The Power and the Money

The border tax and climate change

I am opposed to a 20% tariff aimed at Mexican manufactured goods. I am more ambivalent about the 20% border adjustment tax (BAT) floated by the Trump administration. In fact, I may support it. 

The basic idea is simple. U.S. companies would pay a 20% income tax. Companies could deduct domestically-sourced inputs from their income but not imported goods or services. Those imports would then, in effect, have to be at least 20% cheaper than equivalent domestic competitors. 

The idea is to make the U.S. corporate income tax look like a value-added tax (VAT). If a corporation in Mexico buys an input from overseas, it pays the Mexican VAT on the purchase. If it sells something domestically, then it also pays the Mexican VAT. But if it sells something to a company in France, then it does not pay the Mexican VAT ... but the French buyer will pay the French VAT. Under the BAT, if a corporation in the U.S. buys an input from overseas, then it pays the U.S. BAT on the purchase. Ditto it pays the BAT on all earnings from domestic sales. But if it sells something to a French buyer, then it will not pay the U.S. BAT ... but the French buyer will pay the French VAT.  

As it stands, the BAT will apply to oil imports. So an American refinery that buys foreign crude would have to pay the 20% BAT on those purchases! Right now, WTI trades around $54 per barrel. A refinery using American crude would pay $54; a refinery using imported crudes at a similar grade would pay $65. American oil prices would rise, world oil prices would fall.

And that is good for the world! Higher U.S. oil prices mean less U.S. oil consumption. Moreover, the burden will fall particularly on dirtier forms of oil. Most American crude oil imports (60% in 2015) are heavy grades. Almost half of that consists of heavy crudes from Canada, which  release about significantly more carbon during the production process than other grades of oil. (So much so that the Section 526 of the Energy Security Act of 2007 theoretically banned U.S. federal agencies from purchasing it, although that has had no concrete effect.)

Lower world prices will, of course, stimulate more world consumption. But there are two wrinkles that will reduce that impact. First, transport links lock in most Canadian output to American markets. Last year, the Trudeau government approved an expansion of the Trans-Mountain pipeline from 300,000 to 890,000 bpd, which would allow Canada to divert as much as 28% of its current U.S.-bound exports to other markets. But that will take a long time and is a drop in the bucket of world production. Second, American refineries are optimized to use heavy crudes. They will switch away, but slowly, even if the cost of their primary input rises. Finally, inasmuch as world prices do fall, that will discourage foreign exploration and development, keeping some carbon in the ground for the long-run. 

Winners:

1. Our children;
2. American heavy oil plays, of which there are not many outside Alaska;
3. American light tight oil plays (hooray!);
4. Andrés Manuel López Obrador (see below).

Losers:

1. American oil consumers, who will likely see prices rise about 30₵ per gallon;
2. Refiners who use imported crude oil—although not by very much;
3. Canadian, Ecuadorean, Venezuelan and Mexican heavy oil producers, who are locked into the U.S. market;
4. Mexican consumers, who rely on gasoline produced in the United States from Mexican heavy crude.

As far as energy is concerned, this does not strike me as a bad policy, even if it will impact Mexico quite seriously. At 2015 prices, a 20% BAT would have raised about $2.0 billion from Mexican crude oil imports, although most of that burden would fall on American consumers. The real hit for Mexico is that the increase in U.S. gasoline prices will be passed on to either Mexican consumers or the Mexican government. Inasmuch as the Peña administration hands Mexican voters a second gasolinazo, then it will be another fillip for AMLO’s chances in the 2018 elections.

So a good policy for energy: a net plus for domestic production and a net plus for decarbonization. Probably pretty good Harley-Davidson, as well.

But as far as other products markets are concerned, I’m still undecided as to whether the BAT is a good idea. Thoughts?

When ideology and self-interest meet, Ecuador edition

 The Correa administration admitted to cutting Wikileaks’ internet access over the recent releases of strategically-timed hacks from Podesta’s account. Good for them! They claim that the decision is a high-minded refusal to intervene in the internal affairs of another state, regardless of that state’s imperial record.

But it’s also in Ecuador’s interest. Not because a Clinton administration will be particularly good, of course. Rather, a Trump administration will be astoundingly bad. In immigration and trade, Ecuador may strategically close its market but it depends on the United States remaining open. And it very much depends on a structure of international law that bind investment disputes and prevent the U.S. from unabashedly exercising its power in the pursuit of commercial interest. (I wrote a whole book about that.) 

So good for President Correa, but this is a case where the decision is as much in the national interest as the right thing to do. 

How big is the threat that oil exports will be seized in a Venezuelan default?

 It is pretty clear that oil exports could be attached if PDVSA defaulted on its bonds. It would work as follows. PDVSA would sell oil to a refinery in the United States. Creditors would sue. The refinery would still get the oil, but a U.S. court would attach its payment to PDVSA and transfer it to the creditors. PDVSA, therefore, would get nothing from its exports.

If the Venezuelan government defaulted, however, the legality would get a bit dicier. It is possible that American courts would “pierce the corporate veil” and conclude that PDVSA is an instrumentality of the Bolivarian Republic, but that is not certain. Still, it is the way many investors and lawyers (inclduing myself) would bet. 

So in theory sovereign default would lead to a fall in oil prices, as exporting countries with state-owned companies cast around for alternative markets.

In practice, however, the courts are slow and (as mentioned above) the legalities are far from certain. It is quite possible that a defaulting country would merrily continue selling oil while its buyers merrily continued buying. After all, the buyers might not care. They would still get the oil; what do they care if the seller wouldn’t get its money?

But the seller would still want its money. It would likely therefore sell to middlemen who would demand a discount and then resell the oil at some legal risk to themselves. In other words, the price of oil exports would certainly go down.

The empirical question, however, given all the legal uncertainties, is how quickly it would go down. It is quite plausible that the export price of a country’s oil would not be affected by default for months or years.

Well, Ecuador provides a nice test of that question!

Let me walk you through the data. This is going to be a little chart heavy, so I ask readers to comment if it is ever unclear or you lose the chain of the argument.

Ecuadorean oil generally trades a discount to the WTI benchmark price. That is because its oil is heavier than WTI and needs to travel from Ecuadorean fields to (mostly) Californian refineries. The below chart shows the percentage discount on Ecuadorean oil between the start of 2006 and the end of 2009. It shows a very steep fall in November 2008.

That seems convincing, until you add a control. Mexico also exports heavy oil to the United States. Its discount on WTI also widened in November 2008, although Mexico did not default.

Still, the increase in the discount on Ecuadorean oil was greater than the discount on Mexican oil. Might that have something to do with the default? Certainly! But to be sure of that, you need to also account for the fact that Ecuador and Mexico sell into two different geographic markets. Ecuadorean oil goes primarily to refineries in California, whereas Mexican oil goes overwhelmingly to the Gulf Coast of the United States. The price of crude oil can vary by several dollars per barrel between the two locations, given transport costs and varying demand conditions. 

The below chart, therefore, compared the export price of the two countries’ blends to the price paid by refineries in California and the Gulf Coast (60% in Texas), respectively. Once you account for the fact that the price of oil in California fell more than the price of oil on the Gulf Coast, then the oil price dynamics in the two countries look pretty similar between 2006 and the end of 2008. This chart compares the price received by the exporting countries and the price paid by their primary customers:

 

The dynamics look similar when you express the discounts in dollar terms, rather than as percentages of the sale price. The stark increases in November 2008 go away completely, as artifacts of the general fall in oil prices. Mexican crude is a bit more volatile in the lead-up to November, but otherwise looks similar to Ecuadorean:

It is true that Mexican oil recovered faster than Ecuadorean oil. In fact, after January ‘09, Pemex managed to sell its oil for roughly the average price paid by all Gulf Coast refineries, elimating a long-standing discount. PetroEcuador also managed to improve its position relative to the pre-crisis era, but it took rather longer. 

I do not know what happened in the Gulf Coast oil market. There are two hypotheses to explain the Ecuadorean recovery, however. One is that the Ecuador announced the form of its default in mid-2009 — a form brilliantly and perfectly designed to leave creditors without legal recourse. Freed of fears of attachment, therefore, the discount fell.

The other is that May is around when PetroEcuador began selling its oil to state-owned Chinese middlemen at a significant premium. The discount on Ecuadorean oil fell because Chinese companies absorbed it. 

It is still possible, of course, that without the default Ecuadorean oil prices would have bounced back in January 2009 like Mexican ones and without the need to involve the People’s Republic of China. But there is no direct evidence for that story.

The next thing to do would be to nail down an explanation for the disappearance of the Mexican discount in January 2009. If an explanation for that can be found that Ecuador could not possibly have replicated, then the hypothesis that the Ecuadorean default affected the export price of its oil is likely incorrect. On the other hand, if the strategy employed by Pemex was one that Ecuador was prevented from using because it was in default, then the default cost Ecuador.

To be frank, my prior is that whatever happened to Mexican oil in January 2009 was likely idiosyncratic. I doubt that Ecuador suffered in oil markets for its big sovereign default.

Now, this is not to say that default would be costless for Venezuela. It could prove very costly! Eventually, Venezuelan receivables would probably be attached; sooner if PDVSA debt goes into default rather than Venezuelan sovereign debt. But in both cases Venezuela could continue to sell oil.

In short, the evidence from the Ecuadorean default of 2008 is not completely clear-cut ... but the preponderance of the evidence seems to be that any fall in oil prices will take some time to manifest.

Sources tell me that Venezuelan ministers fervently believe that default will lead to cut off in immediate oil exports, or at least a drastic fall in realized oil prices. I suspect that they are wrong ... but it is a good thing for creditors that they do not know that they are wrong.

Is Ecuador’s resource nationalism hurting it in the oil price crash?

 In comments, reader Cad points out that Ecuador’s oil policy has a downside: the same fixed-price policy that lets the country take all of a price windfall exposes the government to large losses in the event of a price crash. 

Under the best-known service contracts, the Ecuadorean government pays private companies a fixed price per barrel. It then resells the oil at the market price. In other words, it takes all the upside from price rises. (This new policy was the cause of several of the country’s big expropriation disputes.) A subset of service contracts allow private companies to help Ecuador’s state-owned companies (Petroamazonas and Petroecuador) extract oil, also at a per barrel fee.

Finding out Ecuadorean operating costs has proven remarkably hard, although there is some rough evidence that costs have recently risen rather dramatically. What we do know, however, is how much money crude oil extraction has generated for the Ecuadorean state. That revenue, in real terms, has fallen 55% since 2013. On a per barrel basis, revenue for the state has fallen 56%.

Of course, prices have also fallen. Ecuadorean exports fetched $95.63 per barrel in 2013, $84.14 in 2014, and $42.00 in 2015. (Those are weighted averages.) That is a ... 56% decline, which is the same as the per barrel decline in state revenue. 

So not much evidence that resource nationalism has hurt revenues from those data.

What about international comparisons? Sadly, the data for Colombia only runs through 2014, but the Mexico data is available through 2015. In Mexico, oil revenues declined 55% in 2013-15. Revenues per barrel, however, declined by only 50%. So Mexico did slightly better than Ecuador at squeezing the upstream oil sector. (These figures do not count revenues from excise and value-added taxes on refined products.) 

In short, Ecuador’s oil policy has not led the country to do worse than would be expected given the crash in oil prices ... but it is possible that an alternative policy would have kept government revenues from falling quite as far. 

Now, Mexico’s oil tax policy is not particularly recommended. It is fiendishly complex, but it essentially boils down to a tax on Pemex’s gross revenues. The result is a company starved of resources and declining production. (Down 10% on 2013, whereas Ecuador is up 3%.) It is not clear that Mexico is an example to emulate.

But at least from these data it appears that Cad was incorrect when he wrote, “Mashi Correa’s greedy and short-sighted gamble was a disaster and now the people of Ecuador stand to suffer.” Rather, thus far his oil policy seems to be holding up remarkably well both in comparison to the price crash and to at least one benchmark comparison. Colombia may have done better; when we have the numbers, I will analyze them.

Ecuador and falling oil prices

 In comments, reader Cad points out that Ecuador’s oil policy has a downside: the same fixed-price policy that lets the country take all of a price windfall exposes the government to large losses in the event of a price crash. 

Evaluating the size of the problem means constructing a counterfactual: how much income would the government be taking in under a different fiscal regime? As of this moment, I do not yet have the data to construct that counterfactual.

We do, however, have the data to get a general idea of how the oil price crash has affected Ecuadorean public finance. Now, it should be noted that Ecuador is much more oil-dependent than Mexico. In addition, it does not have its own currency. As a result, an oil price crash will hurt Ecuador through channels other than public finance. That said, public finance is still the main channel; it is also the main way in which Ecuador’s policy of paying companies a fixed price to extract the oil will hurt the country should oil prices crash.

This post is not going to evaluate the cost of Ecuadorean resource nationalism. It is just going to lay down the fiscal context for such an evaluation.

So how is Ecuador doing? So far, surprisingly well considering that (unlike Mexico) the country has neither hedged oil income nor imposes any significant domestic petroleum taxes. Here are the basic figures for government revenue, in current dollars:

Oil income has plunged since 2012, but the government has made up for it via other taxes. (Of course, those taxes do impose a burden on the domestic economy, so it is not a free lunch.) Oil revenue is down 63% since 2012 (a fall of $3.8 billion), replaced by a 43% hike in income taxes (raising an additional $1.4 billion), an 18% increase in VAT ($1.1 billion), a 30% rise in tariffs ($0.8 billion), and a whopping 92% increase in other nickle-and-dime taxes ($1.4 billion). 

This is painful, but it is responsible. It also explains much of why President Correa causes such outrage among a certain class of Ecuadoreans: taxes on wealthy people really have increased quite substantially during his administration, especially in the last three years. His opponents are not responding to his rhetoric. They are responding to real economic pain that he has imposed upon them, although it is worth noting that even now income taxes in Ecuador raise revenue equal to only about 5% of GDP, up only a single percentage point since 2012 and two percentage points since Correa took office in 2007. 

On the spending side, the decline in oil income has cut the country’s ability to borrow. (In comments, Federico and I discussed this point in July 2015) Nominal public spending fell by 10% in 2015, with most of those cuts falling on fixed capital investment. (I.e., roads, bridges, railroads, buildings, sewers, etcetera.) This chart shows the basic outline:

In short, the adjustment to lower oil prices in Ecuador has been hard but not catastrophic. It is not immediately obvious what other course the government should have taken; in fact, if you take 2012 as a starting point, the situation has been well managed. 

Of course, it is not unreasonable to take 2007 as a starting point. Perhaps Ecuador should have spent less during the boom, but that is at best unclear: the country’s physical infrastructure was in woeful shape and has improved substantially. Its Human Development Index went from 0.698 in 2005 to 0.732 in 2013. The improvement is not stunning, but it is not terrible. (It is roughly the same proportional rise as in Mexico.) Perhaps Ecuador could have achieved that without the run-up in public spending, but that is not clear. 

What is clear is that Ecuador is not Venezuela.

Which brings us back to Cad’s implicit question: could Ecuador have avoided the 63% fall in oil revenue after 2012? We will take that up in another post; but first, any comments?

Do countries pay arbitration awards? Ecuador and Occidental

 International arbitration is a potentially powerful tool for investors. They can use it to attack governments that have changed contractual terms. Sometimes those defenses are battles by robbed investors against unfair expropriation; sometimes they are attacks by international oligarchs on the democratic rule of law. Usually, they are both.

But there is a problem for investors: arbitration is slow and expensive. This is true even after a decision comes down. To enforce you need to go to national courts and start chasing down assets and sales. That is doable, but it is not easy.

As a result, most arbitrations are settled after a decision comes down, simply to spare the investor the hassle. What we do not know is the gap between the awards granted and the amount paid.

In 2012, ICSID ordered Ecuador to pay Occidental Petroleum $1.77 billion plus interest.  In total, that came to $2.26 billion as of 2012, compounded at 4.188%. After that, the award accrued interest at the 6-month LIBOR (compounded monthly), which would put its total value at $2.29 billion as of November 2015.

That month, a second ICSID panel granted a partial annulment, reducing Ecuador’s liability to $1.07 billion. (Page 133; explanation here.) With interest, that would make the November 2015 value of the award $1.38 billion. 

And how much will Occidental get? $980 million. ($979.9 million, to be exact.) That is a full 29% discount off the arbitral award. In short, Occidental decided that $980 million now was worth an additional $379 million after who knows how many years and legal battles. (I also suspect that Ecuador also agreed to let Occidental back into the country, although that option won’t be worth much until oil prices rise.)

In short, yes, countries pay arbitration awards. They pay those awards because private companies can impose very real sanctions if they do not pay. But the system is slow and expensive ... to in this case almost a third of the headline value. Whether that is a feature or a bug probably depends on your politics. 

Ecuador is still not a colony of China

 Now that the New York Times has breathlessly put Chinese imperialism in Ecuador on the front page of its Sunday edition, I feel like I must point out that China is securing neither physical supplies of Ecuadorean oil nor favorable prices. And it is certainly not earning rents on the money it lends the Ecuadorean government. China may be buying goodwill and it may be buying the rights to develop some of the last untapped conventional oilfields on Earth ... but it is getting neither cheap.

We covered physical shipments back in 2012. Nothing has changed. Most of the molecules pulled out of the ground in Ecuador wind up in Californian refineries.

What about price? The oil might physically end up in California, but most of it passes through Chinese ownership. In theory, that would give the Chinese middlemen monopsony power. In practice, it does not. In fact, the Chinese overpay for the oil.

Up until 2012, the loans-for-oil deals required the Chinese lenders to take Ecuadorean oil in repayment valued at a premium over the WTI price. In December 2012, Ecuador stopped charging a premium for its oil. That sounds like maybe perhaps now the Chinese were finally taking advantage of their position ... but such a conclusion would be wrong. Traditionally, Ecuadorean oil traded at a discount under WTI because it was of low quality and could only be sold to California refineries unless it was shipped through the Panama Canal. In 2012, however, for the first time ever, Ecuadorean crude sold at a premium over WTI around US$4 per barrel. (Californian refineries needed that heavy oil.) The Chinese buyers did not wish to pay a premium over the premium, and so the Ecuadoreans agreed to deliver the oil at the market price.

Maybe the contracts were just folderole? Perhaps canny Chinese traders managed to squeeze out monopsony profits regardless? Well, we can check that. PetroEcuador sells its oil mostly to Chinese buyers. The private companies operating in Ecuador do not. (They technically turn their oil over to the Ecuadorean government for a per-barrel fee, which then sells it back to them, at which point they sell it again at a further markup upon which they pay taxes.) The prices at which PetroEcuador and the private companies sell their oil is publicly available. And what do those prices tell us?

The blue line shows the difference between the price charged by PetroEcuador (which sells to the Chinese) and the price charged by the private producers. PetroEcuador generally receives more money per barrel. In fact, PetroEcuador managed to take advantage of a spike in Californian prices in early 2011 that passed the other producers right by.

The red line shows the difference between the price received by PetroEcuador and the landed price of oil in California, which is the relevant market. It shows no trend: the increase in oil sales to Chinese middlemen does not drive up the spread between the price paid by Californian refineries and the price received by PetroEcuador. (The spread does increase at the end of 2014; that is an effect of the general oil price crash, as all Ecuadorean producers tried to keep up their market share.) 

OK, then. The oil is still going to California and the Ecuadoreans are receiving a good price. So maybe the Chinese are charging extortionate interest on their loans? It certainly could be. But again, that is easy to check. 

How do the terms on the Chinese loans stack up against those offered by private creditors? The red bars show the lending rate on the Chinese loans. The blue bars show the yield on Ecuador’s 2015 bond at the time the loans were made. In every case, the red line is below the blue line. The last loan, from the Chinese Ex-Im Bank, uses Ecuador’s new issue due in 2024 as a benchmark ... which brings home just how incredibly cheap that last loan happens to be. 

The New York Times article mentions “steep interest payments” on the Chinese loans. I have no idea what they are talking about.

The Times article also states, “Along with taking the bulk of oil exports, the Chinese companies also collect $25 to $50 in fees from Ecuador for each barrel they pump.”

What it does not tell you is that said fee is in fact a triumph of Ecuadorean resource nationalism. Remember how private oil producers (Chinese and Western) in Ecuador turn over their production to the government and then buy it back? Well, that fee is what the government pays them for their oil. The difference between that and the market price is pure rent for the Ecuadorean state. It is the exact opposite of imperial exploitation. (The contracts are quite clever; the newest ones give the companies a higher price if they reduce costs.) The government also takes 70% of the profit on oil sales. (Page 178.) 

The article’s phrasing, however, makes it seem as though Chinese companies take the oil for free and then charge a fee on top of that. Very misleading.

The article also says, “China’s terms are putting countries in precarious positions.” But that doesn’t make any sense! The terms of the loans are great for the borrowers. Falling oil prices are what is putting Ecuador in a precarious position. As for China’s ability to threaten trade or other sanctions should Ecuador default ... well, tell that to the Argentines or the Greeks. Western creditors, public and private, are also pretty good at that sort of thing. (I wrote a book about it!) 

Ditto the way that China forces the recipients of its finances to buy its products and contract with its companies. My co-blogger knows more about development aid than I ever will, but from what I saw on the ground in Afghanistan and Africa that sort of thing seems to be the rule ... even if it is technically disallowed. (Doug?) And I must also admit that while the anecdotes about Chinese labor and environmental practices are quite telling, I also doubt that they are much worse than the Western record. (Setty?)

Finally, love it or hate it, the Refinería del Pacífico is a purely Ecuadorean idea. If it turns out to be a bad one (I suspect it is) then perhaps one could blame the Chinese for going along Ecuadorean desires. But the refinery is not a boneheadedly stupid idea. There are real reasons to support it; opponents (like myself) are making a judgment based on the risk of failure; reasonable people can disagree about whether the potential reward is worth the risk. Moreover, most of the debt for the refinery will be effectively collateralized. Many of the losses will fall on Chinese banks.

The above, I think, is the opposite of imperialism. Ecuador sold the refinery idea to China and looks as though it might get the Chinese to put up most of the money and take on most of the risks. 

If this is a Chinese empire, it makes the American empire look well-run and logical. Which is saying a lot.

Does Russian expansion matter beyond the border regions of Russia?

Back in April 2012, we discussed the idea of the “1945 line” in comments. In October of the same year, we discussed it again in reference to the Falkland Islands. Key quote:

“Any planning for a war [with the U.K.] would need very careful diplomatic preparation these days, much more than in 1982. Back then, Argentina was following a long line of actions that held that the “1945 line” did not hold for European overseas territories. Morocco could invade the Spanish Sahara, India could fight a war with Portugal for Goa, Indonesia could march into East Timor and Dutch New Guinea. Given this history, it was not (completely) crazy for the Argentine generals to think that the world would accept their victory. (And to be honest, I suspect that they were right: if they had won, las Malvinas hubieran sido argentinas.)  But that is not the case today, even though plenty of countries support the Argentine claim [to the Malvinas].”

In short, there has been a remarkably effective taboo on unilateral annexations unless they involved European overseas territory. There is only one real exception: Israel after 1967. (Wikipedia adds Sikkim, which India annexed in 1975, but Sikkim had not been an independent state.)

How do we know that the taboo is effective? A case can be made that the taboo limited the extent of interstate wars in Latin America. For example, El Salvador and Honduras fought the Soccer War in 1969 over the status of Salvadoran settlers in Honduras. Since annexing the area settled by Salvadorans was not a possible outcome given the taboo, the OAS (and behind it, the United States) had the leverage to force Salvadoran troops to withdraw. In another example, Peru and Ecuador fought the Cenepa War in 1995. Neither side could reasonably expect to gain or lose any territory outside the disputed region, which made Peru more willing to accept a limited Ecuadorean victory even when Peru had military superiority. (See pages 2 and 3 at the link.) In short, one might believe that the taboo kept both wars from spiralling into protracted total conflicts.

OK ... but the taboo did nothing at all to stop Israel from annexing some border regions. Nor did it prevent the Eritrean-Ethiopian War from turning into a protracted total conflict. Similarly, Paul Collier made arguments that Africa might in theory be better off if governments feared that their states might be forcibly absorbed by neighboring states — but he rejected the implications of that idea by arguing that the lack of interstate conquest was overdetermined: the international taboo was just one of many obstacles to a would-be empire builder in modern Africa. (See pp. 184-85 of Wars, Guns, and Votes.) Considering those examples, perhaps other factors were at work in keeping Latin American wars from spiralling out of control.

The debate matters. If the taboo is key, then Putin’s actions matter beyond near-abroad of the Russian Federation. Successful expansion opens the door to similar actions all over the planet.

But if the taboo on conquest is just a reflection of some other deeper cause, then current Russian actions have implications only for future disputes that involve Russia. Interstate relations between other countries won’t change. David Weman is correct that this will be the only successful non-colonial annexation outside Israel, but maybe that does not matter.

So which is it? Does precedent matter? Will we see territorial aggrandizement that would not have happened absent current Russian actions?

Ecuador can be trusted, says ICSID

On October 5th, 2012, a split ICSID tribunal awarded Occidental Petroleum $1.8 billion ($2.3 billion with interest) for the assets the Ecuadorean government expropriated in 2006.

The Correa administration did not just take Oxy’s stuff for the hell of it. Or even necessarily for the money. (Although that probably was a factor.) Rather, the ostensible reason was that Oxy had sold a 40% stake in it operations to a Canadian company (Encana) in contravention of Ecuadorean law, which clearly stipulated that all such sales required ministerial approval. The ICSID tribunal decided that expropriation was disproportionate to the offense (Ecuadorean law being mum as to the penalty) but knocked 25% off of Oxy’s interest in determining compensation.

Ecuador, understandably, has filed to annul the decision. Oxy asked to be allowed to enforce the decision (i.e., go after Ecuadorean assets and income streams in foreign courts) while the annulment proceeded. They said that they earned 12.6% on their assets while the tribunal granted then only 4.2% interest, and so they were losing money.

And here it gets interesting: the Ecuadorean attorney general stated that Ecuador “does not adopt the same controversial position as the Argentine Republic in ICSID proceedings – i.e. that the enforcement obligations under Article 53 of the ICSID Convention are conditioned upon an award-creditor having recourse to a domestic enforcement procedure in the host-country. Rather, Ecuador’s position as a matter of law, is that ICSID awards are not subject to judicial review by local courts and that the obligation of Ecuador to comply with an award is not conditional upon recourse to a domestic enforcement procedures.” Moreover, the government acknowledged that the award was binding even though the country’s Constitutional Court has declared the Ecuador-U.S. bilateral investment treaty to be unconstitutional. Finally, ICSID pointed out, in somewhat annoyed terms, that Oxy was just making stuff up when they claimed that Ecuador had failed to pay past judgments. Rather, it had only lost two: in one with Duke energy it paid and with another with Oxy it placed part of the award in escrow while a further arbitration determines if the award was too large.

In short, ICSID found that Ecuador has a track record of paying in the past and has promised to pay in the future.

From a putatively Bolivarian government, this is rather interesting.

It also puts that Ecuadorean debt default and buyback of 2009 in a rather different light. Was it a sign of an irresponsible government defaulting for the hell of it ... or a sensible decision for a country locked into a currency union to rid itself of foreign debt when it was still cheap to do so?

I was wrong about Ecuador and Mr. Snowden

This just in: Edward Snowden finds the perfect place of asylum!

No matter where I move on this great globe, I will be a Jets fan until the very end. And do not be thinking that I might give up the Yankees! Not within the American League at least. That is all.

Ecuador backs away from Snowden

 It looks like Ecuador is backing away from Snowden. Their position now boils down to the following: if he can get here (or at least to one of our embassies) then we will consider his petition.

The reason does not seem to be American pressure. The first arrow in the American quiver would be Ecuador’s preferences under the Andean Trade Preference Act. Only now Ecuador has unilaterally renounced its benefits! So it ain’t that.

Rather, it seems that the diplomatic staff in London was going off the reservation and giving the impression that Julian Assange ran Ecuadorean foreign policy. So President Correa cooled things off by stating that Ecuador would do nothing unless and until Snowden got to its territory. 

If I had to guess, I think that Ecuador would grant asylum if Snowden could get there. I think it is a risk that Mr. Snowden should be willing to take. The question really is whether the Russians (and Cubans, since no Ecuadorean jet can reach Moscow directly and the only commercial flights go through Cuba) will let him. I have no doubt that Raúl Castro would be fine with letting him change planes. The Ecuadoreans might be reluctant to let him board a TAME flight in Havana without a passport (although I would bet that Correa would let him) but that would mean only the need for a flight through Venezuela. And honestly, President Maduro would not have a problem.

So it is up to President Putin. Alas for Mr. Snowden. What does Putin want?

Smart move, Mr. Snowden

So, it’s Ecuador. Good move.

First and foremost, while Ecuador has an extradition treaty with the United States, it covers only murder, rape, piracy (as in, of actual physical seagoing vessels), mutiny, burglary, robbery, forgery, and embezzlement of public property. A supplemental treaty (scroll down to page 5 at the link) added other crimes, but not espionage or treason. Moreover, Article 3 explicitly states, “The stipulations of this treaty shall not be applicable to crimes of a political character.”

Second, President Correa is already on-record as supporting Julian Assange. In theory, if the U.S. really wanted to, it could squeeze Ecuador’s economy until the pips squeak. (Ecuador refines most of its consumption of fuel in the United States.) In practice, that isn’t going to happen. Ecuador would likely resist, the attempt would generate outrage across Latin America (and be of dubious legality) and at best the U.S. would simply get custody of a man who no longer poses any national security threat.

Finally, he can get a pretty good quality-of-life. Cuba is ... well, Cuba. Venezuela has out-of-control crime, an economy careening towards collapse, and a burgeoning political crisis. Ecuador has none of the above. There is some (weak) doubt about the recent decline in the homicide rate, but in general crime is, if not quite low, then well within the American experience and not something that would seriously affect day-to-day life. President Correa looks pretty secure and has not generated the kind of opposition that would throw Snowden to the United States just to tweak their Bolivarian predecessor. Finally, the economy is doing okay ... besides which I suspect that Snowden will find some way to monetize his notoriety.

Like I said, smart move.

Brazil scares Ecuador into playing nice with Petrobras

There is something I love about South American interstate politics.

In 2008, problems at the San Francisco hydroelectric dam led the Ecuadorean government to cancel its $243 million contract with Odebrecht, a Brazilian construction company. President Rafael Correa of Ecuador sent troops to seize the San Francisco dam along with an irrigation project, a hydropower plant, a highway, and an airport Odebrecht was building. Odebrecht officials fled to the Brazilian embassy for protection.

In a very 19th-century move, Brazil recalled its ambassador in response. Foreign Minister Celso Amorim said, “There are no plans for the ambassador’s return to Quito.”  The Brazilians then threatened to cancel all development loans and credits. The Ecuadorian government backed down, and Brazil’s ambassador returned in January 2009.

It was an unpleasant experience for the Ecuadoreans.

Around the same time as it (not unreasonably) cracked down on Odebrecht, Ecuador decided to get tough with Petrobras. Again, this was not unreasonable. Ecuador had a remarkably easy fiscal regime. When the country mooted the changes in 2008, Repsol-YFP, Perenco and Andes Petroleum all quickly agreed, but Petrobras was, according to the U.S. embassy, somewhat unenthused. 

In late 2010, the Ecuadoreans finally passed a new oil law, transforming Petrobras’s production-sharing agreements into a service contract offering a flat per barrel fee. The changes would reduce Petrobras’s revenue (at 2008 prices) by $25.0 million per year. Petrobras demanded $344 million in compensation. In 2012, Ecuador paid $217 million.

So Ecuador won! Right? Nope.

First, Petrobras wrote in its annual report that the contract shift would reduce the recovery value of its assets by $174 million. $174 million < $217 million.

Second, the talks between Ecuador and Petrobras failed on November 19, 2010. On that day, Petrobras shares traded at a price-earnings ratio of 8.036. Petrobras earned $25 million from its Ecuadorean assets. $25m × 8.036 ≈ $201m < $217m.

If you click the above link about the price-earnings ratio, you will see that it was stable for most of 2010. What it tells you is that if Petrobras considered its Ecuadorean income streams to be at least as safe as its other income streams (which come mostly from Brazil) then Ecuador overcompensated Petrobras. If you believe that Petrobras considered its Ecuadorean assets to be more risky (and seriously, it did) then Ecuador way overcompensated Petrobras.

It’s good to be the king! Welcome to hegemony, my Brazilian friends. As long as none of the states in your backyard go collapse, or go Communist, it’s a pretty good deal. Your tourists will find it less pleasant when they travel, but believe you me, being from the big boss country more than makes up for it. So enjoy it, mis amigos brasileiros. May it last until we all unite in war against the owners of the robots.

Observatorio argentino 18: The state of YPF

How is Argentina’s nationalization of the YPF oil company panning out?

In short, the nationalization has so far had the salubrious (and rather ironic) effect of getting the Fernández administration to roll back some of the more counterproductive bits of Argentine energy policy, but its confused quasi-Bolivarian foreign policy is now coming back to bite the government via the ruling against Chevron. Fortunately for Argentina (and also ironically) an imperialist foreign court in the Netherlands seems to have tossed the country a lifeline.

Start with Argentine energy policy. YPF’s stock price jumped on November 29 ... because the Argentine government agreed to allow companies to sell natural gas from new developments at $7.50 per MMBTU, more than three times the previous controlled price. YPF shares then rose throughout December as it became clear that Argentina was going to raise the export price of oil from $42 to $70.

In one sense, then, YPF is doing well because the Argentine government has stopped doing some ... er ... counterproductive things. This validates a hypothesis I ventured about the expropriation in a case I wrote about it: nationalization gave the Fernández administration cover to lift some unaffordable subsidies. 

What about attracting capital into the oil industry? In August, YPF laid out an ambitious $37.2 billion investment plan. Most of the cash is supposed to come from the company’s own earnings. (Those earning would not have materialized without the decision to raise oil and gas prices.) But it also calls for $4.5 billion from international partners and $6.7 billion in bond issues.

And that is where it gets sticky. YPF’s chosen partner, Chevron, keeps getting bogged down in legal trouble. In part, that is due to the YPF nationalization. On November 20, YPF’s former owner, Repsol, sued Chevron in Spain. Repsol asked the Spanish court to issue a cease-and-desist order under Spain’s “disloyal competition law.” (“Disloyal competition” sounds weird in English; a better translation would be “unfair business practices” or “antitrust.”) On December 4, Repsol hit Chevron with a second lawsuit in New York.

These lawsuits were not enough to stop Chevron. It isn’t that Repsol has no case. It is that the case is uncertain; moreover, Chevron might not be liable at all unless Argentina refuses to pay some future arbitration judgment against it, and such a judgment is unlikely before 2017 or 2018.  Chevron is taking a legal risk in jumping into the Vaca Muerta oil shale, but it is a reasonable one. (For what it is worth, “reasonable” does not mean “If I were the head of Chevron, I would take the risk.” I would not.)

Chevron’s real problem is the lawsuit Ecuador launched against Chevron in Argentina. That one seems to have brought Chevron’s plans in Argentina to a halt. YPF is now on a roadshow in the UAE looking for partners. YPF has also received a pledge of $1.5 billion from Bridas Holdings. (Here is another description of the deal.) Bridas is half-owned by the Bulgheroni family of Argentina, and half-owned by CNOOC. Repsol, of course, has announced that it plans to sue Bridas.

There is something odd in the Chevron travails. The courts in Argentina are not fully independent, but as Setty has pointed out, the Fernández administration has had some trouble lately getting them to rule its way. (This Economist article gives more details.) In addition, Fernández herself is probably torn between needing Chevron’s money and wanting to support her Ecuadorean ally. What you smell is confusion.

My guess is that the Argentine supreme court will use the recent decision by the Permanent Court of Arbitration in the Hague (PCA) to overturn the lower court ruling and unfreeze Chevron’s assets. The PCA ruled that it had jurisdiction over the case and had previously ordered Ecuador to halt foreign enforcement actions until it made its final decision; it now holds Ecuador responsible for any damages imposed on Chevron by foreign courts. The ruling provides a basis for the supreme court to throw out the case. At that point, the action will shift to the courts in Spain.

That case, unlike the one in Buenos Aires, is a black box from where I sit. It will be fun to watch.

Ecuador attacks Chevron in Argentina: world governance runs both ways

I hate the word “governance,” but it is useful. After all, there are things that are governed without a single government. When those multiple governments are hierarchically ordered (even if legally sovereign) then I prefer the word “empire.” But sometimes imperial institutions can run both ways.

The bilateral treaties that govern the investor-state arbitration system tend to be unequal. Consider for example the U.S.-Ecuador treaty. The United States exempts Ecuadorean investors from using anything but U.S. courts in the following sectors:

• Air transportation
• Banking
• Customhouse brokers
• Government grants
• Government insurance and loan programs
• Energy and power production
• Insurance
• Maritime services and maritime-related services
• Mining on the public domain
• Ocean and coastal shipping
• Ownership of real property
• Ownership and operation of radio and television stations
• Ownership of shares in the Communications Satellite Corporation
• Primary dealership in United States government securities
• Provision of common carrier telephone and telegraph services
• Provision of submarine cable services
• Use of land and natural resources

Meanwhile, the Ecuadoreans exempt:

• Traditional fishing (not including fish processing or aquaculture)
• Ownership and operation of broadcast radio and television stations

Quite a difference! Looks pretty damn imperial, no? You can kinda understand why President Correa wants to withdraw from ICSID and abrogate the investment treaties.

Thing is, these treaties are ultimately enforced not by ICSID or some other sort of world-government-in-drag, but national courts. And the same conventions that allow national courts to enforce foreign rulings (the way Argentina lost its ship in Ghana) can be used to establish extraterritorial jurisdiction. That can do it a bit to reduce the imperial feel to the international system that protects property rights. The Ecuadoreans, in short, can use foreign courts to enforce their laws.

Last year, Ecuadorean courts levied a $18.2 billion damage claim against Chevron for polluting watersheds in the country. Ecuador’s legal team knows that ChevronTexaco doesn’t have many assets in Ecuador, so its strategy is to go around the world looking for Chevron assets that it can attach. (You can read a copy of the plan from the legal team here. They call it the “Invictus memo.”) In February, Chevron won a preliminary victory when it got an arbitration tribunal to take its side. Problem is the ruling applied only to Ecuador.

So it was big news in October when the U.S. Supreme Court ruled [CLARIFICATION: It was not a ruling per se; the SCOTUS decided not to hear an appeal, thus allowing the plaintiffs to proceed] that Ecuador could freely continue its search for Chevron assets. A week later an Ecuadorean court let the plantiffs seize $96.3 million owed to Chevron by the Ecuadorean government (yes, that would be in effect Ecuador taking cash from itself) and all licensing fees owed Chevron from the use of its logo. And now ...

... an Argentine judge has given the plantiffs all of Chevron’s shares in Chevron Argentina, all of Chevron Argentina’s dividends, its 14% stake in the Oleoductos del Valle pipeline, 40% of its bank deposits and 40% of the revenue from future Argentine crude sales!

How much is the above worth? Well, I don’t know how much cash-on-hand Chevron Argentina enjoyed and it’s safe to assume that they won’t be paying any dividends as long as the judgment is in place, but it is possible to calculate the value of its crude production. (Oleoductos del Valle loses money.) The June domestic price of crude in Argentina was US$467 per cubic meter. (If you click the link and download the data, you’ll find that the price didn’t vary much.) Using production data from January through September of 2012, you’ll find that Chevron Argentina will produce crude worth about $833 million in 2012. 40% of that is $333 million; not a bad chunk of change. Of course, the Ecuadorean government will only get about 35% of that, since the income is actually due the plantiffs and their lawyers. Still, $117 million per year is nice, and if the precedent holds it could wind up with a lot more than that as more Chevron assets are attached around the world.

Eventually the Ecuadorean government might even net enough to pay off Occidental.

Around the Revolution again

Hugo Chávez just won re-election by a convincing margin in Venezuela. If I may, my friend Francisco Rodríguez at Bank of America called it correctly. To be honest, although Capriles did have a few good poll results, most of them showed a Chávez win. Anyway, the Bolivarian Revolution will go on until 2019 , even if the President passes away in office in the meantime. His successor probably won’t be Vice-president Elías Jaua. If something happens to Chávez between now and January 10, 2017, a new election will be held within 30 days. If he passes away after that date, then the vice-president will take over, but the Veep serves at the pleasure of the President and there is no guarantee that the person in the office will be the person in the office then.

In Ecuador, meanwhile, the big news concerns Assange and Occidental. With the former, not a whole lot is likely to happen. The Ecuadorians are settling in for the long haul: it is an easy way for Correa to take an anti-imperialist posture and distract attention from press measures at home. Correa is ahead in the polls for the 2013 election, but there is a while yet.

What I love is that Rafael Correa is going to advise Tunisia about dealing with debt! That is awesome.

Bolivia is having a rougher time. Two different groups are in conflict over the mining industry: unionized employees and cooperative independent miners. Until June, the government could play a conciliatory role, with Glencore as the foreign villian. But by nationalizing the mines, Evo has lost his cat’s paw. Now he is smack in the middle of a fight between the union and the small independent miners, which is a bad place to be. Moreover, his nationalization fights are starting to go bad. He just told a Canadian silver mining firm to go hang, no compensation. Legal recourse is not the problem, since the investment happened after Bolivia left ICSID (although there are other options, see next paragraph). Rather, the problem is that the nationalization, like earlier ones, has put the government smack in the middle of a conflict between different local interests. This is trouble.

President Morales has made a habit of nationalizing something every May Day, usually with compensation, but Rurelec has taken Bolivia to arbitration over a 2010 electricity nationalization. Since ICSID is no longer available, the arbitration will be held under looser U.N. rules. The nationalization beat the hell out of Rurelec: it lost 80% of its revenues and its share price crashed from 16p to 9p (U.K.). So it wants its money. It is less clear if it can collect, although the new nationalizations are making its life a little easier. The company sounds confident.

Finally, all-quiet on the Nicaraguan front, including a giant sigh of relief that President Chávez won re-election, what with this project getting underway. We think.

Ecuador is not a colony of China

Since its big default on its foreign debt (which I should really write about, it was ingenious) Ecuador has made a lot of oil-for-loans deals with China. The FT reported that Ecuador sold oil at $14-$15 per barrel. Felix Salmon wrote a post entitled “How Ecuador sold itself to China.” Neat stuff.

But exaggerated. The Bolivarians in Quito have not sold their sovereignty to China. Here’s the deal. The China Development Bank (CDB) loans money to Ecuador. Petroecuador repays by shipping oil to China. The Chinese pay for the oil at market prices. The money is deposited in the CDB, which withdraws 21% of the revenue to repay the loan. China has made three of these loans, at fairly cheap interest rates: 7.25% for the first , 6% for the second and 6.9% for the third, at a time when Ecuador basically could not borrow and paid 8.45% on its outstanding issues.

OK, so no Chinese empire ... but is China freeing Ecuador from dependence on the United States? (We will ignore that whole dollarization thing.) Not really. There are some reports that the country is now exporting all its crude to China and Latin America. The official figures for the first half of 2012, however, tell a different story. By value, 59% of oil exports went to the United States; another 11% went to Chile and 10% to Peru. Only 2% worth (or $137 million) went to China. Ditto, imports of refined products from the U.S. of A. came to 55% of Ecuadorian petroleum imports; an additional 8% came from Panama. Only 5% came from Venezuela and nothing from China. Ecuadorian crude isn’t the best quality, but it’s good enough for Chinese refineries ... except they do not seem to really want it.*

(A useful resume of different oil blends is here: scroll to Table 1.)

OK, then. Unless something drastically changes, Ecuador is going to pay Occidental. Maybe not for a while, but it will pay. And China does not have a colony across the Pacific, fun as it is to imagine such a thing.

I should mention that the international courts thing runs both ways. Maybe Ecuador will pay Occidental with assets taken from Chevron ...

* UPDATE: I imagine that Petroecuador is swapping its oil for oil from other sources to send to China. PDVSA does this all the time, so it would not be unprecedented, and it would explain why the Central Bank reports almost no crude exports to the PRC despite the loan deals.

Ecuador loses round one to Occidental

Ecuador just lost at ICSID, where the panel ruled that it owes Occidental $1.77 billion, plus interest at 4.2% compounded annually back to May 16th, 2006. If the Ecuadorians paid right now, they would owe $2.4 billion. If they delay, it will add up at the six-month LIBOR, compounded monthly. (FWIW, Occidental initially asked for $3.4 billion, but companies always highball their claims.)

What now? Ecuador will attempt to have the award annulled on the basis of some procedural or factual error. If they fail at that, then they will pay. The reason is simple: Ecuador is an oil exporter and its export sales can be attached. There won’t be the need to go fishing around the world for small change (or sailing ships) the way Argentina’s creditors need to do. It gets better: Ecuador exports crude to be refined for the home market! If it thumbs its nose at ICSID, not only will it lose export revenues, it will see domestic gasoline prices spike upwards hard. (Of course, Ecuador has been working overtime to try to get Chinese or Venezuelan interests to finance a refinery expansion.)

Ecuador might, however, pay Oxy and stiff the other claimants. There have been some declarations in this direction. Depends on how much they think China cares about its stake.

Few appreciate how Saudi Arabia undergirds the viability of this system. Ecuador exports 212,000 bpd to the United States. That is not a lot, but its sudden disappearance could upset a tight market ... except for the fact that Saudi Arabia stands every-ready to step in with its extra capacity.

Next up: another entry in the long China-doesn’t-have-an-empire series.

When lawyers declare war!

  You know, the more I learn, the more I think that President Correa of Ecuador is really playing with fire in defaulting on his debts.  Brazil is mad at him, and you don't want to get the new imperial rulers of South America mad at you.  But more importantly, he's got his American creditors mad at you ... and it seems as though those creditors may have a rather powerful legal recourse.  It'll all depend on the definition of a “central bank.”

But let's start at the beginning. What happens when lawyers declare war on a country? Well, remember this post, on the U.S. sanctions against Manuel “La Piña” Noriega ?  Turns out that the sanctions weren't really Elliot Abrams' idea. Rather, the credit goes to a lawyer, William Rogers, acting on behalf of his client, former President Eric Delvalle of Panama. 

La Piña, you see, had an anger-management problem. He decapitated Hugo Spadafora, one of his political opponents.  When the President of Panama, Nicolás Barletta, made the mistake of thinking that he, you know, ran the country, and decided to investigate the head-chopping, Noriega locked him in his office and threatened his family.  At 3am, President Barletta appeared on national television and offered his resignation, which the National Assemby accepted in a late-night emergency session.  Eric Delvalle, the education minister, then became President. A little while later, Delvalle decided to pass on to La Piña an American offer to let him peacefully resign with all his ill-gotten gains. In response, Pineapple-face ejected Delvalle from the presidency.  Delvalle got word that he was going to be arrested the next day, and managed to make it to an American military base. His ambassador-at-large hired Rogers, and then ...

... Rogers' firm filed suits to freeze Panamanian assets in the United States, beginning with the banks.  On March 3, the courts froze the U.S. accounts of the Banco Nacional de Panama (BNP).  The freeze deliberately cut off the BNP’s liquidity — it could no longer access any of the deposit accounts it held in American banks.  Nor could it clear checks through American institutions. The BNP had to close its doors.  In Rogers' words: 

“It was a conscious plan to tighten the financial noose around the neck of the Noriega regime. The consequences were seen with precision: Starve the banking system of cash, force the banks to close, and thus cause —not to put too fine a point on it — considerable financial, economic distress in Panama. The economy doesn’t function now.” 

Since the BNP was also the Panamanian clearinghouse for cashing domestic checks, the subsequent payday, March 14, became a bit problematic. How could Panamanian firms make payroll? Over 145,000 people, twenty percent of Panama’s labor force, had no access to the $30 million in wages they were owed. A general strike quickly ensued, beginning with the dock workers. By the end of March, Panama’s economy was in disarray, and the country defaulted on its foreign debts.   

Rogers was quietly pleased with himself:

“I don’t know of anyone else who — I mean on the assumption that it works, and Noriega is out — I don’t know of any effort to overturn another government by litigation which really was based on, and derived from, litigation in the United States. Or that worked as fast as this, or that had the consequences this one has.”

Well, it didn't work. But think about it for a moment. Could lawyers declare war on Ecuador for defaulting on its debts the same way that they declared war on Panama for ousting a president? After all Ecuador uses the dollar. And sanctions that didn't work on a dictator might be very effective in swinging public opinion against an elected president. Maybe Felix Salmon was on to something. 

It all depends on whether American courts consider the Banco Central de Ecuador (BCE) to be a real central bank. If it is, then its assets are not attachable, and U.S. courts cannot interfere with its functioning. But if it isn't, well, then some enterprising lawyer could go give it the full Rogers. And wouldn't that be interesting to watch? 

From a big distance, that is. Correa may be worried about this possibility. The BCE is buying a lot of gold ... which is weird, to say the least. But is Ecuador vulnerable?

Lawyers read this blog. So help a brother out with his research. Could somebody do to the BCE what Rogers did to the BNP, or is Ecuador safe? 

Correa lo hizo

  “Hay gente que rectifica lo que dice, hay mucha gente que se contradice.”  —René Pérez

Well, it appears that Ecuador just went and defaulted on its foreign debt.  I think that this is a bad idea.   The problem, of course, is that I am on record as supporting the U.S. decision to allow its financial protectorates in Latin America to default in 1931.  The only reason that I think Britain’s subsequent decision to default was bad is that is prevented the union of Trinidad and the United States.  I have also argued that Argentina’s much later default was a good idea. In fact, I have even implied that I think there might be good arguments in favor of an Argentine default right now.  (Really.  Read the linked post closely.  I more than imply that.) 

So why do I think that this move is stupid?  After all, Ecuador is suffering from a collapse in oil prices.  What’s the problem? 

First, Ecuador does not have to default.  Debt is around 21% of GDP, and debt service is only around 1%.  A balance-of-payments crisis this is not, even with the crash in oil prices.

Second, Ecuador is vulnerable.  I don’t know how vulnerable.  Why don’t I know?  Well, I haven’t been able to find Petroecuador’s balance sheets, so I don’t know how many American assets it holds.  Nor do I know how many commercial assets the Ecuadorean government may hold.  And I certainly don’t know how many payments to the Ecuadorean government pass through vulnerable payments centers.  But the fact that I don’t know these things make me think that the country is very vulnerable.  Call it a hunch, but a lack of transparency often means that there is something to hide.

I should point out that I have met the fellows from Greylock and Elliott who will be going after the country.  They are very very good at what they do, and they are very motivated. 

Third, Ecuador could use access to the World Bank.  It will probably lose that.  It has already lost access to Brazilian development funds. 

It could still be a bluff.  This is just a default; many stand to profit from such a thing.  The Ecuadorean government may just be engaging in a complicated political redistribution, and it will restart payments once the relevant parties have taken their profits.  Alternatively, should a second Great Depression really emerge, then early default will seem like a brilliant move. 

But short of those two possibilities — a short-term move or a prediction of disaster — it just seems unwise to me.

Around the Revolution

  “You know, I’ve always wondered what South America would look like if no one gave a damn about coca or Communism.  It’s always impressed me the way you boys have carved this place up.”

“I’ll take that as a compliment, coming from a Brit.” 

Now that the U.S. election is over and James Bond is officially a friend of Evo Morales, it's time to take a trip around the Bolivarian Revolution.  How is the red banner faring around the continent? 

In Venezuela, the Revolution just won what is either an impressive victory or a debilitating blow in the gubernatorial elections.  On the one hand, Socialist party candidates garnered a total of 53.5% of the vote.  They also took control of most state governments.  On the other hand, urban votes shifted dramatically towards the opposition.  More ominously for Sr. Chávez himself, the biggest Socialist vote margins piled up in three states whose incumbent Socialist governors opposed the President’s constitutional reforms in last year’s referendum.  (Monagas, Anzoátegui and, Lara.)  That bodes ill. 

As does the fact that Venezuelan oil is now heading for $40 a barrel.  (You heard it here first!)  Venezuela’s budget is a mess, and a gigantic hole has just been blown through it.  Unless Chávez intends to try to emulate Plutarco Calles (or, more contemporaneously, Vladimir Putin) and become a behind-the-scenes jefe máximo de la revolución, he will be on his way out in 2012. 

Crossing the Caribbean to Nicaragua, we come to the interesting administration of President Daniel Ortega.  One difference between Nicaragua and Venezuela is that Venezuela has a very well developed system for insuring that elections are free and fair, while Nicaragua does not.  There are reports that President Ortega, it seems, has taken advantage of that lacuna to steal municipal elections.  Several Sandinistas have defected, and violent demonstrations have gripped several cities, including the capital.  Things could easily get worse.  The Russian Federation, I should add, is a non-player here, despite its government’s pretensions.  Venezuela is not a non-player, but given Hugo’s trouble at home, I don’t see him upping aid to Managua.  He’s already called off a $4 billion refinery project.  Anyway, I’m not sure that Ortega is at the stage where aid could help:  fraud charges cross a line, and it will be hard for him to buy support back.

Jinking to the north, Honduras has just joined the Alternativa Bolivariana, and the first shipment of 50 tractors from Venezuela has arrived, along with four million energy-saving light bulbs.  El Universal reports that Caracas stands ready to lend Tegucigalpa about $132 million more, along with $82 million in subsidized oil for agricultural use.  (It isn’t clear whether that subsidy is a standard Petrocaribe credit, or an actual grant of free petrol.)  A nice economic gain for President Zelaya, with the additional benefit of sending a shot across the bow of the new American president-elect.  “Pay attention to me or else!” it says. 

The problem, of course, is that there doesn’t seem to be a whole lot to the “or else” part.  Or else Hugo Chávez will give your people much-needed aid?  Okay.  Latin Americans, like other foreigners, may have some trouble adjusting to a non-hysterical foreign policy coming from Washington. 

Jumping across the Pacific, we come to Ecuador, where President Correa recently shepherded through a new constitution.  Ecuador is currently testing how easy it will be to default on its foreign debts.  As regular readers know, there are cases when I think sovereign default is a great idea.  In this case, I think it is pretty dumb.  First, Ecuador would open itself up to lawsuits.  If successful, and given the structure of the loan contracts they probably would be, then Ecuador could find its export revenues attached, or worse.  With oil prices tanking, interference by the Obama Administration wouldn’t be likely.  Second, Ecuador can pay.  It can probably roll over its outstanding debt.  Now, perhaps all the terrible things that the government claims in its audit are true, and the loans really were odious ... but I’m having trouble believing it.  The claims are just too hyperbolic.  Third, even though the Ecuadorean government can pay, it would have a great case in a rescheduling negotiation, what with some of its bonds trading as low as 24¢ on the dollar.  So why run the risk of default when renegotiation is an option?

But President Correa will do what he will do; I just wish I understood what he is trying to accomplish.  Right now, he’s managed to irritate the Brazilian government by threatening to default on a loan from Brazil’s development bank, and he may be about to blunder into a very unnecessary and potentially expensive default on American creditors.  To be fair, the brinksmanship to date has worked.  The country is not in a technical default despite its recent postponed payment, and I suspect that fortunes may have been made by the debt’s recent dip to 14¢.  But my gut feeling is that default would not be wise at the present moment.  How many foreign assets does Petroecuador hold?

If I am missing something, I would very much like to know what.

One country that is not a member of the Bolivarian axis but which has a government that is sometimes considered to be allied to it is Argentina.  Argentina has just run into a bit of trouble that might be relevant for Ecuador’s energetic head of state:  the (in)famous Judge Thomas Griesa of New York has frozen $2 billion in recently-nationalized pension assets.  Argentina could lose those assets on appeal; they would then be used to pay the American “holdouts” from that country’s debt renegotiation and repudiation.  Ecuador could be headed for a similar problem, and that is assuming that the debtors fail to get ICSID involved. 

(I have no opinion on the Aerolineas Argentinas nationalization.  After all, the firm is headed towards liquidation, and its owners don’t have much of a leg to stand on demanding more compensation.  That said, it isn’t clear to me why Argentina needs a national flag carrier.  Unless there is some reason why the airline’s failure will cause some sort of catastrophic economic knock-on — and I am open to arguments of that type in the case of the Big Three in the U.S. — it seems like a dumb idea to take a dying airline under government ownership regardless of who gets compensated by how much.)

Which finally takes us to Bolivia.  The country is back from the political brink.  A draft of a new constitution has been agreed upon, and goes before the voters on January 25th.  More interesting is the Bolivian government’s aggressive stance towards the U.S.:  expelling the ambassador, the DEA, and the Peace Corps.  Where will that lead?  Some cogent analysis here.  What do you think?

And that has been your latest installment of “Around the Revolution.”  Stay tuned, and hasta la victoria siempre. 

A new constitution

Rafael Correa is the president of Ecuador.  He has a Ph.D. in economics from the University of Illinois.  Anti-Chávez well-educated high-earning professional Venezuelan women told me on multiple occasions that they consider him very attractive.

That, however, is not why he's in the news.  He's in the news because Ecuadorean voters approved a new constitution today.  Opponents call it “Bolivarian.”  Even non-opponents have called it “socialist.” Both are silly.  Correa is far from Bolivarian.  (Update:  It has been pointed out in comments that he declared himself Bolivarian in 2006, although he is generally considered to have distanced himself from Venezuela.)  Those same professionals who called Correa handsome also called him sensible, and I tend to agree.  Correa is relatively radical.  But he's also sensible and clearly a democrat. 

Which doesn't mean that the new constitution is a good thing for Ecuador.    

What's wrong with it?  Well, the the 1998 Magna Carta was pretty bad.  Its most innocuous feature is a lot of blather about social policy.  As regular readers know, I've argued that the evidence supports the idea that large social transfers are, at worst, not bad for growth and there is considerable evidence that they speed it up.  That said, spending commitments in a constitution are generally a bad idea.  Either the commitments will be dead letters, or you'll involve the judiciary in making spending decisions --- neither seems wise. 

More problematic was the amount of power it placed in the president.  He or she had control of monetary policy.  (Indirectly, since he or she appointed the central bank board, with Congressional approval.  I'm neutral on dollarization, but placing control of monetary policy in the president's hands was a bad idea.)  It removed cabinet ministers from Congressional oversight.  It allowed the president to control Congress's legislative agenda.  In fact, it prevented anyone but the president from introducing revenue bills.  It limited the kinds of treaties that need Congressional ratification to those that establish "alliances" or "integration."  It let the president call referenda.

I've only give the new constitution a cursory reading, but it doesn't fix any of these things.  In fact, it makes some worse.  Now the president has total control over making and ratifying treaties.  (Article 147, although Article 419 seems to re-establish the same limits as the old constitution.)  It grants the President the power to dissolve Congress and call new elections.  (Article 148.)  Bizarrely, it prohibits the government from assuming private debts while making it easier to renounce public ones.  (Article 290.)  And it puts monetary policy directly in the hands of the President, removing even the old constitution's fig leaf.  (Article 303.)

Plus, it bans genetically-modified products.  That's just a little weird for a constitution.   

Still, it isn't the worst constitution I've ever seen in terms of centralizing executive power.  (The 1917 constitution of Mexico was pretty bad in its original form.)  And Ecuadorean political culture doesn't have a great record of hewing to constitutional rules, so it's not clear how much any of it will matter.  Plus, it does permit limited presidential re-election, which is probably a good thing.

In short, I'm not a big fan, but it's not a disaster relative to the previous constitution, and if the ancilliary stuff brings legitimacy to Ecuador's fundamental law, then that will be good. 

But color me skeptical.