September 5, 2009
By Sean Rakhimov
The Coming Wave of Resource Nationalizations
- Pessimist: Things are so bad, they cannot possibly get worse…
- Optimist: Sure, they can!
Since sometime in 2006 we have had this theory of "The Coming Wave of Resource Nationalizations". The latter has an "s" to impress upon you that we are talking about all natural resources in all countries. Not literally, but we believe it will be a worldwide sweeping event encompassing all classes of natural resources. It sounds scary, yet it will be akin to a depression – it's merely a recession when your neighbor loses his job and will only turn into a depression when you lose yours. We also believe that this will be the Chapter One of what some call the (coming) "Resource Wars".
As is often the case with this type of forecasting, it is hard to find a practical angle to it, especially in the near term. To boot, some brilliant thinkers made good arguments against this theory, but here were are anyway, so you decide how much stock to put in it.
Back in 2006 our thinking was that such a wave could be brought about by higher metal prices as well as worsening economic and social environment. For metal prices, we loosely marked $50/oz silver and $2000/oz gold as potential trigger levels. We had also identified the period of "around 2010" as a possible timeframe in which this process would initiate. Those were general parameters we set as ones to look for if this scenario were to unfold. Recent developments, such as the push for a "new global currency" lead us to adjust our thinking. Before jumping into it we want to make it clear that this is not an attempt to pass judgment on any individual, group, government or their actions. We're simply trying to figure out what is likely to happen and its potential effect investment portfolios. More on that below, but first the "What? Why? and When?" of it.
Let's define what we mean by "Nationalization". We agree with Wikipedia's definition, but for the purpose of this discussion we'd like to broaden it just a bit. In this context, by "nationalization", we mean not only outright expropriation of private property but all other forms of "creeping" or indirect nationalization which ultimately leads to increased control of natural resources by governments at the expense of current stakeholders in a non-free market way. These may include any flavor or combination of increased taxation, excessive/retroactive taxation, breach of contracts, delay or revocation of permits and licenses required to exercise legal owner's rights, support or tolerance of other groups/interests' illegal activities to the detriment of property owners, and so on. For instance, two of the more popular tactics used to push this agenda today are allegations of environmental irresponsibility and unpaid back taxes.
Certainly, natural resource exploitation or, by another name, extractive businesses can be messy, and its participants are far from perfect. Especially from the point of view of paper-pushing bureaucrats, who have long lost the concept of "If it can't be grown, it has to be mined". Indeed, resource developers may be offside in any given situation, so we are not suggesting that some of these claims may not be valid. But, more often than not, when a government decides to "get more of its fair share", there is little or no recourse for resource companies, foreign or domestic. In recent history there are numerous examples to that end in Russia, Zambia, Mongolia, Venezuela, Zimbabwe, El Salvador and other places considered "safe" (see list of countries at the Wikipedia link above). If a country changes the rules mid-game or otherwise pursues policies that put your favorite XYZ Resources company out of business or perhaps merely (by 'making life difficult') drives its balance sheet and your share position deep into the red, you decide if it should be classified as nationalization.
This is not a new development by any stretch. Countries all over the globe do this with some regularity and always have, but it has been criticized by free trade/free market proponents; which until recently included much of the west. Going forward it will become pervasive, systematic and acceptable by the economic and political establishment at large. In that light, we almost titled this article "The Coming Competing Resource Nationalizations" as a play on all too familiar "Competing Currency Devaluations", also known as the race to the bottom. It is when governments deliberately devalue their own currencies to gain economic advantage over their trading partners.
One reason we have not shared this theory sooner was a contra-argument made by some very successful industry experts highly respected by this writer. They correctly pointed out that nationalization has been tried in the not so distant past in various resource rich countries and spectacularly failed to achieve intended results, therefore it is unlikely that they will do it again, at least in the near future. We agree that this is a rather logical and common-sense conclusion.
We are not going to dispute it and we'll leave it for the reader to sort out. However, we have a few arguments of our own to back our reasoning. In no particular order they are:
- We have an unshakeable faith in human nature. If history is any guide, one thing has always happened - when things get tough, people put self-preservation first and everything else (in this case property rights) is pushed aside. This is the same reason why many moons ago we figured that EU and especially the Euro will not survive the test of time.
- Overall standard of living will go down worldwide (more in the west than in the east), at least for the broader populace. If in doubt, consult your favorite doomsday scenario: global depression, peak oil, financial and currency crises, water and energy crises, peak food, wars, mass migration, extreme weather events, geo-political instability, etc., all scheduled to unravel in your lifetime, some sooner than later and some more than once.
- Governments worldwide will face mounting pressure from internal sources to "do something" about the dramatic fall in the standard of living of their subjects.
- Governments worldwide will face mounting pressure from external sources, countries and interests to re-distribute and/or re-dole their natural resources.
- Governments worldwide will find it hard to resist grabbing whatever resources within their reach in order to pay the bills, particularly for foreign trade. As their currencies lose buying power, trade partners will demand better means of payment, such as commodities, while the latter appreciate in value.
- Some countries will do it because others have ("me too" syndrome), or because they were adversely affected by nationalization of resources they import and may be forced to do the same in order to retaliate or out of necessity. This has been happening in the currency markets and we expect the same here.
- Strategic reasons. To date we have seen assets labeled "strategic" when governments wanted to prevent foreign interests from acquiring them. A prominent example of this was CNOOC's (NYSE: CEO) unsuccessful bid for Unocal back in 2005, which was subsequently merged into Chevron (NYSE: CVX). More recently, Chinalco's (NYSE: ACH) bid to increase its 9% stake in Rio Tinto (NYSE: RTP) raised similar concerns and was defeated. We submit that in the future, governments will take control of assets they deem strategic, whether for military or other reasons.
- The “green” movement. The push for environmentally responsible practices is in itself a welcome development. However, its practical application often leaves us worse off than if we did nothing to “protect the environment” at all; such was the case with ethanol mandates in the US. NGOs and political parties are the main players in this space and that alone should have you questioning the cause and methods of the whole thing. It’s not surprising that NGOs succeed in pressuring governments to make poor choices to the detriment of all actual stakeholders. The most recent example of this is taking place in El Salvador as we speak. While neither of the above examples resulted in nationalization of resources, we think it will in the future.
In this context, whoever said that “Every movement starts as an idea, turns into business and ends in a dictatorship” was onto something.
This is the most challenging part to get right, and your opinion is as good as ours in this respect. Earlier we mentioned that higher precious metal prices could serve as an inverse indicator of a brewing currency crisis. In light of a tsunami of money printing worldwide in the last year+, few should disagree that an international currency crisis of an exaggerated degree is baked in the cake. That is on top of an economic crisis we have at hand that. The other thing to remember is that no one will ring the bell when this wave finally arrives. It is already happening and we expect it to spread and intensify in the coming years. If in 2000, someone described all that has happened by 2009 and told us it would still be (for the most part) business as usual or the status quo would remain in tact, we would personally laugh him out of town – yet that's exactly what happened. The lesson therein is: everything takes longer than expected.
Then there is the "boiling frog" effect – when changes, while dramatic in nature, unfold in a creeping fashion and thus do not cause a sudden reaction. Given the nature of this phenomenon and the myriad of variables involved, we think this will be the likely scenario. Privately, we have been advising junior companies that ask our opinion to "get as big as they can as fast as they can and sell". While that would normally be their business model anyway, in this cycle the looming prospect of nationalization could provide additional impetus. We reckon we're 3-5 years early, but in mining that is not a long time.
About eight months ago a friend with interests in the industry shared the following. The Chinese government came to the country where his exploration company is developing a project and offered to build a dam, hydro-power complex, and a few billion dollars in infrastructure investments in exchange for access to its natural resources. “How are you going to compete with that?”– He asked. The answer is: you can’t.
At some point in this cycle commodities – not currencies - will once again resume their role as the ultimate means of account settlement in international trade. If not for other reason, than a temporary backlash against paper instruments that have completely discredited themselves and everyone is onto the game. This does not mean barter, (though, it too will have a place in the bigger picture) but that nations will have to pay for what they buy with something other than paper printable at will, and the current experiment with fiat money will go down in history, as did all before it.
September 5, 2009