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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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The Biggest Energy Crooks

It’s been a tough year for international oil investors in Brazil as Petrobras has come under extreme scrutiny for allegedly paying massive bribes to secure lucrative contracts. The scandal has demolished Petrobras’ stock price and led to heads rolling across its leadership offices (figurative speaking, of course).

Amazingly, the chair of the board of Petrobras during the period when the bribes allegedly took place is none other than Brazil’s President Dilma Rousseff. The scandal is such a big deal that it led to massive protests by hundreds of thousands of people across the country in recent months. Brazil’s Attorney General cleared Rousseff of wrongdoing in the case and she claims ignorance of the bribes, but the public is finding it increasingly difficult to believe that she was entirely unaware of a bribery scandal that was so brazenly widespread.

The scandal has completely eroded trust in both Petrobras and the Brazilian government. After all, if a company would offer bribes and a politician would go looking for them, what other questionable practices could each be involved in? Petrobras’ future may be bleaker than it has ever been, and the company has surely been hamstrung by the scandal with all thoughts of growth and efficiency taking a backseat to damage control. Related: Oil Price Rebound Looking Unlikely

As if the Brazilian scandal is not enough though, international investors now have a second scandal to gawk over. Recently, Nigeria announced that the state oil company stole billions it earned under the watch of former President Goodluck Jonathan. Corporate officials told the government that roughly half of the Nigerian National Petroleum Corporation’s income over the last three years had been stolen. Even for the dismal ethical track record of Nigeria’s oil industry, the news was shocking.

The earnings from the NNPC are supposed to be remitted back to the government, but instead a vast portion of earnings were used for illicit spending and corporate largesse. For a country that is supposed to be Africa’s answer to the BRICs and which is the most populous and richest nation on the continent, the news is disgraceful. The government under new President Muhammadu Buhari dissolved the NNPC’s board and installed a new one, but with corruption this endemic across the continent’s largest oil company, a new board by itself will not change much. Related: OPEC, Get Ready For The Second U.S. Oil Boom

The larger point revealed by both the Nigerian and Brazilian scandals is the importance of good corporate governance. Modern corporations are so large, even in developing markets, that they become very hard to monitor or control. Shareholders in companies never actually see the cash a firm purports to earn.

They rarely ever have the opportunity to actually talk face to face with company management or inspect a firm’s operations. Instead, investors have to rely on financial reports, independent auditors, and third party monitors like boards to advocate on their behalf. Scandals like the ones in Brazil and Nigeria undermine investor faith in the value of those efforts and hence undermine the foundation of the modern economy.

As bad as the Nigerian scandal is, the Brazilian scandal is arguably worse. Nigeria has a worse reputation for corruption than Brazil, a fact not lost on investors. It is therefore a little less surprising. Related: Shale Industry May Need A Complete Rethink To Survive

Brazil, on the other hand, was supposed to be an emerging global power, not only in oil production, but also in terms of its increasingly sophisticated economy. With economic stagnation, however, Brazil’s luster has worn off for investors.

To the extent that investors cannot trust corporations or governments in what are supposed to be the best emerging markets like Brazil, it calls into question the whole foundation of investing internationally. And that destruction of trust is the true crime in both scandals.

By Michael McDonald of Oilprice.com

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