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Rentier States: Feeling the Pressure

Research & Analysis

By Robert Barron

In political science, the term “rentier state” refers to a state that derives the majority of government revenues from the sale of domestic resources to external clients. Today, the term almost exclusively applies to the world’s major oil-producing states, particularly in the Middle East, Africa and Latin America, which boast massive state-controlled oil and gas reserves and firms to utilize them. Academics hypothesize on the effects of rentier economics on democratic, institutional, economic and human development, the general consensus being that the practice is rarely a good thing – the debate over the “oil curse” is a common one. While a rentier economic system may not be ideal for a number of reasons, perhaps the most critical challenge rentier states face is dependence on oil exports and the risk of declining oil prices, which directly affects government coffers. As of mid-February, oil prices are down around 70% since 2014, reaching near 13 year lows.  Could this be the crisis that spurs lasting changes?

The sharp decline in the oil price has led to rumblings about political and economic reform in the rentier states. Generally, the states which carry this label share a number of characteristics. These are states with substantial oil and gas reserves, almost always controlled by a government employing state-controlled companies to produce and sell refined or unrefined oil and gas. Proceeds from these sales are usually relied upon for public services. In most cases, government budgets are heavily, if not almost entirely, dependent on energy sales and rentier state governments are usually less than democratic, prompting the discussion of whether oil is to blame. Followers of energy news over the past year have certainly noticed the increasing signs of distress facing oil states in the Middle East, Africa and Latin America. There are signs that many of these states are changing the way they think about energy and the policies surrounding it, which may have lasting implications even after oil prices recover.

The Effect of Dwindling Oil Prices

Around the world, budgets of the oil states are being squeezed, as countries have watched in surprise and panic as oil prices plummet past almost everyone’s estimates. In Saudi Arabia, perhaps the country most capable of handling low oil prices due to the state’s massive savings, the government has cut its budget by 14% this year. The kingdom ran a $98b deficit in the previous fiscal year, which it hopes to reduce to $86b in the year ahead. However, most states cannot fall back on sovereign wealth funds as the Saudis can, and have watched as reserves evaporate. In Nigeria, currency reserves are at their lowest levels in decades. As oil sales constitute 70% of Nigeria’s public revenue, the country has been debating necessary changes to the national budget through most of 2016. The original budget, released in December, called for a tripling of capital expenditures and the doubling of Nigeria’s deficit, assuming a $38 per barrel oil price. When prices hit $30 per barrel, the president recalled the budget, later ordering a probe to evaluate the extent of budget padding across Nigeria’s ministries in the hope of making spending more efficient. Despite assurances that Nigeria is not seeking an “emergency” loan, rumors remain that the World Bank and African Development Bank will soon offer a $3.5b to assist the country.

These are only the most high profile in a long line of recent cases where governments have expanded budgets in years of high prices, only to now be feeling pressure as prices are the lowest in nearly a decade and a half. The result has been crisis in many states and recalculations in the rest. In Venezuela, where oil constitutes 95% of exports, the government is obligated to make $11b in debt payments in 2016. Such a level of debt in the face of low prices, especially for Venezuela’s heavy crude, has pushed analysts to predict that “the question is not if Venezuela will default, but when they will default.”  Kazakhstan, which planned its 2016 budget at a $40 per barrel oil price, is reevaluating its budget to assess options with a price as low as $16, according to the Prime Minister. Bahrain’s Energy Minister stated “the Bahraini budget for 2016 was based [on] $50 per barrel,” prompting the kingdom to reevaluate spending. In Azerbaijan, where energy exports constitute 75% of the national budget, the government is in discussions with the IMF for up to $3b in assistance. Angola, which expected a $40 per barrel price in its 2016 budget, held negotiations with the World Bank in late January to discuss assistance. Mexico has announced that its budget will be cut considerably, but has not yet specified the amount. In Ecuador, the government budgeted $673m for oil income in 2016, compared to $3b in 2015. Kuwaiti officials expect a budget deficit of up to 60% this year at a $25 per barrel oil price.

The Rest of the Equation

Finding ways to fill these holes in national budgets has not been easy, as raising oil prices does not seem possible at the moment. OPEC, or at least major players within the organization, have been unwilling to cut production as a means of raising prices, at least partially with the goal of squeezing out shale producers in the US. And beyond the coordination required to cut production, which despite the February 16th OPEC agreement to stabilize production seems unlikely to happen soon, state revenues would likely to decline with decreased production, foes of the Gulf States such as Iran and Russia will benefit, and shale players would return to profitability – all potential deal breakers for the GCC states. For the next year, it seems that debt and varying levels of austerity will become the name of the game in the rentier states, although it is uncertain how far many states are willing to go. Will the policies developed follow a short-term approach, or longer-term reform and adjustment? At the moment, there seems to be some of both.

The economic reforms being pursued are reflective of the rentier state system, which critics argue promotes inflated budgets and a lack of accountability. The debates surrounding these cuts are interesting – reflecting the trade-offs and “social contracts” common in these systems: limited political participation, economic opportunity and social space in return for government services and goods. As budgets are cut, what programs will go to the chopping block?  If expensive public services are rolled back, will governments be forced into greater accountability and into providing greater political and economic freedoms, or will they become more brutal, cracking down on dissent that stems from austerity and economic stagnation?  How the balance will change has yet to be seen.

In Saudi Arabia, where the government budget will be cut 15% this year, subsidies are being cut and new taxes are being introduced, while education and social spending have been largely left alone. Similar measures are being taken throughout the Gulf, where by some estimates oil revenues accounted for 85% of government revenues in 2014, and where citizens have developed expectations about government obligations, having almost never faced taxes. Economic adjustments such as these are important steps in achieving greater sustainability, but have led to questions in the press and among analysts about how the political systems of the Gulf States might change. “In Saudi Arabia and the Gulf we are selfish. It’s all about what people get from the government. We treat the government as a father who must look after us. Prince Mohammed is doing what Thatcher did in Britain. That is a part of the solution, though it is not just an economic problem but a political one too,” Saudi politician Haifa al-Hababi told The Guardian. Saud al-Tamamy, a political scientist at King Saud University, argued that “no one talks about income tax so the representation-taxation equation is inapplicable in the Saudi case […] The word representation has a different meaning here.” In a piece called “The Gulf’s New Social Contract,” Emerati columnist Sultan al Qassemi argued that new taxes may start a destabilizing process in the Gulf, stating that “income taxes may sound good on paper, but their implementation and repercussions will be complex and unpredictable.” By most estimations, political changes in the Persian Gulf will be slow, as states continue to spend heavily to coopt potential opposition and crackdown on dissent to coerce opponents. However, new taxes, government repression, sectarian tensions, economic stagnation and high unemployment lead many to believe the regime may feel the pressure to change, or face more threatening internal strife in the future.

Most other rentier states do not have the benefits of the Gulf States – lacking the resources and wealth funds of the GCC states. Particularly notable as of late, Nigeria is an interesting case – seeking to avoid cutting public services and subsidies and to continue the state’s development priorities in the face of low energy prices. Despite declining revenues and the government’s dependence on oil sales for 70% of its income, the original proposed budget for this year was almost 22% larger than 2015. The Buhari government proposed a stimulus package for 2016 which required substantial spending on public works, housing, power sector development and other areas of development that will benefit local governments and the Nigerian population. But with oil prices low and Buhari now seeking to reevaluate spending, Nigeria will need international assistance and budget cuts to meet the goals of the stimulus package. And as international donors will likely require, at the least, greater flexibility of the currency, the Nigerian Naira will likely be substantially devalued, leading to inflation which may undermine some of the goals of the stimulus package.

In many other states, there are undoubtedly signs that populations are feeling pinched, but that the governments have yet to find solutions. In Angola, where oil constitutes 95% of exports, the government budget has been cut 40%. The austerity program begun in 2015 has led to a health crisis, as public sanitation, water sanitation and health care providers are not being paid, leading to government security forces being tasked with resolving the crisis and maintaining stability.  Throughout Central Asia – in Kazakhstan, Turkmenistan, Uzbekistan, Tajikistan and Kyrgyzstan – where government revenues are reliant either on energy sales directly or on remittances from citizens working in energy fields abroad, cuts in government services have led to protests. Unable or unwilling to offer reform, the governments of these states have cracked down on dissent.  In Algeria, the government has recently signed political and economic reforms, in part due to the age of President Bouteflika, but also due to a 41% drop in oil revenues which constitute 60% of the state budget and 95% of the state’s exports. Reforms to the political process, intelligence services and social freedoms have been seen by many Algerians as superficial, and have not overcome cuts made to Algeria’s subsidy system, high unemployment and poverty. The country saw several protests in 2015, with some analysts predicting the possibility of a “delayed Arab Spring” in Algeria. Despite the differences in the strategies and situations of the wealthy and poorer rentier states, the measures being taken showcase the difficult balancing act these states are undertaking.

A Way Out

The other interesting trend among rentier governments has been reform of state oil firms, the golden geese of any rentier economy.  News has broken across the world about reform measures to be taken in state oil firms, sometimes going as far as privatization. The highest profile case of this of late has been the news that Saudi Aramco, by some measures the world’s most valuable company, is considering an IPO on a portion of the firm. In an article in The Economist called “Sale of the Century,” King Salman said he was “enthusiastic” about the idea. As the kingdom relies on oil for 73% of its national budget, the move has been promoted as a possible breath of fresh air for the company and Saudi economy, bolstering the Saudi stock market and improving transparency. Prince Muhammad bin Salman, now managing many areas of the government, said the move would “counter corruption, if any.”

And Saudi Arabia is not alone. Rumors have abounded that Russia is working to sell portions of Rosneft, its massive state oil firm struggling due to low oil prices. In early February, Russian and international media reported that the Kremlin plans to sell portions of Rosneft and Bashneft, among other state-owned firms. While the details are still murky, the move is a far cry from Putin’s former “national champions” doctrine, which saw Russia’s state resource firms as an important means of international influence. Putin famously reacquired majority stakes in Russia’s firms after a decade of oligarch control in the 1990s. Relatedly, Kazakhstan is in the process of partially privatizing a number of state firms, including the KazMunaiGaz oil and gas company, Samruk-Energy and company subsidiaries. Petrobras, Brazil’s massive state oil firm which has fallen on hard times with the rest of the country, may see its benefits as a state-owned company eroded over the next year. Without the capital to pay for new development and production, the Brazilian senate is in discussions to end Petrobras’ status as sole operator in pre-salt oil fields and other joint venture requirements, in an effort to stimulate investment. Shell CEO Ben van Beurden supported the move, telling Forbes that “It’s up to congress to decide. But I think it makes sense to call on other companies who have the technology, who have the money.” In Mexico, Pemex, which has sought to reform and privatize for much of the past two years, is also facing troubles that are spurring reform. New CEO Jose Antonio Gonzalez Anaya has pledged to majorly turnaround the firm, telling Bloomberg that the company must “accelerate the implementation of the energy reform in a very difficult environment.” For Pemex, finding new partners and investors is particularly important in achieving efficiency, consistently a problem for the company.

Across the world, inflated national oil companies are coming under increased pressure and skepticism, as “well-educated technocrats from oil-producing nations are wondering whether their national oil companies are ‘ripping us off’ through corruption or inefficiency,” according to a Chatham House analyst quoted by The Economist. For many state oil firms around the world, infamous for inefficiency and corruption, low energy prices may be the beginning of a death knell, as rentier states reevaluate policies and promote new economic methods. If, when and where this trend is going is yet to be seen, and there are certainly reasons to doubt changes will be revolutionary. State energy companies have historically made a lot of money for a lot of people and been important politically. But if the trend continues, the implications for the global energy industry could be substantial.