Brazil Tested by Latin America Energy Populism
It was going to happen sooner or later.
Last month Argentina and Bolivia each expropriated strategic energy companies controlled by Spanish firms, heightening concern that a new round of populist, market-bashing policies was taking hold in Latin America.
After all, the region is not only the world’s most promising in terms of oil production increase for the remainder of the decade, but also the second-biggest reserve holder. Middle classes are well consolidated, securing political and economic stability, albeit with varying degrees in each country.
But the world can rest easy, as it has indeed. Nothing has changed in Latin America and the expropriations are part of an expected geopolitical evolution featuring a rising region and a declining Europe. More important though, this time around Brazil is acting as a regional overlord that is making sure investment risks are controlled.
The government of Cristina Fern’andez de Kirchner moved to renationalize a 51 percent stake in YPF, Argentina’s biggest oil company, owned until then by Spain’s Repsol. She accused Repsol of being responsible for Argentina’s declining production that made the country a net importer in 2008.
Spain and Europe threw a tantrum, understandably so. Argentina took back not only half of its business and oil reserves, but a big part of its overall operations. But Repsol’s woes in Argentina are a decade old and if anything the expropriation has been long expected.
Days later, Bolivia expropriated the country’s electricity distribution company owned by Red Electrica, another Spanish company. Spain didn’t grumble too much, mostly because the market value of the confiscation is paramount to Bolivia, but spare change for Spain and its former owner.
In both cases, Bolivia and Argentina will inevitably pay fair value that will be set by a combination of national regulators and if need-be international arbitrators. Spain and its companies might complaint, but there is little they can do because, if nothing else, no laws have been broken.
Furthermore, unlike what many observers are claiming, this is not an economic matter. This is geopolitics at its best. Years of economic decline have blunted Spain’s sway of yore.
Spain’s Reconquista, the nickname of the massive foreign investment drive during the 1990s and 2000 when Spanish companies bought up controlling stakes in the region’s banking, energy, and telecom industries, is over. Net investment flows have been increasingly flowing the other way around for a few years.
Spain’s was the second biggest investor in Latin America during the 1990 and most of 2000. Between 2006-2009, Spain’s share was 10 percent, behind the 25 percent of the US, but in 2010 it decreased to 4 percent.
In the meantime, Latin American countries, led by Brazil, underwent a formidable evolution from ragtag unstable countries to stable global players. The shortlist of game changers includes Chile, Colombia, Peru, and Venezuela, albeit as counterweight to other market players.
Brazil, which rose to regional leadership status displacing the US in the process, has the most at stake in Argentina’s and Bolivia’s expropriations. Not only are its companies among the biggest investors in both countries, but its own appeal as investment destination could be hurt.
Brazil has taken the lead in managing the Argentina and Bolivian decision and even the White House has stepped back to allow its diplomacy to manage a potential disaster. And all things considered so far, Brazil is doing a good job, in effect defending global investors.
The end of the Reconquista
This is about Spain’s decline on one hand and Latin America’s ascent on the other.
Spain’s Prime Minister Mariano Rajoy said the expropriation “severs” the historic good relations between the two countries. “After what happened, you could think this could happen to anybody.”
But international markets, other governments and multilateral institutions don’t agree. Markets have punished Spanish companies more than Argentina’s and Bolivia’s in the aftermath, and this during a troubling time for Spain’s economic crisis.
Many of Spain’s biggest companies and banks that are strongly rooted in Argentina have also privately warned of stepping up a diplomatic tussle.
The IMF, World Bank, as well as most countries in the continent, have concluded both expropriations are isolated incidents that don’t speak to the broader Latin American evolution. Argentina finally felt confident enough to repatriate YPF after years trying to pressure Repsol.
“If your job is to defend Spanish interests, and companies are asking for restraint, than you can’t push much harder. Spain needs more of Latin America now than the other way around,” said Jos’e Ignacio Torreblanca, senior policy fellow in the European Council on Foreign Relations.
Repsol, which bought YPF in 1999, was the biggest symbol of Spain’s Reconquista. Spain was only second to the United States in terms of clout.
“It’s true that Spain was very influential in Latin America, but Spain has to be happy that it now has partners it can treat as equals,” Dr. Torreblanca said. “Yes, there used to be a polarization between populists and pragmatics in Latin America, but we are seeing the end of that. This is a Latin America of middle classes that doesn’t like the stereotypes of yore.”
This is not the first time Argentina defies international investors. Of more than three dozen sent to arbitration, it has only lost a handful of cases. Undoubtedly, Argentina’s credibility in international markets and with lenders will suffer. “We expect this to curtail foreign direct investment (FDI) in key sectors such as energy, utilities, and telecom,” Fitch ratings agency wrote.
That may be true for private investors, but not for state controlled companies, namely from China. Argentina was also the second biggest receptor of Chinese investment in 2011, after Brazil.
Kirchner’s government subsidizes fuel and controls prices, meaning the return on investment for private companies like Repsol is limited. But securing oil exports could be enough to convince China.
One of the rumors, not surprisingly, is that Sinopec, one of China’s biggest oil companies and investors in Latin America, has secured a deal to finance Argentina’s promised oil production recovery. That remains to be seen.
Argentina’s ability to raise production without any foreign involvement is also very much in question. It will likely follow the example of its Venezuelan precursors, who despite many more decades of experience in the oil industry still haven’t recovered from pre- Ch’avez times.
Despite much flashy rhetoric from Hugo Ch’avez, Venezuela is once again flirting with foreign investors to secure funding, and Brazil happens to be one of its big partners. Brazil -along with Colombia since 2010- have tamed Ch’avez, and the same is already in play with Argentina and Bolivia.
Brazil’s role is critical. As a regional leader, it will continue to play a stabilizing role, much like it played in the 1990s with Venezuela.
Indeed, the victims are so far Spanish companies. Others might be targeted in the future. But the process is only the natural evolution of Latin America’s coming of age and of unsustainable economic models in the West.