Managing Commodity Lifecycles, Petroleum

4. Petroleum exporting countries experience with price volatility

In this section, selected country cases are briefly reviewed in terms of experience with the volatility of government petroleum revenues and strategy on how to adjust to a large fall or rise in prices or revenues. The selection covers different types of petroleum countries, from very large historic exporters to new or even future exporters with a view to identify the key challenges they faced. Indeed, this short selection shows that any petroleum country, whatever the level of its revenues and its maturity, always suffers at given periods from price and revenue volatility.

Norway has been producing and exporting oil and gas for more than 40 years. During the first fifteen years, no special fiscal rules were applied to the management of the petroleum revenues which were transferred to the central government budget. During the boom up to 1985, Norway spent growing large amounts of petroleum revenues domestically and the macroeconomic consequences were not optimal suffering from overheating. Thereafter, the economy of the country by contrast suffered from the drastic fall in crude oil prices and revenues in 1986-88. Fiscal policy changes became necessary for adjusting to price cycles.

To attenuate the fiscal vulnerability resulting from price cycles a law was passed leading to the creation of the Norway’s Government Pension Fund Global (“the Fund”) set up in 1990. It acts as a fiscal policy tool to support the short- and long-term management of volatile Norway’s petroleum revenues. It is both a stabilization tool in case of budget deficit and a saving tool. All the nation annual petroleum revenues have to be first allocated to the Fund, and not to the annual budget, to prevent overheating the economy and build saving buffers. End 2015, the accumulated savings amounted to $890 bn, becoming the world largest sovereign wealth fund. By law, the Fund has to be only invested abroad. The objectives of the Fund are saving for future generations and also spending but only a limited amount can be fed back into the domestic economy through the annual government budget process approval, up to 4% per year under a 2001 fiscal rule—a percentage which has become significantly higher than the currently expected annual return. Norway is an advanced economy and its experience cannot be directly transposed into developing countries without adaptations.   

Saudi Arabia has been the largest oil exporting country and became a very rich country. In spite of its accumulated petroleum wealth, the 2014-16 fall in oil prices had a major impact on its economy which can be briefly summarized as follows: the country, used to fiscal surplus, has been quickly suffering from a high fiscal deficit (15.9% in 2015, 13% in 2016) and its net foreign assets of $750 bn dropped by near 25% in two years only. Faced again to such petroleum cyclicality, the country was obliged in 2016 to adopt a fundamental macroeconomic policy shift to foster long-term better fiscal sustainability by developing non-petroleum activities and other macroeconomic actions. 

Timor Leste is one of the first oil and gas exporting country which established a petroleum fund from the commencement of production. Its objectives are to mitigate revenue volatility and save for future generations beyond the depletion of the country petroleum resources. The fund was established by law in 2005 with rigid fiscal and investment rules similar to the Norwegian model. During the 2005-15 period the country received total petroleum revenues amounting to $20.7 bn of which only a minority portion of $7.3 bn (35 percent) was transferred to the budget for spending in that developing country while the balance was kept in the fund. The fund reached $16.2 bn at the end of 2015. Under the applied fiscal rules, spending during the first years of production was rigidly controlled. The average annual return of the fund over the period was 2 percent in real terms, less than the “estimated sustainable income” (ESI) of 3% of the petroleum wealth set forth in the law.

Since 2009, annual withdrawals from the Timor Leste fund were higher than the ESI which raised concerns. In 2015, the withdrawals from the fund authorized by the Parliament were even for the first time higher than the annual petroleum revenue, a decision to partly attenuate the large fall in petroleum revenue (-68 percent versus 2013). This striking difference with the Norway Fund model is explained by the fact that Timor Leste is a low-income country and requires spending on domestic education, health and infrastructure investments for the current generation. It should be noted that Timor Leste is a good example of how petroleum revenues can be managed transparently.     

Ghana became a new oil producer in 2010 and decided, as Timor Leste, that its petroleum revenues should be carefully managed to ensure maximum benefits to the nation. To that end, the Petroleum Revenue Management Act (PRMA) was promulgated in 2011, and was recognized by many experts and institutions as best international practice. However, in the reality, the implementation of the Act and the fiscal policy followed by the government have raised a number of issues. Indeed, Ghana rapidly suffered from the “resource curse syndrome”, expecting petroleum revenues higher than the effectively paid revenues, spending too much and over-borrowing abroad from banks offering debt opportunities to the country. A rapid consequence was that in early 2015, Ghana was obliged to arrange a program with IMF to assist its suffering economy and improve debt sustainability in the future.

Analysing the reasons which have caused in Ghana that negative impact on the economy of the ramp-up of petroleum revenues illustrates the importance of carefully assessing the uncertainties and volatility risks when forecasting future petroleum revenues especially for a new exporting country. Among the causes for overstating expected revenues were misinterpretations when forecasting revenue on how the applicable petroleum tax rules work effectively and selecting for budget purposes optimistic price scenarios. In addition, a new oil country should not over-borrow and always carefully decide on contracting any additional debt. Ghana is an example showing that having a petroleum revenue management law and established petroleum funds are not sufficient for eliminating fiscal vulnerability during price cycles.    

Mozambique will probably become a major gas exporter in some years following the discoveries of very important resources near ten years ago. Country expectations in terms of medium-term petroleum revenues were rapidly quite high. However, the large fall in gas prices since 2014 has delayed the decision by companies for firm field development plans and reduced their scale, while the country started already to borrow debt for non-petroleum domestic investments, too early to be able to service that debt before the effective generation of gas revenue from the first field, a situation that has been immediately detrimental to the economy. This other example of revenue schedule uncertainty shows the key priority of carefully controlling the expectations and timing of revenue when a country may become exporter. 

A review of the majority of African petroleum countries would show that most of them have suffered from the boons and busts resulting from the cyclicality of petroleum prices, as well as from the “resource curse syndrome” at some periods of their development. In addition, only a few countries in that region have created petroleum funds or similar saving mechanisms. On the contrary, a number of producing countries have indeed mortgaged their future petroleum revenues for obtaining debt from banks, which is not a recommended practice except in very special circumstances. Most of those countries have therefore greatly suffered during bust periods. By contrast, new exporters try now to adhere to more rigid petroleum revenue management principles, which is commended.