More on Oil and Development

Stephen DeAngelis

September 15, 2008

Most everyone is aware that because of the steep rise in oil prices, the world is in the midst of the greatest transfer of wealth in history. Politicians from countries dependent on foreign oil (including the United States) decry such dependence and are promising to pursue strategies that break it. People are wary of such promises — they heard them following the oil crisis in the 1970s and dependence has only increased since then. The storyline, of course, is very different in countries on the receiving end of the revenue stream. Oil rich countries are flush with money — yet many analysts call this the “curse of oil.” An article in The Economist that focuses on Iraq provides some insight into why oil is considered both a blessing and a curse [“The benefits and the curse of oil,” 16 August 2008 print edition].

“Iraq’s proven reserves, of 115 billion barrels, are the world’s third-largest after Saudi Arabia and Iran. Yet Iraq ranks just 13th in terms of production, suggesting there is plenty of scope to pump more. … What is more, there are probably new fields to be found. Thanks to almost 30 years of war, strife and sanctions, Iraq has never been thoroughly explored. Geologists point to hundreds of promising subterranean structures where no wells have been sunk. Indeed, only 2,300-odd wells have ever been drilled in Iraq, compared to 1m in Texas alone. Best of all, Iraq’s oil is cheap to extract. Most of it lies close to the surface in relatively porous reservoirs. Tariq Shafiq, a former executive at the state-owned Iraq National Oil Company (INOC), says that expanding Iraq’s output from existing big fields should cost $1-3 a barrel, leaving over $100 per barrel in profit at present prices.”

All that sounds like a dream come true for Iraq. You would think that the people there would do everything in their power to exploit their oil while the price is high. As we all know, however, Iraq is nowhere near the point where it can take advantage of emerging opportunities. Conflict and politics are placing big obstacles in the way.

“Insurgents have made a habit of attacking the oil infrastructure; the recent rise in output is due chiefly to improved security. In particular, the United States has paid for a project to reduce sabotage to a pipeline that links the Kirkuk oilfield, one of the country’s biggest, to the main outlets for exports—ports in the south and a pipeline north to Turkey. The Kirkuk-Baiji pipeline is now protected on either side by a ditch, a dirt barrier, a fence topped with razor wire, and three more rolls of razor wire on the ground. There are two guardhouses at every road crossing; the government has recruited local tribesmen suspected of mounting many past attacks to man them and conduct patrols. Oil has flowed freely since the construction of these defences began last summer. The American army says that, as a result, exports in the 11 months to May went up by 91m barrels, worth an extra $8.2 billion. Iraq’s government hopes to improve output by more conventional measures, too. It is negotiating contracts with the biggest Western oil firms, including Exxon Mobil, BP and Total, to refurbish five of the country’s biggest oilfields. It hopes this will raise output by 500,000 b/d. Though Mr Shahristani said the deals would be signed ‘within weeks’ in January, they have yet to materialise.”

I have mentioned in previous posts that there are also political differences over oil between the central Iraqi government and the Kurdistan Regional Government (KRG) in northern Iraq (see, for example, Oil Fuels Kurdistan Economic Boom). Differences have arisen because KRG leaders believe that the central government is moving too slowly in coming up with contracts and legislation that formalizes oil revenue sharing. Oil deals have been slow to materialize for several reasons according the article.

“David Kirsch of PFC Energy, a consultancy, argues that INOC would not have the capacity to transport all the extra oil even if it could be produced. There is some doubt about whether the contracts would last one or two years, calling the production target into question. And the oil giants would not station any staff in Iraq, as it is still too dangerous; they would send only equipment and advice. Meanwhile, critics in Iraq and abroad have denounced the government for failing to assign the contracts by public tender. Suspicions abound that the authorities, under American pressure, will be too generous to the oil firms, though no terms have been published, so it is hard to tell. … Perhaps spurred by this fuss, Mr Shahristani said last month that Iraq would let 45 firms bid for another round of contracts, which he hopes to award next year. Details are scant but it seems these would last for as long as ten years; unlike the short-term ones, they would require participants to team up with an Iraqi partner. The government says both types of contract will comply with the present oil law, which does not allow deals that confer ownership of Iraqi oil on foreigners. It has resorted to these arrangements only because a new oil law approved by the cabinet last year has run aground in parliament.”

The curse of oil always centers on corruption — both foreign and domestic. Where there is the potential to make lots of money there is also an overwhelming temptation to grab as much of that money as one can — legitimately or illegitimately. In order to control the money, you have to control the oil. That is the basis of the disagreements about the oil revenue sharing legislation tied up in the Iraq parliament.

“Its critics say it would give foreign firms too much control over Iraqi fields, an incendiary claim in a country where the nationalisation of the oil industry in 1971 is still seen as a moment of triumph. They view the law’s ‘exploration and production contracts’ as thinly veiled production-sharing agreements, whereby firms win the right to a fixed proportion of the output of fields they develop. Other critics say the government has modified it to give too much power to the regions. But the leaders of Iraq’s autonomous Kurdish region disagree. They want as much control as possible over the oil industry in their area, for fear that neglectful or hostile bureaucrats in Baghdad may otherwise hold back their development. Though oil revenue from the fields INOC runs is meant to be distributed across Iraq in accordance with population, the Kurds want to benefit more directly from the development of new fields in their area and from future exploration. Specifically, they want the federal government to honour the 20-plus contracts their regional government has signed with foreign oil firms. But the government in Baghdad refuses. Instead, it has barred the firms involved from bidding for contracts in the rest of Iraq.”

Political scuffling aside, with all of the money to be made in Iraq’s oil sector, one would think that the country would have no trouble getting others involved in the process. But even the promise of money cannot trump the high risks of doing business in an unstable region.

“Foreign oil firms may still be wary of investing amid such political uncertainty. Yet huge sums are needed: oilmen say tens of billions of dollars are required to overhaul existing infrastructure and fields, and much more to expand output dramatically. Thanks to oil, Iraq is not short of cash. But its oil ministry manages to spend only a small fraction of its investment budget every year. Iraqis complain that the brightest employees have long since gone; many of the remainder are corrupt and overworked, and the ministry is riven by political shenanigans. Workers at the South Oil Company, an INOC subsidiary that controls the majority of Iraq’s production, have been protesting against the proposed oil law. The government, in turn, has reassigned several prominent employees and split the firm in two—hardly a top priority for the industry. Until a comprehensive oil bill is signed, Iraq will continue to lose huge sums it would otherwise earn from the investment it so badly needs.”

The dream, of course, is that oil revenues will turn Iraq into a prosperous and thriving country like others in the region. Even if the current challenges are overcome, the dream of prosperity is not assured. Many oil rich nations remain poor — many of them in Africa. This “curse of oil” is one of the subjects touched on by Matthew Green in an article on Ghana, a country that believes oil discoveries there will bring it into the developed world [“Crude Realities,” Financial Times, 27 August 2008]. Green writes:

“The world needs Africa’s oil, but the stuff has a habit of ruining the places that produce it. From the civil war battlefields of southern Sudan to the slums of Angola and the swamps of the Niger Delta, the discovery of crude has done little to improve local lives. Often, it has destroyed them.”

Green reports that many Ghanaians believe that the discovery of oil is going to make them all rich, just like the Saudis. He continues:

“Ghana, while no match for Saudi Arabia’s roughly 9.5m barrels a day, aims to start pumping 120,000 b/d from the Jubilee field operated by the Anglo-Irish Tullow Oil in 2010 and perhaps double that a few years later – becoming the latest to join the club of African oil exporters.”

Green asserts that the corrosive effects of oil — “autocracy, instability and poverty” — may bypass Ghana. He writes:

“Ghana could be different. Regarded as a pace-setter in economic and political reform, the country of 23m holds Africa’s best hope of proving that oil’s curse can be broken. The revenue could transform Ghana’s economy. According to economists at South Africa’s Standard Bank, gross domestic product growth could rise from some 5-6 per cent in the past few years to top 20 per cent in the first few years of output, assuming oil prices stay above $100 a barrel. The dollar incomes will help stabilise the cedi – the currency has fallen by more than 20 per cent in the past 12 months – and reassure holders of Ghana’s eurobond, which matures in 2017.”

One of the reasons that Ghana could be different is that it knows the whole world is watching. The Jubilee field is a new discovery in a nation without an oil sector. There is no entrenched bureaucracy or ingrained corrupt practices that must be overcome. If the sector is developed transparently, Ghana’s oil could actually be a great blessing to its citizens.

“The first test will come before a drop is pumped. Presidential and parliamentary elections in December will decide who controls billions of petrodollars. With [President John Kufuor] stepping down after two terms, whoever wins will rapidly have to devise a plan to ensure Ghana avoids oil’s pitfalls. The world will be watching.”

The world will be watching to see if an African nation can govern with integrity and it will be watching because it needs Ghana’s oil.

“As fields from Russia to the North Sea and the Gulf of Mexico begin to decline, energy companies from Houston to Beijing are betting on Africa to help make up the shortfall. The continent produced 12.5 per cent of the world’s oil last year and is projected to account for almost one-third of the growth in global production over the next two years. Success in Ghana would augur well for a new generation of foreign investors who argue that Africa’s commodities boom will drive unprecedented economic progress by the continent. Failure would at best mean more uncertainty.”

Green points out that Ghanaian leaders have plenty of bad examples from which they can learn about how to avoid the pitfalls that can accompany the development of an oil sector.

“For a lesson in how not to do it, Ghana need only peer a few hundred miles along the coast to Nigeria, the continent’s biggest oil exporter. The insurgency in the Niger Delta, where attacks on oil installations have helped spur oil prices to record highs, shows how the world economy can suffer when a big producer goes bad. Many of Nigeria’s problems can be traced to the advent of oil production half a century ago. The prize of capturing the flood of dollars accruing to the state turned politics into a no-holds-barred contest that fostered coups and secessionist civil war in the 1960s. Oil encouraged a culture of corruption where political connections rather than business acumen were the key to overnight riches. Fraud and violence at elections last year suggest the competition has become only slightly less raw.”

To date, Ghana has been different. It prides itself on being more enlightened and progressive than many of its neighbors.

“Ghana … has regarded itself as a torchbearer for African aspirations ever since 1957, when it became the continent’s first colony to win independence. Ghana endured its own share of coups in the early years until Jerry Rawlings, the half-Scottish flight lieutenant and military ruler, restored the multi-party system by quitting the armed forces and winning an election in 1992. As limb-chopping rebels marauded their way through other west African countries such as Sierra Leone and Liberia, Ghanaians queued up to vote.”

Ghana is not without other resources, but they pale in potential to what oil could bring to the country.

“High prices for Ghana’s gold and cocoa exports have boosted growth in recent years but global food and fuel inflation has hurt the poor.”

Ghana is not untouched by corruption and crime; but candidates for the presidency are campaigning against corruption and crime — which is a good sign.

“Evidence of growing involvement by the security forces and politicians in trafficking cocaine from South America to Europe has also bolstered opposition feeling [against the New Patriotic Party which is now in power]. An MP from the ruling party was sentenced to 10 years in jail in New York in February for smuggling heroin. John Atta Mills, the NDC [National Democratic Congress] candidate, bills himself as ‘Mr Clean’. Mr Mills, who has lost twice to Mr Kufuor, was quoted this year as warning of a Kenya-style crisis if the result was rigged. Ghana lacks the ethnic polarisation that fuelled the recent killings in Kenya but a regional bias in the parties’ support base has raised concerns among some analysts about potential friction if the outcome is disputed. The big unknown is how much impact the lure of oil may have, but it seems likely to sharpen the competition.”

The reason that the competition is anticipated to be so fierce is because the party that successfully develops Ghana’s oil sector will likely remain in power for a long time.

“Standard Bank projects that oil income could wipe out Ghana’s trade deficit, which stood at $1.1bn in the second quarter of this year, and cancel out the budget deficit, projected to stand at about 8 per cent of GDP in 2008, providing a healthy boost to the macroeconomic outlook. Donor officials say the present government seems committed to finding a transparent mechanism to ensure oil is managed wisely, but so far there is little public detail on what it might look like. ‘Oil has generated too much excitement and too much expectation,’ says Kwesi Aning, a senior researcher at the Kofi Annan International Peacekeeping Training Centre in Accra. ‘Ghana is already rich in mineral resources, but that has not translated into public welfare.’ The government says its record in economic management proves it can cope with an influx of oil money. The country has experience in allocating funds freed up by debt relief. Foreign investors gave their seal of approval in September last year by snapping up Ghana’s $750m eurobond issue while Vodafone of the UK has just spent $900m to buy a 70 per cent stake in the previously state-owned Ghana Telecom.”

If the news to date is favorable, Green reports that questions remain.

“Should the oil be used for infrastructure or simply added to the budget? Should a fund be set up to counter price shocks? Or should Ghana simply invest its earnings and spend the interest? A new oil policy, circulated to MPs this month and seen by the FT, commits the government to use the funds to develop Ghana for current and future generations but is silent on precisely how revenues will be managed. Energy exporters from Norway to Malaysia and Trinidad and Tobago are offering advice, but as Felix Owusu-Adjapong, the energy minister, admits: ‘If you are not used to good management of money and you win a lottery, you can still become a pauper.’ … With Ghana’s oil facilities located reassuringly far out to sea, and little history of violence on the adjacent coastline, few are predicting a Nigerian-style scenario. But demands for preferential treatment echo the discourse in the delta. … Both main parties have pledged to invest in industries that will help achieve broad-based prosperity. But as Nigeria has learnt, oil tends to undermine the very sectors that could be capable of providing mass employment. Nigeria’s oil dollars caused exports to become less competitive and imports to surge. Farming and manufacturing collapsed and idle youths crammed into ever more chaotic cities.”

Whether Ghana suffers a similar fate remains to be seen. Even though many of the conditions that caused problems in Nigeria aren’t present in Ghana, rising expectations alone are enough to create problems if those expectations are not fulfilled.

“The International Monetary Fund projected in an internal report in June that oil production would be worth $3.5bn by 2013, with the state’s take reaching $1.3bn. Oil income could thus outweigh both gold and cocoa earnings, which totalled about $2.8bn in 2007. Plans to create jobs by encouraging local companies to service the oil industry are likely to prove tough to implement. … Oil executives heading to Ghana have an interest in ensuring the country gets it right. Tullow Oil … says it is taking steps to soothe local feeling, such as not flaring gas. ‘We need to manage public expectations,’ says Gert-Jan Smulders, Tullow’s country manager.”

Tullow and local officials are already warning that many jobs created by the oil sector will have to be filled by foreigners because not enough of Ghana’s citizens have the necessary training and education. If Ghana’s leaders act wisely, they will simultaneously invest oil revenues in upgrading its infrastructure and in Ghana’s human capital. A healthy and educated workforce is essential for sustainable development. Nothing creates anger faster than unfulfilled expectations. Ghana’s leaders must be open and honest about how development will come to the country. It may take a generation to bring the kind of prosperity Ghanaians hope for. Constant progress and transparent communications will go a long way towards managing expectations and keeping Ghana on the road to a better life.