Curse of Crude: Higher Prices Result in Greedy Grabs

While the consumer media bemoan rising gas prices, industry insiders understand that crude oil price increases can be a blessing and a curse.

The blessing: oil companies reap greater returns on their investments in drilling, extraction and refining, providing capital for further exploration and drilling operations.

The curse: greedy countries hike royalties, taxes and other fees to grab their piece of the action, or simply nationalize foreign oil companies operating within their borders to reap all of the profits.

Argentina’s recent hostile takeover of Spain’s Repsol YPF is the latest example of the curse, of course. After YPF plowed $10 billion worth of investments into Argentina and just after potentially huge reserves of gas and oil were discovered in Patagonia, the Argentine government expropriated YPF with no warning.

It’s not the first time an oil-rich country has nationalized an energy company, and likely not the last. The fact is that 65% of the world’s gas and oil reserves are under the control of state-owned companies.

Though many industry analysts expect a poor outcome from the Argentine takeover, some nationalizations have been successful. And, successful or not, the desire to gain control over valuable resources will always be a driving force toward nationalization.

Brazil, for example, created its oil industry monopoly in 1953 and today Petrobras is the fifth-largest energy company in the world. Brazil fueled its success by allowing foreign investment via partnerships with Petrobras. It’s now the leader in deepwater and ultra-deepwater oil extraction.

Likewise, Venezuela has increased state control over the oil industry, but at the same time has allowed foreign investment while charging higher rents and drafting fiscal agreements weighted in Venezuela’s favor. And six years after nationalizing hydrocarbon resources in Bolivia, that country maintains an active investor environment through greater incentives to increase oil production.

Even Argentina is hoping that the huge potential of Patagonia will bring oil companies, along with their technology, to Argentina, despite the government’s brutal treatment of YPF. Argentina’s current predicament illustrates one of the main flaws in most countries’ nationalized energy companies: profit structures that serve to provide revenue to the government for social and other programs at the expense of investing in continued exploration and technological advancement. While the initial takeover of the energy company provides a fantastic boost to the country’s economy in the short-term, most countries don’t invest enough in exploration and technology improvements to sustain production levels, creating an inevitable downward spiral of production and profit.

Countries gamble that their reserves will simply prove too tempting for foreign investors, despite unattractive contracts or the risk of takeover. Iran is auctioning new oil and gas exploration blocks, expecting that the lure of some of the last potentially rich unexplored oil fields will outweigh the country’s tough contract terms. And China is pushing for more foreign investment, even though government control of oil and gas has produced a money-losing proposition for oil and gas production. Gas storage and distribution are more attractive investment options, though the government also has its thumb on these downstream segments.

And, guess what? These countries know that they can get away with higher royalties, tougher contracts, and outright takeovers when oil and gas prices are high and vast untapped reserves beckon.