Geopolitical risk for commodity trading

One of the inherent risks of commodities is that the world’s natural resources are located in various continents and the jurisdiction over these commodities lies with sovereign governments, international companies, and many other entities. For example, to access the large deposits of oil located in the Persian Gulf region, oil companies have to deal with the sovereign countries of the Middle East that have jurisdiction over this oil.
Negotiations for natural resource extractions can get pretty tense pretty quickly, with disagreements rising over licensing agreements, tax structures, environmental concerns, employment of indigenous workers, access to technology, and many other complex issues.
International disagreements over the control of natural resources are quite commonplace. Sometimes a host country will simply kick out foreign companies involved in the production and distribution of the country’s natural resources. In 2006, Bolivia, which contains South America’s second largest deposits of natural gas, nationalized its natural gas industry and kicked out the foreign companies involved. In a day, a number of companies such as Brazil’s Petrobras and Spain’s Repsol were left without a mandate in a country where they had spent billions of dollars in developing the natural gas industry.
Investors in Petrobras and Repsol paid the price. So how do you protect yourself from this geopolitical uncertainty?Unfortunately, there is no magic wand you can wave to eliminate this type of risk. However, one way to minimize it is to invest in companies with experience and economies of scale. For example, if you’re interested in investing in an international oil company, go with one with an established international track record. A company like ExxonMobil, for instance, has the scale, breadth, and experience in international markets to manage the geopolitical risk they face. A smaller company without this sort of experience is going to be more at risk than a bigger one. In commodities, size does matter.