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The sovereign risk furphy

By Charles Berger - posted Monday, 16 June 2008


The best way for a business to get what it wants out of government these days is to call any contrary policy a “sovereign risk”.

Sovereign risk - a scary phrase, conjuring up images of hyperinflationary South American economies, failed states in equatorial backwaters, corrupt autocracies on the wrong side of the Urals. No fiscally responsible, investor-friendly government wants to be mentioned in the same paragraph as sovereign risk.

Take the recent announcement that the Government intends to end the exemption of condensate from crude oil excise, a tax break enjoyed by the petroleum industry for 24 years.

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Restoring excise on condensate production is a thoroughly sensible policy. Originally instituted as an incentive to develop the North West Shelf petroleum fields, the exemption for condensate has outlived its purpose. The exemption costs taxpayers at least $250 million per year, according to Treasury estimates. With global prices for petroleum products skyrocketing, the industry hardly needs further support. The government has no contractual or legal obligation to maintain the exemption.

But the petroleum industry is not known for giving up perks without a fight. On June 2, Assistant Shadow Treasurer Michael Keenan referred the condensate issue to the Senate Economics Committee for review, citing - you guessed it - the possibility the tax would “damage Australia’s sovereign risk profile”. In case anyone missed the point, his press release also gave voice to concerns by Woodside and the Australian Petroleum Production and Exploration Association that the policy could drive away investors.

Mr Keenan should know better, but this is hardly the first time the sovereign risk line has been trotted out to protect industry expectations, reasonable or not. When it was suggested some years ago that the Hazelwood power plant reduce its immense greenhouse gas pollution levels in exchange for being granted a licence to mine a new block of coal (over which it had no pre-existing rights), the operators claimed to do so would irretrievably damage Victoria’s sovereign risk.

The Victorian Government softened like butter; Hazelwood continues to chug out the pollution.

TRU Energy’s submission (PDF 152KB) to the Garnaut Review is liberally sprinkled with references to emissions trading as a “sovereign risk”, which the energy corporation says can only be mitigated by the government giving away free emissions permits to companies that might otherwise have to pay to continue to pollute.

Is any of this a fair use of the term?

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In financial markets, “sovereign risk” is a specific concept referring to a government’s willingness and capacity to meet external obligations. The trusty Wall Street Words gives the following examples of policies that might threaten a sovereign risk rating: nationalising private businesses, stopping interest payments, repudiating government debts, devaluing the currency. Serious stuff.

Standard and Poors’ sovereign risk rating for Australia is AAA, the highest possible. This rating has fluctuated over time, reflecting changes in the government’s overall financial position. But increasing a tax rate on a particular petroleum product, or creating an emissions trading scheme, are policy details the good folk at S&P would not even waste a sneeze on during their review of Australia’s risk rating.

Law firm Minter Ellison defines sovereign risk as “the risk of the State using its power to alter the established rights of private sector companies”. The key term there is established rights, meaning for example those secured by contract or under a permit or licence, as opposed to mere expectations about future legislative or policy directions. The firm’s guidance says regulatory risks are “often erroneously described as sovereign risk”.

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About the Author

Charles Berger is the Director of Strategic Ideas to the Australian Conservation Foundation.

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