According to the researchers, “The results suggest that the structure of contracts between IOCs (independent oil companies) and host countries is related to the threat of possible expropriations in a way that is consistent with our predictions: countries that have a higher ability to commit to contracts (as a result of larger costs associated with reneging on them), seem to obtain contracts that shift a larger degree of oil price risk to the IOC. These effects are economically significant. The ability to commit to contracts increases a volatility-averse country’s expected welfare, since in essence it allows the country to obtain an insurance policy against low oil prices.”
While some governments that have low levels of foreign direct investment may not mind losing the opportunity to attract further investments, countries that do have a good reputation among foreign investors will benefit from contracts that provide those nations with “smoother revenues, especially when oil prices are low,” says Van Benthem. “The more stable countries that have the better institutions will get the better deals.” No matter how helpful expropriations may be for their cash flow over the short term, governments need to recognize that they will suffer longer-term penalties, he adds. This includes not just the damage done to their international reputation, but the loss of foreign technical and operational expertise after foreign managers depart following expropriation of their assets.
On that score, however, one empirical finding of their research may be more surprising, notes Van Benthem: All other things being equal, it is riskier for independent oil firms to do business in those countries that are technologically advanced. “If the country has more experience with producing oil (measured by its total oil and gas extraction up to the point when the contract was signed), the country can produce oil quite efficiently, even without help” from the independent foreign firm. As a result, such countries “have less to lose when they expropriate during times of high oil prices.”
Advice for policy-makers
Based on their findings, what advice would the researchers offer to policy makers in resource-rich developing countries? “Even if a country’s reputation is not so good,” suggests Van Benthem, its officials should consider signing bilateral investment treaties with the governments of countries where its foreign investors are headquartered. These kinds of treaties can build confidence among foreign investors because they provide a significant disincentive for governments to expropriate their assets. For example, he notes, if Country X owned assets in the US, and Country X expropriated some assets owned by a firm with economic ties to the US, the firm could then legally seize some of Country X’s assets through an international arbitration procedure. “This is useful, because it makes it more costly for resource-rich countries to expropriate foreign assets.” On the other hand, in such a case, the foreign government “should be able to get a better deal with foreign companies” because foreign investors would realize that they now have less reason to fear that their assets would be seized.
Although this research analyses data about contracts in the oil sector, Van Benthem points out that its major conclusions may be applied “to any foreign investment in any countries where foreign investors are worried about expropriation.”
