Nationalization of Critical Raw Material Industries: Silver Bullet?

Introduction

Significant reserves of critical raw materials for the energy transition are found in countries in the Global South. Some have billed nationalization of the battery raw materials industry as the path of least resistance for the Global South to maximize the economic returns of its resources. As one of my good friends puts it: #Nationalize It! In fact, the governments of Indonesia and Chile have taken measures towards nationalizing their nickel and lithium industries, respectively. However, does nationalizing these industries really offer the best chance at maximizing their value to the economies of the host countries? Let’s see.

Historical origins

For those familiar with international development, the resources in question might be new but the question of maximizing the economic potential of natural resources in the Global South is not. In fact, similar discourses have occurred since the beginning of decolonization of African, South American, Central American and Asian countries. European colonial powers set up extractive economic structures with their colonies as sources of cheap raw materials and captive markets for their finished products. Political self-determination might have been won but the exploitative global economic regime has outlived colonization. The incomprehensible economic reality of today is characterized by the Global South owning natural resources and the Global North reaping the benefits of their extraction. Hence the question of how the Global South can make its natural resources work for its economies.

Schools of Thought

Historically, they have been two major schools of thoughts on how countries should structure their natural resource industries:

1. Privatization: this is an ideal of the proponents of capitalism. Privatization prescribes the exploitation of natural resources by private entities without government interference. Supply and demand should determine the price of goods and volume of production.

2. Nationalization: prescribes state ownership of natural resource industries. The government develops an industrial policy which entails price control and production volumes for the nationalized industry. This approach is usually associated with socialism but has been implemented in liberal democracies, such as the United States, during times of economic and social crises.

Pros and Cons of nationalization

The advantages of nationalization are:

1. More revenue to host countries: governments can obtain more revenues from national enterprises compared to tax income from foreign companies.

2. Growth of local enterprises: nationalization protects the local economy from foreign actors thereby enabling local equivalents to grow due to less competition.

The main disadvantage of nationalization is the perceived instability which can lead to capital flee. Nationalization is usually accompanied by seizure of assets either with or without compensation. Likelihood of expropriation by a sovereign is viewed as a significant investment risk thus investors will tend to avoid such countries.

The good and the bad

In this section, we perform an overview of the outcomes of nationalization of the oil and gas industries in 2 countries: the Kingdom of Saudi Arabia (KSA) and Venezuela. Both nations are members of the Organization of Petroleum Exporting Countries (OPEC) - founded in 1960 to enable members to influence the global oil market. KSA and Venezuela are commonly known as petrostates based on the reliance of their economies on their oil industries and little diversification of their economies. The success of the nationalization of any industry is assessed based on its impact on the country’s economy. Given the complexity of national economies, it is not always possible to determine the impact of a single policy on an economy.

Herein, we assess the effects of nationalization of the oil industry on a host country’s economy using 2 metrics: oil production volumes and oil rents as a percentage of gross domestic product (GDP) - oil rents (% GDP) in short. Oil rent is defined as the difference between the cost of oil production and the value of crude oil production at regional prices. The oil rents (% GDP) metric generally indicates an economy’s reliance on its oil industry.

Saudi Arabia’s oil and gas industry - Saudi Aramco

The KSA government granted a concession to the Standard Oil Company of California (now Chevron) in 1933 leading to the formation of the Arabian-American Oil Company (Aramco). The KSA government gradually increased its stake in the company eventually taking control and renaming it to Saudi Aramco in 1988. The KSA government currently owns 90.19% of Saudi Aramco. In 2019, the company successfully navigated one of the largest initial public offerings (IPOs) in history.

Venezuela’s oil and gas industry (PDVSA)

Venezuela’s oil reserves - the largest in the world - were discovered in 1922 by the Royal Dutch Shell company. The control of 98% of the Venezuelan oil market by Royal Dutch Shell and Standard Oil in the 1930s would lead the Venezuela government to gradually take measures to increase its oil tax revenues. These measures included joining OPEC in 1960, the creation of the state-owned Venezuelan Petroleum Corporation and eventually, the nationalization of the oil industry in 1976 through the formation of the national oil company - Petróleos de Venezuela Sociedad Anónima (PDVSA). PDVSA operated autonomally until 2003 when the government of Hugo Chavez incorporated the company into the executive arm of the government.

Impacts

Figure 1 shows that the oil production volumes of KSA declined between 1980 and 1985 then generally increased till 2021, hitting the 1980 level in circa 2005. Venezuela’s production volume also declined between 1980 and 1985 then increased above the 1980 level until 1998. Venezuela’s oil production volume has generally declined since then. The fluctuations in production volumes are largely reflective of the boom and burst cycles of the global oil market. However, Venezuela’s declining production volume since 2003 can be attributed to the inefficient management of PDVSA.

Figure 2 below shows that KSA’s peak oil rent (% GDP) achieved its peak (~87%) prior to full nationalization (1988). However, Venezuela’s oil rent (% GDP) peaked after nationalization (~36% in circa 1979). It is worth noting that the different trends for the 2 countries can be attributed to the fact that Venezuela’s nationalization occured during a boost cycle while that of KSA occured after the boost cycle. For Saudi Arabia, oil rent (% GDP) has generally stayed above the figure in the year of nationalization. The opposite is true for Venezuela. Overall, both countries have experienced highly fluctuating levels of oil rent (% GDP).

Declining oil rents (% GDP) can indicate that:

1. Oil rents are growing slower than the host country’s economy

2. The host country’s economy is becoming more diversified

It is important to note that oil rent (% GDP) has an optimal range, above or below which it can have adverse impacts on the economy.

Verdict

It is reasonable to argue that government’s control of the production of natural resources, compared to the control of the private sector, is a more effective way to achieve the optimal resource rent as percentage of GDP. Consequently, nationalization could be key to maximizing the potential of mineral wealth, if well executed. The failure of nationalization in most developing countries can be attributed to the phenomenon of ‘phony nationalization’. A phony nationalization occurs when the host country simply switches out foreign personnel for local ones without fixing the underlying extractive practices.

Despite their obvious shortcomings, the private sector has figured out ways to run effective enterprises. A successful public enterprise must adhere to the following:

1. Reinvestment: reinvesting profits - a strategy long perfected by private enterprises - must be adopted by public enterprises looking to grow or sustain their enterprises.

2. Innovation: pursuing and adopting technological advancements is key to keeping a public enterprise competitive with external private competitors with regards to lowering the cost of production and maximizing profits.

3. Effective management: state-owned enterprises in some countries suffer from management inefficiencies stemming from bad governance at the national level. Leadership based on merit should be embraced if any operational success is to be achieved.