Doing business in other countries always has that element of uncertainty that business calls "sovereign risk", and it deals with how a host government may use its power to influence, control or, in extreme cases, take over, companies or industries.
You usually hear about a government "nationalising" a company, which is a euphemism for grabbing total control with no fair compensation to the company. Usually, you see this in developing countries that want more control, power and/or money from a business that is legitimately operating in the country.
Then comes the news that the Papua New Guinea government has passed a parliamentary resolution that it will basically rescind the 63% ownership of the Ok Tedi copper and gold mine, held by a company set up in the wake of an environmental disaster caused by BHP Billiton (ASX: BHP), and issue new shares that it will own and control. They owned the other 37% already, so this makes the government now 100% owners of the mine and its earnings.
The original disaster occurred in the 1980s and early 1990s when mining waste material, "tailings", were not contained properly, and were flushed into the region's river and water system, affecting the environment and ecosystem of 50,000 people who lived downstream of the mine.
A deal was struck between BHP and the PNG government that in exchange for giving BHP immunity to a damages or civil suits, BHP would surrender its 63% ownership of the mine, and have a custodial company set up to administer the mine. Any earnings would be held, invested and used for the local populace as compensation for the industrial accident.
Twelve years on, the PNG government, led by Prime Minister Peter O'Neill, has now moved to take over the mine and income stream, causing controversy in PNG itself because the local populace around the mine and its landowners were receiving money from the revenue the mine was generating, as well as a fund was set up to invest sales proceeds as an ongoing compensation system.
Now, under the newly ratified scheme, the PNG government will be the recipient of earnings, and will administer how those funds are appropriated and invested. The charitable trust that has been managing funds, PNG Sustainable Development Program, estimates that the mine generates in annual dividends about 450 million kina (AU $180 million), and the mine itself may be worth 2 billion kina (AU $804 million).
Along with taking control of the mine, the PNG government has also rescinded the immunity against industrial and civil suits that BHP had agreed to in lieu of giving up its controlling shareholding in the mine. BHP is trying now to downplay liability that it may have in any potential legal suits.
The former Prime Minister of PNG, Sir Michael Somare, has voiced his opposition to this legislative move, and performed a walk-out of the parliament before the vote was taken. He feels that this is sending a very bad message to international companies that work in PNG or are looking at starting business there.
He said," If there was to be any move by Mr O'Neill to bring everything in to Papua New Guinea there should be proper dialogue with people who have so much confidence in this country, they invested so much here, and there should be a dialogue of discussion. You discuss it before you take a drastic decision like this. Parliament are keen to take over an asset it gives a strong message, wrong message, to the international world."
Foolish takeway
Sovereign risk has been involved in Rio Tinto's (ASX: RIO) negotiation battles with the African nation of Guinea's government over control of its Simandou mine project. Also, as we have reported, working with governments as part-owners can cause its own headaches even if they don't try to take over.
When companies propose plans for overseas business and development, they must also project and estimate costs and probabilities of sovereign risk into their budgeting. It's pointless to invest millions and billions into a new venture only to have it taken over or diminished by host governments' need for control or extra income.
As an investor, you too have to factor this credible expense and threat into your own reasons for or against investing in a company.
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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.
