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Calgary Herald: Biting the hand that feeds them

Socialist crusaders would be nowhere without capitalism
SIMON KENNEDY AND RICH MILLER BLOOMBERGNEWS
Sunday, 21 January 2007

Free global markets opened doors for Hugo Chavez and Vladimir Putin, who are now slamming them shut. In reasserting state control over their economies, the leaders of Venezuela and Russia are bucking the very capital flows and expanded markets that buoyed their oil-producing nations in the first place by delivering record energy prices and the strongest global growth in a generation.

“These countries actually benefit from globalization, yet are now turning their backs on it,” says George Magnus, senior economic adviser to UBS AGin London. “It all smacks of a shift in power that comes with money.”

The two leaders, whose economies benefited from a tripling of oil prices since 2002, aren’t alone in thumbing their noses at globalization. Thailand’s military government recently placed new restrictions on foreign ownership of companies. Rafael Correa, who recently became president of Ecuador, says he may default on the country’s foreign debt. Bolivian President Evo Morales is forcing energy companies Petrobras SAof Brazil and Repsol-YPF SAof Spain to give up majority control of assets.

While nationalistic politicians and resource-rich economies may be enjoying the moment, biting the hand that feeds them will lead to less foreign investment and weaker growth, economists say.

“It’s a false hope that they can take these actions and not cause some damage,” says John Taylor, a former U.S. Treasury undersecretary for international affairs now at Stanford University in California.

Chavez, 52, is trying to remake Venezuela along socialist lines following his election last month to a second six-year term. In a Jan. 8 speech, he pledged to nationalize the country’s utilities and strengthen the state’s hold on heavy-oil joint ventures that involve international oil companies including Exxon Mobil Corp., BP PLCand Total SA.

Putin, meanwhile, is tightening his grip on Russia’s energy industry by buying stakes from foreign companies after threatening to revoke licences, having already forced the bankruptcy of OAO Yukos Oil Co. and the eventual sale of most of its assets to friendly hands.

Open markets benefit oil producers as development in China and India, and the fastest global growth since the 1970s, increase energy demand. Oil prices reached a record $78.40 a barrel last July and world daily demand for crude will rise 1.7 per cent to 85.9 million barrels this year, after gaining 1.1 per cent in 2006, the International Energy Agency in Paris says.

Venezuela’s oil revenue added $50 billion to government coffers last year, says Shannon O’Neil, adjunct fellow for Latin American studies at the Council on Foreign Relations in New York. That financed about half of the country’s budget, allowing Chavez to fund domestic subsidies and overseas aid to propagate his “21st-century socialism.”

“It’s global capitalism that’s funding the socialist turn in Venezuela,” O’Neil says.

Russia’s energy exports finance about 30 per cent of the government’s budget and have transformed a country that partially defaulted on its foreign debt in 1998 into a creditor nation, according to Ivailo Vesselinov, an economist at Dresdner Kleinwort in London. Russia’s foreign-currency reserves have expanded sixfold in four years, to $303 billion.

“Oil’s most striking impact has been on Russia’s fiscal accounts,” says Vesselinov.

Russia’s affluence has emboldened Putin, 54, to assert greater economic control. After Kremlin threats to block investment plans and building permits, Royal Dutch Shell PLC, Mitsubishi Corp. and Mitsui & Co. last month sold state-run OAO Gazprom half their stakes in Russia’s Sakhalin-2 oil and gas project.

Repelling foreign capital and driving up energy prices will backfire, says DeAnne Julius, chairman of Chatham House, a London-based research organization, and a former policy maker at the Bank of England. Countries trying to stem globalization have gained technical expertise, infrastructure investment, jobs and taxes from foreign companies, she says.

“Countries with commodities are taking too short-term a view,” says Julius. “They need companies and other countries to exploit the reserves for the benefit of both sides. High commodity prices don’t in themselves buy development.”

For example, Venezuela depends on U.S. refineries to get maximum value from its heavy crude, with its high sulfur content. “Their crude oil is worth more when processed at refineries in the U.S. than it is elsewhere,” says Philip K. Verleger of PK Verleger LLC, a Newport Beach, Calif.-based energy consultant.

The U.S. buys almost all of the 1.2 million barrels of oil Venezuela exports daily, according to Andy Lipow, president of Houston-based consultant Lipow Oil Associates LLC.

Chavez’s use of oil revenue to fund his government’s social programs has come at the expense of investment in oil exploration and development, causing production to stagnate.

“Venezuela has not been producing up to its OPEC quota,” says O’Neil. Chavez, she says, has “scared off foreign investors. He needs their finance to develop the oil industry.”

Not only the oil industry needs foreign capital. New Yorkbased Verizon Communications Inc.’s 28.5 per cent investment in CA Nacional Telefonos de Venezuela, the country’s biggest telephone company, modernized an antiquated system that once took as long as 10 years to connect a new customer, says Jose Luis Betancourt, head of the country’s biggest business group. “Today, requests for a line get an almost immediate response,” he says.

Like Venezuela, Russia suffers from an investment gap in the energy industry that international companies were filling. The international partners that Putin is buying out of the Sakhalin-2 venture had sunk $12 billion into the project, which will be the first in the country to produce liquefied natural gas.

State takeovers have made foreign companies reluctant to increase spending or production, Aslund says. “Russia doesn’t need foreign direct investment for the sake of the money,” he says. “They need it for the technology, for the management it brings.”

A continued plunge in oil prices, which are hovering at 20month lows just above $50, would rob governments of revenue as production stagnates. Chavez “will be in bad shape, he’ll be squeezed,” O’Neil says.

“Commodity-rich countries are living off the success of market oriented-economies,” says Kenneth Rogoff, a former chief economist at the International Monetary Fund. “Twenty-first century socialism will do no better than 20th century socialism did.”

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