POLITICAL RISK
Russian Ban of Grain Exports
The power of a single commodity producer to disrupt global supply was starkly demonstrated by Russia’s ban on grain exports 2010. Despite reports of a strong harvest in the US and high wheat inventories that should cover the reduction in Russian output, Prime Minister Vladimir Putin acted prematurely and the markets reacted wildly with wheat prices rising to a 23-month high since the announcement.
Putin’s announcement cited droughts and fires as the causes of the depleted summer harvest, with expectations for a harvest of 60 million tonnes, down by 40 million tonnes on the bumper crop of 2009. The need to stave off food price inflation and ameliorate social discontent were the driving forces behind the ban as parliamentary and presidential elections approached. This tactic was not new. During the 2007-08 election cycle, which coincided with global food price hikes and shortages, the government intervened to regulate the price of staple food stuffs.
Even if Russia’s poor harvest is not replicated in other grain producing countries, and grain stock piles and lower demand prevents a repeat of the food price riots that shook 35 developing countries in 2007-08, it remains a stark indication of the power of commodity exporting nations over the world economy.
Of course it is possible to sympathise with a government’s need to feed its people, yet the ban demonstrates that there are many governments which, for a mixture of political and economic necessity, are willing to renege on contractual obligations and adopt protectionist strategies.
While the nature and source of risks may
change, political and economic realities mean that the trading and investment environment will remain challenging for commodity traders.
Commodity traders with contracts to supply customers with Russian wheat in this case may have been able to declare “Force Majeure”, as the inability to execute the contract was frustrated by government decree. Those commodity traders and their Lenders who had Political Risk Insurance (PRI) in place and had suffered a loss would have been able to claim under such a policy.
Whilst there is extensive capacity within many organisations to manage risk, ultimately governments do take decisions that impact on business operations, irrespective of the best efforts of management teams. In those circumstances, when risk is well managed, PRI can and does provide a very effective safety net.
traders in a variety of ways: from bank closures slowing payments and protests disrupting transit routes, to forced abandonment of assets due to the impact of civil war. Commodity markets reacted negatively and a political risk premium was added to the price of many commodities, most notably oil & gas due to fears over the stability of transit routes through the Gulf.
Contractual Risk While the trends and triggers that gave rise to the Arab
Spring inflicted collateral damage on the commodities sector, commodities investors are often the victims of direct government targeting their operations. This action has been most notably in the natural resources sector, where the expropriation, confiscation and nationalisation of assets, often referred to as resource nationalism, is one of the most significant challenges confronting traders and investors. Resource nationalism has become more than a
cyclical occurrence linked to rising commodity prices. It has become an instrument of populist government policy and the default position of newly democratising nations. Host governments have forced unilateral restructuring of contracts and concession agreements
30 March 2013
and in many instances ownership structures have been forcibly revised to deprive the foreign investor of a majority stake holding in a project, transferring the controlling interest to the state. As one might expect, a number of cases
are lodged with the ICSID, as investors have taken action against the governments of Ecuador, Russia, Uzbekistan, Bolivia and Uganda which resorted to the outright expropriation of assets to seize a greater share of returns from the exploitation of their natural resources. In contrast, although just 6% of ICSID cases concern North America and western European countries, these governments have proved themselves as adept as their counterparts in the developing world at taking the money from foreign investors. In the UK and Australia this has been done more subtly with the imposition of windfall taxes on lucrative natural resource projects. Pernicious government action is leading
many mining majors to reconsider their investment strategies, with many taking smaller stakes in new projects and pre-emptively renegotiating tax rates for existing projects. Rio Tinto, the world’s third-largest mining company, announced in 2011 that it would limit its investments to smaller or midsize projects costing under US$10 billion. Within the oil and gas sector, national
oil companies (NOCs) are responding to more onerous operating conditions and the favouritism shown to oil majors by turning their attention to non-state controlled deposits like Canada’s oil sands, an area where their technological superiority gives them a huge competitive advantage over NOCs. The surge in south-south investment and the rise
of new economic power centres has given resource rich countries a wider choice of investment partners. China’s voracious appetite for natural resources and that of other emerging economies continues unabated, in striking contrast to the declining power of western consumer nations and changing the investment landscape for multinationals in the extractive sector. The changing pattern of demand for resources, combined with the range of potential investors, has left companies more vulnerable to expropriation or forcible contract renegotiation. If one company withdraws from a territory when confronted with punitive changes to tax, royalties or ownership requirements, there are many other companies willing to take its place. Democracies are often associated with stable
operating environments and autocracies and other non-democracies with instability. In reality, the risk
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