Oil prosperity?

The people from the port of Coveñas, north of Colombia, were surprised late last year with the arrival of the ship Front Crown, one of the largest oil carriers in the world capable of moving two million barrels. The boat arrived for the first time to the country to take a million barrels to the Indian firm Relliance, a negotiation made by the Colombian company Ecopetrol. This kind of operation, by its magnitude, has never been done in the country, but since last August, the story changed and it is now usual. The news illustrates how things have changed in the Colombian oil industry that now experiences a expansion era: the production is on fire, the oil is at a great price, and the main company, Ecopetrol, is conquering markets in the Far East.

The numbers are very positive. Colombia will close 2010 with a production of almost 800,000 barrels per day and it is expected to increase it to one million before the end of 2011, as the Mines Minister Hernán Martínez said. It will be the highest level of oil production ever seen in the country.

Today the oil industry represents nearly 40 percent of Colombian exports, according to the national statistics department, DANE. Last year, Colombia sold 10,268 million dollars in oil, and during the first quarter of this year it sold 3.546 million.

And there is so much left to be seen. The exploration is growing and there are high expectations for new discoveries. As if this was not enough, on June 22 new contracts will be a adjudicated. The National Hydrocarbons Agency and the Ministry of Mines will carry out a meeting to allocate 225 blocks throughout Colombia. 50 companies from different countries will participate. This process opens a new frontier of exploration and technical evaluation in 47 million hectares, that include areas from San Andrés, La Guajira, the Gulf of Urabá, Chocó, Valle, Cauca and the Pacific Ocean.

If the awarding process is successful, Colombia will have oil activity in almost the half of its territory. It doesn’t have any precedents.

However, it is necessary to be aware of the meaning of the exploration and production boom in the country. There are obvious pitfalls, and if the country is no cautious, the dream could become a nightmare.

The concerns come from two issues: first, the management of multi-million dollar royalties from the boom and, second, the risk that the country experience what economists have called the "Dutch disease."

In regard to royalties, the country has not achieved this task. During this administration (2002-2009) nearly 29 trillion pesos (about 15 billion US dollars) have been given to the regions. Only in 2009, royalties came to 5 trillion pesos (about 2.5 billions dollars).

Many of these resources have been used for the construction of arenas, stadiums or wave pools, lavish investments in regions where levels of unsatisfied basic needs are very high. So it is worth to ask what will do local leaders when the production grows 30 percent, as it’s expected to occur over the next three years.

The exit is a substantive reform to the Law on Royalties. In this government there were at least three attempts, but they never flourished because the Congress didn’t care about the issue. The challenge is for the new government. If it is necessary, the new law should let the central administration to manage the resources, since obviously many regions have failed to bring prosperity and development for its people.

The other concern about this oil boom is a strange illness that afflicts the successful countries that export it. It's called the "Dutch disease." This definition appeared in the mid-70s, when the Netherlands had a oil exports boom. This made the country's income to soar and motivated a revaluation of the exchange rate. The final result was a blow to the competitiveness of other non-oil industries. What the industry earned from oil exports was lost later because many firms bankrupted.

That is the fear in Colombia. Right now, the country has an excess of foreign currency explained by the boom of foreign investment and export recovery. So the threat is not just a fiction.

This week Trade Minister Luis Guillermo Plata said the country could reach this year 40 billion dollars in exports. Moreover, the net flow of foreign investment has been between 7 and 8 billion dollars per year, most of it due to the oil sector. This shows a tremendous confidence in the country’s economy, but also an undeniable reality: that U.S. dollars will continue coming in droves, which means a strong possibility of a exchange rate revaluation and a blow to the non-oil export companies. All these are natural ingredients from the "Dutch disease."

The remedy seems to be very simple. This involves defining a 'fiscal rule', so that the government imposes a fixed amount of savings each year, while there is prosperity, to use these funds in times of crisis. So did Norway, which has its oil stabilization fund, and Chile, with earnings from copper. In fact, after the earthquake that affected that country, much of the recovery and reconstruction will be financed with about 25,000 millions of dollars saved during the boom years.

But the issue has not been easily resolved within the government and its technicians. In fact, 15 days ago they announced a press conference to reveal the contents of the new rule, but the event was postponed because there is no consensus on how it will work.

The point is that the numbers don’t match. While the fiscal rule is necessary for the billionaire income that the country will get, on the other side the government will continue spending too much. So, how to save resources if the country needs to spend in order to modernize its infrastructure, keep a growing official roster (especially for the increase in military force) and to cover the spending on social security? If the government doesn’t apply other measures by increasing revenues or reducing expenditure, the fiscal rule could end up being useless.

It is clear that the country did well pushing the oil sector, and the Mines Minister Hernán Martinez, his predecessor Luis Ernesto Mejia, and the president of the National Hydrocarbons Agency, Armando Zamora, deserve all the applause. But if the measures to prevent risks are not taken into account, Colombia’s fate could unravel.