Managing oil windfalls

Written by Stephen Poloz

High oil prices are translating into more spending at the gas pump and less spending everywhere else — the classic symptoms of Dutch Disease. There has been plenty of analysis of the pain of the losers in Dutch disease, but how are the windfalls being managed by the winners?

In 2005 alone, oil exporters are expected to reap some US$200 billion in extra income. The response varies widely. In some countries the windfall is boosting consumption — feeding an era of plenty after years of belt-tightening. In other countries the extra income is boosting saving, which will then be used to finance a more far-sighted program of infrastructure investment.

Consider Latin America, which produces more than one-tenth of the world’s oil. High oil prices present a golden opportunity for the region to cash in. But many countries have under-invested in the energy sector, leaving them unable to boost production quickly to take full advantage of the situation.

Take Mexico, for instance. Because the Mexican government relies heavily on oil revenues to fund its programs, a lot of the rise in oil wealth flows directly into government coffers to fund current spending. However, some of the money is being saved for future investment in the oil business.

Similarly, Ecuador’s new administration revamped its oil stabilization fund, thereby diverting most oil windfalls into spending on social programs. Venezuela has also boosted its government spending substantially — by nearly 40 percent since last year — and oil production has still not even recovered to pre-strike levels.

Contrast that with countries in the former Soviet Union, where oil reserve funds are more common. In particular, Russia and Kazakhstan have both built up large reserve funds and paid down their international debts. In Russia’s budget for 2006, the stabilization is projected to reach US$76 billion, and it could exceed the entire stock of public sector debt by 2008.

From a global point of view, it is fortunate that many of these countries are spending their oil windfalls. Canadian exporters are benefiting from this: For example, Canadian exports to Russia and United Arab Emirates are up by over 40 percent compared to last year, and exports to Kazakhstan are up by more than 70 percent.

The bottom line? These contrasting experiences from oil producers illustrate a simple truth: natural resource endowments only play to a country’s advantage in the right policy setting. Some countries may be missing the boat this time, but continued strong demand for energy means that tomorrow’s energy investments are still likely to generate big benefits down the road.

November 24, 2005

The views expressed here are those of the author, and not necessarily of Export Development Canada.

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