Africa’s new oil and gas finds: the good, bad, and the ugly

They say money can’t buy happiness. But what about a billion barrels of oil?

Recently, a series of spectacular oil and gas finds have been announced in several East African countries, including Ethiopia, Kenya, Uganda, Tanzania, and Mozambique. In just one offshore bloc in Mozambique, 30tn cu. ft. of gas may lie below the surface.

These findings will almost certainly provide these countries with important new sources of income. And yet, we must ask, will they really benefit economic development?

On the surface, the answer should be yes. Making use of the new finds will require huge investments in rigs, pipelines, LNG plants, and larger seaports. Intense competition between Western firms and Chinese and Indian rivals will give the region’s governments an opportunity to secure long-term agreements at favorable terms.

The good: In the dream scenario, hydrocarbon wealth channels income to governments, which carefuly spends the billions to build roads, dams, and schools. Over time, investments in education produce a better educated workforce, while those in infrastructure lower the cost of doing business. The local economy diversifies, creating more value-added industries. A virtuous cycle of development sets in motion.

However, natural resource bonanzas rarely match expectations. For most countries, the record has typically been one of disappointment, and for two reasons:

First, translating oil, gold, or whatever lies under the ground into true wealth requires a government that is good at investing the resource income. While corruption may be unavoidable – to a degree – governing officials must have some capability (and desire) to transfer money to the population, so that it tangibly impacts living standards.

Second, even in cases where the government is able to allocate money toward development goals, the country may fall victim to “Dutch disease.” In this scenario, resource wealth pushes up the value of the country’s currency, which hurts domestic producers, because it makes their production more costly. Meanwhile, “easy money” floods the economy, stimulating new service industries, based on the importation and distribution of products from other countries. Over time, this redefines the economy around the consumption of imports, paid for by natural resource exports.

The bad: The first problem is Africa’s. Africa’s modern states were created by European colonizers to drive the export of natural resources to Europe. Long after independence, many of Africa’s economic and political structures continued to follow the colonial modus operandi of transferring the natual wealth to whoever held power. As a result, the continent fell under the sway of strongmen who stole billions from their impoverished countries. The long list of leaders-cum-theives is led by Abacha in Nigeria, Bongo in Gabon, Obiang in Equatorial Guinea, and Mobutu in the Congo.

The ugly: The second problem is more typically Latin American. Here, resource dependence fueled boom-and-bust cycles, where the “bust” was always greater than the “boom.” Few countries illustrate Dutch disease better than Venezuela. Oil initially brought prosperity, but over time, petrodollars crowded out other sectors of the economy. Venezuela’s economy degenerated into one built around the exchange of oil for everything else. Even the national drink (whiskey) and sport (baseball) were imports.

So, what lies in store for East Africa? If it avoids the “African” trap, will it still fall to the “Latin American” curse? Can its create the “good” outcome by adopting and sustaining the long-term vision that requires careful management of resource funds?

Time will tell the answers to these questions, but here are two thoughts:

  1.  East Africa’s traditionally resource-poor countries never developed “extraction economies” as pronounced as those in, say, Congo. There is less of a “framework” to enable the illegal transfer of billions into leaders’ Swiss bank accounts.
  2. Dutch disease is much better understood than it was a generation ago. Today, there are models for managing this problem. Norway has stashed $600bn of its North Sea oil revenues in a rainy day fund. Perhaps more relevant is Chile, which – unlike Norway – is an emerging market with many pressing spending needs. Despite political pressure (and occasional public protests) to use its copper-derived rainy day fund, Chile’s governments set aside some $20bn over the last decade.

Brazil, which is starting to develop enormous offshore oil reserves, has studied Chile’s model, and at the end of 2008, set up its own sovereign fund. Viable models exist for East Africa’s governments, if they have the willingness and ability to adopt them.

Written by David Gates for Emerging Markets Blog

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