Expropriation of foreign-owned assets—considered passé in the 1990s—became en vogue in the first decade of the 21st century, as the race to control national energy supplies and gain market share prompted an increasing number of governments to nationalize or re-nationalize strategic assets.
The trend toward economic nationalism has also been fueled by greater global income inequality, growing dependency on individual commodities for government revenues, too many countries hitching their economic fortunes to China, and an increasing propensity for oil-producing countries to continue to produce oil outside proscribed multilateral agreements.
Many governments have also demonstrated a willingness to renege on contracts, which international law gives them the right to do as long as compensation is fair, prompt and adequate. As the Spanish company Repsol learned in 2014, when its ownership stake in Argentine oil company Yacimientos Petroliferos Fiscales was expropriated, a decade of profitable operation is no guarantee of future success, and it can take years to reach an agreement on compensation. In the meantime, companies are left to wonder when or if they will ever be paid, while bearing the cost of expensive negotiations and laboring under the burden of halted revenue-generating activities.
If one or two governments were taking such actions, they would be labeled “rogue” and simply avoided by investors, but the rise in economic nationalism is occurring in tandem with “democratic” elections in many developing countries, lending legitimacy to government actions. Venezuelan President Hugo Chavez and Bolivian President Evo Morales, for example, both enforced multiple expropriatory actions of foreign-owned businesses in the natural resource sector in the name of “the people” when they first came to office. The spread of democracy in the new millennium coincided with the rise of extreme political movements on the left and right, with particularly negative consequences for international businesses in certain strategic sectors. Companies operating in mining, power, petrochemicals, telecommunications and technology are particularly prized by governments inclined toward expropriatory activity due to their perceived strategic value.
This is occurring at the same time that the “devolution” process is taking hold in an increasing number of countries. As central governments grant greater political and economic rights to provincial governments, the rules under which contracts were originally negotiated may change, leaving many businesses with little option but to forcibly renegotiate or unilaterally accept the changes imposed on them. This has been seen for years in the coal industry in Indonesia, for example. The quest for political equality on a local level has thus come to transcend borders, with national and international implications.
In some cases, regional autonomy has increased to such a degree that would-be investors must contemplate the possibility that a single country today may become two countries at some point in the future. Some examples of this are Nigeria, which is threatened by ethnic and religious strife between its northern and southern regions, and Iraq, which has been in the process of breaking apart since 2003. The forces unleashed by the Arab Spring will also continue to threaten the sanctity of existing borders throughout the Middle East and beyond.
For foreign-owned businesses operating in strategic sectors of developing economies, the implications are clear. Economic nationalism, rising commodity prices, global competition, extremist political movements and the propensity to expropriate foreign-owned assets all add up to an even more challenging international investment climate in the future. Yet market saturation in the developed world makes the desire to invest abroad—even in risk-prone countries and sectors—inevitable.
With the rise of emerging market titans such as Petrobras, Cemex, Gazprom and PetroChina, international companies of all sizes and degrees of sophistication must become smarter about investing overseas, especially given the rise in south/south and east/west investment. In some respects, emerging market multinationals are better equipped to deal with the multitude of challenges associated with operating in developing countries, thanks to their experience at home in maneuvering through frequently gyrating economic movements, shifting political sands and legendary corruption. Their challenge is to understand that operating abroad will by definition involve new and different norms and standards, with different rules for achieving success.
To maintain their footing, managers must place renewed emphasis on strategic planning and forward-looking risk management at all phases of the trade and investment process. Being reactive is no longer sufficient. Corporate managers must consider how to reevaluate existing activities and analyze new opportunities in light of the rapidly changing global investment climate. The best way to address these risks is to establish risk management procedures that ask the right questions and establish effective methods for managing risk before issues materialize. The ability to conduct realistic and effective scenario planning and stress testing is essential for any international business.
The Curse of Resource-Rich Countries
As governments struggle to meet economic challenges, the propensity of natural resource-rich nations to lash out at foreign investors is likely to grow. Economic and resource nationalism exist everywhere and can have a profound impact on the political, economic, financial, operational, legal, regulatory and judicial climate. What follows is an example of how economic and resource nationalism can play a pivotal role in a critical investment.
In 2009, a consortium led by Exxon Mobil approved a massive and logistically challenging liquefied natural gas (LNG) project in Papua New Guinea (PNG). The PNG LNG project represented a significant vote of confidence in the suitability of PNG’s business environment for foreign direct investment, and a variety of governments backed the project with export credits. Given its size, scope and government support, the project has become a litmus test for future investment in the country.
PNG LNG’s initial $19 billion investment was greater than any other single foreign investment in the country by a wide margin. It was projected the venture would generate $35 billion in revenue over its economic life, and in doing so, double the country’s gross domestic product and triple its export earnings. On completion in 2014, PNG LNG’s production capacity was 6.9 million tons of liquid fuel per year, which will generate more than $100 billion in sales over 20 years. By comparison, the Ok Tedi mine, the country’s largest by export earnings, grossed about $1.5 billion in 2007, representing 32% of total exports and 23% of GDP. Exxon concluded sales agreements with China, Japan and Taiwan, and currently believes the PNG LNG will help meet increased demand, estimated to triple globally by 2030.
PNG’s gas fields are considered the best underdeveloped reserves outside Qatar, and the earning potential exceeds that of PNG’s already substantial gold and copper earnings. Given the lack of indigenous extraction and processing facilities, the sector poses tremendous opportunity for additional foreign investment.
But while LNG could create a windfall for the country, it is also a test. PNG’s economy has long been heavily dependent on the proceeds from resource extraction. The government will likely realize between $5.6 billion and $7.5 billion in total revenue from PNG LNG—more than from any existing single revenue source. But the country has a long history of government interference with foreign direct investment, and of squandering the gains thereof. What’s more, the government has not always competently implemented or managed natural resource projects in the past, which has led to significant downside risks for investors.
The primary risk facing investors is not outright expropriation of foreign investments, but rather blowback from local stakeholders regarding the way resources are developed and how proceeds are allocated, which could cause significant operational disruption. By nature, large-scale extractive projects impact the environment and result in hearty revenue streams, the distribution of which tends to be politicized. Environmental degradation and a perception that proceeds have been distributed inequitably have led to violence and investor loss many times in the past.
The most infamous episode of political violence by indigenous groups against foreign direct investment in PNG occurred with the Panguna copper mine, which opened on the island of Bougainville in 1969. Bougainville leaders claimed the mine, which was operated by London-based Rio Tinto, was causing environmental degradation while the local population received neither compensation nor a share of the mine’s revenue. The local populace perceived the government’s policy as promoting colonial exploitation. In 1989, guerillas began a campaign of sabotage against the Panguna mine. Civil war erupted and more than 20,000 people were killed. The mine never reopened.
In response, a number of foreign investors have adopted internationally recognized best practices to minimize adverse environmental impacts and foster a spirit of cooperation with indigenous communities. For example, Chevron and Oil Search’s management of the Kutubu oil field—the largest in the country—has been described by some as the most rigorously controlled national park in Papua New Guinea. Similarly, Newcrest Mining’s Lihir Gold mine (originally developed and owned by Rio Tinto) was specifically created with heightened sensitivity to local customs and a desire to create the perception of legitimacy and fair play among the indigenous population.
Other firms have tried to address the concerns of all stakeholders from the planning stage onward. By building relationships with local leaders outside government, such project sponsors have gained an understanding of local concerns, built trust, and provided a conduit through which concerns can be negotiated and addressed before they erupt into violence. Instead of relying on the government to ensure local economic development, many companies now commonly include the construction of schools, roads and hospitals in project budgets. Not only are such efforts laudable from a moral standpoint, they also benefit the bottom line by minimizing conflict and disruption.
But as scrupulous and thoughtful as Exxon Mobil has claimed to be with respect to engaging the indigenous population and adhering to internationally accepted environmental guidelines, PNG LNG has encountered many familiar problems. Landowners as a group sought a larger equity share in the project. Others claim to have been unfairly frozen out of benefits or not to have received those that were promised. Unhappy landowners were blamed for disrupting construction of an international airport to service the project site. Tribal disputes related to PNG LNG contracts or funds resulted in multiple fatalities in areas where extraction and processing had been planned.
PNG LNG is evidence that improved performance by the PNG government in implementing and maintaining meaningful foreign direct investment will require changes to existing laws and stronger oversight mechanisms. This will be an uphill battle, however. Transparency International’s 2015 Corruption Perceptions Index ranked PNG 139th of 167 countries surveyed. Despite a modern constitution and a range of laws and institutions designed to attract foreign direct investment, much of the government continues to perform poorly due to years of cronyism, underinvestment in basic services and graft. Politics in PNG has been dominated by “big men,” who have run nepotistic and corrupt governments since the country achieved independence in 1975. The odds of PNG LNG ushering in a new era of government accountability and sustainable economic development are therefore slim in the near or even medium-term. Most likely, PNG LNG will have a neutral or somewhat negative effect on the political environment if its revenue is used to enrich corrupt politicians, as is expected. If that is the case, then the same “natural resource curse” that has bedeviled previously poor/newly rich developing countries will continue in PNG.
The Exxon Mobil consortium and future investors will apply a range of best practices to minimize risk, working around the government as much as through it. Fortunately, most foreign natural resource sponsors have understood the message repeatedly delivered to them by PNG’s people and have taken matters into their own hands, providing infrastructure, housing, education and medical benefits to mine workers and their families.
Learning from History
History plays a critical role in triggering a chain of events that lead to economic or resource nationalism, but so does the prospect of monetary gain (or loss), boundary considerations, and something as simple and ancient as national pride. The spread of democracy over the past several decades is now also coinciding with the rise of extreme political movements on the left and right at the same time that the devolution process is taking hold in an increasing number of developing countries. As central governments grant greater political and economic rights to provincial governments, the rules under which contracts were originally negotiated at a national level naturally change, leaving many businesses with little option but to forcibly renegotiate or unilaterally accept the changes imposed on them. The quest for political equality on a local level has thus come to transcend borders, with both national and international implications.
All of this implies negative consequences for international businesses, particularly in strategic or sensitive sectors. What has changed over time is the degree to which some governments have become emboldened by democratic mandates or their willingness to test the limits of international acceptability, which is becoming more prevalent in an era with limited national budgets, military resources and political resolve. Economic and resource nationalism is here to stay. The challenge is to understand why, how and when.
Agile risk managers and decision-makers invest in countries after surveying the landscape in a multi-dimensional fashion, taking into consideration the lessons of history and what they imply for the future, and developing a realistic, long-term orientation toward the acquisition of profit and ability to operate. Natural resource companies understand and practice this distinction, but many other types of investors do not. In the era of man-made risk, only those companies that understand and integrate such thinking into their risk management and strategic planning practices will survive and thrive in the 21st century.