Tuesday, December 12, 2006

A slippery double standard hampers Globalization

The financial media in the west is all atwitter at Russia's recent "seizure", to quote The Guardian, of the Sakhalin-2 LNG (Liquefied Natural Gas) project, reportedly the largest in the world. Spokesmen for Royal Dutch Shell, the company apparently getting frozen out by the Russian government, via state controlled corporation, Gazprom, warned Russia, the world was watching.

The world is watching. That sounds a bit like what I tell my 5 year old son from time to time when he's about to do something he shouldn't- I'm watching you.

The Russian government, assuming I've interpreted the comment correctly, is not supposed to concern itself with energy security, or try to use its power to craft deals the way it wishes.

That's a good one.

I wonder where Royal Dutch Shell was when Yeltsin was dissolving Parliament and, against the will of some, writing a new Constitution which facilitated much more extensive privatization of formerly state-run industries? Waiting in line to get a piece of the pie, of course,

The Sakhalin-22 PSA, which has been called a Production non-Sharing Agreement, was signed in 1994, when Yeltsin's economic liberalization program was in full swing and the Oligarchs were making money hand over fist. The terms of the agreement include the following quite unique features for an investment contract of this type.


1) At first, ALL proceeds from oil and gas sales (apart from a small royalty) are treated as ‘cost oil’, until both the capital investment AND an IRR (internal rate of return) of 17.5% (a comfortable profit) for SEIC have been received.
2) Once costs and the 17.5% return have been received by SEIC, the Russian Party receives 10% of the hydrocarbons for the following two years.
3) After those two years, the Russian Party receives 50% of the hydrocarbons until SEIC has received a 24% IRR (a large rate of profits).
4) Only after that 24% IRR has been obtained does the mechanism shift to its final sharing of 70% of hydrocarbons to the Russian party.

Given that the Russian government was only going to get paid after all project costs were recouped, one can imagine why they were a bit miffed to learn that MMMMS, the Royal Dutch Shell-led consortium, was raising the expected cost of the project from the original US$12B to US$22B. That's US$10B more worth of LNG that needs to be sold before the Russian government gets a ruble.

The world may be watching Russia now, but Russia was watching Royal Dutch Shell the whole time. And they are not pleased. Thus the new found fear of environmental damage.

Do I think Russia is "playing fair" in this game? No, but then I also don't think MMMMS was playing fair with Russia in the early 90s. As the Russian state has reformed and strengthened under Putin, turnabout, it seems, is fair play.

The aspect of the press coverage of this issue that is least useful, in my view, aside from the lack of history which makes it possible, is the sense of amazement at the Russian government's response.

Consider the following excerpt from a letter to President Bush on the proposed, but terminated deal for Chinese controlled CNOOC to buy Unocal, from US Representative Joe Barton, then Chairman of the House Committee on Energy and Commerce:

U.S. national energy security depends on sufficient energy supplies to support U.S. and global economic growth. But those supplies are threatened by China's aggressive tactics to lock up energy supplies around the world that are largely dedicated for their own use. China has used its state-owned oil companies to advance this strategy, by buying up energy assets around the world without regard to human rights and environmental protection, in countries such as Sudan and Iran. And unlike other companies, these resources are not available to the global market.

CNOOC's bid to acquire Unocal is simply the latest, and most significant, step in this strategy. If approved, the transaction would put vital oil assets in the Gulf of Mexico and Alaska directly into the hands of a company controlled by the government of China. This would be directly contrary to the goal of enhanced energy independence embodied in H.R. 6 as passed by the House.

One of the premises behind globalization is that the national origins of any corporation should not matter. What is supposed to matter is efficiency at delivering product to consumers and profit to share holders. Pure corporate competition.

Yet, as the Unocal and Dubai Ports deal demonstrate this isn't the case for the biggest promoter of Globalization, the US. The US is, rightly in my view, concerned about losing control of strategic resources.

And we are not alone in that concern. National governments around the world are reacting, once again, to fears of loss of control- to fears that the strong will bleed the weak. Intra-nationally in the US in particular, the middle class is becoming as disenchanted with unchecked corporatism as many national governments are.

As ex-US Treasury Secretary Summers recently opined in the FT:

In the past, real wages and corporate profitability have moved together – increasing during economic expansions and when the US became more competitive, declining in recessions and when it encountered significant competitive threats. The unique feature of the current expansion is the divergence between the fortunes of capital and the fortunes of labour. While workers normally receive about three-quarters of corporate income, with the remainder going to profits and interest, the Economic Policy Institute has calculated that, since 2001, labour has received only about one-quarter of the increase in corporate income, as real wages have failed to keep pace with productivity growth.

The same corporations that want
to off-load invesment risk onto the Russian government are the same corporations that have increased the income gap in the US.

Mr. Summers continues:

These economic and political trends are and should be of great concern to the business community as well as to policymakers. They have led to populist policy proposals that cut against the grain of the market system by, for example, limiting free trade agreements, restricting outsourcing or limiting the ability of successful companies to expand.

After calling for a return to a more progressive tax system, noting some of the effects of corporate tax shelters and transfer pricing (the shifting of profits to low tax states and costs to high tax states) on smaller businesses and the common man, Mr. Summers suggests:

Much more can done in a range of areas, from disclosure of executive compensation, to ensuring that the government leverages the volume of its purchases, to making financing of education at every level more equitable, to making sure that businesses continue to take responsibility for their workers’ healthcare costs.

I, for one, am not sanguine about the prospects of a voluntary quick shift in commercial corporate mind-set. Mr. Summers calls for fairness will likely go as unheeded as President Hoover's calls for Volunteerism when the last experiment in Globalization run aground.

If history is a guide, that means, after a period of economic decline and growing popular resentment of corporations, that we can expect a shift back to more state controls on corporations and towards greater national self-sufficiency.

And that might not be such a bad thing.