CASE

PETROLEUM DEVELOPMENT AND THE CURSE OF OIL

An unusual meeting took place in October at St. Matthew’s church in Baltimore. After the sermon, some parishioners stayed behind to hear two emissaries from Africa explain the harm that America’s gasoline guzzling does to the poor in faraway lands. An elderly parishioner raised his hand: ‘‘I know Africa is very rich in diamonds, gold and oil, but the people are very poor. Why are your governments so bad at managing that wealth?’’ Austin Onuoha, a human-rights activist from Nigeria, smiled and conceded, ‘‘You hit the nail right on the head.’’ ‘‘The Curse of Oil: The Paradox of Plenty,’’ The Economist, December 20, 2005, print edition One of the most controversial of topics related to the development of petroleum resources around the globe is what is commonly referred to as the curse of oil or the paradox of plenty. The curse of oil is the argument that the development of oil and gas resources in many emerging market countries results in a slower rate of economic development, increasing both poverty and income inequality, while increasing corruption and fraud. Proponents of the curse point to countries such as Angola and Nigeria as examples of how the development of oil and gas over several decades have resulted in lower levels of economic development despite the country earning billions of dollars from their oil. THE ECONOMICS OF THE CURSE There are at least three different principles at work in the curse. The first is that most petroleum developments in emerging markets are done under contract or license (fiscal regimes) with foreign companies. These companies possess the managerial and technical knowledge necessary for development. They do not typically pass this knowledge to a local or in-country partner for both business and skill reasons. They generate income which, like the oil and gas, is extracted from the country. Employment benefits for national residents are usually limited to the construction phase (three years or less in most cases). Therefore there are limited long-term human resource development benefits. The second argument behind the curse is a derivative argument of what the Economist magazine labeled Dutch Disease many years ago—the impact of a natural resource development on the country’s exchange rate. Dutch Disease, named after the development of North Sea gas properties by the Netherlands in the 1970s, means that the rapid growth of natural resource for export purposes may drive the value of the country’s currency up as the demand for the natural resource rises. The appreciation of the domestic currency then makes other export products and commodities from the country increasingly expensive, and reduces the health, earnings, investment in, and future of those other industries. In recent years the Dutch Disease phenomena has been altered fundamentally, moving away from the impact on exchange rates and focusing more specifically on the economic opportunities—or lack thereof—in competing sectors. For example, in Nigeria, a country that at one time was a major exporter of a number of highly profitable agricultural commodities, the agricultural sector has largely been disassembled as a result of the movement of all labor and capital to the oil industry and its development. In the end, when the oil and gas have been fully developed and largely depleted, the country is left with little in the way of an internationally competitive industry. The third principle at work in the curse is the impact major increases in income and wealth have on the government and politically powerful entities in the country. The income earned by the government of any country as a result of the development of a new oil or gas field may be enormous. Money flows from big oil to the big man, as government is frequently labeled in Africa. The sudden surge in income then may result in enrichment of the people currently in power in the country politically and personally. The inflow of earnings from concessions or production sharing agreements (PSAs) used for oil development then often fill the government’s coffers independently of the health of the domestic economy (independent of sales, excise or corporate income taxes) or the income of the people themselves (personal income taxes). The result is a government which is increasingly distant from its own people. Within this complex web of petroleum development—the international oil companies, the sovereign

states, the national oil companies, the people of the states—lies the problem. And for many people, their attitudes and information may be a bit out of date. The power no longer lies with the IOCs, the power has shifted—onshore. NATIONAL OIL COMPANIES WHEN activists, journalists and others speak of ‘‘Big Oil,’’ you know exactly what they mean: companies such as ExxonMobil, Chevron, BP and Royal Dutch Shell. These titans have been making lots of money for their shareholders; their bosses enjoy vast pay packets; and their actions affect us all. Yet Big Oil is pretty small next to the industry’s true giants: the national oil companies (NOCs) owned or controlled by the governments of oil-rich countries, which manage over 90% of the world’s oil, depending on how you count. Of the 20 biggest oil firms, in terms of reserves of oil and gas, 16 are NOCs. Saudi Aramco, the biggest, has more than ten times the reserves that Exxon does. Those with misgivings about oil—that its price is too high, that reserves are running out, that it damages the environment, that it is more a curse than an asset for countries that produce it—must look to NOCs for reassurance. ‘‘National Oil Companies: Really Big Oil,’’ The Economist, August 10, 2006, print edition. Since the mid-1950s the power of oil, its development and proceeds, have been shifting from the IOCs to the countries owning the oil, their governments, and their national oil companies. In most of the world, the oil and gas that lies beneath the surface of the earth is owned by the state (the United States is one of the last countries in which a private citizen may own natural resources). And as a resource owned by the state, the oil and its development is now subject to a varied list of priorities different from the traditional stockholder wealth or corporate stakeholder wealth maxims of the capitalist markets. Since the future of any oil or gas company is its reserves in the ground, the control of the resource itself by the state has had enormous implications for the goals and strategies of the true oil majors of today. The oil and gas produced by a country today is often one of the largest, if not the largest, sources of export revenues and hard-currency earnings. In many instances, like that of Mexico and Venezuela, oil makes up more than 70 percent of the government’s budget revenues. So when oil prices fall, like the precipitous declines of 2008, the government budgets and governments themselves are not prepared for their reduced budgetary resources. It is a problem that members of the Organization of Petroleum Exporting Countries (OPEC) has been dealing with since the 1970s. One continuing conundrum of national oil companies and emerging market development is the fact that many of these same countries still need the IOCs as much as they ever did. The managerial and technical expertise and the access of the IOCs to the international capital markets make their continuing role a valuable one. As one oil company executive noted, ‘‘The continuing need of oil governments for the big international companies is the difference between economics and business. In economics, all firms are the same. In business—in the real world—all firms are not created equal.’’ Ironically, this continuing relationship has put many of the world’s IOCs in the forefront of the battle over the curse of oil. Whereas the governments of the producing states are not ‘reachable’ in a political sense, the publicly traded IOCs are. And they continue to bear the brunt of growing concern over the curse of oil and are increasingly expected to act in some fashion to solve the problem. That is a difficult task given that a sovereign state is just that – sovereign, and if it has a standing elected government, that government speaks for the people of that country. At least in theory. PROPOSED SOLUTIONS This report argues that transparency in revenues, expenditure and wealth management from extractive industries, is crucial to defeating the resource curse. Achieving transparency requires a higher profile in U.S. diplomacy and foreign policy. When oil revenue in a producing country can be easily tracked, that country’s elite are more likely to use revenues for the vital needs of their citizens and less likely to squander newfound wealth for self-aggrandizing projects. ‘‘The Petroleum Poverty Paradox: Assessing U.S. and International Community Efforts to Fight the Resource Curse,’’ Report of the Minority Staff of the U.S. Senate, Foreign Relations Committee, September 9, 2008, draft, p. 3 The government of any country, elected or not, does not exist and operate in isolation. Any organization that chooses to operate in that country must, however, be subject to the laws and regulations imposed by that sovereign state. That organization, however, is also subject to the laws and rules and regulations and expectations of the various stakeholders it possesses in its home country and the variety of country-markets in which it operates. For example, a specific government may not only Petroleum Development and the Curse of Oil Case 4 467 P4-Case-4 07/17/2010 Page 468 condone bribery payments for access to resources or markets, it may require it. But that same company cannot, typically under the laws of its own foreign incorporation, make those payments whether it is requested or required. This is a lesson learned all too well by many IOCs over the past century. Transparency—the exposure of all payments to all parties involved in petroleum development to the light of day (and the global press), has been the primary proposal. Two of the more visible transparency initiatives, the Extractive Industries Transparency Initiative (EITI), a voluntary program combining governments, IOCs and NOCs, as well as the Publish What You Pay (PYP) program, supported by global philanthropist George Soros have achieved some degree of success. But the solutions to the curse of oil have stressed not only transparency, but the removal of temptation from the hands of the sovereign. A number of oil and gas developments in the past 15 years around the globe have been designed to require the state to either distribute oil proceeds in a specific mix which includes the needs of the people, or set-aside large portions of the wealth for future projects and generations. One such development, the Chad-Cameroon Petroleum Development in Africa (organized between the states, a consortium of IOCs, and the World Bank), has shown some success. Strangely, and probably unfortunately, the World Bank withdrew in August 2008 (after five full years of petroleum production), requesting that the Chadian government pay off its obligation, which it promptly did, so that the World Bank could in essence get out of the oil business. In the eyes of many, that was a confusing and disappointing outcome (though the project itself continues to reap benefits for all remaining parties). At the heart of the issue is what power or influence external parties, like the British or American governments or the United Nations, have over the sovereign states of concern. In a number of key oil developments in the past decade these distribution/saving arrangements were requirements for gaining access to the capital, debt and equity, for petroleum development. But in many cases this has proven to be a very blunt instrument for global policy results. The results have been mixed at best. Questions for Discussion

1. Why are the governments of many countries falling victim to the curse of oil? Why aren’t their people requiring it or demanding it of them?

2. What, in your opinion, is the responsibility of the IOCs for how a government spends the money it earns from the development of its own oil and gas?

3. How will transparency in the payments associated with oil and gas development work to reduce the detrimental impacts of the curse of oil?

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