A royal mess: as commodity prices zoom, governments are raising--even creating--royalties on foreign mining and petroleum companies.

Commodities have long been the bread and butter of Latin American economies, but the price of political instability in decades past has been ironclad promises of investment security and, always, low taxes. As Chinese demand has spiraled upward, however, doubling prices on staples like oil and minerals, politicians both left and right across the region are looking for ways to rewrite their longstanding royalties deals with foreign extraction companies.

Political leaders in Venezuela have forced royalties on foreign oil companies up to nearly 16.7% from 1%. (A royalty is the cut of a profit a country takes from an oil or mining project.) Chile, which put promises of non-interference in its Constitution to lure mining investment, is considering an increase to 5% from zero now. Brazilian politicians want to raise royalties to 10% from 3%. Everywhere you look, the push is the same: High prices mean different rules.

Nowhere is the debate more divisive than in Bolivia, a country where calls for higher royalties on natural gas--an effective 50% cut in profits--have escalated into protests, crippling the country repeatedly. In March, President Carlos Mesa, a political moderate, offered to resign amid roadblocks and marches as protestors urged the government to hike the fees foreign companies pay for extracting natural gas. His predecessor, former President Gonzalo Sanchez de Lozada, resigned in 2003 after similar protests turned violent.

The intensity of the debate in Bolivia underscores the dilemma governments face when considering raising royalties: Will the short-term income derived from higher payments outweigh the cost of increasing the burden on potential foreign investors? "Governments have to decide between the quick money higher royalties can bring and the broader economic good that long-term commitments by investors can provide," says Mark T. Nesbitt, a natural resources attorney in Denver, Colorado.

In 1998, the year after Bolivia established existing regulations for private investments in its oil and gas sector, investors poured US$605 million into the country--equivalent to nearly 8% of Bolivia's current total economic output--mainly in exploration and production ventures, according to the Bolivian Chamber of Hydrocarbon Industries, a La Paz industry group. As the clamor for higher royalties has increased, investment levels plummeted, to $221 million by 2003. "There was an initial boom of investor confidence that has steadily gone downhill," says Cados Alberto Lopez, a former energy secretary in the Bolivian government and now a consultant to private investors operating in the sector.

At press time, lawmakers were considering legislation that would add a 32% increase to existing royalties of 18% on production--a 50-50 split on oil and gas profits in the country. If approved, investors say, the new fees would not only reduce their ability to reap the fruits of past investments--adding up to $3.15 billion since 1997--but would nearly eliminate the advantage the Bolivian energy sector once offered compared to other countries with major reserves in the region, especially Venezuela and Brazil.

In a statement, the hydrocarbons chamber said the royalty hike would amount to "a confiscation of the investments made in the country" The proposed legislation, it added, "is a step backwards and counterproductive to the interests of Bolivia" Major foreign investors in Bolivia--including U.S. oil company ExxonMobil, Spain's Repsol YPF, and Brazilian energy giant Petrobras--declined to discuss the matter.

Supporters of the new fees say paying more is only fair. The country, after all, supplies the raw materials and is entitled to a fair share of the profits, they argue. "We own the gas and we knew where it was well before the foreign energy groups arrived," says Gustavo Torrico, a congressman in the Movement Toward Socialism political party, which proposed the higher fees and organized Bolivia's gas protests. "We're happy to work with them to access and produce the gas, but we should do it as equal partners" he says.

Bolivia, of course, is an example of the trend at its most extreme. But in other countries--even those with some of the lowest tax and royalty levels on commodities in the region--governments are considering hikes of their own.

Venezuelan President Hugo Chavez jacked up royalties applied to oil companies operating in the Orinoco heavy-crude belt to 16.67% from 1%. The government says a law passed in 1943 sets royalties at 16.67%, but that they were lowered in the 1990s when the price of oil fell. An ExxonMobil spokesperson says the company is negotiating an alternative with the government but did not provide details. Nevertheless, ExxonMobil President Rex Tillerson told an oil and gas seminar in La Jolla, California in May 2004 that heavy-oil projects such as the one his company operates in Venezuela are more productive with cutting-edge technology from large, experienced companies such as ExxonMobil.

Favorable tax structures help attract global oil companies and their technology, he told oil executives at the event, attended by Ali Rodriguez Araque, a Chavez advisor and now Venezuelan foreign minister, who at the time of the event ran Venezuelan state oil company Petroleos de Venezuela (PDVSA.) "Successful host governments recognize the strategic advantages of fostering an environment that encourages the very large, long-term investments needed by our industry," Tillerson said. "As we have suggested on many occasions, such an environment requires a predictable tax structure, sanctity of contracts, an impartial court system, respect for intellectual property, elimination of duties and transparency."

At the opposite end of the political economic spectrum, Chile--long considered the most open-market country in the region--is debating its history of low-tax, zero-interference deals. The world's largest copper producer is poised to approve legislation creating a royalty of 5% on the profits of mining companies with sales of more than $5 million. Currently, there is no royalty applied to mining companies, although they do pay other taxes.

Depleted. Chilean Finance Minister Nicolas Eyzaguirre says the government must look for fresh revenue streams to wean it off of billions of dollars in copper exports made by national copper company Codelco. The government wants to recover more of the nation's wealth, he says, in order to "devote it to improving our research and development activities and therefore foster new sources of growth that in the future will be available as our mining resources are depleted."

Eyzaguirre expects mining companies to accept higher royalties and says the new fee should not deter capital spending. Once the legislation becomes law, he expects the government to collect from private mining companies $200 million a year beginning in 2006.

The royalty is a hugely popular measure in Chile, with more than 80% public approval. It first made it onto the public agenda in 2002, when ExxonMobil sold off its La Disputada de Las Condes copper mine to South Africa's Anglo American for $1.30 billion. Considering that Exxon had for 25 years reported net losses on the operation to Chilean tax authorities, the sale price outraged legislators.

Exxon based its argument on a law instituted during military rule known as DL 600, which gave all mining companies royalty-free concession rights to ore deposits. Companies could also deduct earnings from investments and any losses. Independent technical studies concluded that since 1978 the mine posted $3 billion in tax-free profits. Stephen Terni, Exxon's president of operations in Chile, told the financial press in 2002 that Exxon had invested $1.80 billion since 1978 and that the company has never evaded Chilean taxes.

The controversy forced the government to introduce a draft of a royalties bill. The bill required a change to Chile's constitution to eliminate the DL 600 legislation. That mining bill died in Congress for lack of a quorum.

Opposition right-wing legislators, who spearheaded that defeat, argued it was an attack on private property. The bill did not respect contracts the government had entered with mining companies, and it weakens the rule of law by singling out a specific industry, says Rodrigo Delaveau, a lobbyist for the conservative Chilean think-tank Libertad y Desarrollo. "This is an attack against the equality of all taxpayers," says Delaveau.

Congressman Antonio Leal, of the center-left party Partido Por la Democracia political party, supports a revised version of the bill now in Congress. Leal says a new law is needed to put Chile's mining and tax laws in the 21st century. "This legislation places Chile on a similar footing with other mining countries," Leal says. "This bill is similar to legislation found in Australia, Canada, the United States, South Africa and Peru."

According to Leal, mining giants operating in Chile post returns between 120% and 140% on their investments.

"In 2004 the 19 multinational mining companies operating in Chile reported profits of more than $6 billion," Leal says.

Chile's own Codelco, composed in part of formerly private mines nationalized by Socialist President Salvador Allende in the early 1970s but maintained under state control by military dictator General Augusto Pinochet and by center-left governments since, reported record revenues of $3.30 billion in March, up 444% from 2003. Of that, $2.17 billion went to the Chilean government in taxes.

Room to grow. In Brazil, federal law limits royalties on mining to 3% of revenues from raw minerals, depending on the mineral sold. But the prospect of greater revenues has prompted two lawmakers from Brazil's mineral-rich northeast to propose bills that could raise the mining royalty to as much as 10%, a level equal to the royalty the country charges on oil.

A final congressional vote on the bills is expected later in the year.

"The tendency in the sector undoubtedly is for royalties to increase," says Brazilian Senator Rodolpho Tourinho, a former minister of mines and energy and the lawmaker of the center-right Partido da Frente Liberal party who now heads the committee studying the proposed legislation. "Royalties in Brazil remain very low compared to other countries and, considering the growth in the sector, there is room for increases."

Indeed, growth in the sector is driving the trend, even in the private sector. Brazil's Companhia Vale do Rio Doce (CVRD), the world's largest iron-ore supplier, successfully renegotiated a 71% price increase with top buyers in Asia and Europe earlier this year. The "readjustment" as the company terms the increase, merely reflects the reality of the marketplace. "Demand for iron ore has been climbing steadily and we expect it to continue to do so," Roger Agnelli, CVRD's chief executive, recently told reporters.

Higher royalties reflect the effort by governments to get in on the boom. The proposed increases in Brazil, though small compared to the hikes being discussed in Bolivia and Venezuela, "only came about because of the bonanza," says Carlos Vilhena, a partner with Pinheiro Neto Advogados, a Brasilia law firm.

Mining companies in Brazil take the royalty debate in stride. They recall that previous efforts to raise royalties in the country failed, and note that a slight increase in royalties is unlikely to spell disaster. "As long as the government is clear and reasonable in its intentions, the sector can adapt," says Vilhena.

Any effort to alter the landscape more drastically will be sure to ruffle some feathers. "This is an industry that requires long-term investment," says Jose Mendo Mizael de Souza, executive vice president of the Brazilian Mining Institute, a national industry association in Brasilia. "Above all, investors have to know that regulatory changes in the business are going to remain at a minimum."

ALL YOU CAN EAT
As commodity prices rise, governments grab for a bigger slice of the
pie. Most are under discussion, but Venezuela's hike is already law.

Country     Sector        Old regime           New

Bolivia     Oil and gas   18% of all           Fixed royalty payments
                          revenues             at 18%, plus a 32% tax

Brazil      Mining        3% of all revenues   10% of all revenues from
                          from raw materials   raw materials

Chile       Mining        No royalties         5% of profits for
                          applied              companies with sales of
                                               more than US$5 million

Venezuela   Oil           1% of all revenues   16.67% of all revenues

SOURCE: LATIN TRADE