Political Risks and Investments in Ecuador

Stephen Poloz of Canada's Export Development Corporation says that just because something is in the best economic interest of people doesn't mean they will do it. He has two examples from Ecuador, both involving short-term disruptions of oil production there.

The first example:

In mid-August, residents in north-east Ecuador carried out a series of sophisticated protests against the country’s management of the oil industry. The protesters blocked roads, seized the region’s two main airports, occupied hundreds of oil wells and blew up a pipeline owned by a Canadian company. Oil production and exports, usually on the order of 500,000 barrels per day, were brought to a virtual standstill.

In response, the Ecuadorian government declared a state of emergency, granting the military special powers to restore calm. This took several days, but the protesters agreed to negotiate a settlement while oil production was being restored. That settlement will increase benefits to the local economy significantly.

And the second example:

Back in 2002, inhabitants of the same region obstructed the construction of a pipeline in which there was again some Canadian participation. After the declaration of a state of emergency the locals successfully negotiated payments of millions of dollars from the oil companies and the government to fund local infrastructure investment.

What his examples really show is that protests and shut-downs have worked for the protesters. The actions have been rewarded by gubmnt and foreign corporations. Steve says as much:

From the point of view of the foreign investor, this process could amount to creeping expropriation – a gradual erosion of the value of their investment. In countries where political institutions are weak and the distribution of income is highly skewed, the risk of creeping expropriation is higher as foreign investors are forced to compensate for the government’s shortfalls.

The result is that investments in Ecuador must bear a hefty risk premium. In a reasonably fluid capital market, this risk premium raises the cost of capital for all projects and impedes economic growth and development.