Streetwise Professor

April 1, 2007

The Courage of Its Kovykta-ians

Filed under: Energy,Russia — The Professor @ 2:26 am

BP (via its joint venture TNK-BP) has become the latest big oil company to play the monkey to Vladimir Putin’s organ grinder. The license of TNK-BP in Kovykta hangs by a thread; under the license, it is obligated to produce a volume of gas that Gazprom refuses to transport, so the company cannot produce what is required. This gives the Russian government the pretext to revoke the license.

But Vlad the Organgrinder needs a performance. In particular, he needs somebody to pretend to bid on Yukos assets (specifically, a stake in Rosneft) so that a sham auction for these assets meets the formal requirements of Russian law. Not bid with the intent or slightest expectation of winning, mind you. Indeed, to bid with the understanding that the outcome is pre-ordained, and that Rosneft would walk away with the stake at a bargain price.

So Vlad cranks the organ, and TNK-BP obligingly does a little dance, doffing its cap in mimicry of someone bidding at a real auction, and then scurries away when Rosneft shows up.

TNK-BP abases itself so in the hope that Vlad will let it keep a piece of Kovykta. Perhaps he will—for today. But don’t count on tomorrow—unless perhaps Vlad needs another performance.

Despite this latest episode in an ongoing saga of state expropriation of energy assets, western oil companies desperate to find new reserves are still anxious to do business in Russia. Samuel Johnson described second marriages as a triumph of hope over experience; the willingness of BP, and Chevron, and Conoco Phillips, etc. to continue to pursue Russian projects takes that to an entirely new level. The triumph of insanity over experience, perhaps.

This raises the question of whether there is any mechanism that can secure the property rights of foreign investors in Russia (or other resource rich/governance weak polities), especially investors in “strategic” sectors such as energy. History provides a potential model, but I am extremely skeptical that it can be implemented today.

Specifically, Avner Greif’s analysis of medieval merchant guilds (contained in his Institutions and the Path to the Modern Economy) shows that guilds were able to protect the property of merchants from the depredations of foreign rulers. They did so by coordinating and enforcing embargoes on rulers that abused the property rights of any of their members. Greif shows that the threat of an individual merchant (or small group of merchants) to withhold future trade in the aftermath of an expropriation could not impose a sufficient cost to deter expropriation, but that a coordinated embargo by all guild members in response to any expropriation could do so. This required the guild to impose costs on any member who attempted to circumvent the guild’s embargo. Moreover, the guild had to be sufficiently large for its threat to be a credible deterrent.

A modern guild of oil companies, for instance, could serve this role. Expropriate one, and the others withhold investment.

Could it work? I am very skeptical. Even absent legal obstacles, the difficulties of coordination are immense, especially inasmuch as Russia is past master at divide and conquer. Moreover, antitrust laws would likely severely impede any such effort. Furthermore, it would be a challenge, to say the least, to craft credible punishments to enforce defections from the “guild’s” embargoes.

There is another issue. The formal models in Greif show that the guild mechanism works best when time horizons are long and discount rates are short. These factors make the cost of expropriation—a foregone stream of future gains from trade—large. However, as I have noted in earlier posts, time horizons are short and discount rates are likely high in Russia’s unsettled (and brutal, and arguably murderous) political environment. Hence, reputational penalties like those that support trade in Greif’s models are unlikely to be big enough to work in this instance—or in other garden spots where expropriation risks are high (e.g, Venezuela).

Thus, it is likely that some other mechanism—such as the taking of hostages a la Williamson—is required to deter expropriation. In any event, in a world thirsty for new energy supplies, and where these supplies are located primarily in states with predatory governments that show little respect for property rights, meeting the demand for energy will require a new approach to protect energy investors against expropriation. Until such a mechanism is created, however, expect periodic reprises of Organgrinder Vlad’s Monkey Show, with oil company executives starring as the monkeys.

« Previous Page

Powered by WordPress