The Nationalization of Energy Resources and Investment Incentives

The Nationalization of Energy Resources and Investment Incentives

As the price of oil and other energy inputs has risen, countries have attempted to capture a larger share of the profits, often through nationalization of energy resources. However, this undermines the incentive for foreign countries to invest and has led to large losses in production over time since many countries are not capable of duplicating the investment efforts of foreign companies.

These countries could, perhaps, do much better at capturing a share of the profits of oil companies without substantially reducing their incentives to invest by using lessons from incentive compatible utility regulation. A good resource on these issues is "Designing Incentive Regulation for the Telecommunications Industry," by Sappington and Weisman. This regulation is designed to replace older markup over cost regulation that left firms with no incentive to control costs or to increase productivity through new investment and has considerable advantages in that regard. Here's the article on nationalization and falling investment:

Nationalist politics muscle back into world energy, by Carola Hoyos, Financial Times: More than a decade after founding the Organisation of the Petroleum Exporting Countries, Juan Pablo Perez Alfonzo fell out of love with oil. Deeply disappointed by the destructive impact high oil prices had had on petroleum-producing nations such as his native Venezuela, in 1976 he branded it the “devil’s excrement”.

Thirty years on, the price of oil is soaring again and oil-rich countries are following the same route of aggressive nationalism... In the latest manifestation, Bolivia last Sunday nationalised its energy industry, sending in the army to seize gas fields and threatening to expel international oil companies in 180 days if they did not agree to new – and far less favourable – contracts...

As energy-rich countries have become wealthier and less dependent on foreign investors, they have also grown increasingly assertive. Russia has threatened to cut off supplies to its biggest customers unless they agree to higher prices while others, such as Venezuela, have jeopardised investment by imposing onerous new contracts on international companies...

When national governments strengthen their grip, the outcome is more often than not a deterioration in the country’s industry and a drop in output... William Ramsay, deputy director of the International Energy Agency... is in no doubt that the surge in nationalism in Latin America and elsewhere is self-defeating. ... “Look at the production capacity of Venezuela – it has fallen dramatically. ... If you don’t get the balance right between the companies’ interest and the country’s interest, the country ultimately will lose.”...

Julian Lee, of the Centre for Global Energy Studies in London, estimates that factors involving geopolitical crisis and nationalism in Iran, Iraq, Nigeria, Russia, Kuwait and Venezuela have reduced oil supply since 2000 by as much as 7.8m barrels a day – equivalent to the combined consumption of Germany, France, Italy and Spain.

Frederic Lasserre, chief energy analyst at Soci?t? G?n?rale in Paris, adds: “Latin America is the perfect region to witness the impact of nationalism on production. Mexico and Venezuela have stated for the last 10 years that they should be able to increase their oil production. In both cases, the production has not really increased and is even showing some signs of decline.”...

Even where governments remain friendly to international investors, the demands on oil companies sometimes come from rebel groups. In Nigeria, for example, militants have sought direct payments for local communities from oil giants such as Shell.

In Venezuela, the consultancy Wood Mackenzie calculates, the state has seized back $5.4bn from international oil companies by changing contract terms. ... Now the oil ministry is going after contracts in the expensive, heavy oilfield of the Orinoco belt, prompting some foreign executives to assume the worst – the full nationalisation of Latin America’s second biggest oil industry.

Why would that be such bad news for production levels? International energy executives argue that when a national oil company takes over, it does not have access to the technology needed to maximise oil recovery. Meanwhile, other potential fields – such as heavy oilsands – or transport routes, like a project to send Bolivian gas to the US, may not see the light of day because investors are unwilling to commit the amounts needed while the threat of nationalisation hangs over them....

As the oil price rises, and countries become even warier of taking on foreign partners, the balance of power is shifting between international oil companies and the countries in which they are based... No longer can companies get away with asserting their right to exploit oil riches simply on the grounds that they are the best at what they do. “You can’t just say. I am good.... The host country expects more,” ... This could include sharing know-how on building desalination plants and other industrial complexes not necessarily directly connected with the exploitation of oil and gas. ...

Malcolm Brinded, head of exploration and production at Shell, says international oil companies must now ask themselves: “How are we going to make this marriage work?” ... There remains the ultimate prize: Saudi Arabia, which holds the world’s largest oil reserves. But with every dollar rise in the oil price, Riyadh has grown less interested in an alliance with foreign oil companies. Ali Naimi, energy minister, argues ... forcefully ... that Saudi Aramco ... has all the money and expertise it needs to develop the country’s oilfields. But Saudi Arabia may be one of just a handful of oil producers that can make this argument convincingly.