Thursday, June 28, 2007

Nationalism and oil deals

From the Economist comes this article which provides an overview of the deals struck between oil companies and nationalistic regimes around the world.

It says that "
despite all this huffing and puffing there is no consensus on what constitutes a good deal from the energy-rich state's viewpoint; and countries with the fiercest rhetoric do not always succeed in driving the hardest bargains."

This is an insightful piece worth a read.


Barking louder, biting less
Mar 8th 2007, From The Economist print edition

NEO-COLONIALISM, crude exploitation, plunder, blood-money: no term is too inflammatory, it seems, for critics of Iraq's proposed oil law. If passed in its current form, it will allow Iraq's weak, American-backed government to flog the national patrimony on the cheap, by signing unduly generous contracts with foreign oil firms. At least so the argument goes, especially among radical types who are inclined to write off America's whole strategy in the region as one of mercantilism backed by bombs.

In a similar spirit of stridency, Venezuela is now insisting on renegotiating the few remaining contracts with Western oil firms that it has not already overhauled. In Russia, meanwhile, an increasingly abrasive President Vladimir Putin is making it clear that in future foreign oilmen will not receive as warm a welcome as they did in the 1990s. All around the world, from Algeria to China, governments are changing the terms of investment in oil and gas, on the ground that they are not receiving their fair share of the profits. For critics of capitalism, last year's surge in oil and gas prices seemed to present a long-awaited chance to shift the global balance of power away from corporate behemoths and the governments that are closest to them.

But despite all this huffing and puffing there is no consensus on what constitutes a good deal from the energy-rich state's viewpoint; and countries with the fiercest rhetoric do not always succeed in driving the hardest bargains. The proportion of oil revenue that goes to governments can vary from as much as 90% to as little as 10%, according to Saad Rahim of PFC Energy, a consultancy. And there are many reasons—quite apart from differing levels of nationalist self-assertion—why the picture should be so mixed. Some countries have small or relatively inaccessible reserves, or no known reserves at all, and so have to offer favourable terms to entice foreigners' interest. Other states might seem like risky places to do business of any kind (thanks in some instances to past nationalisations of the oil industry) and must therefore offer preferential terms to woo investors. Others agree to sacrifice some of their take for the sake of creating extra jobs or diversifying the economy.

Governments (including those of rich countries, even the United States) often end up with a reduced share of oil revenue for less edifying reasons, such as sheer incompetence. By their own admission, American civil servants accidentally left a critical clause out of contracts signed in 1998 and 1999 with oil firms drilling in federal waters, doing taxpayers out of as much as $14 billion. The same officials are now warning Congress that its efforts to recoup the money might cost the government even more, in the form of expensive lawsuits and delays to future payments. Poor countries, with underfunded and corrupt bureaucracies, often have an even harder time keeping oil firms in line.

A common mistake made by energy-rich states is entering short-sighted contracts that take no account of possible changes in the oil price. Venezuela signed the deals it now wants to repudiate in the 1990s, when oil fetched as little as $10 a barrel. At that price, the arduous process of extracting something useful from the country's plentiful deposits of tar-like “heavy oil” was barely profitable. So the government offered to lower the income-tax rate for such projects and levy royalties of just 1%. As the oil price soared over the past few years, those enticements began to seem impossibly munificent.

Russia is another place where circumstances have changed. It was broke and desperate to attract investment in 1994, when it signed a contract with a consortium led by Royal Dutch Shell to develop oil and gas reserves off its Pacific coast. To persuade the investors to take on such a tricky job in a country with such parlous politics, the government agreed to forgo its share of the revenues until they had recouped their costs. But it did not foresee the long delays and near-doubling of projected costs that have afflicted the scheme and pushed back its payday.

Most oil-rich countries are trying to move away from such rigid regimes. But there is little consensus about what should replace them. Many governments are signing contracts with variable terms, so that as the oil price rises, either tax rates rise with it, as happens in Malaysia, or the state-owned oil company's share of production increases, as in Azerbaijan.

Some countries, including Angola, have gone as far as specifying a fixed rate of return on investments, beyond which almost all profits go to the government. But such deals lead inevitably to rows about what counts as a legitimate expense on which a profit should be earned. Angola's contracts for offshore production are structured in such a way that firms actually make more money if projects exceed their budgets—a set-up that can lead to gold-plated cutlery in the staff canteen, according to Graham Kellas of Wood Mackenzie, a research firm. Iran, in contrast, forces foreign contractors to bear almost all the expense of cost overruns—a massive risk for oil firms given the current run-up in the price of both materials and labour throughout the industry.

Nationalist rhetoric often clouds the substance of the issue. After all, Qatar, which has welcomed big Western oil firms with open arms, has managed to secure a greater share of the revenue from its oil and gas than any country in South America, despite all the tub-thumping talk of ending foreign exploitation. Even after Ecuador introduced a windfall profit tax on oil firms last year, it still offers investors bigger profits on each barrel they pump than Alaska, America's biggest oil province, according to Wood Mackenzie's calculations. Recent tax changes in Britain cost oil firms more money than similar measures in Venezuela. In terms of the percentage of future profits gobbled up, Britain's taxmen have been even greedier than Russia's (see chart).

Self-proclaimed “resource nationalists” do not even agree on what the phrase means. Iraqi firebrands insist that any arrangement that gives foreign oil firms a formal claim on any of their country's oil or gas is an unpardonable affront to national sovereignty. Meanwhile Venezuela's President Hugo Chávez is forcing foreign oil firms to migrate to contracts that do just that. The issue is not as arcane as it sounds: foreign oil firms are often willing to pay handsomely not just for the right to pump oil, but also for notional ownership of it, which makes a big difference to their accounts, in America in particular.

Nationalists also tend to encourage state-owned firms to take an ever-larger role in the oil industry, both as a matter of national pride and to build local expertise. But setting up a state-owned oil firm is a big expense in itself. They are rarely as efficient or capable as their private partners, and often run expropriated assets into the ground. After Rosneft, a Russian state-owned oil giant, took over some oilfields from Yukos, a private rival, their output actually fell, although it is now rising again. The Russian state may have reasserted its control over the oil industry, but production, and government revenues, are almost certainly lower than they would have been with greater private investment.

Raising taxes, which Russia has also done, is a simpler and often more effective method of maximising the government's take. Norway, for example, levies a swingeing 78% tax on oil firms' profits. By contrast, its state-owned oil firm, Statoil, manages to recoup only a further 6-7% of the industry's profits by actively investing in wells and rigs.

Perhaps the most elegant option for governments is to ask investors what share of the revenue from any given field they would be willing to surrender, and award production rights to the one that makes the highest offer. In 2005 Libya held such an auction, in which foreign investors agreed to hand over more than 90% of any oil they found in ten of the 23 areas up for grabs.

As those figures suggest, even oil firms themselves are coming round to the idea that the most profitable contracts are not always the best, since revanchist governments are likely to renege on any deal that seems too onerous in hindsight. Many big projects have prospective lifetimes of 20 years or more, and financing arrangements built around such expectations. In such cases, a stingy but predictable regime might be preferable to a lucrative one that suffers from frequent or dramatic revisions. By that measure, the worst place to produce oil is not Russia or Venezuela, according to Mr Rahim, but Britain, which is constantly tinkering with its tax rates.

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