Sunday, 13 April 2008

Resource nationalism

Oil prices have hit record levels on world markets bringing in huge revenues for oil companies. But these high prices are a mixed blessing for private companies. Along with the increased revenues comes "resource nationalism": some governments in oil rich areas deny private companies access to new oil fields and nationalise the fields that the private companies have started to develop.

Sergei Guriev, Anton Kolotilin and Konstantin Sonin explain in an article, High oil prices and the return of “resource nationalism”, on that
The recent record-breaking spike in oil prices has already claimed a number of casualties. In June 2007, ExxonMobil and ConocoPhillips, both major U.S.-based oil companies, were forced to abandon their multi-billion dollar investments in Venezuela. Some other international majors, including French Total SA, Norwegian Statoil, the UK’s BP, and American Chevron, though not squeezed away, had to concede their controlling interests to the state-run PDVSA company. Neighbouring Bolivia and Ecuador forced international companies to make similar concessions. During the same summer, TNK-BP, a Russian subsidiary of BP, had to sell a major stake in its oil business to the national gas monopoly Gazprom. Before that, in December 2006, Royal Dutch Shell had to sell a 50%-plus-one-share stake in the Sakhalin-2 oil field to Gazprom after the international major was threatened with license withdrawal by a state environmental agency. In August 2007, the government of Kazakhstan also cited environmental violations to suspend Eni’s development of Kashagan, a large oil field.
This raises an important question in the mind of the authors
The issue of forced nationalisations goes back to the most important question in economics: if economists believe in a crucial role of property rights for investment and efficiency, why are the property rights so hard to uphold?
The literature on privatisation (for a survey see Megginson 2005) shows us that switching to private ownership does increase productive efficiency. Thus governments stand to benefit from selling the property rights to the most efficient producer and then taxing the revenues generated. The benefits from private ownership are as large in the oil sector as any other. Due to their economies of scale and better human capital, multinational oil companies are more efficient. Past expropriations of private companies has resulted in losses of output and national income.

Guriev, Kolotilin and Sonin go on to explain
Yet, nationalisations of oil companies do happen. In a recent paper (Guriev et al. 2008), we analyse the determinants of oil nationalisations around the world from1960 to2002 (a total of 73 nationalisations). One immediate observation is that the nationalisation of oil companies took place when oil prices were high (see Figure1). Specifically, most nationalisations took place in the 1970s, when oil prices were at historically high levels. Once the oil price came down in the 1980s and 1990s, nationalisations virtually disappeared and re-emerged only in the last decade when oil prices climbed back to 1970s' levels.
Figure 1. Number of oil expropriations and oil price deviation from long-run trend, 1910-2006 (Source: Guriev et al. 2008)
Up to a point it seems natural that the higher is the price of oil, the more valuable oil assets become and thus the more incentive a government has to expropriate a company. But given the costs of expropriation, it is far from obvious as to why a government would respond to a positive oil price shock with expropriation rather than just with imposing higher taxes. Guriev, Kolotilin and Sonin note
Using taxes contingent on (observable and verifiable) oil prices, the government can preserve oil companies' incentives for investment in new fields and cost-reducing technologies. This straightforward solution, however, relies on the external enforcement of contracts, which is not the case: the government is both an enforcer and a contracting party. Therefore, this contract can only be self-enforced. As BP’s then-CEO recently said, “There is no such thing in the [Petroleum] E[xploration] & P[roduction] business as a contract that is not renegotiated” (Weiner and Click, 2007). The only protection for a private company is the government's desire to benefit from more efficient production in the future and checks and balances that assure that the government in office pursues the long-term national interest.
Guriev et al. (2008) considers a simple theoretical model of a self-enforced contract. Their analysis provides a straightforward prediction:
when current oil prices are high, (inefficient) expropriations may take place in equilibrium. In this case the immediate prize is too valuable relative to future revenues. Therefore, we should expect more expropriations in periods of higher oil prices. Another prediction is that expropriation is more likely when there are fewer checks on the government so that the government cannot commit to not expropriating.
Guriev et al. (2008) then test their predictions on a data set involving all of the expropriations of foreign-owned, oil-producing companies around the world in 1960-2002, using and extending the dataset compiled by Kobrin (1984). They focus on oil as the expropriation of an oil company is a high-profile event and relatively easy to observe and quantify. In addition, oil is a globally traded commodity with a long time series of prices.
[They] show that expropriations are indeed more likely to take place when oil price (controlling for its long-term trend) is high and in countries where political institutions are weak. The results hold for both measures of institutions that we use (constraints on the executive and the level of democracy from the Polity IV dataset). Most importantly, the results hold even if we control for country fixed effects; in other words, in a given country, expropriation is likelier in periods of weakened institutions.
Therefore the Guriev et al. (2008) results are consistent with the notion that high oil prices do induce "resource nationalism," and thus high prices are not as good news for global oil companies as they may at first look.
  • Guriev, Sergei, Anton Kolotilin, and Konstantin Sonin (2008). “Determinants of Expropriation in the Oil Sector: A Theory and Evidence from Panel Data.” CEPR Discussion Paper 6755.
  • Kobrin, Stephen J. 1984. The Nationalization of Oil Production: 1919-1980. In D. Pearce et al. (eds.) Risk and the Political Economy of Resource Development. New York: St. Martin's Press: 137-164.
  • Megginson, William L. 2005. The Financial Economics of Privatization. New York: Oxford University Press.
  • Weiner, Robert J. and Click, Reid W., “Political Risk and Real-Asset Values: M&A Evidence.” (January 2007). Available at SSRN:
Update: At the Free Exchange blog they comment on The resource curse, version 2.0. The point is made that
Most unfortunately for the heavy-handed nations, nationalisation and the threat of nationalisation are inefficient, leading to underinvestment in exploration and production. By seizing their oil fields, then, nations reduce the expected take from their resources. The inability to enforce the contract between the government and the private firm robs the government, and the citizenry, of the full value of their oil.

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