be necessary to reverse a structural trend toward lower production capacity.

WHAT ARE THE EXPLORATION AND PRODUCTION COSTS AND BENEFITS?

In the end, multinational companies will always return to a basic appraisal of a particular project’s potential costs and benefits. The Arab OPEC producers have extraordinarily low production costs, which have added an additional layer of resiliency to their resource nationalist policies in the financial crisis’ aftermath. The international Energy Agency estimates that their production costs are well below $10 per barrel, ensuring that their capital budgets are easier to sustain during financial downturns. A new (perhaps surprising) opportunity has opened more quickly than many predicted. The fields on offer in Iraq include several super-giants with proven reserves of 5 billion barrels or more. If the country’s political stability can survive the large-scale withdrawal of US troops this year, a number of large multinationals will likely find that the combination of low production costs, low exploration risk, and hydrocarbon potential make foreign companies more tolerant of potential above-ground risks than in higher-cost environments. Foreign companies will hedge these risks by slowing the pace of their final investment decisions.

Brazil provides a useful contrast. Lula’s popularity, Petrobras’ financial and technical prowess, and Brazil’s relatively strong post-financial crisis position give it considerable leverage over international companies. But while the Santos Basin project appears to include several super-giant fields, the technical demands imposed by extracting oil from miles beneath the Atlantic will ensure that production costs will reach $40 to $60 per barrel. Until the Lula government (or its successor) takes a more industry-friendly position, foreign investment could remain on hold. High production costs will also limit a government’s ability to pursue resource nationalism in the Russian arctic and Canada’s oil sands as well.

IN SUMMARY

The governments of many developing states blame the financial crisis on American-style liberalised capitalism and some of them will use this story to advance their cases for a more statist-approach to economic development. As a result, privately owned companies in dozens of economic sectors will face new scrutiny and tighter terms as they try to enter foreign markets. But some of these governments will prove more effective than others at managing their country’s natural wealth. In January 2010, Hugo Chavez opened Venezuela’s first major auction for oil-drilling rights in more than a decade. In the end, even the world’s most strident resource nationalists know that foreign investment is sometimes a “necessary evil”.

IAN BREMMER, PRESIDENT, EURASIA GROUP

Ian Bremmer is president of Eurasia Group, the world’s largest political risk consultancy. He is also a columnist for Slate, a contributing editor at The National Interest, and a political commentator on CNN, Fox News and CNBC.

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