The perils of relying on oil as the only resource for development

Workers prepare pipes to service an oil well. Reuters/Shamil Zhumatov

Astrid R.N. Haas, International Growth Centre
Developing off the back of one natural resource is risky for any country. It makes them reliant on external conditions beyond their control, such as global demand and supply. Since June 2014, global oil prices have fallen by more than 70%. Consumers are happy. Oil producing nations are not.
One example of this is South Sudan. It is the world’s youngest nation, having gained independence from Sudan in 2011 after more than 20 years of war. Commercial oil was discovered in 1979 by US company Chevron in what was then one country, Sudan. The main oil reserves are located along the border between Sudan and what is today South Sudan, with an estimated 75% of the oil reserves found on the South Sudanese side. The refinery and most other infrastructure necessary to sell and export the oil are located in Sudan.
When South Sudan gained independence, the two countries negotiated a fixed fee for each barrel of oil produced. The total fee was set at about US$25 per barrel. At this time, the oil price was about $100 per barrel. This was sufficient for the country to make a healthy profit from oil production. Its oil revenues made up more than 95% of government revenue. But by agreeing on a fixed fee South Sudan carried the full risk of an eventual slump in oil prices. The country is still in an estimated $2 billion of arrears to Sudan for the transit fees since 2011.

Internal disputes add to oil production issues

Two major domestic factors compounded the hard times South Sudan faced as a result of the fall in oil prices. First, in January 2012 there was a dispute over the unpaid transit fees with Sudan. This resulted in South Sudan halting oil production, which in turn meant the supply of oil and the country’s main source of revenue fell quickly. Oil production was eventually resumed. Second, in December 2013 a civil war broke out in South Sudan, which led to a renewed shut down of some oil production. In March, the Ministry of Petroleum and Mining in South Sudan said it did not expect oil production to ever reach even half the peak levels it did in 2010.
New negotiations with Sudan have allowed for flexible fees that can rise and fall with the global price of oil. This new negotiation does not affect South Sudan’s outstanding arrears, and has come at a time when the country has, to a large extent, depleted its foreign exchange reserves. At current oil prices and production, it is estimated that South Sudan is earning less than $5 per barrel.
As a result of civil war, South Sudan’s spending went up as its revenues from oil decreased. By October 2015, the government was only able to finance about one-third of its budget from its own revenue. To finance the remaining budget, it started borrowing from the Bank of South Sudan. Initially the bank was able to finance government spending from accumulated reserves. As these were depleted, from about $2 billion at independence to $60 million by October 2015, the bank had to start printing money.
The additional South Sudanese pounds circulating in the economy have severely affected the exchange rate and overall inflation. Current macro-economic indicators estimate that inflation in South Sudan has reached 202.5%.
South Sudan is not the only oil dependent economy that is suffering from the fall in oil prices. There are lessons the young nation can learn from countries such as Angola and Nigeria. If it does not diversify its economy the risks of fluctuating oil prices will continue to mark its development path.

Lessons from other African countries

In Angola, a special cabinet meeting was called recently to discuss the country’s economic problems. Oil makes up 95% of Angola’s export earnings. Participants at the meeting noted the large decrease in the availability of foreign currency, expected to be 50% less compared with 2015 because of the fall in oil prices. This resulted in the devaluation of the kwanza and double-digit inflation figures.
In Nigeria, a much larger and slightly more diversified economy, the fall in oil prices is also taking its toll. Newly elected President Muhammad Buhari experienced a déjà vu situation marked by the fall in oil prices after he became president. On the day of his election the price per barrel stood at $64. When he was sworn in eight months later it had fallen to $32 per barrel. In Nigeria, like Angola, oil revenues make up 95% of export earnings and 70% of total government revenues.
There are ways that countries can manage their natural resource wealth and become less susceptible to external forces.
Botswana, for example, is a country that has managed its resource wealth considerably better. It discovered diamonds in 1966 but has largely avoided many of the challenges now facing oil-dependent economies. One of the major factors that contributed to Botswana’s success is that it remained fiscally prudent even after diamonds were discovered. Botswana resisted the temptation of increasing spending as a result of the new-found wealth. Instead, it continued to adhere to principles of good budgeting, using its national development plan as a template. This resulted in the country having the highest per-capita growth in the world over several decades.
But even Botswana’s growth is not without risk, as 75% of its export revenue is made up from diamond sales.
The major lesson for South Sudan is that aside from prudent management of wealth derived from their oil, it is imperative that countries undertake increased efforts to diversify their economies. They must move away from being overly reliant on the export of just one resource. As the case of Botswana has shown, this will also take strong and well-run institutions. If South Sudan successfully manages to do this, it will not be as vulnerable to external risks of the world economy, such as the fall in oil prices.


Astrid R.N. Haas, Country Economist for South Sudan and Uganda, International Growth Centre
This article was originally published on The Conversation. Read the original article.