Emerging market governments are asserting their sovereignty over valuable natural resources and affecting how companies can do business in these regions

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High commodity prices are creating problems for companies around the world. As well as impacting negatively on their finances, the high cost of food and fuel is creating social tensions and having knock on political effects.

One of the consequences of price rises is government expropriation of natural resources and contract renegotiation, which affects companies that invest overseas and mainly in emerging market economies.

In 2007, Ecuador’s president Rafael Correa announced plans to charge a 99% tax on oil companies. Following a series of arbitration claims from the affected companies that summed around $12bn, the government dropped the tax to 70% but only for those who agreed to drop their claims and sign up to new contracts.

The situation highlights a trend whereby populist governments, inspired by the prospect of lucrative windfalls, are renegotiating contracts with terms more unfavourable for foreign investors, according to new research from the broker Jardine Lloyd Thompson (JLT).

In response, foreign companies are now scrutinising contracts far more carefully than they have done in the past, said Elizabeth Stephens, political risk analyst for the broker.

Emboldened by a stronger hand, which includes higher raw material prices, populist mandates and new sources of investment like China, Russia and Brazil, emerging market states in Latin America and central Asia are choosing to revisit the terms by which companies make use of their natural resources.

And these natural resources are increasingly viewed in terms of their national and strategic value for the countries that control them. Russia recently reduced its oil supplies to the Czech Republic by half for ‘technical reasons’. The cut came just after the Czechs agreed to host an American missile-defence radar. Supplies to neighbouring countries were not affected in the same way.

Political influencers may also be flexing their muscles in the TNK-BP affair. Robert Dudley, the chief of BP’s Russian affiliate, was forced to temporarily leave Russia after visa problems that appear to be linked to a dispute over how best to distribute the oil company’s profits.

Recent Russian regulatory changes, which limit foreign investment to 5 % of mineral exploration companies and 25% of industries relating to national security and defence, have effectively codified resource nationalism in law, noted the report. The national security designation could extend to the telecommunications industry, added JLT.

But legal and regulatory risk isn’t exclusive to emerging markets. Stephens argued that Gordon Brown’s tax on non-domiciles might have made the UK less appealing in terms of long-term investment. The British Prime Minister is also under added pressure from key party backers to levy a windfall tax on the North Sea oil industry, an issue he may have to consider given his weakened political and financial position.

Food riots

High prices in commodities have also triggered a number of strikes around the world seriously disrupting business.

There have been food riots in around 30 countries as wages and incomes fail to keep pace with food price inflation. This has been felt most acutely in developing economies, where the poor spend a greater percentage of their income on food, but it is not limited to these regions. In July, council workers across the UK took to the streets saying a 2.45% pay offer represented a wage cut in real terms.

A government’s response to social unrest is crucial to stability. In Bangladesh the government borrowed about $200m from the Asia Development Bank to help ease the burden of higher food prices, but elsewhere less democratic countries have been known to escalate violence. ‘In Indonesia there is a direct correlation between strikes and riots and the price of rice,’ said Stephens.

A more equitable sharing of the upside of high commodity prices is the right thing. But sensible administrations, even those with expropriating tendencies, are weary of frightening investors away, given that the initial expense in setting up mining or drilling infrastructure often requires outside help.