The pitfalls of protectionism shown by Brazil and Mexico

In Brazil, with a massive new offshore oil discovery, President Luiz Inacio “Lula” da Silva is proposing to award some exploration and production rights to Petrobras, the state-owned but publicly-trading oil group, without options for foreign firms. A new state company Petrosal would also award over half of shallow-water contracts to local companies. In deeper waters beyond the capacity of local companies, foreign bids would be invited but those pledging to incorporate Brazilian staff or technical resources would be favored.

Mexico is on a similar protectionist trend. President Felipe Calderon signed off in December 2008 on plans to increase “local content” in the Mexican energy industry to 25%, partly by creating a support fund for Mexican companies.

Ironically, this protectionism in energy is the opposite of the open trade that Mexico and Brazil have adopted in regional trade agreements and international competition in other fast-developing sectors such as agriculture and aerospace. So why oil?

In fact, governments both rich and poor intervene considerably in oil and gas — including in the labor market — because the revenues can change the fate of the country. Oil allowed Angola to repay IMF debt and helped revitalize the UK economy under Margaret Thatcher. Indeed, blocking bids from foreign companies was a strategy of Norway, which actually postponed drilling to allow the country to build up other domestic oil service activities to run alongside the burgeoning industry.

The logic driving such decisions runs thus: Countries without domestic oil and gas companies find the exploration and production process becomes an enclave economy, with foreign experts shipped in and out and the fiscal proceeds going straight to government by way of royalties instead of to local companies and employees. But there are pitfalls to protectionism.

Firstly, state-owned oil and gas companies have proven less efficient than private corporations. “On average, NOCs (national, state-owned, oil companies) extract resources at a far lower rate than IOCs (independent oil companies),” says Mark C. Thurber, Director of the Program on Energy and Sustainable Development at Stanford University.

This is because monopolies are not subject to competition and are prone to corruption: Gazprom, Russia's state-owned gas company, has debts totalling US$40 billion and has brought only one new Russian gas field on stream since the early 1990s.

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