|Title:||Azerbaijan, Kazakhstan, and Norway macroeconomic importance of oil sector in dollars for 2009|
|Source:||Comparative Economic Studies|
Start of full article - but without data
Macroeconomic importance of oil sector, 2009
Norway Azerbaijan Kazakhstan (memo)
Population (million) X.X XX.X X.X Exports (US$ billion) XX XX XXX of which: oil and gas XX XX XX Government revenue (percentage of GDP) XX.X XX.X XX.X of which: oil-related XX.X X.X XX.X Share of oil sector in GDP (%) XX.X XX.X XX.X
Source: IMF country reports; Statistics Norway website; UN Comtrade
online database; own calculations
Government revenue from natural resources consists mostly of a share of the resource rent, that is the 'unearned' income from the exploitation of a natural resource. In practical terms, the resource rent is defined as the difference between the market price of the resource, which is determined by its scarcity relative to demand, and the cost of extraction. As a source of government revenue, natural resource rents differ in two respects from other sources such as taxes. First, resource rents tend to be very volatile, fluctuating with the world market price for the commodity. Second, for exhaustible natural resources such as mineral raw materials, the annual income stream will end when the stock of the resource is depleted (as any exhaustible resource, by definition, eventually will be).
Thus the prudent use of natural resource rents poses two special challenges. First, since government revenue fluctuates with the world market commodity price, medium-term expenditure plans should be based on cautious assumptions about the future price and related revenue. In essence, when the price is high, governments should spend less than current revenues and accumulate savings, which may be drawn down to keep expenditures stable when the price is low.
Second, to maximize the welfare from government expenditures in the long run, some proportion of natural resource revenues should be saved. In practice, this means building up a stock of capital (be it physical capital, human capital, or foreign financial assets) that will generate income and pay for government expenditures after the natural resource is exhausted.
These strategic considerations need to be framed in time spans over several generations. Such (very) long-term thinking sits uneasily with most countries' annual budget process that is often still driven by cameralistic accounting that says little about the impact of annual flows on a government's or a country's total assets and liabilities. Hence, what institutions can help to guide fiscal decisions to account for the volatility of revenues as well as the eventual depletion of the resource?
One approach practiced by many resource-rich countries and subnational regional bodies is to set up a stabilization and savings fund that is distinct from the annual budget and fed by certain streams of resource-related revenue. Inflows are invested in capital assets; detailed rules specify the allowable types of assets. A large share of investments often goes into foreign assets in order to dampen the Dutch disease effects that arise when resource revenues inflate demand for domestic non-tradable goods and services. Capital income from the fund's assets may be reinvested or transferred to the annual budget.
Earlier studies have concluded that stabilization and savings funds are no panacea for the political pressures that often lead to the twin problems of overoptimistic price forecasts and insufficient concern for long-term fiscal sustainability (Davis et al., 2001). Whether a particular stabilization and savings fund is effective in accumulating assets for the medium and long run depends on whether its rules of operation (i) are appropriate and (ii) are being followed in practice.
Against this background, this paper assesses the rules and operation of the stabilization and savings funds in Kazakhstan and Azerbaijan. Since both countries became independent in 1992, their oil exports have risen sharply and now generate a large share of government revenues. Both countries have also implemented a stabilization and savings fund, aiming for prudent longterm investment of oil-based revenues.
We start out by reviewing forecasts of the time profile of oil extraction and related government revenue in Kazakhstan and Azerbaijan. Oil production in Kazakhstan will provide large revenues well into the XXXXs, whereas Azerbaijan is projected to run out of oil before XXXX, that is within less than a generation. In the following section we consider the economics of stabilization and savings funds in more detail and review the resource funds in Norway and Alaska as benchmarks for good practice regarding operating rules and transparency. Against this standard, we assess the Kazakhstani and Azerbaijani funds in the two subsequent sections. The last section concludes.
OIL RENTS IN KAZAKHSTAN AND AZERBAIJAN
By global standards, proven and extractable reserves of raw petroleum in Kazakhstan and Azerbaijan are relatively modest (Table X). Only Kazakhstan can count as a mid-sized producer at X.X% of global reserves, against X.X% for Azerbaijan. Norway, whose oil fund we will compare to Kazakhstan's and Azerbaijan's in the next section, has reserves similar to Azerbaijan's, but much higher annual production. As a result, at current extraction levels, Norway's reserves will be depleted in X years, versus XX years for Azerbaijan and XX years for Kazakhstan.
Relative to the countries' populations, proven reserves and implied resource rents are nevertheless substantial. For our back-of-the-envelope calculation, we assume discounted resource rents of US$XX per barrel. On this basis, resource rents per resident are estimated at US$XXX,XXX in Kazakhstan, US$XX,XXX in Azerbaijan, and US$XX,XXX in Norway. Although the precise amount of resource rents will depend on the future world market price of oil and is therefore unknown, it is clear that resource rents are large compared to current incomes. While the potential economic benefits from prudently using resource rents are considerable, so are the incentives for rent-seeking behavior of all kinds and conflicts over the distribution of rents.
Although resource rents per capita are much larger in Kazakhstan than in Azerbaijan, the macro-economic importance of the oil sector is greater in Azerbaijan (Table X) where it accounted for nearly all exports, two-thirds of government revenue and almost half of GDP in current prices in 2009. By contrast, in Kazakhstan, the oil sector was responsible for two-thirds of exports, less than half of government revenue and one quarter of GDP.
In both countries, the surge in oil production is a recent phenomenon and occurred only after the dissolution of the Soviet Union (Figure X). Although the hydrocarbon deposits in both countries had been known for a long time and were exploited on a modest scale before 1991, the Soviet leadership emphasized the development of larger deposits in Siberia. Only political independence allowed local elites to push for extended exploration and production in the Caspian basin through agreements with multinational energy companies. By comparison, Norway's oil output peaked around the year 2000 and is now firmly declining.
The future time path of oil output is largely determined by past investment decisions because huge physical investments are required to develop an oil field. In theory, optimizing the time path of oil output might involve keeping oil in the ground longer; in practice, however, this is not economically feasible once the infrastructure has been put in place and the capital cost of the investment incurred. Only when the development of whole new fields can be delayed (such as in the case of the Kashagan field in Kazakhstan) is it possible to shift oil production and the corresponding flows of resource rents and government revenues into the future. Therefore, in the short to medium run, the time profile of oil production and associated government revenues is fairly robust to changes in the world oil price.
[FIGURE X OMITTED]
Available forecasts of the time profile of oil output in Kazakhstan and Azerbaijan reflect the much larger size of reserves in Kazakhstan. Oil output in Kazakhstan is projected to rise to X.X million barrel/day around 2015, decline only marginally until XXXX, and then decline gradually until reaching pre-boom levels from about XXXX (Lohmus, 2005). If the development of the Kashagan field is delayed, output will rise less rapidly and reserves will last longer than projected. By contrast, oil output in Azerbaijan is expected to peak at less than X.X million barrel/day around 2011 and then decline gradually to reach pre-boom levels by the early 2020s (IMF, 2010a, Figure X). Government revenue will follow this time path with a lag of several years because the government share in oil revenues rises after oil companies have recovered their initial investment (IMF, 2007, Figure X). (X)
Oil reserves in Azerbaijan are projected to be largely depleted in approximately half a generation--in other words, in the very foreseeable future when most of the present generation of residents of Azerbaijan will still be alive. By contrast, oil output and related government revenue in Kazakhstan will remain substantial for at least another generation. While decision-makers in both countries are well advised to plan for their countries' economic development after oil reserves are depleted, the issue is clearly more urgent in Azerbaijan.
SUSTAINABLE MANAGEMENT OF RESOURCE REVENUES: BENCHMARKS FOR STABILIZATION AND SAVINGS FUNDS
In addition to accumulating savings to finance government expenditures in the long run, stabilization and savings funds establish an institutional framework for countering the effects of highly volatile commodity prices on government expenditures in the short to medium run. This task would not be too difficult if commodity prices followed a discernable long-term trend with an identifiable cyclical pattern (say, similar to the business cycle). In this case, the current price relative to the long-term trend would determine what stance the fund should take in terms of saving or dis-saving.
Unfortunately, primary commodity price do not follow an easily discernible trend. Indeed, Akerlof and Shiller have recently argued that primary commodity prices are determined largely by the 'animal spirits' of investor psychology, rather than by economic fundamentals (Akerlof and Shiller, 2009). The upshot is that price increases can feed on themselves for prolonged periods to create further price increases. When the bubble ultimately bursts, long periods of depressed prices may follow.
The evolution of the world market price for crude oil since 1970 illustrates this point (Figure X). Starting from less than US$X before 1973, the reference price climbed to almost US$XX just X years later, only to come down to less than US$XX for almost XX years until around 2000. Since then, the price climbed to a high of around US$XXX in mid-2008, fell to just above US$XX at the end of 2008, and mostly remained above US$XX from mid-2009 to mid-2010.
[FIGURE X OMITTED]
Government revenue from the oil industry typically fluctuates with the world market price; in addition, the ownership structure of the industry and the contracts between the government and the energy companies affect how revenue adjusts over time. As a basis for medium-term fiscal planning, the government needs to make an assumption about the evolution of the oil price. Oil-related revenues under this price assumption determine the level of expenditures that can be financed sustainably from oil revenues. If revenues turn out to be higher, the windfall should be saved and drawn down whenever revenues fall below expectations later.
Because of the infrequent but violent swings in the world market prices for many commodities, revenue stabilization schemes may need to adjust their assumed world market prices regularly (typically, annually). Technically this can be achieved, for example, by defining the expected price as the moving average over the last several years and updating the medium-term fiscal framework on a rolling basis (as is indeed the usual practice in medium-term fiscal planning). A formula along these lines could be adjusted in a discretionary way whenever there are strong reasons to believe that a price increase reflects a bubble that will burst sooner or later (as in the case of the oil price in 2008). As the resource fund builds up assets, adjustments to the expected price and projected sustainable expenditures could be smoothed over longer periods.
While such guidelines are reasonable, there is no single, best-practice approach to designing a revenue stabilization scheme. Furthermore, whatever rules are designed on the drawing board must survive the pressures of the political process, including in most countries parliamentary approval of the annual budget. Unless governments err on the side of caution in their price assumption, they may quickly end up overspending and later having to adjust harshly. The longer the period over which expenditures are to be stabilized (a longer period implies a higher potential financing requirement), the more cautious the underlying price assumption should be.
Similar considerations apply to the long-term savings function of resource funds. With oil reserves expected to run out within the lifetime of most current Azerbaijani residents, there is clearly a general case for the government to save now. The underlying rationale is that most individuals prefer stable to sharply fluctuating consumption over their life cycles; they also act accordingly, saving out of current income to sustain consumption in retirement.
Formally, one may think of today's decision-makers as maximizing the discounted utility from all present and future government expenditures; the choice of the discount rate would determine how the welfare of future generations enters the calculation relative to the welfare of those alive today. This optimization calculus would produce a time path for government expenditures along with the annual savings required to build up sufficient assets by the time the resource is depleted.
However, the long-term trend of the resource price is uncertain (as discussed above) and so is the real value of total available resource rents. Therefore, the decision of how much to save in the long run also depends crucially on the assumed time path for the resource price. Furthermore, the chosen discount rate determines the relative importance given to the welfare of current versus future generations and raises difficult ethical issues.
One radical position is represented by the Hartwick rule (Hartwick, 1977): 'Invest all profits or rents from exhaustible resources in reproducible capital such as machines'. In this case, only the capital income from the reinvested resource rents will be used for consumption--none of the resource rents themselves.
This approach gives current and future generations the same weight because they will have the same interest-bearing capital stock at their disposal. From a utility maximization point of view, this approach leaves current consumption too low because future generations will be better off in any case if technological progress continues (which it will, if our experience of the last XXX years is anything to go by). According to this reasoning, it would be entirely defensible for the current generation to consume some resource rents, rather than invest all current rents in reproducible capital. Furthermore, strictly applying the Hartwick would probably be politically infeasible in countries like Azerbaijan or Kazakhstan where average incomes are low and poverty still wide-spread.
While it is difficult to determine how much should be saved out of current resource revenues, it is easier to derive guidelines on the type of assets that resource funds should invest in. In particular, most domestic investments would magnify the Dutch disease effects that often come with the exploitation of exhaustible natural resources. Current investment demand will drive up the prices of non-tradable goods and the real exchange rate, worsen the international competitiveness of non-resource exports, and ultimately lead to de-industrialization ('resource curse'). This concern is particularly relevant because most fund assets will reflect either windfalls from an unexpectedly high oil price or long-term savings. Neither of these should be allowed to lead to 'excess' deindustrialization that may be costly to reverse when the windfall turns into a shortfall or when the resource is depleted. Therefore, resource funds should acquire mostly foreign assets and thereby sterilize the potential impact of resource revenues on demand for (domestic) non-tradables.
On the basis of these considerations, the following questions will guide our analysis of the oil fund of Norway, which is broadly acknowledged as a benchmark case for good practice, in the next section:
* Out of total resource-related revenues, what share goes toward current government consumption or investment? How much goes to the resource fund under the fund's stabilization versus savings function?
* Under what circumstances is capital withdrawn from the fund when government resource revenues fall short of expectations (stabilization function)?
* How is the capital stock of the fund invested?
* How is the fund's investment income spent?
Benchmark: Norway's Government Pension Fund--Global (GPFG)
Norway's resource fund (GPFG) was established in the mid-1990s when oil output was approaching its peak (cf. Figure X). Fund assets grew particularly rapidly when the oil price increased sharply during the early 2000s. Today, the fund is one of the biggest sovereign wealth funds worldwide with total assets of approximately US$XXX billion, equivalent to XXX% of Norway's 2009 GDP (Figure X).
[FIGURE X OMITTED]
Allocations to the fund (as well as possible future withdrawals) are fully integrated with the annual central government budget process. The underlying rules that ensure the sustainability of public finances center on the nonoil deficit (revenues unrelated to the oil and gas sector minus the corresponding expenditures). In principle, annual non-oil deficits are meant to be financed from the capital income of the resource fund alone. The fund aims for a X% real rate of return in the long run, based on a strategy of maximizing financial returns with moderate risk. Therefore, fiscal guidelines established in 2001 set this level as a limit for the government's 'structural' non-oil deficit.