Subsoil Oil and Gas Privatization: Private Wealth for the Common Good (Message for Latin America)

By Guillermo Yeatts -- April 30, 2010

[Editor note: A profile of Guillermo “Billy” Yeatts, an Argentinean and energy expert, author, and free-market philanthropist, is at the end of this post.]

The history of oil and gas production in Latin America has been characterized by a continuing tug of war between the state as owner of the subsurface (Spanish colonial tradition) and private producers in pursuit of profits. Private participation in the industry has been limited to brief periods and restricted to specific phases of oil and gas production.

The typical pattern is that foreign oil and gas companies are allowed into a country to locate and initiate production. Once oil is flowing, governments nationalize the companies’ facilities – with or without compensation – and hand them over to government-owned and operated monopolies.

Whether the oil or gas is produced by private corporations or by a government monopoly, it is almost always the government that receives most of the profits. All too often, the money is used to keep the heads of state in power.

In the United States, by contrast, individuals own and control much of the nation’s subsurface rights to energy and other minerals. The results are starkly different. While the oil and gas industry in the United States expanded quickly, bringing prosperity to many areas that were once underdeveloped or deserted, oil revenues in other countries have propped up corrupt governments with little or no benefits to the general welfare.

State ownership of the subsurface removes incentives for risk-taking, investment, and technological innovation. Farmers and ranchers are pitted against oil development. In Latin America, the prospect of an oil or gas discovery is a farmer’s worst nightmare. They reap no financial benefit from the discovery, but they do suffer land damage and the disruption to their lives from drilling and production operations. Consequently, a landowner’s incentive is to hide any mineral wealth his property might have and to fight any attempt to exploit such wealth.

In the United States, on the other hand, landowners dream of oil being discovered on their property. If they own the mineral rights, they are compensated for the right to explore and receive a royalty for any minerals produced. This more than makes up for the inconvenience of oil and gas operations on their property.

Spread of Oil Nationalism in Latin America

Theories of political and economic nationalism espoused by Latin American intellectuals in 1920s provided the analytical framework for dissatisfaction with the distribution of wealth. Nationalists became convinced that the state had to play a major role in the operation and development of the oil and gas industry. This led to a domino strategy of government confiscations of privately owned energy facilities in both Latin America and the Middle East.

Mexico led the way in the Americas, nationalizing its oil industry in 1938. Yet despite its oil wealth and other abundant resources, 70 percent of the country’s 105 million people still live in poverty. The border problem between Mexico and the United States speaks volumes about the economic system of the two countries.

While most Latin American countries followed Mexico’s lead, some have since “privatized” operations. Venezuela, for example, nationalized in 1975 and then welcomed foreign companies back in 1992. Bolivia partially privatized its operations in 1993.

In practice, however, “privatization” consisted only of allowing private companies (always foreign-owned, since private domestic operations are illegal) to explore for and produce a nation’s oil and gas reserves. Ownership of those reserves remained in government hands, and the proceeds for their sale continued to flow to the government – or rather to those who controlled the government.

That is not to say that there are no real benefits even to such limited privatization. Private corporations, driven by the profit motive, are generally far more efficient and less wasteful than are government-owned companies that have no incentive to use resources to their best effect. Greater efficiency translates into more careful development (less pollution) and more production at less cost. Nor is it to say that nationalization does not have additional costs beyond government mismanagement of natural resources. When private property is confiscated, capital investment flees the country, limiting chances for growth and prosperity.

The real problem, however, is that regardless of who owns the company producing the oil or gas, the lion’s share of the proceeds still goes to the government as owner of the mineral reserves. All too often the money is used to:

1. Consolidate the ruler’s power by rewarding cronies and buying off opposition leaders.

2. Increase the ruler’s personal wealth (e.g., pre-war Iraq).

3. Build armies to subdue the populace and gain influence over neighbouring countries (e.g., Venezuela).

4. Finance terrorist activities to keep democratic ideas from undermining an authoritarian culture nurtured by radical Islamic leaders (Saudi Arabia).

Even when the money is used to benefit citizens, it is typically spent on grandiose “infrastructure” projects that do more to help already wealthy contractors than to aid the nation’s citizens. As a result, wealth is squandered, people exploited, and society continues to be burdened with poverty in the midst of a rich pool of resources neither fully nor efficiently exploited.

Perhaps just as bad, the de facto ownership of such vast wealth by a few leaders enormously increases the stakes of gaining or losing political power. Election winners gain the legal right to loot the country, and line their own pockets as well as those of their supporters. With so much riding on each vote, the battle for political power can become fierce and even deadly. Elections under such conditions are routinely rigged.

Because neither nationalization nor “privatization” (as it has been practiced fundamentally) changes the lives of average citizens, unrest remains the political constant in the Middle East and in Latin America.

Today, Bolivia’s people are in the streets demanding a re-nationalization of the country’s oil industry. Other than less efficient operations and more pollution, such an action will accomplish little. After a few decades of mismanagement by an inefficient and corrupt government-owned company, the pendulum may swing back, and “privatization” will again be tried.

Breaking the Cycle

Government ownership of the subsurface throughout history has had profoundly negative consequences for not only the domestic economy but also—in the case of petroleum—consumers around the world. The power to control production, to squander resources, to determine prices for domestic markets has produced political instability, corruption, and poverty. The surge in oil prices in recent years is due in part to socialist governments not being entrepreneurial enough to anticipate and meet rising demand.

True privatization—granting individuals ownership rights to the subsurface—would enable mineral-rich but impoverished nations to break this vicious cycle. This could be done by simply granting land owners complete rights to any mineral wealth that lies below their property. These rights must include the right to buy, sell, trade, and inherit such property.

In many of the nations in question, however, surface rights are not privately owned any more than are subsurface rights. In such cases, the land itself, together with what lies beneath it, would also have to be privatized. The mechanics of how this is accomplished, while irrelevant to theoretical economists, are of paramount importance. We have seen, for instance, how after the break up of the Soviet Union, state property was given or “sold” to members of the old ruling regime – continuing the cycle of corruption and exploitation by the political elite in different guise. Assignment of property rights must not only be just, it must be seen to be just.

True privatization of the subsurface is the institutional change that will reduce the stakes in political elections, reduce corruption and political instability, reduce the waste of valuable resources, and allow individuals to break free of government control over their lives and destinies.

Looking to the Future

It is hard to predict what the new oil market will look like if subsurface ownership is transferred from state control to the surface owners. But the new environment will create a new set of incentives to increase growth and productivity. The change is about freeing minds from government restrictions. It will appeal to the initiative of thousands of surface owners who will discover new business opportunities and new means to obtain profits.

Society at large will benefit hugely from a transfer of wealth from the political sector to the private sector. Greater resources will go to exploration and production, and the greater production will benefit consumers worldwide. At the same time, fewer resources will be available for political elites to distribute among their cronies, promote their own ambitions, and, in some cases, fund terrorism.

Private ownership of the subsurface will ensure that benefits as well as the costs of oil production will remain in the private sector, rewarding the efficient and punishing those who are not. This, in turn, will increase productivity and general prosperity. As individual citizens gain economically, civil and social power will increase and political power will decline, leading to the end, or at least the weakening, of authoritarian regimes in Latin America, Africa, and Middle East. Petroleum, in particular, can literally be turned from a political bad into a social good, a noble vision for a world that needs affordable energy in ever greater quantities.

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Guillermo M. Yeatts, born in Buenos Aires, received a BS in Finance and a MA in Economics at at New York University (NYU).  He went on to complete the plural year program of OPM at the Harvard University School of Business in Boston, Massachusetts.

Mr Yeatts is a former Chairman of:  SOL Petroleo S.A. ( refining and marketing );  Diamond Shamrock Boliviana S.A., Santa Cruz, Bolivia ( exploration and production of crude and gas); Cadesa S.A., Rio Grande, Tierra del Fuego ( petroleum drilling ); Joss S.A., Buenos Aires ( petroleum transportation ) ;Massey Ferguson Argentina (an agriculture machinery) and worked in management positions in Ford Motor Company (Dearborn and Buenos Aires) and Citibank, New York.

Mr. Yeatts is the Chairman and founder of Atlas Foundation 1853, Buenos Aires; ex-Chairman  Junior Achievement Argentina; ex- member of the Board of Directors of the Foundation for Economic Education (FEE), Irvington-on-Hudson, New York; ex-Chairman and co-founder of  ESEADE (graduate school of business), Buenos Aires; ex-member of the Board Institute Energy Research, Houston, Texas; ex-Chairman FEEL, Buenos Aires; and  member of the Mont Pelerin Society Foundation in Switzerland.

Mr. Yeatts is the author of six books, three relating to the petroleum industry and three to the causes of poverty in Latin America.  In 1998, his book El Robo del Subsuelo received first prize in the Sir Antony Fisher Memorial Award presented by the Atlas Economic Research Foundation of Fairfax, Virginia.