Author: Paula L. Green

FOCUS / ECONOMIC NATIONALISM


As if the global credit squeeze were not enough, multinationals, particularly in the commodities industries, are also facing a surge in resource nationalism.

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Horne: Companies are investing in riskier areas.

Fueled in part by soaring commodities prices and a socialist response to economic and political turmoil, a new brand of 21st century economic nationalism is engulfing multinationals, decades after anti-imperialist fervor swept the developing world and led to the outright takeover of foreign assets. This latest wave of expropriation—also referred to as resource nationalism—has emerged largely in developing nations where oil, gas, metals and other commodities are extracted.


One of the most high-profile examples of the phenomenon occurred in Venezuela last year when two US oil companies, ExxonMobil and ConocoPhillips, were forced to abandon multi-billion-dollar investments. More recently, gradual yet persistent pressure from the Russian government prompted TNK-BP, a Russian subsidiary of British energy giant BP, to sell a major stake in its oil business to the national gas monopoly Gazprom.

Sergei Guriev, associate professor and rector of the New Economic School in Moscow, believes the growing trend toward nationalization of key industries in developing nations has been prompted by the sharp rise in commodities prices. “It is related to the high oil prices when immediate benefits of outright expropriation are just too tempting and outweigh all future potential benefits of maintaining good relations with the West,” he says. “The oil and mining [industries] are the leading examples. The reason is, it is easier to capture the rents.”

Yet the expropriation of foreign-owned assets, which enveloped the gas industry in Bolivia more than two years ago and threatens the mining sector in neighboring Ecuador, recently engulfed cement manufacturers in Venezuela. In late August president Hugo Chávez ordered national guard troops to seize two plants owned by Mexico’s Cemex, the country’s largest cement producer. Two other foreign-owned cement companies, Lafarge of France and Holcim of Switzerland, agreed to a compensation price before the deadline, but Cemex was unable to reach an agreement on price with Venezuela.

“It’s gone way beyond commodities,” says Corina Monaghan, vice president at global reinsurance firm Aon’s trade credit and political risk division. Industry observers say Chávez is attempting to meet the country’s home-building and infrastructure goals by nationalizing the cement industry.

Creeping Expropriation
Keith Dunford, worldwide underwriting manager and vice president at Chubb Political Risk, agrees that resource nationalism is a troubling trend that multinationals around the world have been grappling with for the past four to five years. “As commodities prices have skyrocketed and the agreements between governments and companies were signed beforehand, we’re starting to see governments more prone to move against a company and take it over,” he says.

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Riordan: The perception of risk has risen sharply.

Dunford says some of the events occurring in Russia, such as those surrounding Yukos, the former Russian oil giant, were not outright expropriations but examples of what he calls “creeping expropriation.”
So-called creeping expropriation occurs when a series of small acts eats away at the profit of the company. “The government meddles and pushes and pulls and goes back and forth; [company executives] throw up their hands and get out,” Dunford explains.

This more subtle political risk can emanate from a number of sources, ranging from new laws that favor local companies, to taxes slapped on a specific product manufactured by a foreign firm, to provincial governments’ bureaucrats arbitrarily and abruptly changing the operating rules for foreign firms. “The government just keeps eating slices of the pie one by one,” says Monaghan.

Many of the companies involved are reluctant to talk about what is happening, Monaghan asserts. “They’re not going to be talking about it. They don’t want to offend their future business partners,” she says. “And they don’t want to upset the host government.” For this reason, it is difficult to nail down numbers detailing the increase in expropriation incidents. “Companies don’t advertise when their assets are expropriated,” she says. “It’s a competitive issue.”

Yet the trend is translating into a sharp rise in corporate inquiries about political risk insurance—the most common method for mitigating the risk. Dunford says he has seen inquiries about political risk cover jump 20%-30% over the past year. The other alternative is self-insurance, when a company simply decides to absorb the loss on its balance sheet if an overseas investment turns sour.

Daniel Riordan, president of Zurich North America’s surety, credit and political risk group, says concern has escalated among executives, shareholders and ratings agencies. “The overall perception of risk has risen significantly all over,” he says, adding that demand for insurance is up 25% over last year. “This news is in all the papers and has grabbed the attention of CEOs and boards,” says Monaghan. “They all want information about this product.”

Banks Take Cover
While banks do not appear to be in the front line of this latest wave of nationalism, financial institutions do face risks if a corporation is unable to repay a loan once its assets are expropriated. Most banks in such situations have insurance cover and also secure cover for loans made to sovereigns or entities run by government ministries to cover their credit risk if the loan is not repaid.

Though insurance capacity is tight in certain countries, such as China, Russia and Mexico, where demand is great, the private industry is well able to meet the growing need, industry experts agree. But with the appetite for political risk cover also picking up among multinationals from emerging markets, such as China, India or Brazil, that are venturing into commodity-driven projects in Latin America and Africa, that capacity will be stretched even further.

Some of the riskiest countries include left-leaning nations in South America, while the businesses most at risk are natural resources ventures in Indonesia, Pakistan, the central Asian nations and African countries, including the Democratic Republic of Congo, Nigeria and Côte d'Ivoire. But companies are still willing to take the plunge, says Ken Horne, a managing director and head of the political risk practice at New York-based insurance broker Marsh. “On the one hand, companies are investing in riskier areas and taking on more risk for more reward,” he says. “On the other hand, some of these countries are promoting a socialist agenda.”

Agencies such as the Multilateral Investment Guarantee Agency (MIGA), part of the World Bank in Washington, DC, and the Overseas Private Investment Corporation, an agency of the US government that supports US companies in risky markets, act as stabilizing forces for the political risk market. Edith Quintrell, director of operations at MIGA, says the agency helps provide coverage in the least-developed countries, South-to-South investment projects and post-conflict countries. MIGA, for example, is working with investors on projects in Liberia and just wrapped up ventures in Afghanistan, the Democratic Republic of Congo and Ukraine this year.

It is perhaps indicative of the abrupt rise in political risk, though, that the volume of MIGA’s business nearly doubled over the past four years to $2.1 billion for the bank’s fiscal year that ended on June 30. “Many investors looking at challenging environments come to MIGA because of its status as a multilateral organization,” says Quintrell. “The agency’s shareholders are the governments of 172 member countries, which means when it comes to issues of dispute resolution, MIGA’s working relationships with host governments are instrumental in getting the parties to come together and reach a resolution.”

With no decline in political risk on the horizon, the agency and the other political risk insurers are likely to see some busy times ahead.




Paula L. Green