Oil and Development

Stephen DeAngelis

November 19, 2007

The news has been filled over the past few weeks with the economic repercussions of rising oil prices. Some analysts have blamed rising prices on commodity traders (prompting a call from the Indian government to stop just futures trading). Other analysts insist that it is not the futures market, but rising demand that has caused the sharp increase. During recent OPEC meetings, suppliers blamed the weakening dollar. There is truth in all these arguments; but regardless of the cause, the bottom line remains that the cost of a barrel of oil has skyrocketed. This situation has created both winners and losers. China, for one, has started to feel the pinch [“China fuel crisis spreads,” by Jim Bai and Rujun Shen, Washington Post, 31 October 2007]. Growing Chinese demand for fossil fuels has been encouraged by generous government subsidies according to Bai and Shen.

“China’s worst fuel crisis in two years spread to the capital and other inland areas by Wednesday, and one man was killed in a brawl at a petrol station queue, upping pressure on the government to intervene. Diesel shortages in China’s political heart, which escaped previous supply crunches unscathed, highlight tensions between the government and its increasingly independent oil firms about who should pay for the country’s generous fuel subsidies. Top refiner Sinopec on Wednesday pledged more supplies and bought additional diesel fuel abroad, but it may fall to Beijing to end the stand-off by raising domestic prices, easing taxes, promising another year-end pay-off — or simply strong-arming suppliers into selling more fuel at a loss. … In scenes reminiscent of the weeks-long shortages in summer 2005, also caused by the yawning gap between domestic prices and global crude costs, petrol stations across the country were turning away trucks and rationing supplies.”

While consumer countries are struggling to cope, supplier countries are enjoying flush times. I say supplier countries because according to Tina Rosensberg “77 percent of the world’s oil reserves are held by national oil companies with no private equity, and there are 13 state-owned oil companies with more reserves than ExxonMobil, the largest multinational oil company.” [“The Perils of Petrocracy,” New York Times, 4 November 2007].

“The popular perception in the United States is that if leaders of oil countries nationalize their oil, they are bucking a global trend toward privatization. In reality, nationalized oil is the trend. And the percentage of oil controlled by state-owned companies is likely to continue rising, mainly because of the demographics of oil. Deposits are being exhausted in wealthy countries — the ones that exploited their oil first and generally have the most private oil — and are being found largely in developing countries, where oil tends to belong to the state. Nationalization is also a political trend in some regions, mainly Latin America, where the populist presidents of Bolivia and Ecuador have made it part of their discourse. They are led, of course, by Hugo Chavez of Venezuela. He has made private producers accept state control of their operations. When they wouldn’t, as in the case of ExxonMobil and ConocoPhillips, he simply nationalized their holdings. Chávez has also asserted his control over Venezuela’s state oil company, which before him operated very much like a private, profit-driven enterprise. … Now as the record high price of oil has made exploitation worthwhile even in places that are remote or geologically complicated (Chad comes to mind), more underdeveloped countries have to choose what to do with their oil. Those that have long held oil must decide how to spend the incomprehensible amounts of money oil is now bringing them.”

Spending money is the problem. Few oil-rich governments have had the wisdom to invest their revenues in the future of the country by improving education, creating sustainable jobs, and building much needed infrastructure. Leaders like Chavez use the money to bribe constituents in order to remain in power. Other leaders use the money for personal enrichment. Bai and Shen report that bad spending is the norm.

“Historically, almost every country dependent on the export of oil has answered this question [“how do you spend the money”] in the same way: badly. It may seem paradoxical, but finding a hole in the ground that spouts money can be one of the worst things to happen to a nation. With one or two exceptions, oil-dependent countries are poorer, more conflict-ridden and despotic. OPEC’s own studies show the perils of relying on oil. Between 1965 and 1998, the economies of OPEC members contracted by 1.3 percent a year. Oil-dependent nations do especially badly by their poor: infant survival, nutrition, life expectancy, literacy, schooling — all are worse in oil-producing countries. The history of oil-dependent countries has produced what Terry Lynn Karl, a Stanford University professor, calls the paradox of plenty. Oil not only creates very few jobs, it also destroys jobs in other sectors. By pushing up a country’s exchange rate, the export of oil distorts the economy. ‘Oil rents drive out any other productive activity,’ Karl says. ‘Why would you bother to produce your own food if you could buy it? Why would you bother to develop any kind of export industry if oil makes your money worth more and that hurts all your other exports?’ The most successful societies develop a middle class through manufacturing; oil makes this extremely difficult. Oil concentrates a country’s wealth in the state, creating a culture where money is made by soliciting politicians and bureaucrats rather than by making things and selling them. Oil states also ask their citizens for little in taxes, and where citizens pay little in taxes, they demand little in accountability. Those in power distribute oil money to stay in power. Thus oil states tend to be highly corrupt.”

The money pouring into oil country coffers is immense. Stephen Mufson, writing for the Washington Post, reports that rises in oil prices is generating one of the greatest shifts in wealth in history [“Oil Price Rise Causes Global Shift in Wealth,” 10 November 2007].

“High oil prices are fueling one of the biggest transfers of wealth in history. Oil consumers are paying $4 billion to $5 billion more for crude oil every day than they did just five years ago, pumping more than $2 trillion into the coffers of oil companies and oil-producing nations this year alone. The consequences are evident in minds and mortar: anger at Chinese motor-fuel pumps and inflated confidence in the Kremlin; new weapons in Chad and new petrochemical plants in Saudi Arabia; no-driving campaigns in South Korea and bigger sales for Toyota hybrid cars; a fiscal burden in Senegal and a bonanza in Brazil. In Burma, recent demonstrations were triggered by a government decision to raise fuel prices. In the United States, the rising bill for imported petroleum lowers already anemic consumer savings rates, adds to inflation, worsens the trade deficit, undermines the dollar and makes it more difficult for the Federal Reserve to balance its competing goals of fighting inflation and sustaining growth.”

Another consequence of this windfall is that oil rich developing nations are becoming major international investors [“Oil and Trade Gains Make Major Investors Of Developing Nations,” by David Cho and Thomas Heath, Washington Post, 20 October 2007].

“The government of Libya, flush with oil, has amassed $40 billion and is ready to put it in play on Wall Street. China recently acquired a huge stake in one of the biggest names in U.S. finance. Tiny Qatar is adding $1 billion a week to its investment coffers and is trying to buy the leading grocer in Britain. Developing nations, especially in Asia and the Middle East, are aggressively stockpiling some of the largest concentrations of investment money in history. The cash hoards, called sovereign wealth funds, are controlled not by state-run companies or private investors but by governments. These investment pools are equal to or even bigger than the largest pension and private-equity funds in the United States, and many are highly secretive about their activities. The Abu Dhabi Investment Authority has an estimated $875 billion to invest, while China’s first stab at a sovereign wealth fund, which started last month, has $200 billion. The largest private-equity firm has about $90 billion under management. Sovereign wealth funds have been around for decades. But enriched by the surge in the price of oil … and the trade gap between the United States and Asia, these funds have grown to gigantic proportions. This has alarmed U.S. politicians and regulators, some of whom held a series of meetings on the topic here this month. Some on Wall Street say the growing prominence of these funds portends a fundamental shift in financing power away from Western nations.”

These sovereign wealth funds could do an enormous amount of good if used wisely. Most of these countries need a substantial amounts invested in internal infrastructure. Gap countries, at the bottom of the pyramid, also need vast amounts of money to build infrastructure. Whether this money is invested in such ventures is yet to be seen. To date, it has been used to help the rich get richer. Money is not the entire answer [see my post Will Money Solve Africa’s Problems?] — the proper use of money, however, can make a big difference. The flush days won’t last forever and strategic plans need to be put in place now to make sure that this shift in wealth doesn’t simply disappear down empty well holes. In other words, these emerging market countries need to become more resilient.