The IMF and oil: It’s the politics, stupid

Producer nations should take serious steps to mitigate against volatility and economic disparity among their citizens.

A labourer pours oil that he scooped up from the oil spill with a helmet into an oil drum, near Dalian port, Liaoning province
In some cases, governments may benefit from separating oil exploration from extraction [REUTERS]

This is the second in a two part series on how the International Monetary Fund should interact with the global oil industry. Read part one here.

Berlin, Germany – There’s virtually a petro-politics story a day right now. If it’s not the two Sudans on the verge of war, it’s a sudden resurgence of economic nationalism in Argentina, where the government gave Repsol 15 minutes to pack their bags, or economic growth slowing in India because there’s not enough coal, or even arguments over whether an independent Scotland would be oil-dependent or not.

There’s no escaping the geopolitics of energy. This has got to be the single biggest axiom for the IMF, now reviewing its ideas on how to advise governments on oil and other extractive industries, to take on board. It’s the politics, stupid. Counterintuitive, perhaps, for an institution whose whole raison d’etre is to eschew politics and achieve technocratic nirvana. But, perversely, any policymaking for the oil industry that fails to take into account the specific nature of rents – money for nothing and the things people will do to get near it – is doomed to perfection on paper and irrelevance, at best, in the real world.

So here are a few generic policy approaches to oil and extractives, which start from the simple premise that the peoples of producing countries must be persuaded that the benefits from the development of these global industries be made to outweigh their real total cost, including social capital and environmental degradation, and that the benefits of extraction will be fairly allocated, and lead to real human and economic development, rather than to corruption and conflict. Call that political if you like. In fact, ownership of sub-soil natural resources by the entire people is recognised by law and in many cases by constitution, in most producing countries.

  • Human Stabilisation Funds – resource-rich countries with many poor people could pool resources to create emergency response funds.
  • Citizen Dividends – since the people own the resources they should see some of the rent directly, in the form of a flat universal dividend, Alaska-style.
  • Sousveillance – systems such as satellite imagery and real-time metering are cheap and can be put in the service of public scrutiny.
  • Embrace Dutch Disease – recognise the systemic effects of rent so that policies are framed specifically as antidotes. Paul Collier’s “Investing in investing”, human capital development and gender programmes are three such generic approaches.
  • State-sponsored exploration – the end of neo-liberalism and the “Risk Versus Reward” mantra touted by Big Oil.

Human stabilisation funds

Because commodity markets are volatile, thinking on how to manage petrodollars normally focuses on the huge ebb and flow of earnings. Iraq’s income, for example, increased 60 per cent between 2007 and 2008, then dropped 40 per cent between 2008 and 2009. That’s not an Iraq issue: any government in the world would have trouble managing that level of uncertainty. So experts debate the pros and cons of financial stabilisation funds, revenue smoothing, and sovereign wealth funds.

Meanwhile, the world outside carries on. Nations burn, vested interests seize the state and the billions of dollars it offers, insurgents and secessionists oppose them and, when they succeed, tear up agreements. Because this layer of policymaking doesn’t explicitly address politics, the resulting instability often renders such technical assistance mechanisms null and void.

As more new oil producers come online, we need human, not financial, stabilisation funds. Producing countries could pool petrodollars into regional emergency response funds. International financial institutions could manage them and provide matching funds. It is intolerable to have a situation such as we have in parts of Africa, where populations languish in desperate poverty while petrodollars sit in the bank and humanitarian response relies on appeals by Save the Children or the World Food Programme.

If extractive industries were clearly identified as providing the ultimate insurance to their populations, the wherewithall for effective locally owned response to crop failures and natural disasters, the dynamics of human-generated conflict around rent would start to shift dramatically – for the better.

Citizen dividends – give it back

If states manage natural resource wealth on behalf of the people, why don’t they give some of it back to them directly? Not as welfare state; means tested and administered by a bureaucracy, but as a flat universal citizen dividend.

Ironically, this idea has been been vehemently opposed on ideological grounds by large sections of both the left and the right. The right are repelled by the decadence of giving away something for nothing. The point that natural resources actually belong, legally, to the people in the first place, so no-one is giving away anything, eludes them.

Parts of the left sometimes see it as a sinister libertarian plot to undermine the state, making an unfortunate and imported equation between the legitimacy of a state and the amount of money it has. The mental paradigm generally invoked is of throwing bundles of dollars off the back of lorries into a refugee camp.

In fact, in the 21st century a citizen dividend would be more likely to take place by digital transfer over mobile phone. Harnessed properly, it would be a massive asset for social and economic development – multiplying the tax base, a key IMF concern, transforming the local finance sector, putting the small business sector on steroids and, in many countries, coming close to eliminating absolute poverty.

Sousveillance – let’s watch Big Brother

If you ever go to an oil trade show and approach the stand for Schlumberger or Halliburton, it won’t be long before someone tries to sell you an oil meter. Twelve different grades of crude, each with their own specific gravity, flowing down a trunk line? No problem! For a few hundred thousand dollars you can buy meters which measure the amount of crude flowing through pipelines to within a fraction of a per cent, and transmit the data to a collation center in real time. So your company can check to within 0.15 per cent the amount of oil the other company is transferring to you.

There are also companies which can sell you satellite and aerial surveillance – able through a variety of techniques to capture the smallest of spills of oil, or produced water, or toxic chemicals, fluctuations in the water table, and a whole lot else, for less than $100 a square kilometre.

Any fiscal regime must consider enforcement: if and how it is possible to assess property rights and values. In this case, an industry worth billions can be monitored relatively cheaply if a range of technologies already in standard commercial use are adopted for the public benefit.

No country in the world has yet put a system which could comprehensively monitor the nation’s wealth online, but in 2012 there is absolutely no reason why they couldn’t. Best candidate to take that step? Brazil, where Lulu and now Dilma Roussef drove progressive use of oil revenues and state-owned Petrobras is one of the most innovative companies in the world, bar none.

Embrace Dutch disease

Recognise the symptoms and you can provide the antidote. The development of natural resource wealth often withers other economic sectors, and affects specific demographics. Since this is well understood, it should be factored into planning.

The IMF call for comments on its policies recognises that many countries may be better served investing surpluses in their own development than in global financial markets. And yet the history of oil producing countries is littered with failed prestige and white elephant projects. The question is how to ensure a new surge of commodity rents doesn’t lead to a re-run of this kind of paternalistic and grandiose modernism?

One approach is what Paul Collier, author of The Bottom Billion, calls “investing in investing”, the creation not of industries but of the infrastructure to support them, that infrastructure being partly physical, such as roads and utilities, and partly social, such as developing trading and legal systems which encourage private investment.

Some countries, such as Libya and Iraq, are so rich they could consider using their wealth to carry them through a decade of massive investment in training and education to emerge sometime in the 2020s as knowledge economies. There is also the uncomfortable fact that oil-led economies have a gender dimension, as so ably outlined by Michael Ross in his new book The Oil Curse. Of its nature capital intensive, it fails to absorb large numbers of people, and the revenues it produces often spawn huge government bureaucracies, both of which disadvantage women.

The end of neo-liberalism?

The IMF makes two surprising observations in its consultation document, albeit in carefully coded language. The first is that oil and mining companies might be “under-taxed” relative to their profits and internal rates of return. The second is that “in some cases, governments might benefit from separating exploration from extraction – for example, by auctioning known deposits to the highest bidder”.

Behind these mundane words lies scope for a considerable shift in thinking. The time-honoured argument of Big Oil in response to its huge profits is the “Risk Versus Reward” mantra, the insistence that the company has taken huge risks, drilling one dry well in deep offshore can cost $100 million, and so on. Like Big Pharma, the claim is that what appears to the outside world to be massive windfall profits from this or that particular field, or drug, are in fact only the bets that came good, disregarding all the human and financial risk invested in other ventures which failed.

But there’s only so long you can maintain you’re “just an engineering company” – a phrase I recently heard from an earnest VP of a Big Oil firm – if you keep posting ginormous profits. The claim could be fairly easily tested in fact: how do internal rates of return on projects compare with other industries? What does the return on investment in share price and dividends look like, averaged over decades and continents? One preliminary indicator: In the past ten years, ExxonMobil have posted seven out of ten of the largest corporate profits in history.

But what if governments could use the wealth of geological data now acquired, and the exponentially increasing power of the processing of that data, to mitigate exploration risk? What if a government simply decided to do its own exploring and then engage the oil companies in a Dutch auction to produce what they found? Sounds like an insane throw-back to state-planned economy? In January the Canadian province of Nova Scotia landed $900 million of investment from Shell after launching a bid round based on $15 million of public funds it put into exploring offshore areas hitherto ignored by the companies. As Sandy McMullen, the engineer who led the initiative, said: “When we said we wanted to do the exploration ourselves, the companies said you can’t do that. We said ‘No, no, no. It’s our oil. You want to produce it. Let’s start from there’.”

Low risk, low reward – no rent. Now if that started to happen, Shell really could become “just an engineering company”. And oil just another industry. And the world would be a better place for it.

Johnny West is founder of OpenOil, a Berlin-based consultancy in oil and other extractive industries. He has covered global energy markets since the early 1990s. In 2011, he published the first book-length account of the Arab Spring, Karama! Journeys through the Arab Spring now translated into Arabic by Dar al-Shorouk in Cairo, which includes an analysis of the role of Libya’s oil industry in maintaining Muammar Gaddafi in power.

He regularly contributes to The Guardian, Huffington Post and Petroleum Economist. West is currently working on a new book outlining the role of the oil industry and the Arab Spring.