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The development of the petroleum sector has been characterized by a succession of cycles of investment and expropriation (i.e., forced renegotiation of contracts, nationalization, changes in fiscal rules, etc.). These cycles have been particularly pronounced in Latin America, although other regions and even developed countries have also experienced this phenomenon. This essay intends to provide elements for understanding why these cycles occur in light of the regional experience and to derive lessons to be considered during the implementation of the petroleum reform in Mexico.
The fiscal and contractual framework for the exploitation of petroleum resources in Latin America has undergone important changes over the course of the past decades. During the 1990s, the hydrocarbons sector of the region was opened up to private investment and the fiscal and contractual frameworks were made more flexible to attract foreign investment; during the first decade of the 21st century, the significant increase in the price of oil generated great political and social pressures to increase the government-take and exercise more state control. This trend materialized strongly in countries such as Argentina, Bolivia, Ecuador, Venezuela, and, more recently and with less intensity, Brazil, although in one way or another, it had an impact in all productive countries. Expropriation, forced renegotiation of contracts, and other regulatory changes that negatively affected foreign investors had significant effects in terms of reputation, which contributed to the fact that the region did not take advantage of high oil prices in order to increase investment and production, with the significant exceptions of Brazil and Colombia. Considered as a whole, Latin America produced slightly less in 2013 than when the price boom started in 2003. Latin America lost one percentage point of the worldwide market share and now has the lowest rate of extraction among regions in the world.
The specific characteristics of the sector—among them the presence of significant revenue, a high proportion of sunken costs, and changes in the risk profile of projects—contribute to making it particularly vulnerable to expropriation cycles. Petroleum nationalism, and its absence, have not only been motivated by the ideological preferences of the governments of the region, but rather to a great degree have been the result of the incentives generated by geological characteristics, investment and price cycles, and other structural and institutional variables.
The same country has had different policies depending on the type of resource, and even the policies of a given administration have been different whenever circumstances have changed. One of the basic variables has been the amount of revenue present at a given time; therefore, the international price of oil is a key element. Significant price increases tend to generate significant incentives for the renegotiation of contracts and fiscal conditions as well as for expropriation or nationalization. The end of a significant investment cycle, when significant projects that incorporate production and reserves are completed, also generates incentives for changing the rules.
Another relevant variable is the progressiveness of the fiscal and contractual framework; that is, to what extent the government-take automatically rises in response to an increase in revenue, particularly one generated through price increases. Fiscal and contractual frameworks that are barely progressive or are even regressive, such as those that have characterized the region, have caused states to have powerful incentives to raise the tax burden or to expropriate during periods of significant price increases. In general, the fiscal frameworks of petroleum resources have been unsophisticated and have not incorporated significant contingencies in terms of price and profitability. The lack of adaptability and progressiveness of the fiscal and contractual frameworks has contributed to creating cycles of tax structures that are more flexible or stringent.
The lack of institutional capacity and credibility of certain countries makes their fiscal and contractual frameworks unreliable for investors. This may cause those countries to adopt rigid rules or instruments that are not suitable for changes in profitability; use international mechanisms of commitment, such as arbitration or investment treaties, thereby losing sovereignty and flexibility; or offer very high yields at the start of the projects to compensate for high regulatory risks. It could also result in in less investment in the sector than what it could have been obtained with a more solid institutional framework. If lack of credibility is the reason for offering very attractive conditions in order to attract investors, such conditions would tend to be more prone to renegotiation. This problem of “time inconsistency” is one of the reasons why the stability of the tax and contractual framework is precarious and leads to the cycles of investment and expropriation that have characterized petroleum resources in the region and a great part of the world.
The Mexican petroleum reform has the advantage of being able to apply lessons learned from the experience accumulated over the past two decades in the region. Among these lessons, the following are noteworthy: 1) there are significant risks of reversing reforms; 2) the failure of reforms to attract investment and increase production can be a reason for their reversal, but significant success in terms of reserves and production can also exert pressure to renege on contracts; 3) significant changes in the international price of oil can generate incentives for renegotiation as long as contracts do not properly cover such contingencies, and sometimes even when they do; and 4) the credibility of the regulatory framework is an essential condition for maximizing the benefits of the petroleum sector, since regulatory insecurity leads to either less investment or a smaller share of profits for the state.
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