Often, natural resource extraction (such as oil, natural gas or
metals) has been a curse more than a blessing.
But it does not have to be always this way. A number of countries have demonstrated that
good management can contribute to sustainable development and well-being of
their citizens. For lessons on good
management, study Malaysia (oil and natural gas) and Chile (copper). For lessons on what to avoid, look at the case
of Cameroon (oil). Of course, there are
many examples of in-between cases.
But let's look in more detail at the essentials for success. Natural resource management should ensure
that each of the three links of the decision-making chain is successful:
1.
Discovery and development;
2.
Capturing substantial percentage of the value of the
extracted resources by the Government; and
3.
Investment of the captured (by the Government) value
on productive assets, especially domestic investments which diversify the
economy and contribute to sustainable development and long-term prosperity.
Failure of one of the links, breaks the chain irreparably.
1. Discovery and development: The most critical aspect of the
discovery and development phase is the role of information (knowledge). Usually, resource extraction companies know
more than the governments about the resource, both in terms of the amount of
recoverable resource and the economics of development. This is the case especially before any
substantial exploration takes place. As
more exploration is carried out, information is generated not only for the specific
location, but neighboring locations too.
For example, discovery of natural gas off-shore by Israel enhanced the
likelihood for similar discoveries in Cyprus.
So, governments enhance their knowledge and improve their negotiating
position with every new piece of information generated from additional exploration. This may lead to the false conclusion that
the longer a Government waits, the better deal it will strike.
The ideal sequence is for the government to start investing in pubic
geological information and if possible exploration. Then, share the information with all
potential bidders. This reduces the
asymmetry of information between government and private companies, but also
reduces the risk for the companies, as it provides them with information about
the recoverable resource. Both sides are
in a better position to make a commitment (sign a binding contract).
Of course, the world is not ideal; most often, governments can not
invest in early exploration. So, the
appropriate strategy may be to auction plots gradually and sequentially; new
discoveries add to the knowledge of the government and enhance the value of
future auctions.
When negotiating a contract, a commitment period of two-three years
is typical, within which the private company should carry out the exploration
and development. A relatively short
commitment period is important as the private sector may have an incentive to
delay exploration too; if a company has the rights to explore an area, it may
be best to wait for others to strike first in neighboring lots. Of course, this is highly inefficient for
both sides; reasonable commitments on both sides are needed at a reasonable
time.
In general, balancing the rights of the public and the interests of the
private companies is always a challenge.
As each case is different, striking the right balance is an art;
balancing risks-rewards in a fair manner results in the most equitable solution. In this process, information and knowledge
are the most valuable resources.
Finally, it is important to mention that nearly all deals associated
with discovery and development are Public-Private Partnerships (PPP), in the
general meaning of the term. For this
reason, it is essential for the Government to have the capacity to design and
negotiate PPPs.
2. Revenue capture: The design of an appropriate revenue capture
system is complicated and politically sensitive. Key aspects of revenue capture include: a)
knowledge of the geology; b) ability to adopt to changing circumstances over
time; c) revenue capture vehicle; and d) level of revenue. Knowing the geology allows for accurate
estimate of both the resource which could be extracted and the associated
costs. The difference between market
price and production cost is an essential element for the design of the revenue
capture system. For example, if
production cost is substantially lower than market prices, government rents
could be substantial and independent of fluctuating market prices. However, if production costs are high, the
government may have to forego revenue collection in periods of low market prices
and demand higher revenue when prices are high.
The design of the revenue capture mechanism should take into account
that substantial changes are likely to occur in the future; new discoveries and
substantial changes in world market prices are the most common changes. A well-design revenue capture system allows
for future adjustments. Locking into a
fixed system imposes undue risks and makes the deal less attractive for both
sides in the long term.
Revenue can be captured through direct taxation of profits or a
royalty system. There have been cases,
where the government established a national company which participates in ownership
of the resource and the extraction business.
The national company could be subject to the same tax regime as private
companies, but it can also build the national capacity to develop resources in
general. Most examples of national
companies are outright failures, but there are a few cases demonstrating that
the concept could be successful and highly beneficial. Failures are characterized by inefficiency,
corruption and inappropriate use of the revenues. A successful example is Malaysia which
staffed the national company with technocrats, who were protected from
political and populists pressures by the prime minister; the staff showed
commitment to their mission to benefit society in general rather than enrich
themselves. The company kept a smaller
percentage of the revenues (compared to world norms) and invested in assets
with long term benefits.
It is important for the government to have the capacity to audit the
private companies. When this capacity is
not available within the government, it is essential to hire qualified auditors
to monitor the performance and avoid the case of un-reported or under-reported
revenues.
The level of revenue collection is impacted mainly by the
differential between production cost and market price, as well as the
government's strategy regarding the development of the resource (short-term vs.
long-term focus).
3. Invest into productive assets, especially domestic investments which
diversify the economy and contribute to sustainable development and long-term
prosperity. Firstly, the balance between savings and spending needs to
be settled. This balance depends on the
needs of the country; 30-70% savings rate is common.
Then, the type of investments need to be determined, especially with
respect to domestic vs. international.
Domestic investments could have higher rate of return compared to
foreign investments (especially in capital-scarce economies) and could
transform the economy, if they are properly chosen. International investments provide more
liquidity. The right balance requires
careful evaluation.
In addition to the economic and financial aspects of resource
extraction, it is essential to remember that the wealth generated is often a
cause of violence both internally (within a country's political or ethnic
groups, as well as organized crime) and with neighboring countries. However, resource extraction has also proven
to be a force for national reconciliation and social peace.
Last but not least, environmental damage needs to be kept to a
minimum and any damage to society needs to be compensated. The easy option is to ask the private
companies to pay the full social costs, often directly to the affected
populations. However, private companies
would tend to compensate the population in the immediate vicinity of the extraction
operation and may ignore adverse impacts far beyond the development area. So, the government needs to develop the
compensation approach and possibly participate in its implementation.
In conclusion, natural resource extraction could become an engine
for sustainable development and prosperity for a country, if the Government strikes
the right balance between the interests of the public and private sector
reflective of the risks and uncertainties.
Such balance requires specialized knowledge and a sophisticated
organization which is able to determine the right timing for key decisions, design
and negotiate appropriate contracts, and manage the wealth generated to foster
sustainable economic growth for the benefit of its citizens.
P.S. Good reference documenting lessons learned from various
countries: "Plundered Nations? Successes
and Failures in Natural Resources Extraction" by Paul Collier and
Anthony Venables.
