Venezuela, oil prices and political risk

Following the extraordinary people power uprising that toppled the government of Ukraine, and after weeks of protests in Caracas, Venezuela’s capital, many are asking, “will Venezuela be the next Ukraine”? There are asking the wrong question. The question is, will Venezuela be the next Iran? Resource prices and political risk have long been correlated. When resource prices go up, governments tend to seize the assets of natural resource investors, whether through expropriation or extreme levels of taxation. The oil price boom of the 2000’s was accompanied by seizures of foreign-owned oil investments in, for instance, Venezuela, Bolivia, Russia, and Kazakhstan. This was by no means a new pattern. In the 1970s, the same phenomenon occurred: oil prices skyrocketed following the Arab oil embargo. Within a few years, nearly every major Western-owned oil and gas (and mining) investment in the emerging world had been seized – expropriated or nationalised – by host governments. There is another lesson to learn from the 1970s resource-price surge. That is that eventually, resources prices will fall. And when they do, a new type of risk emerges. Regimes that have become dependent on oil revenues suddenly find they are desperately short of money. If these regimes have been relying on measures such as seizures of the assets of foreign investors to stay afloat, chances are their macroeconomic management is not very good. The result is that when oil prices fall, the hitherto fast-rising incomes in these countries tend to crash (bad economic policy is procyclical), just when the fast-rising flow of resources available to the government to pay off supporters comes to a sudden stop....

A new wave of expropriations?

With oil prices near $60/barrel, it seems like the best of times for oil companies. But it easily could be the worst of times. Recall the tumultuous sequence of events that followed the last global surge in commodity prices, during the 1960s and 70s. In the mid-1960s, copper prices jumped by more than 50 percent and then kept on rising. 1968 was the best year yet for Anaconda Copper’s Gran Mineria mine in Chile. Profits had more than doubled. US-based Anaconda contended for the title of the world’s largest metal producer; and in Chile, Anaconda owned the world’s largest open-cast copper mine. Then, in 1969, the Chilean government announced it was revising Anaconda’s concession. Two years after that, the government seized the mine, paying Anaconda little compensation. Following this political risk loss in Chile, Anaconda Corporation suffered a financial meltdown. By 1977, Anaconda had ceased to exist, its remaining assets snapped up by Atlantic Richfield. The demise of Anaconda was only one among many such incidents. During the 1960s and 70s, host-country seizures of foreign direct investments claimed a staggering one-fifth of the value of US investment in the developing world. Well over 1,500 foreign affiliates of multinational firms were taken, many with little or no compensation. It is widely assumed this could never happen again. The conventional wisdom has it that these expropriations were driven by ideology – communism and post-colonial nationalism. The incidents most remembered today are the seizures of private property that accompanied upheavals like the Cuban revolution. These were complete, indiscriminate, uncompensated and clearly political. But the conventional wisdom is wrong. The number of such...