On the Oil Curse and Resource Management

On the Oil Curse and Resource Management

There might come a day when the poor citizens of a country benefit from their country’s natural resources


East Africa is experiencing a rush in oil and gas exploration activities largely owing to some sustained stability in the political landscape in the region and recent hydrocarbon discoveries. Mozambique for example is in the midst of a rapid economic transformation following major gas discoveries of its coast, while Somalia, a relative latecomer to the party, is seeing large multinationals competing to secure a foothold in its territories, where Soma Oil and Gas recently completed an offshore seismic survey.

Somalia and Mozambique are just two of several states in the region hoping to exploit their hydrocarbon sectors to bring some much need finances. Kenya, Tanzania, Djibouti and Ethiopia have also been actively engaging oil contractors, and are at varying phases in their hydrocarbon development and extraction endeavours.

The oil curse
It is obvious why these governments are keen to exploit their natural resources. The formula is fairly straightforward. Selling natural resources will yield large influx of income which can be used to enrich the lives of the ordinary populace.

History however has shown that this is typically an exception to the rule, and that too often the outcome is the creation of large wealth disparities between the elite and the general public with little change in the wellbeing of the average citizen, together with more entrenched dictatorships supported by the extra income.

Poor countries gifted with natural resources, especially oil, overwhelmingly seem to be unable to meaningfully improve the living standards of their general population. This phenomena is commonly known as the resource or oil curse due to its prevalence. Numerous theories have been presented to explain its causes.

One popular explanation is the Dutch-Disease, named after the difficulties the Netherlands experienced after starting extraction of its North Sea gas reserves. This led to a sharp rise in foreign currency inflows which appreciated the domestic currency and made the country’s other goods less price competitive in the export market. This is consistent with the observations that the economies of some resource rich countries tend grow slower than those of other developing countries even after trade policies are taken into account, as highlighted in the studies by Jeffrey Sachs, director of the Earth Institute at Columbia University.

Another pitfall of the oil curse is that it often engulfs the economies of emerging economies and creates an overwhelming reliance on the hydrocarbon resources to solve many of the country’s economic needs. The Persian Gulf states are prime examples in this respect. Some argue that the Gulf has escaped the oil curse because of the improvements in living standards and to access to health care in this region. True, oil riches have brought better living standards though subsidised welfare programmes, however they have not addressed the rampant unemployment that persists. There is also little diversification in the Gulf economies, for whom typically government budgets largely consist of oil revenues, making it susceptible to fluctuations in commodity prices. A sustained period of low oil and gas prices are likely to deplete government reserve funds without corresponding cuts to welfare spending programmes.

Moreover, the oil industry does not generally employ many unskilled people, and oil companies tend to import their skilled labour from developed countries. This increases a developing country’s’ dependence on the oil companies and impedes the development of a skilled indigenous work force. In general there is little chance of this industry alone solving a state’s employment needs. This responsibility falls to the government which must manage its share of the income to not only better improve the lives of its citizens, but also to cultivate the capabilities of its citizens.

A better plan for the future

This leads to the next explanation for the oil curse, namely government failures and politics. For a start many developing countries are typically impromptu about the management of their income, and are unprepared for seeking favourable terms when negotiating with big multinationals. This arises because of a general lack of expertise, or leaders being unwilling to delegate decision making to those with more relevant skill sets.

Consider the case of Somalia, a country ravaged by civil war that has jumped from one humanitarian crisis to the next, which has been without a functioning central government for the better part for 25 years. Following some recent moderate improvements in security and stabilisation of governance, it is now seeking to exploit its natural resources to deliver some urgently needed funding for reconstruction and development efforts. There has been a flight of skilled labour from Somalia over the last two decades, and the government under tight a budget has cobbled together a small team to run its Ministry for Natural Resources and Petroleum. However, there is a lack of technical capacity to effectively engage with oil companies to seek good fiscal terms, as is openly admitted by member within the Ministry. This suggests that Somalia like many other developing economies despite its pressing need for financing is not necessarily ready to effectively take advantage of its natural resources.

Transparent oil

Complicating the discussion further is also the tendency for the terms of the contracts between oil companies and developing countries to be secretive, covered by confidentiality agreements, and unavailable to citizens. The lack of transparency creates an atmosphere of mistrust between the government and the general public, and makes oil revenues more vulnerable to misdirection and mismanagement. This is especially true when the wealth is concentrated in a few hands as is typically observed. Transparency and accountability are being hailed as possible solutions.

This topic has been gaining traction with institutions like the World Bank and the International Monetary Fund, and there have been calls to make the extractive industry contracts publicly available as a way of enabling better democracy and reducing corruption. A few countries have endorsed this call for more transparency, including East Timor and Ecuador which have made some of their agreements public. While others like Liberia and Ghana have also show support for this idea.

The typical argument against contract transparency is that the contracts contain commercially sensitive information, including environmental management plans, financial terms, and other commitments, which can harm competition if disclosed. The issue with this argument is that often much of the information, such as the financial terms, are roughly known to industry competitors and it is hard to justify why general issues of concern such as those relating to decommissioning of oil fields and environmental protection should be hidden from the public. Some information redaction prior to disclosure may be plausible if the information is highly sensitive and does not go against public interest. Some oil majors like BP have recently expressed support for more transparency as a way of not only cultivating more government accountability, but also to reduce negative perceptions about the oil industry.

On the Oil Curse and Resource Management


Sustainable economics


There are also questions about the long term sustainability of oil and natural resource driven economies. Renewable energy is steady becoming more viable and a corner stone for a number of developed economies. Germany for example, a standard bearer for large scale green energy, generated 30% of its energy from renewables in 2014, and is targeting 60% by 2050. The inevitable question  of what happens when the oil runs out or when alternative forms of energy become more feasible is worth some consideration.

Alaska and the Persian Gulf states have resorted to direct hand outs of oil revenues to households as a fixes for the oil curse and as way of improving living standards. This policy has yielded some mixed results. Although living standards have been improved with this approach, it has also shown the potential to disincentives employment, especially if the size of the hand-outs permit a moderately comfortable lifestyle and employment opportunities are lacking or below a certain expected standard. There is also the possibility of hindering economic development, as other sectors of the economy become dependent on oil subsidised consumer spending, which further entrenches the dependence on the oil industry.

Stabilisation schemes have also been proposed as possible solutions. In this scheme some oil revenues are set aside to cushion the blows from periods of oil prices or production, which also reduces the risk of large domestic currency appreciation. In this regard, Norway’s sovereign wealth fund is typically promoted as a model for developing countries.

Since the discovery of oil and gas in the North Sea in the 1960s, the oil sector has played a major role in the Norwegian economy. However, unlike many developing countries, Norway has saved the overwhelming majority of its oil income into its national sovereign wealth fund. The fund currently stands at around $900 billion, and offers financial stability and security to a land with just over five million residents. Norway has no doubt been successful in accumulating considerable wealth in to its fund, nevertheless, it still has a largely oil dominated economy in which economic growth is highly vulnerable to changes in the demand and pricing for its natural resources.

Although the Norwegian model appears good in principle and offers some lessons in resource management, it is nonetheless a privilege many developing countries cannot afford. Even setting aside government mismanagement, oil revenues tend to be the major and only reliable income source in developing economies, and the pressing needs for better infrastructure, education and employment often mean that stabilisation or reserve funds take a back seat to these priorities. Norway had the advantage of starting its oil industry from a relatively strong position with viable governmental Institutions, and a good living and educational standards already established.

Conclusions

Institutional weaknesses in resource rich African countries are also cited as a cause for the oil curse. Concerns about accountability, corruption, and the rule of law hamper economic growth and deter investment. Capital flight that is the exodus of financial capital and assets from a country due to political
or economic instability is also another impediment to economic growth and better living standards in these countries. This is an issue in which many developed economies try to address through more transparency, accountability, and a more active engagement with investor concerns.

In general the issues related to oil curse and resource expectedly require a country-specific multifaceted approaches, but East Africa can draw lessons from history and nations which have fared better than the average at managing their resources. The aim should principally be to achieve a diversified economic model capable of sustained growth with viable reliance on resource extraction income, together with some form of reserve wealth funds for budgetary and economic stability. This should be undertaken in the spirit of transparency, accountability and foresightedness in the decision making process.

“ There might come a day when the poor citizens of a country benefit from their country’s natural resources.”



Dahir Dini
Financial Quantitative Researcher

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