Friday, May 12, 2017

“There you go again…”

Earlier this week, the manifesto of the British Labour  Party was leaked, and it contained some eye-popping revelations, among them, the pledge by its leader Jeremy Corbyn to renationalize British Mail, the railroads and the electric distribution and transmission companies. 

In their early years, newly privatized railroad companies in the UK did have customer and maintenance problems.  But to imagine that public sector status is the panacea takes one’s breath away when there are such glaring examples to the contrary.

Across the Channel, Areva, the French government-controlled nuclear reactor builder, went almost bankrupt and had to be rescued by the state and EDF.  EDF itself, because of government-mandated electricity pricing policies, saw its debts balloon and needed a large capital increase.

But the most graphic demonstration of the damage government meddling brings to national champions is Brazilian giant oil and gas producer, Petrobras.  Until 2005, it was a company famous for its technological excellence in deep water drilling and its ability to navigate the Brazilian political and commercial waters with ease.

All that changed when global oil prices soared, Petrobras made huge offshore discoveries and President Lula decided that the company’ riches should accrue exclusively to Brazil and bankroll his political movement.

In 2010, a $70 billion capital increase[1] and a new Hydrocarbon Law gave the government a very tight hold over the company.  That control pushed Petrobras to the brink: its debts ballooned from $21 billion in 2006 to $132 billion by the end of 2014 through a combination of excessive investments, “diworsification” and corruption[2].  Meanwhile, the company systematically missed its production targets.

The steep fall in oil prices, the discovery of the vast corruption scheme and a change in government forced Petrobras and the state into a hard restructuring.  The results have come quickly for a company of this size, and have left many analysts incredulous;  this was evident in the quarterly conference call this morning.

The company has already shed $13 billion worth of assets, cut its workforce by 17%, and reduced its annual capex by close to $10 billion.  Crucially, while its capex used to far exceed its operating cash flows, Petrobras is now looking to generate free cash flows of over $14 billion this year and next.

In France, Emmanuel Macron has been less sanguine about nuclear energy than his opponent François Fillon, but it is fair to expect that he will not want to pony up billions into Areva and EDF.

Mr. Corbyn’s manisfesto is unlikely to come to fruition, but it is amazing that the lure of nationalization remains so strong for educated people who should know better.  But when a politician wants to change society rather than making it better (whatever this means), sound economics rarely stand in the way.




[1]  Actually the exercise was not as successful as the government expected as the Brazilian state did not win a 2/3 majority as a result.  While minority investors contributed cash, the state contributed rights to produce deep offshore oil.  In itself, this capitalization was a model of bad governance.
[2]  The cumulative amount of the bribes was not in itself life threatening, but the massive cost overruns and uneconomic projects that corruption allowed clearly was.

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