We keep hearing about unrest in the Middle East and Northern Africa, with Libya being the latest country to get top billing. Why all of the concern, especially related to oil?
Libya is a relatively oil-rich country. According to the CIA World Factbook, its per capita income is more than double Egypt’s. While Egypt is clearly on a down-hill slope with respect to exports based on my earlier analysis, Libya still has high export income and little debt. The fact that revolution could hit Libya shows that it is possible for revolution to hit any of the countries in this region, not just ones that don’t have the money to maintain their promises.
One issue that Libya has in common with other oil producing countries is a high unemployment rate, listed as 30% by the CIA Factbook. Its population has been growing rapidly also, so there are many young people looking for work. While the country provides subsidies, this is not the same as each individual being able to provide for himself or herself.
Another issue is that Libya is an oil exporter, and news sources are reporting that oil companies are closing up operations and trying to move employees out of the country. To make matters worse, the above-linked article also reports:
Meanwhile, local tribes in the North African country on Monday took control of the headquarters of an oil company in Ubari city in southwestern Libya.
So the problem is worse than just the oil companies leaving. There is also the threat (and reality) of dissident groups taking over oil company operations. There are reports of protesters setting fire to government buildings in Libya. It is all too easy to imagine protesters setting fire to oil infrastructure as well.
In Egypt, there appears to be a possibility of an orderly transition to a new government, but this seems far less certain in Libya. Part of the problem is that Libya had so much oil relative to its small population that it could use wealth to pay high subsidies on fuel, and most likely on food as well. With all of these subsidies, it was relatively easy for Moammar Gadhafi to remain in power for more than 40 years. The Financial Times writes about countries with high “rents” from the oil industry (or other industries) not needing to put in place the political structures that other countries have. With Gadhafi remaining as dictator for so many years, the tradition for elected government had not really developed. According to the Financial Times:
The history of economic development suggests that rent-ridden countries create governments with few incentives to build strong political institutions or listen to their people. In Egypt, for instance, these various rents account for about two-thirds of foreign exchange earnings. Directly or indirectly they generate at least a third of government revenues. This is not as large as other oil exporters in the region, like Libya, but substantial nonetheless. And Egypt’s state, in common with others across the Middle East, has used these rents to appease and suppress dissent, creating circumstances in which they have little need to develop competent political institutions.
Even if the people of Libya and Bahrain join those of Egypt and Tunisia in overcoming their cursed political systems, the economic manifestations of their rent curses will remain. Even if they become more democratic, because these countries benefit from substantial rents they will have less need to tax their peoples. This precludes the need to reform state controlled industries to create private sector wealth. It also will stop the development of genuine democratic systems, the usual basis for the legitimate taxation of citizens.
Weak economic institutions will be the consequences of these nations’ ongoing reliance on rents. These will fail to deliver essential services, such as education and skill creation, in turn limiting the pool of entrepreneurial talent. Such institutions also create bloated bureaucracies, weak legal enforcement of property rights, and obstacles for starting businesses, especially for those outside the regime’s inner circle. Without reforms the private sector will still likely thrive only through connections to a rent-addled state, not because of the raw dynamism found in many Asian countries.
With a weak governmental tradition, appart from the dictator in charge, one concern is that the country will dissolve into civil war, which will ultimately break up the country. Libya’s historical leadership has come from a network of tribes, and it is possible that the country will break into pieces, reflecting tribal alliances. Such an environment could be a poor one for oil companies, especially if protestors have set fire to important oil infrastructure.
We take for granted that oil production in the Middle East and North Africa will continue as planned, and that the reserves that these countries have can actually be extracted in coming years. But for oil and gas production to continue, there needs to be a government in place that provides at least some basic services and keeps order. In Libya, there is a threat that such a government won’t remain in place. If this kind of break-up is a possibility in Libya, it raises the question of whether it could happen elsewhere–in a worst case–Saudi Arabia.
All of the concern about Middle Eastern and North African protests is raising the price of oil. Because of the connection of high oil prices with recession, high oil prices are in and of themselves a concern. Also, higher oil prices make it harder to pay back debt, and tend to worse problems with debt default that are already threatening European countries.
Another issue is replacing the oil and natural gas that is being exported. One of the issues is whether OPEC will be able to provide the support they have promised. Libya’s oil exports amounted to about 1.5 million barrels a day in 2009, based on EIA data. While this is a relatively small amount compared to world oil consumption, loss of the full amount might prove to be a challenge for OPEC to replace, if they are not telling the truth about their true spare production capacity. So far, the loss in production seems to be relatively small, we are told. The same source indicates that OPEC is to hold a special session in case of oil price soaring, and furthermore, that Saudi Arabia will make up for the shortfall in Libya’s exports.
But all of this is concerning to those currently receiving Libya’s exports (Figure 3). Gas imports are also at risk, and there is not a comparable back up supply for them.
Hopefully, OPEC will in fact make up oil shortfalls, and things will settle back down. But if discontent spreads to other countries, the amount of the shortfall could easily exceed OPEC’s capacity. And historical experience suggests that OPEC tends to provide more assurances than it does actual support. Theoretically, OPEC could have acted long ago, to keep world prices at $80, but now Brent oil is over $100, and an increase in supply has not been provided.
One of the big lessons that may come out of this is that we really can’t count on OPEC as much as we had hoped. First, there is the problem of oil supply from individual countries, like Libya, being reduced, because of political problems. Second, OPEC’s ability to actually deal with disruptions may be less than advertised.