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Resource nationalism meets the market: Political risk and the value of petroleum reserves

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Abstract

This paper investigates the effect of resource nationalism on the value of petroleum (crude oil and natural gas) reserves. We develop a framework for treating resource nationalism as political risk, and utilize data on reserve transactions (from John S. Herold) and political risk ratings (from International Country Risk Guide and Institutional Investor) for the period 2000–2006. Controlling for other factors that affect reserve value, we demonstrate the value destruction of political risk, and estimate the political risk discount for 37 countries. The paper contributes to both the international business literature and practitioner approaches to political risk analysis in demonstrating use of publicly available market data from real-asset transactions to measure the cost of political risk. We also show that the discount depends on market conditions: the higher expected future petroleum prices are, the larger is the discount at any level of political risk. This insight adds a new dimension to analysis of political risk, which is typically measured and examined without regard to market conditions.

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Notes

  1. A justification for resource nationalism from a practitioner is illustrative: “In less than three years of exploitation, the consortium has earned $5 bn for a $3 bn investment. In contrast, Chad has just received crumbs: $588 m.” Idriss Deby (president of Chad), quoted in Miarom (2006).

  2. “These companies had much greater apprehension concerning the possibility of expropriation and they mentioned more frequently than other groups a favorable foreign tax situation” (Barlow & Wender, 1955: 128). An early teaching case on resource nationalism (Harvard Business School, 1974–1976) examines the Bougainville Copper Mine in Papua New Guinea.

  3. This interaction takes many forms far less dramatic than expropriation. For example, Jones (1984) and Makhija (1993) examine government intervention in the Venezuelan petroleum industry in the period prior to nationalization.

  4. Berry and Wright (2001) summarize the literature on financial statement disclosures of petroleum reserves. These are analogous to asset restatements in manufacturing firms (Francis, Hanna, & Vincent, 1996).

  5. Values are converted from local currency to US$ using exchange rates on the day of the announcement. The former deal's reserves are primarily in Norway, the latter's in the Russian Far East. See the discussion of the two deals in Timmons (2006) and Crooks and Ostrovsky (2006), respectively.

  6. The political risk literature is extensive. Recent examples include Desai, Foley and Hines (2008) and Vaaler (2008) on managerial decisions, and Alfaro, Kalemli-Ozcan, and Volosovych (2008) on cross-border capital flows.

  7. Adelman, De Silva, and Koehn (1991), Thompson (2001), and Adelman and Watkins (2005) test the theory using reserve data from US petroleum-reserve transactions. Adelman and Watkins (1995) use a sample of 34 Canadian reserve transactions. These articles all find that the data are not consistent with the predictions of the simplest version of the Hotelling (1931) theory.

  8. A small literature (e.g., Harris & Ohlson, 1987; Magliolo, 1986; Miller & Upton, 1985; Thompson, 2001) focuses on book value and market value information in US petroleum exploration and production firms’ 10-K filings, rather than market transactions.

  9. Royalty interests belong to the owner of the subsurface rights, typically the owner of the land underneath which the reserve lies, but can be sold to third parties. Non-royalty interests are referred to as “working interests”.

  10. We are indebted to JSH for access to their transactions database.

  11. Smaller deals tend to be less well documented, and we do not include them in our analysis. The JSH database includes deals under $10 million, but JSH does not include them in its reports on transaction activity.

  12. We are grateful to Energy Security Analysis Inc. for providing strip data. BPT data are from DataStream.

  13. For more information, see www.prsgroup.com. The fact that these variables are not based on asset prices or petroleum reserve values implies that endogeneity between petroleum reserve values and the political risk score is unlikely to be a problem.

  14. Because transactions are acquisitions of assets or companies, rather than greenfield investment, they are not public information prior to their announcement dates. The larger issue that political risk in petroleum-based economies may itself arise from the petroleum sector is one that we cannot control for empirically using ICRG and Institutional Investor data; we consider the possibility of such simultaneity in the section on robustness checks below. We thank an anonymous referee for calling our attention to the endogeneity issue.

  15. We are grateful to the editor (Witold Henisz) and referees for their suggestions on this section.

  16. The database and supporting documentation are taken from the website http://www-management.wharton.upenn.edu/henisz/.

  17. Petroleum reserves offshore may be under shared or disputed waters (e.g., Caspian Sea, Gulf of Guinea, South China Sea, Timor Sea).

  18. For example, the Movement for the Emancipation of the Niger Delta in Nigeria.

  19. Johnston (2008) provides insight into recent fiscal evolution and complexity in the industry.

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Acknowledgements

We are grateful to Chris Ruppel, John S. Herold Inc., Energy Security Analysis Inc., and Petroleum Intelligence Weekly for data; however, use of the data to examine political risk is solely our responsibility. We are also grateful to the editor (Witold Henisz), referees, and participants at the Fifth JIBS Emerging Frontiers Conference, the Temple International Business Research Forum, Wesleyan University, HEC Montréal, and the AIB, ASSA, and FMA annual meetings for comments. We thank the GW-CIBER for research support.

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  1. Department of International Business, George Washington University School of Business, Washington, DC, USA

    Reid W Click & Robert J Weiner

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  1. Reid W Click
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Correspondence to Robert J Weiner.

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Accepted by Witold Henisz, Area Editor, 28 July 2009. This paper has been with the authors for three revisions.

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Click, R., Weiner, R. Resource nationalism meets the market: Political risk and the value of petroleum reserves. J Int Bus Stud 41, 783–803 (2010). https://doi.org/10.1057/jibs.2009.90

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