Resource Nationalization: A Smaller Piece of the Pie
Benjamin A. Eisterhold and Michael E. Webber

Soaring energy prices and record-breaking corporate profits have emboldened countries around the world to “reconsider” their relationships with the international oil companies operating within their borders. (Think Hugo Chavez and Venezuela.) While some of these leaders want a “larger piece of the pie,” others think that a strong show of force against international oil companies can boost their political popularity. And it seems to work: Demagogues who rail against Big Oil have been distinctly successful at convincing the proverbial man on the street in an oil-rich country that confiscating foreign-owned assets, levying higher taxes and raising royalty rates will be good for their economic situations.

But the ultimate effect is all too often a “smaller piece of pie” for everyone. Instead of seizing the largest piece they can today, these countries should optimize government royalties and revenues — without making existing and future energy projects unprofitable.

Though nationalization is a time-honored tradition — such as in the Middle East in the 1970s — today, Venezuela embodies the practice. Since his rise to power in 1998, Chavez has been vocal about his desire to return the operation and profits of Venezuela’s vast oilfields to the people. This trend is hardly new: Venezuela underwent its first round of nationalization in 1976. Now Chavez is attempting to take over four projects that are worth $31 billion. But he has run into problems, as both ConocoPhillips and ExxonMobil have filed for arbitration.

Venezuela sits atop the Orinoco Belt, which holds some of the world’s most extensive reserves of hydrocarbons. But because the Orinoco crude is very heavy — making it more difficult to produce, transport and refine — it requires more expertise, specialized equipment and money. Recognizing these difficulties, Venezuelan leaders partially privatized the oil industry in 1995, allowing companies such as Exxon, Chevron and Conoco to bring those tools to bear on the problem. But since Chavez assumed power, the country has moved back toward public ownership, raising concerns about declining production and loss of technical expertise. The extent of these declines is not clear because oil production figures from Venezuela are not transparent — but according to some estimates, since 1999, Venezuela’s oil production has fallen almost 50 percent.

Bringing production back up will require vast amounts of capital and technical expertise, but it is unlikely companies that have just had their properties seized will rush to reinvest. In hindsight, it looks like Chavez’s decision was a poor one.

But before anyone assumes that this kind of backwards intervention is restricted to socialist, non-Western countries, it’s important to recognize that democratic, industrialized, market-oriented Western countries are guilty too. But instead of outright nationalization, they use subtler methods, including attempts to increase government revenues from oil and gas extraction and production by raising royalty or taxation rates. While taxes are a critical way to compensate a society for the extraction of its mineral resources (and countries would be foolish to let oil companies talk them into rates that are too low), raising taxation rates too much can sometimes be counterproductive, not only to the nation’s people, but also to the government’s coffers and the oil companies being taxed.

This scenario played out in the North Sea in 2006 when then-U.K.-Chancellor Gordon Brown doubled the supplementary charge to tax rates for corporations to 20 percent for oil companies — in addition to the already existing 30 percent tax. That brings the total corporate income tax rate for oil companies operating in the United Kingdom to a whopping 50 percent. The government predicted this hike would increase 2006/2007 North Sea tax revenues significantly, but instead, these tax revenues fell from £13 billion to £8 billion. In total, Deloitte’s Petroleum Services group estimated this tax will reduce the cumulative net present values of all North Sea oil and gas projects by 16 percent because companies are pulling back now that the economics of investing in capital-intensive production in declining fields has lost its luster.

Oil has always been a capital-intensive industry, and this is even truer today, with expensive and complex methods like 3-D seismic and directional drilling growing more common. In the long run, nationalization and expropriation, which may have short-term benefits, erode investor confidence and drive out experienced oil companies. And it’s foolish to think that international oil companies won’t remember that their projects were seized the next time a country tries to bring them back in again to boost production.

Unfortunately, higher energy prices lead to more nationalization, which leads to higher energy prices, and thus the cycle feeds itself. So the trend is likely to continue, at least for the foreseeable future.

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