The Rising Influence of Rising Affluence

[DewDiligence]

A Wrong Turn on Natural Resources

[This is an op-ed piece in Monday’s WSJ.]

http://online.wsj.com/article/SB20001424052748704596504575272790583630252.html

›JUNE 1, 2010
By JOSEPH STERNBERG

For all that talk about a new knowledge economy, things still matter a great deal in this world. And whether it's the steel beam holding up the floor of your office, the gasoline you put in your car or the circuitry in your new iPad, "things" mean natural resources. So it's worrying that one of the major policy trends emerging in recent days is that the capitalist West is cutting itself out of the resource game.

Witness President Obama's extension of a moratorium on offshore drilling in the wake of the Gulf oil spill. His move blocks 33 exploration projects in the Gulf of Mexico, as well as progress on drilling off the Virginia coast and in the Arctic.

Meanwhile, Australia—a key supplier of minerals such as iron ore and uranium—is debating a confiscatory 40% tax on "excess" mining profits. This already is hampering investment in the country's mining industry. India, Brazil and Chile also are contemplating various forms of windfall profits taxes.

Domestic political concerns explain these policy blunders. Oil drilling of any sort has been contentious with environmentalists and coastal NIMBYs in the U.S. for decades—and those folks tend to vote Democratic. While the tragic and destructive Gulf spill is being cited as the main reason for the latest ban, in truth it is simply providing cover for policies the left has wanted to implement for years, and a convenient excuse for President Obama to backtrack from earlier promises to drill offshore. As for all the windfall-profits taxes, blame governments grasping for new revenue to make up budget shortfalls.

It all adds up to a global problem. One common thread running through these cases is that all the countries involved are democracies. The danger is that if these countries won't supply minerals to the world on market principles, others—like China—will step into the gap with other ideas.

China's alternative is to expand its own non-transparent resource grabs around the world. If capitalism can't provide, Chinese companies will make their own deals in places like Africa, Mongolia and Russia. Expect to see more stories about new Chinese-funded mining or drilling projects in the third world. Expect also to see a lot of hand-wringing about whether this means the authoritarians in Beijing are extending their political influence in smaller, weaker developing countries.

Meanwhile, America's policies to keep its own oil reserves untapped mainly benefit Russia, the Middle East and Venezuela, which are left to fill the unmet demand—and profit handsomely as a result. Especially when combined with weak-dollar policies from the U.S. Federal Reserve, these regimes enjoy enormous windfalls the less Western competition they face.

Sometimes capitalist countries themselves may benefit from this, since state-owned companies can invest in resource extraction with less regard for profitability than Western listed companies. Such has been the case in Canada, which in 2006 announced that as of next year it will increase taxes on the corporate "income trust" structure that is popular in the resource industry. The corporate profits tax rate on such enterprises will rise to above 30% from zero today. That has crushed valuations in the oil industry, which is capital intensive since Canada's petroleum reserves are mainly in the form of hard-to-extract oil sands.

Smelling a buying opportunity, Chinese state-owned companies, which aren't controlled by private shareholders and can accept a lower return, have been willing to move in, investing at least $4.6 billion in Canadian oil companies since the tax increase was unveiled. Abu Dhabi has also become a bigger investor.

But this means the West will have to become more receptive to that kind of investment. Canada has, but Australia and the U.S. in particular are still hesitant. Remember the controversy over an attempted Chinese purchase of Unocal in 2005? One point of this story is that Western governments will have to either get out of the way of Western companies that want to extract resources or prepare for the Chinese and others to try.

Without giving too much credence to China alarmists, it is still possible to say the world is better off if resources are in the hands of transparent companies that will trade on market principles free of the risk of excessive government interference. The third and worst alternative is to stay on the current track of crippling Western resource reserves while also blocking capital from the willing investors that remain.

Yes, companies will continue to extract resources in the West even under the taxes (though the outright drilling ban is another story). But those bad policies will make a major difference at the all-important margins of the market, which drive pricing decisions. The choice for Western policy makers now is simple: They can clamp down on their resource industries for domestic political reasons and hand pricing and supply power to non-market and non-democratic governments. Or they can allow their own companies to run a truly global resource market capable of meeting the world's need for things.‹