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Chinese takeaway

Dear potential investor,

Millions of years ago – before the dinosaurs – heat and pressure under the surface of the earth converted the remains of animals and plants into crude oil. In my country.

Some of this valuable material has already been retrieved. But, far away from the coast, under the ocean, some has been overlooked.
I hereby notify you that you will be given exclusive access to these resources. In order to facilitate this cash payment, we would ask you to pay a signing-up fee – mainly to cover administrative costs. This would not run to more than a few hundred million dollars. You would also be expected to spend some money helping us build airports, roads, refineries and other infrastructure. This would amount to a few billion dollars (possibly slightly more).

Once these unfortunate but necessary bureaucratic hurdles have been cleared you will be free to drill – if you still have the available funds – for this oil, which we are almost certain exists.
If you are lucky, you will be entitled to produce it and sell it, assuming some future government does not later decide to nationalise or expropriate your assets.

For and on behalf of the state oil company of *****

YOU CANNOT blame governments for trying to wring as much value as possible from their natural resources. It is a duty to push up state revenue as far as possible without killing off investment. But high commodity prices are underpinning a fresh burst of resource nationalism.

South America seems to be going the way of its coastline – slightly pear-shaped – as governments jump on Hugo Chávez's nationalist bandwagon. The energy sector has become more central to politics and elections: politicians have attempted – successfully in Bolivia's case – to carry the popular vote by promising to nationalise energy assets or adjust the fiscal regime in the state's favour.

In Africa, Nigeria and Angola have linked access to upstream assets to investments in other parts of the economy and continued to demand large signature bonuses. In Russia, President Vladimir Putin has largely accomplished his goal of renationalising hydrocarbons resources. The Kremlin now directly controls around a third of Russian production and legislation introduced last year makes foreign investment in the country's most geologically attractive areas much more difficult.

Meanwhile, the economic risks of oil exploration are being exacerbated by the growing involvement of investors motivated less by profits than by strategy – such as the Chinese state-owned oil companies. This is inflating the price of assets and upstream licences.

Resurgent resource nationalism is bad news for the private sector, but will it benefit countries? It depends. If, like Saudi Arabia, you can afford to develop your own resources yourself, then good luck to you. But not all hydrocarbons producers have the luxury of 260bn barrels of easily accessible, low-cost, predominantly onshore reserves, a plum geographical position and a long coastline.

On 1 May, Evo Morales, Bolivia's newly elected populist leader, made good on an election-campaign pledge to nationalise the country's hydrocarbons resources (see p4). This is, to varying degrees, a setback for a few companies. But it could be worse for Bolivia's economic development. Most of Bolivia's hydrocarbons assets consist of gas, which is far more difficult to monetise than oil, especially because it has no coastline. Without large amounts of private investment, how will Bolivia develop its gas resources? The success of Bolivia's industry is largely the result of private-sector investment, as Figure 1 on page 4 shows.

Bolivia needs expensive export infrastructure and mutually beneficial long-term supply agreements. The only piece of gas-export infrastructure at the moment goes to Brazil, which Morales has done a good job of alienating through aggressive diplomacy, threats to put up gas prices and by nationalising Petrobras' assets.

Yes, Brazil is heavily reliant on Bolivian gas, which puts La Paz in a position to dictate terms. But if Morales maintains his uncompromising stance, it may work to Bolivia's disadvantage. Petrobras has already killed off any prospect of expanding the Bolivia-Brazil pipeline, it is assessing alternative gas sources, considering ways of slowing consumption growth and pushing ahead with the development of its own gas resources. More generally, Morales' nationalisation has undermined confidence in Bolivia as a reliable supplier and as a safe place to invest.

Venezuela has seen a more creeping form of nationalisation, as Chávez, emboldened by high oil prices, has marginalised the private sector. The heavy-oil projects, which have so far remained under private control, look set to fall under state control soon. However, under Chávez, Venezuela has struggled to reach its production potential – although the damaging effects of underperformance have been masked by high oil prices.

Last month, Ecuador cancelled Occidental's block-15 contract over alleged violations of the US firm's concession agreement (see p40). In Peru, energy has played an important part of the electoral campaign of the populist, leftist presidential candidate, Ollanta Humala, who said he would revise the fiscal terms of the Camisea gas project if elected. (At the time of writing, however, opinion polls suggested he would lose and that vocal support from Chávez and Morales had undermined his campaign).
The cost of energy investment is also being inflated by the state-owned companies of China and India. Their aim is to secure access to equity barrels of oil for 10 or 20 years from now, not to please financial analysts with this year's reserves-replacement figure. As such, they are able and prepared to outbid Western companies.

The favoured partner
As Petroleum Economist reported last month (PE 5/06 p20), Sinopec seems to have become Angola's favoured investment partner. China is now the second-largest lifter of Angolan crude and Angola is China's largest source of crude. Similarly, Nigeria is linking upstream access to substantial downstream investments. In last month's so-called mini-licensing round, China's CNPC won the highest number of blocks and ONGC-Mittal, a partnership between India's ONGC and Mittal Steel also picked up acreage. Growing Chinese influence in west Africa should also worry Washington, which has a stated aim of sourcing more of its oil from the region. Eventually, it may even encourage Western oil firms to change the way they assess projects.

But technology is one area where the international operating companies still have a considerable advantage. That point was emphasised by Shell last month. The firm said it might fall short of its 100% reserves-replacement target (under Securities and Exchange Commission rules) for 2004-2008. But it rightly said that measure of value does not tell the full story because it fails to take account of unconventional oil. Unconventional hydrocarbons "and Shell's technology, should help us drive full replacement of our production", the firm said.

That claim may have a relevance well beyond diminishing the stature of the obsessively quoted reserves-replacement rate as a measure of oil-company value. Shell's unconventional operations do not just differentiate it from rival Western firms, but from national oil companies too.

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