Choices in Oil Depletion Policies: The theory and the Practice

1. Choices in Oil Depletion Policies: The theory and the Practice Professor Paul Stevens Senior Research Fellow (Energy) - Chatham House Professor Emeritus University of Dundee – Scotland Consulting Professor PESD Stanford University - California Conference on Natural Resources and Economic Development Dubai School and Management and OxCarre 9-10th December Dubai 2009

2. Presentation outline • Based upon ….http://www.chathamhouse.org.uk/publications/papers/view/-/id/638/ • Why does oil depletion policy matter? • Why do you need a policy? • What is the nature of the choices • Theory versus practice

3. Why does oil depletion policy matter?http://www.chathamhouse.org.uk/publications/papers/view/-/id/652/ • The international oil market will need more oil • The producer countries need to optimize their hydrocarbon resources

4. Why do you need a depletion policy?Why not just leave it to the market? • Property rights issues • Fluid migration and the Law of Capture • Managing externalities = The speed of development • Recovery rates and good oilfield practice • Avoiding “resource curse” • Maximizing the linkages to promote development • Future generations, asset management and the myth of “sustainable development” for oil producers?

5. HYDROCARBON RESOURCES (?) EXPLORE IGNORE NO COMMERCIAL FIND COMMERCIAL DISCOVERY DO NOT DEVELOP DEVELOP PRODUCING CAPACITY DO NOT PRODUCE PRODUCE Government Choices as the Owner What is the nature of the choices? Access to acreage Development policy Production policy

6. HYDROCARBON RESOURCES (?) EXPLORE IGNORE NO COMMERCIAL FIND COMMERCIAL DISCOVERY DO NOT DEVELOP DEVELOP PRODUCING CAPACITY DO NOT PRODUCE (1) PRODUCE SPEND/SAVE/INVEST DOMESTICALLY INVEST ABROAD What is the nature of the choices? Access to acreage Development policy Production policy Revenue deployment policy Depletion policy must consider development policy

7. HYDROCARBON RESOURCES (?) EXPLORE IGNORE NO COMMERCIAL FIND COMMERCIAL DISCOVERY DO NOT DEVELOP DEVELOP PRODUCING CAPACITY DO NOT PRODUCE (1) PRODUCE SPEND/SAVE/INVEST DOMESTICALLY (2) INVEST ABROAD (3) What is the nature of the choices? Access to acreage Development policy Production policy • Outcomes • Rate of return? = f (future oil rents) • Rate of return? = f (resource curse) • Rate of return? = f (role of oil funds) Revenue deployment policy

8. What is the nature of the choices?Produce today versus tomorrow • Theory based on: p= growth in “rent” i = discount rate/rate of interest • p>i –leave it in the ground p<i –produce it today • But great uncertainties • Very restrictive assumptions regarding “perfect knowledge” Whose view of p and whose view of i? • Assumes a “fixed stock” of reserves • Unproved reserves, proved reserves, existing capacity must be treated differently • Option values …… • “The choice of depletion policy is thus much more complex than is usually represented in the economics literature.” (Page 15) … “it fails to provide serious practical guidance to policymakers” (Page 36) • Its only value is to ensure the right questions are being asked?

9. What is the nature of the choices? Deploy domestically • Defining “resource curse” • Casual empiricism: “The Curse of Oil” Middle East Money March 1975 • Early empirical research suggested poor performance • The growing debate – “natural resources” plus the time frame • Transmission mechanisms • Started with economics –Dutch Disease, Crowding out, etc. • Growing interest in the political economy • Managing “resource curse” • Politicians versus bureaucrats and the “usual suspects” • Good versus bad institutions • Paul Stevens & Evelyn Dietsche Resource Curse: an analysis of causes, experiences and possible ways forward. Energy Policy Volume 36 Issue 1 January, 2008. Pp. 56-65.

10. What is the nature of the choices?Deploy abroad [1] • In Theory Oil Funds provide an alignment between depletion policy (and is a hedge against its uncertainties) and development policy (long term, slow changing aspirations and constraints) • Objectives of the Funds • Revenue stabilization • Inter-generational saving • Sterilize revenue inflows • Allow transparent arm’s length management of revenues insulated from day-to-day politics. • Offset low returns on domestic investment (for whatever reason)

11. What is the nature of the choices?Deploy abroad [2] • How Funds work • Virtual/ Informal funds • Formal funds –need to integrate into overall fiscal framework • Problems of “raiding” and “waiving the rules” • The case for Funds • Creates a compact between government and people • Helps manage expectations • The case against Funds • Simply creates an attractive trough for politicians to feed from • Only works where it doesn’t need to work. Success of Funds= f (quality of public finance management systems) • The empirical evidence • Mixed

12. Conclusions on optimal depletion? • Theory not very helpful • Better to forget optimal depletion and think of optimal spending?

13. Optimal spending • Hartwick Rule (1977): Invest all revenues net of production = maintains stock of wealth and creates permanent income. Very simple… • “Genuine Savings” –changes in capital stock including changes in natural resource stocks i.e. new assets net of the depreciation of old assets including oil reserves. Very complex… • Optimal spending ultimately means reducing dependence on hydrocarbons i.e. economic diversification. • Measuring dependence: primary non-oil balance –Non-hydrocarbon fiscal balance (NHFB) and Non-hydrocarbon current account balance (NHCB) as a practical means to assess performance.

14. Non-hydrocarbon balances as % of non-hydrocarbon GDP, 2006 John Mitchell and Paul Stevens Ending Dependence: Hard choices for Oil Exporting States http:/www.chathamhouse.org.uk The key issue is transition…

15. John Mitchell and Paul Stevens. Ending Dependence: Hard choices for Oil Exporting States http:/www.chathamhouse.org.uk The concept of transition

16. Time for change John Mitchell and Paul Stevens Ending Dependence: Hard choices for Oil Exporting States http:/www.chathamhouse.org.uk

17. Thank you for your attention