Political Risk In The International Oil And Gas Industry

Howard L Lax, Calvin Goldscheider

• Publisher: Routledge
• Year: 2019
• Print ISBN: 9780367283568
• eBook ISBN: 9781000307344
• Topic: Politics & International Relations
• Subtopic: Politics
• Index: Politics & International Relations

In this book, the author draws upon his training in political science and experience as an energy consultant at Atlantis, Inc. It explores the conflicting interests of host and firm, and discusses the way firms use political risk analyses leads us to the issue of managing political risk.

I
Introduction

1
Political Risk and Corporate Decision Making

Foreign Investment Decisions

The separation of economics and politics has been one of the key assumptions in the Western approach to the study of social sciences since the Industrial Revolution. Previously, economics was considered a branch of political philosophy or was ignored. The Greek oikonomikos referred to the management or rule over a household or estate. The mercantilist notion of the Renaissance era posited the acquisition of wealth (which actually meant filling the coffers of the King, the head of the "national household" or state) as an obligation of the state.

The era of contemporary economic thought was spawned by Adam Smith—who held a chair in moral philosophy, not economics—with the publication of The Wealth of Nations in 1776. Although the approach was a study in political economy and Smith acknowledged that politics and economics are inseparable, he and his followers drove a theoretical wedge between politics and economics. By positing "a natural economic order with laws of its own, independent of politics and functioning to the greatest profit of all concerned when political authority interfered least in its automatic operation,"¹ questions of economics and politics came to be seen as conceptually discrete.

The doctrines of eighteenth-century laissez-faire capitalism and nineteenth-century liberalism both assumed a separation between the respective domains of economics and politics and advocated a strict distinction as the most sound approach to solving international and domestic economic problems. Carried into the twentieth century, this classical approach viewed politics as an interference that introduced value conflicts and power concerns into the otherwise rigorously rational logic of economics.

The international economy was seen as the national economy writ large. This extrapolation usually was based on the examples of the United States or England. In making the leap from an individual country with a shared set of values and institutional processes to a far more heterogeneous world, theorists continued to assume a commonality based on "sound" economic reasoning. Discounting the political role of states in world affairs, economists spoke (and still speak) in terms of an economic rationality that assumes a harmony of interests that transcends national borders. Ignoring the political motivations implicit in such concepts as the national interest, solutions to economic problems were found in removing political influences from the international economy. It was at this higher plane of human affairs that economic questions were to be isolated from the unwarranted influence of international politics.

Although this idealistic approach has been modified greatly during the course of the century, the pragmatic capitalism that emerged in the post-World War II era still played down nonmarket influences in analyzing and formulating economics and business policies. Domestically, investment decisions were to be dictated by the anticipated rates of return from alternative business opportunities. Similar logic was applied to questions of foreign investment: investments should be made abroad when the expected foreign rate of return exceeded that offered on domestic investments.

In the "ideal" free market economy, companies no doubt would prefer conditions under which their operations were totally removed from political concerns. Increasingly, however, firms have come to realize that political variables constantly impinge upon economic issues that affect the company's operating environment. More immediate to a company's interests, political events and decisions often have a direct impact on even the most routine operations. Particularly in the international setting, the failure to treat economics as a field thoroughly interrelated with politics is a serious shortcoming in most modern economic thought.

In addition to traditional economic or business risks, corporate decision makers have begun to recognize a new category of risks that is political in nature. Foreign government interference in corporate operations was the exception rather than the rule throughout the 1950s and most of the 1960s. By the late 1960s, changing political conditions began to have a greater impact on the interests of firms with investments abroad, and the pattern of politically motivated changes in foreign operations became the norm during the 1970s. In the past five years, more than 60 percent of the U.S. firms operating abroad reported being subject to "politically inflicted damage."²

Although the domestic political environment affects company affairs, most of the focus on political risks deals with investment abroad. Companies tend to be more familiar and comfortable with the domestic environment. Executives understand the political processes at home, know how to influence political outcomes, and see the future as predictably stable. Foreign political conditions, on the other hand, are less well understood and therefore are seen as inherently more risky and less predictable.

Because each country constitutes a distinct business environment and political risks are usually identified with foreign investments, transnational corporations (TNCs)—frrms that operate in a number of countries—are particularly concerned with the impact of political changes on corporate interests. Confronted with a multitude of operating environments, TNCs must cope with a variety of "political and economic systems, each with its attendant controls and risks, advantages and disadvantages, opportunities and dangers."³ Because each state has its own interests, traditions, and institutional processes, TNCs are subjected to a broad range of operating environments under a seemingly endless variety of conditions. The result is a proliferation of both traditional and political risks.

Having experienced repeated confrontations and negotiations with foreign governments and other political entities, TNCs have come to understand that the foreign investment relationship is inherently political. It is now recognized that transnational corporate operations cannot but be affected by and affect the political environment of the host country. The litany of forced divestitures, foreign exchange restrictions, unilateral agreement abrogations and changes, nationalizations, and expropriations,* to name but a few of the risks to which TNCs have been prey for the past two decades, provide mountains of evidence of how politics affects the operations of frrms abroad.

Similarly, corporate activities, even if their motives are apolitical, affect political conditions in host countries. In the natural resource sector in particular, TNCs are essential to the performance of the national economy: many developing countries are almost totally dependent on earnings from exports of resources for hard currency and on tax receipts for government revenues. By the nature of their operations, the ac tivities of TNCs are inseparable from issues of modernization, economic power, employment, and the distribution of wealth. Even in developed countries, the foreign control or ownership of natural resources—and their underlying value—is a sensitive political issue. Foreign frrms also affect the foreign policy and international concerns of states in terms of such issues as trade, balance of payments, hard currency earnings, and the global distribution of wealth and consumption of resources.

Whether as a result of the exigencies of modernization in the Third World or of the demands of economic nationalism in the developed countries, governments are trying to exercise greater control over foreign investors (and, in some instances, over domestic investors). In the most simple economic terms, state governments are trying to maximize the economic and political returns netted by the country and minimize the costs incurred through the operations of foreign companies. Conversely, TNCs are interested in maximizing their earnings from foreign operations and minimizing the additional cost burdens placed upon them by foreign governments.

The use of public policy to regulate sectors in an economy is not new, nor is the wont of governments to circumscribe the activities of foreign firms. What is new is that:

1. the trend to greater government control involves almost all host countries, developed fe and developing, while in the past only a few of the more "radical" regimes were taking such actions;
2. the policies are becoming more explicit and detailed;
3. host government objectives have grown both in range and depth; and
4. host efforts are more likely to succeed than ever before because of the shift in bargaining strength (particularly with respect to natural resources) in favor of host countries.⁴

The reality confronting firms going abroad is that political events influence operations more than ever before. The future promises to follow a similar pattern, by which political conditions will remain a central variable determining the viability of foreign investments and presenting TNCs with risks and opportunities.

Oil and Gas

To a large degree, host governments' assertiveness of control over their respective national economies has centered on the issue of natural resources. Petroleum—the most important resource, measured in terms of the value and tonnage of world trade,* its use as a material input in advanced economies, and the political intensity of concern on the part of host and home governments and TNCs—occupies center stage in the world political economy. As a logical correlation to the amount and intensity of political activity that has been focused on oil (the focus on natural gas has traditionally been low-key and only in the early 1980s has begun to assume international political proportions), the attendant political risks confronted by oil companies have been particularly high.

Virtually every major oil-production agreement abroad has been subjected to renegotiation or unilateral alternation in favor of the host country. Foreign equity in crude has all but disappeared, exposing the oil firms to risks of supply shortages and interruptions and price instabilities. Although the nonconcession modes of agreement often imply a reduced capital investment on the part of the companies, which translates into a reduced amount of economic exposure to risk, the uncertainty and vagaries of the political economy of petroleum create a high-risk environment. Many of the modern service agreements, moreover, require that the oil companies assume the burden of the initial capital outlays involved in the preexploration stages of a project. As such expenses may involve tens of millions of dollars, the political risk that a host government will alter the terms of an agreement after a commercial find has been proved is very real to the companies involved.

All four of the previously mentioned trends are painfully evidenced in the world petroleum industy. Host governments of all political complexions, and states spanning the gamut from the Third World to the industrialized nations, have intervened to play a larger role in the devdopment and disposition of their petroleum and natural gas resources. Democracy or autocracy, capitalism or socialism, North or South—when it comes to regulating foreign involvement in a state's petroleum and natural gas resources, countries tend to pursue similar goals of maximizing domestic economic returns and political control.

The explicitness and detail of host intentions are usually clear. Since the 1968 OPEC Declaratory Statement outlining ten particular policy goals, most petroleum producers have openly expressed their intentions. Often the policy aims with respect to the country's hydrocarbon development are incorporated into the general policy plans of the state. As a state's hydrocarbons policy has become increasingly important to broader domestic and foreign policy concerns, moreover, the range and type of government objectives with respect to petroleum and natural gas have expanded. Beyond the mere reflex action of maximizing economic returns, governments often seek to channel the petroleum sector to further multiple goals, including regional development, manpower training, welfare concerns, the distribution of wealth, political stability, and an array of other national priorities.

Finally, the measure of success that the oil-producing countries have enjoyed is evidenced by both the reactions of the consumer countries and the attempts at mimicry by countries whose economies are dependent on other primary resources. In economic terms, success is quantifiable in terms of the relative and absolute increases in petroleum prices,* the trade surpluses enjoyed and economic reserves (mostly U.S. dollars) hdd by the more wealthy OPEC producers, the rdative terms of trade between crude and other goods entering world trade, and the profit split between producer countries and oil companies. Although the current crude "surplus" (which has been partially engineered by Saudi Arabia) appears to have given oil companies and consumers some respite from price and supply pressures, the market in the 1980s is largely producer controlled. The success that oil-producing states have realized, moreover, has spilled over from the marketplace and has been translated into a wide range of political, social, military, and economic goals.

What is Political Risk?

Thus far we have not defined the concept of political risk. Like many terms in the social sciences, political risk is surrounded by a vast array of definitions, some better than others. We use the term better not in the normative sense of preference, but in reference to the descriptive and explanatory value of a definition.

By itself, risk commonly is used to refer to the "chance of injury, damage, or loss, compared with some previous standard."⁵ Unlike uncertainty, which deals with a subjective potentiality of a loss, risks are measurable probabilities. Although the distinction between risk and uncertainty is often difficult to ascertain and may seem academic, there is a crucial conceptual difference: both terms refer to future likelihoods, but risk implies the ability to calculate probabilities and therefore to protect against and manage future contingencies, whereas uncertainty does not.

Risk is a dynamic concept that revolves around the probability of changes. Cur rent conditions are not risks; rather, risk stems from changes in those conditions. The rules governing an investment are a current parameter at the time an investment decision is made. Risks are future occurences that may change the rules.

The adjective political c...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Dedication
• Contents
• Foreword
• PART I INTRODUCTION
• PART II THE INTERNATIONAL PETROLEUM INDUSTRY
• PART III THEORY AND PRACTICE IN POLITICAL RISK ANALYSIS
• Selected Bibliography
• Index