The Political Economy of Oil Production in Latin America
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The Political Economy of Oil Production in Latin America

The 1990s witnessed a significant increase in investments in the oil and gas sector in Latin America. In most countries, private investment took the lead after the privatization and liberalization of the sector. In Argentina, Bolivia, Brazil, Ecuador, and Venezuela, private oil investment or some form of privatization (or both) generated significant increases in hydrocarbon production and reserves. In the last five years, however, the region has experienced a new wave of resource nationalism, with increases in the government’s take and state control. Oil taxes have risen significantly in Argentina, Bolivia, Ecuador, and Venezuela. In addition, Bolivia and Venezuela have partially nationalized oil projects. We argue that the recent trend is largely the outcome of the rise in the international oil price. Furthermore, we show how the likelihood of expropriation increased after a period of successful investment in exploration and production. At the same time, the timing of these changes and direction in which the sector has evolved varies considerably across the region. In contrast to most other countries in the region, Brazil, Colombia, and Peru have generally strengthened the institutional framework and the property rights of private oil producers. This paper provides a political economy rationale for the divergent evolution. [End Page 59]

The general pattern of development unfolding in the oil sector is not new. Historically, the evolution of oil and gas production in Latin America has seen cycles of investment and expropriation. For example, in Venezuela large oil investments were made throughout the 1940s and 1950s; a process of systematic increase in the government’s take then began in the late 1950s. The fiscal take on profits rose from levels around 50 percent in 1943–58 to a maximum of 94 percent in 1974, the year before nationalization.1 Similar episodes have occurred in Argentina, Bolivia, Ecuador, Mexico, Peru, and other developing countries.2 Even in some developed countries, governments have reneged on the fiscal and contractual conditions after considerable investments were made. A recent example is the increase in royalty rates in Alberta, Canada.

This paper studies the cycles of investment and expropriation in the context of the Latin American oil sector. In particular, it provides an explanation for the state’s difficulties in capturing the oil rents and rationalizes the tendency of governments to periodically renege on their prior agreements pursuing the quasi-rents. The paper does not try to provide a general proposal for the right fiscal and contractual structure, however, as the right structure must be tailored to each country.

Although the discussion on expropriation is typically an emerging-market issue, it is important to emphasize that changes in the tax and contractual framework of the oil sector have not happened only in less-developed or oil-dependent countries. For example, the United Kingdom has instituted important tax modifications, most of which have coincided with oil price changes.3 Besides the corporate income tax, oil projects in the British North Sea pay a special tax called the petroleum revenue tax (PRT), which is a form of tax on returns. The PRT was originally set at a rate of 45 percent, but it was increased to 75 percent when prices increased in the 1970s. In the 1990s when the North Sea began to be depleted, the PRT was reduced to 50 percent for existing projects and eliminated for new projects.4 When oil prices increased again in 2002, the British government established a supplementary charge of 10 percent [End Page 60] , effectively increasing the tax on upstream profits.5 A comparable history can be written for oil taxation in the United States and Canada.

The oil industry has some specific features that strongly influence the way the institutional framework and the political economy of the sector evolve. Some of those features are shared with other sectors in different degrees, but the oil industry is one of the few in which their combined importance is significant. First, oil extraction and, to a lesser extent, natural gas extraction generate important rents. Second, oil and gas extraction require major sunk investments. Third, a high proportion of oil reserves are concentrated...