JULIA KENNEDY: Welcome to Just Business, a series of interviews on global
Today I'm talking about political risk and investment in emerging markets
with Justin Harlow, a managing partner at Tau Energy Partners.
Justin, it's a great pleasure to have you here on Just Business.
JUSTIN HARLOW: It's great to be here.
JULIA TAYLOR KENNEDY: You have made a priority of working in emerging markets.
Even the so-called BRICs—Brazil, Russia, India, and China—are too
mainstream for you. What drew you to this space, and why work in especially
JUSTIN HARLOW: Tau Energy Partners is an energy investment advisory
business dedicated to the emerging markets. You probably know that the vast
majority of energy resources are in the emerging markets, so it's natural to
be there. Over 90 percent of the proven oil and gas reserves are in what are
called the emerging markets.
BRICs—we don't focus on that much for a couple of reasons. One is competition. India and China tend to be a lot of the focus of private equity funds, which are the bulk of the businesses in which we advise. They also, from the oil and gas side, aren't the most resource-heavy nations in the world. Brazil is becoming increasingly important, and we do look at Brazil.
Russia has been very relevant for a long time. Obviously, with the whole privatization
process, there has been a lot more investment there. But we just haven't focused
on it. There's no real rationale for that. But I think there is a lot of investment
to be made outside of the BRICs. I think there is a lot less investment competition
in some of the other emerging markets. That's really why we focus on them.
JULIA TAYLOR KENNEDY: Justin, tell me how you got into this political risk/energy
JUSTIN HARLOW: Sure. I have always been interested in emerging markets.
My undergraduate degree is in Eastern European business. My master's is in developing
economics, focusing on Asia and Africa. I started my career working for a small
advisory firm, but was seconded to the Saudi Arabian Ministry of Foreign Affairs,
where I advised them on my WTO
[World Trade Organization] export strategy. So that gave me a really interesting
flavor on the emerging markets. It also enabled me to travel to Saudi Arabia,
which was a lot of fun and extremely fascinating, as you can well imagine.
I then moved to BP's trading group. I then moved to the United States. You
can probably tell by my accent that I didn't start here. I joined a boutique
consulting firm that was spun out of one of the big investment banks. I headed
up some very interesting M&A [mergers & acquisitions] work, mainly for
BP, in Indonesia, in Oman, in Kuwait. That gave me increased geographical knowledge
of the energy space.
I was actually then hired by a client to head up global investment for Abu Dhabi National Energy Company, which was a startup company that is now at $20 billion, three or four years later. I headed up their global investment group and I headed up their global trading group. That gave me very useful levels of exposure, as you can probably imagine, being a national company of Abu Dhabi, to energy investments across the world.
From there is when I set up Tau Energy Partners.
JULIA TAYLOR KENNEDY: Why are you passionate about the energy sector?
JUSTIN HARLOW: One, I've always been intellectually curious. It's so varied. There are so many dynamics. The problems are so complex to solve and so interrelated. It's just a fascinating industry to work in. There aren't many industries where you can take technical risks, political risks, macroeconomic—trying to boil all these down and make an investment decision. I love traveling, so having a job where I have an excuse to travel—and especially to the places in the world where you wouldn't normally go on vacation. I don't think Saudi Arabia is that high on the vacationer's list, but it's probably the most interesting place I have ever been to.
JULIA TAYLOR KENNEDY: There is a bit of a preconception of risk in those
emerging, developing markets. Talk about that risk and why you think it's not
that much of a barrier.
JUSTIN HARLOW: Sure. There is risk in the emerging markets. A lot of people think that all the emerging markets are as risky as one another. I'll give you some examples. Maybe this is another reason why we haven't focused so much on India and China.
If you look at the World
Bank's Ease of Doing Business
as an example, in the 2009 statistics, India was ranked 133rd in the world.
If you know how many countries there are in the world, that's pretty far down
the list. If you look at Saudi Arabia, a country that most people in the West
would think is not a place where we should necessarily do business, it's ranked
13th in the world. Japan is 15th.
When you look at the risks, you can talk about political risks, but there is
business risk and everything else. If you look at corruption as an example,
if you look at China, it's ranked 79th in the world. If you look at Qatar, it's
ranked 22nd. That's better than France. France, I think, was ranked 24th.
So there are a lot of risks, but I think there is a lot of misconception about
what those risks are. You really need to look at it on a country-by-country
basis. It's not that the emerging markets are risky and the developed markets
are not, that's for certain.
JULIA TAYLOR KENNEDY: Interesting. You do a lot of work in Latin America, too. What kinds of preconceptions are there with specific countries? Then maybe within countries they can be subverted.
JUSTIN HARLOW: Actually, one of the major projects that I'm working
on at the moment is, I'm developing a private equity fund focused on Latin American
oil and gas. My partner in this venture happens to be a Venezuelan investment
bank. Venezuela is a very resource-heavy nation with respect to oil and gas,
with the top two or three reserves in the world. It's difficult to extract,
but they are there. But when you look at Venezuela, there has been a lot of
political risk recently. There has been a lot of expropriation of assets.
But one thing I will say about political risk is that it's generally there
in the emerging markets. It can be good; it can be bad. But it also differs
on, depending on the entity that you are working in, how that risk can perhaps
My first real exposure to Venezuela was working with the Saudi sovereign wealth fund that was looking to go into Venezuela as everybody else was coming out. Why is that?
Saudi Arabia and Venezuela were founding members
of OPEC [Organization of Petroleum
Exporting Countries]. They have a long history of strong relations government
to government. Therefore, this Saudi entity, which has very strong ties to the
Saudi Arabian government, thought that they would be in a position to handle
that political risk.
So even if there is political risk there, there are ways to manage it. Political
risk insurance is one way, but government relations is another. Just because
there's political risk doesn't mean you should necessarily stay completely out
of those countries. It depends who you are a lot of the time.
With respect to Brazil, from a political risk perspective, that has been a
real success story. Even though the regimes have been thought of as somewhat
in nature, they have adopted very pro-business policies. It looks as if that
has continued with Rousseff.
So from a political risk perspective, I think Brazil is great.
JULIA TAYLOR KENNEDY: And that's Dilma Rousseff, the new Brazilian president.
JUSTIN HARLOW: Exactly right.
In Colombia, a lot of the political risk has been historical, with entities
such as FARC [Revolutionary Armed
Forces of Colombia] and the guerilla movements. That has been very well-managed
under Uribe. That
continues to be well-managed. From the oil and gas side of things, which I work
in, a lot of those guerilla movements have been pushed to the borders of Venezuela
and Ecuador, which aren't as important in oil and gas. But as exploration continues to move out into the jungle areas, that will become more important.
Argentina is somewhat important in energy, but those are the countries that
I have tended to focus on.
JULIA TAYLOR KENNEDY: It seems like the energy space in particular has a
lot of this political risk embedded in it. Why is that?
JUSTIN HARLOW: One of the major reasons is that a lot of these countries
have dominant national oil companies. They are extensions of the government.
Therefore, you have to deal with the government, and therefore you are naturally
exposed to political risk. You can't get away from it. But they are highly strategic
resources. Historically, I think, in the emerging markets, they have mainly
There has been a change in recent years to increasing value-add from your resources,
developing businesses internally, creating jobs, et cetera, et cetera. A lot
of the people are saying, "We have all these great oil resources. Why is
our GDP [gross domestic product]
per capita so low?"
It's all very political. Historically, it's just been that the regimes say
what happens and that's what happens. But you are seeing people, through demonstrations
and protests and everything else, becoming much more involved in the political
process. You have seen that a lot in Peru in the energy space, where the indigenous
groups are actually very organized and they have created some headaches for
Peru's government with respect to new developments in the oil and gas space
that are going deeper and deeper into the Peruvian jungle.
JULIA TAYLOR KENNEDY: It seems that the elements that investors have to
worry about in the energy space are very complex. Walk me through a project
and tell me where the risks come in.
JUSTIN HARLOW: We have talked about the political risks. They are well understood. There is the macroeconomic risk. If you are a U.S. company that is investing in a foreign country, you need to understand not only how the exchange-rate regimes work, but how you repatriate capital, what the tax regimes are, whether they are likely to change.
But there is also a lot on the social side as well. Historically, energy companies
have done an okay job, I would say, in working with local communities. But it
has been more of a case of charity rather than what we encourage, and that's
actual investments in local communities. Dealing in these countries, which I
have dealt with for a while, charity is okay, but what they really want is to
be able to stand on their own two feet. So you have seen some pushes from the
government perspective whereby they have encouraged domestic supply obligations
and supply to the local community—
JULIA TAYLOR KENNEDY: And that's energy supply, right?
JUSTIN HARLOW: That's energy supply. Often with a big oilfield, there might be some associated gas. That gas goes to local power plants at a subsidized price that helps stimulate the local economy.
I would say that's a really big risk. I think the governments are starting
to think about this. Companies are starting to think about this. It has caused
more of an integrated approach to a project being developed, where you can't
just look at it as purely an export project, in most countries.
Most countries in the emerging markets need power. They need energy to enhance
their industrial base. I would say that's something that
needs to be thought of well ahead of time, because it does impact economies
because the energy is often supplied at subsidized rates. It has an impact on
the overall viability of the project itself.
JULIA TAYLOR KENNEDY: But then the upside is that you have buy-in from the
JUSTIN HARLOW: You have buy-in from the local community. It's not just something that's touchy-feely anymore. We have seen real examples of how that has seriously impacted project development.
You can't get past a project without all the other risks, which are the risks that investors in the United States are more familiar with—geological risk and production risk and transportation risk and all these other kinds of risks that the bulk of investors in the United States are familiar with. They may be more acute in the emerging markets, but they are the same problems they have been dealing with for 100 years.
haven't been dealing with political risk and economic risk and repatriating
capital and dealing with local communities. In the United States the infrastructure
is there. It doesn't tread on too many toes anymore. It still does. It's still
controversial. But it's nothing like what you'll see in emerging markets.
JULIA TAYLOR KENNEDY: How do you keep investors calm?
JUSTIN HARLOW: A lot of the time we start working going in. So a lot
of investors are relatively calm going in. The ones that are serious about going
in have already thought a little bit about this and have made a decision. There
isn't a whole lot of convincing we can do. Somebody is either interested in
Brazil or Colombia or they're not.
The way we try and differentiate ourselves from, say, an investment bank is
that we try and stay involved in the project on an ongoing basis. With investment
banks and the M&A groups, it's often that you do the transaction and then
that's it. But in the emerging markets there are so many problems that need
management on an ongoing basis.
A lot of our clients haven't invested in the emerging markets before. How we keep them calm is, to be honest with you, having them very fully informed going in. There aren't any surprises. There are scenarios that they wish to happen and scenarios that they don't wish to happen, but there aren't that many surprises.
With that, you also have contingency planning. Again, to the extent that Chávez
expropriates our asset in Venezuela, we already have an idea of the plan to
realize the most value from that investment.
So a lot of planning, a lot of scenario analysis, a lot of what-ifs, but that's
generally how we keep our clients calm.
JULIA TAYLOR KENNEDY: So then how do investors go about weighing the viability
of a project? Risk is sometimes unquantifiable. How do you try and decide this
is worth taking?
JUSTIN HARLOW: I agree, to a certain extent, it's unquantifiable. The
way we approach it is through scenario analysis. You can't have 300 scenarios.
You need to pick four or five. But if an election is coming up during your investment
horizon, you need to think about the repercussions: Will there be an increase
in taxation, et cetera, et cetera? With respect to currency uncertainty and
the volatility around that, there are ways that you could build that into valuation
through very sophisticated risk valuation-based methods.
A lot of the time people just value the project and take a punt on it, to be
honest with you. It doesn't sound very sophisticated, but that's often what
happens in the energy space. You're right, there are so many risks—a lot
of the time, it's like, well, there are so many, and we can't perceive so many
of them at all; let's just kind of cross our fingers and hope it happens. But
that isn't the approach that we encourage our clients to take.
JULIA TAYLOR KENNEDY: Say your client believes the government where they are operating will expropriate their asset. What's a way you can mitigate that risk?
JUSTIN HARLOW: One of the ways in which we could help clients mitigate
is that we have relationships throughout the world and we actually know companies
that may want to come in. A lot of the contracts—you can handle some of
it contractually by having the international arbitration clauses, et cetera,
JULIA TAYLOR KENNEDY: And how do those work?
JUSTIN HARLOW: They work very slowly. I think a lot of them are based
in The Hague. You go through an international arbitration and you request damages,
if you know what the value of the property that was expropriated was. Time
value of money, which is an economic concept—by the time you make your
investment and you go through arbitration, you're years away.
How we help our clients is that we have built relationships throughout the
world. We understand companies or institutions or investment funds that actually
may be willing to step in. They're going to ask for a heavy discount, but it
might be much more preferable than to go through a five-, six-, seven-year arbitration.
Sometimes these projects can take that long.
So our advice would be, contractually, obviously well-designed contracts, which
is generally the case. They have improved over the years. But when you're stuck
in a bind, entities like ours can really add value by giving you options. You
still may want to go through the international arbitration, but at least you'll
have another data point to see that you could just go for a straight sale that
could be done within a month; what is the haircut that we would have to take
on that valuation?
JULIA TAYLOR KENNEDY: And that sale is contingent upon, okay, if we are
expropriated, then the sale goes through? Is it a certain amount of time into
JUSTIN HARLOW: It's a really good question. I actually was going through a similar process in Venezuela. I was not only targeting cases that were already in arbitration that were easy to find, but I was also targeting Venezuelan lawyers to find out which of their clients are starting to get concerned that their assets will be expropriated.
If it gets expropriated, then you go through international arbitration. The option is, if you think it's going to be expropriated, can you sell out prior to that event occurring? There's some gray area in the middle as well, where it's not clear who owns what and the government is saying one thing and you are saying the other.
But generally I would definitely encourage investors that are in these countries,
that see these risks, to start thinking proactively about ways to get out, as
opposed to just simply crossing your fingers and hoping, and then going through
the international arbitration process.
JULIA TAYLOR KENNEDY: I also want to ask you while I have you here—we
are at the Carnegie Council for Ethics in International Affairs, and there is
a lot of talk in the energy space lately about clean
tech, alternative tech. What do you think of those industries as an investment
and from a sort of ethical investing perspective?
JUSTIN HARLOW: From the U.S. perspective, I think everybody is kind
of clear on what needs to happen in the energy space in the next 20 to 30 years.
Today we are reliant on foreign imports of oil and petroleum products. We can
get into a debate on how hostile those suppliers really are. I think it's grossly
overinflated. But I do fully recognize that in 20 to 30 years clean tech is
going to take over. It just has to happen.
That being said, before I get on to my views on clean tech, I think the gap
in the middle, which is the piece that I generally work in, is not talked about.
That is, we are reliant. How do we manage those relationships in some of those
countries? How do we ensure that the United States and everybody has continued
supply in the presence of China investing greatly in some of these countries?
What does that mean for supply, et cetera?
With respect to clean tech, my personal view is that it needs to happen, but
I fear it's like the next Internet bubble. There are so many private equity
funds, venture capital funds targeting this sector, and there are going to be
very few winners. Not all those winners are going to be based in the United
States either. As Obama says,
China is playing the clean tech game to win. And they really are. Even in areas
where America used to kind of lead, like solar, now Germany leads there.
JULIA TAYLOR KENNEDY: And now you're seeing a lot in Japan, too.
JUSTIN HARLOW: As part of my due diligence when I set up my company—I really wanted to see, in the energy space—and that encompasses conventional and renewable energy—how many investment funds are out there, how many venture capital funds are out there, et cetera, that concentrate on the various aspects of the energy chain. Emerging markets' private equity is dramatically underserved.
But when you go to clean tech, my main fear is that I see—I
have not done an exhaustive check, but I would guess there are 300 or 400 at
least private equity or venture capital funds involved in clean tech. As I said,
there are going to be very few winners. There is a lot of money and a lot of
investors chasing those.
Also the worrying thing, from my perspective, is that you are seeing a lot
of funds go into clean tech that just do not have the people that can make credible
investment decisions. So you'll see some private equity funds that historically
have been in completely unrelated sectors—real estate—going into clean
tech. There's just no justification for it. If you see private equity funds
that have been in the scientific business, manufacturing business, I can understand
how that process works.
I do fear that there is going to be a massive shakeout in the clean tech space.
There are going to be a lot of people who lose a lot of money.
JULIA TAYLOR KENNEDY: Let's return to what you were talking about, the middle
that you are thinking about and actively involved in, which is foreign markets
that are emerging. It sounds like what you are describing is that there is a
scramble going on that the United States is not very involved in for those resources.
Is that what you see?
JUSTIN HARLOW: I've seen the start of it. There are still reliable suppliers
to the United States, both at the government level and also in the free-market
level. If you take the government level, Saudi Arabia has been a very trusted
ally. I actually used to advise the Saudi Arabian government. I had a lot of
time in that country—very misunderstood. They have been able to rely on
The Exxons, the Shells, the BPs of the world generally rely on the market.
The United States is still a very nice home for crude oil.
On the natural gas side, with shale
gas, it's not so much of a concern anymore. But on the oil side it is a
With respect to the kind of grabbing of resources, it has started to happen.
It's often the case that China is stepping in. If you look at Iran as an example,
the United States does not get its oil from Iran anymore. Who has stepped into
that void? China has stepped into that void. I think Iran is the third-biggest
supplier of crude oil and petroleum products to China.
If you look at Venezuela, America still sources a fair amount of its oil from
Venezuela, I think 10 or 15 percent. But who has been stepping in recently,
during the Chávez times, when the IOCs
[International oil companies], mainly U.S.-based, have come out? The majority
has been China, along with some Russian involvement.
What I will say is that a lot of people assume that if a Chinese company goes and invests, that oil is necessarily being directed to China and that oil company is completely governed by the Chinese state. It's difficult to get data on these things, but it seems like that's actually not the case.
How you would phrase
it is that these Chinese companies are majority government-owned, but they are
not government-controlled. They actually have more of a commercial outlook on
resource allocation. PetroChina; CNPC [China National Petroleum Corporation],
which is PetroChina's parent; Sinopec; Sinochem as well, which is a chemical
company; and CNOOC [China National Offshore Oil Corporation]—
JULIA TAYLOR KENNEDY: Oh, I'm impressed.
JUSTIN HARLOW: Don't ask me what all those things stand for.
They have made a huge amount of investment in foreign oil. I saw an estimate
that it was something like, in the last two years, they have invested $40 billion
in M&A transactions in foreign oil and gas assets.
That being said, these are long-term projects. Just because that oil is going
on the market right now, it doesn't mean that that's going to happen forevermore.
These deals tend to be 15-, 20-year types of transactions. I think it could
be a problem in the longer term.
JULIA TAYLOR KENNEDY: I also was curious—every election cycle, we hear rhetoric about how the United States has to reduce its dependence on foreign oil. We have to look domestically. Then there is the debate on whether to look for traditional oil domestically or clean tech domestically. How frustrated do you get when you listen to politicians talking about energy?
JUSTIN HARLOW: It's great for me, because the longer they disagree, the less they're going to do and the more we'll be reliant on the emerging markets, which is my business.
The big sticking point, to me, is transportation fuel. What
you have seen in the United States—and you see this in a lot of developed
countries—is that they have moved towards more gas-fired power generation
and other forms of generation, but they have reduced their use of oil and petroleum
products for power generation, which is a great thing for pricing. It's a great
thing for the environment.
Transportation is just a completely different beast. Of the petroleum products
that get imported into the United States, I think about 70 percent—you
have seen measures like increased vehicle efficiency standards coming in, and
that's great, moving in the right direction. But it's barely going to keep up
JULIA TAYLOR KENNEDY: I guess another piece of that question is whether you think that the discourse is informed enough, if people are talking about issues in an intelligent enough way that they actually understand what is possible and what is not possible?
JUSTIN HARLOW: I think people are talking about it in an informed way.
It's just this gap, this transition gap of the 20 years. I think people understand
the situation now. A lot of business has been getting involved, not just through
businesses investing, but business councils, et cetera, to help the
government understand the future challenges in 20, 30 years' time. They are
challenges now, but a lot of the prescriptions are just not going to be material
in the next 10, 15 years or so. It's this piece in the middle that nobody seems
to be talking about, which is the space that we're involved in.
JULIA TAYLOR KENNEDY: Great. These are fascinating issues, Justin. Thank
you so much for making the time to talk to me about them.
JUSTIN HARLOW: No problem. It has been great.