George Esiri / Reuters A woman walks along an oil pipeline in Otu Jerenmi in Nigeria's oil-rich Niger Delta March 5, 2006.

From a Curse to a Blessing

Turbulent Oil Prices Prompt Infrastructure Reforms

In just a few years, the international oil market has changed profoundly: new oil deposits discovered off of Brazil and Africa’s shores have boosted supply, as has the massive development of the shale oil in the United States. And instead of reducing its output, the Organization of Petroleum Exporting Countries (OPEC) decided to hold steady. Saudi Arabia, which leads the group, wants to protect its market share from U.S. competition and seeks to hamper Iran’s ability to take advantage of high oil prices when sanctions against the nation are lifted. These three factors have led worldwide oil production to increase from83.2 million barrels per day in 2010 to over 88.6 million barrels per day in 2014. This has happened just as demand has contracted, thanks to slowing growth in China, stagnation in Europe, and potential recessions in emerging countries (such as Brazil, Russia, and Turkey).

In turn, Brent prices plunged from $115 in June 2014 to $45 in January 2015, averaging $56 since then. Low oil prices are particularly hard for African producing countries, such as Angola and Nigeria, which belong to OPEC but which were ignored in OPEC’s decision-making. Their 2015 national budgets were based on higher prices for Brent crude, thus leaving both countries with major financing gaps. Indeed, many are concerned about the potential disruption that low oil prices could cause to still fragile economies, and the chance that the resource curse will claim its next victims.

AN EMBARRASSMENT OF RICHES

The concept of the resource curse arose from the observation that in the postcolonial era developing countries that were endowed with natural resources lagged behind those that were not. The reason seems to be that in hyperspecialized, natural-resource-based economies most resources are exported rather than used and transformed domestically. Flush with income from commodities, these governments don’t need to create economic growth and collect taxes. Since they don’t tax citizens, states don’t need to be accountable to them. Rather, they just need to keep the peace through subsidies and to please those groups whose support is vital for government leaders to stay in power, which leads to cronyism and corruption. The system breaks down when the money from exports dries up.

The natural resources curse is one of the explanations given for the “lost decades” that African countries experienced in the 1980s and 1990s: per capita GDP of the continent went from $900 in 1980 to $740 in 2000. At the dawn of the new millennium, many economies throughout the continent seemed to shake off decades of economic disarray thanks not only to the commodities boom but also to greater economic diversification and the development of a middle class. Experts hoped that the resource curse would become a distant memory.

Experts likely spoke too soon; the prolonged impact of weak commodity prices should not be underestimated. 

Many commodity-rich African countries have indeed undertaken important political and economic transitions, but they are still vulnerable. For example, Nigeria’s recent elections were a success: the nation transitioned power from the People’s Democratic Party to the All Progressives Congress, marking the first time that power shifted between parties since democratic elections were reinstated in 1999. But its GDP growth slowed to 2.35 percent in the second quarter of 2015, compared with 6.54 percent in the same period last year, while the country remains highly oil-dependent (making up close to 80 percent of government revenues). Likewise, Angola experienced over a decade’s worth of economic growth, but 45 percent of its GDP still comes from the oil sector. Complex presidential elections are coming up in a year and a half, and hard economic times thanks to declining oil prices could significantly destabilize the country. Further, Algeria’s $160 billion in foreign currency reserves may be colossal, but they decreased by $20 billion in the first six months of 2015, causing a 9 percent cut in spending for 2016. 

SILVER LININGS PLAYBOOK

A worker walks at the Olkaria Geothermal power plant, near Naivasha, 145 km (90 miles) west of Kenya's capital Nairobi, April 2, 2011.

A worker walks at the Olkaria Geothermal power plant, near Naivasha, 145 km (90 miles) west of Kenya's capital Nairobi, April 2, 2011.

The risk of turmoil as oil prices decline is real, but so is the opportunity. The fall in global oil prices is steep enough to be visible and understandable by the public, but not steep enough to be economically life-threatening. Governments thus have a rare opportunity to maintain and reinforce their efforts to develop infrastructure and reform policies—two vital steps toward bolstering national economies and reducing dependence on the profits of commodities.

On the infrastructure side, the recent oil boom has triggered the development of export corridors with integrated roads, railroads, deepwater ports, and power lines. These are most prominent in Kenya (with the Lamu Port and Lamu-Southern Sudan-Ethiopia Transport Corridor infrastructure projects ) and Mozambique (the Nacala corridor, which links the Tete coal basin in the north to the Indian Ocean). These offer a solid base for further countrywide infrastructure development.

Likewise, high oil prices have made it possible to for countries to postpone the reshaping of their power sector. The issue with power is that it needs not only heavy investments but also regulatory changes: unbundling of public companies in order to separate production, transmission, and distribution; the definition of pricing formulas; and the privatization of energy companies, among other concerns. Much political courage is necessary to move forward, and it can be tempting to delay the process—which is possible when oil revenues are sufficiently high to allow the use of short-term uncompetitive solutions (old power stations running on fuel, utilization of generators).

A general view shows the Paipai-1 drill site in Turkana, northern Kenya February 13, 2013.

A general view shows the Paipai-1 drill site in Turkana, northern Kenya February 13, 2013.

An insufficient number of gas pipelines and power stations has led to gas flaring in the Gulf of Guinea, where offshore oil fields must burn gas that could otherwise be used efficiently to produce electricity. It is also associated with environmental degradation and financial losses—flared gas was valued at close to $870 million in 2014, according to the Nigerian National Petroleum Corporation. At the same time, power outages throughout the region act as a bottleneck on economies that may end up stifling growth, as is becoming the case in Ghana. And now that these nations have instituted basic democratic reforms, their populations will likely keep growing—as will their expectations—expanding the need for states to upgrade their infrastructure before its too late.

High commodity prices have also prevented a number of governments from taking steps to solve the issue of subsidized goods. The subsidies system is one of the few benefits to citizens of living in oil-producing countries, and rare attempts at reform in the past (notably in Cameroon and Nigeria) have triggered violent riots. But reforms nonetheless remain necessary: subsidies are a heavy burden on national budgets, and they incentivize overconsumption, smuggling, and corruption while decreasing industry productivity, since electricity and power are cheap.

An oil rig used in drilling at the Ngamia-1 well on Block 10BB, in the Lokichar basin, which is part of the East African Rift System

An oil rig used in drilling at the Ngamia-1 well on Block 10BB, in the Lokichar basin, which is part of the East African Rift System.

Thankfully, falling oil prices decrease subsidies automatically because the gap between market prices and subsidized prices decreases, making reform efforts more palatable. When subsidy reforms are paired with progressive social policies, they become more acceptable by the citizenry. Egypt serves as a prime example of this phenomenon: President Abdel Fattah al-Sisi began a project that distributed smart cards to Egypt’s poor, allowing them to buy a limited number of products through subsidies. Once the limit was reached, the cardholder would then have to pay market rates. Reforms are back on the table in Nigeria as well after former President Goodluck Jonathan attempted partial, chaotic reductions that ultimately backfired. Depending on the countries this dynamic is different: Gabon announced its decision to cut subsidies earlier this year, Ghana tends to go back and forth between cutting and reinstating them (which might not change ahead of the 2016 elections), while Angola brutally moved forward in April, with an almost 30 percent price increase. And in Algeria, although it was announced that subsidies would not be touched, the situation is now requiring an increase in taxation.

SEIZING THE MOMENT 

The dip in oil prices is scary. But it is also an opportunity to move on from the past. It is a chance to start using commodities for what they should have always been: a blessing, rather than a curse. International oil markets remain volatile, and show few signs of stabilizing. Oil-rich countries could react by trying to further postpone transition processes currently underway. Hopefully they will pursue the opposite course while financial resources still allow it: maintaining infrastructure investments that will make economic diversification achievable will reduce vulnerabilities to commodity prices. Reforming subsidies, along with targeted social policies and improved governance, will create an economic impact that will reinforce the accountability link between governments and their citizens, which will strengthen their democratic transitions as well.

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