Sunday 1st February 2015
NEWS TICKER FRIDAY, JANUARY 30TH: Morningstar has moved the Morningstar Analyst Rating™ of the Fidelity Japan fund to Neutral. The fund was previously Under Review due to a change in management. Prior to being placed Under Review, the fund was rated Neutral. Management of the fund has passed to Hiroyuki Ito - a proven Japanese equity manager, says Morningstar. Ito recently joined Fidelity from Goldman Sachs, where he successfully ran a Japanese equity fund which was positively rated by Morningstar. “At Fidelity, the manager is backed by a large and reasonably experienced analyst team, who enjoy excellent access to senior company management. While we value Mr Ito’s long experience, we are mindful that he may need some further time to establish effective working relationships with the large team of analysts and develop a suitable way of utilising this valuable resource,” says the Morningstar release - The Federal Deposit Insurance Corporation (FDIC) today released a list of orders of administrative enforcement actions taken against banks and individuals in December. No administrative hearings are scheduled for February 2015. The FDIC issued a total of 53 orders and one notice. The orders included: five consent orders; 13 removal and prohibition orders; 11 section 19 orders; 15 civil money penalty; nine orders terminating consent orders and cease and desist orders; and one notice. More details are available on its website - Moody's Investors Service has completed a performance review of the UK non-conforming Residential Mortgage Backed Securities (RMBS) portfolio. The review shows that the performance of the portfolio has improved as a result of domestic recovery, increasing house prices and continued low interest-rates. Post-2009, the low interest rate environment has benefitted non-conforming borrowers, a market segment resilient to the moderate interest rate rise. Moody's also notes that UK non-conforming RMBS exposure to interest-only (IO) loans has recently diminished as the majority of such loans repaid or refinanced ahead of their maturity date - The London office of Deutsche Bank is being investigated by the Financial Conduct Authority (FCA), according to The Times newspaper. Allegedly, the bank has been placed under ‘enhanced supervision’ by the FCA amid concerns about governance and regulatory controls at the bank. The enhanced supervision order was taken out some months ago, says the report, however it has only just been made public - According to Reuters, London Stock Exchange Group will put Russell Investments on the block next month, after purchasing it last year. LSE reportedly wants $1.4bn - Legg Mason, Inc. has reported net income of $77m for Q3 fiscal 2014, compared with $4.9m in the previous quarter, and net income of $81.7m over the period. In the prior quarter, Legg Mason completed a debt refinancing that resulted in a $107.1m pre-tax charge. Adjusted income for Q3 fiscal was $113.1m compared to $40.6m in the previous quarter and $124.6m in Q3 fiscal. For the current quarter, operating revenues were $719.0m, up 2% from $703.9m in the prior quarter, and were relatively flat compared to $720.1m in Q3 fiscal. Operating expenses were $599.6m, up 5% from $573.5m in the prior quarter, and were relatively flat compared to $598.4min Q3 of fiscal 2014. Assets under management were $709.1bn as the end of December, up 4% from $679.5bn as of December 31, 2013. The Legg Mason board of directors says it has approved a new share repurchase authorisation for up to $1bn of common stock and declared a quarterly cash dividend on its common stock in the amount of $0.16 per share. - The EUR faces a couple of major releases today, says Clear Treasury LLP, and while the single currency has traded higher through the week, the prospect of €60bn per month in QE will likely keep the euro at a low ebb. The bigger picture hasn’t changed, yesterday’s run of German data was worse than expected with year on year inflation declining to -.5% (EU harmonised level). Despite the weak reading the EUR was unperturbed - The Singapore Exchange (SGX) is providing more information to companies and investors in a new comprehensive disclosure guide. Companies wanting clarity on specific principles and guidelines on corporate governance can look to the guide, which has been laid out in a question-and-answer format. SGX said listed companies are encouraged to include the new disclosure guide in their annual reports and comply with the 2012 Code of Corporate Governance, and will have to explain any deviations in their reporting collateral. - Cordea Savills on behalf of its European Commercial Fund has sold Camomile Court, 23 Camomile Street, London for £47.97mto a French pension fund, which has entrusted a real estate mandate to AXA Real Estate. The European Commercial Fund completed its initial investment phase in 2014 at total investment volume of more than €750m invested in 20 properties. Active Asset Management in order to secure a stable distribution of circa 5% a year. which has been achieved since inception of the fund is the main focus of the Fund Management now. Gerhard Lehner, head of portfolio management, Germany, at Cordea Savills says “With the sale of this property the fund is realising a value gain of more than 40%. This is the fruit of active Asset Management but does also anticipate future rental growth perspectives. For the reinvestment of the returned equity we have already identified suitable core office properties.” Meantime, Kiran Patel, chief investment officer at Cordea Savills adds: “The sale of Camomile Court adds to the £370m portfolio disposal early in the year. Together with a number of other asset sales, our total UK transaction activity since January stands at £450m. At this stage of the cycle, we believe there is merit in banking performance and taking advantage of some of the strong demand for assets in the market.” - US bourses closed higher last night thanks to much stronger Jobless Claims data (14yr low) which outweighed mixed earnings results. Overnight, Asian bourses taken positive lead from US, even as Bank of Japan data shows that inflation is still falling, consumption in shrinking and manufacturing output is just under expectations. According to Michael van Dulken at Accendo Markets, “Japan’s Nikkei [has been] helped by existing stimulus and weaker JPY. In Australia, the ASX higher as the AUD weakened following producer price inflation adding to expectations of an interest rate cut by the RBA, following other central banks recently reacting to low inflation. Chinese shares down again ahead of a manufacturing report.” - Natixis has just announced the closing of the debt financing for Seabras-1, a new subsea fiber optic cable system between the commercial and financial centers of Brazil and the United States. The global amount of debt at approximately $270m was provided on a fully-underwritten basis by Natixis -

Game set and nationalisation

Wednesday, 23 May 2012
Game set and nationalisation In mid-April Argentina seized control of 51% of YPF, the country’s largest oil group, by taking over the holdings of its biggest shareholder (Spanish oil company Repsol) in a move that stunned foreign investors and provoked the EU trade commissioner to seek settlement at the World Trade Organisation (WTO). It is the latest in a series of grandstanding moves by Argentine president Christina Fernández de Kirchner and begs the question: how could this decision possibly be beneficial for the country in the long term? Elsewhere in Latin America, Bolivia says it will expropriate Transportadora de Electricidad, the assets of Spain’s Red Eléctrica, sending armed troops to its headquarters. Vanya Dragomanovich reports from Buenos Aires on the long term implications. http://www.ftseglobalmarkets.com/

In mid-April Argentina seized control of 51% of YPF, the country’s largest oil group, by taking over the holdings of its biggest shareholder (Spanish oil company Repsol) in a move that stunned foreign investors and provoked the EU trade commissioner to seek settlement at the World Trade Organisation (WTO). It is the latest in a series of grandstanding moves by Argentine president Christina Fernández de Kirchner and begs the question: how could this decision possibly be beneficial for the country in the long term? Elsewhere in Latin America, Bolivia says it will expropriate Transportadora de Electricidad, the assets of Spain’s Red Eléctrica, sending armed troops to its headquarters. Vanya Dragomanovich reports from Buenos Aires on the long term implications.

Foreign direct investment in so-called strategic national assets can be a risky business.  Just ask BP about its investments in Russia’s oil exploration industry; the ups and downs of that particular history would make a pretty hairy ­fairground ride. Nascent and high growth markets are often caught in a miserable quandary. They need foreign investment and expertise to lift their own industries (some strategic, some otherwise) out of the workaday and into the international league tables. However, once that happens, it requires a particular temperament to accept that a good slug of nationally earned cash goes abroad. Privatisation too is a double edged sword for countries that at one time needed foreign inputs to inject capital and efficiencies into ­moribund state run businesses and which later find themselves frustrated at the business strategies of the private sector business owners.

Going forward, it might be time for high growth markets to reassess their approaches to FDI and privatisation in strategic industries; perhaps adopting contract structures that allow returns to gravitate to investors over a defined period, with a buy-back agreement scaled over mutually agreed terms. That seems to be one moral perhaps of a growing (and somewhat worrisome) trend in some Latin American countries to expropriate the assets of foreign direct investors when local market developments create problems for governments.



Argentina has stunned foreign investors by its decision to nationalise Repsol’s stake in oil company YPF. Until April Repsol owned 57.4% of YPF. Some 25.5% was (and still is) held by the wealthy Argentinian Eskenazi family, which owns Grupo Petersen; 17% is traded on the local stock exchange and 0.02% belonged to the government. Now the government owns 51% of the shares, all from Repsol’s stake, dealing a massive blow to the company.

Repsol’s shares in YPF had accounted for 42% of the company’s total global reserves of crude oil (estimated to be in the region of 2.1bn barrels). It is a big deal in other ways too: YPF is Argentina’s largest company (and is valued at approximately $13.6bn) and operates more than half of the country’s oil refineries. Spain is the biggest single investor in the country followed by the United States and the value of YPF is around $13.6bn.

The government has indicated that Repsol will be compensated, but that the amount will be determined by an Argentine tribunal. For its part, Repsol has said it will demand compensation of up to $10bn for its 57% stake.

Argentine president Fernández cut to the heart of the matter in an official address to the nation that the move was an attempt to recover sovereignty over Argentina’s hydrocarbon resources. Argentina is one of the few South American nations without an influential state-owned company in the energy sector. She explained the government had become increasingly frustrated with Repsol and YPF, in a speech peppered with patriotic references and culminating in a tearful mention of the president’s late husband and former president Nestor Kirchner.

The government claims Repsol has repatriated 90% of its profits; the country has had to spend more than $9bn on oil and gas imports in 201 and that nationwide oil production stood at 796,000 barrels per day in 2011, virtually unchanged since 2009. The expropriated shares will be divided between the Argentine government and provincial governors, leaving Repsol with a meagre 6.4% stake.

The appropriation of YPF has popular appeal and is in line with other political dynamics in the country. Since ­Fernandez’s husband, the late Nestor Kirchner was elected president in 2003, public policy and elector preferences have shifted towards a bigger role for the state and a reversal from free-market policies which many have blamed for the economic crash of 2001-2002. President Fernandez, elected as her husband’s successor in 2007, has continued his economic programme, re-nationalising the flagship airline Aerolineas Argentinas and pushing through reforms giving the government the right to use central bank reserves to pay off the country’s foreign debt.

Nationalisation of strategic assets also plays well to the political gallery in the country. Governors of a number of oil producing Argentine provinces, including Santa Cruz and Neuquén, have rapidly withdrawn up to 16 oil concessions that had been awarded to YPF alleging that the company failed to live up to its promises to develop the fields and increase production. It is an accusation that YPF has countered, saying that the revoking of concessions came shortly after Repsol-YPF presented provincial authorities with a plan to invest more than $4bn between 2012-2017, ­including the drilling of 2,249 new wells and the upgrading of some 2,664 existing wells.

Moreover, according to LatinMinerìa, the Spanish minerals and mining news service, over the past five years, Repsol has participated in some of the hottest oil exploration plays in the industry in Brazil, the Gulf of Mexico and West Africa. It has also invested in Alaskan oilfields and US shale gas, as part of the firm’s strategy to have 60% of its upstream assets in politically stable OECD countries. The data services company expresses surprise that Repsol would not have done the same in Argentina.

The future of FDI

The move now calls into question Argentina’s appeal as an FDI destination. Ironically, up until the end of 2010 and possibly early 2011 Argentina was attracting a lot of interest from foreign investors. Since it defaulted on $95bn debt in 2001 the country had turned around its economy and towards the end of 2010, when large chunks of the global economy were fighting to stay out of recession, Argentina’s economy grew by over 8% per year.

In 2010 too, the FTSE Argentina 20 Index, which consists of ADRs of the country’s top 20 companies, rose 44%, against a gloomy global economic backdrop. Investors flocked not only into Latin American stocks but into Argentina’s in particular. Even so, “It is difficult to distinguish how much of the growth had to do with government policies and how much it was helped by a boom in international commodity prices given that Argentina is a major exporter of soy, wheat and corn,” explains Carlos Maria Regunaga, a former adviser-in-chief to the Argentina’s secretary of commerce and a director at Menas Consulting Argentina, a boutique political risk consultancy. Moreover, for a number of years the country not only enjoyed rapid economic growth fuelled by grain exports but also self-sufficiency in oil and gas generation.

However, the domestic economy started slowing down last year as stagnation in commodity prices began to have an effect on the surplus in the balance of payments and as did reduced growth in Brazil, Argentina’s largest trading partner. According to Regunaga, this coincided with the worst harvest in decades, the maturation of a large slug of long-term debts, and the drain on foreign reserves which resulted from the purchasing of foreign currencies, payments for oil and gas imports and local inflation of 22%.

Over the last decade Argentina’s oil production has steadily fallen and domestic demand has grown, creating a squeeze for a government which was trying to keep prices artificially low in order to maintain public support, ­particularly as president Fernández is hoping to overturn constitutional ­limitations on presidential terms and run for office indefinitely.  As well, the cost of rising oil imports began to have a significant negative effect on the domestic trade balance. In that context, it is no surprise that the government began focusing its attention on YPF and Repsol.

There have been other long term factors in play too. The crisis in 2001 left as one of its legacies an emergency law which gives the government a major tool to regulate the economy by executive order, and which Fernández’s government wields freely. Pension funds were nationalised in 2008, for instance, instantly giving it key positions on the boards of major companies. The central bank also limits how much foreign currency can leave the country and—a decision which has particularly riled foreign fund investors —capital controls stipulate that money invested in the country cannot be ­expatriated for a number of years.

With regard to Repsol, Argentina’s former president and Christina Fernandez’s late husband Nestor Kirchner pushed the firm in 2007 to sell a 25.5% stake to Enrique Eskenazi, a close friend and a supporter of the Kirchners, under extraordinarily favourable terms which involved no direct payments. Instead, Repsol agreed to cover his payments on some $3.45bn in debt with dividends that accounted for 90% of the company’s profits. The payout of the bulk of YPF profits as dividends rather than their reinvestment in production was an integral part of the deal. Ultimately it meant that Repsol had no motive to invest in the country; though the firm continues to insist that it did. To add insult to injury, the government capped the price of a barrel of oil at $55 at a time when oil was trading at over $100/bbl in global markets. Naturally, Repsol began to invest capital in Brazil, Trinidad and Bolivia, where it could generate better returns.

Snowballs and avalanches

However, the snowball that started the YPF avalanche was the company’s announcement that it had found a major deposit of 800m barrels of shale oil in Patagonia. The significance of this cannot be underestimated. When US oil companies developed and perfected a technology to extract oil and gas from continental shale deposits the boom in gas production made the US completely self-sufficient in gas generation in the space of three to four years.

A working shale gas supply has massive implications for any country’s economy; not only because it no longer has to spend money to import gas, but also because gas is used in power ­generation and the lower cost of energy feeds through to manufacturing ­industries which can in turn significantly cut production costs. If Argentina develops its shale oil deposits in Patagonia it could reach the same levels of self-sufficiency as the US within a relatively short period of time. However, the terms of agreement between Repsol, YPF and the government were such that there was little incentive for Repsol to spend the money in the country.  “Repsol had no interest in developing the deposit given that the government was bleeding it dry,” said one foreign investor who did not want to be named.

“Fundamentally the government does not care how this decision is taken internationally. They feel that if Spain will not invest in the country there will be always somebody else who will be interested, most likely Chinese investors, and that they will be able to raise the money to develop shale gas,” the investor added. So far, reactions by international investors have been fairly pragmatic.

Stock investment has taken the immediate hit. FTSE's Argentina Top 20 Index dropped 11% for the year to-date. However, the FTSE Latin American Index increased 11% over the same period.

“In the long term, Argentina will remain part of benchmark indices. It is well positioned as an economy, it has massive shale gas reserves, it has good trade particularly with Brazil, infrastructure is good and it has a well educated population. But this has to be balanced out with high inflation which is close to 30%, massive wage increases and a mixed outlook on resources. This has to be reflected in the valuation of the stocks and while stocks have priced in some of that I still don’t see that valuations are reflecting that,” says Adam Kutas, who manages two Latin American funds for Fidelity Advisors. Fidelity’s Latam funds were among the ten most successful Latam funds this year, according to Morningstar.

“You have to ask yourself why invest in Argentina when you have better options for instance in Colombia’s energy sector? I can for instance find great opportunities in Colombia, Chile or Brazil,” adds Kutas. He notes that a major deterrent to fund investors is the fact that money invested in Argentina has to be kept in the country for a number of years. “As a fund manager I need to have access to money, I cannot afford for it to be tied up and to have to be able to wait for a few years,” he adds.

 “Latin America is a pretty dynamic region and these situations create opportunities. If, for instance, you already are an investor in the country and you have dollar-funding then you can command higher returns on your investment,” explains Ernest Bachrach, managing partner at Advent International, a global private equity firm.

Companies active in the country include Americas Petrogas Inc, a junior Canadian exploration company operating in Neuquén, the province in which the shale oil was discovered, and major oil services firm Schlumberger, as well as Cargill, the agriculture exporter.  “Nobody says that this ­decision is a good thing but it is a question of returns. Emerging market investors are fairly resilient, they are used to these kinds of situation and they will stay in a country even if the red tape becomes more complicated as long as they can make good returns on their investment,” says the head of emerging markets research in a London-based bank.

What investors are trying to assess now is how long policies such as the current strict foreign-exchange controls will stay in place. Argentina’s political system is modelled on the one in the US and allows the president a maximum of two terms in power. The current government was voted in for its second term at the end of 2011 and will most likely stay in place until late 2015. However, in a move reminiscent of Putin’s manoeuvring in Russia there has been talk about changing the constitution to allow for a longer presidency.

Before that happens however Argentina will likely lose Spain, and potentially Netherlands, as one of its major trade partners and face repercussions from the EU for breaching international trade regulations. China is likely to take up the space left open by European investors. What kinds of strings this will bring with it remains to be seen.

Bolivia’s investor assault

In early May came the news that Bolivia’s president Evo Morales intended to seize Bolivia’s main ­electricity company, reinforcing the divide between free market Latin American leaders and those seeking more state control. Bolivia is nationalising the local assets of Alcobendas, Spain-based Red Eléctrica Corp., giving him control of the country’s power grid. Reminiscent of Fernandez’s reasoning, Morales says the company’s local investment was inadequate.  However, Morales has been at the nationalisation game for a lot longer. He began his nationalisation drive in 2007 when he took control of the country’s largest telecommunications company and an electricity company and forced foreign oil companies into minority shareholder agreements as part of joint ventures. Then, on May 1st 2010, he nationalised four power companies, including assets from the UK’s Rurelec Plc and France’s GDF Suez SA.

Bolivia’s latest announcement is not of the magnitude of the Argentine move. The benchmark IBEX 35 index dropped 1.2% on the news; Bolivia generated €45.7m ($60m) in revenue for Red Eléctrica in 2011, less than 3% of total sales.

However, the impact of the spectre of nationalisation has been felt in the debt markets. Venezuela’s dollar bonds yield 913 basis points (bps) over ­Treasuries while Argentina’s spread is 953bps, according to JPMorgan. The countries post the two highest yield gaps among major emerging-market countries. Colombia by comparison has a yield spread of 148bps and Brazil has a yield gap of 184bps. The latter two juris­dictions are liberalising with a bullet; with Brazil having raised $14bn earlier this year from a ­February auction of licenses to operate three of the country’s busiest airports in an effort to accelerate investments ahead of the 2014 World Cup (please refer to www.ftseglobalmarkets.com, for more details).

The timing of the moves is clever. Spain (and in fact the EU) is in a greatly weakened position on the international stage. Look at opprobrium the UK faced in the American and Latin American press and in Latin American seaports having underscored its claim to the Falkland Islands following Fernandez’s revival of a claim on the island group at the end of last year. Now, as in 1982, the American presidency happily stood on the sidelines. It is presidential election year in America, and no one wants to upset the bloc Latino vote.

Equally, Fernandez and Morales (together with Venezuela’s Chavez) have calculated that Asian investors have few qualms in substituting their investment dollars in place of disenfranchised Europeans. It’s a new power play by resource-rich nations and institutional investors will have to take note of the new political risks in play in cross border investment as this decade matures. How they respond will be telling. What is certain is that this story will run and run.

In mid-April Argentina seized control of 51% of YPF, the country’s largest oil group, by taking over the holdings of its biggest shareholder (Spanish oil company Repsol) in a move that stunned foreign investors and provoked the EU trade commissioner to seek settlement at the World Trade Organisation (WTO). It is the latest in a series of grandstanding moves by Argentine president Christina Fernández de Kirchner and begs the question: how could this decision possibly be beneficial for the country in the long term? Elsewhere in Latin America, Bolivia says it will expropriate Transportadora de Electricidad, the assets of Spain’s Red Eléctrica, sending armed troops to its headquarters. Vanya Dragomanovich reports from Buenos Aires on the long term implications.

Foreign direct investment in so-called strategic national assets can be a risky business.  Just ask BP about its investments in Russia’s oil exploration industry; the ups and downs of that particular history would make a pretty hairy ­fairground ride. Nascent and high growth markets are often caught in a miserable quandary. They need foreign investment and expertise to lift their own industries (some strategic, some otherwise) out of the workaday and into the international league tables. However, once that happens, it requires a particular temperament to accept that a good slug of nationally earned cash goes abroad. Privatisation too is a double edged sword for countries that at one time needed foreign inputs to inject capital and efficiencies into ­moribund state run businesses and which later find themselves frustrated at the business strategies of the private sector business owners.

Going forward, it might be time for high growth markets to reassess their approaches to FDI and privatisation in strategic industries; perhaps adopting contract structures that allow returns to gravitate to investors over a defined period, with a buy-back agreement scaled over mutually agreed terms. That seems to be one moral perhaps of a growing (and somewhat worrisome) trend in some Latin American countries to expropriate the assets of foreign direct investors when local market developments create problems for governments.

Argentina has stunned foreign investors by its decision to nationalise Repsol’s stake in oil company YPF. Until April Repsol owned 57.4% of YPF. Some 25.5% was (and still is) held by the wealthy Argentinian Eskenazi family, which owns Grupo Petersen; 17% is traded on the local stock exchange and 0.02% belonged to the government. Now the government owns 51% of the shares, all from Repsol’s stake, dealing a massive blow to the company.

Repsol’s shares in YPF had accounted for 42% of the company’s total global reserves of crude oil (estimated to be in the region of 2.1bn barrels). It is a big deal in other ways too: YPF is Argentina’s largest company (and is valued at approximately $13.6bn) and operates more than half of the country’s oil refineries. Spain is the biggest single investor in the country followed by the United States and the value of YPF is around $13.6bn.

The government has indicated that Repsol will be compensated, but that the amount will be determined by an Argentine tribunal. For its part, Repsol has said it will demand compensation of up to $10bn for its 57% stake.

Argentine president Fernández cut to the heart of the matter in an official address to the nation that the move was an attempt to recover sovereignty over Argentina’s hydrocarbon resources. Argentina is one of the few South American nations without an influential state-owned company in the energy sector. She explained the government had become increasingly frustrated with Repsol and YPF, in a speech peppered with patriotic references and culminating in a tearful mention of the president’s late husband and former president Nestor Kirchner.

The government claims Repsol has repatriated 90% of its profits; the country has had to spend more than $9bn on oil and gas imports in 201 and that nationwide oil production stood at 796,000 barrels per day in 2011, virtually unchanged since 2009. The expropriated shares will be divided between the Argentine government and provincial governors, leaving Repsol with a meagre 6.4% stake.

The appropriation of YPF has popular appeal and is in line with other political dynamics in the country. Since ­Fernandez’s husband, the late Nestor Kirchner was elected president in 2003, public policy and elector preferences have shifted towards a bigger role for the state and a reversal from free-market policies which many have blamed for the economic crash of 2001-2002. President Fernandez, elected as her husband’s successor in 2007, has continued his economic programme, re-nationalising the flagship airline Aerolineas Argentinas and pushing through reforms giving the government the right to use central bank reserves to pay off the country’s foreign debt.

Nationalisation of strategic assets also plays well to the political gallery in the country. Governors of a number of oil producing Argentine provinces, including Santa Cruz and Neuquén, have rapidly withdrawn up to 16 oil concessions that had been awarded to YPF alleging that the company failed to live up to its promises to develop the fields and increase production. It is an accusation that YPF has countered, saying that the revoking of concessions came shortly after Repsol-YPF presented provincial authorities with a plan to invest more than $4bn between 2012-2017, ­including the drilling of 2,249 new wells and the upgrading of some 2,664 existing wells.

Moreover, according to LatinMinerìa, the Spanish minerals and mining news service, over the past five years, Repsol has participated in some of the hottest oil exploration plays in the industry in Brazil, the Gulf of Mexico and West Africa. It has also invested in Alaskan oilfields and US shale gas, as part of the firm’s strategy to have 60% of its upstream assets in politically stable OECD countries. The data services company expresses surprise that Repsol would not have done the same in Argentina.

The future of FDI

The move now calls into question Argentina’s appeal as an FDI destination. Ironically, up until the end of 2010 and possibly early 2011 Argentina was attracting a lot of interest from foreign investors. Since it defaulted on $95bn debt in 2001 the country had turned around its economy and towards the end of 2010, when large chunks of the global economy were fighting to stay out of recession, Argentina’s economy grew by over 8% per year.

In 2010 too, the FTSE Argentina 20 Index, which consists of ADRs of the country’s top 20 companies, rose 44%, against a gloomy global economic backdrop. Investors flocked not only into Latin American stocks but into Argentina’s in particular. Even so, “It is difficult to distinguish how much of the growth had to do with government policies and how much it was helped by a boom in international commodity prices given that Argentina is a major exporter of soy, wheat and corn,” explains Carlos Maria Regunaga, a former adviser-in-chief to the Argentina’s secretary of commerce and a director at Menas Consulting Argentina, a boutique political risk consultancy. Moreover, for a number of years the country not only enjoyed rapid economic growth fuelled by grain exports but also self-sufficiency in oil and gas generation.

However, the domestic economy started slowing down last year as stagnation in commodity prices began to have an effect on the surplus in the balance of payments and as did reduced growth in Brazil, Argentina’s largest trading partner. According to Regunaga, this coincided with the worst harvest in decades, the maturation of a large slug of long-term debts, and the drain on foreign reserves which resulted from the purchasing of foreign currencies, payments for oil and gas imports and local inflation of 22%.

Over the last decade Argentina’s oil production has steadily fallen and domestic demand has grown, creating a squeeze for a government which was trying to keep prices artificially low in order to maintain public support, ­particularly as president Fernández is hoping to overturn constitutional ­limitations on presidential terms and run for office indefinitely.  As well, the cost of rising oil imports began to have a significant negative effect on the domestic trade balance. In that context, it is no surprise that the government began focusing its attention on YPF and Repsol.

There have been other long term factors in play too. The crisis in 2001 left as one of its legacies an emergency law which gives the government a major tool to regulate the economy by executive order, and which Fernández’s government wields freely. Pension funds were nationalised in 2008, for instance, instantly giving it key positions on the boards of major companies. The central bank also limits how much foreign currency can leave the country and—a decision which has particularly riled foreign fund investors —capital controls stipulate that money invested in the country cannot be ­expatriated for a number of years.

With regard to Repsol, Argentina’s former president and Christina Fernandez’s late husband Nestor Kirchner pushed the firm in 2007 to sell a 25.5% stake to Enrique Eskenazi, a close friend and a supporter of the Kirchners, under extraordinarily favourable terms which involved no direct payments. Instead, Repsol agreed to cover his payments on some $3.45bn in debt with dividends that accounted for 90% of the company’s profits. The payout of the bulk of YPF profits as dividends rather than their reinvestment in production was an integral part of the deal. Ultimately it meant that Repsol had no motive to invest in the country; though the firm continues to insist that it did. To add insult to injury, the government capped the price of a barrel of oil at $55 at a time when oil was trading at over $100/bbl in global markets. Naturally, Repsol began to invest capital in Brazil, Trinidad and Bolivia, where it could generate better returns.

Snowballs and avalanches

However, the snowball that started the YPF avalanche was the company’s announcement that it had found a major deposit of 800m barrels of shale oil in Patagonia. The significance of this cannot be underestimated. When US oil companies developed and perfected a technology to extract oil and gas from continental shale deposits the boom in gas production made the US completely self-sufficient in gas generation in the space of three to four years.

A working shale gas supply has massive implications for any country’s economy; not only because it no longer has to spend money to import gas, but also because gas is used in power ­generation and the lower cost of energy feeds through to manufacturing ­industries which can in turn significantly cut production costs. If Argentina develops its shale oil deposits in Patagonia it could reach the same levels of self-sufficiency as the US within a relatively short period of time. However, the terms of agreement between Repsol, YPF and the government were such that there was little incentive for Repsol to spend the money in the country.  “Repsol had no interest in developing the deposit given that the government was bleeding it dry,” said one foreign investor who did not want to be named.

“Fundamentally the government does not care how this decision is taken internationally. They feel that if Spain will not invest in the country there will be always somebody else who will be interested, most likely Chinese investors, and that they will be able to raise the money to develop shale gas,” the investor added. So far, reactions by international investors have been fairly pragmatic.

Stock investment has taken the immediate hit. FTSE's Argentina Top 20 Index dropped 11% for the year to-date. However, the FTSE Latin American Index increased 11% over the same period.

“In the long term, Argentina will remain part of benchmark indices. It is well positioned as an economy, it has massive shale gas reserves, it has good trade particularly with Brazil, infrastructure is good and it has a well educated population. But this has to be balanced out with high inflation which is close to 30%, massive wage increases and a mixed outlook on resources. This has to be reflected in the valuation of the stocks and while stocks have priced in some of that I still don’t see that valuations are reflecting that,” says Adam Kutas, who manages two Latin American funds for Fidelity Advisors. Fidelity’s Latam funds were among the ten most successful Latam funds this year, according to Morningstar.

“You have to ask yourself why invest in Argentina when you have better options for instance in Colombia’s energy sector? I can for instance find great opportunities in Colombia, Chile or Brazil,” adds Kutas. He notes that a major deterrent to fund investors is the fact that money invested in Argentina has to be kept in the country for a number of years. “As a fund manager I need to have access to money, I cannot afford for it to be tied up and to have to be able to wait for a few years,” he adds.

 “Latin America is a pretty dynamic region and these situations create opportunities. If, for instance, you already are an investor in the country and you have dollar-funding then you can command higher returns on your investment,” explains Ernest Bachrach, managing partner at Advent International, a global private equity firm.

Companies active in the country include Americas Petrogas Inc, a junior Canadian exploration company operating in Neuquén, the province in which the shale oil was discovered, and major oil services firm Schlumberger, as well as Cargill, the agriculture exporter.  “Nobody says that this ­decision is a good thing but it is a question of returns. Emerging market investors are fairly resilient, they are used to these kinds of situation and they will stay in a country even if the red tape becomes more complicated as long as they can make good returns on their investment,” says the head of emerging markets research in a London-based bank.

What investors are trying to assess now is how long policies such as the current strict foreign-exchange controls will stay in place. Argentina’s political system is modelled on the one in the US and allows the president a maximum of two terms in power. The current government was voted in for its second term at the end of 2011 and will most likely stay in place until late 2015. However, in a move reminiscent of Putin’s manoeuvring in Russia there has been talk about changing the constitution to allow for a longer presidency.

Before that happens however Argentina will likely lose Spain, and potentially Netherlands, as one of its major trade partners and face repercussions from the EU for breaching international trade regulations. China is likely to take up the space left open by European investors. What kinds of strings this will bring with it remains to be seen.

Bolivia’s investor assault

In early May came the news that Bolivia’s president Evo Morales intended to seize Bolivia’s main ­electricity company, reinforcing the divide between free market Latin American leaders and those seeking more state control. Bolivia is nationalising the local assets of Alcobendas, Spain-based Red Eléctrica Corp., giving him control of the country’s power grid. Reminiscent of Fernandez’s reasoning, Morales says the company’s local investment was inadequate.  However, Morales has been at the nationalisation game for a lot longer. He began his nationalisation drive in 2007 when he took control of the country’s largest telecommunications company and an electricity company and forced foreign oil companies into minority shareholder agreements as part of joint ventures. Then, on May 1st 2010, he nationalised four power companies, including assets from the UK’s Rurelec Plc and France’s GDF Suez SA.

Bolivia’s latest announcement is not of the magnitude of the Argentine move. The benchmark IBEX 35 index dropped 1.2% on the news; Bolivia generated €45.7m ($60m) in revenue for Red Eléctrica in 2011, less than 3% of total sales.

However, the impact of the spectre of nationalisation has been felt in the debt markets. Venezuela’s dollar bonds yield 913 basis points (bps) over ­Treasuries while Argentina’s spread is 953bps, according to JPMorgan. The countries post the two highest yield gaps among major emerging-market countries. Colombia by comparison has a yield spread of 148bps and Brazil has a yield gap of 184bps. The latter two juris­dictions are liberalising with a bullet; with Brazil having raised $14bn earlier this year from a ­February auction of licenses to operate three of the country’s busiest airports in an effort to accelerate investments ahead of the 2014 World Cup (please refer to www.ftseglobalmarkets.com, for more details).

The timing of the moves is clever. Spain (and in fact the EU) is in a greatly weakened position on the international stage. Look at opprobrium the UK faced in the American and Latin American press and in Latin American seaports having underscored its claim to the Falkland Islands following Fernandez’s revival of a claim on the island group at the end of last year. Now, as in 1982, the American presidency happily stood on the sidelines. It is presidential election year in America, and no one wants to upset the bloc Latino vote.

Equally, Fernandez and Morales (together with Venezuela’s Chavez) have calculated that Asian investors have few qualms in substituting their investment dollars in place of disenfranchised Europeans. It’s a new power play by resource-rich nations and institutional investors will have to take note of the new political risks in play in cross border investment as this decade matures. How they respond will be telling. What is certain is that this story will run and run.

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