Thursday 5th May 2016
NEWS TICKER: MARKET ROUNDUP —Markets tanked today (almost everywhere bar the PRC) as economic data from China and an 18% lunge in profits at HSBC sapped market confidence. The bank reported an adjusted profit before tax of $5.4bn for the first quarter, down 18% on the same period last year. Citing challenging market conditions, the bank reported first quarter(Q1) pretax profit before adjustments of $6.1bn, down from $7.1bn in the first three months of 2015 but beating analysts’ forecasts of a pretax profit of $4.3bn, according to Reuters. In Hong Kong this morning the bank’s shares were up on the news, as expectations had been for much worse. Earnings per share came in at 20 cents, down from 26 cents per share in the same period last year. HSBC held its first-quarter dividend in line at 10 cents per share. In London HSBC fell 3.5p to 449p as the bank said it put in a "resilient" performance in difficult market conditions, with the entire investment banking sector suffering after stock markets tumbled at the start of 2016 amid an oil price rout. However, as we reported earlier today indexes across Europe paid the price of lower than expected manufacturing data from the Caixin/Markit Manufacturing Purchasing Managers' index (PMI), rather than Chinese bourses. The DAX fell 1.5% lower and the CAC40 dropped 1.1%. Commodity stocks were also on the back foot despite the price of oil rising 0.4% to 45.99 US dollars a barrel. Glencore ended the day down 7.5p to 155.5p, Rio Tinto fell 96.5p to 2205p and BHP Billiton slipped 34.8p to 897.4p – AQUISITION—M&A maven Cavendish Corporate Finance has advised bfinance on the investment in the company by private equity funds managed by Baird Capital. Current bfinance CEO David Vafai will continue to lead the consultancy in this next, exciting phase of its growth. He will be joined on the board by Andrew Ferguson, managing director at Baird Capital, and CFO Mark Brownlie, as directors. Also joining the board as chairman is Tim Trotter, who founded public relations group Ludgate, co-founded Citywire, the information service for the global fund management industry and is a non-executive chairman at a number of financial services and asset management related blue-chip companies. The deal with Baird follows a strong period of successes for bfinance. Recent high-profile mandates for bfinance include advising on a $1bn alternative beta strategy programme for a U.S. corporate pension plan, a USD 1.2bn private equity search for Swedish State pension fund AP7, and multiple searches across asset classes on behalf of Australian superannuation funds. The deal marks a strong start to the year for Cavendish. It follows shortly after the sale of Periproducts to Venture Life Plc, the sale of Gloucester Rugby club to new owner Martin St Quinton, the sale of B2B creative marketing agency Twogether to Next 15 Plc and the debt raise for Pets Corner following a highly successful 2015 during which the company completed over 20 deals –AIIB/ADB— In a shift in strategy the Asian Infrastructure Investment Bank has signed a financing memorandum of understanding (MoU) with the Asian Development Bank, the second partnership signed in the space of a few month by the challenger development bank. AIIB, set up to counter the ‘hegemony’ of Western dominated aid institutions, has been struggling to dispel its image as a rival to existing NGOs. The bank secured a similar arrangement with the World Bank during the International Monetary Fund-World Bank spring meetings in Washington last month. This MoU sets the stage for the banks to share funding costs for projects. The ADB said it is already in talks with the AIIB around ventures in the road and water sectors, the first of which is expected to be a 64-kilometre highway connecting two cities in Pakistan’s Punjab Province. - ASIAN TRADING SESSION - The Nikkei and Topix indexes took the brunt of risk off sentiment today as investors gave a distinct thumb down to last week’s decision by the Bank of Japan not to cut rates further. The Nikkei225 fell 7.41%, while the Topix went down 7.25% in a somewhat bloody trading session. Continuing with the pattern set down for most of this year, the yen by contrast continues to appreciate, touching at one point 105.81 again the dollar, the yen’s highest point for almost two years. The Bank of Japan in response rattled a few sabres, threatening to intervene should the yen appreciate further; but investors continued to test the yen’s upper limit. Yann Quelenn, market analyst at Swissquote noted this morning: “The yen has climbed 13% against the dollar since the start of the year and there a strong support lies at 105.23, which is now clearly on target.” The other story in the Asian session was the surprise move by the Reserve Bank of Australia to cut The Reserve Bank of Australia on Tuesday cut the cash rate to a record low of 1.75 per cent in a bid to head off falling prices and an economic downturn. Market commentators now expect a second cut before the end of the year, although some say the June quarter inflation figure, out in August, will determine the RBA's next move. The latest cut puts Australia firmly into the group of countries with an ultra-loose monetary programme, or should that be a noose around falling interest rates and bond yields. Reserve Bank governor Glenn Stevens said the decision was based on last week's surprisingly weak inflation figures. "Inflation has been quite low for some time and recent data were unexpectedly low," he said in a statement. The AUDUSD fell to 0.7572 from 0.7720 on the news, though the ASX All Ordinaries rose 1.94% on the day, with the S&P/ASX100 rising 2.24%. The index is now up 6.8% on the month, though up only 1.32% over the year. Aside from China and Australian indexes, boards across the region ran red for most of the session. The S&P BSE Senses was down 1.75%. The Kospi100 was also off by 1.50%, while in Singapore the Straits Times took a beating, losing 4.39% today, bringing it down 0.26% over the month and down 2.58% over the year. The Hang Seng also had a tough day, falling 3.68% today, though it is up by 0.87% over the month and down 5.65% over the year. In China, the Shanghai Composite was up 1.13% in trading today, though it is still down 0.56% over the month and down 15.44% over the year. The Shenzhen Composite had a better day, up 3.29%, and is up 1.45% over the month, but still down 16.45% on an annualised basis. The upbeat market sentiment was interesting, given that the Caixin Manufacturing PMI weakened to 49.4 in May from 49.7 in April, softer than market expectations and marking a 14th month of contraction; data that usually would have sent investors to the hills. Go figure. The data indicated that softness in labour markets and exports continue. Meantime, the central bank set the USDCNY mid-point at 6.4565. There is still mixed data emanating from China. Bank of America Merrill Lynch’s latest China: An Equity Strategist’s Diary research report highlights the nugget that YTD 241 non-government bond issuances have been cancelled or postponed, 120 of which were deferred in April, compared with 315 across the whole of last year. Some 709 bonds worth a total of RMB1.04trn came to market in last month (an 85% success rate). However, says the bank, if the bond market corrects sharply, sectors that rely most on the credit markets to support their day-to-day activities (including developers, banks, brokers, industrials and utilities) could suffer disproportionately as their reliance on credit has grown significantly during the past six months. Among the 120 bond issues affected in April, 70% were from industrials (50 bonds), financials (18) and materials (17). The bank also says a perceived implicit government guarantee on bonds and other moral hazards in the shadow banking sector, including wealth management products, is largely behind the mispricing in corporate credit. With the country’s overall default risk perceived to be low, bonds have become a cheap source of long-term financing for corporations compared to other traditional credit products. At the end of April, an AA+ rated five-year bond yielded 4.3% while the benchmark rate for a one-year to five-year loan was 4.75%. A five-year AA- rated bond offered 6.6%. The overnight repo rate annualised was 2%; seven-day repo, 2.5%; six-month discounted bill, 3%; and the one-year benchmark loan rate came in at 4.35%. Alternative sources of finance cost between 12% and 15% for P2P; 8% for a two-year trust; 19% for private lending in Wenzhou; and 18% to 20% for offline wealth management companies. BAML says a sharp uptick in the number of corporate defaults, coupled with the increasing number of cancelled or postponed bond issuances, shows that the market is starting to reprice risk although this process could last until the end this year. The peak maturing period is April/May with between RMB80bn and RMB790bn of bonds maturing over the period. From June onwards maturities fall to around RMB600bn a month for the rest of the year—SAUDI ARABIA—In another move to liberalise the Saudi Arabian capital markets, the Capital Market Authority (CMA) has approved a request by the Saudi bourse to relax settlement cycles for investors, making the country’s inclusion in the MSCI Emerging Markets Index more likely from next year. It has also announced an overhaul of foreign ownership regulations for listed companies, as it seeks to encourage participation by international institutional investors in a wide ranging programme of privatisations. The CMA announced today that it was widening the definition of Qualified Financial Investors (QFI) to include financial institutions such as sovereign wealth funds and university endowments as well as banks. The regulator says the minimum value of assets under management for QFIs will be reduced to SAR3.75bn (about $700m), compared with the current level of SAR18.75bn ($3.5bn). From the end of June 2017, QFIs will be able to own up to 49% of a company’s capital, “unless company’s bylaws or any other regulation provides for foreign ownership to be limited to a lower percentage". Individual QFIs will be able to own up to 10% of a company’s share capital, compared with the current level of 5%. Foreign investment is now an important element in the government’s wide-ranging economic diversification program, which will also involve partial privatisation of some of the country’s key state owned firms. Over the last few weeks Saudi has signalled its intention to list a 5% stake in Saudi Aramco, a move that could raise in excess of $100bn. The opening of the Saudi stock exchange, the GCC’s largest, to QFIs in June of last year was hailed as a milestone at the time, but has so far failed to attract large scale foreign investment into Saudi equities. Licensed QFIs to date include Blackrock, Ashmore Group, Citigroup and HSBC. However, up to now the firms, in combination own less than 0.1% of the Tawadul’s market capitalisation—STOCK EXCHANGE NEWS—Börse Stuttgart reports turnover in excess of €6.7bn in April 2016. The trading volume was almost on a par with the previous month. Securitised derivatives accounted for the largest share of the turnover. The trading volume in this asset class was more than €2.7bn. Leverage products contributed more than €1.4bn to the total turnover, while the trading volume of investment products was more than €1.2bn. At more than €1.4bn, turnover from equity trading at Börse Stuttgart was around 9% higher than in the previous month. German equities accounted for more than €1.1bn of the total turnover – an increase of more than 7% in comparison with March - while international equities contributed about €299m. Trading in debt instruments generated turnover of around €1.6bn in April, with trading volumes almost as high as in the previous month. Corporate bonds accounted for the largest share of the turnover, with approximately €918m.The order book turnover in exchange-traded products (ETPs) was more than €916m in April. Trading in investment fund units generated turnover of €8m —ASSET MANAGEMENT —Aberdeen Asset Management says pre-tax profits have fallen to £98.8m in the six months to March 31st, down from £185.4m over the same period a year earlier after investors have backed off from emerging markets. The asset management has been affected by changes in end investor asset allocation choices as fund outflows over the period amounted to £38.2bn (£16.7bn on a net basis says the asset management maven); however, the pace of outflows has slowed, compared with the previous six months, when investors withdrew £41.7bn (£22.6bn in net basis). Aberdeen has £292.8bn worth of assets under management, down from £330.6bn a year ago, although it marked an improvement on the £283.7bn at its financial year-end. Despite the challenges, Aberdeen has been active in turning around its fortunes, promising to cut annual costs by £70m by 2017 and has diversified its business proposition by a series of acquisitions, including the takeover of hedge-fund manager Arden, risk-graded portfolio provider Parmenion, and fund-of-funds investment manager—CORPORATE NEWS—Advance Utilico Emerging Markets Ltd says it has has extended its £50m senior secured multi-currency revolving credit facility with Scotiabank for a further two years to April 2018. Shares in Utilico are down 0.1% to 176.75 pence—SPANISH ELECTIONS – Looks like Spain is heading for another hung government. News agency The Spain Report says the latest poll of polls data from Electograph shows only minor changes compared to the results of the last general election on December 20th last year. The order of the parties remains the same: PP, PSOE, Podemos, Ciudadanos and United Left. No party is currently forecast to be close to an overall majority, of 176 out of 350 seats in Congress. Over the past four months, polls have at times suggested a slight shift towards a right-wing PP-Ciudadanos coalition and, in the latest round, the possibility that a joint Podemos-United Left electoral list might overtake the Spanish Socialist Party (PSOE) as the reference for the Spanish left, says the news agency—POLITICAL RISK—maven Red24 advises professionals to avoid visiting Kabul. The firm reports that yesterday, the US Embassy, issued a statement warning of an increased threat of attacks in the Taleban’s spring offensive (Operation Omari) against Afghanistan's government and its Western-backed allies, including the US, on April 12th. Crowded public areas, police and military interests, foreign embassies, foreign guest houses, hotels and government buildings/sites have been listed as probable targets; no information was provided regarding the timing of any planned attacks. Red24 says Taleban attacks in Afghanistan generally increase during the spring and summer months, which generally extend until September, when warmer weather allows militants greater access through usually snowed-in mountain passes from their traditional strongholds along the mountainous Afghanistan-Pakistan border. “Given the extreme and ongoing threat of terrorism in Afghanistan, such warnings by government authorities are taken seriously and regularly result in additional security force deployments. The warning is particularly pertinent given the attacks carried out in the capital on 19 April, following the launch of the offensive, in which at least 24 people were killed as a result of a car bomb attack, in the vicinity of several government ministries and the US Embassy in the Pul-e-Mahmood Khan and Shahr-E-Naw areas. Further incidents are expected to persist,” says the firm in an alert issued today.

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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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