What Latin American nationalism means for miners
By Nick Louth*
moneyweek.com
Since September 11 2001, almost everything that could go wrong in US foreign policy has gone wrong.
President George W.Bush, while right to pursue Al Qaeda into Afghanistan, has failed to catch its leader or destroy its operational ability. He made the huge mistake of invading Iraq on a false premise about weapons of mass destruction. He then squandered the goodwill generated by the overthrow of Saddam Hussein by failing to set a workable plan for rebuilding the country.
He has antagonised Iran when the oil market is tight, allowing the world's second largest oil producer to trump any Western diplomatic or political pressure. And finally, he has utterly neglected Latin America, his own backyard, when even a little attention could have curbed the spread of left-wing nationalism.
Such political failings have economic consequences. Yes, tight fundamentals and soaring demand from China and India were inevitably going to put a floor beneath the price of oil and key metals. To some extent, the recent wave of nationalisations in Latin America was automatic.
But Washington's blunders have raised global commodity prices, and added a geopolitical premium to the price of oil. By pushing in the wrong places and at the wrong time, the US has added fuel to the commodity supercycle bonfire.
Latin American nationalisation: relations with the US
In the years of Bush senior and Bill Clinton, the US had a real dialogue with South America, a continent emerging from dictatorship into democracy. US Treasury Secretary Nicholas Brady helped end Latin America's long, debt-induced recession; the US, Canada and Mexico signed the North American Free Trade Agreement (NAFTA); Central America's brutal civil wars were largely settled; Washington hosted the hemisphere's first summit in a generation; and in 1995 Washington intervened to prevent the collapse of Mexico's economy.
It's very different now. George W.Bush seems to look at the continent as James Bond might, strictly on a need-to-know basis, fighting ideological opponents like Fidel Castro as though the Cold War never ended. He's provided little help for vital countries like Brazil, teetering between trade-minded reform and nationalistic retrenchment. As the academic Peter Hakim observed in the journal Foreign Relations:
"Relations between the United States and Latin America today are at their lowest point since the end of the Cold War."
As a result of this neglect, nationalist bandwagons in "Latam" now have real momentum. In Venezuela, President Hugo Chavez has followed up his anti-US rhetoric by taking control of four heavy oil ventures in the Orinoco belt, worth $17bn. In Bolivia, recently-elected president Evo Morales has set about nationalising the country's oil and gas sector. Troops were sent to gas fields on 2 May. One of the unexpected casualties is Bolivia's neighbour Brazil, whose Petrobras company is the biggest user of Bolivian natural gas.
In Ecuador, President Alfredo Palacio has sanctioned the nationalisation of $1bn of assets owned by US oil firm Occidental. The move follows an imposition of a 50% tax on extraordinary profits of foreign oil firms. Palacio, a US educated cardiologist who had hitherto been seen as a moderate, has certainly given the White House a heart attack.
Latin America has 8.5% of proven global oil reserves, compared with 5% for the US, Canada and Mexico. It has 4% of the world's proven natural gas reserves, about the same as North America. These are tiny compared to those in the Middle East and the former Soviet bloc, but with the US locking horns with Iran, and an Al Qaeda attack on crucial Saudi refineries widely expected, these reserves matter. Indeed, Latin American oil production at 6.7m bpd could supply a quarter of US consumption.
Latin American nationalisation: the base metals supply
But it's in base metals that Latin America really matters. It accounts for half the world's copper output, and a quarter of its tin. Peru alone accounts for 13% of global zinc. Its 2006 presidential loser, Ollanta Humala had promised that foreign mining companies would have to renegotiate contracts. Now he's forming the official opposition to his victorious opponent, Alan Garcia, who plans higher taxes and royalties from mining firms.
So in Bolivia, investors in silver, tin and zinc are most worried. In Peru it's copper and gold that look threatened, while in Venezuela gold, aluminium, copper, nickel and zinc are all at risk. Investors are already losing out. Shares in US miner Crystallex have plunged by a third in recent weeks since Hugo Chavez nationalised the Orinoco oil deposits.
Crystallex has exclusive rights for one of the largest undeveloped gold deposits in the world, at Las Cristinas in Venezuela. That holds gold reserves of 13.6 million ounces. Apex Silver, which runs silver, zinc and lead operations in Bolivia has also lost one-third of its value since Morales came to power, even before the recent stock market falls.
None of this is new, however. The typical cycle of mineral investment sees Western firms getting a cheap deal when prices are low and producer countries are crying out for investment. Then, when demand expands and prices start to climb, investment rockets and even marginal sources are chased up. Finally, when prices reach record heights and supply is tight, producer countries demand a greater share of the riches reaped by foreign investors.
Once nationalisation begins you can be sure that the peak for new minerals supply is near. Investors are scared off by political posturing. While output may be maintained, investment for the next cycle dries up.
Latin American nationalisation: the oil supply
The same thing happens in the oil market. The IMF's latest world economic outlook showed how the increasing power of oil exporters since 2002 exactly matches what happened during the oil shock of the late 1970s. From 2002 to 2005 the rise in exports was worth $437bn to oil exporters, almost identical to the $436bn (in 2005 dollars) earned in 1973-81.
Geopolitics and commodity prices almost always follow hand in hand. It is no coincidence that the collapse of the Soviet Union coincided with a trough in oil prices, which in December 1998 hit $12.11, the lowest since before the Yom Kippur war of 1973. As for last week's political opportunism, it is likely to remain transitory – at least as far as Latin America is concerned.
Hugo Chavez may rage at his powerful northern neighbour, but the reality is that Venezuela and the US are locked into an uneasy trading embrace. Venezuela has no other significant export earnings, and only the US and its near neighbours can easily refine the heavy sour crudes which make up most of the country's oil output.
Royal Dutch Shell Chief Executive Jeroen van der Veer called this rise of economic nationalism a "new reality" that energy companies have to accept. He could have added "...so long as prices stay high." For in a time of high prices, copycat tactics pay dividends. The Mongolian government recently passed a bill which imposed a windfall tax on copper and gold developers, triggered when market prices in the two commodities move above £1,380 per tonne and $500 an ounce respectively.
Latin American nationalisation: advice for investors
Readers planning to jump into metals or oil stocks once the current correction is over should look carefully first. Miners with their main assets in Australia, Canada or South Africa look the safest bet, hence the higher price of their assets reflected in their share prices.
You should certainly steer clear of one-project minnows exposed to the caprice of individual governments in Bolivia, Venezuela and the former Soviet Union. The nationalisation of Bolivian oil assets by President Evo Morales has rattled investors in Latin America. His reasoning – that "Bolivia's natural resources had been exploited for 500 years and it ends now" – harked back to the ransacking of South America by the conquistadores. It is clearly motivated by a desire to cure economic hardship. And despite his views on legalising cocaine for medicinal purposes, Morales is no fruitcake.
But his political manoeuvres could well backfire, as such moves usually do at the peak of the commodities investment cycle. Morales has promised to renationalise the local mining industry too. What if the banks start withdrawing letters of credit for Bolivian companies? Morales has taken a big risk that local investors will not panic.
If Bolivia is to be starved of foreign investment, the natural response is to get cash out of La Paz. To be sure, the ease and speed at which the Bolivian government moved, and the lack of any real redress, will increase the equity risk premium attaching to Latin American oil assets in the short-term. But relatively few Latin American countries have big oil deposits worth nationalising. And in Colombia, for instance – where a key play in the Fleet Street Letter's current equity list operates - the policy has been to encourage junior oil companies. The same is true of Panama.
So yes, discretion is needed at this stage of the "commodity" cycle now that it has turned political. But your opportunity – to pick up potentially undervalued mineral and energy investments amid the confusion – is clear.
*Formerly a reporter for Reuters in New York, Amsterdam, London and Hong Kong, Nick Louth is now a regular contributor to the Financial Times, Investors Chronicle and MSN website. He is the author of 'Multiply Your Money: The Easy Guide to Savings and Investments' (McGraw Hill), and a key member of the Fleet Street Letter's investment team. To read more from Nick and many other contributors, go to dailyreckoning.co.uk. |
