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AFX UK (Focus): FOCUS Oil companies driven to emerging markets are loading up on political risk

Published: Sep 10, 2007

LONDON (Thomson IM) – High oil prices and the increasing scarcity of resources mean future disputes between oil companies and governments of emerging markets are highly likely, even though government expropriation of foreign companies’ assets is “nowhere near” the level it has been in the past, industry watchers said.

According to one analyst, globally the issue has settled down, but some emerging market investors see ample scope for future problems, in particular over strategic assets and in countries where resource ownership has become a significant political issue.

Dr Keith Myers of Richmond Energy Partners, said: “If you’ve got a share of a strategic project in a country where resource nationalism is a hot political issue, then risk has gone up.”

As a whole, “the risk of expropriation isn’t increasing globally, but in certain countries resource nationalism is a hot political issue”, he said.

“Companies with operations in countries where resource nationalism is potent may well have their valuations changed; a barrel of oil in Russia is not the same as a barrel of oil in Columbia, partly because of political risk,” Myers said.

In the past week, a number of international oil firms have run into trouble over projects in developing markets.

Italian firm Eni is facing a 10 bln usd compensation claim from the government of Kazakhstan over escalating costs and production delays at the Kashagan project.

According to Myers, Kashagan is an exceptional project and therefore not indicative of a wider trend.

“The government’s reaction is unsurprising given the size and strategic nature of the Kashagan project and its political implications,” he said.

Elsewhere, Repsol and Gas Natural have been dismissed from the 5 bln usd Gassi Touil project by government-owned Algerian oil company Sonatrach, and Royal Dutch Shell has had a refinery in Buenios Aires closed on the grounds it lacked permits.

Myers predicts the dismissal of Repsol and Gas Natural will prove to be another “isolated incident”, the problems caused by Repsol’s failure to anticipate certain technical difficulties.

Sylvester Walczak, portfolio manager of Absolute Capital Management’s East West Fund, said he is wary of investing in companies with this kind of exposure: “Russia considers oil and gas strategic sectors, where they want state-owned companies to have an ever-larger role. Therefore the risk of harassment and ‘contract renegotiation attempts’ for private companies is quite high.”

He believes political risk is more significant in the current environment: “With oil becoming more expensive and increasingly scarce it is almost natural for governments in developing countries to change the rules for resource owners and there are many examples of this happening over the years.”

Walczak, whose fund invests in Russia and Kazakhstan, said he is particularly wary of investing in oil companies which have big joint-agreements with governments.

Others in the market downplay the risks. John Payne, portfolio manager of the Hexam Global Resources Absolute Return Fund, said it is necessary to be aware of the political risks for oil companies operating in emerging markets and the size of any operations they have there but it does not deter him from investing.

“For a small company going into a country with a patchy political record it might put me off, but with the majors it’s less of a concern,” Payne said.

Jon Clark at Ernst and Young agrees the risk is more acute for smaller companies that only operate in one country.

He believes oil majors like Shell or BP, who operate across several markets, can manage their risk better. Payne acknowledges risks may increase longer-term for oil companies as the hunt for new resources takes them into markets previously seen as too risky.

“Today, it’s a different situation because oil consumption is growing, the price of oil is rising and companies are having to go to new lengths to find reserves,” Payne said.

Whether risks were increasing or not, it seems international companies would have little option but to move ever further into emerging markets.

By James Molony and Kathy Sandler: +44 (0) 20 7422 4926; [email protected] jdm/ks/jad/am/jms COPYRIGHT Copyright AFX News Limited 2007. All rights reserved

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