Market principles and the rule of law are under assault. From Russia to Latin America to the US, high oil prices have touched off a round of government activism. While consequences are impossible to predict, they can’t be good for oil and gas companies or their customers.
No country illustrates the seductive power of oil money better than Russia. The vast country is not the rich opportunity that it seemed to be just a few years ago. Its geology holds as much promise as ever, but its political risks have leaped. The government has asserted iron control over Russian oil companies, raised taxes, and limited participation by international investors. This would not be happening if crude prices hadn’t doubled in the past 4 years and fattened national accounts.
Forced renegotiations
High oil prices similarly have enriched the Venezuelan government enough to fund President Hugo Chavez’s socialist mischief. With threats of expulsion, he has forced international operators to renegotiate contracts in favor of the state oil company. And he is coaching Bolivian President Eva Morales in the nationalization of oil and gas. Ecuador’s government, meanwhile, is expropriating a major license from Occidental Petroleum Corp.
The US government, too, is trying out bad old habits. Congress may yet punish producers with a tax hike for earning profits in a strong market, coerce holders of Outer Continental Shelf leases into negotiating away deepwater royalty relief, rescind production incentives passed only last year, and criminalize gasoline “price-gouging” even though the Federal Trade Commission says there hasn’t been any.
If crude still languished below $30/bbl, as it did for most of the preceding decade and a half, Russia, Venezuela, Bolivia, and Ecuador wouldn’t be treating international capital so dismissively, and oil wouldn’t be a US political demon. But prices can’t stay at any level indefinitely. It was inevitable that rising demand would test supply’s ability to expand and that prices would increase. It was just as inevitable that governments would claim growing shares of the new wealth generated in the process. Renegotiating production-sharing arrangements to adjust government and contractor takes is one thing, however; expropriating property-including through capricious taxation-is something quite different.
International oil companies thus face new levels of risk in the relatively small portion of the global hydrocarbon resource base to which they have access. They can’t count on the sanctity of contracts to the extent they once did, and they have growing reason to worry, in a growing number of countries, about the rule of law.
So far, companies have responded to these setbacks with resilience no doubt fortified by profits. They might not be pursuing direct investment in Russian projects as aggressively as they did before Moscow’s crackdown, but few of them are fleeing. The reaction to state heavy-handedness in Latin America has been mixed; most companies apparently will try to renegotiate contracts unless terms become horrid. And if tantrum becomes taxation in the US, companies will adjust investment thresholds accordingly and, as they did in the early 1990s, begin to find prospects more attractive elsewhere.
Companies know governments always become more demanding when oil and gas prices rise. They recognize that the menu of world-scale oil and gas opportunities open to private capital is shrinking. They also know that the price surge enabling or encouraging governments to misbehave won’t last. No price trend ever does.
Activism’s costs
The downward excursion of this price cycle, however, may hold surprises. Crude prices won’t have to slide far, for example, to destabilize some of the regimes now crazed by oil money or to amplify costs of whatever mistakes the US decides to make.
Eventually, wayward governments will rediscover that activism breeds costs. If history is a guide, some of them will return to privatization, deregulation, and new appeals for private investment. An open question is how this latest round of state activism will by then have reshaped parameters for oil and gas investment decisions. The question is central to future oil and gas supply. It’s therefore crucial to energy consumers, few of whom know what’s at stake.