Guyana needs an informed and dispassionate debate on local content policies for oil industry

The heading of yesterday’s Sunday Stabroek column by Professor Clive Thomas “Why local content measures are considered ‘backward backdoor protectionism?”, while framed as a question, conveys in my view, an unfortunate negative connotation about local content policies. Dr. Thomas holds the prestigious and influential position of Presidential Advisor on Sustainable Development and his writings will no doubt help to shape national policies. Admittedly, the two preceding columns seemed more disposed to local content requirements (LCR) in oil and gas contracts but in this latest column, I am less sure.

Oil discoveries have been made in deepwater areas off Guyana, which means that the first time we will be able to use our oil is after it has been shipped off to a refinery and re-imported into Guyana. If the advisers, policy makers and the managers of the economy, choose to think that local content is not an important matter, the public needs to understand that the major difference between when the first oil flows and now, will at best be manifested in lower domestic fuel price and the balance going into the public revenues. Under Guyana’s model Production Sharing Agreement, there is no separate tax revenue: the Government’s share of profit oil includes the taxes. What this means is that we can use our share of profit oil as we see fit: the Government can sell the oil on the domestic market at reduced prices, or put the value into the Consolidated Fund, or a combination of the two. At this stage, the Constitution allows only for a single Consolidated Fund and would need to be amended to create a Sovereign Wealth Fund.

Dr. Thomas’ column yesterday seeks to summarise two reports on local content policies in the petroleum sector. The first is by the United Nations Conference on Trade and Development (UNCTAD) and the other by the World Bank. I do not share Dr. Thomas’ view of these as examples of “even more formidable body of empirical studies examining the operations of LCRs in the oil and gas sector”. Guyana has certainly gone through an intellectual transformation from the days when the World Bank-endorsed IMF’s Economic Recovery Programme (ERP) was parodied as Empty Rice Pot by the leadership of both the PPP and the WPA. Continue reading Guyana needs an informed and dispassionate debate on local content policies for oil industry

Facing the threat of rising oil and food prices

Oil seems to have a talismanic role in the world’s psyche. More than gold its price causes predictions of apocalyptic proportions, paralysis in the modern world and fears of wheels grinding to a halt. Those of us of an earlier generation will recall how the four-fold rise in the oil price in the seventies sent shockwaves across the world and caused a tectonic shift in global resources as more money poured into the oil-producing economies than they could handle. The dramatic increases in oil prices in 1973-74, 1978-80 and 1989-90 were all followed by worldwide recession. Yet with unerring regularity and often defying the predictions of doom, the economies would return to the historical pattern of periods of unprecedented growth, low interest and inflation, consumer confidence and spending.

In the decade of the eighties, the economies of Asia grew (real GNP) astronomically ranging from 120% growth in the Republic of Korea, Taiwan 90%, Hong Kong 65% and Singapore 80%. Even the Asian crisis went almost as soon as it had arrived, leading the region and the world’s economic managers to take the credit for having fixed the system – once and for all. The more hubristic were even prepared to say that inflation had been bottled up, the economic cycle of periods of recovery and prosperity characterised by relatively rapid growth followed by contraction and recession or the more extreme form ‘depression,’ had been neutralised and the central bankers and the IMF were in complete control.

Storm clouds
Even Bush could not mismanage the US economy given the magical powers of Alan Greenspan of the Federal Reserve Bank, while Gordon Brown, the ambitious Chancellor of the Exchequer was credited with all the economic achievements of Tony Blair. The only threats that the revered gurus could see was the bin Laden-inspired terrorism, and more mundanely, the impact of washing drug money in the pure financial stream overseen by the ever more confident central bankers. But then suddenly storm clouds began to gather on the horizon and the respected Economist publication, ‘The World in 2006’ cautioned that the global growth rate of close to 5% for two consecutive years was too good to be true and that things could not remain so rosy for ever.

Real oil prices had already begun to climb, a housing boom or rather bubble financed by sub-prime loans, extravagant consumer spending with the gas-guzzling Hummer and SUVs being the vehicles of choice and negative personal and national savings rates were facilitated and masked by cheap money. History is replete with examples that such a party could not last, that the night would come to an end and the hangover would be long and painful. That unfortunately has now happened, and almost quarterly we see leading institutions like the IMF and the European central banks revising their economic outlook, shaving a few decimal points with each revision. The decline started with the sub-prime mortgage crisis in the US, which now affects the global financial system with fears that the system can collapse and that Bear Stearns in the US and Northern Rock in the UK were only the early casualties.

A matter of opinion
How the crisis will play out, however, is a matter of dispute, and there are conflicting projections by influential players in the system. The influential Bank for International Settlements – the central banks’ central bank – considers that the world economy is probably facing a deeper and more prolonged slowdown than many assume, and that even though the worst of the credit crisis may be over that did not indicate an all-clear for the world economy.

Barclays Capital and the Royal Bank of Scotland seem to have a more pessimistic view of the state of the world’s major economies, and in mid-June the latter advised its clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.

The UK right of centre newspaper the Daily Telegraph quotes the bank as warning that the S&P 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as “all the chickens come home to roost” from the excesses of the global boom, with the contagion spreading across Europe and emerging markets.

Global inflation has jumped from 3.2% to 5% over the last year. Tim Bond, chief equity strategist of Barclays Capital, believes that the “emerging world is now on the cusp of a serious crisis; that inflation is out of control in Asia,” and that the need to slam on the brakes will cause “a deep global recession over the next three years as policy-makers try to get inflation back in the box.”

One of the less discussed implications of globalisation is that it spreads both its virtues and its vices, and whether it is a matter of inflation, interest rates or a credit crunch, the dangers will move across borders. Of course it also means that every economy becomes its brothers’ keeper with a real and direct stake, and as is evident with the EU countries complaints of loss of independence is not infrequent. Now with oil and food costs soaring, inflation has returned with a vengeance; economic managers, investment managers are nervous; the genie of inflation has re-appeared; and the dangers of inflation are now so great that those managers would readily sacrifice growth to control inflation. But even that is a major challenge and many are now saying that what has in fact changed is that the long-term growth trend is under threat. And again oil is a major factor, with active wars less so with stability gradually returning to Iraq so that even presidential hopeful Barack Obama is now shifting his position on the drawdown of US troops.

The jury is out
So far it is hard to say which of the two scenarios predicted by BIS and RBS is correct. It is true that the wage-price spiral has been avoided but jobs are disappearing whether in the closure of 600 Starbucks coffee houses or among major car manufacturers, and during this week the stock market actually reacted positively as one of America’s major car manufacturers reported only an 18% decline in sales – it was expected to be higher! Let it not be forgotten that America is still by miles the world’s largest economy and it is the spending habits of the American consumer that have driven the meteoric rise of China and India. The reverse may not be entirely proportional because demand in the numerically significant China and India has increased, but not even America’s worst critic would wish for the collapse of the US economy.

The double edge of the twin
It is one of the ironies that these two economies are partly responsible for the sustained oil and food price increases. While past oil shocks have been caused by supply constraints, the current increases have a significant element of being demand-driven as China’s industries and their growing middle class along with their Indian counterparts find that they can afford cars that are still dependent on oil. The search for alternative energy sources which accompanied pervious oil shocks waned as things returned to relative normalcy with the significant exception of electricity companies which started to move away from oil. The current one will have some similar effect as car manufacturers accelerate their efforts to produce hybrid cars. The airline industry has cut back its flights with immediate effects on the region’s tourism industry that is so pivotal to its survival. And as tourism falls, so too will remittances from the rich countries as migrants struggle to stave off the foreclosure of their homes. Just getting over the next five years without a major catastrophe will be a major achievement.

But while oil has stolen the limelight, food is an equally grave and direct concern, and for the first time in decades countries are suddenly talking of food security. Heads of governments of the region and the world are holding conferences to address the dramatic increases in the price of basic food items, some of which it has to be said are related to the search for alternative energy sources with corn being the most popular cited example. In fact at the World Food Summit (WFS) some NGOs called for a moratorium on ethanol production arguing this would cut wheat prices by 20%.

With oil there may be several alternatives that would be both technically feasible and economically attractive, but food is a different story. The escape of hundreds of millions in the developing world from hunger and poverty means that there are far many more mouths to feed with a growing demand for meat, which itself demands more feed. Like oil, agriculture is not susceptible to dramatic short-term fixes, but that does not mean that more cannot be done, and as we witnessed recently the placing of an export ban on one type of rice by India had an immediate adverse effect on the international price. Countries and their politicians are particularly vulnerable to fears of hunger among their populace and countries are reluctant to co-ordinate national strategies for the global good. For example, while Japan has agreed to release its government-controlled stockpile, Egypt has extended its ban on the rice trade for another year. To compound all of this, the interest of the private operator/producer/exporter and that of the government seldom converge and short of government control regional and international agreements are hard to make and even harder to enforce.

The problem with agriculture is also structural – in both the developed and developing world there is a reducing appetite for participation in the sector with weather and price fluctuations making it like a night at the casino. Added to the challenges of global warming, the reduction of water supplies, declining investment funds, reduced land for agriculture and a long-term trend of falling prices for agricultural produce, we see an industry that can only grow if there is a significant increase in agricultural productivity.

Alas, giving seeds to the populace may appear politically attractive, but it is no more than a very limited short term measure with some impact at the level of the poor household.

Note: I have delayed the column on taxation as I have been promised some additional information.