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School of International and Public Affairs
Columbia University
May 14, 2004
Connecting the Source:
The Case for Private Investment in
Infrastructure
Jefferson Clarke (MPA, 2007)
Adam Glatzer (MPA, 2007)
Alexander Kasuya (MPA, 2007)
Daniel Kosinski (MPA, 2007)
1
Table of Contents
1
2
Introduction ............................................................................................ 3
Overview ................................................................................................. 3
2.1
2.2
2.3
3
The Case for Infrastructure Investment............................................ 11
3.1
3.2
3.3
3.4
3.5
3.6
3.7
3.8
3.9
3.10
4
Economies in transition....................................................................................... 5
The Political Economy........................................................................................ 5
Funding ............................................................................................................... 8
Literature Review.............................................................................................. 11
Data Sources and Methodology ........................................................................ 13
Dependent Variable .......................................................................................... 13
Independent Variables ...................................................................................... 14
Adjusting for Limited Data ............................................................................... 16
Correction Strategies ......................................................................................... 16
Results ............................................................................................................... 16
Process for Omitting Outliers ........................................................................... 19
Discussion ......................................................................................................... 20
Future Directions .............................................................................................. 21
The Consequences of Limited Industry Diversity ............................ 22
4.1
The Natural Resource Curse ............................................................................. 22
4.1.1
Dutch Disease ........................................................................................... 23
4.1.2
Increased Volatility ................................................................................... 25
4.1.3
Inefficient Specialization .......................................................................... 27
4.1.4
Rent-Seeking Behavior ............................................................................. 27
4.1.5
Conclusion ................................................................................................ 28
5
Case Studies .......................................................................................... 29
5.1
Case Study: Russian Trans-Siberian Pipeline ................................................... 29
5.1.1
Background ............................................................................................... 29
5.1.2
Economics ................................................................................................. 30
5.1.3
Politics....................................................................................................... 31
5.1.4
Conclusion ................................................................................................ 32
5.2
Case Study: Georgia- The South Caucasus Pipeline ........................................ 33
5.2.1
Complications ........................................................................................... 35
5.2.2
Future of the Pipeline ................................................................................ 36
5.2.3
Conclusion ................................................................................................ 36
6
The Strategic Approach ...................................................................... 38
6.1.1
6.1.2
7
National Oil Funds .................................................................................... 38
Regional cooperation ................................................................................ 38
Citations ................................................................................................ 41
2
1 Introduction
In the 1960’s the Karmet Steel Works in Temiritau, Kazakhstan was the largest
industry producer in the Soviet Union employing 70,000 people and running a majority
of the town services, but after the break-up of the Soviet Union in 1991, the company
could no longer rely on guaranteed orders from the government and output fell by 50
percent. The local economy fell apart, drugs became rampant, and AIDS increased
dramatically1.
In 1995 the LNM Group, an international steel group owned by Lakshmi N.
Mittal, bought the dying steel mill and revived it into the largest private employer in
Kazakhstan with 56,000 workers. The mill, now named Ispat Karmet, runs a majority of
the private enterprise in the region, largely to ensure a steady supply of intermediate
inputs necessary for production in the steel mill2.
Ispat-Karmet exemplifies how private investment can promote economic
development in the Commonwealth of Independent States (CIS). Increasing privatesector investment in physical infrastructure networks such as energy, transportation, and
telecommunications allows for industrial diversification, which prevents economic and
political structures from becoming overly reliant on large industry sectors and enhances
productivity in small and medium sized enterprises.
This paper examines the impact of the private investment in infrastructure on the
economic and political development in the Commonwealth of Independent States (CIS).
It attempts to distinguish socially responsible infrastructure investments from investments
that are motivated by politics and designed to benefit small but powerful interest groups.
The abundance of oil and natural gas in the CIS region makes the latter problem
particularly acute as infrastructure development is often aimed at simply producing oil
and natural gas for export and not creating value along the supply chain. This paper
neither asserts nor claims that resource extraction firms are behaving irresponsibly,
indeed in many cases they are, it instead emphasizes the negative effects of a sovereign
economy becoming overly dependent on the natural extraction industry and the positive
effects that can occur from increased investments in infrastructure.
This report consists of five sections. The first, Section 2, takes a broad overview
of infrastructure in the CIS and is broken down into three themes. The first theme is the
economic story and the role infrastructure plays in reducing poverty, investment, and
growth in the region. It explains how spatial demography has changed in the CIS,
including urbanization, rural settings, and other factors, and how these factors impacted
the demands set upon infrastructure. The second theme explores the political economy
and its role in infrastructure development, specifically addressing who captures the
benefits from infrastructure and who are the providers, the recipients, and the funding
entities. The third theme observes the funding of infrastructure investments to determine
the scale of the regions infrastructure needs and how to resource those needs. This latter
theme looks at what group is paying for the infrastructure and who is funding its
construction.
1
Lewis, Charles Paul.” How the East was Won. The Impact of Multinational Companies on Eastern Europe and the
Former Soviet Union”. pg66-73
2
Lewis, Charles Paul. How the East was Won. The Impact of Multinational Companies on Eastern Europe and the
Former Soviet Union”. pg66-73
3
The second section of the paper is an economic analysis of the relationship
between infrastructure and economic development. Based on well-documented evidence
linking a positive relation between GDP per capita and physical infrastructure such as
telecommunication, energy infrastructure, and transportation, this analysis builds upon
evidence showing how infrastructure creates inclusive development by diversifying the
industry sector.
The third section of this report examines the consequences of little or no physical
infrastructure. Countries with unsophisticated levels of infrastructure become reliant on a
small set of industry sectors increasing their economic fragility. This is especially true for
the CIS countries that are heavily reliant on energy production. A well documented
phenomenon in development economics is the natural resource curse. As defined by the
International Monetary Fund, the natural resource curse can be the result of four factors:
loss of competitiveness in the non-resource traded sector, increased volatility in
commodity prices for the particular resource, inefficient specialization, and rent-seeking
behavior.3
Section four includes specific case studies in private infrastructure investment and
their contribution, or lack thereof, to inclusive economic development. The case-studies
are the: Baku-Tbilisi-Cheyan Pipeline, the South Caucasus Pipeline, and the TransSiberian oil pipeline.
The final section of the report examines the strategic approach to investing in
infrastructure. It looks at ways that countries can alleviate the natural curse such as
establishing National Funds, increasing cooperation through regional initiatives, and
assuming different investment schemes.
3
Barnett, S., and R. Ossowski “Operational Aspects of Fiscal Policy in Oil-Producing Countries,”
4
2 Overview
2.1
Economies in Transition
As a region, the Commonwealth of Independent States has been growing at a
breakneck pace. From 2000 to 2004, the GDP of the CIS countries grew at an average
rate of 8.7 percent, a large portion of this increase due to consistent growth in industry
value-added; not a small feat given the economic hardship the entire region went through
during and after the 1998 Russian Crisis. Inflation for the entire region has decreased
significantly during the same period, averaging 34.38 percent in 2000 and 10.94 percent
in 2004. The significant decrease in inflation was largely due to Belarus combating their
initial inflation rate of 185 percent in 2000 down to 21.83 percent in 2004. The Gross
National Income per capita of the region increased for the region as well from 747 USD
to 1,279 USD by 2004. Unfortunately, the high economic growth rate is not spread
equally throughout the CIS countries. A large majority of the GNI per capita remains in
the Russian Federation, Kazakhstan, and Belarus (see Table 1). If we exclude the three
countries from the regional average, the GNI per capita is only 840 USD in 2004.
Additionally, CIA estimates of the percentage of the population living below the
national poverty line varies considerably throughout the countries with Moldova having
80% of the population living below the poverty line compared to the Russian Federation
and Kazakhstan at 17.8% and 19%, respectively. A major determination of poverty and
inequality lies in the dedication to reforms that countries within the region have
undertaken.
Table 1: Macroeconomic Overview: Commonwealth of Independent States, WDI and CIA
2004 GDP Bil
GDP Growth Rate
GNI per Capita
% Pop Below
USD
2000 - 2004
2004, USD
Poverty Line
Armenia
3.55
10.55
112
43%
Azerbaijan
8.52
10.79
950
49%
Belarus
22.80
6.7
2120
27%
Georgia
5.09
6.34
1040
54%
Kazakhstan
40.70
10.36
2260
19%
Kyrgyzstan
2.21
4.972
400
40%
Moldova
2.59
5.912
710
80%
Russia
582.00
6.866
3410
18%
Tajikistan
2.08
9.68
280
60%
Turkmenistan
6.17
18.55
1340
58%
Ukraine
65.1
8.36
1260
29%
Uzbekistan
12.0
4.78
460
28%
2.2
The Political Economy
The political economy of infrastructure is determined by who reaps the rewards of
infrastructure and who withstands the burden of its costs. Successful infrastructure
within a country requires a prospective government with the long-term vision to
recognize that its benefits will accrue over time. Thus, with government intent on
realizing short-term gains for electoral purposes, infrastructure investment is often
neglected and overlooked. Additionally, CIS countries with significant resources in oil
and natural gas have resisted the urgency to build sufficient infrastructure, and in some
5
cases prevented the necessary reforms in the public sector in order to diversify their
economies and take advantage of the foreign investment to better the standard of living.
Within the CIS region, infrastructure development has generally moved at a slow
pace since the fall of the Soviet Union. An inefficient public sector and deteriorating
infrastructure represent a significant challenge for the region’s prosperity. The region as
a whole has had difficulties privatizing the public industries. The decision to privatize is
often problematic because of a history of government involvement in the economy. In
Azerbaijan, deteriorating infrastructure is due in large part to the government’s reluctance
to privatize public services. Georgia has also recognized problems with privatization as it
has experienced difficulty trying to sell its largest public firms to private investors. The
selling of large firms requires significant capital investments, which are often deterred by
weak governance and corruption. In Kazakhstan, attempts at privatization has occurred in
several phases. The initial steps towards privatization were in housing and medium-sized
firms with more than 200 employees. The program of privatization was performed using
a voucher system, based on the Czech Republic, in which private citizens were given
vouchers representing a set value, which could be deposited into established investment
privatization funds. Although there were 170 investment funds set up, about ¾ of the
vouchers went into ¼ of the funds, providing a few fund managers with an extraordinary
amount of wealth4. The final stage of privatization, designed to sell the largest factories –
largely ferrous-metal manufacturing plants – was scheduled for 1995, but was
subsequently postponed several times. The government, reluctant to let go of its mineral
and petroleum wealth, in lieu of selling the physical capital of large factories sold
management contracts. The process of privatization has been slow, only 62 of the 194
enterprises listed for privatization were actually offered for sale, largely because the
asking price was too high5.
Weak political institutions have also resulted in the proliferation of large-scale
shadow economies in the CIS countries. Official statistics in Georgia indicate that 30%
of economic activity takes place in the shadow economy, where government regulation
and rules are nonexistent.6 In reality, these official estimates are usually grossly
underestimated and the effect of the shadow economy within the CIS region has had
serious implications on tax revenue. Until strong government institutions are fully
developed, significant potential tax revenues will continue to be unrecognized and lost.
In Azerbaijan, although a new tax code was introduced in 2001, there has been a failure
to implement tax laws due to a weak administration and corrupt practices.7 Moreover,
ratios of revenue and expenditure to GDP are small, reflecting the government’s inability
to raise tax revenues outside of the oil sector. A lack of meaningful tax reforms
compromises economic development. The latter effect is exemplified in Russia where
stifling taxes and overregulation has impeded the growth of small firms within the
country.
A history of socially planned economies has also produced a tradition of
government interference in the economy. In Kazakhstan, the government has initiated
efforts to reduce the size of its bureaucracy, but still uses the national budget as a political
4
Olcott, Martha Brill. Kazakhstan: Unfulfilled Promise pg 137
Olcott, page 140
6
“Country Profile: Georgia 2005.” Economist Intelligence Unit.
7
“Country Profile: Azerbaijan 2005.” Economist Intelligence Unit.
5
6
tool to blunt unrest that has occurred in the neighboring Kyrgyz Republic. Russia has
witnessed triple digit inflation because of its political commitment to promote the heavy
industries regardless of profitability. The Russian government faces a serious challenge
to impose meaningful budgetary constraints on enterprises and to foster a competitive
environment that rewards successful companies and requires unsuccessful and inefficient
firms to restructure or shut down operations.
The Business Environment and Enterprise Performance Survey (BEEPS) was
a joint creation between The World Bank and the European Bank for Reconstruction and
Development (EBRD), which interviewed over 4000 firms in 22 transition economies in
1999-2000. In a 2002 paper based on results from the Survey, authors Hellman, Jones
and Kauffman found that corruption reduced FDI inflows. The paper also determined
that foreign firms exacerbated the problems of state capture and procurement kickbacks
in weak governance settings. The authors concluded that attracting a broader, more
diverse set of foreign firms was vital in combating state capture and corruption.8
Corruption, weak governance, and a lack of economic diversification within
the CIS region is a serious impediment to foreign investment. A World Bank Investment
Climate Survey in 2005 found that of foreign firms surveyed in Azerbaijan, Georgia,
Russia, Tajikistan, and Ukraine, over 70% of respondents indicated that bribes were paid
either before or during operations.9 The 1999 BEEPS report also found that
administrative corruption – namely unofficial payments, such as bribes and kickbacks to
public officials – was markedly greater in the CIS compared to the Central and Eastern
European (CEE) states.
However, it should also be recognized that CIS governments are beginning to
address the corruption issue. In 2005, BEEPS carried out an updated survey on the CIS
region and found that the percentage of firms that felt corruption was a problem for doing
business had decreased. The same survey also found access to financing as a problem for
doing business had decreased. CIS governments are beginning to recognize the negative
effect corruption has on foreign investment and many states have shown a concerted
effort to combat these issues. In Georgia for example, the targeting of several highprofile businessmen on charges of corruption and tax evasion has had a positive effect on
persuading large firms to begin paying taxes, thereby improving the business climate.
States also have the ability and obligation to allow citizens to follow where money is
being spent. The creation of oil funds in Azerbaijan and Kazakhstan has also helped
provide fiscal transparency by diverting oil income above the budgeted oil price into an
oil windfall fund.
An important aspect of the BEEPS survey is that it attempts to address the
hurdles faced by small- and medium-sized enterprises. Some of the most important
roadblocks of development in transition economies are increasing the ability of smalland medium-sized firms to operate in a competitive atmosphere.
Hellman, J., Jones, G., Kaufmann, D. “Far From Home: Do Foreign Investors Import Higher Standards of
Governance in Transition Economies?”
9
“World Development Report 2005.” The World Bank Investment Climate Surveys
8
7
2.3
Funding
The goal of the World Bank Energy Group is to improve access to clean, modern
and affordable energy services for the world’s poor and to achieve sustainability in the
environmental, financial, and fiscal aspects of the energy sector.10 In fiscal year 2004, the
World Bank approved $1.05 billion in loan grants and guarantees in addition to $340
million net commitments by the International Finance Corporation 11. Much of this
funding, however, has gone towards power generation facilities as opposed to dedicated
infrastructure. During the 1990s, the World Bank’s infrastructure business shifted from
focusing on tangible industrial assets to a model of comprehensive service delivery. The
shift in strategy attempted to create a more balanced composition complementing
investments with regulatory reforms and institutional capacity building. It reflected a
growing consensus that the right policy environment and institutional capacity are crucial
for ensuring sustainable infrastructure investments. As a result, World Bank
infrastructure investment lending, especially in IBRD countries, declined by 50%
between 1993 and 2002.12
Over the same period, growth in much of the developing world remained flat
aside from the economies of East Asia. In recent years, the World Bank has gained
renewed appreciation for “bricks and mortar” projects as opposed to less tangible assets.
As a result, it plans to ramp up infrastructure investment in the coming years. 13 We
believe this is indeed the best prescription for promoting sustainable economic growth
and our model attempts to validate this in practice based on the World Bank’s own data
sources.
Because of the large-scale requirements of infrastructure investments, there are
different strategies of financing between private and public interests that need to be
addressed. The World Bank looks at three different sources of financing for
infrastructure, the private sector, public government, and official lenders and donors14.
Different strategies of financing are associated with different levels of risk and
accountability.
World Bank “Sustainable Energy.”
ibid
12
http://siteresources.worldbank.org/INTTRM/Resources/InfrastructureActionPlan.pdf
13
ibid
14
Asia Development Bank,The International Bank of Reconstruction , World Bank(May 2005) .
Connecting East Asia:A New Framework for Infrastructure
10
11
8
Figure 1: CIS Private Sector Investment in Infrastructure (US$ billions)
CIS Private Sector Investment in Infrastructure (US$ Billions)
7.00
6.00
5.00
4.00
3.00
2.00
1.00
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0.00
The World Bank maintains: “There are vital macroeconomic questions: Is there
too much public expenditure on infrastructure, thus jeopardizing fiscal stability. Or is
there too little expenditure, thus endangering economic growth and poverty reduction? 15”
The World Bank defines four different investment strategies, these strategies are
concession, divestitures, Greenfield projects, and management and lease contracts. Table
2 shows specific investment amounts from 1990 to 2004 for each strategy.
The concession investment strategy is based on a private entity taking over the
management of a state-owned enterprise for a given period, for which it will assume a
certain significant investment risk. As indicated in the table investment using concession
strategies totaled $441 million.
A Greenfield Project is a private entity or a public-private joint venture that will
build and operate and build a new facility under the contract project period. Under this
strategy it will be held in the private sector with the ability to return to the public sector at
the end of the contract period. Depending on the type of Greenfield, the private investor
will build, lease, own, operate, or transfer at its own risk. Table 2 indicates Greenfield
investments totaled $16.484 billion, the largest out of any investment strategies.
Divestitures is a concept in which the private equity will buy a large stake in a
state-owned enterprise through an asset sale, a public offering, or a mass privatization
program. Divesture is the second largest investment amount with $12.577 billion.
Management and Lease Contracts is where a private entity takes over the
management of a state-owned enterprise for a fixed period while ownership and
investment decisions remain with the state. There are two subclasses of management and
lease contracts with investment at $20 million.
15
East Asia Infrastructure, World Bank page 35
9
Table 2: Private investment in infrastructure, World Bank
Azerbaijan
Armenia
Belarus
Georgia
Kazakhstan
Kyrgyzstan
Moldova
Russia
Tajikistan
Turkmenistan
Uzbekistan
Ukraine
Total
Concession
(US$_billions)
0.375
0.050
0.000
0.000
0.000
0.000
0.000
0.000
0.016
0.000
0.000
0.000
0.441
Divestiture
(US$_billions)
0.000
0.583
0.000
0.172
0.172
0.088
0.085
11.065
0.000
0.000
0.000
0.412
12.577
Greenfield
Project
(US$_billions)
0.369
0.000
1.064
0.215
0.215
0.021
0.085
11.400
0.010
0.000
0.696
2.409
16.484
Management
and Lease
Contract
(US$_billions)
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.020
0.000
0.000
0.000
0.000
0.020
Greenfield Project are as we can see the highest number of private-sector ventures
undertaken. These projects are creating new facilities, and managing projects privately
and can be shared with the help of some publicly sponsor ventures. With the ability to
lease from the government and manage these infrastructures fully, the private sector will
have major control of the project with the ability to return it to the public sector. The
public sector, in this case, would not have to burden their asset flow and have the ability
to spend the government’s money on other resources or investments that would not
otherwise have as much or any private sector investment. The risk of private investment
will fully be given to the private sector until the contract has expired, and the risk will be
handed over to the public sector or kept with the private sector if it is maintaining the
project still. The private sector will also have the ability to use more efficient methods of
investment and growth of infrastructure then might the public sector hindered by
restrictions.
10
3 The Case for Infrastructure Investment
Different industries have different requirements of factor inputs in their
production process. The production function of industries is usually dependent on a
certain ratio of labor, capital, energy, and intermediate materials to produce their final
goods and services. In an idealistic economy, the geographic location of an industry is
dependent on two important criteria: the availability of highly productive inputs
necessary for production and the ability for the industry to transport their final product to
the consumer.
With the above in mind, does it become possible to predict the specific
composition of industries located in a country based on its existing infrastructure? For
example, do countries with a sophisticated physical infrastructure system foster a specific
portfolio of manufacturing industries heavily sensitive to transportation and energy
prices? To ascertain the answers to these questions, this section will use each country’s
existing infrastructure, including electricity, transportation, and telecommunications to
calculate the level of diversity in the existing manufacturing industries. This analysis will
focus on energy dependent manufacturing industries, such as steel, glass, and food
production that require significant amounts of electricity during their manufacturing
processes compared to other industries, such as tobacco.
Our empirical evidence shows that countries with more sophisticated levels of
telecommunication, energy, and transportation systems are associated with a smaller
proportion of energy dependent industries. We believe this is because less developed
economies get stuck because of a breakdown in factor coordination. Typically reliant on
energy intensive industries, they lack the advanced infrastructure necessary to support a
diverse and highly developed industrial composition. Developed countries, which in
comparison typically do have sophisticated infrastructure systems, are less likely to have
energy intensive industries as the majority component of their manufacturing as a whole.
Because of the limited data availability for CIS countries, our empirical analysis was
expanded to the global scale to look for trends that can be applied regionally.
3.1
Literature Review
The origins of analyzing the relations between industry sectors in an economy
began with the development of input-output analysis by Wassily Leontief, earning him
the Nobel Prize in Economics in 1973. In his seminal work, Input-Output Economics
(1966)16, Leontief traced the interactions of firms within economies as a function of the
outputs of one production function becoming the inputs of another. He describes the
process best in his prize lecture:
“The world economy, like the economy of a single country, can be visualized as a system
of interdependent processes. Each process, be it the manufacture of steel, the education of
youth or the running of a family household, generates certain outputs and absorbs a
specific combination of inputs. Direct interdependence between two processes arises
whenever the output of one becomes an input of the other: coal, the output of the coal
mining industry, is an input of the electric power generating sector. The chemical industry
uses coal not only directly as a raw material, but also indirectly in the form of electrical
16
Leontif, Wassily W. Input-Output Economics 2nd ed. New York: Oxford University Press. 1986
11
power. A network of such links constitutes a system of elements which depend upon each
other directly, indirectly or both.”17
Input-output modeling is an effective analytical tool for tracing out the indirect
ripple effects among economies and helped intimately trace the true factors of production
for industries beyond the aggregate of land, labor, and capital as defined by Karl Marx.
The model also helped re-evolve the debate around comparative advantage, or a
country’s ability to produce goods more efficiently due to cheaper processes of
production, into terms of technology. This is set apart from the Heckscher-Ohlin theory,
which described trade between countries simply in terms of labor and capital. However,
Leontief’s model could not show changes in factor productivity due to increased
technology and economies of scale. Input-output modeling is still widely used today. The
Bureau of Economic Analysis annually produces the Regional Input-Output Modeling
System, RIMS II, which tracks the interactions and trade flows between 473 industry
sectors in the United States18.
The most recent gains in relating infrastructure with industry composition and
comparative advantage lay in economic geography and gravitation modeling. Based on
the idea of Newton’s Laws of Gravitation, gravity models predict trade flows based on
the economic sizes and distance between units; a concept first used in the early days of
econometric modeling. Additionally, Jan Tinbergen, who received the first Nobel Prize
in Economics with Ragnar Frisch in 1969, utilized this concept with their basic gravity
model as early as 1962.19 In modern economic modeling, New Economic Geography
theory advanced with a new paper put forth by Masahisa Fujita, Paul Krugman, and
Anthony Venables, in “The Spatial Economy”.20 Using a gravity model, the paper
theorized that urban centers, which previously confounded economic modeling due to
high transaction costs developed through the increase in access to labor and resource
inputs. In other words, urban centers are expensive to live and operate in; high congestion
drives up capital and labor costs, but these elements outweigh the benefits gained from
access to productive inputs.
Spatial analysis creates the link between infrastructure and comparative
advantage. Sophisticated infrastructure systems allow cheap access to factors of
production. An efficient transportation system expands a geographic region’s ability to
purchase labor and commodities that are more productive and suitable to their particular
production function. The idea also translates into energy and telecommunication systems.
Regions with a critical mass lend to cheaper production costs. The idea of critical mass,
reinforced by Michael Porter’s theory of a competitive cluster, theorizes that geographic
clusters of specific industries, such as the high technology in Silicon Valley affect
competition by increasing productivity for the companies located in the cluster, driving
innovation, and stimulating new businesses.21Another study performed for the
Transportation Research Board through the joint efforts of three consulting firms,
Regional Economic Models, Inc., Cambridge Systematics, and Economic Development
Research Group, Inc., analyzed the economic effects of congestion and found in their
17
Nobel Lectures, Economics 1969-1980, Editor Assar Lindbeck,
RIMS II. The Bureau of Economic Analysis.
19
Nobel Lectures, Economics 1969-1980, Editor Assar Lindbeck,
20
Fujita, Masahisa; Krugman, Paul; Venables, Anthony. The Spatial Economy. MIT press, July 1999.
21
Porter, Michael. Clusters and the New Economies of Competition.
18
12
labor cost model that doubling the labor force size by improving a transportation system
will on average lead to an increase of productivity for all businesses in the region by 6.5
percent.22 Many of these same theories and concepts hold true for energy infrastructure.
According to the World Bank, energy services are vital for poverty reduction and the
Millennium Development Goals (MDG’s).
3.2
Data Sources and Methodology
The goal of our final model was to be able to predict the percentage of energy
dependent manufacturing industries in a country given its level of physical infrastructure.
In developing our regression model, we sought to regress variables that best represent a
diverse and sophisticated infrastructure framework against an index variable created to
represent the proportion of energy intensive manufacturing industries over the entire
manufacturing sector. Described in greater detail below, our independent variables
consisted of electricity consumption per capita, electricity production, percentage of
paved roads, and the number of mobile telephones per 1,000 people. The variables were
intended to be proxies for the energy, transportation, and telecommunications
infrastructure. We also initially included a variable for the percent of energy imports used
in consumption, although this variable was later dropped after thorough investigation and
provided a theoretical backing to omit four observations (see Process for Omitting
Variables section).
Data for our analysis was obtained from two data sets: the 2003 World
Development Indicators (WDI) provided by the World Bank and the 2005 edition of the
Industrial Statistics Database (INDSTAT3) at the 3-digit level (Rev.2) provided by the
United Nations Industrial Development Organization (UNIDO). Our dependent variables
for physical infrastructure were taken from the WDI and our independent index variable
was created using different output numbers from the INDSTAT3 dataset.
3.3
Dependent Variable
INDSTAT3 Revision 2 database contains time series data for the period 1963 to
2003, for 180 countries, although data is not available for every country and year. The
dataset is arranged using the 3-digit level of the International Standard Industrial
Classification of All Economic Activities (ISIC), Revision 2, pertaining to the
manufacturing sector, which comprises of 28 manufacturing categories, plus the
manufacturing sector as a whole. Due to data availability, we focused solely on the
industry output series. We would have preferred to use the value-added time series,
although this would have severely affected the number of observations viable for our
regression model. All fiscal data are converted into current U.S. dollars using the average
period exchange rates as given in the International Financial Statistics (IFS). Data for
OECD countries were obtained from the OECD and data from non-OECD was obtained
from national statistics offices by UNIDO23.
22
23
Weisbrod, G; Vary, D; Treyz, G. Economic Implications of Congestion.
User’s Guide, INDSTAT3 2005 ISIC Rev. 2. United Nations Industrial Development Organization
13
In constructing our dependant
variable, we chose specific industries
Code
Industry Description
that are highly energy intensive and
300
Total manufacturing
expressed them as a percentage of the
311
Food products*
manufacturing sector as a whole. For
313
Beverages
purposes of this analysis, energy
314
Tobacco
intensive industries are manufacturing
321
Textiles*
industries requiring a significant
322
Wearing apparel, except footwear
amount of energy in their production
323
Leather products
function. Compared to other industries,
324
Footwear, except rubber or plastic
energy intensive firms are more
331
Wood products, except furniture*
sensitive to changes in energy prices.
332
Furniture, except metal
We
selected
8
manufacturing
341
Paper and products*
industries
out
of
29
as energy
342
Printing and publishing
intensive. They are: food product,
351
Industrial chemicals*
textiles,
wood
product,
paper,
352
Other chemicals
industrial
chemicals,
glass,
iron
and
353
Petroleum refineries
steel, and non-ferrous metals. In Table
354
Misc. petroleum and coal products
4, industries in the dependent variable
355
Rubber products
are indicated with an asterisk.
356
Plastic products
Our
selection
of
energy
361
Pottery, china, earthenware
industries was based on information
362
Glass and products
provided by the Energy Information
369
Other non-metallic mineral products
Agency (EIA), a data and research
371
Iron and steel*
agency with in the Department of
372
Non-ferrous metals*
Energy. For our analysis we used the
381
Fabricated metal products
EIA listed seven and eight most energy
382
Machinery, except electrical
intensive manufacturing sectors24. Our
383
Machinery, electric
dependent variable was the summation
384
Transport equipment
of the output for each industries
385
Professional & scientific equipment
divided by the total output of the
390
Other manufactured products
manufacturing industry.
Because of data availability, we used the industry sector output instead of valueadded. While value-added is a better measure of economic activity, the number of
observations in our study was cut by half.
Table 3: ISIC list
3.4
Independent Variables
Due to availability, we were not able to use the 2006 WDI data. The 2003 WDI
dataset includes 575 time series indicators for 208 economies, although data availability
is not constant over the 10-year time horizon of our project. The World Bank is not the
primary data collection agency for most of the WDI, with exception to living standard
surveys and debt. Each variable used by the WDI was obtained from various sources.
To capture energy infrastructure we used two variables, electricity production and
electric power consumption. Energy generation, measured in kilowatt hours, is a
24
Energy Information Agency, Department of Energy
14
necessary component to this equation because higher levels of electricity production are a
measure of large scale infrastructure development and industries that are energy intensive
would require a large amount of energy to be produced, theorizing a positive relationship
between energy intensity and electricity production. The variable is measured at the
terminals of all alternator sets in a station. In addition to hydropower, coal, oil, gas, and
nuclear power generation, it covers generation by geothermal, solar, wind, and tide and
wave energy, as well as that from combustible renewables and waste. Production includes
the output of electricity plants that are designed to produce electricity only as well as that
of combined hear and power plants. Data sources for this variable are obtained by the
World Bank from the International Energy Agency, Energy Statistics and Balances of
Non-OECD Countries, Energy Statistics of OECD Countries, and Energy Balances of
OECD Countries25. The difference in scale and magnitude between the upper and lower
bounds of the variable required us to perform a logarithmic transformation so as to
measure it as a percentage increase on the dependant variable.
Electric power consumption, measured in kilowatt hours per capita, provides an
efficiency measure that includes net electricity imports, which is not accounted for in
electricity production. Electric power consumption measures the production of power
plants and combined heat, less distribution losses. The data sources for this variable are
the International Energy Agency, Energy Statistic and Balances of Non-OECD Countries
and Energy Statistics of OECD Countries, and United Nations Energy Statistics
Yearbook26. As in electricity production, we transformed the variable into a logarithmic
function to measure it as a percentage change on the dependant variable.
Our variable representing telecommunications infrastructure is mobile phone use,
measured in mobile phones per 1,000 people, refers to users of portable telephones
subscribing to an automatic public mobile telephone service using cellular technology
that provides access to the public switch telephone network, per 1,000 people. The
sources for this variable were obtained from the International Telecommunication Union,
World Telecommunication Development Report and database27. We were initially
indecisive about the variable because mobile phones may be implemented because of the
lack of dedicated infrastructure and are more prevalent in lesser developed countries. But,
we found that in practice it is more common for mobile phone systems to be prevalent in
industrialized nations as addendums to dedicated infrastructure. Additionally, mobile
telephones act as a proxy for economic development, a well documented case when
regressing GDP per capita across mobile phone use.
Initially we had also included a variable for land line phones, which we thought
was an indicator of the density of the power grid since energy lines are often laid in
tandem with phone lines, and we did not have a measure for power lines specifically.
Understandably, we ran into problems of multicollinearity with the mobile phones
variable since mobile phones often augment existing infrastructure capabilities in land
line transmission. Since we deemed mobile phones significant to serve both purposes
indicating a more sophisticated telecommunication infrastructure generally, we chose to
omit the land lines from our final model.
User’s Guide, World Development Indicators, 2003 CD-ROM. The World Bank
User’s Guide, World Development Indicators, 2003 CD-ROM. The World Bank
27
Ibid.
25
26
15
To capture the effect of transportation infrastructure, we included paved roads,
measured as a percentage of the total road system. As measured by the World Bank,
paved roads are those surfaced with crushed stone (macadam) and hydrocarbon binder or
bituminized agents, with concrete, or with cobblestones, as percentage of all the
country’s roads, measured in length. The data sources for this variable are obtained from
International Road Federation, World Road Statistics, and Eurostat28. As a measure of
development, advanced economies have large transportation infrastructure systems,
serving a variety of industries. In this case, a logarithmic transformation was not
necessary because the variable is already represented in percentage terms.
3.5
Adjusting for Limited Data
Initially we intended to create the model using panel data, but that limited our
model to a total of 50 observations out of a potential 180. We were considered with
largely with data between 1990 and 2000, but data for different countries was available in
different years, making a panel analysis difficult. Running cross-sectional analysis for
different years also yielded highly different regression models. A few specific years,
1990, 1995, 1998, and 1999 had the largest amounts of data, but not consistently among
countries. To adjust for this issue we collapsed the variables over the 10 year period,
between and including 1990 to 2000, into average value for all countries. We then
applied the mean value of the variables to a cross-section analysis. Using this technique
we increased our observations increased approximately 60% to 79 observations.
3.6
Correction Strategies
We tested for heteroskedasticity using the Bruesch-Pagan test and running bivariate
regressions of the model residuals against each of the independent variables. The model
failed the Bruesch-Pagan test at the 5% level, but passed it at the 10% level, indicating
some amount of heteroskedasticity. Looking at the scatter plots of energy intensity
against each of the independent variables indicates some heteroskedasticity for both
electricity production and consumption, although it is difficult to tell. We adjusted for
heteroskedasticity by using the robust standard errors.
We tested for multicollinearity initially by looking at the correlation between all
variables. Again, electricity consumption per capita provided some evidence of
multicollinearity with mobile phones and pave roads, however after running the variable
across the other independent and the variance inflation factor did not provide evidence of
strong multicollinearity inflating the variance. Also, the significance test scores for all
variables passed at the 1% level.
3.7
Results
The final model contained 79
observations. This was largely due to the
dependent variable with the fewest
observations. As seen in Table 5, the
average energy intensity indicates 45
percent of all manufacturing industries in
28
Table 4:Detailed summary statistics
Percentile
1%
25%
50%
75%
99%
Energy Intensity
0.2283
0.3717
0.4473
0.5136
0.7707
User’s Guide, World Development Indicators, 2003 CD-ROM. The World Bank
16
countries are heavily dependent on energy in their production process29. Important to note
are countries below the 25 percentile, 37 percent of industries are energy intensive,
include the USA, Spain, and Japan. Countries above the 75 percentile, 51% of industries
are energy intensive, include Kazakhstan, Ukraine, and Pakistan. There is clearly a
relation between economic development and increased industry diversity.
Table 6 summarizes the four independent variables used in the regression. Due to
the functional form of the mobile phones, electricity production and electricity
consumption per capita variables, is it difficult to infer meaning. Paved roads has a high
standard deviation and variability across countries.
Table 5: Summary table
Variable
Mobile phones
Roads, paved
Electricity production
Elec. consump/capita
Mean
1.6885
48.0075
23.5286
7.0820
Std. Dev.
2.0194
32.8349
1.9615
1.5922
Min
-2.7331
0.8000
-1225.0470
17.5505
Max
5.5683
100.0125
28.8973
9.7616
Figures 2 through 5 show the bivariate relationships between each of the independent
variables and the dependent variable. Each scatter plot indicates a negative relationship
between different aspects of physical infrastructure and the diversification of energy
intensive industries. It should be noted with caution electricity consumption per capita is
regressed across energy intensity indicates a negative relationship, but is a positive
relationship in the full regression model. This is most likely due to the effects of
economic development being absorbed by mobile phones.
Figure 3:Energy intensity across percent of total roads
paved
.2
.2
.4
.4
.6
.6
.8
.8
Figure 2: Energy intensity across phone mobiles (per
1000 people
-2
0
2
(mean) lnphonembl
(mean) enintense
4
Fitted values
6
0
20
40
60
(mean) paverd
(mean) enintense
80
Fitted values
29
Although this number is useful in the regression model, it should be used with caution. Due to the nature
of the model, the United States of America is given the same weight as Kazakhstan. 45% does not imply
45% of all manufacturing industries’ output are energy intensive.
17
100
Figure 5: Energy intensity across
electricity production (kWh)
.2
.2
.4
.4
.6
.6
.8
.8
Figure 4: Energy intensity across electricity
consumption per capita (kWh per capita)
2
4
6
(mean) lneleconcap
(mean) enintense
8
Fitted values
10
18
20
22
24
(mean) lnelecprod
(mean) enintense
26
28
Fitted values
Shown in Table 7, our final model was highly significant to the 99 percent level
across all variables with an adjusted R-squared of 48.43 percent. As opposed to what we
had originally theorized, increases in sophisticated infrastructure such as mobile phones
and paved roads is associated with a decrease in energy intensive industries as percentage
of the manufacturing sector as a whole.
More specifically, a 1 percent increase in mobile phone is associated with a 4.6
percent decrease in energy intensive industries as a percentage of the manufacturing
sector as a whole holding all other variables constant; and a 1 percent increase in paved
roads is associated with a 0.01 percent decrease in energy intensive industries as a
percentage of the manufacturing sector as a whole holding all other variables constant.
We observed a negative coefficient on the variable for electricity production. According
to our observation a 1% increase in electricity production is associated with a 2.2 percent
decrease in energy intensive industries as a percentage of the manufacturing sector as a
whole holding all other variables constant.
Unlike the electricity production variable, our electricity consumption per capita
variable was positively correlated with the dependant variable as we initially expected.
Our model predicted that a 1 percent increase in electricity consumption per capita is
associated with a 6.2 percent increase in energy intensive industries as a percentage of the
manufacturing sector as a whole holding all other variables constant.
18
Table 6: Final regression model
3.8
Process for Omitting Outliers
In our early regression runs we included an energy imports variable, measured as
energy use less production, both in equivalents. A negative value indicates that the
country is a net exporter30. The theoretical intuition behind the variable was to include an
energy indicator that was not represented by electricity production. We believed it to be
important because many manufacturing industries in developing countries generate their
own electricity through generators running on imported fuel. Running the regression,
however, created results that were highly heteroskedastic. Running a bivariate regression
showed four outliers in the negative direction strongly influencing the entire regression.
A seen in Figure 6, the observations are Kuwait, Oman, Gabon, and Norway, countries
with economies largely dependent on exporting oil and natural gas. Attempting to
validate the variable, we omitted the four observations and reran the bivariate regression.
Without the four observations, the variable became a poor indicator of energy intensity
overall and was dropped from the equation.
.8
Figure 6: Energy intensity across energy imports (percent
of commercial use)
NAM
NOR
.4
(mean) enintense
.6
KAZ
GAB
.2
OMN
ISL
SEN
PAK
KGZ
CHL
CRI
UKR
LVA
GTM
MAR
ARM
MDA
BGD
IDN
RUS
NPL
TTO
IND
IRN
ZWE
BHR
HND
FIN
CMR
EST
TUN
SVK
ECU COL
ALB
PAN
AZE
EGY
URY
MOZ
PER
LTU
GRC
BOL
SLV
POL
TUR
VNM
ETH
VEN
AUSARG
DNK
CHN
TZA
HRV
IRL
ZAFROM
MEX
BGR
PHL
JOR
PRT
QAT NGACAN SWE
AUT
HUN
ESP
LKA
THA
ISR
FRA
MYSGBR
USAKOR
ITA
CYP
HKG
DEU
JPN
0
KWT
-1500
-1000
-500
0
(mean) enimp
30
User’s Guide, World Development Indicators, 2003 CD-ROM. The World Bank
19
Later on in our modeling process, we reran the entire model without the four
observations. The total number of observations in our model drops from 83 to 79, but the
explanatory power increases by 25 percent. Table 8 shows the original regression model
with the four outliers included. Compared to the original regression, the four outliers
decrease the r-squared to 32.9 percent and the adjusted r-squared drops to 29.46 percent.
The large increase in explanatory power variable occurs even without the inclusion of the
energy imports variable in either regression. The four variables have a commonality
between them that significantly decreases the ability of the model to explain industry
sector diversity through enhancements in infrastructure. Because of the strong
commonality of the four observations and that we came across them through observation,
our final model has those four observations omitted.
Table 7: Regression model with outliers
3.9
Discussion
The results of our final model31 indicate there is a strong association with
infrastructure and the proportion of manufacturing industries that are heavily dependant
on energy. Countries with advanced infrastructure development rely less on energy
dependant industries and therefore have a diverse economy. We observed that as the level
of development increases, the level of dependency on energy dependant industries also
decreases.
We were also surprised with the result of our electricity production variable since
we expected it to be positively correlated with the dependant variable i.e. as electricity
production increases, the percentage of energy intensive industries as represented by the
manufacturing sector as a whole should have also increased. We speculate that electricity
production is a development indicator like mobile phones and percentage of roads paved.
As a country’s ability to produce energy increases, its ability to move into more diverse
industrial sectors also increases thereby having a negative effect on energy intensive
industries as a percentage of the manufacturing sector as a whole.
31
With the four outliers omitted.
20
What started as an infrastructure analysis ended as a study of risk. We found that
economies with highly developed infrastructure are less dependant on energy intensive
industries and are therefore more diverse. Diversity decreases risk so therefore an
economy with more advanced infrastructure is less susceptible to swings in the economy
than a country with lesser developed infrastructure. Section 4 will analyze the negative
consequences of countries heavily reliant on a few industry sectors.
3.10 Future Directions
There are several assumptions made in this analysis that may have affected the
regression model. First, the dependent variable was developed using industry sector
output data, although value-added data would have been more representative of true
manufacturing activity in an economy. As data for value-added becomes more available,
future regressions should include value-added data instead.
Second, to perform a cross-sectional analysis across all countries, we had to assume
that the production function of energy intensive industries was the same in all countries.
This a large assumption as productivity and energy efficiency varies for similar industries
across countries. A possible correction strategy would be to include a measure energy
elasticity or productivity, by industry, by country. Additionally, a productivity parameter
would be to show the true increase in competitive advantage that infrastructure to
economies through enhanced total factor productivity.
Finally, the idea of the analysis was to judge whether it is possible to determine the
composition of industry sectors within an economy due to its physical infrastructure. To
this end we looked specifically at energy intensive industries in the manufacturing sector.
It would be useful to see whether there is any relation between infrastructure and
different types of industry dependence, for example, the prevalence of transportation
dependent industries over the whole. Additionally, it would be useful to expand the
analysis beyond manufacturing and include the service and agricultural sectors,
especially for more developed economies which are more reliant on the professional and
service sector.
We believe the most important concept to come out of the model is the negative
relation between levels of infrastructure and industry diversity. An interesting analysis
would be to take this a step further and analyze the relation on the economic development
of a country, such as GDP per capita, with a variable such as energy intensity. Based on
our regression model, we theorize a negative relation between GDP per capita and energy
intensity. Countries more reliant on a specific industry sector may be economically more
fragile.
21
4 The Consequences of Limited Industry Diversity
The previous section showed the relationship between investment in infrastructure
and country’s ability to diversify their economy. This section takes the analysis a step
further to show the negative consequences for a country if the economy does not
diversify and is dependent on a few industry sectors. A limited number of industry
sectors can be counterproductive for several reasons. First, it correlates the revenue
streams for the government with the economic activity of that particular industry. Second,
the government and industry become increasingly intertwined, either through national
control of the industry or clientism in which the government bends to the whims of the
industry. The first reason increases the volatility of the economy to one market price.
The second prevents productivity increases. Several countries in the CIS face the problem
of over reliance with the energy production industry creating the conditions for the
natural resource curse.
The natural resource curse is an economic phenomenon in which countries
endowed with a significant amount of natural resources – oil, natural gas, diamonds, etc.
– experience economic and/or political decline with increases in their extraction. The
International Monetary Fund states the curse can be the result of four factors: loss of
competitiveness in the non-resource traded sector, increased volatility in commodity
prices for the particular resource, inefficient specialization, and rent-seeking behavior.32
One of the founders of OPEC, Juan Pablo Perez Alfonso, said of oil in 1975, “I call
petroleum the devil’s excrement. It brings trouble… Look at this locura – waste,
corruption, consumption, our public services falling apart. And debt, debt we shall have
for years.”33
4.1
The Natural Resource Curse
Four countries in the CIS have large energy export industries making their
economies susceptible to the negative effects of the extraction industry: Azerbaijan,
Kazakhstan, Russian Federation, and Turkmenistan. All other CIS countries have to
import energy for local production. Table 7 indicates the amount of energy the country
exports in relation to their economies34. Countries with large negative amounts, such as
Turkmenistan, are highly susceptible to the natural resource curse. The oil sector in
Azerbaijan is responsible for 2/3 of industrial production and 90% of the country’s
exports.35 Data is difficult to obtain, from Turkmenistan, but the oil and natural gas
industries account for about three-quarter of the countries export earnings and more onehalf of GDP36. Russia’s economy is heavily dependent on oil and natural gas exports,
making it vulnerable to fluctuations in world oil prices. However, it is also a large
beneficiary in today’s environment of rising demand and higher prices. Typically, a $1
per barrel change in oil prices will result in a $1.4 billion change in Russian revenues in
the same direction.37 The World Bank has suggested that Russia's oil and gas sector may
Berengaut, Julie “Republic of Kazakhstan: Selected Issues”
Devils, Excrement. The Economist
34
This is the same variable used in Section 3: Process for omitting outliers
35
Ibid
36
Economist International Unit, Turkmenistan
37
Energy Information Administration. Russia Country Analysis Brief and Non-OPEC Fact Sheet.
32
33
22
have accounted for up to 25% of GDP in 2003 while employing less than 1% of the
population.
Table 8: Energy imports (% of commercial use)
Azerbaijan
Kazakhstan
Russian Federation
Turkmenistan
1992
-8.84558
-11.7322
-44.3823
-331.519
1994
7.767829
-21.5953
-50.4313
-143.017
1996
-20.7267
-39.4929
-53.6447
-169.687
1998
-38.1746
-63.1889
-59.691
-50.2945
2000
-64.7151
-97.7197
-57.4173
-217.612
2002
-68.9794
-104.091
-67.4404
-245.519
High energy exporting countries are not the only countries susceptible to the
natural resource curse in the CIS. Countries such as Georgia and Ukraine earn money on
the transit of oil and natural gas through pipelines in their country. If the revenue stream
from tariffs is a significant portion of the budget the economy can become susceptible to
currency appreciation and volatile swings in energy prices.
4.1.1 Dutch Disease
The first possible cause of the natural resource curse occurs from a loss of
competitiveness in the non-resource traded sector. This economic phenomenon is
nicknamed the “Dutch Disease” after observing the economic decline in the Dutch
economy soon after the discovery of natural gas in the North Sea in the 1950’s. A
merchant marine economy, more than 50 percent of the GDP relied on exports.38 With
the discovery of natural gas, foreign direct investment in the economy drove up demand
for the national currency increasing the cost of other export commodities resulting in a
decrease in economic competitiveness. Sachs and Warner (2001) took this debate a step
further to the manufacturing sector. The empirical analysis in their study suggested that
resource abundance could inhibit the growth of key sectors in the economy, such as the
tradable manufacturing sector, that are the engines of mass employment and growth.
Theoretically applied to Sach’s and Warner’s conclusion, Azerbaijan,
Kazakhstan, Russian Federation, and Turkmenistan would all potentially be sensitive to
the Dutch disease. Table 8 aggregates and compares four industry sectors in the
economy: Agriculture, Manufacturing, Mining, Energy, and Construction39, and Services.
The data, value-added as a percentage of GDP, shows a drop from 1992 to 2004 in the
value add of the manufacturing sector as a percentage of GDP for Azerbaijan and a small
increase for Kazakhstan. For Azerbaijan, the decrease in the manufacturing sector is
transferred into the mining, energy, and construction, strong evidence of the Dtuch
disease in the economy. The majority of other countries show traditional patterns of
economic development by decreasing reliance on the agriculture and manufacturing
sectors and increase value-add as a portion of GDP in the service industry. Kazakhstan
does not appear to exhibit adverse affects from the Dutch disease. Looking at the annual
growth rate in value-add for the manufacturing sector for Kazakhstan, as seen in Table 9,
shows strong growth from 1999 to 2000 and steady annual growth until 2004. This is
38
Wheelan, Charles. page 223
Mining, Energy, and Construction sector variable comprises of the mining, construction, electricity,
water, and gas. Corresponds to the International Standard Industry Classification (ISIC) divisions 10 – 14
and 40 – 45. The variable was created for this study for purposes of isolating the resource extraction sector
(mining) from the manufacturing sector.
39
23
largely due to the strong growth in the non-ferrous metals industry from foreign direct
investment by firms such as Ispat Karmet.
Table 9: Value-added for major ISIC sectors (percent of GDP), World Bank
Agriculture
Manufacturing
Min, En, Con
Service
Armenia
1992 2004
31
23
33
23
6
14
30
40
Azerbaijan
1992
2004
29
12
24
9
16
46
32
32
Belarus
1992
2004
24
11
41
32
7
8
29
49
Georgia
1992
2004
53
18
18
19
6
7
23
57
Kazakhstan
1992
2004
27
8
9
15
36
24
29
52
Kyrgyzstan
1992
2004
39
37
34
14
4
8
23
42
Agriculture
Manufacturing
Min, En, Con
Service
Moldova
1992
2004
51
21
n/a
17
n/a
7
18
55
Russia
1992
2004
7
5
n/a
n/a
n/a
n/a
50
60
Tajikistan
1992
2004
27
24
34
22
12
8
27
45
Turkmenistan
1992
2004
11
n/a
n/a
n/a
n/a
n/a
78
n/a
Uzbekistan
1992
2004
20
12
44
23
7
13
29
51
Ukraine
1992
2004
35
31
n/a
10
n/a
15
29
44
Table 10: Manufacturing, value-added (annual % growth) for Kazakhstan, World Bank
Year
Agriculture
1996
0.3
1997
4.1
1998
-2.3
1999
2.0
2000
14.0
2001
13.7
2002
7.6
2003
7.9
2004
8.9
24
4.1.2 Increased Volatility
Revenue from natural resources may be more volatile than revenue from a broad
base of export goods40. The IMF paper sites a study performed by Barnett and Ossowski
in 2002 that volatile swings in resource revenues often lead to procyclical expenditures
that may increase uncertainty and reduce investment and growth. Bartsch developed the
idea further in 2004 by comparing public expenditure in selected countries to oil price
fluctuations. For example, the study noted a strong positive correlation between the drop
in public expenditure, measured in percent of GDP, and the drop in the world oil price for
Venezuela and Nigeria. Additionally, the paper noted a small correlation between public
expenditure and oil price fluctuations for Indonesia. The paper theorized the spending
programs are often launched during periods of high resource prices or on the basis of
expected future earning, without regard for the risks or costs associated with having to
reverse them. If these spending programs become entrenched and the price of the
resource falls, governments may have to borrow at a high cost without prudent regard for
sustainability.41
Applying the same methodology to the Commonwealth of Independent States,
this analysis compares government final consumption42 as a percentage of GDP with
average annual world spot price of crude oil shows43. Figure 6 compares annual crude oil
prices with government final consumption for energy importing countries in the CIS.
There does not seem to be a strong affect from price fluctuations oil with exception for
Moldova and Ukraine. Moldova has very little natural resources, its strong correlation
with oil prices is the possible results of strong dependence of the economy with Russia.
Ukraine’s tandem movement is not surprising due the large amount of revenue it receives
in transportation tariffs is receives from natural gas shipped through pipelines from
Russia to the European market. There does not seem to be any relation for Armenia,
Belarus, Georgia, Kyrgyzstan, Tajikistan, and Uzbekistan. Figure 7 compares the same
variables, but for energy exporting countries. Initially, Azerbaijan, Kazakhstan, and
Russia exhibit similar patterns of spending movements in relation to the oil price, but
start to level off in 2000. Notably, this is the when Kazakhstan and Azerbaijan establish
their national oil funds.
Berengaut, Julie “Republic of Kazakhstan: Selected Issues”
Ibid
42
As defined by the World Bank, General government final consumption expenditure (% of GDP) includes
all government current expenditures for purchases of goods and services (including compensation of
employees). It also includes most expenditures on national defense and security, but excludes government
military expenditures that are not a part of government capital formation. All figures for this variable are
taken from the 2005 World Development Indicators
43
All figures for this variable are taken from the Energy Information Agency, historical prices.
40
41
25
Figure 7: Average annual spot price for crude oil (US$/bbl), EIA, compared to government final
consumption (% of GDP), WDI, for energy importing countries
40
35
30
25
20
15
10
Ann Oil Price
ARM
BLR
GEO
KGZ
MDA
TJK
UKR
UZB
5
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
0
Figure 8: Average annual spot price for crude oil (US$/bbl), EIA, compared to government final
consumption (% of GDP), WDI, for energy importing countries
40
35
30
25
20
15
Ann Oil Price
AZE
KAZ
RUS
TKM
10
5
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
0
26
4.1.3 Inefficient Specialization
Inefficient specialization of production with weak financial markets may lead to
higher volatility in relative prices (Hausmann and Rigobon 2002)44. Hausmann and
Rigobon study also theorized that a country highly dependent on a natural resource
extraction industry would be sensitive to exchange rate fluctuations, although due to a
relatively poor domestic financial system. With the over specialization of on particular
industry, such as the oil industry, the financial system become over burdened with high
bankruptcy costs driving up the local interest rate, again undermining the non-resource
tradable sector.
This analysis will use similar conclusions found in the Dutch disease section, the
strong growth of the ferrous manufacturing industry does not provide strong evidence of
inefficient specialization as a factor of the natural resource curse.
4.1.4 Rent-Seeking Behavior
Rent-seeking behavior in reference to the natural resource curse is the link
between the increase of corruption, weak government institutions, and poor economic
policies, and even armament with windfall oil revenues. Easterly (2001) found that a vast
common pool of resource accruing directly to the state will encourage misappropriation
by interest groups and may undermine the governments commitment to transparency or
accountability.45
Rent-seeking behavior is a serious issue in the CIS. In all four energy exporting
countries of the CIS, the oil and natural gas industries are owned by the state providing a
substantial revenue stream in the hands of the political elite. For Kazakhstan and
Turkmenistan, much of the economic an political power has been provided to specific
ethnic groups. In Kazakhstan, much of the power has been placed with the Kazakhs
causing a large migration of the ethnic Russians to emigrate out of the country. Before
the breakup of the Soviet Union, the ethnic split between the two groups we pretty even
in terms of numbers – Kazakhs accounted for 40 percent of the population and Russian
37 percent46, although not in terms of power. Currently the ethnic divide country has
shifted strongly in favor of the Kazakh population: 53.4 percent Kazakh and 30 percent
Russian47. In Turkmenistan, recent estimates put ethnic Turkmen at 85 percent of the
population48, up from 72 percent Turkmen in 198949. Much of the emigration in both
states – due to corruption and discrimination – potentially decrease the local economy to
cooperate and appreciate the benefits of increased productivity through economies of
scale.
Another rent-seeking effect common in the CIS was the establishment of
oligarchs through during the privatization process. Much of the valuable assets in the
energy industry was provided to small elite. In Kazakhstan, the privatization process, or
lack-of for the energy industry, combined with oil windfalls allowed the development of
corruption and collusion between the government and energy industry. The domestic oil
Berengaut, Julie “Republic of Kazakhstan: Selected Issues”
Berengaut, Julie “Republic of Kazakhstan: Selected Issues”
46
Olcott, page 11
47
CIA World Factbook, Kazakhstan.
48
CIA World Factbook, Turkmenistan
49
Economist Intelligence Unit, Turkmenistan
44
45
27
and natural-gas production industry still remains in state control through one company,
KazMunaiGaz, also called Kazakhoil, remains is run by Nazarbayev’s nephew. Oil and
gas transportation remain solely in the hands of KazTransGaz, heavily influenced by
Nazarbayev’s son-in-law, the vice-president of the firm.
4.1.5 Conclusion
Looking at the four factors of the natural resource curse, the CIS, and especially
Azerbaijan, Kazakhstan, Turkmenistan, and Russia are largely susceptible to its negative
consequences. Unfortunately, all four countries show increased signs of rent-seeking and
corruption that provides large benefits to a small interest group, either ethnic or
economic.
If the resource curse then countries can help prevent the Dutch disease through
increased investments in physical infrastructure. Investing in infrastructure increases the
competitive advantage of the economy as a whole. Kazakhstan and Azerbaijan have been
making strides to prevent the economic consequences from the Dutch Disease by
establishing the National Oil Funds. Discussed more in Section 6, revenues in National
Oil Funds can be specifically set aside to invest in infrastructure.
28
5 Case Studies
5.1
Case Study: Russian Trans-Siberian Pipeline
Oil pipelines have many purposes, only one of which is to transport oil. In Russia’s
Far East, the actors constructing a trans-Siberian oil pipeline from the fields in Angarsk
to the Pacific Ocean port of Nakhodka know this fact well. The Russian, Chinese, and
Japanese governments as well as the Chinese National Petroleum Corporation (CNPC)
and Transneft all have interests in seeing oil flow across the continent by means of pipe,
yet their interests differ greatly and are only somewhat related to business and economics.
What should be a matter of cost feasibility based upon market needs is instead mostly a
political issue being exploited by competing interests in a rapidly changing region of the
world. The Siberian Pacific Ocean Pipeline is not and perhaps has never been economic,
but its impending construction proves that insecurity and offsetting power balances exist
with great relevance in East Asia.
5.1.1 Background
Early versions of the Siberian pipeline project were far less ambitions than they
are today. In 1994, China and Russia began cooperation on feasibility studies to examine
the viability of an oil pipeline from the fields in Angarsk to China’s Daqing province to
feed industrial centers within China. The original actors charged with carrying out that
work were Yukos, the now bankrupt Russian oil major headed by the now imprisoned
Mikhail Khodorkovsky, and CNPC50. The feasibility study was a complex technical
undertaking due to the remoteness of the region and the lack of existing resources from
which to conduct the study. Yukos and CNPC labored over the work for close to a
decade.
During this phase, progress was being made on the political front to facilitate
details of the deal. In 1999, Prime Ministers Yevgenii Primakov and Zhu Rongyi signed a
framework agreement to investigate the export of oil and gas from Russia’s Far East
signaling an improvement in bilateral relations and a proposed commitment of the natural
resource.
Suddenly the climate started to change. Undoubtedly due to the events on and
surrounding September 11th, nations around the world began to seek means by which
they could diversify their dependence on Middle East oil. In 2002 Japan began buying
Russian oil as a strategy to meet this end – a resource that had been forgone since 1978.
Having ample supply, Russia was and is seen as a resource of strong significance for
Japan’s energy strategy.
Simultaneously, the relationship between the Kremlin and Yukos began to
deteriorate and so did the Yukos-CNPC deal. On May 28, 2003 Russian President
Vladimir Putin declined to attend a signing ceremony between Yukos and CNPC to
consummate the development of the Angarsk to Daqing pipeline at which Yukos and
CNPC signed agreements committing CNPC to purchase up to 5.13 Billion barrels of
Russian oil between 2005-203051. The signal was clearly taken in Beijing: warm relations
had suddenly turned cold.
50
51
Shue, Stephen “The Chinese Perspective on the Daqing Pipeline Project.”
Daly, John C.K. “China and Japan Race for Russian Crude.”
29
Behind the scenes, the Japanese government had been aggressively lobbying the
Russian government to consider a pipeline not from the proposed Angarsk to Daqing,
which would terminate deep within China, but rather from Angarsk to the Pacific port of
Nakhodka, where it could theoretically serve the entire Pacific basin while remaining
entirely within Russia’s territorial realm. As part of the enticement, the Japanese
government offered to finance a large portion of the project in addition to allocating
monies for exploration and social projects52.
The deal seemed to be sealed when Russian officials announced that the pipeline
would run from Angarsk to Nakhodka as laid out in the Japanese plan over New Year’s
Celebrations in 200453. Much to analysts’ dismay, however, the plan took yet another
turn with the recent announcement by the Minister of Industry and Energy of Russia at
the 2006 G8 Summit that a spur would be built off the Angarsk-Nakhodka pipeline
running into China and terminating in Beijing making the proposed pipeline one of the
largest most expensive ever built.
5.1.2 Economics
The East Asia oil market is extremely enticing. Economic growth in the region
will cause the number of people living on $2 a day to fall from more than a billion in
1990 to a projected 340 million by the year 201554. This increase in wealth will beget
large increases in energy consumption especially in the transportation sector.
Currently, China is the world’s second largest oil importer behind the United
States equating to 6.5 million bbl/d. Chinese demand is expected to skyrocket over the
next two decades, which according to the U.S. Department of Energy’s 2006 forecasts, is
projected to be 14.2 Million bbl/d with net imports of 10.9 million bbl/d by 202555.
For Yukos and CNPC, these forecasts proved reasonable enough to gamble big.
The originally planned Angarsk-Daqing pipeline was estimated to cost $2.8 Billion
adding considerable transportation costs to unproven reserves56. Given this estimate of
Rutland, Peter “Pipeline Pirouette in Northeast Asia.”
Blagov, Sergei. “Russia Walks Thin Line Between Japan and China.”
54
Editors. “Seven Futures.” CSIS.
55
Editors. “Major Russian Oil and Natural Gas Projects.”
56
Jamestown, ibid.
52
53
30
capital expenditures and the pipeline’s proposed output of 0.6 bbl/d, Yukos and CNPC
could expect to pay a $1.01 per barrel premium under normal financing conditions. If,
however, concessionary financing arrangements were arranged, that cost could be
roughly lowered to $.69 per barrel depending on the arrangements of the loan. Such oil
would have to compete directly with crude imported from the Persian Gulf.
As a region, Asia has the fastest growing oil demand in the world equating to
annual increases of 3%-4%. Japan closely rivals China as the world’s 4th largest oil
importer at 5.35 million bbl/d57. An estimated 75%-80% of Japanese oil comes directly
from the Persian Gulf – a condition that politicos in Tokyo would like to see undone.
The Russian government sees great potential in the Asian oil market. According
to recent statements by the Russian Minister of Industry and Energy, the government
expects the Asian portion of Russian oil exports to rise from today’s levels of 3% to 30%
by the year 2020 equating to an upper bound projection of 2 million bbl/d. The AngarskNakhodka plan was designed to capitalize on this growing demand.
Cost estimates for the Angarsk-Nakhodka pipeline are extremely murky.
Originally, the cost was projected at roughly $9 Billion of which the Japanese had
pledged $7 Billion with upstream exploration and social development costs included, but
more recent estimates project the cost to be between $15 and $18 Billion. Furthermore,
the Russian government has committed to building a spur from Skovorodino that does
not appear to be included.
The end capacity of the pipeline is expected to be 1.6 million bbl/d of which 0.6
million bbl/d are slated for China58. Roughly speaking, assuming capital expenditures of
$16.5 Billion for 2,500 miles of pipeline and an additional 30 miles from Skovorodino to
the Chinese boarder at $198 Million, net back expenditures could be $6.29 per barrel for
the entire output of 1.6 million bbl/d. Concessionary financing arrangements might lower
this to around $4.29 per barrel depending on the arrangements of the loan. These
estimates do not account for varying expenditures based upon delivery location and
output, which are both important factors in determining the final net back costs. One fact
is clear, The Angarsk-Nakhodka pipeline with the Skovorodino spur will be the most
expensive pipeline in history.
5.1.3 Politics
While China is booming to the south, Russia is quite literally a dying nation. The
Japanese National Institute for Research Advancement approximates the number of
permanent residents in Russia’s Far East to be 7.2 million people and predicts a decrease
to 6.8 million people by the year 201559. A declining Russian population means less
inhabitants in an already sparsely populated region that is rich in natural resources held
up by little infrastructure and economic opportunity. In historical perspective, the
Cossacks began entering the Far East as late as the 16th century (which qualifies as recent
history under the long chronicles of the region). Three centuries later, the trans-Siberian
Railroad brought the first consolidation of Russian authority and with it access to the
region’s natural riches. Today, the Russian government sees a trans-Siberian pipeline as a
Editors. “Japan-Oil.”
DOE. “Major Russian Oil and Natural Gas Projects.”, ibid.
59
Editors. “NIRA Policy Research.”
57
58
31
means to build additional infrastructure, create job growth, and promote economic
development60.
The Chinese are seemingly content within their geopolitical boundaries, but it is
provocative to suggest that China could become enticed into an energy-rich region
depleted of Russians and rapidly filling with ethnic Chinese if the opportunity presented
itself peaceful or otherwise. Most likely, however, China will seek to improve its position
relative to sourcing diversification while creating sufficient economic incentives for
Russia to be involved. At what point those incentives prove to be too costly, remains to
be seen. Under the recently proposed plan, China would contribute to an $18 Billion
project that was originally $2.8 Billion. Financing arrangements, therefore, are largely
unresolved as the Japanese have pledged less than half the cost of the main branch with
nothing at all slated for the Skovorodino spur. Chinese pipeline deals underway with
Kazakhstan indicate that they are willing to go elsewhere if Russo-Sino relations become
too complicated and indeed they might.
Japan is concerned with sourcing diversification as is China, but even so
constructing the largest most expensive pipeline in history seems like a heavy premium to
achieve such ends. More likely, the threat of increased cooperation between Russia and
China – Japan’s largest trade partner – and an unresolved territorial dispute over the Kuril
Islands are also factoring into the cost benefit analysis. The Japanese financing
concessions enable the Russians to build a favorable infrastructure project, restrict the
Chinese from accessing Russian oil unfettered, and coax the normalization of RussoJapanese relations.
5.1.4 Conclusion
According to a recent statement by the Ministry of Industry and Energy of Russia at the
G8 Summit:
In the 21st century geopolitics is being replaced with geoeconomics, which gives
priority to a nation’s ability to compete with others. Geoeconomics is determined by the
market capacities and positions, flow of goods, capital, services and manpower,
integration, and cooperation in the economy and other spheres61.
60
61
Khristenko, Viktor. “Breakthrough to the East.”
Khristenko, ibid.
32
Such defines the battle being waged over the Siberian Pacific Ocean Pipeline. The
manner in which the Minister refers to the decision making process itself is revealing:
The pattern has been determined, and will now be followed by designing and
commercial calculations. Discussion of the first stage of construction (TaishetSkovorodino section) has moved onto a corporate, pragmatic level – potential forms of
participation of different companies, and risk diversification.62.
The Siberian Pacific Ocean Pipeline has not been designed under a competitive
market and is not suited to serve competitive market. Pragmatism is a convenient way to
organize the numbers rather than drive the decision making process. Therefore, economic
motivations are not ends but means by which competing states in a rapidly changing
region can exercise influence.
5.2
Case Study: Georgia The South Caucasus Pipeline
On January 22, 2006 two explosions in Russia’s North Ossetia province shut down
the main pipeline exporting natural gas to Georgia. The explosions prompted Georgian
President Mikhail Saakashvili to conclude that the accident was carried out by Russian
forces in order to create a destabilizing energy crisis within his borders. Following the
crisis, Saakashvili declared, “This is the last winter when it will be possible to launch an
energy offensive against us... because a new gas pipeline [the South Caucasus Pipeline]
will be launched in the fall [2006].”63 The President followed his remarks with an op-ed
in The Washington Post on January 9, 2006 in which he urged the international
community to seek alternatives to Russian energy supplies.
Regardless of who was behind the explosions, the accident raised concerns about
the future security of Caspian oil and gas exports across the Caucasus. The Caucasus
region is notorious for conflict and pipeline attacks have been widespread in the past. For
Tbilisi, the gas disruption highlighted its complete dependence on Russia for its gas
supplies. Russia has used this dependence to its advantage by bullying the State to meet
its needs. In December 2005, a deal was reached in which Georgia agreed to pay
$110/cubic meter (cm) for Russian gas- a nearly 200% price increase over its previous
rate of $62.50/cm- yet still substantially lower than the European gas rates.64 Recently,
the Russian gas monopoly, Gazprom, has insisted it will force Georgia to pay European
rates unless Tbilisi increases its dependence by selling a trunk pipeline and its main gas
distribution systems to Gazprom for $250 million.65
However, three factors have prevented Georgia from accepting this deal. First, the
pipeline explosion illustrates Gazprom’s inherent unreliability; second, Georgia recently
received the US Millennium Challenge Account Funds (which are partially earmarked for
the rehabilitation of the trunk pipeline); and third, the South Caucasus Pipeline (SCP) will
be providing natural gas to Georgia by September 2006.66 For Georgia, the SCP will
have a monumental effect in reducing dependence on Russian gas, strengthening ties with
the European Union (EU) and the United States, and providing much needed transit
revenues in the form of natural gas.
62
Khristenko, ibid.
Ismayilov, Rovshan. “Azerbaijan: An Unlikely Solution to Georgia’s Energy Woes.”
64
“Geopolitics.” Petroleum Economist
65
“Georgia fears upcoming agreement could give Gazprom control.” Alexander’s Gas & Oil Connection
66
Socor, Vladimir. “Georgia Extricating From Gazprom’s Bear Hug.”
63
33
The 690 km SCP will transport gas from the Shah Deniz field, one of the largest
gas fields in the world, from Azerbaijan through Tbilisi to Erzurum, Turkey where it will
connect with the Turkish gas grid. The field has proven gas reserves of 625Bcm (22.1
trillion cubic feet), and British Petroleum (BP), the technical operator overseeing the
Shah Deniz project, is confident that recent assessments will result in a 25 percent
increase in its proven reserves.67 The Shah Deniz project was cultivated from Turkey’s
exaggerated gas demand projections in the 1990s, Georgia’s desire to divert its energy
imports away from Russia, and Azerbaijan’s aspirations to connect to European markets.
BP and Norway’s Statoil each hold a 25.5% stake in the Shah Deniz project; 10% stakes
are held by Total, Azerbaijan’s State Oil Company (SOCAR) and the National Iranian
Oil Company (NIOC); and a partnership of Russia’s Lukoil and Italy’s Agip hold 10%
between them, while Turkish Petroleum maintains 9%.
At a cost of over $4bn, the South Caucasus Pipeline will ultimately have a
20Bcm/year capacity.68 The SCP, which will follow the same route as the Baku-TbilisiCeyhan (BTC) oil pipeline to Turkey, will consist of a 42 inch pipeline, supported by a
compressor station, as well as two sales gas off-takes in Turkey and Georgia. Because of
Turkey’s diminished demand for the gas, it will buy approximately 2-3Bcm in 2006, 35Bcm in 2007, and 6.6Bcm/yr from 2008-2020.69 Georgia, meanwhile, will receive 5
percent of the transported gas as a transit fee in lieu of cash and will be able to purchase
an additional 0.5Bcm per year at a cost of $55/cm.70 By the time the pipeline reaches its
capacity toward the end of the decade, the SCP producers hope the route can be used as a
transit to European markets where it can compete with Gazprom for market share.
Georgian Implications
While the South Caucasus Pipeline will greatly affect all countries involved,
Georgia will reap the largest rewards from the new gas route. At present, Georgia’s
natural gas is received solely from Russia. Even natural gas imported from Turkmenistan
is re-routed through Gazprom’s pipelines by Russia’s private company, Itera, which leads
to higher transport costs. Under the previous President Eduard Shevardnadze, Tbilisi
strengthened its energy ties to Russia with agreements signed in 2001-2002, in which
Gazprom was awarded nearly complete control over the national pipeline network. The
United States voiced its concern over Gazprom’s “extending monopoly” in the Caspian
and advised the Georgian government to refrain from any steps which could affect the
viability of the SCP and BTC.71 During this time, Russia also undertook efforts to
undermine the feasibility of the SCP. On June 4, 2003 the Russian Deputy Prime
Minister Viktor Kalyuzhny proposed that Azerbaijan should use a Gazprom-manned
underwater route connecting Russia to the Turkish port of Samsun rather than rely on the
SCP for its exports.72 Gazprom also announced plans to modernize a pipeline running
through Georgia’s southern region of Ajara and extend it to Turkey. In the buildup to the
2005 Georgian presidential elections, the importance of ensuring gas supplies was vital to
“BP’s Shah Deniz Gas Marketing Puzzle.” World Gas Intelligence
Ibid
“We were fairly confident in sizing the pipeline at 20Bcm that there would be more gas,” stated David
Woodward, President of BP Azerbaijan
69
“South Caucasus Pipeline close to beating the odds.”
70
“BP’s Shah Deniz Gas Marketing Puzzle.”
71
“Georgia fears upcoming agreement could give Gazprom control.”
72
Ibid
67
68
34
President Shevardnadze, who responded by increasing his country’s dependence on
Russia in exchange for uninterrupted gas supplies.
Yet with the SCP due to come online in September 2006, Caspian gas will be
available for the first time in Georgia. Aside from reducing its energy dependence on
Russia, the pipeline will benefit Tbilisi in several areas. During negotiations, Azerbaijan
agreed to double Georgia’s transit fee at its own expense, which will lead to the latter
receiving 5% of the gas transported through the pipelines as a payment-in-kind. It can
then sell that gas if it chooses at a rate of $100/cm in the first year with this price rising
by 2% each year. The state will also benefit from low gas prices to meet most of its
additional demand. Georgia will be able to purchase an additional 0.5Bcm/yr at a fixed
price of $55/Mcm, with this price increasing by 1.5% annually.73 With both the BTC and
SCP routed through Georgia, the government expects to receive 1% of GDP, around $80
million, in additional revenues per year over the medium term (see Figure 9).74
Figure 9: Georgia Oil and Gas Transit Revenues
5.2.1 Complications
However, while the South Caucasus Pipeline will benefit Georgia in many ways,
the project also brings several complications. Georgia currently demands 1.34Bcm/yr in
gas, yet it can only receive approximately 1.00Bcm/yr in the near to medium term.75
“BP’s Shah Deniz Gas Marketing Puzzle.” World Gas Intelligence
Billmeier, Andreas, Jonathan Dunn, Bert van Selm. “In the Pipeline: Georgia’s Oil and Gas Transit
Revenues.”
75
This is assuming the pipeline transports around 10Bcm/yr in the near to medium term (5-10 years).
Georgia will receive 5% of this as a transit fee, which equals .05 x 10Bcm = 0.5Bcm. It also has the ability
to purchase 0.5Bcm, this giving it a total of 1.0Bcm, which is less than its present demand of 1.34Bcm.
Even under most optimistic assumptions in which the SCP has a capacity of 30Bcm, transit revenues to
Georgia will only equal 1.5Bcm.
73
74
35
Georgia is presently engaged in discussions with Azerbaijan over purchasing additional
gas from the pipeline. The Georgian government is prepared to guarantee the payments
and pay for the gas upon delivery, yet some Azerbaijani experts are skeptical Georgia
will be able to make its payments. Compounding the problem, Georgian gas-fired power
and fertilizer plants are owned by Russian companies and it is probable they will insist on
acquiring Russian feedstock. Thus, it is unrealistic to assume that Russian gas will be
completely removed from the Georgian market in the near future.
5.2.2 Future of the Pipeline
As commercial operator of the SCP, Statoil has begun assessing European
markets as an alternative destination due to Turkey’s reduced demand for the gas.
European gas demand is projected to increase substantially in the future- conservative
estimates believe EU demand will double from 200Bcm in 2002 to 400Bcm by 2030.76
A gas pipeline between Turkey and Greece is expected in 2006 and will provide the first
opportunity to send Caspian gas directly to European markets (see figure 3). This
prospect has prompted Russia to try to prevent new entrants from entering the EU gas
market. Russian gas exports to the EU comprise 25% of Gazprom’s total production and
a whopping 75% of its revenues. Gazprom’s exports also account for 20-25% of
Russia’s total export revenues, a significant amount which will likely decrease with the
emergence of Caspian gas.77 As Georg Gundersen, President of Statoil Azerbaijan has
stated in referring to the EU’s demand projections, “We want to have our share of that
cake.”78 With Europe pursuing diversified energy supplies and the Caucasus interested in
accessing these markets, there may be a good strategic, if not economic, match between
the interests of Europe and the South Caucasus.
5.2.3 Conclusion
The SCP and BTC Pipelines will benefit Georgia both politically and
economically. As one of the few CIS countries with limited resources, Georgia’s
economic development is dependent on serving as an important transit state for the
Caucasus region. The projects offer significant revenue potential and provide an
opportunity for further foreign investment as long as the government provides an
attractive setting for investors. Positive signs include the government’s commitment to
structural reform, such as the simplification of obtaining licenses and permits to
encourage private-sector activity. The reforms have resulted in renewed foreign loans
and praise from the IMF in 2005 on the country’s reform process. Higher revenues from
taxes, as well as rising privatization receipts are providing the government with the
opportunity to increase public spending especially in infrastructure and the energy sector.
Until Georgia achieves energy independence, the importing of oil and gas will
continue to spark energy shortages, hamper economic activity, and produce unfavorable
macroeconomic conditions. However, by serving as a transit state for the SCP, Georgia
now has a direct stake in the supply and shipment of Caspian gas. The SCP significantly
reduces its dependence on Russia for energy supplies, provides natural gas at favorable
rates, and strengthens relations with the US. In recent years, Georgia has finally come to
Tsereteli, Mamuka. “Caspian Gas: Potential to Activate Europe in the South Caucasus.”
Ibid
78
“With Shah Deniz gas two years off, quest to grow project in motion.” Platts Oilgram News
76
77
36
the realization that its greatest economic, political, and strategic benefits hinge on its
ability to become an important transit state. The South Caucasus Pipeline illustrates that
Georgia has emerged as a significant actor in the Caspian region, and one in which both
European and American interests converge.
37
6 The Strategic Approach
There are several strategies governments in the CIS can use in combination to
increase public and private investment in infrastructure. Countries heavily endowed with
natural resources can establish and effectively manage national oil funds as seen in
Kazakhstan and Azerbaijan. Also, regional initiatives such as the CIS-7 and CAREC can
increase the cooperation between governments necessary for large-scale projects.
Regional initiative can also increase investment from multinational donors and
institutions.
6.1.1 National Oil Funds
In 2000, the President of Kazakhstan established the National Oil Fund of the
Republic – a means of growing popularity in the CIS region. In its most basic form, an oil
fund amounts to a foreign-currency investment account owned by the state. Oil funds can
help to both save funds from oil windfall revenues and act as a stabilization tool to lessen
the burden from the price volatility of oil79. Many countries have developed funds to
protect against the natural resource curse, the most notable being the Norway Oil Fund,
upon which NFRK is modeled.
The Fund is administered by the Ministry of Finance and proceeds from oil
royalties, sale of mineral assets and privatization are all placed in the Fund. The assets are
held at the National Bank of Kazakhstan and managed according to the Ministry of
Finance guidelines. Government oversight is provided by the Management Council
formed by the President, the Prime Minister, and members of Parliament, with an annual
independent audit80.
In 2003, the Fund had accumulated $2.3 billion. Unfortunately, there was still a
lack of transparency with the Fund81. In May 2004, $3.7 billion (equivalent to 10 percent
of GDP) had accumulated. Initially, the government identified 12 major companies in the
natural resource sector to deposit revenues from the NFRK. By 2004, the number of
entities was reduced to 6 and the list was limited to petroleum companies. Flows to the
NFRK consist of a savings component equal to 10 percent of the budgeted baseline
revenue from the listed natural resource companies ($100 million in 2003), invariant to
price changes. The “stabilization” component includes all revenues from listed
companies above the baseline price, which has remained fixed at $19/bbl. The use of
NFRK resources (for specific projects), in the event of petroleum revenue shortfalls from
the budgeted levels established at an assumed $19/bbl, is to be channeled through the
budget.82
The establishment of national oil funds as a means of distributing oil revenues is
an important step taken by the governments in Azerbaijan and Kazakhstan. The funds
aim to provide transparency and accountability in directing excess revenues to directly
benefit the citizens through economic diversification and social services. As both
Azerbaijan and Kazakshtan increase foreign investment within their borders, the impact
79
Caspian Revenue Watch
The National Embassy of Kazakhstan
81
The Economist. June 12, 2003
82
Berengaut, Julie “Republic of Kazakhstan: Selected Issues”
80
38
and importance of these funds will continue to take on greater importance. With its
decreasing reserves, Azerbaijan will rely heavily on its national oil fund to properly
distribute wealth in an attempt to diversify the economy before its oil production is
exhausted.
However, for the national oil funds to utilize their full potential, open and
transparent institutions must be established within the country. Accountable, political
institutions must prosper not only within the energy-rich CIS countries, but to transport
states, such as Georgia and the entire CIS region as well. For oil funds to achieve their
aim, transparency, accountability, and checks and balances need to be in place. These
characteristics are found most predominantly in democratic societies where the rule of
law is determined by, and enforced by, the citizens rather than a single individual.
Without the necessary level of accountability, the oil funds run the risk of becoming a
political tool at the hands of the powerful, ruling elite.
With its increased orientation to the West, there is increasing optimism that the
former Soviet states of the CIS region will become increasingly more democratic and
open. With significant investments in the region, the United States and EU must foster
strong relationships and continue to assist in promoting democratic institutions and free
and fair elections. A stable CIS is of increasing importance to the western world and can
best be achieved if the government is representative of the citizen’s needs and wants.
For their part, foreign oil and natural gas companies can best provide corporate
social responsibility if they encourage citizens to monitor and observe their governments’
use of resource funds. In the absence of democratic institutions and the rule of law, these
companies must provide the terms of their PSAs and the amount they pay the
governments for the agreements. In Azerbaijan, the BTC consortium led by BP has
already disclosed their production-sharing agreements for the project. It is in the best
interest of oil and natural gas companies to ensure long-standing relationships with their
host countries and to make certain the oil and gas funds are properly distributed to the
citizens. Because the oil and natural gas sectors are capital-intensive rather than laborintensive, it is also imperative that the capital obtained from these projects is allocated to
providing economic development in labor-intensive industries, as well as social
development. As mentioned earlier, the Russian oil and gas sector which accounts for
25% of GDP, employs less than 1% of the population.
We do not suggest that in order for corporations to be socially responsible, they
must ignore profit-maximization strategies. Rather, we believe that within the CIS
region, companies will be best served in the long run by providing the terms of their
agreements to the public. This way, governments can be held accountable for the use, or
lack thereof, of oil and gas funds. Ultimately, governments as opposed to multinational
corporations, are responsible for the economic development of their countries.
6.1.2 Regional Cooperation
Regional cooperation can also go a long way in improving the economic
conditions of the CIS countries. The first attempts at regional cooperation began with the
initial development of the Commonwealth of Independent States. The CIS was
established in December 8th, 1991 with the signing of the Minsk Agreement by Belarus,
Ukraine, and the Russian Federation. The formal treaty dissolving the Soviet Union was
signed in Almaty, Kazakhstan soon after and included the original CIS states plus the
39
Central Asian states. By December 1993, Georgia and Azerbaijan joined the CIS bringing
the total inclusion to 12 nations. The main political institution of the CIS is the Council of
the Heads of State, which intends to coordinate the cooperation of the each sovereign
states leaders. The CIS also has a secretariat, labeled the Executive Committee, and an
Inter-Parliamentary Assembly. The politics of the CIS is divided between nations wary of
a large influence from Russia and other nations seeking a close integration 83. However,
the CIS does provide the framework for the region to work together on large-scale
infrastructure projects, for example the Central Asian Power Grid.
Another regional strategy, the CIS-7 Initiative, was launched in 2002 to promote
economic growth and poverty reduction through reform efforts including structural
reforms in the energy and financial sectors, as well as preserving macroeconomic
stability. The Initiative brings together the seven low-income CIS countries with bilateral
donors, international financial institutions and the international community. The main
object of the initiative is to assist the CIS-7 with the implementation of their poverty
reduction strategies
The Central Asia Regional Economic Cooperation (CAREC) which includes
Azerbaijan, Kazakhstan, Turkmenistan, and five additional Central Asia countries,
focuses on improving the standard of living through regional economic cooperation. The
Program concentrates specifically on financing infrastructure projects and is also an
alliance of multilateral institutions including the Asian Development Bank (ADB), the
European Bank for Reconstruction and Development (EBRD), the International
Monetary Fund (IMF), the UNDP and the World Bank. The partnership, which is
expected to contribute over $1.5 billion in assistance for transportation, energy and trade
in 2006-2007, is an illustration of the importance of regional cooperation and the positive
effects from bilateral cooperation.84
Both the CIS-7 Initiative and the CAREC have raised awareness and attracted the
attention of multinational donors including the World Bank and the EBRD. Within the
energy sector, the World Bank has fostered important discussions on power sector
reforms and regulations within the region, while the EBRD has joined with the ADB to
provide loan assistance for an Uzbekistan-Turkmenistan Power Transmission
Modernization Project.85 Regional cooperation has provided the necessary funds for
infrastructure projects and has also comforted foreign investors worried about regional
instability.
83
Economic Intelligence Unit: Turkmenistan
“CAREC Program.” Asian Development Bank (2006)
85
Ibid
84
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