The challenging future of an oil-dependent economy

Like all asset bubbles, the oil bubble that began in the early 2000s was never going to last. It was fuelled by China’s energy-intensive growth surge, easy credit creation in the West, and the “irrational exuberance” of investors, which drove “hot money” into commodities. The fate of the oil boom was thus inextricably tied to China’s economic bubble, the health of Western economies, and the vagaries of speculative capital flows. Little wonder, then, that as things began to go a little awry in China and other major economies, causing a reduction in demand for oil, and as the massive production of shale oil by the US created a glut of supply, the prices of oil began to crash, dropping to a four-year low since June, and putting the economy of many oil-exporting countries, including Nigeria, out of kilter.

Now, external shocks are one of the certainties of life. They will always happen. The question is whether a country is well-positioned to withstand them. At a conference organised by Oxford University’s Global Economic Governance Programme last year, the speakers agreed that adverse growth shocks from the developed economies affect resource-dependent states more than other countries because of the inherent nature of their economies. For instance, according to Mthuli Ncube, chief economist of the African Development Bank, who spoke at the conference, a percentage point decline in Eurozone real GDP growth could lead to 0.34 percentage point decline in output growth in the investment-driven economies, while the comparable effect on the oil-dependent states would be 0.6 percent.

Of course, as long as there are external growth shocks, oil prices will remain volatile because monetary or fiscal spill-overs from the developed economies transmit largely through trade and commodity price channels. Furthermore, as the financial analyst and Forbe.com columnist Jesse Colombo points out, the transformation of the commodities market into an investment asset class has exposed oil to “hot-money”-fuelled speculative mania. All of this leaves oil-dependent economies vulnerable to perennial price shocks.

In the past, developing countries responded to the problem of commodity price volatility by calling for the establishment of an international mechanism to stabilise prices. Indeed, the United Nations Conference on Trade and Development (UNCTAD) adopted a resolution in 1976, calling for an Integrated Programme for Commodities to ensure price stability. It was, of course, naïve to expect the prices of such a strategic commodity to be determined by altruism and not self-interest. Unsurprisingly, the West flatly rejected the proposal. They need cheap oil for economic and social stability, which was why they established the International Energy Agency (IEA) in 1974 as a counterbalance to OPEC.

On the other hand, OPEC, established in 1960 to protect the price of oil and the revenues of its members, suffers from the game-theoretic problem of Prisoners’ Dilemma, which prevents parties from cooperating for fear that others might cheat. Even if OPEC can achieve unity among its members and agree to cut production to stabilise prices, its power has waned considerably. From controlling 85 percent of the world’s oil exports in its first decade, it now accounts for just about a third. The balance of power has shifted to non-OPEC oil producers. As Nigeria’s petroleum minister and in-coming OPEC president, Diezani Alison-Madueke, put it after last month’s OPEC meeting: “If non-OPEC countries don’t cooperate with us there is little that can be done.”

Yet, the future is very challenging for oil-dependent countries. On the supply side, the world will be awash with oil within a decade or two, contrary to the Peak Oil theory, which posits that the world is near a point of maximum oil output and the end of cheap oil. In fact, the fear of peak oil and high oil prices has led to the development of new oil drilling technologies, such as hydraulic fracturing and horizontal drilling, which are creating oil booms across the US, while unlocking a potential 2 trillion barrels of domestic US oil, based on a recent study. The oil field recently discovered in China is estimated to hold enough oil and gas to be “the next Saudi Arabia”, according to analysts. New oil fields are being discovered all over the world, including in Africa. A world awash with oil is bad news for oil-dependent economies, as a glut of supply will depress prices.

On the demand side, it is clear that as countries produce their own oil they will rely less on imports. For instance, in 2012, the US halved oil imports from Nigeria, and has now virtually closed its market to Nigerian oil. The IEA forecast last year that over the next five years, North America would cut imports by a hefty 2.6 million barrels per day (b/d), while, overall, crude oil imports by industrialised countries would decrease by 4.3 million b/d. The aggressive shifts in Europe and North America towards conservation (IEA and EU members are subject to strict oil stockholding obligations), energy efficiency and the development of alternative forms of energy will also make demand increasingly elastic. Transport is the largest oil-consuming sector in most developed countries, but the development of electric cars and regulations on new car fuel economy will impact on future demand for oil. So will lifestyle changes, which have resulted in a waning enthusiasm for cars or in preferences for more economic vehicles. These possible future developments have raised concerns about peak demand, and pose a fundamental threat to oil-dependent economies, like Nigeria. But what can they do?

At a minimum, an oil-exporting country facing such a volatile world of oil must ensure self-insurance through reserve accumulation. Saudi Arabia and other Gulf producers are doing that, with their large foreign exchange reserves and investments in foreign assets, which bring them additional income. By contrast, Nigeria is a profligate country. It is unwilling to save in boom times for a rainy day, let alone invest in foreign assets to boost earnings. The costs of running the country are astronomical, with the associated wastes and corruption. Furthermore, in a classic value-claiming rather than value-creating manner, Nigeria’s constituent parts are more interested in sharing a fixed pie, the so-called national cake, than enlarging it; they would rather quibble over how to share a small cake than bake a bigger one!

This can be seen from the failure of the country to diversify its economy even though this is the surest route to an enduring self-insurance against perennial oil price shocks. Most of the successful Asian countries financed their own development out of savings. But Nigeria cannot mobilise its huge resources to rebalance its economy. According to WTO’s trade statistics, Nigeria’s merchandise exports are dominated by fuel and mining products (96.4 percent), with agriculture and manufactures accounting for 2.6 percent and 1 percent, respectively.

Political economists often think of crisis as a trigger for reform. In Nigeria, after each crisis, the right noises are made about reform but nothing substantial will be done to bring it about until the next crisis … and the next! The current austerity measures are necessary to retain the confidence of foreign investors and credit rating agencies in the economy. They could also help achieve some fiscal consolidation. But they will not address Nigeria’s structural challenges as an oil-dependent country. A future tied to the unstable world of oil is an unsettling future indeed. That should be enough to keep Nigeria’s political leaders and policymakers awake at night!

Olu Fasan