List of Tables .............................................................................................................
Introduction ..............................................................................................................
Chapter 1
The Grounds of State Entrepreneurship ................................................................
1.1. Nationalistic Impetus ...........................................................................
1.2. Economic Pragmatism .........................................................................
Chapter 2
Institutional Design .................................................................................................
2.1. Oil Allocation Models ..........................................................................
2.2. Oil Exploitation Models ......................................................................
2.3. The Public Financing Strategy ...........................................................
Chapter 3
The Challenges of Investors’ Protection ................................................................
3.1. Direct Investors ....................................................................................
3.2. Portfolio Investors ...............................................................................
Conclusion …............................................................................................................
References .................................................................................................................
iii
1
4
7
15
23
24
29
39
46
48
56
75
77
1.1. Features of Latin American first wave of nationalization ..............................
2.1. Roots of Latin American domanial regimes ....................................................
2.2. Latin American shifts ........................................................................................
2.3. Risk and rewards of exploitation models ........................................................
2.4. NOCS public financing ......................................................................................
3.1. Corporate law protective measures for minority shareholders in Latin American ..
12
29
35
38
45
64
Ever since the first oil boom of mid-late 19th century in Pennsylvania and the
enshrinement as one of the most important primary commodities to start the
engine of modern societies, oil industries of resource rich-countries have been
subject to a number of schemes whereby states and private individuals interact to a
greater or lesser extent. Recent years have seen a number of contradictory events in
Latin America concerning the top five oil producers of the region, whose National
Oil Companies (NOCs) frequently fill the international news headlines.1
Consider on one end of the spectrum Petróleo Brasileiro S.A. (PETROBRAS)
and Empresa Colombiana de Petróleos (ECOPETROL). Equity and debt securities
issued by both companies are traded not only in domestic capital markets but also
in international platforms, such as NYSE, TSX, BME LATIBEX, Luxemburg, among
others. This fact itself is well seen by experts from a macro perspective, despite
drawbacks that have lately affected their stock prices.2 After all, the respective
administrations appear to put aside the classical debate according to which private
and public cash flows should be kept isolated from each other and they even make
such discussion sound impractical and out-of-date. PETROBRAS, particularly, saw
years of international splendor. In 2000, the company raised US$ 4 billion which
was deemed at that time the second largest offering ever made by an emerging
economy behind China Unicom.3 After the seasoned public offering of 2010, the
“Brazilian largest” was even considered by Bloomberg among the top four biggest
companies in the world alongside with ExxonMobil, Apple, and PetroChina,
surpassing other giants such as Microsoft and Wal-Mart.4 In addition, over the
recent months the news concerning the de-monopolization of the Mexican oil
industry spread throughout the globe. By the end of 2013 a remarkable
constitutional amendment was approved, putting an end to a 75-year-formal-
monopoly of Petróleos Mexicanos (PEMEX) over the oil and hydrocarbons sector.5
1 Mexico, Brazil, Venezuela, Colombia and Argentina are in that order the most important oil producers within
the region. See U.S. Energy Information Administration (EIA), International Energy Statistics: Petroleum
Production (2014), available at
http://www.eia.gov/cfapps/ipdbproject/iedindex3.cfm?tid=5&pid=53&aid=1&cid=AR,BL,BR,CI,CO,EC,M
X,PE,UY,VE,&syid=2000&eyid=2013&unit=TBPD 2 “The company’s market cap is currently $75.6 billion, a billion dollars less than it was when the FT did its
review. By comparison, ExxonMobil’s market cap is $407 billion. PetroChina has a market cap of $188
billion. Colombia’s Ecopetrol is now larger than Petrobras, with a market cap of $76.7 billion as of market
close today”. See Petrobras Now Smaller than Colombia's Ecopetrol, FORBES, MAR, 21, 2014, available at
http://www.forbes.com/. See also Ecopetrol Overtakes Petrobras by Market Cap, FINANCIAL TIMES, JAN,
27, 2013, available at http://www.ft.com/. 3 See William L. Megginson, The Financial Economics of Privatization (OUP 2005).
4 See Petrobras Raises $70 Billion in World's Largest Share Sale, BLOOMBERG, SEP, 24, 2010, available at
http://www.bloomberg.com/. 5See Oil’s well that ends well, THE ECONOMIST, DEC 14 2013, available at
http://www.economist.com/news/americas/21591579-bumpy-year-ends-high-note-oils-well-ends-well.
2 Introduction
On the other side, the negative perception towards Petróleos de Venezuela S.A.
(PDVSA) and Yacimientos Petrolíferos Fiscales (YPF) is the outcome of recent events
whereby the incumbent heads of government boosted the role of the state in their
industries. In 2007, Venezuela compelled companies such as BP, Chevron, Statoil
and Total to accept the terms of a new exploitation regulatory scheme of
mandatory joint ventures by which PDVSA preserved a majority interest of 60% in
all upstream and downstream carried out within the country; in contrast to the
above-mentioned companies, ConocoPhillips and ExxonMobil simply decided to
dump activities.6 In 2012, the Argentinean administration re-nationalized YPF
expropriating 51% out of 62.9% outstanding shares owned by Repsol, meaning that
such company lost control and turned into a minority shareholder.
Going deeper, however, the five scenarios look more alike to what they do
at first glance. The first homogenous feature is quite straightforward; today
Argentina, Brazil, Colombia, Mexico and Venezuela are characterized by the
existence of state entrepreneurship in the matter of oil; five resource-rich
countries, five state crown jewels. Secondly, the five industries are tending to
converge in regards to allocation of oil property and exploitation rights. Therefore
the regulatory schemes of their industries have similar features. As if this were not
enough, domestic and foreign private investors have join these states as “business
partners” not only within classical concessions, taxes and royalties systems or non-
corporate joint ventures, but also within a corporate context: at the very heart of
developed capital markets are the five NOCs resorting to public financing.
Precisely, not only PETROBRAS, ECOPETROL, and YPF play in the big leagues. Even
PEMEX and PDVSA issue public debt in worldwide capital markets, offering only
debt securities perhaps as a way to keep their public statuses intact. Regardless of
the status of partially-owned or wholly-owned, these state-run companies are all
linked to a diverse array of public investors, including institutional and retail as
well as domestic and foreign investors.
The importance and significance of this technocratic way of conceiving the
oil industry is that, despite the relative hegemony of private entrepreneurship, an
alternative model is openly challenging the purist versions of neoliberal thoughts.
On that basis, mass media has termed this phenomenon as “state capitalism”7, a
refurbished concept which describes the deployment by states of a wide array of
corporate and securities law advantages to enhance the overall performance of
See also Expertos ven Fin de Monopolio de Pemex, CNN. DEC 8 2013, available at
http://www.cnnexpansion.com/economia/2013/12/08/expertos-ven-fin-de-monopolio-de-pemex 6 See Exxon Mobil and ConocoPhillips Reject Venezuela Deal, THE NEW YORK TIMES, JUN, 26, 2007,
available at http://www.nytimes.com/. 7 See The Visible Hand, THE ECONOMIST, JAN 19 2012, available at
http://www.economist.com/node/21542931.
Introduction 3
their enterprises. This is how states have achieved to talk the same language as
private firms; in other words, new state-run enterprises acknowledge the
importance of key factors such as profitability, long-term sustainability,
reputational benefits, competitive management performance, operational
efficiency, innovation, and corporate culture, among others. Under this so-called
state capitalism, in broad outline, NOCs have entered the world of securities
offerings.
To this end, daunting challenges arise concerning the protection of this
two type of investors within the Latin American oil industry, on the one hand
foreign direct investors in the form of IOCs, and on the other domestic and foreign
portfolio investors in the form of minority shareholders and bondholders of NOCs.
Sovereign expropriation and no compensation is perhaps the worst case scenario
the former might face; hence, a first agency conflict arises between host countries
and foreign direct investors. In turn, public external financing gives room to a
second type of conflict between self-interest insiders and outside investors, which
is even aggravated by the inherent characteristics of NOCs; they might be used as
public welfare maximization devices, clientelistic vehicles, and piggy-banks, all at
the expense of non-state-shareholders’ wealth.
This master thesis suggests that the current set of regulatory protective
measures for direct and portfolio investors within the top five Latin American oil
producers does not provide sufficient shielding. Moreover, it aims to show how
market-based remedies bridges gaps left by the absence of law. In this sense, the
central research question is no other than how direct and portfolio investments in
the Latin American oil industry are protected. For such purpose, three side
questions are put forward and methodically addressed: Why are NOCs prominent
in Latin America? How does law shape private investment in oil? Which are the
conflicts and remedies? The development goes as follows. By analyzing the
nationalistic and economic forces pushing in one or other direction of the
privatization-monopolization cycle, Chapter 1 serves as departure point to
contextualize the reader about how complex the surrounding of state
entrepreneurship within the region has been. Through a comparative perspective,
Chapter 2 illustrates the big picture of institutional design and it assess how every
legal regime is the result of the selection of a precise set of alternatives in the
matter of ownership and exploitation. Finally, Chapter 3 critically address the wide
array of conflicts that may occur within the current institutional designs embraced
by Argentina, Brazil, Colombia, Mexico and Venezuela to develop their oil
industries. Findings close.
In a world where the dominant trend struggles to maintain economic freedom and
private initiative as main axes of modern economy, state entrepreneurship and
state intervention on a permanent basis are regarded as abnormal phenomena,
even quixotic, that without further ado, distort the functioning and performance of
conventional capitalist markets. In accordance to this economic line of thought,
the level of state interventionism in the market must be reduced to the mere
implementation of macroeconomic policies, or at most, exceptional regulation in
regards to pricing or monopolies whenever it is necessary to ensure efficient
allocation of resources in non-efficient markets.8 Latin America, however, whose
political and economic history has proved dictated by sharp contrasts, has not
always waved the free market flags. In fact, it was not until the period of the
Washington Consensus that most Latin American states adopted their own
versions of laissez-faire, because to this day the majority is but vastly removed from
such postulate including countries that historically have leant towards the right
side of the political scale.
By 2012, the existence of State Owned Enterprises (SOEs) is widely accepted
in Latin America. This fact itself is quite eccentric into the eyes of the purest
version of neoliberalism.9 Brazil is the country with the highest number of SOEs,
147 in total, followed by Argentina with 112, Mexico with 110, and Colombia with
105.10 Moreover, the oil and hydrocarbons industry is by far dominated by regional
giants such as Petróleo Brasileiro S.A. (PETROBRAS), Petróleos Mexicanos (PEMEX),
Petróleos de Venezuela S.A. (PDVSA), Empresa Colombiana de Petróleos
(ECOPETROL), Yacimientos Petrolíferos Fiscales (YPF), and Yacimientos Petrolíferos
Fiscales Bolivarianos (YPFB). And this phenomenon is not only common in Latin
8 David Harvey, A Brief History of Neoliberalism (OUP 2005).
9 Nowadays the US is facing a similar phenomenon in which the Federal Government became controlling
shareholder of important companies as a result of the bailouts granted after the last financial crisis. This has
been subject to great controversy and the role of the state has said to be mainly transitory. See Marcel Kahan
and Edward B. Rock, When the Government Is the Controlling Shareholder (2011) TEXAS LAW REVIEW
Vol. 89, pp 1293-1364. 10
See OECD, Trends and Factors Impacting on Latin American Equity Market Development (2013) available
at http://www.oecd.org/daf/ca/2013LatinAmericaCGRoundtableEquityMarketReport.pdf.
Chapter 1 The Grounds of State Entrepreneurship 5
America. To give an example, 204 out of the 2000 largest companies are SOEs.11
Within the oil industry prominent companies such as Saudi Aramco, National
Iranian Oil, Kuwait Petroleum, PetroChina, Gazprom, Sinopec, China National
Offshore Oil, Rosneft, Abu Dhabi National Oil, Qatar Petroleum, Statoil, and
others, are well spread among resource-rich countries including Saudi Arabia, Iran,
China, Russia, Kuwait, United Arab Emirates, Qatar, Norway, and India.
In Latin America, as many other regions, the development of the oil
industry has gone through several phases. Open exploitation, concessions, taxes
and royalties systems, joint ventures, monopolies, and even partially-owned or
state-run companies; meaning that private investors have seen enough room to
engage in oil activities alongside with the state. In fact, the current set up displayed
by the top five oil producers entails a high degree of involvement of private
capital. 12 However, since two different approaches have been taken by the
incumbent administrations to regulate the industry and run their NOCs, working
alongside with some specific states may also become a great concern for private
investors, particularly because inward international cash flows can turn into
permanent sunken investments. At one pole, privatization of NOCs has been used
by some administrations as the main means of setting up a friendly investor
environment; at the other, in contrast, extreme hostility has come in the form of
selective expropriation to foreign investors. Whereas Brazil, Colombia and Mexico
opened the core of their NOCs and welcome portfolio investors; Argentina, Bolivia,
Ecuador and Venezuela tend to take over the oil industry as in the old days. These
opposite approaches are essentially due to disparities in public policies concerning
the level of state interventionism. Interestingly, both Latin American current
visions of NOCs have been considered as part of an economic cycle rather than a
continuous line with no return point, which has proved to take place particularly
in emerging economies and resource-rich countries.13 The first question that arises
is what the rationale behind the cycle liberalization-monopolization is. The
literature has developed an array of hypotheses in an attempt to explain the
determinants behind the Latin American opening and state interventionism
policies in the oil and hydrocarbons industry. The traditional theory posits that
leftist ideologies deeply influenced public policies in Latin America.14 Under this
11
See Przemyslaw Kowalski et al., State-Owned Enterprises: Trade Effects and Policy Implications (OECD
Trade Policy Papers, No. 147, 2013), available at http://dx.doi.org/10.1787/5k4869ckqk7l-en. 12
See infra sections 2.2 and 2.3. 13
See Roberto Chang, Constantino Hevia, and Norman Loaysa, Privatization and Nationalization Cycles,
(World Bank Policy Research Working Paper No. 5029, 2009), available at http://elibrary.worldbank.org 14
See, e.g., Stephen J. Kobrin, Diffusion as an Explanation of Oil Nationalization (1985) JOURNAL OF
CONFLICT RESOLUTION Vol. 29, No. 1, pp. 3-32; Amy L. Chua, The Privatization-Nationalization Cycle:
The Link Between Markets and Ethnicity in Developing Countries (1995) COLUMBIA LAW REVIEW Vol. 95,
No. 2, pp. 223-303; Jorge G. Castañeda, Latin America's Left Turn (2006) FOREIGN AFFAIRS Vol. 85, No. 3;
6 Why are NOCs Prominent in Latin America?
perspective the so-called “redistributive movements”, stimulated by nationalistic
impetus and collective sense of inequality, triggered a “domino effect” of
nationalizing retaliations of IOCs on a region whose historicity makes it more
responsive to reformist movements encouraging egalitarianism and strong
presence of state institutions. Economists, conversely to political scientists, have
suggested privatization and state ownership in the oil sector are nothing but
strategies relying upon economic rather than ideological factors.15 They posit, for
instance, one of the main drivers of nationalization is the rise of international
crude oil price as well as low returns from taxes and royalties.16 As scholarship in
general tend to classify and stereotype privatization-nationalization patterns as
“good” (e.g. right-wing, center and moderate left) and “bad” (e.g. radical left), other
academics aim to remove from literature such labels based on more objective
comparisons among NOCs. Either case, analysts in general coincide that Latin
American countries have intervened certain markets through entrepreneurial
activity aiming either the implementation of public policies on social welfare or the
generation of wealth and subsequent redistribution for the very group of citizens.
Interestingly, historic reviews show that state entrepreneurship does not usually
entails built-from-scratch state companies; in fact, nationalization of mature
companies has been the method of choice in the region well above other forms of
intervention, particularly in the upstream segment of the oil industry. At the end of
the day, however, the other side of this phenomenon is embodied by foreign
investors, who might be even pushed out in the face of any shift in the respective
public policy. Nationalization in the form of unilateral non-compensated
expropriation is perhaps the most severe risk that private capital may encounter in
developing countries whose political and economic situation proves prone to
volatility. Thus, if this behavior is part of a vicious cycle, investors need to know
Robert Kaufman, Political Economy and the ‘New Left’ in Cynthia J. Arnson with José Raúl Perales (eds),
THE NEW LEFT AND DEMOCRATIC GOVERNANCE IN LATIN AMERICA (Woodrow Wilson International
Center for Scholars 2007); Leslie Bethell, The Cambridge History of Latin America - VI Latin America since
1930: Economy, Society and Politics (CUP 1994). 15
See, e.g., William L. Megginson and Jeffry M. Netter, From State to Market: A Survey of Empirical Studies
on Privatization (2001) JOURNAL OF ECONOMIC LITERATURE, 39(2): 321-389; Alberto Chong and Florencio
López-de-Silanes, Privatization in Latin America: What Does the Evidence Say? (World Bank publications
2005); Sergei Guriev, Anton Kolotilin and Konstantin Sonin, Determinants of Nationalization in the Oil
Sector: A Theory and Evidence from Panel Data (2009) JOURNAL OF LAW, ECONOMICS, AND
ORGANIZATION, 27 (2): 301-323; Roderick Duncan, Price or politics? An Investigation of the Causes of
Expropriation (2006) THE AUSTRALIAN JOURNAL OF AGRICULTURAL AND RESOURCE ECONOMICS, 50, pp.
85–101; Osmel Manzano and Francisco Monaldi, The Political Economy of Oil Production in Latin America
(2008) ECONOMÍA Vol. 9, No. 1, pp. 59-103; Roberto Rigobon, Dealing with Expropriations: General
Guidelines for Oil Production Contracts in William Hogan and Federico Sturzenegger (eds), POPULISM AND
NATURAL RESOURCE (MIT Press 2008). 16
See, e.g., Guriev et al., supra note 15; Rubén Berríos, Andrae Marak and Scott Morgenstern, Explaining
Hydrocarbon Nationalization in Latin America: Economics and Political Ideology (2011) REVIEW OF
INTERNATIONAL POLITICAL ECONOMY, 18:5, 673-697.
Chapter 1 The Grounds of State Entrepreneurship 7
symptoms in advance and make sure they have the optimal protective tools against
such risk. The study of investors’ protective measures featured by Latin American
legal systems, particularly IOCs, would be incomplete if it neglects to address first
the driving forces leading to such daunting conflict. Hence, this segment accounts
for the political and economic foundations upon which lies the position that
governments have assumed on privatization and state intervention.
According to political scientists and critical historians, the 20th century represented
for Latin America a constant political swinging shaped by tensions among
preexisting oligarch elites, liberal merchant forces, populist movements, military
commanders, and even spontaneous insurrection groups; the outcome differed
from country to country. In general, the existing literature emphasizes the fact that
the Latin American power struggle was featured by three ideological streams. In
the first place, conservative movements represented by landed elites, who
advocated for power centralization, ecclesiastical hegemony in legal affairs, and
trade barriers; secondly, liberal movements mainly represented by merchants and
upper middle class, arguing for a decentralized political system, secularization of
the state, and market liberalization; and thirdly, populist factions composed of
lower middle and lower classes, whose effusive and even radical speeches claimed
for nationalistic and anti-imperialist measures, including the protection of what
they termed working class, domestic industries shielding, health care and other
services broadening, among others. 17 As a result of this power struggle, the
frontline of Latin America economics witnessed the coexistence of a chaotic
divergence of concepts dispersed all around the Central, Caribbean, Andean
Region and the Southern Cone, such as neoliberalism, egalitarianism,
protectionism and interventionism. All these policy agenda contrasts made some
classical analysts to suggest that the region, taken as a whole, lacked of
homogeneous patterns or simultaneous uniformity in regards to political
ideologies.18 For instance, Argentina and Uruguay at one extreme or Colombia and
Venezuela at the other are not only contiguous countries but also share cultural
roots; this is why analysts found deep political differences quite paradoxical.19 By
mid 20th century, and as a result of the late influence of the so-called “redistributive
17
See Bethell, supra note 14; Enrique C. Ochoa, The Rapid Expansion of Voter Participation in Latin
America: Presidential Elections, 1845-1986 in James W. Wilkie and David Lorey (eds), STATISTICAL
ABSTRACT OF LATIN AMERICA (UCLA Latin American Center Publications 1987). 18
See Bethell, supra note 14. 19
ibid.
8 Why are NOCs Prominent in Latin America?
movements” of the previous century, a significant part of Latin American nations
was characterized by the dominance of leftist ideologies, among them, Argentina,
Bolivia, Brazil, Cuba, Costa Rica, Mexico, Nicaragua, Peru and Venezuela. In other
countries, the exercise of power by left-wing parties was merely a shooting
phenomenon unable to overcome the death of its leaders, as in the case of most
Caribbean countries, Chile, Colombia and to some extent Uruguay, in which right-
wing streams have dominated the political landscape by tradition.20
Put all together, these social and political elements are invoked to support
the ideological hypothesis of modern state entrepreneurship. Under such classical
theory, the political juncture, driven by egalitarian and redistributive ideologies,
transformed the (relative) aversion of Latin American public opinion in regards to
the role of the state as active entrepreneur, even in right-wing countries in which
market stability and macroeconomic policies’ orientation were driven by the
sometimes volatile perception of voters.21 The scholarship argues disproportional
wealth allocation in conventional capitalist economies, gave rise to intense social
divisions between “victors and losers” which ultimately drove to “deep
exacerbation” in the form of nationalizing behaviors against the wealthy.22 It has
been widely recognized centre-left and radical left movements put a vast pressure
when it came to defining the state’s role towards the level of interventionism in
each country’s economy. These claims largely focused on strong state presence in
order to directly address and minimize factors such as poverty, inequality,
analphabetism, and labor exploitation. More remarkably, inequality has been
deemed by sociologists and other scholars as one of the most decisive dynamics in
Central and South America’s history.23 During the 20th century, inequality evolved
from being a conflict between landowners and impoverished peasants to one
involving wealthy and high income individuals on the one hand and those lacking
of fluid sources of income on the other.24 Yet, egalitarian, protectionist and welfare
causes serve as inspiration for politicians.
That said, the most important effect brought by leftist movements, in
accordance to the ideological hypothesis, was the justification given to the state for
having a leading role in markets that (owing their own specificities) were prone to
social inequity. In welfare-economic terms, the state sought to behave as producer
or supplier of goods and services to promote the reestablishment of those markets
20
ibid. 21
See infra note 47 22
See Chua, supra note 14.
23 Inequality has such deep roots that even trace back to the colonial age when Creoles, that is European
descendents born in the New World, were excluded by the Iberian oligarchies. 24
See Evelyne Huber, François Nielsen, Jenny Pribble and John D. Stephens, Politics and Inequality in Latin
America and the Caribbean (2006) AMERICAN SOCIOLOGICAL REVIEW 71: 943.
Chapter 1 The Grounds of State Entrepreneurship 9
vital for human preservation. Even since then, maximization of social welfare
through public services such as health care, education, access to drinkable water,
electricity, gas and transportation is widely accepted in Latin America like many
other regions in the world.25 From then on, SOEs were conceived as important
components of social development and NOCs were especially supported owing the
importance of state ownership over “key elements of the production structure”.26
In fact, the oil industry was particularly sensitive to nationalistic behaviors under
the idea of wealth redistribution, and the truth is that this sector had seen a
monumental growth in the international landscape feed by the continuous
industrial development and the massive use of the non-renewable commodity. In
the 19th and early 20th centuries, IOCs alongside with financial institutions were the
major worldwide corporate empires; IOCs particularly were composed by extensive
nets of subsidiaries vertically integrated, allowing them to focus on the three
segments of the oil exploitation activity. To give an example, Standard Oil, owned
by the legendary and controversial John D. Rockefeller, fueled the gears of US
economy. 27 Notwithstanding the increasing success, such companies also
experienced tremendous public rejection owing to high profile scandals concerning
labor abuses and competition, which were suffocated in their home countries
through legislative intervention. Latin American nations took longer to identify
and address those difficulties, and the response as it will be described was even
more radical. Although enrichment of foreigners was seen by some as necessary
evil to foster the development of (laggard and unexploited) national oil industries,
leftists considered a new form of dependence of Latin American countries towards
global powers, and sometimes more radically, as an offense from certain local elites
which granted the firsts sweetheart concessions for their personal gain at the
expense and without the pre-approval of common citizens.28 Some authors argue
that nationalization of IOCs was not in itself the first assault of nationalizing
governments, but instead they first used an aggressive tax strategy consisting on a
sharp increase of oil exploitation taxes; this took place in countries like Argentina,
Bolivia, Ecuador, Mexico, Peru and Venezuela.29 In this latter case, for example,
taxes were raised to 94% in 1974 after being at stable rate of approximately 50%
between 1943 and 1958.30 The truth is that Latin America, in general, replaced the
25
State ownership is in general acknowledged on non-profitable primary service markets, aiming price
reductions, increase of coverage and access for low income individuals. 26
See Samuel A. Morley, The Income Distribution Problem in Latin America and The Caribbean (United
Nations Publications 2001). 27
For anecdotic evidence see Daniel Yergin, The Prize: The Epic Quest for Oil, Money & Power (Simon &
Schuster 1991). 28
ibid. 29
See Manzano and Monaldi, supra note 15. 30
ibid.
10 Why are NOCs Prominent in Latin America?
tax strategy for a more radical one. One by one, Latin American states took over
the work carried out by IOCs; sovereignty over the subsoil resources was the
hegemonic rhetoric that eased the supremacy of the state monopolistic scheme.
Argentina was the first in the region to embrace the search of social welfare
and redistribution of wealth through state entrepreneurship. Academics coincide
certain legislative lethargy existed even after the discovery of Comodoro Rivadavia
oil field, especially in regards to tax and royalties policies since revenues for the
state were not proportional to the volume of the oil activity carried out by locals
and foreigners like Anglo-Persian and Standard Oil; on top of that, some level of
rejection towards the increasing power of foreign investors floated around
common citizens.31 The creation of YPF in 1922 was a moderate response from the
incumbent government, and even though the government attempted to establish a
de facto monopoly through the generalized rejection of new concessions based on
legislation established in 1924, the truth is this NOC coexisted with few IOCs within
the oil market due to political commitments.32 Uruguay, although being a net
crude oil importer, was the second country to do so. Administración Nacional de
Combustibles Alcohol y Portland (ANCAP) was created in 1931, and was granted with
monopoly in the refinery and distribution. In 1936, Bolivia’s military dictator gave a
first nationalization strike in the form of the expropriation of the assets owned by
Standard Oil.33 Since its foundation in the same year, YPFB was granted with
exclusive oil exploitation. In 1969, after a brief opening to private capital, military
occupation took place on the lands and refineries owned by Gulf Oil, expelled the
day after.34 The case of Mexico even surpassed Bolivia’s. In 1938, in the clear pursuit
of retaliation produced by the refusal to comply with a labor arbitration award, the
incumbent government enacted the Expropriation Law which by 17 IOCs were
outrageously pushed out, including subsidiaries of Standard Oil, Royal Dutch Shell
and Chevron; as a result PEMEX was founded to take on the respective activities.35
Nationalizations carried out in Bolivia and Mexico were emblematic and also the
starting point for the so-called “domino effect” in the remaining Latin American
countries since these two episodes are considered by academics as the real first
31
See Marcos Kaplan, La Pol tica del Pet leo del Estado entino: 1907-1957 in Marcos Kaplan, ASPECTOS
DEL ESTADO EN AMÉRICA LATINA (Universidad Nacional Autónoma de México 1981). See also Carl E.
Solberg, Oil and Nationalism in Argentina: A History (SUP 1978). 32
ibid. 33
See Brent Z. Kaup, A Neoliberal Nationalization?: The Constraints on Natural-Gas-Led Development in
Bolivia (2010) LATIN AMERICAN PERSPECTIVES 37: 123. See also Thomas D. Lumpkin, Gulf Oil’s
Experience in Bolivia (1971) HOUS. L. REV Vol. 8:457, 472-8. 34
ibid. 35
See Jaime Cárdenas, En Defensa del Petróleo (Universidad Nacional Autónoma de México 2009). See also
José J. Gonzales, The Scope and Limitations of the Principle of National Property of Hydrocarbons in
Mexico in Aileen McHarg et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES
(OUP 2010).
Chapter 1 The Grounds of State Entrepreneurship 11
expropriation acts within the region in the matter of oil and hydrocarbons.36 Even
though Argentina and Uruguay were the first countries to claim state presence in
such industry, these institutional reforms did not have that impact and
reverberation due to several reasons; firstly because Argentina did not have a
relevant portion of crude oil exportation worldwide, secondly Argentina did not
banned IOCS until 1949, thirdly Uruguay was a net importer country with virtually
no upstream activity, and fourthly because both nationalization processes were
indirectly achieved and barely controversial. Empresa Nacional del Petróleo (ENAP),
in Chile —also net importer—, was granted with monopolistic activities in
downstream activities since its creation in 1950. The turn of Colombia took place in
1951, when the head of government decided not to renovate the voluminous Mares’
Concession which enabled Tropical Oil to exploit major oil national fields; the state
founded ECOPETROL to carry on upstream activities; however, it is important to
note that the then-regulation did not impose full monopoly since private activity
was still allowed.37 Brazil did not truly nationalize its industry until the second mid
of the 20th century. Been characterized by its virtual lack of interest concerning
IOCs, Brazil reversed the traditional public policy in 1946 and claimed monopoly
over the oil industry under the campaign “the oil is ours” which led to the creation
of PETROBRAS seven years later; the then-President described such decision as “a
new milestone in our economic independence”.38 In Peru, Empresa Petrolera Fiscal
(EPF, renamed PETROPERÚ) had coexisted with foreign privately held companies
until the appropriation of La Brea and Las Pariñas oil reserves and the subsequent
expulsion of International Petroleum Company in 1968.39 At that time, local
newspapers published the effervescent speech of Peruvian dictator in the sense
that nationalization was “a recognition instance of sovereignty and dignity”.40 In
Ecuador, Corporación Estatal Petrolera Ecuatoriana (CEPE, succeeded by
PETROECUADOR) was incorporated to continue the activities left Texaco after
36
See Kobrin, supra note 14. 37
See Juan Benavides (ed), Ecopetrol 60 años: Energía Limpia para el Futuro (Villegas Editores 2011). See
also Hernán Vasquez C., La Historia del Petróleo en Colombia (1994) Revista Universidad Eafit Vol. 30
No. 93, pp. 99-109. 38
See Marilda Rosado de Sá Ribeiro, The New Oil and Gas Industry in Brazil: An Overview of the Main Legal
Aspects (2001) TEXAS INTERNATIONAL LAW JOURNAL Vol. 36, pp.141-66; Yanko Marcius de Alencar
Xavier, Legal Models of Petroleum and Natural Gas Ownership in Brazilian Law in Aileen McHarg et al.
(eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010); Laís Palazzo Almada
and Virgínia Parente, Oil & Gas Industry in Brazil: A Brief History and Legal Framework (2013)
PANORAMA OF BRAZILIAN LAW Vol 1, No 1, pp. 223-252. 39
See Expropiación de los Yacimientos Explotados por la International Petroleum en Perú, LA VANGUARDIA,
OCT 11 1968, available at http://hemeroteca.lavanguardia.com/preview/1968/10/11/pagina-
16/34313159/pdf.html 40
ibid.
12 Why are NOCs Prominent in Latin America?
hostile acts during 1972.41 Venezuela was the last country in Latin America to
nationalize the oil industry within this first extended wave. The industry in
Venezuela, the largest oil producer in the region throughout much of the 20th
century, was entirely featured by IOCs and local private companies. By the 1970s,
the incumbent administration had seriously considered not renovating concessions
which were meant to end by 1983; however, the nationalization was executed in
advance in response to what some foreign companies did in order to dismantle
their facilities. Hence, PDVSA was incorporated in 1976 to manage all 14 preexisting
IOCs as subsidiaries; yet, the statutes left the door opened for potential reentry of
foreign investors.42
In sum, conversely to common belief, this first wave of nationalization was
not achieved completely through hostile expulsions as this was only the case of
50% the analyzed countries, of course this fact does not mean processes were
exempt from controversy. Only Bolivia, Mexico, Peru and Ecuador expelled IOCs. In
turn, preexisting concessions were not renewed by Colombia and Venezuela but
IOCs remain present in various forms. Argentina and Brazil are the only exceptions
that practically developed their upstream segment from scratch; tough the former
could face more difficulties in doing so bearing in mind the combination of
41
See, e.g., Guillaume Fontaine (ed), Petróleo y desarrollo sostenible en Ecuador (Flacso 2003). See also
Ecuador: Fin del Nacionalismo Petrolero, OILWATCH, DEC 22 2013, available at
http://www.oilwatchsudamerica.org/petroleo-en-sudamerica/ecuador/3741-ecuador-fin-del-nacionalismo-
petrolero.html. 42
See PDVSA official website
http://www.pdvsa.com/index.php?tpl=interface.en/design/readmenuprinchist.tpl.html&newsid_temas=13.
Table 1.1. Features of Latin American first wave of nationalization
Year Country Political Regime
Ideology NOC Hostility Full
Monopoly
1922 Argentina Democracy CL YPF - -
1931 Uruguay Democracy CR ANCAP - X
1936 Bolivia Authoritarian L YPFB X X
1938 México Democracy CL PEMEX X X
1950 Chile Democracy CL ENAP - X
1951 Colombia Democracy CR ECOPETROL - -
1953 Brazil Democracy CL PETROBRAS - X
1968 Peru Authoritarian L PETROPERÚ X X
1969 Bolivia Authoritarian L - X X
1972 Ecuador Authoritarian L PETROECUADOR X -
1976 Venezuela Democracy CL PDVSA - -
Sources: Alencar Xavier, Benavides, Berríos et al., Bethell, Cárdenas, Coppedge, Fontaine, Gonzales,
Kaplan, Kaup, Lumpkin, Ochoa, Palazzo & Parente, Rosado de Sá Ribeiro, Solberg, Vasquez.
Complemented by the author.
Chapter 1 The Grounds of State Entrepreneurship 13
circumstantial factors such as the aftermath of The Great World, The Great
Depression and technology availability. Uruguay and Chile had modest upstream
activities hence monopolizing such segment was from far traumatic for foreign
investors. Moreover, Mexico, Venezuela, Bolivia, Uruguay, and Chile established
NOCs and monopolies simultaneously; Brazil established monopoly and much later
founded its NOC; and Argentina established its NOC first and decades later
established an absolute monopoly. In general terms Brazil, Mexico, Bolivia, Peru,
Chile and Uruguay formally set full monopolistic exploitation models for the
industry; Colombia and Ecuador, in contrast, had a neutral market were NOCs
coexisted alongside with IOCs. Argentina and Venezuela did not commit to full
monopoly in their first phase of nationalization. Unlike the case of Peru, all these
processes were finally settled with compensation arrangements. 43 The most
remarkable characteristics of oil nationalizations in Latin America are synthesized
in table 1.1.
One important remark on Latin American state entrepreneurship is that
the occurrence of such oil nationalizations is spread throughout the whole 20th
century timeline. This entails that much of the wave was certainly exempt to the
influence of the world scale expropriation movement that took place during the
1960s and 1970s.44
Table 1.1 also notes the region’s circumstantial heterogeneity at the specific
time when nationalizations were executed. For example, countries such as
Argentina, Brazil, Chile, Colombia, Mexico, Uruguay and Venezuela enjoyed
relatively stable democratic institutions, helped by legal measures such as the
introduction of anonymous vote and the progression of voting rights (which
gradually enabled peasants, analphabets and women).45 Conversely, Bolivia Peru
and Ecuador were subject to military dictatorships.46 Besides the diversity of
political regimes it is clear that, at least from a formalistic standpoint,
nationalizations were not only executed by leftist parties, as the case of Colombia
and Uruguay in which right-oriented governments were responsible to promote
the state expansion towards the market. Notably, the fact that conservative and
right-wing administrations existed among nationalizing states does not account
against the ideological hypothesis of state entrepreneurship. Indeed, this theory is
43
See Berríos et al., supra note 16. 44
It has been widely acknowledged that during this period, the nationalizing attitude towards energetic
international firms was feed by the embargo of the Organization of Arab Petroleum Exporting Countries
(OAPEC) and the oil crisis, as well as the US massive increase of hydrocarbons consumption and the
subsequent equilibrium point where US supply and demand represented the end of the US oil surplus. See
Yergin, supra note 27. For the exhaustive list of nationalizing countries between 1960 and 2006 see Guriev
et al., supra note 15. 45
See, e.g., Bethell, supra note 14, Ochoa supra note 17; infra note 47. 46
ibid.
14 Why are NOCs Prominent in Latin America?
not based on the formal ideology of the incumbent governor party itself, but
properly in the historic influence that redistributive movements had upon them.
Due to this phenomenon’s complexity, and in order to illustrate comparative
analysts, an important body of literature in political science took the task of
creating a taxonomic chart and classified all Latin American political parties and
electoral trends in the classic left-right scale.47 High rate of changes in party
fragmentation and volatility throughout the evaluated periods was observed,
besides the fact that none of the parties were thoroughly static in matter of
ideology trends. Experts coincide feedback with the contemporary social context
was a significant key element of Latin American politics since definitions of “left”
and “right” “vary greatly from decade to decade”.48 Therefore, they conclude there
is no fixed manual to create right-wing or left-wing political parties; instead, each
party adopts lines of thought according to contemporary socioeconomic context.49
In light of these considerations, it is plausible to conclude —according to
the ideological theory of the rationale behind state entrepreneurship— that a
combination of collective inequality, national proud, mass movements and
populism, was the cornerstone of the nationalizing behavior; and therefore much
of the Latin American first wave was carried out not by a specific political regime
or same-ideology parties, but same-objective parties aiming the eradication of
inequality through wealth reallocation. Naturally, domestic political and
socioeconomic dynamics as well as side factors such as “diffusion” had great
importance in the sense that nationalization in one country (e.g. Bolivia and
Mexico) considerably contributed to a “domino effect” in others.50 Besides, the
nationalistic impetus was also accompanied by other exogenous factors, such as
the rise of “world superpowers”, US and UK on one side and USSR on the other.51 It
is still plausible that nationalizations worked to some extent as reprisal on the
basis of historical resentment towards global oil producers and the so-called “seven
sisters” whose worldwide domination (e.g. Achnacarry agreement) struggled with
popular sovereignty.52 Or less drastically, Latin American versions of “welfare state”
47
See, e.g., Michael Coppedge, A Classification Of Latin American Political Parties (Working Paper No. 244,
1997), available at kellogg.nd.edu/; Nina Wiesehomeier, The Meaning of Left-Right in Latin America: a
Comparative View (Working Paper No. 370, 2010), available at kellogg.nd.edu/; Manuel Alcántara and
Cristina Rivas, The Left-Right Dimensions in Latin America Party Politics (Prepared for the annual meeting
of the American Political Science Association 2006), available at http://gredos.usal.es/. 48
“For example, in Latin America during the 1960s support for political democracy was often considered
incompatible with being on the left, but in the early 1980s it was often considered incompatible with being
on the extreme right”. See Coppedge, supra note 47. 49
See Alcántara and Rivas, supra note 47. 50
See Kobrin, supra note 14. 51
See Chua, supra note 14.
52 See Roger G. Noll, Telecommunications Reform in Developing Countries in Anne O. Kreuger (ed),
ECONOMIC POLICY REFORM: THE SECOND STAGE (University of Chicago Press 2000) quoted by
Megginson and Netter, supra note 15.
Chapter 1 The Grounds of State Entrepreneurship 15
in the 20th century simply implicated the expansion of the functions of the states as
means to recover control over markets full of foreign investments as well as to
ultimately promote growth maximization.53
One final remark is that interesting deviations of the nationalistic impetus
hypothesis, but still political, are pointed out by other scholarship. Firstly, some
authors suggest that the increase of crude oil price entails in itself an increase of
IOCs’ political power; hence, nationalization is used as a means to restraint such
influence. 54 And finally, other experts consider the possibility of residual
smokescreen nationalizations set forth to cover domestic troubles.55
In opposition to the classical and prominent ideological hypothesis, the economic
theory of modern state entrepreneurship finds its grounds on a series of
macroeconomic patterns that are believed to affect the decision making of
emerging economies’ administrations. As it will be assessed, not only privatizations
but more interestingly nationalizations are highly linked to economic drivers.
Latin America has not been unfamiliar to the neoliberal economic trend, in
particular during the late 20th century. The so-called Washington Consensus
marked the beginning of a new period for Latin American countries; technocrat
and pragmatic public policy choice was the critical pillar of such new perspective.
The downfall of international communism, together with deep contraction in the
economy and severe fiscal deficit, dragged the influence of leftist policies in the
region.56 In order to fight back poor economic performance of the last decades
(especially the labeled “lost decade”), Latina American countries almost in unison
gave up to the neoliberalism and neoconservatism theses and embraced most of
the points of such stabilization plan.57 The consensus suggested the convenience of
rerouting the economic systems of developing nations to the paths of deregulation
and liberalization. This included adopting free markets which by efficient
allocation of resources was eased and foreign cash flows welcomed; plus the aim of
reducing the institutional framework for state intervention in economic affairs,
53
See Dennis Rondinelli and Max Iacono. Policies and Institutions for Managing Privatization (International
Training Centre, International Labor Office 1996) quoted by Megginson and Netter, supra note 15. 54
See Raghuram Rajan and Luigi Zingales, Saving Capitalism from Capitalists (Princeton University Press
2003) quoted by Guriev et al., supra note 15. 55
See Duncan, supra note 15. 56
Gustavo A. Flores-Macías, Statist vs. Pro-Ma ket: Explainin Leftist Gove nments’ Economic Policies in
Latin America (2010) COMPARATIVE POLITICS Vol. 42, No. 4, pp. 413-433. 57
Cuba is the most prominent exception. See Bethell, supra note 14.
16 Why are NOCs Prominent in Latin America?
including trading barriers reduction, state monopolies abolition and privatization
of SOEs.58 Prior to the consensus, as a matter of fact, privatization was one of the
hottest western economic trends since neoliberal US and UK policies had spread to
a greater extent to countries such as France, Germany, Italy and Spain; all of them
carried out dismount or denationalization programs in large scale.59 The failure of
the state as an entrepreneur was a generalized idea among academics and policy
makers. On one hand, SOEs recalled governmental bureaucracy and even
corruption in some cases. On the other, SOEs were not generating enough returns
for public expenditure, and in the contrary, given the evident inefficiency when it
came to income maximization, such companies acted as non-sustainable and loss-
making black holes that used to survive by means of bailouts (demanding and
wasting collected taxes from the same society they intended to benefit). Important
compilations of empirical studies related to privatizations conclude that the critical
factors in which state entrepreneurship’s inefficiency lies, in comparison to private
companies, are basically higher operating and manufacturing costs, less
profitability, over-capitalization and over-hiring of labor force, on top of that SOEs’
management tend to be less proactive and even less committed to bargain
contracts.60 Although originally conceived as an academic suggestion, embracing
the consensus was in part the result of the tremendous pressure put by
international financial institutions such as the International Monetary Fund and
the World Bank through their bargaining power in the matter of international
lending.61 By early 1990s Chile had externalized 96% of its SOEs to private investors;
as numbers in Mexico are said to decrease from 1115 to just 80.62 Others like
Ecuador, Nicaragua and Uruguay did simply not follow the large-scale privatization
program.63 Those financial organizations lobbied and pressed in particular for the
total or partial privatization of well-recognized NOCs, which have always proved
state crown jewels evoking the power of Latin America.64 Thus, under enthusiasm
and pressure, Argentina and Bolivia gave up all the oil and hydrocarbons industry
to IOCs and their principal NOCs; YPF and YPFB respectively, were privatized.65
58
See John Williamson. The Washington Consensus as Policy Prescription for Development (lecture in the
series “Practitioners of Development” delivered at the World Bank 2004), available at http://www.iie.com. 59
See Megginson and Netter, supra note 15. 60
See, e.g., Dennis C. Mueller, Public Choice III (CUP 1989); Chong and López-de-Silanes, supra note 15;
Megginson and Netter, supra note 15. 61
As described by its own author, the consensus was an ideal prescription containing the public policy formula
with reactivating effects. See Williamson, supra note 58. 62
See Morley, supra note 26. 63
See Chong and López-de-Silanes, supra note 15. 64
See Diego Mansilla, Petroleras Estatales en América Latina: entre la Transnacionalización y la Integración
(2008) REVISTA DEL CCC [online], available at http://www.centrocultural.coop/revista/articulo/30/. 65
See supra notes 31 and 33.
Chapter 1 The Grounds of State Entrepreneurship 17
Venezuela and Brazil allowed the entry of IOCs to the market.66 Mexico and
Colombia, in turn, privatized the bulk of their SOEs as established on the
stabilization plan, but they did preserve their ownership in PEMEX and
ECOPETROL.67
However, at this point in time Latin American’s landscape is quite different
to the extent that some authors have referred to a sort of “Washington
Dissensus”.68 After two decades from the start of the “modernization process” of
Latin American economic models, more than ever the region is ruled by political
parties sympathetic towards state interventionism. The victories of leftist
candidates have been repeated and emphatic in Venezuela, Brazil, Argentina,
Bolivia, Ecuador, Nicaragua, and even Uruguay and Paraguay; by 2007 this
contemporary trend peaked nearly 60% of the region’s population under leftist
governments.69 And it still accounts the vast majority. Voters in Chile and Peru
have taken mixed decisions. Colombia, Mexico, Panama and few Caribbean
countries are the ones whose heads of government account for right-wing and
centre-right political parties.
And the importance and significance of all these events is that they appear
to account for the renaissance of the left. Nonetheless, even political scientists find
key differences with the first wave of nationalization. Even when the region would
seem to be immersed into a harmonious left wave, analysts identify two types of
left but not “diametrically opposed”; the populist and the radical.70 In the matter of
macroeconomic, the former has embraced lukewarm and orthodox lines of thought
which smelt with pro-market neoliberal postulates, while the latter has gone back
to state interventionism including the same old nationalizing way. Prominent
experts acknowledge today’s moderate left diverges to a greater extent in
comparison to old days’ left; and they also estimate state ownership policies by
66
See Mansilla, supra note 64; Luisa Palacios, The Petroleum Sector in Latin America: Reforming the Crown
Jewels in Judith Burko (ed), LES ETUDES DU CERI ETUDE (CERI 2002). 67
See, for Mexico, Rafael La Porta and Florencio López-de-Silanes, The Benefits of Privatization: Evidence
from Mexico (1999) THE QUARTERLY JOURNAL OF ECONOMICS Vol. 114, Issue 4, pp. 1193-1242; for
Colombia, Carlos Pombo and Manuel Ramírez, Privatization in Colombia: A Plant Performance Analysis
(Working Paper No. 166, 2003), available at http://www.ssrn.com/. For a study of privatizations in Latin
America see, e.g., Chong and Florencio López-de-Silanes, supra note 15. For a worldwide study see, e.g.,
Megginson, supra note 3. 68
See Ramón Casilda Béjar, América Latina y el Consenso de Washington (2004) BOLETÍN ECONÓMICO DE
ICE No. 2803, pp. 19-38. 69
See Cynthia J. Arnson, The New Left and Democratic Governance in Latin America (Woodrow Wilson
International Center for Scholars 2007). 70
See, e.g., Castañeda, supra note 14; Arnson, supra note 69; Tomáš Došek, Las Dos Izquierdas en América
Latina: Determinantes del Voto a Morales y a Mujica (Working Paper, Instituto de Iberoamérica 2011-
2012), available at http://americo.usal.es/iberoame/sites/default/files/dosek_paper_seminarioInstituto.pdf.
18 Why are NOCs Prominent in Latin America?
radical left are mere strategic adjustments in the aftermath of neoliberal policies of
the 1990s since original goals could not been satisfactory achieved.71
The case of Brazil, whose macroeconomic behavior has revealed a
preference to internationalization of the country’s economy, is one of the most
influential paradigms of moderate left and technocratic policies within the region.
Through the Constitutional Amendment Nº 9 and the subsequent Law 9.478,
carried out in the mid 1990s, Brazilian policy makers gave green light to the entry
of private competitors within the oil and hydrocarbons market and from then on
PETROBRAS must bid for upstream concessions under equal terms and conditions
with the rest of privately held companies.72 This economic measure ultimately got
the traditional monopoly blurred and established a neutral industry model. Given
the huge operational deployment, PETROBRAS still maintains the largest market
share in Brazil, but such liberalization has been exploited by other IOCs like Royal
Dutch Shell. This new Brazilian strategy is not only aimed to renovate the market,
but also their NOC. In 2000, PETROBRAS finally opened their corporate cuirass to
public hands and listed into BM&F BOVESPA (São Paulo) leaving its conventional
closely-held status. Today non-state ownership accounts for 54%, also tradeable in
NYSE, BME LATIBEX and BCBA (Buenos Aires).73 In addition, the state has put
forward sophisticated techniques that are not fully well accepted by conventional
jurists, including a dual-class share structure which enables to preserve voting
control in the shareholders’ assembly meetings by holding only a 28.7% stake of
the total equity.74 Colombia followed the path of the Brazilian paradigm and
developed a mass privatization (“democratization”) plan for ECOPETROL consisting
on a gradually progressive public offering. The first step of such challenging
process was the transformation of the company’s legal status; thus, through the
Law 1118 of 2006, ECOPETROL changed from public enterprise to join stock
company. After two rounds of issuance in 2003 and 2011, the company placed 11.5%
of its outstanding capital as free float, on BVC (Colombia) as well as NYSE, TSX and
BVL (Lima) in the form of ADRs.75 Owing the friendly investor environment, the
success of policies in Brazil and Colombia has attracted not only domestic portfolio
investors but also FPI. Even Mexico, old-guard nationalizing state in the region, is
stepping out of the path of interventionism. By 1995 Mexico had allowed
midstream activities to private individuals under certain rules. In 2008 PEMEX was
71
See Kaufman, supra note 14; Kenneth Roberts, Leslie Bethell and René Antonio Mayorga, Conceptual and
Historical Perspectives in Cynthia J. Arnson with José Raúl Perales (eds), THE NEW LEFT AND
DEMOCRATIC GOVERNANCE IN LATIN AMERICA (Woodrow Wilson International Center for Scholars
2007). 72
See Mansilla, supra note 64. 73
See infra section 2.3 for further details. 74
See PETROBRAS official website www.petrobras.com. 75
See ECOPETROL official website www.ecopetrol.com.
Chapter 1 The Grounds of State Entrepreneurship 19
legally enabled to “assign areas” to IOCs in order to carry out exploration and
exploitation activities under the strong guidance and surveillance of the NOC. By
the end of 2013 a remarkable constitutional amendment known as the Energetic
Reform was approved, putting an end to a 75-year-formal-monopoly over the oil
and hydrocarbons sector and allowing the potential entry of independent IOCs.76
As to the corporate aspect of PEMEX, even though Mexican authorities have not
officially allowed the entry of portfolio investors, of major importance is the
strategy of public debt issuances the company has frequently relied on (which may
be described as conservative); such debt instruments are tradable on local and
foreign exchange markets like NYSE, and therefore portfolio investors are still
present not in the form of shareholders but bondholders.
Latin American net importer countries, in turn, have also opened the
downstream and midstream segments of the oil business. For instance, in 2002
Uruguay suppressed all kind of trade barriers and de-monopolized imports, exports
and refining of crude oil. Even more remarkably, Uruguay’s new regulation also
enabled the ANCAP to partner up with private investors.
In flat opposition, radical left oriented countries have embraced pro-statist
policies, being the case of Venezuela, Bolivia, Ecuador and Argentina. After a
rowdy electoral campaign promising the reversal of neoliberal measures, the
government of Venezuela enacted in 2007 the Decree Law 5.200 or commonly
known as Hydrocarbons Law pursuant to which total control over the exploitation
of the oil industry went back to PDVSA. International oil producers were forced to
partner up with PDVSA under a mandatory joint venture system whereby the NOC
preserved a majority interest of 60% in all upstream and downstream activities
carried out within the country.77 Whereas ExxonMobil and ConocoPhillips opted
to cease activities, other major international oil companies reluctantly accepted
minority partaking and lesser autonomy. Venezuelan government’s intention to
recover state control over the economy was such that the nationalistic trend also
spread to other sectors like energy overall, telecommunications, concrete, among
others.78 The case of Bolivia is quite similar to Venezuelan’s. The recently elected
head of government, in a maneuver described as “hostile takeover” rather than
expropriation, regained control over the energy industry for the third time in
Bolivian history and for such purpose he deemed Supreme Decree 21.060
unconstitutional which allowed private exploitation as of 1985.79 Whit the help of
tax aggressive policies and further political pressure, in 2005 the government
76
See THE ECONOMIST and CNN articles, supra note 5. 77
See Berríos et al., supra note 16. 78
See Flores Macías, supra note 56. 79
See supra note 33.
20 Why are NOCs Prominent in Latin America?
compelled international investors to give up the majority ownership interest in
YPFB. By that time, the Bolivian nationalizing measures had even affected political
relations with Brazil —also leftist— owing the tremendous harm suffered even by
PETROBRAS.80 As to the case of Argentina, the partial expropriation of the majority
block owned by Repsol and the subsequent renationalization of YPF took place in
2012 after a dramatic turn in the matter of incumbent government public policies.
Law 26.741 was enacted to seize Repsol 51% out of 62.9% ownership interest in YPF;
the company is still listed in BCBA AND NYSE, though.
Based on such recent events, economists have sought room to refute the
classical hypothesis in regards to the privatization-interventionism phenomenon,
and this has been possible thanks to the increasing availability of greater data. The
first thing they note is the lack of political patterns, suggesting there is no such
relation between nationalization and political trends.81 In addition, they point out
the multiplicity of behaviors that even leftist Latin American administrations have
adopted, and this gives rise to argue that neither ideologies nor populism are able
to explain by themselves the vast diversity of behaviors displayed by social-
content-policy governments like Brazil and Mexico at one pole, and Argentina,
Bolivia and Venezuela at the other. Likewise, the economic hypothesis suggests the
continuous shift in public policies is not determined by certain ideologies or
collective nationalism; instead the privatization-nationalization behavior
applicable to emergent economies is nothing but a cyclical phenomenon driven by
macroeconomic dynamics. In this respect, economists consider that both
embracing and disregarding the state entrepreneurship strategy in oil firms merely
obeys to a rational economic behavior which is shaped, above all, by global
economy, international crude oil price and governments’ returns on tax take.
Privatization of SOEs, basically considered as a mechanism to realise an
asset, is one of the most common drivers brought into play by economists in order
to explain the opening phase of the neoliberalism-interventionism cycle. This type
of transaction frees up by virtue important cash flows so that state spending is
better off without compromising the incumbent government budget. 82 Such
maneuver enables the state to overcome fiscal deficits or simply increase liquidity
with no need to increase taxes or subject the modification of any state budget
constraint to cumbersome public scrutiny. As a matter of fact, experts calculate
revenues from Latin American privatizations from 1990 to 1999 worth an aggregate
US$ 177,839 billion; and more remarkably, proceeds of privatizations carried out by
80
See Latin America ponders nationalist energy policies. OIL AND ENERGY TRENDS. JUN. 16, 2006, available
at http://onlinelibrary.wiley.com/doi/10.1111/j.1744-7992.2006.310613.x/pdf. 81
See Duncan, supra note 15. “Political language of ‘sovereignty’ and ‘revolution’ may thus just be cover for
actions motivated by more mundane considerations”. 82
See Megginson and Netter, supra note 15.
Chapter 1 The Grounds of State Entrepreneurship 21
countries like Brazil, Venezuela and Mexico exceed the 5% threshold of GDP, as
sales in Paraguay, Peru, Bolivia, Panama and Argentina represented 10% of GDP,
and even more.83 Sales of SOEs are still quite controversial for welfare economists,
though.84 The classical argument lies upon the abandonment by states of stable
cash flows generated by the company (i.e. short-term profits vs. long-term losses);
nonetheless, technocrats respond with empirical literature indicating
underperformance even before being privatized.85
As to the interventionist phase, some findings have been recently achieved.
One extraordinary econometric analysis processes information about
nationalization in several regions of the world including Latin America, carried out
between 1960 and 2006. Applying the linear probability regression model, such
study estimates that although IOCs’ nationalizations are more common in
countries with weak political institutions, the likelihood of nationalization
increases when international oil crude price proves high.86 In similar vein, other
remarkable study tests two classic economic explanations of expropriation posited
in the literature. 87 According to the first explanation the state would act
opportunistically seizing industries when real price is high (i.e. “opportunistic
explanation”); the second premise conceives expropriation as a mere reaction, even
protectionist, when real price is low (i.e. “desperation explanation”). This study
focuses on different mineral industries and shows how feasible expropriations were
in almost all examined industries during price boom, ultimately supporting the
first premise.88
In the frontline of the discussion, another economic pattern has surfaced
suggesting that countries with substantial oil reserves are more prone to takeover
such industry when rents from taxes and royalties prove ineffective to capture
revenues in the same proportion as to the volume of the activity.89 A recent
analysis of the Latin American oil sector, especially net exporter countries (e.g.
Venezuela, Mexico, Ecuador, Colombia, Argentina, Brazil, Bolivia and Peru), has
proved highly influential among economists.90 Such study indicates that the
employ of non-progressive fiscal systems triggers the nationalizing behavior; and
systems can be considered inefficient in the face of design errors whereby crude oil
83
See Chong and López-de-Silanes, supra note 15. 84
“[P]rivatizations are generally part of an ongoing, highly politicized process”. See Megginson and Netter,
supra note 15. 85
See Chong and López-de-Silanes, supra note 15. 86
See Guriev et al., supra note 15. 87
Both explanations were posited by Cole and English. See Duncan, supra note 15; Michael Tomz & Mark
L.J. Wright, Sovereign Theft: Theory and Evidence about Sovereign Default and Expropriation (2008),
available at http://www.ssrn.com/. 88
See Duncan, supra note 15. 89
See Berríos et al., supra note 16. 90
See Manzano and Monaldi, supra note 15.
22 Why are NOCs Prominent in Latin America?
price long-term volatility is not foreseen (i.e. unexpected price contingencies), and
consequently, rents from any abrupt increase would be allocated in greater
proportion to the private exploiter rather than the state. Put differently,
disproportional revenues from tax and royalties systems would turn the state
efforts towards any other optimal instrument; and therefore interventionism
through NOCs may be stimulated by such lack of efficiency. This may be also linked
to the degree of dependence of the state in oil tax revenues. For instance,
Venezuela had stronger dependence on tax revenues by the time statist measures
were taken in comparison to other net product exporters, suggesting
nationalization by resource-rich countries is to a greater extent subject to fiscal
dependence.91
In summary, economists reduce political factors to mere basics: “the more
democratic the political institutions of the host country are, the more sensitive to
price is the decision to expropriate”.92 Likewise, unprofitable tax and royalties
strategies increase the likelihood of statist policies.93
91
In Venezuela, oil exportation accounted for 80% of total exportations and 50% of tax revenues by the time
the Expropriation Law was enacted. See Palacios, supra note 66. 92
See Duncan, supra note 15. 93
See Chang et al., supra note 13.
Ever since oil became one of the most important primary commodities to start the
engine of modern societies, the industry has been subject to a number of schemes
by which states have allocated property rights and exploitation rights. Every regime
is the result of the selection of a precise set of alternatives in the matter of
ownership and potential exploitation, and it has ultimately shaped the composition
of every oil and hydrocarbons market. Of course law is the ultimate tool to set up
such framework and depending on the specific selection two types of investors may
be openly involved, foreign direct investors at one end of the spectrum and
domestic and foreign portfolio investors at the other. For instance, some
jurisdictions may opt to benefit from large multinational firms and allow for such
purpose the entry of foreign direct investors in the form of IOCs; this modality
ensures investors plenty management control in their business affairs and
depending on other factors of the institutional design they may have plenty control
over the oil industry itself. Other jurisdictions may for instance restrict
independent entrepreneurship in the oil sector, but allow portfolio investors in
NOCs as either shareholders or bondholders, case in which investors’ interests
would solely rely on the actions carried out by the state either as controller
shareholder or debtor, respectively. Conversely, some host countries may prefer to
develop the oil industry on their own with no non-state cash flows. Likewise, of
particular relevance in oil production and commercialization is the comparative
theoretical framework where states have relied upon to implement their own
institutional design. The regulatory scheme proves plenty functional and capable
to serve as a means to implement greater public policies as detailed in Chapter 1.
Thus, it is not by chance that a great diversity of IOCs on one hand and NOCs either
wholly or partially-owned on the other compete within the Energy 50 world
ranking in commercial oil production.94
94
See IHS, The Definitive nnual Rankin of the Wo ld’s La est Listed Ene y Fi ms (2014) available at
http://cdn.ihs.com/www/energy50/IHS-Energy50-2014.pdf.
See also PFC, The Definitive Annual Ranking of the Wo ld’s La est Listed Ene y Fi ms (2013) available
at http://www.cpzulia.org/ARCHIVOS/PFC_Energy_50_Ranking_Jan_2013.pdf
24 How Does Law Shape Private Investment in Oil?
As briefly anticipated, the first element to be determined in any regulatory
framework is the being upon which property rights over such non-renewable
commodity will be vested with; allocation models particularly serve this function.
Legal systems have basically allocated ownership either to private individuals or
the state itself; what change is the way they have access to property rights. In those
jurisdictions where oil is kept as national wealth, ownership allocation legal
measures as such do not even put societies halfway in the legal phase of achieving
competitive oil extracting rates and sustainable high profitability. Even if states are
entitled to claim ownership over crude oil, they may lack technology, human
resources, and more importantly, know-how to exploit it. Likewise, lawmakers and
authorities in general are also meant to adopt specific strategies by which real
experts see green light to develop a real life oil and hydrocarbons industry; this is
achieved through exploitation models. Jurisdictions around the globe may opt in a
number of ways to promote sustainable growth and development; including full
liberalization, concessions, licensing, taxes and royalties systems, joint ventures,
service agreements, and corporate vehicles either state-owned or state-run. As it
will be analyzed in this chapter, states may also move freely within the theoretical
framework; put it differently, change strategies for what they believe is optimal
(either in ideological or economic terms as set forth in the previous chapter). In
fact, shifting among industry exploitation strategies is what academics have
regarded as the so-called cycle.
Eventually changing models may entail daunting costs for both, the state
itself and investors, and the latter are quite sensitive especially when shifts tend to
implement state entrepreneurship. One thing to note is that much has been said
by analysts about nationalization, state monopolies and expropriation; however,
these are just components of a more extended framework, and are frequently
mixed up in literature. As will be detailed, dispossession of foreigners’ assets is in a
higher level of the interventionism scale than forcing IOCs to act under mandatory
joint ventures with the NOC. And this is a core understanding since risks and costs
vary as well depending on the shift’s range.
An important body of legal literature has developed a comparative core taxonomy
that enables to accurately classify all regulatory schemes that may be used by
jurisdictions around the world in order to allocate property over subsoil resources,
Chapter 2 Institutional Design 25
crude oil included.95 Four schemes are identified, access commons, community
commons, private property and state property.96 This framework is of a vital
importance especially when it comes to natural resources maximization; whereas
systems of major worldwide oil players such as US vest surface landowners or those
who extract oil first with property rights, systems like UK, The Netherlands, Spain,
Denmark, Poland, and the vast majority of resource-rich nations differentiate land
surface from subsoil resources; as a result these legal systems grant ownership
rights of crude oil and other subsoil resources to the state.
The first and most basic regulatory scheme is access commons which
enables all individuals to openly access the specific resource and, therefore, anyone
has the potential to become proprietor on to the extent to which the resource is
being seized. Similarly would be the case of community commons, in which access
is still open but limited to a specific group; the resource would seem as private
property into the eyes of outsiders but as access commons to insiders. Private and
state property schemes, in broad outline, represent the so-called “bundle of rights”
privates-state are vested with, and no further seizure or “capture” would be
required. From a comparative standpoint, these four regulatory schemes have
proved the legal base for the oil allocation models; namely, absolute ownership
theory, rule of capture, ownership in place theory and domanial regime.97 Legal
systems in which oil property and potential commercialization is granted to private
individuals make use of any of the first three models; the first one deems
landowner as proprietor and settle disputes from phenomena like percolation, the
second one considers proprietor the one who first extract crude oil and the third
one is a sort of a combination of the aforementioned two models. In turn, state
property is represented by the fourth model. Whereas the absolute ownership
theory and the domanial regime vest property rights with no need to extract oil
and “reduce it to possession”98, the rule of capture and the ownership in place
theory require owners to extract the resource in order to be deemed as such, and
therefore may be put on the same level as access commons. It goes without
95
A large number of classifications have been set forth in order to clarify oil’s legal nature. Nevertheless, many
domestic Latin American authors tend to accommodate such classification within the preexisting dogmas of
their own legal systems (some overlook the divergence between allocation and exploitation models; and
their exegetic and cumbersome postulates even discuss semantic issues on terms like “state property” and
“national property”). 96
See Jonnette Watson Hamilton and Nigel Bankes, Different Views of the Cathedral: The Literature on
Property Law Theory in Aileen McHarg et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL
RESOURCES (OUP 2010). 97
See Yinka Omorogbe and Peter Oniemola, Property Rights in Oil and Gas under Domanial Regimes in
Aileen McHarg et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010);
Terence Daintith, The Rule of Capture: The Least Worst Property Rule for Oil and Gas in Aileen McHarg
et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010). 98
See Omorogbe and Oniemola, ibid.
26 How Does Law Shape Private Investment in Oil?
mentioning that this brief description is made in broad strokes and all these
allocation models may clearly find further and miscellaneous regulation in each
jurisdiction.
Nowadays the vast majority of crude oil worldwide producers have formally
established domanial regimes, including the top five Latin American producers.
However, one thing to note is that neither all jurisdictions claimed state property
right from the start nor all jurisdictions had expressly enacted statutes to allocate
oil property. In fact, in the years leading the acknowledgment of oil industrial
properties, setting forth an oil allocation model was not a big concern and only few
countries like Mexico and Brazil provided at some point private property over oil,
while the remaining countries remained long time with de facto allocation models
since their legal regimes had no expressly referred to the matter.
Mexico witnessed continuous adjustments. Being, the first country to be
influenced by the discoveries made in Pennsylvania, Mexico granted the firsts oil
concessions in 1864; which arguably may be understood as if oil was state property
from then on because granting concessions (and setting up concession systems)
imply sort degree of proprietorship by the state even if no formal recognition had
been made. By 1884 Mexican statutes then provided that landowners were
“exclusive proprietors” of oil and no authorization was required to exploit it; this
statute was confirmed by further legislation in 1892.99 Finally, the authorities
implemented a formal concession system through the Petroleum Law in 1901 and
officially vested ownership to the state by means of its Constitution in 1917.100
Similarly, in 1891, the then-Federal Constitution of Brazil vested landowners with
ownership rights simply because there was barely oil activity within the country.101
In the same line than Mexico, the 1934 Federal Constitution of Brazil channeled
such towards the state and this represented a formal shift from the previous private
allocation scheme to a domanial regime.102 This means that both jurisdictions
embraced at some point in time their own versions of the absolute ownership
theory, prior to consolidate the contemporary domanial regime.
Conversely, allocation of oil property in the remaining countries was
gradually achieved. Lawmakers simply lagged behind heads of government who
did not doubt following the dynamics of oil activity through concessions even
before their legal systems provided state ownership. In other words, no recognition
over oil proprietorship was expressly made by Argentina, Colombia, Venezuela,
among others. However, this does not mean that oil was private property. They, in
99
See supra note 35. 100
See supra note 35. 101
See supra note 38. 102
See supra notes 38.
Chapter 2 Institutional Design 27
fact, granted oil concessions and established early concession systems in their legal
systems by the first decades of the 20th century, and this can be interpreted as if oil
was state property from then on.103 Venezuela first granted concessions in 1865
implicitly recognizing a domanial regime; then in 1905 enacted its Mines Law
establishing a concession system, followed by official recognition of state property
in 1920 when the first Hydrocarbons Law was approved.104 Bolivia did the same
enacting Organic Oil Law in 1938. In 1958, Argentina granted property rights to the
state by means of Law 14.773; in 1907 the government had done so but limited to
the then-newly discovered Comodoro Rivadavia oil field.105 Colombia granted the
first concessions in 1905; in 1913 officially claimed rights over vacant lots’ subsoil
and finally enacted Law 20 in 1969 whereby state property over subsoil was
proclaimed.106
As it turns out Mexico was the first country (from the current top five
regional producers) to take proprietorship away from private individuals in 1901,
and the other countries followed it gradually. Interestingly, net importers also
adopted the state property model. For example, in Chile Law 4.109 was enacted in
1926 to claim state ownership over all hydrocarbons fields, and Law 8.746 in
Uruguay claimed any “existing and future oil fields”. One important remark is that
Latin American nations in general maintained preexisting private property rights
over fields owned by individuals prior the establishment of domanial regimes (i.e.
non-retroactivity). After all these years, even in the aftermath of the
aforementioned neoliberalism phase of the privatization-nationalization cycle, oil
ownership has remained within the states. All the details are summarized in table
2.1.
International level policy makers were not indifferent to such policy trend.
United Nations General Assembly approved its first resolution in 1952 by which
sovereignty of peoples to freely use the right of “exploit their natural wealth and
resources” was recognized. This text was subject to controversy by countries like
US and others in which private models of oil allocation were embraced, owing the
fact that resolution’s wording was open to ambiguous interpretations concerning
the autonomy of the states to recognize the other side of the oil allocation
phenomenon.107 In fact, some countries like Guatemala and Iran were immediately
influenced by such regulation and began the nationalization of international
103
Some local authors use early after-independence bilateral treaties between Spain and Latin American
countries in order to trace back subsoil state ownership; however, such discussion is unnecessary since oil
commercialization was insignificant prior to mid 19th
century. 104
See supra note 42. 105
See supra note 31. 106
See supra note 37. 107
See James N. Hyde, Permanent Sovereignty over Natural Wealth and Resources (1956) THE AMERICAN
JOURNAL OF INTERNATIONAL LAW Vol. 50, No. 4, pp. 854-867.
28 How Does Law Shape Private Investment in Oil?
companies engaged in natural resources exploitation.108 On the basis of such
controversy, this international institution adopted further texts recognizing states
permanent sovereignty in determining whether onshore oil property rights are
vested in privates or the state, as well as sovereignty rights to drill, extract and
commercialize oil found offshore within the borders of their respective continental
shelves.109
For years economists have analyzed the positive and negative effects
entailed by oil allocation models. Important scholarship, for example, considered
the access commons regulatory scheme —by which private individuals are vested
with property rights at the moment they size the resource— potentially entails an
externality termed as the tragedy of the commons or common pool problem.110 This
phenomenon relies on the grounds of a combination of scarcity and high-
population density; if the resource is scarce, individuals would have higher
inventive to overexploit it on their personal gain for the sake of shortage reduction;
and therefore this situation would lead to inefficient allocation and even
termination of the resource. Arguably in the oil and hydrocarbons industry, where
a non-renewable commodity is commercialized, IOCs would serve as intermediaries
whereby efficient allocation is achieved (e.g. by means of the private property
regulatory scheme) potentially overcoming a sort of tragedy of commons.
Nevertheless, this argument is also subject to criticism as other scholars extend the
tragedy of the commons to private property. They suggest that private individuals
—even having the guarantee that oil is theirs— may pursue the maximization of
their profit margin through overexploitation. These scholars highlight the
importance of public surveillance to maintain “conservation” instead of
“extermination”.111 In light of these discussions, oil’s non-renewable nature still
incentivizes overexploitation by private individuals despite the context of supply
and demand. On the other hand, state property may simply not an ideal
alternative. As it will be described in the Chapter 3, SOEs efficiency is constantly
put under scrutiny by economists and corporate law experts due to the fact they
may be prone to inefficiency, interventionism, protectionism, populism,
bureaucracy, conflicts of interest and so on.
108
ibid. 109
United Nations General Assembly, Resolution No. 626 (VII) 21 DIC. 1952; Resolution No. 1803 (XVII) 14
DIC 1962; Resolution No. 2158 (XXI) 1966; Resolution No. 3281 (XXIX) 12 DIC 1974. 110
See Garrett Hardin, The Tragedy of the Commons (1968) SCIENCE Vol. 162 No. 3859, pp. 1243-1248. 111
See Colin W. Clark, The Economics of Overexploitation (1973) SCIENCE NEW SERIES Vol. 181, No. 4100,
pp. 630-634.
Chapter 2 Institutional Design 29
Taken together, allocation and exploitation models prove the main pillars of the
institutional design embraced by states all over the world to organize their oil and
hydrocarbons industries. Whereas the allocation models vest property rights in
either particulars or states, the oil exploitation models outline the way in which the
Table 2.1. Roots of Latin American domanial regimes
Country Allocation Model
Argentina
18xx-1907: De facto private property (no legislation)
1907-1958: Private property in general, state property over Comodoro
Rivadavia (Decree of December 14, 1907)
1958-present: State property (Law 14.773)
Brazil
1891-1934: Private property (Federal Constitution)
1934-present: State property (Federal Constitution)
Chile
1926-present: State property (Law 4.109)
Colombia
18xx-1905: De facto private property (no legislation)
1905-1913: De facto state property (concessions to Martinez, Mares and
Barco)
1913-1969: Private property over previous discovered oil fields, state
property over vacant lots (Law 75)
1969-present: State property (Law 20)
Mexico
1864-1884: De facto state property (first oil concessions granted)
1884-1901: Private property (Mines Code and Law of July 4, 1892)
1901-1917: De facto state property (concession system established through
Petroleum Law)
1917-present: State property (constitutional status)
Uruguay
1931-present: State property (Law 8.746)
Venezuela
1865-1904: De facto state property (concession to Ferrand, Pulido,
Hamilton & Phillips)
1905-1920: De facto state property (concession system established through
Mines Code)
1920-present: State property (Hydrocarbons Law)
Note: The aforementioned statutes are intended to trace back historical roots; such pieces of legislation have
been replaced over time.
Sources: Alencar Xavier, Benavides, Cárdenas, Gonzales, Kaplan, Palazzo & Parente, Rosado de Sá Ribeiro,
Vasquez. Complemented by the author.
30 How Does Law Shape Private Investment in Oil?
industry is developed. The way private individuals and the state interact within the
market is, in essence, established through exploitation models. The central issue is
the extent to which the formers may freely and independently explore, drill,
extract, refine and commercialize oil by their own with no state interference
further than average fiscal treatment and compliance with special environmental
regulation. Or put another way, the extent to which the state may block private
capital and carry out the whole activity on its own. By means of certain oil
exploitation models, foreign direct investors directly engage in oil activity in the
form of IOCs.
Essentially there exist five models to exploit the oil industry’s upstream
segment which are spot from comparative appreciation of historical events and
public policies; such taxonomy is based on functional business features rather than
mere legal concerns, thus, it takes into account criteria such as the degree in which
IOCs are involved with the market, autonomy of IOCs, level of NOCs’ control over
the market and power to force other actors to comply with their policies, and in
general the level of liberalization-monopolization; as follows, private exploitation
strategy, moderate private exploitation strategy, middle way strategy, moderate
state exploitation strategy and state exploitation strategy. This classification relies
upon the level of liberalization-monopolization deployed by the respective legal
system.112
The private exploitation strategy entails open maneuverability for IOCs. In
this case contractual arrangements to carry out the exploration and exploitation
phases would be determined between IOCs and subsoil resources proprietors,
either a private individual or the state according to what the institutional design
and particularly the allocation model set. Because the oil market is seen in this case
as any other through the eyes of the state, there only would be standard
restrictions associated with the natural resource industrialization and the
entrepreneurial activity would be charged with a simple income taxation rate; that
is to say, oil would be regarded as any other product or commodity. A second type
of private exploitation is the moderate private exploitation strategy, which is a less
open variable compared to the previous one. Once being authorized by the state
for such purpose IOCs have great margin to develop the upstream segment of the
industry, regardless of the method used to grant exploration and exploitation
rights, that is, bilateral negotiation or a competitive bidding. With this model IOCs
would be entitled to carry out activities limited to fixed location and duration or
other terms of the license or contract. In exchange of the state’s prior
112
See, e.g., Michael Likosky, Contracting and regulatory issues in the oil and gas and metallic minerals
industries (2009), available at http://unctad.org/en/docs/diaeiia20097a1_en.pdf; Kirsten Bindemann,
Production-Sharing Agreements: An Economic Analysis (Oxford Institute for Energy Studies, 1999).
Chapter 2 Institutional Design 31
authorization, special income taxes or royalties are collected. 113 This strategy
encompasses all those legal regimes whereby licensing, concessions, tax and
royalties systems are implemented. With the middle way strategy the market would
have the presence of IOCs and NOCs which are given the same conditions to
auction and being awarded concessions. Interestingly, both types of firms may
even enter into joint ventures and production sharing contracts, so that joint
bidding would let them engage together in upstream activities. From the use of the
moderate state exploitation strategy IOCs lose their operational autonomy; firstly
they need to comply with NOCs policies and secondly all affairs related to oil would
be under total control and surveillance of NOCs. Service and risk service contracts
are the most common forms of this type of strategy, where IOCs simply receive a
flat fee or a short percentage of earnings, respectively. Mandatory joint ventures
may also be regarded within this moderate state exploitation model since IOCs are
compelled to enter with NOCs into production sharing contracts as unique
alternative to engage in oil activities within the national territory, and normally in
exchange of ownership interests below 50%.114 And last, the state exploitation
strategy gather up a set of the most intense interventionist features. Under legal
instruments such as exclusive exploitation, the NOC would be the only participant
in the market, and the role of IOCs would be none. Latin American states have shift
their institutional designs in multiple occasions according to what current public
policies believe the optimal model is. All the details are summarized on table 2.2.
Mexico is one of the most notorious examples of the region since it has
oscillated through the entire strategies spectrum. Owing its proximity to US, the
influence of the northern country and the subsequent rejection were projected in
the Mexican oil exploitation model. The origin of the Mexican oil institutional
design trace back to 1864, when the country adopted the moderate private
exploitation strategy when awarding its first concessions. This model turned
towards the private exploitation strategy provided on the Mines Code of 1884 and
the subsequent Law of 1892, both legislative acts allowed oil extraction and
commercialization to landowners without prior consent by the state. By 1901
Mexico went back to the previous model; the Petroleum Law established a new
concession system and royalties tariffs. This model remained until the enactment
of the emblematic Expropriation Law and the creation of PEMEX in 1938, from then
on absolute monopoly and state exploitation strategy were embraced. Between
113
See Anita Rønne, Public and Private Rights to Natural Resources and Differences in their Protection? in
Aileen McHarg et al. (eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010). 114
Remarkably, this type of maneuver does not fit within the middle way strategy due to two reasons; firstly
because IOCs do not have the aptitude to engage in oil activities autonomously; that is, they cannot compete
with the NOC; and secondly, owing the minority ownership interest, IOCs lack of control to adopt decisions
within the joint venture.
32 How Does Law Shape Private Investment in Oil?
1949 and 1951 Mexico allowed risk service contracts with IOCs and this represented
a new shift towards the moderate state exploitation strategy. Until 1960 IOCs were
allowed to partake in the market; that year Mexican constitution was amended and
monopoly was brought back. The 21st century has witnessed the most drastic
changes of traditional Mexican exploitation model. In 2003 Mexico signed
multiple-service contracts opening the door for IOCs after almost half century.
Such policy represented a shift to the moderate state exploitation strategy. Finally,
the constitutional amendment in 2013 indicates, at least from a formalistic
standpoint, the end of PEMEX’s monopoly and the adoption of the middle way
strategy.
The process in Argentina has also been surrounded by complexities. The
country adopted the moderate private exploitation strategy at the time the first
concession was granted back in 1916. The creation of YPF in 1922 as such did not
indicate the adoption of absolute monopoly, because although there was a
deliberate rejection of new concessions from 1924, due to political commitments
YPF coexisted with few IOCs that already were in the industry. Likewise, the middle
way strategy is the most accurate description of the Argentinean institutional
design at that time, even if the model was set up reluctantly. Such model lasted
until 1949, from that point on YPF carried all the weight of the oil industry. In the
subsequent years Argentina witnessed continued instability concerning its oil legal
framework. The state exploitation strategy was reverted in 1958, and established
back again in 1963.115 From 1976 a global opening process that lasted for decades
was implemented gradually. First, IOCs were allowed to engage in oil activities first
by means of service contracts and then through concessions, by the 1980s the
middle strategy had been embraced. The total privatization of YPF in 1993 meant
the adoption of the moderate private exploitation strategy by Argentina. Finally,
the expropriation carried out in 2012 gave room to a new episode in the
Argentinean institutional design because the return of the state to the market does
mean nothing but a shift towards the middle way strategy.
The Brazilian institutional design accounts for fewer shifts and is perhaps
the most stable of the region in recent decades. In 1891 the Federal Constitution
embraced the private exploitation strategy. Up to 1934 the oil entrepreneurial
activity remained private, because the Decree 24642 enacted the same year
established previous authorization and concession by the Brazilian administration
for subsoil industrial exploitation. In 1946 the state exploitation strategy set forth a
monopoly which was not fully materialized until 1953 through the incorporation of
PETROBRAS. In 1977 the conventional statist strategy was moderated since IOCs were
115
See Palacios, supra note 66.
Chapter 2 Institutional Design 33
allowed to participate under risk service contracts. This shift was reversed in 1988
when this type of contract was banned again. Ever since 1995, after the adjustments
articulated by the Constitutional Amendment Nº 9 and Law 9.478, Brazil has had
the middle way strategy.
The government of Colombia granted its first concessions in 1905. This
moderate private exploitation strategy remained for many decades until the
creation of ECOPETROL in 1951 which, added with the formal coexistence of IOCs
within the legal framework, represented the adoption of the middle way strategy.
Certainly the creation of ECOPETROL itself shoo away foreign entrepreneurship —
bearing in mind regional precedents of expropriation—, but it is important to note
that the “public enterprise” label was the mere result of circumstantial elements
since the unsuccessful original intention of Law 165 of 1948 was to set up a
company from public and private foreign capital, or at least domestic private
capital.116 In 1969, as mandated by Law 20, IOCs were put under control and policies
set forth by ECOPETROL by means of risk service contracts; a shift towards the
moderate state exploitation strategy. During 1974 new legislation allowing
associations by ECOPETROL and IOCs was enacted, however, this did not
represented further change in the matter of institutional design since joint
ventures were the only alternative for the latter to engage in exploring and
extracting activities. Finally, Colombian legal system embraced in 2003 the middle
way strategy when Legislative Decree 1760 was introduced; this piece of legislation
enabled IOCs to develop the industry freely in fair competence with ECOPETROL
under a concessions system.
Even though Venezuela has experienced several shifts, changes have not
turned out that drastic from a strategic standpoint, as opposed to common belief.
Having granted the first concessions back in 1865 and enacting the Mines Code in
1905, Venezuela adopted first the moderate private exploitation strategy. Then, in
1938, the statutes formally enabled the state to engage in oil entrepreneurial
activities; that is the middle way strategy, though the truth is that no activity was
observed in this respect. The concessions system was adjusted in 1943 and royalties
were increased, nonetheless, the pre-establish model was still in force. In the early
years before the mid-1970s, Venezuela considered to create its own oil firm and
carry on the concessions already given to IOCs. However, the creation of PDVSA in
1976 was not as such a radical drift objectively speaking. In fact, the
Nationalization Organic Law kept the possibility by which IOCs could legally re-
enter the market, put it differently, a moderate state exploitation strategy.
Likewise, new risk service contracts were signed in the 1990s within the context of
116
See supra note 37.
34 How Does Law Shape Private Investment in Oil?
the neoliberal opening process based on a “reinterpretation” of preexisting laws.117
More interestingly, this moderate state exploitation strategy remained even after
the renationalizing statutes enacted in 2007. In spite of the political tensions, the
decision of the incumbent government to use mandatory joint ventures for IOCs
did not represent any shift in terms of institutional design since the model is in
essence the same.118
Many factors account for the adoption of one or another strategy. And
precisely is at this point where the bulk of academic debate and empirical analyses
have relied upon; ranging from the classic ideological responses concerning the
enigmatic privatization-monopolization cycle, through market deregulation
considerations, up to the debate of the supremacy of private enterprise over public
enterprise.119 Taken as a whole, all these studies are part of a more extensive
framework, one intended to determine what the optimal institutional design is and
its advantages to achieve specific ends. In a word, the optimal model is a mere
means. As to the end, it is also subject to further debate. On the basis that oil
market is not prone to failures and thus performs proficiently with sole presence of
private capital, an end may be providing necessary incentives so that individuals by
their own create new wealth and foster economic growth and development. The
end may also respond to geopolitical grounds due to finite nature of oil, mass
consumption and indispensability of petroleum products. Other approaches aim to
reallocate wealth through infrastructure and social welfare programs once the state
has engaged in outperforming business activities. Yet, all these ends have also been
subject to scrutiny by academics trying to decipher the most appropriate role for
the state.120 Ultimately, this debate boils down to balancing benefits and costs; it is
a matter of strategies where broad elements such as efficiency, rents, stability of
revenues and agency costs should be taken into account.121
117
See PDVSA official website www.pdvsa.com; David Hults, Petróleos de Venezuela, S.A.: The Right-Hand
Man of the Government (Working Paper No. 70, 2007), available at http://iis-
db.stanford.edu/pubs/22067/Hults,_PdVSA_case_study,_WP_70.pdf. 118
“Transforming the operational agreements to ‘joint ventures’ sends the illusory message that the oil
business is reverting to ‘public patrimony’. But Horacio Medina, a former PDVSA employee, points out that
the new mixed companies constitute privatization for the state-owned oil company, because the former
operators are now partners in joint ventures. Previously, transnational companies worked at their own risk;
now, they have a stake in a joint business”. See PDVSA: Nationalization or Privatization?, ENERGY
TRIBUNE, JUN, 1, 2006, available at http://www.energytribune.com/437/pdvsa-nationalization-or-
privatization#sthash.2WaPuk2R.y4GW7ZJR.dpbs 119
See, e.g., supra notes 14 and 15. 120
ibid. 121
See Rigobon, supra note 15.
Chapter 2 Institutional Design 35
Table 2.2. Latin American shifts
Country Exploitation Model
Argentina
1916-1922: moderate state exploitation
1922-1949: moderate state exploitation (reluctant)
1949-1958: state exploitation
1958-1963: moderate state exploitation
1963-1976: state exploitation
1976-1993: moderate state exploitation / middle way
1993-2012: moderate private exploitation
2012-present: middle way
Brazil
1891-1934: private exploitation
1934-1946: moderate private exploitation
1953-1977: state exploitation
1977-1988: moderate state exploitation
1988-1995: state exploitation
1995-present day: middle way
Colombia
1905-1951: moderate private exploitation
1951-1969: middle way
1969-2003: moderate state exploitation
2003-present: middle way
Mexico
1864-1884: moderate private exploitation
1884-1901: private exploitation
1901-1938: moderate private exploitation
1938-1949: state exploitation
1949-1960: moderate state exploitation
1960-2003: state exploitation
2003-2013: moderate state exploitation
2013-present: middle way
Venezuela
1865-1938: moderate private exploitation
1938-1976: middle way
1976-present: moderate state exploitation
Note: Non-shift measures were left out.
Sources: Alencar Xavier, Benavides, Cárdenas, Gonzales, Kaplan, Palazzo & Parente, Rosado de Sá Ribeiro,
Vasquez. Complemented by the author.
When onshore drilling became important in the late 19th and early 20th
century, few foreign companies had enough equipment and technology to ensure
drilling of proper and efficient exploration wells and maximizing resources for
finding oil of. These firms had developed complex vertical integration structures
covering all phases of the oil industry, including the upstream, downstream and
midstream segments, which ultimately meant full know how on the market inner
36 How Does Law Shape Private Investment in Oil?
working. As if this were not enough the oil industry as such demands risk capital
from the very beginning; the exploratory phase is considered the most risky part of
the whole entrepreneurial activity and investments may only be recouped within
the long-term —in fact most exploration investments are frequently regarded as
sunken investments—. 122 All these circumstances made states came up with
different alternatives. At that time most Latin America states did lack of enough
infrastructure and logistics to build an oil industry from scratch, resulting in a
potentially expensive and risky option. Moreover, states also lacked information
concerning the costs required for oil extraction. 123 In light of the foregoing
considerations, embracing a model that celebrates private entrepreneurship may
then be the result of technocrat decisions by which states decide to let others to
build the industry from scratch as well as avoiding risk of failure in finding new oil
reserves. In this line of thought, even expropriation may be deemed as the result of
technocracy in the way to find that optimal model; put differently, once local oil
subsidiaries are mature and stable enough, the state may turn to resume the
activity on its own, which would give explanation to any of the alternative
exploitation models in which state entrepreneurship is vastly present. Of course
this controversial strategy is subject to criticisms in the sense that it is nothing but
a behavior in conflict with loyalty and respect to private property which ultimately
deters private investment. The first rational strategy, embraced by nature and even
necessity, could be to let IOCs in. In fact, as addressed in the Chapter 1, some
countries like Bolivia, Colombia, Ecuador, Mexico, Peru and Venezuela set up their
NOCs to continue the work already carried out by foreign investors. The cases of
Argentina and (to a lesser extent) Brazil would be the only ones in which the
industry started virtually from the scratch.
States may also put in practice a model that enables them to enjoy the
benefits of commercializing such commodity with no need to expropriate private
individuals. Using concessions, licensing, or taxes and royalties systems may be an
alternative to promote friendly environments for private investors and to send a
message of little intervention. Should the state decide to boost its returns,
increasing tariffs of special income taxes and royalties is a simple static alternative
which does not entail to shift the exploitation model (generally it requires
coordination of a number of authorities). In this case states may opt to increase
taxes and royalties under the ideal of creating enough incentives for IOCs to
maintain operations and constant extraction rates because any excessive increase
would effectively discourage oil entrepreneurial activities, in fact IOCs cannot just
simply increase price to mitigate taxes since the price of crude oil fluctuates in
122
See Bindemann, supra note 112. 123
See Manzano and Monaldi, supra note 15.
Chapter 2 Institutional Design 37
response to macroeconomic factors and is trade based on international
benchmarks which are barely influenced by local phenomena with few
international repercussion. To give an example, high percentages of royalties
hinders exploration to a greater extent, especially when such state take is
calculated on the basis of gross incomes; in this case the oil activity is less
attractive when low extraction rates are faced and the likelihood of regarding
investment as sunk increases; therefore, legal mechanism like preemptive cost
recovery agreements are quite useful in such landscape. 124 Despite the
aforementioned, the truth is that states are more incentivized to shift strategy
when (e.g. expropriate) when revenues from tax takes and royalties fail in giving a
proportional take. There remains a residual possibility for the oil industry to be
kept in private hands as a mere result of negligence and legislative lethargy. The
absence of regulation in most Latin American jurisdictions and civil law regimes in
general just enables private individuals to act with no constraints by the state.
At the other pole, the participation of both states and private individuals
also has its rationale behind. The first of these alternatives is open competition
among producers which may promote market stability in general as private
individuals would be able to make great discoveries on their own; this ultimately
allows to boost national oil reserves, hence national wealth, and maintain highly
sustainable extraction rates within the long-run. As for the states, in this case they
would bear no expenses in the exploratory phase and allocation of property rights
over oil plus fiscal takes and royalties may be enough incentive to let private
individuals in. Joint ventures, in turn, allow splitting costs and rewards
proportionally; besides the fact that private individuals and the respective state
may create synergies in order to add dynamics in the industry development,
especially when it comes to technology, for instance, in the extraction of heavy
crude oil.125 The so-called production sharing agreements allow states to retain
profits even when they do not to sink risk capital for the exploratory phase,
although private individuals bear all the risks of exploration they do not have the
pressure of finding a new oil field, recoup investments and boost gains within a
limited time framework established through other systems like concessions.126 Yet,
participation level of private individuals is subject to specific needs of the oil sector
like the pressure of increasing oil reserves or other factors concerning geography,
geological conditions and infrastructure. Still relevant, regardless of the
exploitation method, the price of oil is volatile; hence, rents are so as well.127
124
See supra note 37. 125
“[T]here are high geological risks involved in oil exploration, whereas in the phases of field development
and production these risks significantly decline”. See Manzano and Monaldi, supra note 15. 126
See Likosky, supra note 112. 127
See Manzano and Monaldi, supra note 15.
38 How Does Law Shape Private Investment in Oil?
In sum, going for one or another exploitation model may be regarded as
strategic dynamic for states, and therefore the adoption of any strategy depends
either on state’s capability maximization or incompetence minimization. As for
direct investors, the loose side of the institutional design spectrum and the middle
way entail major benefits than the tight side, but they also have to bear in mind the
more tight the exploitation model the less risk of expropriation (e.g. service
contracts) as will be addressed in chapter 3.128 Table 2.3 summarizes risks and
rewards of all exploitation models.
Table 2.3. Risk and rewards of exploitation models
Exploitation Model Risk and Rewards
Private
All risks and rewards on IOCs. The state collects average
income tax.
Moderate private
Licensing, concessions, tax and royalties systems: All
risks and rewards on IOCs. The state collects royalties on
gross rewards and special income taxes after allowing a
preemptive percentage on costs of recovery. State
incomes fluctuate according to the level of rewards.
Middle way
Open competition: All risks and rewards on IOCs or
NOCs, respectively. The state collects royalties and
special income taxes upon the terms of concessions or
licensing.
Joint ventures: IOCs or NOCs share risks and rewards
according to their ownership interest.
Production sharing contracts: IOCs take all exploration
risks and share exploitation and rewards with NOCs.
Moderate state
Risk service contracts: NOCs take all exploration risks
and share exploitation and rewards with IOCs.
Service contracts: All risks and rewards on NOCs. IOCs
are entitled to a flat fee.
State All risks and rewards on NOCs. The state may also
collects taxes.
Adapted from Bindemann
Sources: Bindemann, Likosky, Palacios.
128
See Duncan, supra note 15.
Chapter 2 Institutional Design 39
Empirical evidence on firm-level data shows no cash flow is becoming more
quintessential for the functioning of Latin American NOCs than portfolio
investments. Remarkably, by joining market economy not only from a regulatory
perspective but also as real life business entrepreneurs, emerging economies as
well as a great number of emerging economies appear to put aside the classical
debate between private and public cash flows and make it even sound impractical
and out-of-date. These states are on a steady path of pragmatism implementing
external financing practices for the sake of institutional leadership promotion.
Precisely, in recent years analysts have witnessed how regional top oil producers
have tended to resort to public financing strategies and corporate state-of-the-art
measures whereby large portfolio investments are received in their oil crown jewels
in exchange of both equity and debt financial instruments, and this is achieved
through worldwide capital markets. When states use corporate equity financing
the result would be a partially-owned NOC where the role of the state as controller
shareholder is methodically ensured.129 Argentina, Brazil, Chile, Colombia, Ecuador
and Peru have an average ownership interest of 66% in their SOEs.130 Similarly, due
to political or similar reasons, states may opt to use corporate debt financing by
which NOCs receive cash flows from outside investors without creating an
additional layer of shareholders, perhaps as a way to keep their public statuses
intact. Regardless of the status of partially-owned or wholly-owned, these state-run
companies are all linked to a diverse array of public investors, including
institutional and retail as well as domestic and foreign investors. Through this
scheme resource-rich countries are raising capital to develop their oil investment
plans; and the consideration is quite straightforward; that is, sharing the harvest
with outside-passive shareholders or making fixed payments to bondholders.
The first question that arises is why NOCs resort to securities offerings. And
the answer relies on a number of factors. Access to new cash flows, diversification,
banking constraints and liquidity prove the most important determinants when
receiving portfolio investments through capital markets. As expected, the
advantages of this practice are not exclusive to states; instead, raising funds from
outside investors is more than a widely known strategy for entrepreneurs trying to
129
“Indeed, at the end of 2000, after the largest privatization wave in history, governments retain control of
62.4% of privatized firms. In civil law countries, governments tend to retain large ownership positions,
whereas in common law countries they typically use golden shares”. See Bernardo Bortolotti and Mara
Faccio, Government Control of Privatized Firms (ECGI - Working Paper No. 40/2004; FEEM Working
Paper No. 130.04; EFA 2005 Moscow Meetings Paper; AFA 2006 Boston Meetings Paper, 2007), available
at http://www.ssrn.com/. 130
See OECD, supra note 10.
40 How Does Law Shape Private Investment in Oil?
benefit from public exchanges. Firstly, the common wisdom according to the
business cycle theory is that steady and sustainable growth will necessarily require
constant and progressive capital infusions, particularly in capital-intensive
businesses.131 In the case of oil, inherent circumstances of the upstream and
downstream segments of the industry have a direct impact on costs; for instance,
offshore extraction is resource demanding, though this not even compares to the
amount of risk capital or sunken investment required during the exploration phase
which is also boosted by pressure of finding new oil reserves within a limited
timeframe; also research and development programs are one of the most important
expenses in the industry. In fact, exploration and development prove the largest
expenses in the business; between 2008 and 2012 expenditures in exploration and
development by 75 oil companies from 18 different countries totaled US$334.5
billion and US$1430 billion respectively. 132 As if this were not enough even
maintaining the same level of performance and extraction rates progressively
becomes more capital demanding; analysts point out how operating costs (i.e.
marginal costs of producing one additional oil barrel) increase over time.133 In
absence of sufficient internally generated funds, states —as sole investors— would
be compelled to provide the entire necessary resources to cover these capital
expenses; and the issue, however, is that states may eventually either lack the
resources or find formal limitations for public expenditures. Securities offerings
through the primary market, in essence, enable NOCs to channel new resources
from outside investors so that the impact of cash flow shortfalls is cut and financial
needs met.134 Secondly, even if states have enough financial muscle to meet such
capital expenses and no budgetary constraints, they may opt to diversify their risk
by accepting outside investors. Likewise, costs of failure would be eventually
shared in accordance to the terms in which liquidation rights are articulated in
each type of security held by outside shareholders and bondholders; in practice
senior debt enjoys preference over junior to recoup the investment, bondholders
over shareholders, preferred stock over common stock and outside shareholders
over insiders.135 Even though the likelihood of rescue from bankruptcy by means of
financial aid and bailouts is high in the case of SOEs, the truth is that formally
speaking the state is externalizing part of the risk of failure to other investors, plus
131
See Stephen J. Choi and A.C. Pritchard, Securities Regulation: Cases and Analysis (Foundation Press
2008). 132
See Global Oil and Gas Reserves study 2013. EY, available at
http://www.ey.com/Publication/vwLUAssets/EY_-_Global_oil_and_gas_reserves_study_2013/$FILE/EY-
Global-oil-and-gas-reserves-study-2013.pdf 133
See, e.g., Palacios, supra note 66; Bindemann, supra note 112. 134
See Thomas Lee Hazen, The Law of Securities Regulation (Tomson Reuters 2009). 135
See Choi and Pritchard, supra note 131.
Chapter 2 Institutional Design 41
eventual bailouts are subject to political considerations. 136 Thirdly, corporate
finance functions as alternative investment platform for insiders to avoid or at least
reduce typical bank financing constraints.137 Bank financing may turn out costly
due to adverse selection measures carried out by financial institutions; over
collateralization of clients’ assets is frequently used as means to secure loans and
this eventually compromises indebtedness capability; moreover, banks also
demand costly covenants which tend to restrict the firms’ ability to operate on
their regular basis. Both equity and debt issuances are open alternatives to banking
finance and may even increase the bargaining power of firms against financial
institutions, since the latter are exposed to increasing competition of public
interested in serving as lenders.138 Fourthly, in the case of equity issuances, once
these types of securities are registered in public exchanges, preexisting
shareholders including the controller may opt to step out of the company and this
would be easily achieved through the benefits of the aftermarket.139 Besides, since
shareholder activism and proxy contests are null within concentrated ownership
models —where the board of directors is virtually appointed by the controller
shareholder—, secondary market liquidity ensures to a greater extent that minority
shareholders will remain passive in management seeking as they find less costly to
sell their stakes than attempting to gain higher board representation.140 And fifthly,
by issuing debt or any other type of security lacking of voting rights, insiders
ensure for themselves plenty corporate maneuverability as outside investors would
lack of voice in the company’s affairs; put differently, management would lie in the
former —and this is compensated through significant yields and liquidation
preferences—.
This final feature of public financing raises a much greater pitfall of major
concern to insiders: public equity offerings may eventually entail “loss of control
over management matters”.141 Corporate control is nothing but the most important
136
See Chong and López-de-Silanes, supra note 15; Mariana Pargendler, Aldo Musacchio and Sergio G.
Lazzarini, In Strange Company: The Puzzle of Private Investment in State-Controlled Firms (Working
Paper 13-071, 2013), available at http://www.ssrn.com/; Aldo Musacchio and Sérgio G.Lazzarini,
Leviathan in Business: Varieties of State Capitalism and Their Implications for Economic Performance
(Working Paper, 2012), available at http://www.ssrn.com/. 137
See Marco Pagano, Fabio Panetta and Luigi Zingales, Why Do Companies Go Public? An Empirical
Analysis (1998) THE JOURNAL OF FINANCE Vol. LIII No. 1, pp. 27-64. 138
ibid. 139
See supra note 134. 140
The more diversified the portfolio investor, “the less likely to join the insurgent coalition”, increasing the
likelihood to opt for the so-called “Wall Street Rule”. See Stephen Bainbridge, The Case for Limited
Shareholder Voting Rights (2006) UCLA LAW REVIEW, pp. 601-36. See also Andrei Shleifer and Robert
W. Vishny, A Survey on Corporate Governance (1997) THE JOURNAL FINANCE Vol. LII No. 2, pp. 737-83.
The authors suggest retaining larger share blocks increases the likelihood of legal protection effectiveness.
Also, minority shareholder activism legal measures generally set up a minimum threshold for proposals. 141
See supra note 134.
42 How Does Law Shape Private Investment in Oil?
instrument in the inner functioning of any company since it allows plenty
command over invested cash flows. In practice, the purest version of the voting
proportionality postulate grants voting rights in proportion to the invested cash
flows, and it ensures to a greater extent that control is exercised by the investor
with the largest stake or at least a sufficient number of shares that allows to
domain the decision making process in the shareholders’ assembly.142 By issuing
common and preferred stock or any other type of equity instruments, the number
of shares in which capital divides is increased and consequently the percentage
originally held by insiders decreases as outside investors purchase issued shares.143
Loss of corporate control through public offerings is in essence explained on the
basis of this phenomenon which is labeled “percentage dilution”. In other words,
the larger the issuance the more likely to result diluted in the aftermath of the
public financing strategy. The outcome is the loss of voting power and therefore
corporate control. Likewise, insiders may will to issue a limited number of shares
that enables them to retain corporate control; however, if such “limited” offering
does not meet capital needs, the public financing strategy would remain ineffective
to access sufficient cash flows. Such dilemma may be solved through corporate law
state-of-the-art measures. Depending on the specific jurisdiction, a number of
control-enhancing mechanisms may be articulated in order to retain control after
letting outside shareholders in with considerable investments. The most common
means, and still controversial, is disproportional ownership.144 Deviating from the
aforementioned one-share-one-vote rule and setting up a dual-class shares
structure enables to structure a decision making system whereby shareholders hold
more or less voting rights than those conceived under the original investment or
cash flow rights. In other words disproportional ownership allows “detaching
voting rights from cash flow rights”.145 On that basis, by keeping more voting power
than public outside shareholders, insiders may issue larger portions of equity
without facing the risk of relinquishing control. Such practice has been termed by
academics as “leveraged control”.146 This type of control-enhancing mechanism
142
The expression “the purest version of the voting proportionality postulate” encompasses both sticking to the
so-called one-share-one-vote rule on one hand and precluding the use of dual-class structures on the other. 143
See Michael Woronoff and Jonathan Rosen, Understanding Anti-dilution Provisions in Convertible
Securities (2005) FORDHAM LAW REVIEW Vol. 74, p. 129. 144
See José Miguel Mendoza, The Challenge of Disproportional Ownership in Boris Kozolchyk and Francisco
Reyes (eds), LATIN AMERICAN COMPANY LAW: A COMPARATIVE AND ECONOMIC DEVELOPMENT
PERSPECTIVE (Carolina Academic Press 2012). 145
ibid. 146
Insider investors would exercise control not by having the largest stake (i.e. majority controller) or a
considerable stake (i.e. controlling blockholder surrounded by widely dispersed shareholders) but through
leverage (i.e. leveraged controller). See Ronald J. Gilson and Alan Schwartz, Constraints on Private
Benefits of Control: Ex Ante Control Mechanisms versus Ex Post Transaction Review (Yale Law &
Economics Research Paper No. 455; Stanford Law and Economics Olin Working Paper No. 432; Columbia
Law and Economics Working Paper No. 430; ECGI - Law Working Paper No. 194/2012, 2012), available
Chapter 2 Institutional Design 43
comes in the form of dual-class share structures, multiple-voting shares, non-
voting shares, golden shares and even pyramidal structures.147 Intricate cross-
ownership structures (e.g. keiretsu, chaebol) and even shareholder voting
agreements serve at some point as control-enhancing mechanisms as well.148
To this end, either ideological foundations or rational economic behavior,
the truth is that the precise set of characteristics already adopted by some
resource-rich countries allows them not only to coexist with multinational firms in
one of the most profitable activities of primary commodities’ commercialization,
but also to enjoy the economic and legal benefits that public financing without
releasing corporate control entail. As it will be detailed, Brazil, Colombia and
Argentina use public equity financing on the one hand. Whereas Brazil reserves
control in its crown jewel through the use of voting power leverage, Argentina and
Colombia have a traditional majority control. Though, the Argentinean
administration has a golden share inherited from the days of total privatization. In
the other hand, public debt financing is quite prominent among these three
countries as well as Mexico and Venezuela. NOCs public financing is summarized
in table 2.4.
The public financing strategy has enabled equity investment in PETROBRAS,
YPF and ECOPETROL. By listing in BM&F BOVESPA, NYSE, BME LATIBEX and BCBA,
PETROBRAS became a public company controlled by the Federal Government. The
Brazilian administration directly owns a stake of common stock that ultimately
accounts for 28.7% of all outstanding shares and the remaining shareholdings are
widely dispersed among domestic and foreign investors, with the exception of
BNDES Participações and BNDES which have important blocks of 10.4% and 6.9%,
respectively.149 The bulk of retail shareholding consists of ADR investors with
20.6%, non-resident investors 12.9%, and free float of 17.4%.150 Even though the
Federal Government itself is not a majority shareholder —not even exercising the
voting rights of BNDES Participações and BNDES (which are also state-owned
firms)—, dividing the capital between common and preferred stock and deviating
from the one-share-one-vote rule ensures absolute control for the state. Whereas
common shares account for one vote, preferred shares are non-voting stock, and
therefore the incumbent government controls PETROBRAS through 50.3% of voting
rights in the shareholders’ meetings. In turn, the National Government of
at http://www.ssrn.com/; Sang Yop Kang, Understanding Controlling Shareholder Regimes (Doctoral
Thesis at Columbia University 2011), available at academiccommons.columbia.edu/. 147
See Lucian Aye Bebchuk, Reinier Kraakman, and George Triantis, Stock Pyramids, Cross-Ownership and
Dual Class Equity: The Mechanisms and Agency Costs of Separating Control From Cash-Flow Rights in
Randall K. Morck (ed), CONCENTRATED CORPORATE OWNERSHIP (UCP 2000). 148
See Mendoza, supra note 144. 149
See PETROBRAS official website www.petrobras.com. 150
ibid.
44 How Does Law Shape Private Investment in Oil?
Colombia is the majority controller of ECOPETROL with an ownership interest of
88.5%; the remaining 11.5% is traded in BVC, NYSE, TSX and BVL. Pension funds are
among major blockholders (e.g. Porvenir 1.6%, Protección 1.3% and Colfondos
0.4%), followed by foreign institutional investors.151 An important 5.5% circulates
among retail investors, mainly regular Colombian citizens, while a small 0.9%
fraction circulates in foreign markets as ADRs. 152 In the aftermath of re-
nationalization the Argentinean state holds 51.01% of the capital in YPF, 51% in
common stock “class D” expropriated from Repsol and 0.01% in common stock
“class A” which is basically an exclusive golden share provided with veto rights in
sensitive corporate affairs. Repsol is the largest blockholder of YPFs with an
ownership interest of 11.9%; the remaining 37.09% is free float.153 YPFs’ shares are
traded in BCBA and NYSE.154
One thing to note is the great heterogeneity of these three legal systems
towards the postulate of voting proportionality. The Brazilian and Colombian
regimes mandate the one-share-one-vote rule and ban multiple voting rights, but
at the same time enable to partially deviate from such principle by allowing non-
voting stock.155 As previously detailed, Brazil has made use of non-voting shares
while Colombia remains fully proportional. Argentinean law allows both, multiple
voting (capped to five votes per share) as well as non-voting stock.156 However,
none of these measures has been applied to its NOC. As the case of the golden
share, this simply consists on absolute veto rights for decisions like statutory
151
See ECOPETROL official website www.ecopetrol.com. 152
ibid. 153
See YPF official website http://www.ypf.com. 154
The case of YPF diverges to some extent from the aforementioned cases and deserves a special
consideration. The way these investors and the Argentinean state interact as business partners is not as such
the outcome of a deliberated public offering strategy in which outsider investor adhere to state
entrepreneurship; instead it is the result of a reverse process where the state came after public investors. It is
quite plausible the incumbent government had two main considerations in mind when expropriating only
51% of YPF; in the first place this percentage was sufficient to exercise corporate control; secondly
“cheaper is better” and therefore compensating just a percentage was less costly than expropriating the
whole company. Likewise, the existence of portfolio shareholders is to some extent the result of a unilateral
decision and this would give room to argue they are non-voluntary investors (investors still have secondary
market liquidity to exit the investment). Yet, YPF maintained the status of listed company; thus, like Brazil
and Colombia, Argentina is enjoying the advantages of public financing since YPFs’ shares are still traded
in BCBA and NYSE. 155
See Francisco Reyes, Corporate Governance in Latin America A Comparative Law Perspective (Paper
prepared for the LSU Law Center Conference: “Mediating the Divide: Challenges to Hemispheric Trade
Posed by the Common Law/Civil Law Divide” 2006), available at
http://users.wfu.edu/palmitar/Courses/ComparativeLaw/CourseReadings/Corporate%20gov%20in%20LA.p
df. 156
ibid.
Chapter 2 Institutional Design 45
mergers, change of control, dissolution, relocate the company outside the national
territory, and the assignment of oil exploitation permits.157
Additionally the public financing strategy has also enabled debt investment
in all Latin American major NOCs; PETROBRAS, PDVSA, PEMEX, ECOPETROL and YPF.
In the recent decade PETROBRAS has issued senior notes in NYSE and Luxembourg
Stock Exchange (LUX) that account for approximately US$35 billion and €7 billion,
with fixed maturity dates ranging from three years to 30 years, being 11 years the
average.158 During the last two years, YPF has issued mainly domestic short-term
notes with fixed maturity periods no higher than 10 years, though recent issuances
have been made in LUX; in total US$8 billion and AR$11.5 billion have been issued.159
ECOPETROL has made few domestic and international offerings compared to the
rest; US$6 billion and COP$1.900 billion in both short-term and long-term debt.160
Interestingly, PEMEX and PDVSA have used debt issuances instead of equity as a
more conservative way to reach portfolio investors. PEMEX has placed bonds in BMV
(Mexico) and NYSE, while PDVSA in NYSE, LUX and Berlin Exchange.161
Table 2.4. NOCs public financing
NOC Equity
financing
C-E
Mechanism
Debt
financing
Domestic
Markets
Foreign
Markets
PETROBRAS X Leveraged X X X
YPF X Majority X X X
ECOPETROL X Majority X X X
PDVSA - - X - X
PEMEX - - X X X
Sources: Public available information compiled by the author.
157
YPF bylaws. See YPF official website www.ypf.com. For golden shares see, Stefan Grundmann and Florian
Möslein, Golden Shares - State Control in Privatised Companies: Comparative Law, European Law and
Policy Aspects (Working Paper, 2003), available at http://www.ssrn.com/. 158
See PETROBRAS official website http://investidorpetrobras.com.br/en/shares-and-
indebtedness/prospectus/full-view/full-view.htm. 159
See YPF official website http://www.ypf.com/enu/InversoresAccionistas/Paginas/Emisiones-de-titulo-de-
deuda.aspx. 160
See ECOPETROL official website http://www.ecopetrol.com.co/contenido.aspx?catID=555&conID=77451
and http://www.ecopetrol.com.co/contenido.aspx?catID=556&conID=80526. 161
See PEMEX official website
http://www.ri.pemex.com/index.cfm?action=content§ionID=20&catID=12175
Taken as a whole, the previous chapters aimed to assess the wide array of
regulatory alternatives considered by resource-rich countries when developing
their oil and hydrocarbons industry, and how each selection in Latin America has
been the outcome of a privatization-monopolization cycle driven by a great
number of determinants. Chapter 1 focused on the discussions deployed by the
existing literature regarding the explanation of the drivers that led to the current
set of public policies concerning National Oil Companies (NOCs), foreign direct
investors and portfolio investors within the region. At one pole, political scientists
and critical historians posit the restart of the cycle is triggered by ideological and
political grounds such as national proud, popular sovereignty, egalitarianism,
populism, reprisal towards foreigners, foreigners’ influence restraint, and even
smokescreen for local governance issues. At the other pole, economists argue
economic and technocratic determinants like the increase of international crude
oil price, deficiencies in the taxation and royalties systems, and liberation of new
cash flows, have been decisive when moving across different phases of the cycle.
Furthermore, Chapter 2 analyzed thoroughly and from a comparative perspective
the extended regulatory framework where states may select their own institutional
design to implement choices of public policy towards oil; in broad outline, the
outcome of each institutional design depends on the allocation of ownership and
exploitation rights over such commodity. To this end, moving back and forth
through such framework and changing institutional designs has been explained as
a cyclical phenomenon. The importance and significance of such formulation lies
in the fact that each phase of the cycle or each institutional design entails either
greater or lesser participation of NOCs and private investors. Remarkably, Latin
American top oil producers are nowadays converging and adopting similar
institutional designs, no matter what the starting point is. The combination of the
middle way or moderate state entrepreneurship plus public financing entrench a
great presence of both foreign direct investors and portfolio investors in the oil
business. Brazil, Argentina, Colombia, Venezuela and recently Mexico embraced
industries in which NOCs coexist with IOCs and the former companies resort to
outside private investors’ financing, either shareholders or bondholders.
Chapter 3 The Challen es of Investo s’ P otection 47
It is difficult to imagine how this complex set up could be exempted from
costs. In fact, recent literature points out the multiple agency conflict that may
arise from such type of institutional design. 162 Two value-reducing forms of
opportunism emerge. Consider first the relation between host countries and IOCs.
Foreign direct investment is made on the basis of particular conditions subject to
legal and political certainty; however, by means of sovereignty the states may
reshape at any time the scheme which governs the relationship with foreign
investors to benefit NOCs. Even if such adjustment is “unbiased” and simply
intended to find what governments consider an optimal strategy either socially or
economically speaking, any shift towards other oil exploitation model may
considerably alter the performance of IOCs. The risk in this case is nothing but the
modification of the preexisting conditions by which the original investment was
made; as for the costs, lower revenues for IOCs and reputational harm for the host
country. Moreover, under lower level of governmental commitments, IOCs could
be left out of the landscape; expropriation and no compensation is perhaps foreign
investors’ worst case scenario. Recently, an unprecedented phenomenon in Latin
America has switched on the alarms in the matter of investor protection: being
partially expropriated turns direct investments into pseudo portfolio investments.
As it follows, this first agency conflict arises between host countries and private
individuals, mostly foreign direct investors. In turn, public external financing gives
room to a second type of principal-agent relation; and therefore an additional
conflict might be witnessed between insiders and outside investors; NOCs on one
hand, NOCs’ shareholders and bondholders on the other. The classical horizontal
agency problem involving controller and minority shareholders arises within
partially-owned NOCs, including information asymmetries, mismanagement and
appropriation of private benefits of control. In certain cases, the likelihood of
extracting private benefits of control is increased by the use of leverage; the state
ensures plenty voting power despite holding a minority stake of ownership interest
but afterwards such strategy reduces state’s dividends. In addition, owing either
reluctance or simply conservatism, some states have opted to maintain NOCs as
wholly-owned enterprises to avoid a second layer of private shareholders; as a
result outside investors are given with the label of creditors and this ultimately
boosts the level of information asymmetry. As if this were not enough, this insider-
outsider conflict is not exempt from the sovereignty power of the state, which may
use the NOC as a political vehicle for public welfare instead of wealth
maximization, bureaucracy and clientelism in detriment of both outside
shareholders and bondholders.
162
See, e.g., Rigobon, supra note 15; Pargendler et al., supra note 136; Musacchio and Lazzarini, supra note
136.
48 Which are the Conflicts and Remedies?
Accordingly, Latin American legal systems must offer sufficient protective
measures for the full spectrum of investors within the oil business in order to
prevent and mitigate any potential misbehavior that may arise from states’
controlling position and sovereignty power. At the same time, the challenge
consists in granting protection without hampering value creation. Each of the
following sections of this chapter will separately address the aforementioned
conflicts.
Market uncertainty and other macroeconomic conditions like fluctuation of
currency exchanges and loss of purchase power through inflation are only one
fraction of what international investors face when making foreign direct
investment in developing economies. In such countries, exogenous risks are also
present as institutional instability for maintaining public policies comes to play.163
In spite that a large number of elements do have effect on the level of foreign direct
investment inflows, the oil and hydrocarbons industry especially relies upon legal
and political stability —the so-called “good governance”—. Since host countries set
up the conditions by which foreign direct investors decide to invest, the latter’s
best interest depends on the former. Likewise shifting oil exploitation schemes
compromises nothing but political and legal certainty, and IOCs embody the other
side of what might be a strategic behavior in favor of the state. Put differently,
what brings benefits for the state may create daunting costs for IOCs. In fact from
private investors’ standpoint, shifting among exploitation models is a delicate issue
in itself since it unveils lower levels of commitment from the host country
involving the preexisting rules by which investments were originally made. Even
worse, institutional designs are quite sensitive even to subtle changes and any
slight adjustment in one of their components may potentially create adverse
circumstances that turn the preexisting conditions of oil exploitation unfavorable.
If exploitation models were put into a linear scale being private exploitation at the
left and state exploitation at the right, any shift towards the right side would
invariably entail externalities for IOCs, regardless of the fact such adjustment aims
163
See, e.g., Tim Buthe and Helen V. Milner, The Politics of Foreign Direct Investment into Developing
Countries: Increasing FDI through International Trade Agreements? (2008) AMERICAN JOURNAL OF
POLITICAL SCIENCE Vol. 52, No. 4, pp. 741–762; Glen Biglaiser and Karl DeRouen, Economic Reforms
and Inflows of Foreign Direct Investment in Latin America (2006) LATIN AMERICAN RESEARCH REVIEW
Vol. 41, No. 1, pp. 51-75; Kyeonghi Baek and Xingwan Qian, An Analysis on Political Risks and the Flow
of Foreign Direct Investment in Developing and Industrialized Economies , available at
http://faculty.buffalostate.edu/qianx/index_files/PoliRiskFDI_Baek&Qian.pdf..
Chapter 3 The Challen es of Investo s’ P otection 49
to pursue the “optimal institutional design” within the Coase-efficiency thinking.
Certainly, these types of shift are deemed by investors as disloyal maneuvers by
which market opportunities are decreased and therefore business stability and
confidence harmed. As it turns out, the more left-sided the preexisting exploitation
model the more risk bared by IOCs. It also follows that the overall level of reliability
in such host country is affected in the face of any shift and this eventually
decreases inward foreign direct investment flows not in the specific sector but
overall.164 This, however, may not serve as deterrent for states, since losses are not
directly suffered but externalized among the population, and Latin America in
general has an extend record filled with plenty of swings within the theoretical
framework of institutional designs over time and therefore investors .165
To this end, one may argue that there is nothing wrong with shifting since
the central issue of discussion is to acknowledge the fact that the top Latin
American oil producer countries are tending to converge into related scenarios.
And in part this is true. No matter the starting point they come from, there is a
generalized tendency to adopt similar institutional designs from the whole
framework and this may be observed by just glancing factual, historical conditions
of each country and market-level data. This phenomenon can be interpreted as a
final convergence.166 Accordingly, movements towards the left or the right side of
the scheme award the respective host countries with the “good” and “bad” labels.
For example, the progressive adjustments that allowed the entry of private
investors to compete with PETROBRAS, ECOPETROL and PEMEX led to the “good state”
label. Conversely, recent measures in PDVSA, YPF and YPFB whereby control over
the industry was regained rewarded the incumbent heads of government with the
“bad” label, even when significant compensations were involved. Whether the
starting point requires some states to go towards interventionism for achieving a
neutral oil industry, reputation may get harmed. Meanwhile if the starting point
requires other states to adopt partial privatizations, public opinion and investors in
general may be delighted. Depending on the starting point, Latin American nations
and investors are faced with either benefits or costs when shifting towards the
same state entrepreneurship strategy. One may suggest terms such as “left”, “right”,
“pro-statist”, and “pro-market”, among others, should be regarded as mere
technicalities due to the fact that Latin American oil producers are converging into
164
See, e.g., Jimmy Ng, The Political Economy of Democracy and FDI Inflows in Oil Countries (Master
Thesis for MA in QMSS 2010) available at http://qmss.columbia.edu/storage/qmss-pdf-files/student-
theses/The%20Political%20Economy%20of%20Democracy%20and%20FDI.pdf. Nonetheless, other
academics have challenged the veracity of such classic belief, see, e.g., Turan Subasat and Sotirios Bellos.
Governance and Foreign Direct Investment in Latin America: A Panel Gravity Model Approach (2013)
LATIN AMERICAN JOURNAL OF ECONOMICS Vol. 50, No. 1, 107-131. 165
For the other factors see supra note 163. 166
Phenomenon also labeled as “starting point”. See Berríos et al., supra note 16.
50 Which are the Conflicts and Remedies?
similar regulatory schemes, no matter the previous exploitation model they come
from. However, the truth is that serious costs are faced by multinational companies
already established and this is what distinguishes state entrepreneurship shifts
from private entrepreneurship shifts and what makes it sensitive to further
protection.
Either unilaterally or negotiated, friendly or hostile, directly or indirectly;
shifts may take a number of forms. Specific terms such as “interventionism”,
“nationalization”, “expropriation”, “monopolization”, “expulsion” or any other
similar type-of-taking expression are indistinctively mixed up in literature and kept
to describe worst case scenarios for investors. Even though adding definitions to
the debate surpasses the scope of this work, brief considerations are aimed to
enhance the explanation of the whole theoretical framework for the oil industry.167
First of all the aforementioned expressions represent direct shifts towards statist
exploitation models or the right side of the regulatory scheme. Secondly, they all
differ in the extent to which the adjustment is aimed. In broad strokes,
interventionism consists in unexpected readjustments of the preexisting model
towards any right sided strategy without taking into account IOCs’ consent and
best interests; nationalization entails the articulation of at least one NOC within the
inner working of the market (regardless of exclusivity exploitation rights);
monopolization implies NOC’s control in at least the upstream segment; expulsion
of IOCs gives rise to NOC’s hegemony in all oil activities; and expropriation refers to
confiscation of property rights, wealth deprivation or dispossession.168
This differentiation is essential because investors react in different ways
when exposed to different situations. As long as modern states enjoy the privilege
of shaping their legal regimes and changing the rules of the game, the risk to
regain control of the oil market generates a sort of a principal-agent relation
between the host country and foreign investors whereby the former has the
potential to worsen the latter and even to expropriate them. Likewise, externalities
from such risk may range depending on the scope of the respective adjustment or
shift. For instance, setting up an absolute NOC monopoly plus confiscation of
property rights would eventually entail more costs and strict mitigation measures
than just forcing IOCs to act under mandatory joint ventures. This would be the
case of Venezuela in 2007, where BP, Chevron, Statoil, Total and other IOCs
accepted the terms of the new exploitation scheme while ConocoPhillips and
167
For the divergence of definitions, see Kobrin, supra note 14; Duncan, supra note 15; Christopher Hajzler,
Expropriation of Foreign Direct Investments: Sectoral Patterns from 1993 to 2006 (2012) REV WORLD
ECON 148:119-149. 168
See OECD, “Indi ect Exp op iation” and the “Ri ht to Re ulate” in Inte national Investment Law (2004)
available at http://www.oecd.org/daf/inv/internationalinvestmentagreements/33776546.pdf.
Chapter 3 The Challen es of Investo s’ P otection 51
ExxonMobil decided to dump activities within the country.169 To give another
example, being partially confiscated and afterwards remain in the industry with a
minority interest transforms foreign direct investments into pseudo-portfolio
investments; and such maneuver would potentially entail more costs for IOCs than
just being totally expelled due to the fact that investors are squeezed and lose
direct command over their cash flows.170 The recent Argentinean expropriation
case of 2012 is the perfect illustration for such level of problem; the administration
expropriated 51% out of 62.9% outstanding shares from Repsol, which not only lost
control over the company but also turned into a minority shareholder as their
stake was reduced to 11.9%.
Under an ideal landscape, it would be difficult to imagine how IOCs would
not be able to apply different mechanisms in order to fend against the specific set
of problems brought through an unexpectedly-adjusted exploitation model,
including formal, informal, ex ante and ex post measures. The truth, however, is
that the postulate of state sovereignty is one of the key elements of modern
societies and therefore few protective mechanisms exists against it for such cases.
As anticipated earlier, international law recognizes state sovereignty to openly
determine how property and exploitation rights over subsoil resources within the
respective national territories up to continental shelves are allocated.171 Moreover,
international investment postulates also recognize state sovereignty to withdraw
property rights by means of formal expropriation and establish few protective
mechanisms such as fair compensation as well as miscellaneous rights concerning
equitable treatment like non-discriminatory expropriation, foreigners’ right to fend
in local courts, among others.172 However, there are several reasons to conclude
such principles do not offer effective protection. Firstly, states may —virtually—
take property at will; public interest and foreigners’ non-discrimination are
“necessary conditions” that may remain inapplicable in practice. Secondly,
protection of property rights as such may be ambiguous and even toothless in the
oil business whenever the adjustment of the exploitation model does not entail
confiscation of foreigners’ assets. This would be again the case of Venezuela, where
plenty of IOCs were simply put under pressure to adapt to a new scheme of joint
ventures with PDVSA articulated through the Hydrocarbons Law. 173 Thirdly,
compensation is arguably a protective mechanism; instead it is regarded as natural
consequence of withdrawal. Fourthly, it is still subject to debate how
169
See THE NEW YORK TIMES article, supra note 6. 170
See Baek and Qian, supra note 163. 171
See supra note 109. 172
See Catherine Redgwell, Property Law Sources and Analogies in International Law in Aileen McHarg et al.
(eds), PROPERTY AND THE LAW IN ENERGY AND NATURAL RESOURCES (OUP 2010). 173
See Hults, supra note 117.
52 Which are the Conflicts and Remedies?
compensations should be calculated, the institution who resolves disputes, and
more importantly, who the compensated individuals should be. As for the first
segment of this debate, much has been argued about the applicable standard to
measure compensation. After Mexican dispossessions took place in 1938, the so-
called Hull Formula was set forth proposing “prompt, adequate and effective”
compensation ruled under international justice; however through Resolution Nº
3281 (XXIX) of 12 December 1974 the United Nations General Assembly accepted
the Calvo doctrine whereby states may pay “appropriate compensation” “settled
under domestic law”.174 Moreover, the conventional wisdom is that the reimbursed
price should be proportional enough to cover losses at the time expropriation took
place. However, measurement faces serious challenges different than the classical
discussion between market value and book value as benchmarks; that is, price
fluctuation. This is the case of registered securities tradable in public exchange
markets whose value instantaneously reflects publicly available information. In the
recent case of YPF, for instance, analysts reported stock price plummeted nearly
40% in BCBA and 56.9% in NYSE within a timeframe of less than one year from the
day the first rumors of expropriation were liked by the press to day expropriation
was announced by the Argentinean government; the very same day of the official
announcement the price went down 11% in BCBA 11.16% and in NYSE. 175
Consequently, the stock price was greatly depressed at the time Law 26.741 was
enacted one month later, ultimately adding further debate to the measurement
discussion; in a word, whether compensation should rely on the price when
expropriations become publicly known. In addition, Repsol stock also fell 28.4%
after news spread overseas and 6% the day of announcement176; the question that
immediately arises is whether this indirect loss should be compensated as well,
bearing in mind the direct loss is represented in the seized 51% stake itself and not
the market value of Repsol stock as such. As for who the compensated individuals
should, there are certain cases in which compensation fails to reimburse, especially
adjacent losses within a corporate context. YPF minority shareholders were not
directly expropriated; however, since almost all shareholders had the same type of
security held by Repsol (i.e. common stock “class D”), news about expropriation
ineludibly affected their stock. More interestingly, adjacent losses also become
visible in partial expropriations of corporate control blocks whereby the majority
174
See OECD, supra note 168. 175
See, e.g., Las Acciones de YPF caen con Fuerza Tras su Vuelta a la Bolsa de Argentina , EL PAÍS, APR. 17,
2012, available at http://economia.elpais.com/economia/2012/04/17/actualidad/1334645833_467867.html;
Pablo Fernández, Valoation of an Expropriated Company: The Case of YPF and Repsol in Argentina
(Working Paper 1055E, 2012), available at http://www.iese.edu/research/pdfs/WP-1055-E.pdf; Joaquín
Melgarejo Moreno, María Inmaculada López Ortiz and Borja Montaño Sanz, From Privatisation to
Nationalisation: Repsol- YPF, 1999–2012 (2013) UTILITIES POLICY Vol. 26, pp. 45-55. 176
ibid.
Chapter 3 The Challen es of Investo s’ P otection 53
controller is expropriated and the remaining minority shareholders are put under
the control of the state as new decision maker. The fact that portfolio investors
may opt to buy shares in outperforming firms which are controlled (and even run)
by insiders with specific qualities suggests to a greater extent that losing the
controller shareholder as business partner may be a great loss of added value.177 As
if this were not enough, the combination of sovereignty and expropriation breaks
by virtue any existing corporate mechanism set forth to limit transferability or to
ensure co-sale rights (e.g. tag along for minority shareholders whenever the
controller seeks to exit, dissenter remedies, etc) and therefore minority
shareholders have nothing left to do from a corporate law perspective. To give an
example, YPF’s bylaws had introduced mandatory tender offer protection in case
the Argentinean administration targeted to acquire stock under certain
circumstances, as an attempt to protect shareholders with no bargaining power;
and such provision was virtually irrelevant at the time expropriation took place.
The discussion of compensating minority shareholders for the loss of their original
principal is seen by some academics as a trade-off between the Pareto-efficiency
and Kaldor-Hicks efficiency. Whereas the former entails full compensation to all
loses, the latter only demands compensation to those who suffer the direct loss.178
Determining the extent to which compensation should be granted is quite
important and significant as, for instance, the case of YPF, because an important
minority block was left subject to the will of the Argentinean administration as
new controller. Even though non-expropriated shareholders still have exit
mechanisms ensured mainly by secondary market liquidity, the decision to sell
may also be costly owing depressed stock prices caused by the host country.
Fifthly, compensation also fails to mitigate “creeping”, “de facto” or simply indirect
expropriations such as excessive increases in special oil income taxes, fines,
penalties or any other regulation that objectively affects the price of the
investment. 179 Yet, this precise set of international law postulates turns out
inefficient in addressing such daunting problems.
Bilateral Investment Treaties (BITs) as well as free trade agreements are
more useful and tailor-made mechanisms to protect IOCs than customary
international principles.180 Precisely, after suits brought under the North American
Free Trade Agreement, modern legal designs account for functional provisions to
177
See Mendoza, supra note 144. 178
See Redgwell, supra note 172. 179
See supra notes 167 and 168; Suzy H. Nikièma, Best Practices Indirect Expropriation (The International
Institute for Sustainable Development 2012), available at http://www.iisd.org/. 180
See, e.g., Jennifer Tobin and Susan Rose-Ackerman, Foreign Direct Investment and the Business
Environment in Developing Countries: The Impact of Bilateral Investment Treaties (Yale Law School
Research Paper No. 293) available at http://www.ssrn.com/.
54 Which are the Conflicts and Remedies?
prevent further issues like indirect expropriations and price fluctuation.181 Based on
the Hull Formula, disputes arising under these treaties are usually competence of
the World Bank’s International Center for Settlement of Investment Disputes or
the International Chamber of Commerce, which are the most common
international arbitration panels. Through BITs, international investors not only
overcome deficiencies of international law but also avoid eventual non-impartial
judicial procedures carried out by home authorities while enjoying the benefits of
specialized tribunals. However, of significant relevance is the fact that this type of
protection is only possible whenever BITs exist between the host country and the
country where foreign direct investors come from. This is a vital issue; in absence
of such legal instruments, the likelihood of misappropriation by the state increases
as the costs of expropriation are fewer.182 A prominent solution to this problem
relies on a corporate maneuver termed by some commentators as “treaty
shopping”.183 Based on a combination of widely accepted postulates of corporate
planning such as choice of law and corporate mobility, companies around the
globe may deliberately restructure their holdings offshore to fall under the scope of
any BIT. Likewise, investors form a non-treaty countries may close gaps in political
and legal uncertainty and benefit from a particular BIT by setting up a corporate
vehicle in a jurisdiction where such type of instrument is in force with respect to
the host country. Joining BITs does not prevent dispossession of property rights but
still ensures IOCs to fight the battle for compensation in front of international
tribunals. Although controversial, this strategy is quite useful within the context of
the oil business, since shifts on exploitation models may be compensated as
creeping expropriations regardless of whether assets are confiscated. It goes
without mentioning that it is still plausible the arbitral tribunal consider such
practice as abuse of the corporate form, in particular when the respective
restructuration is carried out with the sole purpose of filling the complaint.184 The
solution, in essence, is barely complex; the business vehicle is required to be
incorporated beforehand rumors about public policy change take place.185 The core
question is whether IOCs are protected in Latin America. Regional top oil
producers have entered into significant BITs (e.g. 58 by Argentina, 28 by Venezuela,
28 by Mexico, 19 by Bolivia, 14 by Brazil, 7 by Colombia), but still countries that
181
See OECD, supra note 168. 182
See Guriev et al., supra note 15. 183
See Juan C. Boué, Enforcing Pacta Sunt Servanda? Conoco-Phillips and Exxon-Mobil versus The
Bolivarian Republic of Venezuela and Petróleos de Venezuela (University of Cambridge Working Paper
Series 2 No.1, 2013) available at http://www.latin-american.cam.ac.uk/library/WP2Boue1.pdf; G. Kahale,
Is Investor-State Arbitration Broken? (2012) TRANSITIONAL DISPUTE MANAGEMENT, available at
http://www.curtis.com/siteFiles/News/Is%20Investor-State%20Arbitration%20Broken.pdf. 184
See Boué ibid. 185
ibid.
Chapter 3 The Challen es of Investo s’ P otection 55
account for important outward international cash flows are in principle left outside
this type of foreign direct investors’ protection.186 As a matter of fact Central and
South America as well as the Caribbean are the regions that account for the larger
number of BIT disputes in the world; that is, an average of 30.3% of worldwide cases
registered between 2009 and the first quarter of 2014.187 Interestingly the oil, gas
and mining sectors are the principal issue of debate accounting for nearly 26.3%
within the same timeframe.188 In fact, the main reason why Latin America oil
business is subject to continued dispute is the recent wave of interventionism,
particularly in Venezuela and Argentina. In light of the foregoing considerations,
two important issues arise; the “Netherlands effect” on the one hand and
settlement bargaining dynamics on the other. Because of its extended network of
97 BITs, The Netherlands is widely used as “treaty shop” or tax “base camp” by
international companies with operations in emerging economies; accordingly the
country has witnessed an increase of “letterbox” companies, estimated in 20.000 by
2006.189 To give an example ConocoPhillips and ExxonMobil, both US companies,
had previously established corporate links with The Netherlands and were awarded
with compensation that must be paid by the Venezuelan administration under the
Netherlands-Venezuela BIT; US$ 68.8 million and US$ 907 million respectively.190
As for settlement bargaining dynamics, the combination of information asymmetry
and overestimation of losses may lead to a number of negotiation tactics. In the
first place, states may not have the same level of information in regards to the
value of IOCs’ sunken investments, operations and facilities; hence, IOCs tend to
overestimate their losses during the pre-litigation phase to reach overrated
186
See United Nations Conference on Trade and Development, Country-specific Lists of Bilateral Investment
Treaties, available at http://unctad.org/ 187
Author’s calculations based on The Caseload Statistics provided by the Institutional Centre for Settlement of
Investment Disputes, available at https://icsid.worldbank.org/ 188
ibid. 189
See Roos van Os and Roeline Knottnerus, Dutch Bilateral Investment T eaties: ateway to ‘T eaty
Shoppin ’ fo Investment P otection by Multinational Companies (2011) SOMO, available at
http://www.s2bnetwork.org/fileadmin/dateien/downloads/Dutch_Bilateral_Investment_Treaties.pdf. For
taxation see also Francis Weyzig, Tax Treaty Shopping: Structural Determinants of Foreign Direct
Investment Routed through The Netherlands (2013) INTERNATIONAL TAX AND PUBLIC FINANCE, Vol. 20,
Issue 6, pp 910-937; Michiel van Dijk, Francis Weyzig and Richard Murphy, The Netherlands: A Tax
Haven? (2006) SOMO, available at http://somo.nl/html/paginas/pdf/netherlands_tax_haven_2006_NL.pdf. 190
See ConocoPhillips Wins A Significant Victory In Ongoing Arbitration Battles With Venezuela, TREFIS,
SEP 24 2012, available at http://www.trefis.com/stock/cop/articles/144996/conocophillips-wins-a-
significant-victory-in-ongoing-arbitration-battles-with-venezuela/2012-09-24; Venezuela to Appeal World
Bank Ruling on ConocoPhillips Compensation Claim, VENEZUELAANALYSIS.COM, SEP 5 2013, available
at http://venezuelanalysis.com/news/10004; Exxon Mobil’s Dispute with Venezuela Has Global
Implications, ABA JOURNAL, APR, 1, 2011, available at
http://www.abajournal.com/magazine/article/exxon_mobils_dispute_with_venezuela_has_global_implicati
ons/; Conoco-Phillips and Exxon-Mobil v. Venezuela: Using Investment Arbitration to Rewrite a Contract ,
INVESTMENT TREATY NEWS, SEP 20 2013, available at http://www.iisd.org/itn/2013/09/20/conoco-
phillips-and-exxon-mobil-v-venezuela-using-investment-arbitration-to-rewrite-a-contract/#_edn2.
56 Which are the Conflicts and Remedies?
settlement amounts. ConocoPhillips, for instance, claimed first US$30 billion and
the government offered US$570.5 millions, that is, a higher offering compared to
what the tribunal finally set.191 Similarly, ExxonMobil claimed US$15 billion and the
government offered US$2 billion.192 Filing a complaint against Argentina via the
Argentina-Spain BIT, the Spanish firm Repsol estimated compensation in US$10.5
billion; this is still subject to litigation.
Although BITs are conceived as effective mechanism to protect foreign
investors, they do not prevent shifts in public policies or weaknesses in local
protection of property rights; they only mitigate effects.193 To this end, IOCs are also
prone to accept the terms of a new exploitation model in order to recover at least
part of sunken investments.194 This would be the case of BP, Chevron, Statoil, Total
and other IOCs operating in Venezuela.195
Finally, international political pressure and unilateral diplomatic sanctions,
particularly from neoliberal economies, are usually put as indirect non-legal
attempts to prevent changes towards interventionism as well. Yet, the effectiveness
of political costs varies from case to case.
In summary, the current set up does not enable IOCs to thoroughly protect
from sovereignty which has proved the most powerful instrument in the hands of
resource-rich nations.196
Much effort has been put forward by academics, policy makers and practitioners in
minimizing costs and externalities arisen from the corporate form. The unwearied
and reiterated discussion in corporate governance has essentially relied on two
core issues: the individuals under friction on the one hand, and the prevention
method of negative effects on the other. The first of these affairs has found answer
under the economic agency theory, according to which three types of conflicts of
interests among corporate actors may rationally occur.197 As for the prevention, the
191
ibid. 192
ibid. 193
See Selen Sarisoy Guerin, Law and Foreign Direct Investment (Institute for European Studies Working
Paper No. 4/2011, 2011), available at http://www.ssrn.com/. 194
See Manzano and Monaldi, supra note 15. 195
See THE NEW YORK TIMES article, supra note 6. 196
See Tomz and Wright, supra note 87. 197
The first conflict, known as the vertical agency problem, finds its origin in the relationship existing between
corporate managers and shareholders; secondly, the horizontal agency problem involves controller
shareholders and minority shareholders; and the third form of agency problem refers to the conflict between
the company and its stakeholders, mainly employees and creditors. See John Armour, Henry Hansmann and
Chapter 3 The Challen es of Investo s’ P otection 57
literature has posited a wide array of remedies, including ex ante, ex post, legal,
market-based, formal, functional, mandatory and reputational remedies.
Nonetheless, the outcome of such discussions does not appear to fit entirely the
phenomenon of state entrepreneurship and more specifically NOCs; and many
challenges in the matter of portfolio investors’ protection remain unaddressed.198
In the first place, much of the theorizing and empirical research under one
side of the corporate governance literature, mainly in the US, has focused in
resolving frictions between corporate managers and shareholders. Such discussion
relies upon the formulations made in the midst of global recession of early 20th
century, when academics witnessed a highly dispersed pattern of ownership
concerning companies traded on US securities exchanges.199 Ever since then, the
so-called “modern corporation” —where managerial control arises in listed
companies owing dispersion and lack of coordination among shareholders, and
where a prominent separation between ownership and control exists— has been in
the frontline of debate among corporate law experts and economists. Reluctance,
shirking, negligence, opportunism and moral hazard by directors are the most
frequent agency problems that may lead to severe agency costs such as firm
underperformance, increase of cost of capital, and private benefits, all at the
expense of spread and passive shareholders. These studies have attempted first to
explain the reasons that caused the dispersion phenomenon, which even to this
day are quite debated.200 Moreover, a wide array of measures has been proposed to
prevent and mitigate the negative impact of this principal-agent relationship. US
lawmakers and courts responded with their own set of deterrents including the
reduction of information asymmetries by means of disclosure and liability, insider
trading, directors’ fiduciary duties, ex post scrutiny of related-party transactions,
among others. Positive incentives have also been applied by practitioners; aligning
interest through reward-based compensations is a common market-based ex ante
governance remedy, for instance. The literature also coincides how market for
Reinier Kraakman, Agency Problems and Legal Strategies in Reinier Kraakman et al. (eds) THE ANATOMY
OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL APPROACH (OUP 2009). 198
Pursuant the key indicators displayed by the World Economic Forum in the 2013-2014 timeframe Brazil
accounted for 26, Mexico 56, Colombia 76, Argentina 129 and Venezuela 131 in the world rank of minority
investors’ protection. http://www3.weforum.org/docs/WEF_GlobalCompetitivenessReport_2013-14.pdf 199
A classic: Adolf A. Berle and Gardiner C. Means, The Modern Corporation and Private Property
(Transaction Publishers; Reprint edition, 1991). 200
For the common-law-supremacy-over-civil-law theory see Rafael La Porta, Florencio López-de-Silanes,
and Andrei Shleifer (LLSV), Corporate Ownership Around the World (Harvard Institute of Economic
Research Paper No. 1840, 1998), available at http://www.ssrn.com/; Henry Hansmann and Reinier
Kraakman, The End of History for Corporate Law (Yale International Center for Finance Working Paper
No. 00-09, 2000) available at http://www.ssrn.com/. For the broader theory see John C. Coffee, The Future
as History: The Prospects for Global Convergence in Corporate Governance and its Implications
(Columbia University School of Law Working Paper No. 144, 1999); Mark J. Roe, A Political Theory of
American Corporate Finance (1991) COLUMBIA LAW REVIEW 10.
58 Which are the Conflicts and Remedies?
corporate control is perhaps the ultimate tool to discipline managers and avoid
shirking within the dispersed ownership model, since it creates a potential threat
of hostile takeover against directors.201 Thus, managerial control may be attenuated
within dispersed structures and the gap between ownership and control may be
somewhat bridged. Whenever a blockholder manages to gain a considerable
minority ownership percentage, it could be able to exercise enough voting power
to appoint its members for the board of directors and this may serve as a call for
management efficiency.202 Yet, this practice has arisen its own costs as well; the so-
called “prisoners dilemma” within the context of control premium, greenmailing,
or certain usages of antitakeover devices by corporate directors may entail
additional problems for dispersed shareholders.203 Moreover, after recent corporate
scandals, much stricter check-box rules were introduced to enhance shareholders’
protection in US listed firms (e.g. Sarbanes-Oxley Act).
In light of the foregoing discussion, the core issue of concern that arises in
the context of NOCs relies on the fact that “dispersed remedies” may not function
properly in different environments. And the reasons are quite straightforward.
Under concentrated ownership structures —where holdings are strongly
concentrated in few individuals— there is no such thing as managerial control or
separation between ownership rights and command over cash flows; the contrary,
majority and leveraged controller shareholders enjoy plenty domain over corporate
affairs.204 Although similar, this is not the same phenomenon of controlling
minority shareholders or controlling blockholders, where certain level of
dispersion is still strategic while seeking control.205 Moreover, jurisdictions in
which concentration of ownership interest is hegemonic tend to articulate statutes
by which the shareholders’ assembly is provided with broader powers in the matter
of business decision making than in dispersed ownership structures; shareholders
are in charge of determining distribution of dividends, for instance. That said, it
can be plausible argued that the so-called “erosion theory” does not seem to have
taken place in the concentrated ownership structure as opposed to its dispersed
counterpart; in other words, shareholders’ voting power has not been constrained
201
See Henry G. Manne, Mergers and the Market for Corporate Control (1965) THE JOURNAL OF POLITICAL
ECONOMY Vol. 73, No. 2, pp. 110-120. 202
See John J. McConnell and Henri Servaes, Additional Evidence on Equity Ownership and Corporate Value
(1990) JOURNAL OF FINANCIAL ECONOMICS 27 595-612. 203
See Stephen Bainbridge. Mergers & Acquisitions (Foundation Press 2012). 204
Concentrated ownership structures are almost a universal pattern excepting US and UK. See LLSV, supra
note 200. 205
One can say there is a negative relation in the matter of controlling blockholders, the more dispersed the
capital, the less percentage required to exercise minority control.
Chapter 3 The Challen es of Investo s’ P otection 59
to give way to the director primacy postulate.206 Through such authority, majority
and leveraged controllers are not only the ones who virtually set forth general
guidelines for corporate managers, but even more controversially, the latter might
just function as “corporate puppet” at service of the former. As a result of such
uniqueness, moral hazard by directors is not itself a major pitfall given the fact that
directors are openly monitored by controlling shareholders, and consequently
management efficiency is secured to a great extent. Unlike dispersed ownership
structures, the agency conflict in this different scenario barely exists between
directors and shareholders; instead the principal conflict arises between
controlling and minority shareholders.207 As it turns out, it can be plausible argued
that even though important externalities may be prevented through some of the
protective measures embraced in dispersed ownership structures, not all of them
can be simple borrowed and transplanted into the second type of ownership
model.208 Insider trading and self-dealing judicial ex post review could be effective
mechanisms to prevent the extraction of private benefits of control by corporate
insiders within concentrated structures; but the central issues of concern are
different: minimizing disproportionate returns for controlling shareholders at the
expense of their minority counterparts and deterring the autocratic use of voting
power as legitimizing device to ultimately seize the company’s assets.209 Market for
corporate control, for example, is simply not feasible in concentrated ownership
structures because any attempt to replace the principal —controlling
shareholder— needs to be directly negotiated and this is owed to the combination
of large holdings and underdeveloped capital markets. To this end, it is worrying
therefore that a great number of Latin American states —characterized by high
concentration of corporate ownership interest in few individuals— have
implemented the ex post standard of fiduciary duties for directors but not its
concentrated-structure counterpart; that is, abuse of voting rights, fiduciary duties
for shareholders or any other similar instrument. And this is of a great importance
since controlling shareholders may easily circumvent liability in absence of such
206
Pursuant the “erosion theory”, certain corporate functions that were originally vested in the shareholders
were gradually passed to directors. See Stephen Bainbridge, The New Corporate Governance in Theory and
Practice (OUP 2008). 207
“What is a problem in one system may not be a problem (or perceived as one) in another. The very act of
deciding what is a problem involves a value judgment. Thus, for example, the separation of ownership and
control is perceived as a central problem in American corporate law and is therefore assumed often to be a
central problem in other jurisdictions”. See Donald C. Clarke, “Nothin but Wind”? The Past and Futu e of
Comparative Corporate Governance (2010) AMERICAN JOURNAL OF COMPARATIVE LAW Vol. 59, pp. 75-
110. 208
See Reyes, supra note 155. 209
“Shareholders meetings are reduced to a formality”. See Donald C. Clarke, Corporate governance in China:
An Overview (2003) CHINA ECONOMIC REVIEW 14, pp. 494-507. This aim of corporate governance is
subject to debate, see, e.g., Gilson and Alan Schwartz, supra note 146.
60 Which are the Conflicts and Remedies?
legal remedy. Whereas Argentina, Brazil, Chile, Colombia, Mexico, Panama and
Peru implemented fiduciary duties for directors, only Brazil and Colombia have
specific statutory provisions providing actions against abuse of corporate voting
rights.210 Therefore, unlike minority shareholders of PETROBRAS and ECOPETROL,
minority shareholders of YPF lack of this legal protective measure. Evidently, such
type of remedy is of a great importance in the matter of Latin American partially-
owned NOCs where states have kept their controlling position after public equity
financing, as detailed in Chapter 2. One additional thing to note is that empirical
evidence shows how extraction of private benefits of control is intensified in the
case of leveraged shareholders because —despite the benefits of accessing fresh
cash flows and sharing risk of failure— the great effort put forward in the
management of the company is somewhat not thoroughly rewarded through
conventional means (i.e. dividends) hence expropriation of minority shareholders
occurs.211 This would be the case of PETROBRAS whose control is leveraged via dual-
class structures. For all these reasons, abuse of voting rights or shareholders’
fiduciary duties have been “visible absences” in the Latin American regulatory
schemes despite the fact they turn out crucial to properly address the conflict
between self-interested controlling shareholders and minority shareholders.
The second challenge faced by corporate governance in the matter of state
entrepreneurship and minority shareholders’ protection is the effectiveness and
efficiency of rules and standards that Latin American jurisdictions do implement in
order to close the gaps left by incomplete contracts and to alleviate particular
problems that may arise in NOCs. As anticipated above, the classical agency
problem of the concentrated ownership structure appears when self-interested
controlling shareholders extract private benefits of control and expropriate
210
See Francisco Reyes, A New Policy Agenda for Latin American Company Law: Reshaping the Closely-Held
Entity Landscape (Tilburg University 2011). See also Joseph A. McCahery and Erick P.M. Vermeulen,
Corporate Governance of Non-Listed Companies (OUP 2008). The authors show how some of the most
innovative jurisdictions in corporate law have articulated duties for controlling shareholders; for US and
UK, fiduciary duties brought by case law; for France, abus de majorité; for Germany, duty of loyalty; and
for The Netherlands, dictates of reasonableness and fairness.
Moreover, two important remarks need to be made. Firstly, this type of protections differs to a greater
extent from responsibility of holding companies during subsidiaries’ bankruptcy. Abuse of voting rights is
not limited to corporate groups or bankruptcy; it can be applied in a more day-to-day basis including
situations such as tunneling, percentage and economic dilution, exclusion through freeze out mergers, etc.
Secondly, a more generalized institution of abuse of rights does exist in Latin American jurisdictions owing
its French tradition; however, the lack of a specific statutory provision creates a gap in corporate law since
judges are barely specialized in such branch of law and usually find difficult to spot and such generalized
remedy. 211
See, e.g., Gilson and Alan Schwartz, supra note 146; Jan Bena and Jan Hanousek, Rent Extraction by Large
Shareholders: Evidence Using Dividend Policy in the Czech Republic (Discussion Paper 556 Financial
Markets Group, London School of Economics and Political Science, 2006) available at
http://eprints.lse.ac.uk/24510/1/dp556.pdf; Mara Faccio, Larry H.P. Lang and Leslie Young, Dividends and
Expropriation (2000) AFA 2001 New Orleans; EFMA Athens 2000, available at http://www.ssrn.com/.
Chapter 3 The Challen es of Investo s’ P otection 61
minority shareholders’ wealth, and this can be achieved through tunneling, major
corporate transactions, insider trading and even more subtle and unnoticeable
practices like dilution.212 However, additional specific problems originated from the
role of the state as controller shareholder are also present: NOCs might be used as
public welfare maximization devices, or even worse “clientelistic vehicles” and
“piggy-banks”, all at the expense of non-state-shareholders’ wealth.213 But before an
evaluation of the existing remedies can be assessed it is indispensable to outline
some key features of Latin America corporate law. One essential aspect is the
intrinsic tightness and rigidity of Latin American legal systems in general, in which
the rule of law lies primarily in statutes rather than judicial discretion. As many
other branches, corporate law and basic housekeeping rules that serve as corporate
governance devices were originally transplanted from Napoleonic Codes; and
because of such tight nature, corporate law regimes have been described by
literature as “confined to the letter of law”. 214 As if this were not enough, Latin
America is also characterized by highly-politicized legislative procedures and
cumbersome filters that make it difficult to modernize law and to pass new
innovative bills; thus, legal modernization is hampered to a greater extent and
corporate law remains attached to preexisting statutes ultimately leading to an
indefinite status quo.215 Yet, previous successful legislative efforts have been late
responses to world trends more than any other thing.216 As a result of all these
drawbacks and considering the nature of civil law in which judges carefully follow
the dictates of the statutes, the lack of specific corporate governance laws makes
experts coincide that Latin America, as many other civil law jurisdictions, lags
behind expectations in terms of innovative functional protection.217 To give an
212
Though, this aim of corporate governance is subject to debate. See Ronald J. Gilson and Jeffrey N. Gordon ,
Controlling Controlling Shareholders (Columbia Law and Economics Working Paper No. 228; Stanford
Law and Economics Olin Working Paper No. 262, 2003), available at http://www.ssrn.com/. “[W]e have
argued that Delaware doctrine restricts the extent to which controlling shareholders can extract private
benefits of control to a level at which it is plausible that the benefits to minority shareholders from
reduction in managerial agency costs as a result of concentrated monitoring by a controlling shareholder
exceeds the costs of the controlling shareholder’s private benefits of control”. 213
See, e.g., Manzano and Monaldi, supra note 15; Pargendler et al., supra note 136. 214
“Civil law countries subjected corporations to a strict legislated regime, whereas common law countries
allowed substantially more flexibility and by implication a reallocation of control rights from shareholders
to managers”. See Katharina Pistor, Yoram Keinan, Jan Kleinheisterkamp and Mark D. West, The
Evolution of Corporate Law a Cross-Country Comparison (Working Paper No. 232, 2003) available at
http://www.ssrn.com/. 215
For instance, public scandals are widely used by politicians as a means to achieve popularity. Statutes might
be opportunistically enacted for the sake of citizen perception towards the politic parties which promoted
the respective legislation. 216
The regulation enacted in Latin America after the Sarbanes-Oxley Act is quite illustrative. See in Argentina,
Decree 677 of 2001; in Brazil, Law 10.303 of 2001; and in Colombian, Law 964 of 2005. 217
See Francisco Reyes and Erik P. M. Vermeulen, Company Law, Lawye s and ‘Le al’ Innovation: Common
Law versus Civil Law (Lex Research Topics in Corporate Law & Economics Working Paper No. 2011-3,
2011), available at http://www.ssrn.com/.
62 Which are the Conflicts and Remedies?
illustration, most Latin American systems resort to the traditional array of
theoretical strategies designed under the roots of civil law when it comes to fight
back against unlawful misuses of the corporate form and the principle of limited
liability against third parties. Public deeds, fixed lifetime, minimum capital
requirements, capital maintenance and ultra vires theories have been the main
corporate governance measures that offer shielding for non-shareholder
constituencies. And after all, wrongdoing is not thoroughly prevented by means of
those mechanisms since the statutes themselves may not contain explicit solutions
for every single case; on the contrary, they ultimately become formalistic barriers
or “entry prices” to carry on business activities due to the increase of transaction
costs.218 Few jurisdictions like Argentina, Colombia and Uruguay have formally
established specific rules for veil piercing by means of corporate law itself; but the
truth is that owing the primacy of statutes over judicial opinions, such regulation
finds limited applicability as judges are granted with higher discretion than what
they are accustomed to.219
Protection of shareholders’ faces the same kind of challenges in Latin
America. So far, the bulk of minority shareholders’ regulatory protection against
self-interested controlling shareholders has consisted basically in mandatory
corporate law rules regarding the shareholders’ assembly meetings. Supermajority
is the first type of these protective measures; one the one hand it provides minority
shareholders’ with plenty protection in particular circumstances in which they
might be eventually expropriated; on the other hand, supermajority is quite
relevant for gaining potential investors’ confidence as minority shareholders’
decision rights are enhanced. In general, Argentina, Brazil, Colombia and
Venezuela articulate supermajorities in a number of sensitive corporate affairs like
218
Since the company’s equity is theoretically aimed to serve a dual function (i.e. start-up financial muscle and
common pledge for stakeholders), capital requirements are jealously guarded in Latin America. However
they could be simply fulfilled through shareholders’ initial investment subtle overpricing; thus, creditors
could not be completely satisfied at once under any enforcement procedure simply because of infra
capitalization of entity’s equity covered under overpricing and leverage aid. Due to such inefficiency,
minimum capital requirements have been publicly replaced by different means such as covenant
agreements. This is exemplified by bondholders who are attracted not only through considerable interest
rates but also through the voluntary use of covenants in all corporate debt instruments which by the
company promise not to materially alter certain assets via asset-equity or asset-debt ratios. In similar vein,
ultra vires theory and fixed duration terms are innocuous rules that could end up creating uncertainty to
creditors whenever the company executes agreements outside its corporate purpose or after its dissolution
term. For capital requirements criticism see John Armour, Legal Capital: An Outdated Concept? (2006)
EUROPEAN BUSINESS ORGANIZATION LAW REVIEW Forthcoming, available at http://www.ssrn.com/. 219
“By and large, civil law countries have taken the approach that the legislature should make the allocation,
leaving little room for shareholder to reallocate rights the legislature had vested with them”. See Pistor et
al., supra note 214. See for Argentina Law 22,903; for Uruguay Law 16.060; for Colombia Law 1564 of
2012 (however its application for other joint stock corporation is still uncertain). In absence of statutes,
other countries had developed jurisprudence in this regard.
Chapter 3 The Challen es of Investo s’ P otection 63
mergers, spin-off, dissolution, removal of preemption rights, among others.220
Nonetheless, it also has a downside. The excessive recognition of supermajority
may give way to permanent veto power that can lead to serious deadlocks,
eventually hindering the day-to-day development of the business. A second form of
protection comes in the form of box-ticking and housekeeping rules for the
functioning of the shareholders’ assembly meetings, which are not only aimed to
organize the functioning and developing of the assembly but also serve an
important role in corporate governance. Calling in advance for the shareholders’
meeting, entitling minority shareholders to initiate extraordinary meetings and
granting access to corporate books and records are the most outstanding checks-
and-balances. They, however, prove ineffective since “shareholders meetings are
reduced to a formality”.221 Other important forms of protection are preemption
rights, cumulative voting and dissenter remedies.222 Dilution through the issuance
of new stock is a common means of expropriating minority shareholders; and
preemptive rights prevent to some extent this practice. Such protection, however,
fails whenever controller shareholders deliberately make repeated issuances
without legitimate business purposes, knowing beforehand that minority
shareholders lack sufficient financial muscle to purchase the newly issued stock. In
turn, the cumulative voting system deployed in most Latin American legal systems
ensures board representation for minority shareholders, but even more
importantly, access to firsthand information. Therefore, even though cumulative
voting might not be sufficient to exert effective influence over management, it still
reduces information asymmetries. As for dissenter remedies, this allows minority
shareholders to step out of the company in exchange of fair compensation under
certain circumstances, mostly when their economic interests may result harmed
(e.g. major corporate transactions). Notwithstanding the fact that the entire region
is strongly attached to the heritage left by the Napoleonic Codes, there is a
tremendous lack of harmonization in one of the most controversial corporate law
postulates; that is, voting proportionality.223 Academics point out how voting
proportionality finds different regulation from country to country.224 The region, in
general, does not strictly adhere to voting proportionality since Argentina, Brazil,
Chile, Colombia, Ecuador, Mexico and Venezuela allow the issuance of non-voting
stock and the establishment of dual-class share structures. Brazil and Colombia
220
See table 3.1. 221
See Clarke, supra note 209. 222
ibid. 223
Widely known as one-share-one-vote rule. However this expression only represents one part of the voting
proportionality principle, since legal systems may adopt dual-class structures and at the same time stick to
the one-share-one-vote rule. 224
See Reyes, supra note 155.
64 Which are the Conflicts and Remedies?
have a cap for non-voting stock, which must not exceed 50%.225 Whereas Brazil,
Chile, Colombia, Ecuador and Mexico compel companies to stick to the one-share-
one-vote rule, Argentina and Venezuela allow multiple-voting shares; the former
set a cap of five votes per share, tough.226 Notwithstanding the above divergence,
the discussion whether voting proportionality effectively protects shareholders has
been recently challenged by some scholars.227 Dual-class shares structures are
justified in average listed companies as long as outside investors acknowledge the
fact that the founders or insiders in general turn out the core element of the high
sustainable growth of the business.228 Similarly, considering the institutional
background of NOCs and their significance as “national champions”, dual-class
share structures simply ease the process of fundraising without releasing corporate
control. Therefore such corporate practice should not be banned per se.
In summary, much of the traditional set of remedies provided by Latin
American legal systems is innocuous in mitigating conflicts (e.g. shareholders’
assembly check-and-balances), other remedies are double-edged (e.g.
supermajority) and some are increasingly deemed as business development
barriers (e.g. dual-class share structures and one-share-one-vote rule). 229
Preemptive and dissenter rights still serve a decisive role within the regulatory
scheme. A summarize of remedies is presented in table 3.1.
Table 3.1. Corporate law protective measures for minority shareholders in Latin American
Country
Abuse
of
V.R.
Pure
voting
proport.
Superma-
jority
Preemptive
rights
Dissenter
remedies
Cumulative
voting
Books
direct
access
Brazil X - X X X X X
Argentina - - X X X X -
Colombia X - X X X X X
Venezuela - - X - X X X
Mexico - - X X X X X
Chile - - X - X X X
Ecuador - - X X X X X
Source: Reyes; complemented by the author.
225
Prior to the enactment of Law 10.303, Brazil allowed issuing no more than 2/3 in non-voting shares. 226
See Reyes, supra note 155; and complemented by the author from statutes. 227
“[W]hat do the corporate governance experts generally think of Google’s [dual class] ownership structure?
The one dimensional thinkers, who tend to look at it in principal-agent extremes, criticize investors’ lack of
control, which is a fundamental weakness in their view. Apparently, they have issues with the issuance of
non-voting stock which makes it easier for the founders to maintain perpetual control”. See Joseph A.
McCahery, Erik P. M. Vermeulen and Masato Hisatake, The Present and Future of Corporate Governance:
Re-Examining the Role of the Board of Directors and Investor Relations in Listed Companies (ECGI
Working Paper No. 2011, 2013) available at http://www.ssrn.com/. 228
ibid. 229
ibid.
Chapter 3 The Challen es of Investo s’ P otection 65
Furthermore, owing the fact that PETROBRAS, YPF and ECOPETROL are listed
SOEs in local capital markets, important domestic securities law rules reinforce
minority shareholders’ protection, particularly concerning disclosure. As a matter
of fact, the three countries have implemented stricter rules driven by the
prominent influence of the US Sarbanes-Oxley Act.230 Such regulations address
matters such as duties and personal liability of directors, board composition (e.g.
independence, separation between chairman and chief executive manager) and
board committees.231 In the aftermath of such enactments, by 2014 Latin American
listed NOCs’ boards of directors prove widely standardized. PETROBRAS has 2
independent directors out of 9, YPF has 8 out of 17 and ECOPETROL has 4 out of 7.
This regulatory trend, however, gives room to an additional concern: much of the
respective regulation focuses too much on board practices and monitoring
management; that is, the director-shareholder agency conflict within the dispersed
ownership structure. Three questions that remain in this regard are: whether or
not Latin American policy makers intend to establish US market standards without
taking into account the proper agency conflict in NOCs, whether or not Latin
American policy makers intend to isolate controlling shareholder from
management, and if not —as one may rationally believe— whether such regulatory
implementation is an effective deterrent for preventing controlling shareholders
value-reducing opportunism. This is a delicate issue because companies directly
bear expenses of implementing such mandatory legal measures, meaning that the
implementation of ineffective remedies may create direct and unnecessary costs. If
the case is achieving sustainable high profitability, appointing prepared and
experienced board members and top managers is sufficient itself, regardless of the
“independent” or “non-executive” statuses; appointing independent and non-
executive directors neither adds value per se nor protects minority shareholders
per se, and it needs to be determined from case to case.232 All in all, prominent
specialized scholarship emphasizes how complementarity between the
transplanted measure and the host legal regime is essential for achieving an
230
See for Argentina, Decree 677 of 2001; for Brazil, Law 10.303 of 2001; for Colombian, Law 964 of 2005. 231
See OECD Roundtable Latin American Roundtable on Corporate Governance, Achieving Effective Boards. A
comparative study of corporate governance frameworks and board practices in Argentina, Brazil, Chile,
Colombia, Mexico, Panama and Peru (2011), available at http://www.oecd.org/brazil/48510039.pdf. 232
“However, it is far from clear whether other typically crisis-driven corporate governance considerations,
such as independent directors, the separation of chairman and CEO, board diversity, active minority
shareholder engagement, the disclosure of quarterly reports and, more recently in Europe, transparency
regarding company group structures, are in fact truly material to a company’s sustainable growth and value
creation… In this sense, it can be argued that the mechanisms are often perceived as ‘nice-to-have’ instead
of ‘must-have’”. See Joseph A. McCahery and Erik P.M. Vermeulen, Six Components of Corporate
Governance That Cannot Be Ignored (Tilburg Law School Legal Studies Research Paper Series No. 8,
2014) available at http://www.ssrn.com/.
66 Which are the Conflicts and Remedies?
efficient reform; and yet, the problem within concentrated ownership structures
appears not to be properly addressed through such type of measures.233
On the other hand, domestic securities laws do provide related-party
transactions’ disclosure and insider trading which are decisive remedies in
preventing the classical extraction of private benefits of control. Firstly, disclosure
on related-party transactions (e.g. public officials, politicians, employees of the
administration, relatives), has by virtue the potential to switch on the alarms of
public investors and eventually discourage self-dealing or tunneling.234 In general,
all Latin American jurisdictions establish mandatory disclosure and endogenous
scrutiny to determine if the transaction is made on legitimate business purposes
and under market-value basis or arm’s length principle; besides this class and
derivative actions are eventually permitted.235 This entails that Latin American
countries have followed the global trend by restricting self-dealing on an ex post
basis rather than just prohibiting it.236 Some experts suggest the likelihood of this
type of misbehavior is increased during the days leading to privatization.237 And
secondly, there are protective measures against insider trading. As a conduct that
is said to affect public confidence in capital markets, it has found stronger set of
rules over time in developed economies.238 The truth is that the use of corporate
non-public information for making profits on capital markets is a powerful reason
in itself to ban such practice. In general terms, insider trading reduces welfare
overall. Since it produces mistrust in capital markets, the cost of capital increases
directly affecting the issuer. Liquidity in the aftermarket is reduced as well. And
more importantly, whenever insider trading takes place, individuals who execute
such transactions are taking wealth away (e.g. sell at inaccurate inflated prices) or
233
“The foregoing point about the ubiquity of patterns of concentrated share ownership in much of the world
leads to a much general observation: what is efficient in one context may not be efficient in another… In
short, having an “independent” board when other firms are using their boards to knit together a closely-
linked web of interlocking alliances may be a counterproductive innovation. Innovations, even if copied
from a well recognized model, must be able to adapt to local conditions if they are to survive”. See Coffee,
supra note 200. 234
See Lucas Enriques, Gerard Hertig and Hideki Kanda, Related-Party Transactions in Reinier Kraakman et
al. (eds) THE ANATOMY OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL APPROACH (OUP
2009). See also Pierre-Henri Conac, Luca Enriques and Martin Gelter, Constraining Dominant
Sha eholde s’ Self-Dealing: The Legal Framework in France, Germany, and Italy (2007) EUROPEAN
COMPANY AND FINANCIAL LAW REVIEW Vol. 4, No. 4. 235
See OECD Roundtable Latin American Roundtable on Corporate Governance, Latin American Corporate
Governance Roundtable Task Force Report on Related Party Transactions (2012), available at
http://www.oecd.org/daf/ca/LatinAmericanReportonRelatedPartyTransactions.pdf. 236
See Simeon Djankova et al., The Law and Economics of Self-dealing (2008) JOURNAL OF FINANCIAL
ECONOMICS 88 430-465; Gilson and Schwartz, supra note 146. 237
“Government restructuring of state-owned enterprises prior to their sale is an issue that is likely to be
fraught with political difficulties given that this is probably the last chance for government officials to
extract benefits”. See Chong and López-de-Silanes, supra note 15. See also Michał Kałdonski and Jacek
Mizerka, Politicians and Private Benefits of Control (2007) available at http:www.ssrn.com/. 238
See Choi and Pritchard, supra note 131.
Chapter 3 The Challen es of Investo s’ P otection 67
the potential to increase wealth (e.g. buy at inaccurate depressed prices) from
others who lack information under the misbelieve of market’s efficiency when it
comes to unveil new material information; and this may affect public investors
ranging from professional giant investors to common citizens. Following the global
trend, such practice has been addressed from the criminal law standpoint in many
countries of Latin America.239
Moreover, as anticipated earlier, extraction of private benefits is not the
only agency problem faced by minority shareholders in NOCs, where a tremendous
political risk is involved. 240 A great body of empirical evidence shows the
underperformance and inefficiency of SOEs compared to privately companies relies
on higher operating and manufacturing costs, less profitability, over-capitalization
and over-hiring of labor force.241 In fact, those are the primary reasons why the
mass privatization wave of the 1990s occurred. The question that arises is whether
governments may again in the aftermath of the Washington Consensus prefer to
promote social efficiency rather than economic efficiency. Increasing employment
can be directly achieved through public enterprises.242 Similarly, given the high
dependence on oil, selling such non-renewable commodity under market price
may also be feasible under social and protectionist goals.243 In other words, state-
run enterprises in general are prone to pursue public welfare instead of
shareholders’ return maximization. 244 And this struggles with the economic
expectations of outside investors themselves particularly when social welfare leads
to losses for the company. In addition, SOEs in general are prone to a great
governmental interference, and they might be used by politicians as “clientelistic
vehicles” to enhance political relations or to increase the popularity of certain
political party.245 In this respect, appointing unprepared and inexperienced public
officials as board members or top managers does not add any value to the
company.246 Moreover, net exporter NOCs in particular might serve as “piggy-
239
For an important estimation of insider trading in Latin America see Juan J. Cruces and Enrique Kawamura,
Insider Trading and Corporate Governance in Latin America (IDB Working Paper No. 208, 2005)
available at http:www.ssrn.com/. 240
See Tomz and Wright, supra note 87. 241
See supra note 60. 242
The oil industry in Brazil accounts for “13.5% of federal SOE employment (with PETROBRAS as the most
important company)”. See OECD, Ownership Oversight and Board Practices for Latin American State-
Owned Enterprises (2012),
http://www.oecd.org/daf/ca/2011LatinAmericanCorporateGovernanceRoundtableSOEOwnership2013.pdf. 243
PETROBRAS, for instance, disclosed on Form 20-F of 2011 that the government can set prices “for crude oil
and oil products below prices prevailing in world markets”. See Pargendler et al., supra note 136. 244
See Megginson and Netter, supra note 15. 245
See Manzano and Monaldi, supra note 15. 246
“Government interference in the NOC decision making processes seems to be more closely related to the
degree of economic or strategic relevance of the petroleum sector to the specific country, rather than the
percentage of independent BOD or BOD committees’ members”. See Silvana Tordo with Brandon S. Tracy
and Noora Arfaa, National Oil Companies and Value Creation (The World Bank 2011).
68 Which are the Conflicts and Remedies?
banks” whenever the state suffers budgetary setbacks that can be covered through
rents from oil.247 Additionally, management tend to be less proactive in achieving
high sustainable profitability and less committed to bargain contracts and this is
the result of the lower pressure which monopolistic SOEs are subject to owing the
lack of competition and permanent financial aid and bailouts.248 The truth,
however, is that no formal mechanism has been implemented in Latin America
legal systems to address such particular problems. Therefore the solution can by
now come in the form of self-given standards. Interestingly, PETROBRAS’ minority
shareholders, for instance, are entitled to appoint at least one board member in
case the cumulative voting fails to give representation; similarly preferred
shareholders are entitled to appoint one member when their ownership interest
accounts for at least 10% of the outstanding stock.249 In the opposite end is
ECOPETROL whose bylaws provide that three board seats are directly filled by the
incumbent government.250 Yet, other type of informal mechanisms can play the
role. NOCs are prone to political control and mass media attention, which can in
some way serve as deterrent.251 However, this entails high uncertainty for outside
minority shareholders.
In aggregate, poor investors’ legal protection accounts for “reputational
loss” in detriment of listed companies.252 As a result of negative perception, lack of
confidence and adverse selection avoidance, potential investors involuntarily apply
a market-based discounting strategy by which the company’s stock price is lowered
to cushion the impact of eventual private benefits of control, ultimately keeping
balance between the investment and expected returns.253 This, in essence, increases
the cost of capital since the respective company is supposed to issue a higher
number of shares to raise the same amount. Yet, by improving firm-level corporate
governance measures, listed companies are able to increase their reputation
towards investors and access capital at lower costs.254 Therefore reputation may by
virtue function as an informal non-mandatory remedy against agency conflicts. In
line with the above, of particular importance in the landscape of emerging
economies is what a prominent body of literature has labeled “functional
247
See Manzano and Monaldi, supra note 15. 248
See Pargendler et al., supra note 136. 249
PETROBRAS bylaws. See PETROBRAS official website www.petrobras.com. 250
ECOPETROL bylaws. See ECOPETROL official website www.ecopetrol.com. 251
See Pargendler et al., supra note 136. 252
See José Miguel Mendoza, The Controlling Shareholder as Reputational Intermediary (Oxford Centre for
Corporate Reputation Working Paper No. 302, 2012), available at http://www.ssrn.com/. 253
ibid. 254
“The prospective variations in the firm’s cost of capital create an incentive for controlling shareholders to
invest in building up their reputation for fair dealing, which sets in motion the chain of events described in
the first two models”. See ibid.
Chapter 3 The Challen es of Investo s’ P otection 69
convergence”.255 As opposed to formal convergence, in which the rule of law of
certain jurisdictions is supposed to follow the set of improvements dictated by
advanced economies, functional convergence refers to the phenomenon in which a
great number of companies unilaterally improve their corporate governance and
voluntarily undergo stricter standards in order to gain investors’ confidence.256
Evidently this is nothing but a response to “legislative inertia”.257 The segmentation
of BM&F BOVESPA in Brazil is one prominent example of this type of self-
improvement within the region, whereby listed firms can commit to higher
standards (i.e. level 1, level 2 and Novo Mercado); including pure voting
proportionality (i.e. no non-voting stock, one-share-one-vote rule), 25% of free
float, and tag-along rights, among others.258 International cross-listing is the most
widely acknowledged form of functional convergence, whereby foreign companies
trade their securities in developed markets (e.g. NYSE, NASDAQ) via depositary
receipt programs (e.g. ADRs) and undergo higher disclosure requirements so that
they can obtain positive increases in their stock price and benefit from the so-
called cross-listing premium.259 In general terms, cross-listing does not only ease
the process of reaching non-resident investors; it also proves to offer great
economic benefits due to the additional layers of investors’ protection provided by
developed capital markets (i.e. the bonding hypothesis).260 In US, for instance, a
variety of ADRs exist and each is aimed to fulfill diverse needs of both, issuers and
investors.261 PETROBRAS and YPF stock is traded as ADR level III, while ECOPETROL is
255
See Coffee, supra note 200; Gilson and Schwartz, supra note 146; Alberto Chong and Florencio López-de-
Silanes, Corporate Governance in Latin America (Inter-American Development Bank Working Paper No.
591, 2007), available at http://www.iadb.org/res/publications/pubfiles/pubWP-591.pdf. 256
“… [L]aws may not be necessary to support external financing if, for example, companies deliver on their
promises not because they are forced to do so, but because they want to build a good reputation to facilitate
their access to capital markets”. See Chong and López-de-Silanes, supra note 255. 257
See Coffee, supra note 200. 258
See John C. Coffee, Racing towards the Top?: The Impact of Cross-Listings and Stock Market Competition
(2002) INTERNATIONAL CORPORATE GOVERNANCE COLUMBIA LAW REVIEW Vol. 102, No. 7, pp. 1757-
1831. 259
Additional studies suggest the benefits of cross-listing are also subject to other market conditions, for
instance engaging in business activities within the US. See Michael R. King and Dan Segal, International
Cross-Listing and the Bonding Hypothesis (Bank of Canada Working Paper No. 2004-17, 2004), available
at http://www.ssrn.com/. 260
Cross-listing can also be observed as an interesting case of legal extraterritoriality, meaning that even non -
US-based companies have to comply with US securities and listing rules if they wish to be listed on US
stock exchanges; in this way developed jurisdictions export their regulation beyond their borders without
formal transplants. 261
Firstly, Restricted ADR (Rule 144A) offers low level of protection. No registration statements must be filled
in; no US GAAP required. Nonetheless, there is a major restriction: no private placements to retail investors;
only to Qualified Institutional Buyers (QIB). Secondly, ADR level I offers a semi-low protection. This
means that a company seeking to distribute ADRs under this type only has to fill Form F-6 (depositary
receipts and depositary agreement) since Rule 12g3-2b gives them an exemption to provide other
periodically info. No US GAAP. But companies cannot raise funds nor acquire a listed company. Thirdly,
ADR level II offers medium level of protection. Form F-6 (depositary receipts and depositary agreement)
and Form 20-F (annual results and general info) are needed. Is not compulsory to a reconciliation with US
70 Which are the Conflicts and Remedies?
level II. Broadly speaking this means that unlike the first two companies, the latter
cannot raise funds, but the three of them are subject to US liability rules in favor of
ADR holders under the so-called “Morrison’s transactional test”.262 For all these
reasons, insiders may find great reputational incentives to strengthen their
relationship with outside shareholders particularly when the former repeatedly
raises funds from the same players.263 In the specific case of states as controlling
shareholders, reputation may ease the process of new fundraising for their NOCs as
well as for other state-owned or state-run firms.
Protection for minority outside shareholders is only one side of the full
spectrum. Protection of NOCs’ bondholders arise special concerns as well. The first
thing to note in this regard is that bondholders in general are simply deemed
“other constituencies”, and this ultimately changes the whole picture in the matter
of protection. Owing the permanent dividing line between shareholders and
creditors set by corporate law regimes, bondholders are regarded as lenders (i.e.
contract creditors or voluntary creditors) of the company who ex ante were able to
deal with adverse selection and bargain for the conditions in which their sources
were put under the command of the firm as well as sufficient risk compensation.264
Since bondholders in general are non-shareholder constituencies, they are nothing
but “residual claimants” thus legal protection becomes a concern of conventional
civil, corporate and bankruptcy law. And the assumption that bondholders are just
lenders is to a greater extent acceptable but still arguable in specific cases. Firstly,
GAAP, but explanation of local accounting system is needed. The main restriction is basically fundraising.
Finally, ADR level III offers the higher protection level. In this sense Form F-6 (depositary receipts and
depositary agreement), Form F-1 (concerning deposited foreign shares) and Form 20-F (annual results and
general info) need to be filled in. US GAAP must be followed. Non-US companies also have to disclosure
any information disclosed on their own jurisdictions. Foreigner issuers still tend to fill in Form 10-q to
create confidence in both retail and institutional investors; these voluntary periodic disclosures are used as
means of increasing liquidity. See Choi and Pritchard, supra note 131. 262
Disclosure is just part of average statutory protection. But liability is not as simple as applying Rule 10b-5
in all cases. Speaking of ADRs, there is a thin line between national and foreign transactions and the
application of §10b of the Securities Exchange Act specifically relies on that. According to the so-called
“Morrison’s transactional test” misleading disclosure, fraud or insider trading on RADR and ADR level I
cannot be subject to enforcement under Rule 10b-5 since the underlying stock is not listed on US markets.
In this respect, those causes of action can only reach liability within the context of ADR Level II and III. See
further V.M. Chiappini, How American Are American Depositary Receipts? ADRs Rule 10B-5 Suits, and
Morrison v. National Australia Bank (2011) 52 B.C.L. Rev. 1795. 263
“Perhaps the most salient example of an informal institution at work is the mechanism known as
reputational intermediation. This institution is based on the existence of repeat players in capital markets
that can instigate trust between listed firms and potential investors. Reputational intermediaries provide
assurances to investors concerning the accuracy of a firm’s disclosure and the behavior of insiders. As these
intermediaries expect to interact with investors over a long-term horizon, they have incentives to build up a
positive reputation ‘on the basis of consistent behavior over time’. If the assurances provided to the market
turn out to be hollow, these intermediaries will suffer a ‘reputational loss’ that will impact negatively on
their ability to deal with investors at a future stage”. See Mendoza, supra note 252. 264
See John Armour, Gerard Hertig and Hideki Kanda, Transactions with Creditors in Reinier Kraakman et al.
(eds) THE ANATOMY OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL APPROACH (OUP 2009).
See also Stephen Bainbridge, Abolishing Veil Piercing (2000), available at http://www.ssrn.com/.
Chapter 3 The Challen es of Investo s’ P otection 71
the assumption is accepted in the sense that insiders may openly pick the
fundraising mechanism to finance their business plans or mitigate cash shortfalls
depending on a variety of pros and cons, including legal factors; hence what turns
portfolio investor either in outside shareholders or bondholders is nothing but a
rational management decision based in a great number of factors. Going for
external equity means that insiders only have to share the harvest in the form of
periodical dividends, but at the same time they get diluted. Going for debt
ineludibly means fixed payments, but the ownership interests remain intact.
Precisely, economists have studied what the main determinants of going for either
external equity or debt are; and two theories have dominated such discussion. In
broad strokes, the “pecking order theory” estimates the costs of adverse selection
when raising different type of resources and predicts a “financing hierarchy” by
which companies resort first to retained earnings or bootstrapping, then debt and
finally external equity; whereas the “trade-off theory” calls for a balance of leverage
and equity.265 In this respect, bondholders voluntarily accept or reject the terms in
which the issuance is made. They bear adverse selection by analyzing whether or
not the issuance is properly valuated, and sometimes the issuer may even grant
some guarantees in the form of negative covenants in order to limit an eventual
risk shifting problem, ultimately making the debt securities look more attractive
into the eyes of public investors.266 Nonetheless, assuming that all bondholders are
“other constituencies” in the case of NOCs deserves a revision. Generally NOCs
recall the power of the nation among citizens and nationalistic rather than
economic grounds may lead them to purchase bonds issued without even telling
the difference between holding equity or debt. In other cases states might just
simply exert political and even legal pressure to get its bonds bought. Even though
it is unlikely to happen, legal regimes must be prepared beforehand and should
consider granting higher protection in such cases. Consider for instance what
occurred in Brazil in the early days of PETROBRAS when car owners were compelled
to buy bearer bonds as a result of a yearly compulsory contribution statute.267 To
this day, the return of a great number of this type of bondholders was subject to
prescription in courts because no claims were made on time by their surviving
relatives, and of course this circumstance owing the fact that they were bearer
bonds. Unlike average bondholders, regular citizens are not able to bear adverse
selection or to lessen the risk shifting problem. As it turns out, self-interest states
might just decide to issue debt instead of equity and not only to circumvent
265
See Murray Z. Frank and Vidhan K. Goyal, Trade-Off and Pecking Order Theories of Debt (2007),
available at http://www.ssrn.com/. 266
See Richard D. Macmin, The Fischel Model and Financial Markets (World Scientific Publishing, 2005). 267
See PETROBRAS website
http://www.investidorpetrobras.com.br/en/investor-s-center/shareholder-information.htm.
72 Which are the Conflicts and Remedies?
monitoring pressure, but also to maximize the state wealth at the expense of these
individuals by offering risky bonds with unreasonable yields. The truth, however, is
that even the more extensive approach of corporate governance does not even
appear to foreseen such daunting problems; therefore bondholders are treated as
simple contract creditors and consequently they are only left with a preferential set
of liquidation rights in the case of bankruptcy. According to the stockholder-
oriented approach of corporate governance, corporate law must concern only
about endogenous corporate relationships as different branches of law vest
stakeholders with adequate shielding.268 In other words, employees, creditors,
neighboring community, among others, would find protection basically under
labor, civil, tort and environmental law. On the other hand, the stakeholder-
oriented approach claims for the expansion of the protective scope of corporate
governance towards other constituencies and exogenous corporate relations.269
The bulk of the discussion between these two perspectives, however, mainly lies in
whether employees and involuntary creditors proved sufficiently protected, but
literature is quite absent concerning SOEs special bondholders.270 And this is a
delicate issue since the protection of such individuals is left for the latest phase of
the business life cycle. Some interesting measures that are not related with
bankruptcy were at some point of history embraced in some jurisdictions to
enhance protection of bondholders. In 1929, for instance, Chile provided that a
bondholders’ committee was entitled to demand for the replacement of directors
in case of default.271 Evidently, according to the current line of thought in which
shareholders are on one end and bondholder on the other, measures like this
might sound odd and out of proportion. Even if this was revised, granting such
degree of control over management might be counterproductive and can
eventually hinder the inner working of the company (e.g. possibility of losing
influence in the board when issuing large amounts of debt to such “unqualified
investors”, ultimately deterring public financing and reinforcing traditional
banking). But the debate is opened. In this respect, Latin American legal systems
268
See Klaus J. Hopt, Comparative Corporate Governance: The State of the Art and International Regulation
(Law Working Paper N°.170, 2011) available at http://www.ssrn.com/. See also Hansmann et al., supra
note 200. 269
ibid. 270
To give an example, an important number of employee-oriented jurisdictions articulate not only two-tier
management systems (in which one segment of the board is vested with management functions as such and
the other with monitoring functions), but also the so-called “labor codetermination model” whereby
employees are directly represented on the supervisory board —employees of PETROBRAS and PEMEX have
seats in the supervisory board; 1 and 5 members respectively—. Similarly, the discussion of ignoring the
limited liability postulate becomes greater when it comes to tort victims. This ex post judicial standard
known as corporate veil piercing has been reserved as last resort for extraordinary cases in which no other
protection results effective. 271
See Pistor et al., supra note 214.
Chapter 3 The Challen es of Investo s’ P otection 73
can innovate in order to grant protection to such individuals outside the
conventional bankruptcy protection. For instance, mandatory conversion of debt
instruments held by unqualified investors (e.g. regular citizens) into equity
securities can be a straightforward and accurate remedy. Unlike the old Chilean
remedy that allowed appointing directors indirectly, mandatory conversion may
not affect control insomuch as controlling shareholders still may retain control
through dual-class shares. Such remedy would at least enable investors to switch
from the risk shifting problem between the company and creditors to the classical
agency problem between insiders and outside investors —benefiting from the
broader set of protections to shareholders and not only through bankruptcy
postulates—.
To this point, it is plausible argued that Latin American jurisdictions offer
lots of protective measures to portfolio investors in general, but only few appear to
provide effective protection. Reputation plays an essential role whenever insiders
and outside investors are repeated players, bridging the gap between law and real
life. However, the triumph of market-based remedies over legal remedies means
portfolio investors’ protection still faces plenty challenges. How committed are
Latin American policy makers to enhance their corporate legal regimes?
Considering the background of Latin American institutions, one additional
challenge in this regard consists in the formal implementation process of corporate
governance policies within the region. As previously assessed, the so-called
“functional convergence” of corporate governance is one of the most remarkable
formulations since listed companies find reputational incentives to voluntarily
embrace efficient protective measures to enhance the confidence of portfolio
investors.272 Because standardization is essential in emerging economies serving as
cost reduction instrument for investors, the question that remains, however, is
whether Latin American states can converge in a standardized set of corporate
governance measures through legislation. And the answer is somewhat
disappointing. In spite of the fact that regional efforts towards integration and
business constraints reduction have been materialized in the form of supranational
organizations such as Mercosur and Andean Community of Nations (ANC);
corporate law and corporate governance do not seem to be principal concerns in
their agendas. In fact, domestic corporate governance regimes have been barely
influenced by such entities. To give an example, the most prominent arrangement
in this regard was made by early 1990s when the ANC established the “Andean
Multinational Enterprise”; that is, a voluntary set of rules which local join stock
corporations were able to opt-in as an attempt to ease the process of external
272
See Coffee, supra note 200; Gilson and Schwartz, supra note 146; Chong and López-de-Silanes, supra note
255.
74 Which are the Conflicts and Remedies?
corporate expansion towards other member states.273 The truth, however, is that no
significant impact was witnessed due to the fact that such piece of legislation did
not offer further protection nor advantages than those offered by local corporate
statues. In absence of regional leadership, other international institutions have
taken the initiative. The Organization for Economic Co-operation and
Development (OECD), for instance, has enacted tailor-made recommendations for
the region in order to close such gap. The White Paper on Corporate Governance
in Latin America is one of the most notorious efforts intended to foster regulatory
renovation, and relies basically in the importance of equitable treatment of
shareholders, voting proportionality, board composition, and disclosure of
beneficial ownership and control. Of course, some of its contents have been subject
to persuasive criticism by regional academics, but still remains as an essential
guideline for regional policy makers.274 The OECD also promoted the creation of the
Latin American Roundtable on Corporate Governance, a forum where participants
from a great number of Latin American countries as well as Canada, Italy, Spain,
Turkey, UK and US discuss the latest trends in corporate governance.275 More
interestingly, the OECD has particularly promoted corporate governance for state
entrepreneurship since 2011 through the Latin American Network on Corporate
Governance of State-Owned Enterprises, which is expected to have a great impact
on formal convergence of corporate governance, at least in the matter of SOEs.276
Yet, Latin American traditional organizations have proved indebted.
273
See The Commission of The Cartagena Agreement, Uniform Code on Andean Multinational Enterprises
(1991) in INTERNATIONAL INVESTMENT INSTRUMENTS: A COMPENDIUM, available at
http://unctad.org/sections/dite/iia/docs/Compendium/en/47%20volume%202.pdf. 274
For the full critic see Reyes, supra note 155. 275
See http://www.oecd.org/corporate/ca/latinamericanroundtableoncorporategovernance.htm. 276
See
http://www.oecd.org/fr/gouvernementdentreprise/ae/gouvernancedesentreprisespubliques/latinamericannet
workoncorporategovernanceofstate-ownedenterprises.htm
Using a comparative view, this master thesis analyzed the current set of regulatory
protective measures which investors within the top five Latin American oil
producers are vested with. For this end, it aimed to illustrate how a wide array of
regulatory alternatives can be considered by resource-rich countries when
developing their oil and hydrocarbons industry, and how each selection in Latin
America has been the outcome of a privatization-monopolization cycle driven by a
great number of determinants. Moving throughout the framework and changing
institutional designs has been explained as a cyclical phenomenon driven by
ideological and political grounds (e.g. national proud, popular sovereignty,
egalitarianism, populism, reprisal towards foreigners, foreigners’ influence
restraint, smokescreen) and economic determinants (e.g. increase of international
crude oil price, deficiencies in the taxation and royalties systems, liberation of new
cash flows). Either case, each phase of the cycle entails either greater or lesser
participation of National Oil Companies (NOCs) and private investors. The
institutional design currently set up by the Latin American top oil producers,
involves high participation of direct and portfolio investors; that is, International
Oil Companies (IOCs) and outside shareholders and bondholders of NOCs.
Such complex design is not exempted from conflicts. Two value-reducing
forms of opportunism emerge. At one pole, host countries may reshape at any time
the scheme which governs the relationship with IOCs to benefit their “crown
jewels”. Even worse, under lower level of governmental commitments, IOCs could
be push out of the industry. At the other, since NOCs are resorting to public
external financing, a conflict arises between them as insiders and portfolio
investors. As if this classical agency problem were not enough, outside
shareholders and bondholders are also faced with specific political risks, namely
politicization, bureaucracy, populism, and so on.
After assessing each conflict, the analysis shows how investors’ protection
is mostly faint. Although controversial, “treaty shopping” has proved a market-
based remedy in the absence of formal effective means of protection for direct
investors. However, its success fighting back against the sovereignty postulate
(which is the most powerful instrument in the hands of resource-rich nations) is
relative because it does not prevent shifts in public policies or weaknesses in local
protection of property rights; it only mitigates the effects through the recognition
of compensation. The Netherlands has specially served as “treaty shop”. As for
portfolio investors, the existing legislation mainly lies in the classical corporate law
remedies such as supermajority, cumulative voting, preemptive rights and
dissenter remedies as well as other housekeeping rules regarding the shareholders’
76 Conclusion
assembly meetings. Owing the prominent influence exerted by developed
jurisdictions in fighting back against the latest corporate crises, Latin American
lawmakers have attempted to tight even more the existing legislation. Recent
enactments, however, provided a wide set of check-box rules that focus on
conflicts that arise from dispersed and not concentrated ownership structures,
creating direct and unnecessary costs. One prominent failure is that the most
important formal remedy of concentrated ownership structures —abuse of voting
rights or shareholders’ fiduciary duties— have been a “visible absence” in Latin
America, exempt for Brazil and Colombia. Naturally, the success of such ex post
remedy relies on institutional strengthening insomuch as civil law judges would
have higher discretion than what they are accustomed to. Remarkably, investors
have found market-based strategies to deter opportunist behavior by insiders. In
the combination of international cross-listing and ex ante discounting, NOCs have
found market incentives for growth to commit to higher disclosure standards as
well as market deterrents to not misappropriate minority shareholders’ wealth.
Finally, one daring claim is made in regards to the conventional protection
provided to certain bondholders of NOCs, meaning that an additional footnote in
the pages of the corporate governance discipline is needed.
In spite of the fact that each Latin American country is to some extent
trying to tune up according to the world trend in the matter of investors’
protection, the truth is that the region taken as a whole has proved indebted in
embracing tailor-made and value-creating protective measures. As a result of such
absence, investors have been compelled to resort to market-based remedies.
Results, however, are mixed up. Whereas some administrations strength their
reputation to generate confidence among investors, others simply use the power of
sovereignty to achieve any goal. And the reason is quite straightforward. The
former are subject to market discipline (i.e. discounting) and therefore may
potentially suffer direct losses, whereas the latter are not and losses are simply
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