Economic Development & Hydrocarbons: Old or New Challenges?

15.10.15

Macroeconomic Impacts of the Oil & Gas Industry

Oil production and oil dependency

Source: Unctad, IMF; EIA (data from 2014)

Some of the top oil producers are also the most oil-dependent.

Countries % of GDP % of Exports Oil Production Ranking China 0% 1% 4 United States 1% 8% 1 Brazil 1% 9% 9 Mexico 3% 11% 10 Canada 6% 22% 5 Colombia 7% 52% 19 Norway 10% 36% 15 Iran 13% 60% 7 Nigeria 14% 81% 13 Russian Federation 17% 61% 3 Qatar 23% 37% 14 Venezuela 31% 79% 12 Saudi Arabia 38% 81% 2 Iraq 40% 98% 8 United Arab Emirates 46% 51% 6 Kuwait 52% 83% 11

Oil price volatility Oil dependency makes countries more vulnerable to swings in international oil prices. The most oil-dependent countries have seen large fluctuations in terms of trade in line with oil price movements.

Source: World Bank; EIA

0

20

40

60

80

100

120

0

50

100

150

200

250

300

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Terms of Trade (2000=100)

United States Saudi Arabia China IraqMexico Kuwait Venezuela Nigeria

US$ Brent Spot Price

Index

Oil price volatility

-60.0

-40.0

-20.0

0.0

20.0

40.0

60.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Brazil Colombia IraqNigeria Russian Federation Saudi ArabiaUnited Arab Emirates United States Venezuela, RB

Oil Price Change

Oil Price & Government Revenue in % of GDP (% change)

Source: IMF

Government revenues are also vulnerable to volatile oil prices.

Dutch disease

0200400600800

1,0001,200

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

USA

0

100

200

300

400

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Saudi Arabia

0500

1,0001,5002,0002,500

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

China

020406080

100120

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Kuwait

050

100150200250300350

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Mexico

0

20

40

60

80

100

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Venezuela

Unit: Billion $US Source: Unctad

Primary Manufacturing

Oil dependent countries are highly concentrated in primary rather than manufacturing goods exports.

How to avoid the pitfalls

• Sovereign wealth fund: Norway • Fiscal rules: Chile • Hedging: Mexico

In general, the key to addressing large fluctuations in oil prices is to smooth out spending.

Sovereign wealth fund

Sovereign wealth funds insulate the domestic economy from commodity price fluctuations and avoid inflation & Dutch disease. Norway’s Government Pension Fund continues to grow in value, even when oil prices drop.

* January – August 2015 Source: Norwegian Petroleum Directorate, Norwegian Ministry of Petroleum & Energy, US Energy Information Administration, Norges Bank

6,431

311.6

57.81

0

20

40

60

80

100

120

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000 Market ValueNorway'sGovernmentPension FundGlobal - left axis

Net governmentcash flow frompetroleumactivities - leftaxis

Europe BrentSpot Price FOB($/barrel)- rightaxis

Billion kroner US$

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

-20

-15

-10

-5

0

5

10

15

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Public Net Debt (% of GDP)-leftaxisEconomic and Social StabilizationFund Balance (% of GDP)-left axisCopper Prices-right axis

Fiscal Rules

Source: COCHILCO (Ministerio de Minería de Chile) & Oficina de la Deuda Pública, Ministerio de Hacienda & IMF

% US$

A fiscal rule imposes a constraint on fiscal policy through numerical limits on budgetary aggregates. Chile’s fiscal rule reduces macroeconomic uncertainty, lowers volatility and protects social programs during cyclical downturns.

Note: Public Net Debt is public sector liabilities minus public sector assets.

Hedging

0

20

40

60

80

100

120

140

160

Jan-

07M

ay-0

7Se

p-07

Jan-

08M

ay-0

8Se

p-08

Jan-

09M

ay-0

9Se

p-09

Jan-

10M

ay-1

0Se

p-10

Jan-

11M

ay-1

1Se

p-11

Jan-

12M

ay-1

2Se

p-12

Jan-

13M

ay-1

3Se

p-13

Jan-

14M

ay-1

4Se

p-14

Jan-

15M

ay-1

5Se

p-15

Jan-

16M

ay-1

6Se

p-16

Mexico's Oil Hedging Program

WTI MME (Mexican Maya Crude-Oil Mix) Hedge

US$/barrel

NYMEX future price

Hedging uses market-based instruments to manage commodity price volatility. Mexico’s finance ministry hedges the country’s exports to ensure a steady revenue stream.

Local and Microeconomic Impacts of the Oil & Gas Industry

Local level revenue distribution

Source: Instituto Nacional de Estadística de Bolivia, Unidad de Análisis de Políticas Sociales, and YPFB

In most countries, oil-producing regions receive a larger share of oil revenue to compensate for local impacts. This improves incomes for producing regions, but may lead to higher inequality.

05

10152025303540

0.0 5.0 10.0 15.0 20.0 25.0 30.0

# of

Hyd

roca

rbon

Wel

ls (Y

PFB)

GDP Share (%)

Hydrocarbon Production and GDP Share by Region

Santa Cruz

La Paz Cochabamba

Tarija Chuquisaca

Oruro Pando

Beni

Potosi

30.035.040.045.050.055.060.065.0

0.0 10.0 20.0 30.0

Pove

rty R

atio

(%）

GDP Share (%)

Poverty Ratio and GDP Share by region

Santa Cruz

La Paz

Tarija

Cochabamba Oruro

Potosi

Chuquisaca

Pando

Beni

Local conflicts over natural resources

4%

28%

26% 4%

20%

18%

NorthAmerica

Oceania

SouthAmerica

CentralAmerica &theCaribbean

Cases by location 2% 4% 4%

6%

10%

4%

22%

34%

4% 2%

8%

Zinc

Silver

Iron

Nickel

Coal

Shale Oil

Copper

Gold

Uranium

Diamonds

Platinum

Cases by Primary Commodity

Source: Proceedings of the US National Academy of Sciences (PNAS)

There are many conflicts over oil & gas as well as other extractive industries projects all over the world, leading to large investment losses.

Sources of local conflicts

• Economic demands

• Land rights • Environmental

concerns

The reasons behind protests vary greatly by country.

Corruption Corruption and weak local government capacity may prevent local communities from reaping the benefits from oil investment.

0%

20%

40%

60%

80%

100%

120%

0 20 40 60 80 100

Oil

Expo

rts in

% o

f Tot

al E

xpor

ts

Corruption Score (Transparency International)

SAU KWT

COL

VEN

IRQ

NGA

IRN UAE

QAT NOR

CAN

USA BRA MEX

CHN

Source: Transparency International, IMF, Unctad, 2014

0%

10%

20%

30%

40%

50%

60%

0 20 40 60 80 100

Oil

Expo

rts in

% o

f GDP

Corruption Score (Transparency International)

IRQ

VEN

NGA IRN

SAU

QAT

UAE

KWT

NOR CAN

USA BRA

COL

MEX

CHN

Oil Exports in % of Total Exports and Corruption Score

Oil Exports in % of GDP and Corruption Score

Mitigating local conflicts

• Increase Government Intermediation • Expand Human Capital • Improve Local Content • Improve Environmental Regulation • Invest in Sustainable Projects

Some measures have proved successful in improving relations with local communities and increasing the microeconomic benefits of oil industry activities.

Increase Government Intermediation

• Increase institutional capacity to improve dialogue with communities • Clear legal processes • Provide more information for communities and government officials • Clarify the role of companies versus the role of the state

The key to reducing conflicts appears to be proactive and sustained government-led engagement from the start of each project.

Expand Human Capital Developing local human capital & service suppliers can mitigate conflicts and enhance benefits for local communities. Mexico provides an interesting case study.

0 400,000,000 800,000,000 1,200,000,000

Geothermal Energy Innovation Center

Solar Energy Innovation Center

Wind Energy Innovation Center

Institutional Strengthening for Energy…

Science and Technology Projects for Border Issues

Mexican Postdoctoral Projects in Sustainable…

Non-Fossil Fuel Technology Demands

Energy Sustainability Innovation Labs

Bioenergy Innovation Center

Ocean Energy Innovation Center

EstimatedHumanResourceDevelopmentInvestment

TotalInvestmentApproved

Support for Human Resource Formation from Mexico's Sustainability Fund in pesos (Jan 2013-Jun 2014)

Source: Programa Estratégico de Formación de Recursos Humanos (PEFRHME)

Improve Local Content

• Norway (positive example): • Prioritized technology transfer to develop

competitiveness of local industry suppliers • Encouraged R&D partnerships through tax incentives • Timing and international context were important

• Brazil (negative example): • Onerous & complicated local content requirements

were created without enough preparation for local industries to meet the standards.

While local content requirements can be challenging, they also present an opportunity for companies to create jobs by developing local supply chains.

Improve Environmental Regulation Upholding environmental standards is critical to gaining confidence of local communities. In the US, regulation for the shale industry has been a critical challenge, but a body of best practices has been established.

• Establish baseline of water quality before drilling starts • Separate environmental regulator & licensing agency • Integrity of well construction • Transparency on fracking fluids • Address air pollution

Invest in sustainable projects

• Invest in education, research, training

• Energy subsidies are less efficient than direct transfers

• Extractive Industries Transparency Initiative (EITI) can provide transparency about distribution of rents

Investment and tax revenues should be used to promote long-term local economic development.

Source: International Energy Agency

Thank you

Lisa Viscidi

Director, Energy, Climate Change & Extractive Industries Program

Inter-American Dialogue