Can Local Participation Help Solve the Oil Curse?

Oil production in low-income countries tends to be dominated by a handful of multinational “supermajors” and state-run firms. Local private firms typically lack the know-how, financing, and technology to conduct the capital-intensive work of drilling and pumping oil.

But this ownership arrangement hasn’t worked out particularly well for the citizens of oil-exporting developing nations. Despite the billions in production revenue, many oil-dependent countries remain mired in poverty. This so-called “resource curse” has long intrigued scholars of development economics and political science.

Oil extraction is often accompanied by corruption, violence, political instability, poverty, and environmental devastation. And in recent years, a transnational illicit economy for petroleum products has grown to hundreds of billions of USD annually. That’s more than the combined annual net profit of BP, Chevron, Eni, Shell, ExxonMobil, Total, and ConocoPhillips.

Nowhere is this situation more acute than in Nigeria, sub-Saharan Africa’s largest producer at 2.3 million barrels per day. Political competition for oil revenues has frequently turned violent, provoking a long-running insurgency in the country’s southern Niger Delta region—home to the vast majority of oil reserves—between local militants, oil companies, and the Nigerian state.

Against this volatile backdrop, oil theft in the region has grown into an industrial-scale black market valued at roughly 4.2 billion USD in 2016, or 15% of Nigeria’s total annual production. This market accommodates a complex web of participants—local gangs who tap the oil, state security agents who provide them with cover, militants who control pipeline territory, small-scale entrepreneurs who refine stolen oil for local sale, politicians who receive kickbacks, and oil companies who spend vast sums on security to little avail.

Is there a better way? In particular, might divesting resource ownership to the domestic private sector alleviate some of these pathologies? Such “indigenization” policies conjure up the nightmarish experiences of forced divestment from countries like Venezuela and Zimbabwe. But in a recent working paper, I study the starkly different results of a long-run trend toward multinational divestment in Nigeria.

In response to persistent unrest, multinationals have voted with their feet, moving offshore or exiting the Nigerian market entirely. This retreat has opened opportunities for indigenous firms. A wave of multinational divestments since the mid-2000s has increased the market share of Nigerian firms from 4.7% in 2001 to 20.8% in 2015.

Takeover of oilfields by local firms leads to a large increase in asset productivity. Local firms also significantly reduce the rate of “shut-in” fields—those that are taken offline due to disruptions from militant- or theft-related sabotage.

Local firms are able to achieve this by alleviating the resource curse—they experience significantly less militant violence and oil theft on their assets. This creates substantial benefits to society, both by increasing the government’s oil revenue and alleviating the social ills of the black market.

However, these gains come at a cost. Consistent with lower quality standards, local firms pollute substantially more that their multinational peers. Local takeover leads to large increases in both oil spills and gas flaring, the primary local environmental risks of oil production.

How did local firms succeed where the multinationals failed? In a word, corruption. Locally owned oilfields see substantial increases in law enforcement protection, ultimately reducing criminality and violence. This preferential law enforcement treatment is, in turn, driven by local firms’ superior connections to political figures, particularly those in the Nigerian security forces.

Furthermore, multinationals are hamstrung in their ability to buy state protection by international anti-bribery laws. This is certainly not a rosy picture of good corporate citizenship achieving harmony with local communities. But in a second-best world of endemic crime and violence, corruption may be more efficient than the alternative. As such, increasing the market participation of politically connected local firms may well benefit society as a whole.

This post highlights research presented at the Northeast Workshop on Energy Policy and Environmental Economics, hosted this year at the University of Pennsylvania.

Jonah Rexer

Doctoral Student, Wharton School

Jonah Rexer is a Ph.D. student in the Wharton School at the University of Pennsylvania.