Wednesday, August 16, 2006

Energy Nationalism

Energy nationalism has been on the rise for some time, with oil- and gas-rich states such as Russia and Venezuela flexing their muscles in foreign markets and harassing private-sector operators at home. In its lead article on August 15th the Economist Intelligence Unit of The Economist magazine outlines why a key player in this movement--Bolivia--has seen its plans for energy nationalisation grind to a halt. Could this signal a turning of the tide?

Bolivia industry: Easier said than done
August 15th 2006
COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT

Bolivia’s government, led by socialist President Evo Morales, has been forced to suspend its programme to nationalise the country’s oil and gas resources. A key element of Mr Morales’s electoral platform last year, the nationalisation was announced on May 1st and was to have been completed within 180 days. However, the truncated state energy company, Yacimientos Petrolíferos Federales Bolivianos (YPFB), has proved incapable of meeting that target owing to a lack of capital, personnel and technical expertise.

YPFB’s troubles should come as no surprise. Mr Morales’s nationalisation deadline was an overly ambitious one, particularly given the weakened condition of the state company. His timetable for restructuring YPFB, 60 days, was even less realistic. Following the privatisation of the industry in the late 1990s, YPFB was little more than an administrative entity with no direct operations or role in exploration and exploitation of the country’s vast natural-gas reserves, the largest in Latin America after those of Venezuela. After his inauguration in January Mr Morales immediately began taking steps to resuscitate the virtually defunct state company, but time, and money, proved lacking.

The biggest operators since the 1997-99 privatisations have been foreign companies. These include Brazil’s Petróleo Brasileiro (Petrobrás), Spain’s Repsol, France’s Total, British Gas and BP of the UK, and ExxonMobil of the US. Some 20 foreign energy companies operate in Bolivia, and their investments total around US$3.5bn.

Too bold

Mr Morales had been expected to put the industry back under state control, given his campaign promises and passage of a newhydrocarbons law a year earlier. But the boldness of his May 1st actions was unanticipated. His announcement of a swift nationalisation was filled with populist rhetoric, and he called in troops to temporarily take over and “guard” 53 privately run energy installations, including gas fields, pipelines and refineries.

Most surprisingly, he made the announcement at a field operated by Petrobrás. The Brazilian firm, itself majority state owned, is the biggest operator in Bolivia’s energy industry, and relations between the two countries had been very co-operative until then. (Petrobrás has invested about US$1.5bn in exploration, production, pipelines and refineries since 1999, not including a majority stake in the US$2bn Bolivia-Brazil gas pipeline, which was completed in 1999.) Brazil is also the largest market for Bolivia’s gas exports, and is essential to the government’s plans to expand gas exports and industrialise natural gas.

Although the May 1st actions could be viewed to a large extent as political theatre designed to satisfy the demands of the most hardline nationalists among Mr Morales’s supporters, they nonetheless hit the headlines internationally and upset foreign operators and Brasília in particular, which had hoped for a more accommodating stance.

The plan was not to outright expel foreign companies. Instead, the operators were given 180 days to sign new contracts and agree to give the state majority (51%) ownership and to channel all their sales through YPFB, or else “leave the country”, the president said at the time. Taxes on the country's two largest gas fields operated by Petrobrás were raised from 50% to 82% (which was the second substantial tax increase on the hydrocarbons sector within a year).

This approach mirrors that of Venezuela’s controversial president, Hugo Chávez, last year, when foreign oil companies were forced to renegotiate new production contracts that gave the government more control and higher royalties. Early in 2006 Venezuela’s government seized oilfields operated by two companies, France’s Total and Italy’s ENI, that refused to sign new agreements. The state oil firm, Petróleos de Venezuela (PDVSA), is advising Mr Morales.

Big limitations

Mr Morales has a close relationship with Mr Chávez, and has clearly taken a page out of Mr Chávez’s playbook in dealing with energy multinationals. But unlike Venezuela, Bolivia is not awash with oil export revenues to reinvest in its economy and energy industry. The poorest country in South America, it is dependent on foreign company financing and expertise to exploit and transport its huge gas reserves. These, in turn, are crucial to generating the fiscal revenue needed to increase social and infrastructure spending and meet the country’s debt obligations.

With the announcement on August 11th that the “full effect” of the nationalisation would be suspended, it is clear that YPFB is in no shape to manage Bolivia’s energy industry on its own, at least not yet. Indeed, most of the industry remains in the hands of the foreign operators.

YPFB has a shortage of qualified technical and management personnel and lacks the money to bring in the required expertise. According to the Ministry of Hydrocarbons, YPFB has annual financing of US$22m but needs US$180m to take control of the productive facilities. The company has asked Bolivia's central bank for the funding, but Bolivian law prohibits the bank from extending credit to public entities except in emergencies.

The suspension of the nationalisation process also reflects the difficult ongoing price negotiations between Petrobrás and the Bolivian government. The May decree envisaged the renegotiation of prices paid by Brazil and Argentina for Bolivia's gas. The Morales administration managed to reach a temporary agreement with Argentina’s government in late June, which established a 40% increase in the export gas price. However, Petrobrás has resisted a similar agreement, which forced the Bolivian government to announce on August 11th that negotiations between the two countries–previously expected to be concluded by end-July—would be extended for 60 more days.

Studying its options

The government now plans to study three models for restructuring YPFB, in order to convert the 70-year-old firm into a modern enterprise while complying with the nationalisation decree. To achieve this, and to operate the industry, it will probably have to rely on substantial help from the Venezuelans, but this too may not be enough. Instead, it will have to convince the existing foreign operators to stay, albeit under tightly controlled conditions, and will have to attract new investment.

Yet the Morales government’s energy policies have jeopardised future investment in the industry. Petrobrás alone had a US$5bn investment programme to develop Bolivia’s gas resources in partnership with YPFB, but that programme is currently suspended. Further, according to an association of Bolivian oil and gas companies, more than 30 foreign and domestic firms have ceased operations or taken their business to other South
American countries since May 1st.

Since Mr Morales’s election and in particular since May 1st, foreign investors have worried increasingly about contract stability, property rights, the leftist orientation of the government and the influence of Venezuela’s Mr Chávez. The latest developments only add to the uncertainty surrounding Bolivia’s energy policy and its ability to sustain its critical gas industry.


Venezuela/Russia politics: Newfound friends
August 1st 2006
COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT

Venezuelan President Hugo Chávez’s fourth visit to Moscow, to meet Russian counterpart Vladimir Putin, signals a burgeoning bilateral relationship. The trip focused on new arms deals and energy co-operation. Both countries also used the occasion to further their international ambitions, inflated by windfall oil revenues. Yet while the Venezuelan president aspires to a strategic partnership, Mr Putin has a more limited agenda—and views Venezuela almost as much as an instrument as a partner.

On July 27th the two presidents sealed a US$3bn agreement whereby Russia will sell to Venezuela advanced fighter jets and helicopters. Caracas has sought the accord for a year and a half, since the administration of US President George Bush—with which Mr Chávez has a hostile relationship—banned the sale of military supplies and spare parts to Venezuela. The Russian aircraft will begin to replace Venezuela’s ageing fleet of US-supplied fighter jets and other equipment. The US opposed the sale, arguing that Venezuela’s purchases of military materiel are unnecessary for its own defence and are a threat to regional security.

As relations between Caracas and Washington have grown colder in recent years, Mr Chávez has reached out to other countries, including many with similar nationalist and anti-US ideologies. These include Cuba, Iran, Syria and North Korea. Before arriving in Moscow, Mr Chávez also visited—and avidly embraced—the authoritarian president of Belarus, Aleksandr Lukashenko.

Energy burst

While the military supply deal was of most concern to the US, the meetings between Messrs Chávez and Putin focused largely on energy accords. Both countries are major oil producers—Russia is the world’s second-largest and Venezuela the fifth—and are benefiting from record high oil prices. In terms of natural gas output, Russia is the largest and Venezuela the eighth-largest in the world.

Russia’s biggest oil company, Lukoil, has begun exploration work in Venezuela’s Orinoco basin. And Gazprom, the state-controlled gas monopoly with aspirations to be a global energy giant, has obtained licences to work in the Rafael Urdaneta gasfield. It has also agreed to work with state energy company Petróleos de Venezuela (PDVSA), to develop the Venezuelan gas industry over the next 50 years. These are the first forays for Russian companies into Venezuela, and Mr Putin said they might eventually spend billions of dollars there. Gazprom might even participate in the construction of a massive US$20bn, 8,000-km pipeline project extending from Venezuela to Argentina. The company has a penchant for, and plenty of experience with, huge infrastructure projects.

The axis of oil?

The meeting in Moscow was not one of minds, however. Motives differ markedly. Mr Chávez, who consistently fuels tensions with Washington with his anti-US rhetoric, had both business and ideological reasons for visiting Moscow. The military deal was a slap in the face to the Bush administration. The US also strongly protested previous arms sales, involving 100,000 Russian Kalshnikov assault rifles that were agreed in 2005, with first shipments arriving this year. Venezuela has said it is interested in buying 920,000 more, or, alternatively, building a factory to manufacture them on Venezuelan soil. It reportedly may even have ambitions to become a supplier of Russian weaponry to other governments in Latin America.

Oil, however, is a still more potent weapon for Mr Chávez, and he is keep to forge an anti-US oil bloc with other major energy producers. This is despite the fact that the US is the largest market for Venezuelan oil, taking some two-thirds of Venezuela’s exports.

As Venezuela’s efforts to lead an anti-American bloc in Latin America, his first front, have floundered—other leftist or radical nationalists recently have lost elections in a few countries in the region—he has expanded his outreach beyond the Western Hemisphere. Mr Chávez is also trying to bolster international support for his bid to get Venezuela a non-permanent seat on the UN Security Council, which opens up in 2007. The US resists this, and is lobbying for Guatemala instead.

Putin’s prosaic vision

Russia, for its part, is not entirely welcoming of Mr Chávez’s overtures. It did not treat the Venezuelan’s trip as a top-level state visit, but rather downgraded it to a working meeting with informal talks between the two presidents. Mr Putin was even cautious with his body language, avoiding the brotherly embraces that Mr Lukashenko of Belarus so willingly accepted. He also stated publicly that his government’s co-operation with Venezuela was not aimed against any particular country but was rather designed to “develop our economies and raise the living standards of our people".

Mr Putin is not interested in a strategic relationship with Venezuela, nor in leading a global, anti-US bloc—even though the mix of co-operation and competition in his approach to the US has tilted towards the latter of late. Rather, the embrace of Mr Chavez serves a few specific political and commercial interests.

Commercially, the openings in Venezuela’s oil and gas industry are valuable for Russian companies. It is not surprising that Lukoil is leading the way in Venezuela, as it is the only Russian major at present to have sizeable production located outside Russia. Opportunities in gas may be greater still, and this is all the more important for Mr Putin because the Russian beneficiary would be state champion Gazprom. The company’s leadership, with Mr Putin’s support, is determined to make Gazprom a global energy giant, with upstream and downstream assets in gas, oil and power both in Russia and abroad. A presence in gas-rich Latin America, which is oriented primarily to markets that Gazprom will not otherwise tap, is highly desirable.

Arms sales are another important element, as they constitute Russia’s major source of foreign exchange after the export of raw materials. Faced with the loss of many of its traditional markets in eastern Europe to NATO suppliers, Russia has a strong interest in breaking new arms markets in Latin America. Mr Putin noted other areas of potential collaboration for Venezuela: finance, machine-building, mining, metals, chemical, transportation, and other military and technical co-operation.

The new Cuba

Politically, by receiving Mr Chávez just days after the G8 summit in St Petersburg, Mr Putin has demonstrated Moscow’s determination to pursue a foreign policy line independent of the US. It is doubtful whether, two years ago, Mr Putin would have agreed to schedule Mr Chávez’s visit so soon after meeting his fellow G8 leaders. Now, however, the country’s leadership is suffused with confidence on the back of strong economic growth and huge oil revenues. The impression that the US is bogged down in Iraq and struggling to deal with the Iranian nuclear problem heightens Russian confidence.

For Mr Putin, the Chávez visit had specific political attractions. Moscow has been irritated recently by US criticism of Russia’s record on democratic and political freedoms, as well as high-profile US support for Georgia, Ukraine and other pro-Western states in the former Soviet Union. By embracing the Venezuelan president, Mr Putin probably feels he is paying back Mr Bush in kind—and signalling that if the US administration is intent on mischief-making in Russia’s backyard, then Moscow will reciprocate by supporting Mr Bush’s foes in the Americas.

Venezuela is thus a bit-player in Russia’s own global power game. For this reason, Moscow is likely to continue to rebuff calls by Caracas for some type of grander geopolitical alliance. Instead, it will keep the relationship within the realm of energy and other sectoral co-operation—while perhaps relishing the fact that its growing ties to Mr Chávez are another thorn in Washington’s side.

Russia economy: Another oil asset grab?
May 26th 2006
COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT

Russia’s ministry of natural resources has suggested that local firms take majority control in three major oil and gas developments operated by foreign majors, including the giant Sakhalin-1 and -2 projects. Opportunities for foreign investors in oil and gas have been curtailed recently, but this proposal threatens to roll back existing deals. With oil prices high and global opportunities for oil-sector investment limited, the authorities perhaps calculate—with some justification—that they can seek to change investment terms without unduly negative consequences. Just as worryingly for the economy, this seems underpinned by an erroneous belief that the oil sector can be more efficiently run by state companies than private ones.

Russia’s ministry of natural resources on May 25th announced its backing for a review of the Production Sharing Agreements (PSAs) that underpin the development of three major oil projects: the offshore Sakhalin-1 field, which is operated by ExxonMobil; Sakhalin-2, which is led by Shell; and the Kharyaga field in the Arctic, which is operated by Total. The ministry’s statement was occasioned by a report from the Russian Academy of Sciences which criticised the foreign companies for delays and cost overruns, and argued in favour of changing the contract terms in favour of the Russian state and Russian companies. A ministry spokesman added that this did not (yet) reflect the ministry’s position, but that the proposals appeared sensible and that it was desirable to have stronger Russian ownership in the two Sakhalin projects.

Almost certainly the ministry was floating a trial balloon with this statement. Representatives of the economy and industry ministries rejected any suggestion that the PSAs were open to review.

Less open

The reaction of other ministries underlines that any move against existing PSAs would be resisted within the government. Nevertheless, the mere suggestion is worrying for foreign investors, particularly given the context.

Already the Russian investment environment has become less open towards foreign oil companies. It is all but certain that BP’s 2003 link-up with TNK, by which the UK major gained 50% of the merged venture’s operations, represents the high-water mark for foreign investment in Russian oil. ConocoPhillips’ 2004 investment in Lukoil, which was limited to a maximum of 20%, reflects the ceiling level of foreign participation in an established Russian oil major or oil project today.

With regard to new projects, which have huge development costs and are often technologically demanding, foreigners have more to offer—and hence have the potential to insist on a greater share. Yet here too the government has sought to place limits on foreign participation, insisting that foreigners cannot have more than 49% of any venture engaged in developing a “strategic” deposit. Currently any field with reserves of more than 150m tonnes of oil or 1trn cubic metres of gas is defined as strategic; however, the natural resources ministry is now considering a proposal to lower these thresholds to 50m-100m tonnes of oil or 500bn cu metres of gas. For the major projects that need development, such as the third, fourth and fifth blocks at Sakhalin, the authorities still envision a role for foreign capital and expertise. The difference today is that they hope this will be provided in return for less than 51% of the equity.

This narrowing of investment opportunities in Russia is frustrating for international oil companies. The threats to Sakhalin-1 and Sakhalin-2, however, are qualitatively different—they involve an attempt to rewrite existing deals without which those projects would not have been developed. If acted upon, it will mark a move from legitimate behaviour to illegitimate.

It is worth noting that Russia’s government, if it decides to seek changes in the Sakhalin PSAs, might struggle to achieve its goals. PSAs evolved as a way of offering protection to foreign investors for long-term, high-cost investments in unstable business environments (which is a reason why the current Russian government decided several years ago to discontinue signing them). As a result, the Sakhalin PSAs should be legally watertight. Amending or revoking them could, for the government, be prohibitively costly.

Energy nationalism unleashed

Regardless of how easy or difficult it will be to change the PSAs, the government’s intentions are now open to question. In Latin America, oil- and gas-rich nations such as Venezuela, Bolivia and Ecuador have recently taken control of hydrocarbon assets owned by foreign investors. Although the Russian government embraces a stronger national presence in the oil sector, principally through state-controlled vehicles such as oil firm Rosneft and gas monopoly Gazprom, it has yet to cross the line of seizing foreign-owned assets. The Yukos example is often cited, but that was primarily a political dispute that only later developed an economic character. Unless a foreign oil company presented a political threat to the Kremlin, the Yukos affair offers no grounds for believing that such a firm would be in danger of having its assets seized.

Rather than Latin American-style energy nationalism, Russia has thus far followed a similar path to Kazakhstan. It has sought not to overturn existing contracts, but to seek their revision on terms more favourable to foreign players. TNK-BP has not been ousted from the Kovykta gasfield, but it has found itself unable to begin production in earnest because Gazprom has withheld its cooperation. Almost certainly this will only be forthcoming when TNK-BP offers terms that meet with Gazprom’s approval (to date TNK-BP’s offers have been refused). Gazprom has, however, taken a 25% stake in Sakhalin-2, while Rosneft is hoping to secure a 10% stake in Sakhalin-1.

So far it is more plausible to suggest that Russia is acting like Kazakhstan rather than Venezuela. In the 1990s the Kazakh authorities cut a number of large deals with foreign oil majors on terms that were very favourable to the investors. In the last few years, the Kazakh authorities have succeeded in rewriting these deals—to gain greater tax receipts, equity stakes, employment opportunities and oilfield service contracts—by exerting legal and political pressure. Perhaps a similar process is now underway in Russia. The Kazakh example suggests that this is likely to be successful, in that it will not result in foreign investors walking away. After all, there is still money to be made in Russia and Exxon and Shell have sunk billions of dollars into the country. Besides, there are few other oil regions in the world that allow foreign investors even modest access to the national patrimony.

The Midas touch, reversed

The natural resource ministry’s announcements are interesting not only from the perspective of foreign investors; they also have a bearing on the Russian economy’s prospects. The oil sector has been the main engine of growth in the economy since 1999 and it is certain to remain so for the foreseeable future. In this context, the Academy of Sciences’ assertion that Russian (state) control is more efficient than private foreign control is important, not least because it seemingly reflects a rising conviction in some government circles.

Unfortunately for the Academy of Sciences, the data does not support its assertion. Russian oil output growth averaged 9% between 1999 and 2004, driven overwhelmingly by privately-owned companies. Since 2004, when state champions have taken a greater role and private investment has fallen, output growth has slowed to 2-3%. The performance of Yukos’s former subsidiary, Yuganskneftegaz, underlines this. Between 2000 and 2003 it recorded output growth of 15-20% annually. This fell to 4% in 2004, when the company suffered from financial problems as the attacks on its parent company intensified. In 2005, under Rosneft’s management and with all operating restrictions on it removed, Yuganskneftegaz’s output actually fell by 1.9%. And in the first nine months of that year, its costs rose by 32% year on year in real terms.

Yuganskneftegaz’s experience merely confirms the obvious: state ownership is less efficient and productive than private ownership. Although Russia’s Academy of Sciences disagrees, the further extension of state control over Russia’s oil sector does not bode well for Russia’s economic growth prospects—and for President Vladimir Putin’s hopes to double GDP within a decade. Whether the government, awash with petrodollars and brimming with self-confidence, heeds this message is another question.


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