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Managing natural resources: an attempt to clarify the debate

Yves Jégourel | January 05, 2016

Managing natural resources is a matter of great importance, both politically, socially, environmentally and economically. The subject is, though, vast and varied and sufficiently legitimate to clarify the terms of the debate. Since we cannot obviously claim to present a complete and exhaustive picture, this policy brief sets out to identify some of the substantive issues tied to natural resources, from an economist’s perspective.

Any subject that is of major importance from a policy-making perspective will involve an overlap in the approaches used. As far as managing natural resources is concerned, it is clear that economists, politicians, environmentalists, any direct and indirect stakeholders or observers each hold -at best- only part of the answer. It obviously entails that they should not only all be involved in reaching the widest possible consensus on what should be done but also, prior to this, in trying to share the same language or, at least, expound the criteria and the mechanisms that underpin their mind-set. Hopefully, this task is rather simple as far as the economical aspect is concerned. At least, that is the way it looks. “Management” is, in one way or another, about prices and quantities. As is often the case when it comes to economics.

Defining and classifying “natural resources”

In this respect, we firstly need to recognize that the notion of “natural resources” encompasses different realities, depending in particular on whether these resources are freely available and exploitable or, conversely, part of a whole agro/industrial process having, all along the supply chain, explicit market prices that prevail over any other possible implicit prices, whether social, environmental or societal. As an example, clean water management is today of crucial importance for most economies and has very little to do with what can be done to make optimal use of mineral or fossil resources that are usually managed along pure economic criteria. By the same token, a clear distinction should secondly be made between non-renewable and renewable resources, bearing in mind that, for the latter, renewal can be jeopardized when removal is excessive. According to the economic theory of natural resources, the former should indeed be considered as stock variables, whereas renewable resources can reasonably be considered as flow variables.

Trying to refine the concept leads thirdly to ponder whether the considered natural resource is extensively traded on an international basis and its price determined on a commodity financial exchange, as are most commodities, from agricultural products (grain and oleaginous, soft commodities, dairy, livestock, etc.) to base and precious metals (copper, aluminium, tin, gold, etc.) or energy. This price-setting criteria has obviously an overriding importance since it will determine the capacity of the sector’s players and policy makers to influence prices. Finally, local market dynamics should be distinguished from seaborne markets. Although the integration of the commodity market has unquestionably increased steadily over the last two centuries, driven by technology in the nineteenth century and politics in the late twentieth century (Findlay and O'Rourke, 2001), it has been neither a monotonic nor a monolithic trend. Stabilization programmes aimed at insulating domestic market conditions from international food prices through stock building, subsidized inputs or limits on selling prices have for example been an overriding element of strategy during the last two decades for developing countries, where food security is at the very core of social calm. Nonetheless, the effectiveness of such measures remains a moot point. The existence of various export restrictions, in which we saw a gain in interest when commodity prices went through the roof prior to 2014, are for example acknowledged to have numerous impacts, some of which are adverse. Martin and Anderson (2012) suggest for instance that export restrictions on agricultural commodities adopted by producing countries to insulate local markets from sky-high international prices have not only proven to be ineffective in reaching their objective, but also contributed to greater worldwide price instability.

Table 1: Examples of export restrictions

 Export tax 

 Dual pricing scheme

 Export surtax  

 VAT tax reduction/withdrawal

 Fiscal tax

 Restriction on customs clearance point for exports

 Export quota 

 Qualified exporters list

 Export prohibition

 Domestic market obligation

 Export licensing requirement 

 Captive mining

Source: OECD

Managing production, storage and investment

Once these notional and classification criteria are clarified, it becomes necessary, as straightforward as it may sound, to specify whether the quantities under consideration are designed to be produced, consumed, stored and, since most natural resources are traded internationally, imported and/or exported. At a country level, oil management in Nigeria –which has to export - has indeed nothing in common with what could be done for an importing economy such as Morocco, even for countries from the same side of the market where the “one size fits all” concept does not hold. As brought to the fore by the recent developments in crude oil markets, the Venezuelan view to prevent prices from dropping further could not, for example, be shared by Saudi Arabia, because –to keep it simple- they do not have the same endowment in crude oil and consequently do not share the same timeframe in which to maximize their revenues. It is also crucial to point out that these forms of reliance on natural resources are not mutually exclusive, meaning that some countries – China being one of the best examples – are at the same time huge producers and prominent end-users, and that any disequilibrium in domestic supply and demand would affect exports or imports with presumably significant rippling effects for other players on the market. Managing natural resources implies having to take these endogenous dynamics on board. Now the economics of the situation might suddenly not look quite as easy as they did at the beginning.

If we focus on the production side, it is well known that natural resources are usually characterized by low price elasticity for supply, economic jargon meaning that production cannot in the short run fully adjust to any variation in demand. Optimally, as stated by Pindyck (2001), any temporary shock will end up in inventory adjustments and, to some extent, in variations in production capacity utilization rates, whereas permanent shocks should entail only long term variation in production capacities. At this point, it has to be said that introducing more variables into the system makes the global equation increasingly complex because production now implies having invested upfront, sometimes several years earlier, be it for energy, minerals or even agricultural products such as cocoa. Economists have over time developed a suite of decision-making tools, from net present value (NPV) simple arithmetic to so-called “real option” complex calculations ((Brennan and Schwartz, 1985), but it always end up with forming expectations that will turn out to be either right or wrong. In this respect, these instruments are not only imperfect, they are also useless when investment is somehow financially constrained. Having said that, the perennial “what, when, how and by who” questions remain to be addressed: The “what” refers to the fact that a commodity should not be considered per se but within a global industry perspective. “What commodity should be produced?” is the question. This is, once again, not as simple as it may seem (Jégourel, 2015). To illustrate this assertion, it is no secret that one of the most strategic issues for Guinea’s economy is not really about how many tonnes of bauxite should be produced, but rather to what extent this bauxite could be locally refined into alumina, which will in turn be exported. This is obviously not an isolated example as the same goes for Gabonese manganese, Ivorian cocoa beans or Moroccan phosphate. The production and export of unprocessed minerals or agricultural products are indeed often not sufficient per se to capture a sufficient level of added value to spark economic and social development. Downstream integration is therefore the key but this much more dependent upon technological, logistical and financial criteria than it is on political goodwill. This ties in with the “by who” question. To what extent should production be carried out by State-owned enterprises (SoE), multinational firms or even joint ventures with international partners so as to foster the transfer of technology? From this perspective, some academic articles have brought to the fore the fact that public policies towards foreign investors can be highly dependent on the global economic context surrounding commodity markets. As far as oil is concerned, it has specifically been highlighted that the extent to which the so called “majors” (or international oil companies, IOC) can reach oil fields (reflected by the contracts and fiscal conditions imposed by hosting countries) may be inversely correlated to the price of oil. Depressed prices can indeed put a strain on local NOC ability to invest and incite governments willing to overcome tightly squeezed public spending budgets to grant IOC more favourable investment conditions (Fattouh & Darbouche, 2010). Finally, we have to bear in mind that it is not production that is ultimately at stake, rather the selling process on international markets. This may require developing own trading units, whose purpose would be not only to optimize commodity flows but also to manage the financial risks that arise along the supply chain, namely forex and commodity price risks. The financing of land and maritime transport infrastructures and vessels to convey minerals, oil or gas to ports of departure, to load cargo ships or tankers via sometimes complex processes such as gas liquefaction, and then to unload them at the ports of landing, is also essential.

Managing prices and/or quantities in a “game theory” framework

Obviously, price and quantity must be regarded as two different sides of the same coin. In this perspective, very simple rational microeconomic behaviour would lead either to determining the optimal level of production (consumption), maximizing a producer’s (consumer’s) inter-temporal profit (utility) subject to own technological (budget) constraints. Or, conversely and as far as producers are concerned, to managing the quantities available on the market in order to maximize the inter-temporal price of the commodity that is being produced. A firm’s behaviour would naturally depend on how competitive the market structure appears to be, but in very general terms and assuming that no one player can wield real pricing power in the long term, it is simple to consider that the producer will try to maximize output when prices are high, whereas the end-user will be prompted to buy, be it for immediate consumption or storage purposes, when prices are low. In the short run and within an imperfect competitive framework, things do not always go this way. If a given commodity market functions within an oligopoly market structure, which is often the case, the interdependence between firms should indeed be considered. According to the game theory, there are many ways to characterize how each “oligopolist” plays and reacts, from the renowned Cournot, Stackelberg or Bertrand competition models to more recent approaches, such as Klemperer and Meyer (1989). In this respect, falling prices may lead producers with the lowest marginal production cost to maintain or to ramp up their production in order to protect (increase) their market share, to the detriment of competitors. Once again, recent developments in the crude oil markets are a key illustration. However, as strange as it may seem, high prices may not be such good news for producers in the long term. They may indeed favour the entry of new players into the market, operators who regard the promise of a better future as a clear incentive to overcome strong entry barriers. In this respect, an oligopoly where tacit collusion prevails should theoretically manage supply in order to prevent this from happening. In the history of economics, though, no cartel (not even OPEC, whose role as a cartel remains debated) has managed to do this for any length of time.

Mitigating macroeconomic instability and reducing negative externalities

Commodity markets are characterized by a high level of short-run price uncertainty combined with boom and bust cycles. This consequently beggars several questions, from the choice of optimal hedging strategy using financial derivatives to the adoption of precautionary measures to mitigate the impact of structural instability on a given economy. Each has been the subject of copious research and academic articles trying to identify appropriate solutions to tackle these problems. Concerning macroeconomic instability, Frankel has suggested for example linking the interest paid by a commodity exporting country to the prices of the said commodity (Frankel, 2014). Sovereign wealth funds, the first of which was created by Kuwait in 1953, were also established to act as a stabilization tool, but also to allow trans-generational allocation of the non-renewable resources bonanza, another key aspect of managing natural resources. Additionally, it must be said that this task requires that the policy maker manage both the positive and the negative externalities implied by the production and consumption of natural resources. According to the economic concepts of “Dutch disease” and the wider “natural resources curse” (Frankel, 2010), it is no secret that producing and exporting raw materials may severely harm an economy, but, beyond economics, many externalities and adverse environmental, social and societal effects should also be cited, whether deforestation, land grabbing, pollution, corruption when local institutions are weak, or even civil war. These are all examples which demonstrate, if any such demonstration were needed, that managing natural resources is a key topic to ensure world stability. Over the last decade, much seems to have been done, from the extractive industries transparency initiative (EITI) to the recent COP21, but there is still a long way to go. Economists can usefully contribute to the debate, but the approach should obviously remain global and be a shared worldwide concern.