IMANI Alert! A Modest Proposal to an African Country Newly Blessed With Oil

by Franklin Cudjoe, Bright Simons & Kofi Bentil

June 2011

The economic duty of the government in a country with a new oil industry is not to maximise the extent of local content in the new sector at all costs. From both a financial prudency and social equity perspective, the primary obligation of such a government is to maximise the profitability of the sector.

We argue that this maxim holds for most African states where the profile of the new oil resource is highly likely to be deepwater or even ultra-deepwater. The high risks and costs (finding, development and lifting) often mean that only about 40% of the gross proceeds made from the sale of oil is available for sharing between the host country and the investors, usually private-sector and foreign-originated players. In such circumstances, over the medium-term, there is barely any real difference between the rivals in vogue at present: the "production-sharing" and "royalty and tax" systems. It follows therefore that for either system the overall profitability of the sector must be key, if national revenues are to be optimised for investment in comparatively-advantageous, tradable, sectors of the economy.

We concede that profit maximisation and local content promotion are not, logically speaking, mutually exclusive. But in practice, especially in the typical case of a small African country with a marginal find, excessive emphasis on local content promotion by overstretched public sector managers almost always lead to uncritical resource nationalism and an inability to appreciate the complex dynamics of profitability.

Consider that in the new oil economies of Africa, annual production typically hovers or are projected to hover around 100,000 barrels. Total recoverable reserves would usually be projected to last for 25 years. Meanwhile building credible local content infrastructure takes upwards of a decade. By the time the artificial cap of 60% or so had been reached, the finite resource is nearly spent, or the structure of the economy would already have grown so imbalanced that said local content strategies would seem like "mini-enclaves" within the original oil enclave. The disjunction would have been complete.

Rather than go to every length to create narrow synergies in the service of an enclave sector with a stunted growth cycle, and short lifespan to boot, it seems obvious to us that it would be profitable to aim at comparative advantage – led general diversification. If an example is warranted, the case of Venezuela’s love for investing in American refining capacity even as its own oil sector atrophies, and the relative success of the Bolivarian Republic’s CITGO in the US, is ample testimony to the triumph of profitability over control.

But if so, then how may oil receipts be channelled properly into this diversification business? We argue against stabilisation, overflow, buffer, and smoothening funds that aim to lubricate the existing fiscal structure, which in all probability would be far from the most dynamic part of our beloved country’s endowment.

We argue instead for national investment vehicles with separate functions: at least one to grow the money and at least another to channel the winnings into profitable enterprises. Both categories of vehicle should be placed on open, private, "auction". The local capital market players should periodically bid to manage these, for commissions. The discipline and ruthlessness of the process shall ensure that returns are sustainable, particularly as over time the funds decouple from the underlying oil resource.

And the government? They should focus on what they do best: tax the joy out of the game.

Franklin Cudjoe is founding President of IMANI & Managing Editor of Bright Simons is Vice-President for Development and Research at IMANI. Kofi Bentil is Vice-President and Senior Fellow on Energy and Regulatory Affairs at IMANI.