Repsol, one of the largest oil exploration firms in the world, agreed in 2000 to invest millions of dollars to financially and technically underwrite Cuba’s search for oil and gas. Repsol invested heavily to avoid U.S. economic sanctions on Cuba by leasing an Italian deep-water drilling rig built in China and Singapore with less than 10 percent of U.S. components that flies the Bahamian flag. It is estimated that Repsol has since spent $150 million in its Cuba operation.
Four years later, in 2004, when its first well came up dry, Repsol did not abandon its efforts and continued drilling for 8 more years at an estimated cost of $150,000 per day. These are the operational and business risks inherent in oil exploration.
Cuba, with Hugo Chávez fighting terminal cancer and facing a contested election in October, desperately needs to find alternatives to the subsidized oil it currently receives from Venezuela. Recently, however, Cuba illogically acted to increase Repsol’s political risk.
In April, Argentina’s President Cristina Fernández dramatically announced that the country was expropriating 51 percent of the interest in Yacimientos Petrolificos Fiscales (YPF) held by Repsol. Repsol, headquartered in Spain, was YPF’s parent company. No compensation has been announced for the expropriated assets.
In language reminiscent of the statist policies popular in the last century, the nationalization rhetoric spoke of recovering control of Argentina’s national patrimony. “Efficiency and the motherland are not incompatible,” noted President Fernández.
Cuba, in ideological solidarity with the expropriation, applauded the Argentinian decision and accused Repsol of having purchased its controlling interest in YPF for less than its “fair” value. The paradox is that Repsol was then a key Cuban partner in offshore oil exploration. Cuba’s joy at the misfortune of its business partner losing its Argentinian investment must have made Repsol executives cringe with the thought of “with a business partner like Cuba who needs enemies.”
In the calculus of current and prospective investors in partnership with Cuba’s government, what may once have been considered acceptable business operational risks must now be recalculated to include prohibitive host-country political risks.
Host-country risk refers to the risk of investing in a country where new adverse economic policies may be instituted such as expropriation of assets, nationalization of private companies, currency controls, inability to expatriate profits, higher taxes or tariffs, and more. Host-country risk requires a risk premium that must be added to the normal commercial risks.
For a commercial enterprise, country risk increases the cost of doing business and consequently requires a much higher return on investment to compensate for the additional risk. Cuba, with a commercial environment dominated by bureaucrats with little sympathy for private enterprise, ranks as one of the countries in the world with the worst investment climate and the highest level of country risk.
Given Cuba’s dire need for foreign investment capital, and the necessity to compete for such capital with other countries, what were these guys thinking in publicly praising the Argentinian expropriation? Cuba’s government officials did not have to comment publicly on the nationalization announcement. They could have simply kept their feelings private as a modicum of respect for Repsol’s partnership with Cuba.
In rushing to side with Argentina’s expropriation of Repsol’s assets, Cuba signaled to its business partners and to the world that, for Cuba, ideology trumps over economic rationality or business agreements, and that the Cuban government remains committed to the Marxist principle of eradication of all private property.
This does not bode well for the ability of Castro’s Cuba to attract international business partners, or in particular for its offshore oil exploration projects. But it is not so much a case of dry wells as it is a case of having an avowed ideological enemy as a business partner. Who needs that? Repsol decided to invest in less risky waters.
José Azel is a senior scholar at the Institute for Cuban and Cuban-American Studies, University of Miami and the author of the book, Mañana in Cuba.