An Upside to Low Crude Oil Prices — International Operations May Face Fewer Risks

By Terry Hallmark, Instructional Assistant Professor, Honors College

As the saying goes, trying to predict long-term crude oil prices with any precision is the business of fools and liars. I try hard not to be either, so I’m not going to predict crude oil prices here. However, for the sake of argument I will say this much: it’s reasonable to assume we are in a period of sustained low crude oil prices in the $40-$60/barrel range, and that will likely last awhile. I have no idea exactly how long, but I’d guess at least five years – maybe 10 – and longer still before the world sees $80/barrel crude oil. We may never see $100/barrel crude oil again, absent some cataclysmic geopolitical development.

Oil prices are one of many factors that shape the host-country environments in which international oil companies (IOCs) operate. Over the years, as oil prices have gone up, the above-ground risks that threaten oil company operations have tended to go up as well (e.g. political violence, regime instability, adverse contract changes). It stands to reason: when crude oil is worth more, attacks by insurgents or terrorists hurt IOCs and the governments of oil producing countries more. This is not to suggest that oil price is the sole driving force behind above-the-ground risks – it’s only one piece of a much larger puzzle – but I got to thinking: what effect, if any, might today’s low crude oil price environment have on above ground risks in the near-to-medium term?

The initial efforts at oil industry-specific risk assessment by exploration companies focused mostly on identifying the potential nationalization or confiscation of company interests by foreign governments. This was a response to the emergence of “resource nationalism” and a rash of expropriations of oil sector interests between 1960 and 1976, as well as the expropriation of all foreign oil company holdings in Iran after the 1979 revolution. Countries came to understand that they possessed a valuable commodity and wanted to control it.

Beginning in the mid-1980s, the relationship between foreign operators and host-country governments changed. The governments realized the uncompensated taking of oil company assets severed ties to the funds, expertise and technology needed to sustain their petroleum sectors and secure economic growth. Further, there was a general turn toward free-market economics and progressive petroleum laws to make exploration more attractive to foreign companies. These moves were, in large measure, a response to generally low oil prices.

But even though oil prices were low, so long as the geology looked promising, acreage was open and fiscal terms guaranteed an acceptable rate of return, oil companies were willing to explore for oil almost anywhere in the world. Nationalizations and expropriations slowly faded from the scene, and oil exploration companies and analysts alike began to speak in terms of a “post-nationalization” operating environment.

As expropriations and nationalizations became a thing of the past, other threats materialized. During the 1990s, a mix of less-than-completely democratic governments in lesser developed, oil-producing countries (which frequently filled their coffers with oil earnings at the expense of the citizenry), sizable new discoveries and rebounding crude oil prices all came together to spur countless attacks on oil installations, pipelines and personnel by rebels and political activists in Latin America, Africa, Asia and elsewhere. The work of the political risk analyst shifted from trying to predict if, and when, an uncompensated taking of an IOC’s interests might occur to trying to figure out when and where attacks might take place, who or what was the likely target or targets, and whether the attacks might shut down operations or force the evacuation of personnel – and then whether the attacks might ultimately destabilize the host-country government.

Something unexpected happened in the early 2000s. Resource nationalism, along with expropriations and numerous other adverse contract changes (increases in “state take” – royalty and tax rates), re-emerged. The reason was jacked-up crude oil prices, along with the nationalist or leftist ideological leanings of the host countries. Unlike the earlier nationalizations and expropriations that claimed oil assets the host countries believed were theirs, this new batch of takings were more akin to an “oil weapon” used to punish adversaries and advance a broader foreign policy aimed at securing certain geopolitical or geostrategic ends.

Consider Venezuela. While President Hugo Chavez did not execute a complete expropriation in one fell swoop, he did implement several adverse contract changes that amounted to creeping expropriations. For example, in 2004, with prices hovering around $40/barrel, Chavez raised taxes on a handful of heavy oil projects. In April 2005, with crude oil prices near $60/barrel, Venezuela announced existing operating agreements would be converted to joint ventures. Two years later, as crude prices trended upward to $80/barrel, Venezuela took operational control of the holdings of BP, ChevronTexaco, ConocoPhillips, ExxonMobil and Statoil – so that Venezuelan state company PDVSA could secure a minimum 60 percent stake in projects in the Orinoco Belt.


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