Chapter

Chapter 10. Chad: Lessons from the Oil Years

Author(s):
Bernardin Akitoby, and Sharmini Coorey
Published Date:
August 2012
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Author(s)
Jean-Claude Nachega and Jaroslaw Wieczorek 

Chad’s oil was developed in the uniquely difficult conditions of a landlocked nation with extremely low levels of human and physical capital, and in the virtual absence of basic infrastructure—which had to be created by the oil industry in the oil-producing region.

Initial expectations at the industry level were modest; oil prices were particularly low when the development decision was made in 2000, and multiple difficulties were expected during the development phase (2000–03). Government revenue from oil was expected to be $45 million to $50 million per year, or equivalent to ¼ of annual donor assistance (including expected debt relief under the Highly Indebted Poor Countries Initiative). The World Bank’s participation in oil development and establishment of a transparent revenue-management system, including the institutional arrangements for using oil revenue for poverty reduction along with the resources provided by external donors, were unique to Chad.

As a result of the surge in international oil prices in the second half of the decade, the revenue from oil vastly exceeded expectations, raising prospects for ending the country’s endemic poverty and laying the basis for creating a modern economy. However, this unexpected oil boom also complicated the politics of the country. It raised public expectations and created more competition for political control. In December 2005, a rebellion erupted with Sudanese support. The rebel threat peaked twice (in April 2006 and February 2008) when, on both occasions, the capital was nearly taken. In these circumstances, the carefully crafted oil revenue management system proved untenable. Resources were redirected toward security needs, and the development strategy changed. However, the transparent oil revenue collection system remained in place.

The record of the oil years in Chad is mixed. The promise of a better future materialized to some extent, with visible progress in the development of infrastructure and urbanization, especially since 2009. At the high prices that have lasted into 2012, oil continues to attract new investors (notably, China) and—rather than only for exports—oil is also being used to broaden the country’s industrial base, including the oil refinery opened in June 2011 and related increased electricity generation capacity, and the cement factory inaugurated in February 2012. In addition, a number of industrial production facilities, including a fruit juice factory launched in July 2011, are being built in partnership with India. At the same time, Chad’s poverty indicators and progress toward the Millennium Development Goals have continued to lag behind many countries in sub-Saharan Africa (SSA) that operate without significant oil or other mineral resources.

Chad has also been faced with important economic and political challenges stemming from oil production. Although no evidence indicates that Dutch disease has taken hold in Chad in the full sense of the term, oil rents have clearly reduced the incentive to reform the ailing cotton sector (Chad’s traditional export industry) and, more generally, to improve the business environment. Oil wealth has also been a factor in the spillover into Chad of violence from neighboring Darfur, which required major military and financial efforts to stop.

The main challenge before Chad, though, is that its oil is expected to be exhausted in 20 years, and strong policies are needed to engineer a smooth transition into the post-oil era.

Oil Production and the Petroleum Revenue Management Program

The development of the Doba project started the oil era and required the construction of the Chad-Cameroon pipeline, which was partly financed by the World Bank. Oil production began in October 2003. Owing to the small size of oil reserves in Chad, the expected trend in oil production is downward. The World Bank’s participation in oil development ensured the establishment of a transparent revenue-management system.

The Three Fields Project

In 1988, Chad signed a convention with a consortium of oil companies led by ExxonMobil (the project operator), that (i) permitted exploration of three oil fields in the Doba basin (Miandoum, Kome, and Bolobo, or the “Three Fields”); (ii) regulated the processes for environmental protection, land acquisition and compensation, and royalties and tax payments; and (iii) granted a 30-year concession to develop, exploit, and commercialize the Three Fields.

The construction of the Chad-Cameroon pipeline, indispensable for developing the Doba project, was the largest enterprise of its kind in SSA. In 2000–01, the consortium initiated the Chad-Cameroon Petroleum Development and Pipeline Project (in an amount of US$4.2 billion). Lack of direct access to the Atlantic Ocean meant that the consortium would have to construct a 1,070-kilometer underground pipeline to carry oil from the Doba basin to Kribi in Cameroon. The governments of Chad and Cameroon joined the consortium in setting up the Chad Oil Transportation Company and the Cameroon Oil Transportation Company; 85 percent of the length of the pipeline is located in Cameroon. The pipeline was completed in July 2003 and oil production began in October 2003.

Oil Production and Pricing

Chad’s oil resources are small relative to those in other SSA countries and will not last long. Compared with Angola, Gabon, or Nigeria, Chad’s oil production started just recently and its reserves—estimated at 1.5 billion barrels (145 barrels per capita)—are expected to be depleted by about 2030 (Figure 10.1). After reaching a peak of 63 million barrels, or 172,000 barrels per day in 2005, oil output has been declining since, falling to 45 million barrels, or 123,000 barrels per day (2.3 percent of SSA production) in 2010.

Figure 10.1Oil Production in Selected Sub-Saharan African Countries

Source: IMF.

Note: CEMAC = Central African Economic and Monetary Community.

The expected trend in oil production is downward. Annual output from the Doba basin is projected to drop to about 30 million barrels in 2015 and to 10–15 million barrels per year thereafter, until about 2030. Doba crude sells at a variable discount with respect to Brent crude, as a result of its low quality and high unit transportation costs, which affect the implicit well-head price and the revenue base.

The contribution of the new oil field near Bongor (developed by China National Petroleum Corporation), with production of 20,000 barrels per day starting in mid-2011, will not significantly alter the downward path of total production given that this field is only a third the size of the Doba field. A few other fields of similar size are being explored, but the production decision has not yet been reached in any of those cases.

Fiscal Regime for the Oil Sector

Unlike most SSA countries—where production-sharing agreements are standard operating procedure—Chad relies on a concession contract system and a tax and royalty regime to govern the exploration, development, and exploitation of the Doba oil fields. Under this regime, the government is entitled to (i) signature bonuses and exploration permits, which were paid upfront when the concession contract was signed; (ii) dividends and share premiums, which are derived from Chad’s equity shares in Chad Oil Transportation Company and Cameroon Oil Transportation Company, and paid twice per year; (iii) royalties, which are paid monthly at a rate of 12.5 percent and on the basis of a “provisional quarterly well-head oil sale price”1; (iv) corporate income taxes, which are filed annually on tax liabilities of previous year’s profits plus an equal advance payment that can be credited against profit tax in the following year2; and (v) value-added taxes and custom duties, which are paid on non–oil-related purchases.

Petroleum Revenue Management Program

The government took a loan from the World Bank to finance its stake in the pipeline project.3 The loan agreement provided for putting in place a petroleum revenue management program (PRMP) to ensure transparent use of oil revenue for priority sectors. Under the PRMP, all revenue from the project would pass through an offshore escrow account. The PRMP was the basis for the 1999 Petroleum Revenue Management Law, which specified the allocation of oil revenues. After deduction of debt service to the World Bank and the European Investment Bank, 10 percent of direct revenue (royalties and dividends) were earmarked for a future generations fund. The remaining 90 percent of post debt-service oil revenues were allocated as follows: 80 percent of royalties and dividends to priority sectors4; 5 percent of royalties to the Doba oil-producing region; and 15 percent of royalties and dividends to the general government budget. Furthermore, 42.6 percent of expenditure not financed by earmarked oil revenue (the “ordinary budget”) was to be allocated to priority spending to ensure “additionality” compared with the 2002 (pre-oil) budget. An autonomous joint government–civil society oversight body (the Collège) was to authorize and monitor oil-financed priority spending.

The Economic Impact of Oil

Oil extraction was the main source of Chad’s economic growth during the development phase and the initial production phase, but this effect tapered off quickly. In 2000–05, oil investment and production pushed the average real GDP growth rate to 12.6 percent (9 percent in per capita terms). In 2006–10, however, real GDP growth dropped to 1.1 percent (−1.4 percent in per capita terms)—one of the lowest rates in SSA—on account of declining oil output (as expected) and weak growth in non-oil GDP.

Structural Shift, Poverty Impact, and Political Economy

Before the oil era, the economy was predominantly agrarian, with GDP per capita about US$205 in 2001–02—less than half the average in SSA. Chad’s traditional exports were cotton, which provides livelihoods to about one-third of Chad’s population, and cattle. A major structural shift occurred with the advent of oil production. In 2006–10, GDP per capita had risen to an average of US$750 with oil accounting for half of nominal GDP, 70 percent of government revenue (excluding grants), and 90 percent of merchandise exports.

Despite the oil-driven increase in GDP per capita, Chad remains among the least-developed countries in the world, with a very high incidence of poverty.5 The bulk of the population still depends on livestock and agriculture. A 2003 consumption survey revealed that 55 percent of the population was affected by poverty and 36 percent by extreme poverty (World Bank, 2008). These indicators are to be reassessed by a new household consumption survey (to be completed in June 2012) but other measurements suggest that significant progress has yet to be made in poverty reduction. Chad ranks 163 out of 169 countries in the United Nations 2010 Human Development Index and similarly poorly on indexes for rule of law, governance, business climate, and policy performance compiled by various organizations. Chad’s health indicators are particularly worrisome, with the maternal mortality indicator among the highest in the world, and recent reports pointing to a resurgence in previously eradicated diseases (notably, cholera and polio).6

Oil also complicated Chad’s political economy. The exploitation of oil wealth has exposed Chad to aspects of the “resources curse”: nonproductive public spending, corruption, weak external competitiveness, sharply rising public indebtedness, low non-oil taxation, rentier state behavior, and risk of conflict. The political dynamics were affected when a broad spectrum of political and military actors came to expect a significant share of oil-financed spending. Leaders believed that maintaining these flows was key to ensuring the stability and security of the state.

The Experience with the PRMP

Government revenue from oil has been significantly higher than projected: $6.3 billion cumulatively through the end of 2010, nearly 20 times the amount initially expected in that period. With the surging price of oil outweighing declining production and enabling accelerated amortization of the development costs, government revenue from oil rose from 4.7 percent of non-oil GDP (33.3 percent of government revenue) in 2004 to 35 percent of non-oil GDP (76.2 percent of government revenue) in 2007–08 (Figure 10.2). In 2009–10, on account of the fall in oil prices (and changes in oil tax payment in 2008), oil revenue dropped to 19.5 percent of non-oil GDP (59.2 percent of government revenue). At the same time, however, the government was also subject to unforeseen spending pressures, mainly security related.

Figure 10.2Oil Production, Fiscal Policy, and Public Financial Management, 2003–10

Sources: Country authorities; and IMF staff estimates.

Note: CEMAC = Central African Economic and Monetary Community; WEO = World Economic Outlook.

In these circumstances, the PRMP turned out to be short-lived. Facing mounting security threats, the Chadian authorities modified the PRMP unilaterally in December 2005 to divert a greater share of oil revenue to security and military spending and away from the future generations fund and agreed-on poverty-reducing spending. The government also revised the PRMP to change the definition of “priority sectors” (to include justice, territorial administration, and security) and to increase the share of non-earmarked oil revenue to 30 percent from 15 percent.

The World Bank disagreed with these amendments to the PRMP, but renegotiated the use of oil revenue. The 2007 budget would allocate at least 70 percent of all budgetary resources to a list of priority sectors, extended to include governance. However, in the face of increased rebel activity, the government was unable to adhere to the agreement. The rebels’ second attempt to take over the capital in February 2008 led to widespread damage, loss of life, and the evacuation of international agencies, including the World Bank, which closed its offices. In September 2008, the government fully repaid the loan balance on the pipeline and associated credits. The World Bank reopened its offices in January 2009 and resumed dialogue with the government about Chad’s development challenges outside the oil sector.7

Even with the amendments, the PRMP ensured that Chad’s oil revenue flows were uniquely transparent and secured increased budgetary appropriations for priority spending.8 In nominal terms, priority sector expenditure increased by about 70 percent during 2004–06, albeit by less than overall spending—primary current expenditure rose from 10 percent of non-oil GDP to 29 percent, and domestically financed investment from 2 percent of non-oil GDP to 12 percent.9 Priority (nonsecurity) spending was later crowded out by exceptional security spending, which peaked at an annual 10 percent of non-oil GDP in 2006–08. The execution of priority spending was also hindered by procurement irregularities (a lack of competitive bidding) and overpricing of goods and services.

Fiscal Policy

Fiscal policy has been expansionary throughout the oil era. The oil revenue windfall fueled a spending spree, resulting in a sharp increase in the non-oil primary deficit (NOPD).10 With total expenditure (excluding interest payments and foreign financed investment) quadrupling (as a percentage of non-oil GDP) since 2003 and reaching about 40 percent of non-oil GDP in 2009–10, the NOPD (on a commitment basis) increased from 3 percent of non-oil GDP in 2003 to 30 percent in 2009–10.

Both domestically financed capital and primary current spending have increased as a share of non-oil revenue beyond levels that could be sustained if oil revenue were to decline significantly. Domestically financed capital spending as a share of non-oil revenue increased from 23 percent in 2003 to 106 percent in 2008–10. Likewise, primary current spending as a share of non-oil revenue rose from the already high level of 112 percent in 2003 to 240 percent in 2008–10. In particular, the wage bill as a share of non-oil revenue increased from about 60 percent in 2003 to 75 percent in 2008–10.

Meanwhile, traditional revenue sources have been neglected. In spite of moderate growth in non-oil GDP in the 2000s and significant growth in taxable imports, non-oil revenue effort has increased from 8.2 percent of non-oil GDP in 2000 to just over 12 percent in 2008–10 (a level below the average observed among other SSA oil exporters), and tax reforms have stalled.

The oil-driven fiscal expansion strained absorptive capacity and public financial management, and raised governance concerns. The conjunction of fast growth of investment spending and neglect of the multiyear implications of investment decisions has prompted concerns about absorptive capacity.11 At the same time, allocations for recurrent spending on infrastructure maintenance, health, and education have remained insufficient. Public financial management issues relate to weak links between annual budgets and the poverty reduction strategy, and the limited role of line ministries in elaborating their budgets. Concerns about governance result mainly from weak procurement practices and the frequent bypassing of normal budget procedures; in 2007–10, about a third of domestically financed spending (excluding wages and debt) was executed using procedures normally reserved for emergency spending.

Debt Sustainability

The fiscal expansion also called debt sustainability into question. The fall in oil prices in 2009 led to a large overall fiscal deficit (cash basis, including grants) of 10 percent of GDP (compared with a surplus of 3 percent of GDP on average in 2006–08), which was financed by a drawdown of government deposits and borrowing from the central bank. Although the 2010 overall fiscal deficit was estimated to be lower, the government had to rely on nonconcessional external borrowing to finance it. As a result, the public sector debt-to-GDP ratio rose from 24 percent in 2008 to an estimated 33 percent in 2010. If the government were to stick to its 2010 fiscal stance (an NOPD of about 30 percent of non-oil GDP and an overall fiscal deficit [cash basis, including grants] of more than 4 percent of GDP), the resulting public debt and debt-service burden would quickly become unmanageable.

External Competitiveness: A Case of Dutch Disease?

Evaluating Dutch disease symptoms in Chad is difficult because of data limitations and preexisting underdevelopment of the non-oil sector.12 The real effective exchange rate appreciated during the 2000s, largely reflecting the effect of a strong euro, but Melhado and Op de Beke (2009) and Kinda (2010) found no strong empirical evidence of overvaluation vis-à-vis fundamentals.13 Although the influence of oil cannot be ignored, Chad’s competitiveness appears to be affected more by preexisting constraints, such as low levels of human and physical capital and weak institutions and governance, than by oil-induced real exchange rate appreciation. The sharp decline in the production of cotton (along with livestock, Chad’s main exportable commodity before the oil boom) since its peak in 2004 could be consistent with Dutch disease, but could also have as much to do with weather conditions, international trade policy, state ownership, or Chadian regional politics as with the real exchange rate. Other non-oil exports were stagnant during the past decade, but they did not perform well in the pre-oil era, either.

The endemic character of the problems underlying Chad’s weak competitiveness become apparent in a comparison with other SSA countries. Its indicators of human and physical capital remain below those of peer countries. Chad also ranks at the bottom of various measures of governance and business climate.14 Development of the oil sector has not translated into faster economic and human development, expanded employment opportunities, and sustainable economic growth. The direct impact of the petroleum sector on the rest of the economy has been limited, because the oil sector is not well integrated into the local economy. Also, the benefits of sizable oil-financed public investment spending have not yet produced a supply-side response in the non-oil sector, although, in theory, appropriately timed and well-designed public investment spending on infrastructure could alleviate supply-side constraints (without increasing inflation) and thus unequivocally strengthen external competitiveness.15

Lessons Learned and Policy Conclusions

The arrival of oil opened a new chapter in Chad’s history, carrying a promise of a better future. However, Chad has struggled to turn oil wealth into productive public spending, faster growth, or poverty reduction. Moreover, the arrival of oil intensified security tensions and changed the country’s political economy. Chad’s experience with oil also illustrates the vulnerabilities stemming from a procyclical, volatile, and unsustainable fiscal policy in an oil-dependent economy. These vulnerabilities became particularly pronounced in the context of the 2008–09 global financial crisis, which affected Chad through the decline in oil prices, leading to a sharp deterioration in both the fiscal and the external positions.

Poor budget discipline and weak administrative capacity were the main reasons that priority spending and its monitoring fell short of expectations. When facing cash flow constraints, the government borrowed from oil budget accounts (earmarked for priority spending) to finance the ordinary budget, leaving insufficient resources for priority social spending.

However, Chad’s experience still offers some positive lessons for other oil-rich economies, mainly in the area of revenue transparency. All oil revenue flows are visible and captured well in the budget, although the distinction between the oil and non-oil parts of the budget no longer serves any useful purpose. The oil fiscal regime is relatively simple compared with other SSA oil producers and has worked for both the project operator and the government, notwithstanding large and rapid swings in oil prices.

The PRMP helped to make the use of oil resources transparent, but it complicated fiscal management and made heavy claims on Chad’s weak administrative capacity.16 Persistent public financial management problems eroded the credibility of the PRMP and its efficacy in promoting priority spending. Also, spending pressures resulting from heightened security tensions rendered the PRMP untenable. If the PRMP is to regain its pivotal role, it must be redesigned with appropriate consideration for capacity constraints and must gain political ownership before it is implemented. Most important, it must remain sufficiently flexible to deal with either an unexpected revenue windfall or expenditure pressure.

The experience with the PRMP also shows the importance of designing frameworks that have comprehensive coverage. One way to generalize the positive experience with revenue transparency stemming from the PRMP would be to accelerate Chad’s accession to the Extractive Industries Transparency Initiative.

Chad’s struggles after the collapse of oil prices and revenue in 2009 also vividly illustrates the need for a predictable multiyear budget and some level of precautionary saving, to smooth the public consumption path. The relatively short expected productive life of Chad’s oil fields supports the call for long-term saving of a portion of oil revenue in anticipation of full depletion, and for continued policy focus on improving the environment for non-oil investment and diversifying the revenue base.17 Otherwise, Chad faces a future of wide swings in revenue and expenditure and the risk of an unsustainable debt overhang at the end of its oil era.

Chad must develop its non-oil economy to strengthen its competitiveness and ensure a successful transition to the post-oil era. Chad should use its oil revenue to make targeted improvements in physical infrastructure, develop human capital, and create a business-friendly environment. In particular, devising a clear strategy for agriculture and the cotton sector—to include encouraging increased domestic and foreign private sector participation in the transformation and marketing of cotton and other agricultural products—would help Chad diversify its export base and would endow it with a good measure of protection against the potential for oil-driven Dutch disease.

References

For a complete description of the pricing mechanism, see Daban and Lacoche (2007a and 2007b).

The corporate income tax rate varies with the level of oil prices and rose to 60 percent in the high oil price environment of 2005–06.

According to Ghazvinian (2007, p. 250), the World Bank was approached, at ExxonMobil’s insistence, for two main reasons: (i) covering for “political legitimacy”—the company did not want to “sink billions into a risky project whose commercial value was untested”; and (ii) covering for public relations (reputational) risk—the project had a potential environmental cost.

Priority sectors are health and social welfare, education, infrastructure (including energy), rural development (agriculture and livestock), environment, and water resources.

According to the 2011 World Development Indicators data published by the World Bank, per capita gross national income rose from US$195 in 2001–02 to an annual average of US$548 (or about 55 percent of the US$1,006 middle-income threshold defined by the World Bank) during 2006–10.

According to the Millennium Development Goals Report 2010, only two Millennium Development Goals for Chad are within reach: primary education and fight against HIV/AIDS (United Nations, 2010).

The International Finance Corporation remained involved in the pipeline program when the International Development Association and the International Bank for Reconstruction and Development (all members of the World Bank Group) exited from Chad’s oil sector; its loans to the pipeline companies remained in place and continued to be repaid as contractually scheduled. See World Bank (2011).

Although the authorities no longer abide by the PRMP framework, they continue to adhere to the revenue transparency framework, which was created within its context. Information on oil revenue is published routinely. Also, the Collège publishes quarterly reports on the execution of oil-financed programs.

Allocations in the ordinary budget were increased as stipulated by the additionality provisions, but actual priority spending accounted for less than the required 42.6 percent of expenditure in the ordinary budget.

The NOPD is defined as total revenue excluding grants and oil revenue, minus total expenditure excluding net interest payments and foreign-financed investment.

Kinda (2011) finds strong empirical links between public investment spending and inflation in Chad during the period 1983–2009, suggesting that absorptive capacity deserves serious consideration when programming new investments.

Dutch disease emerges when an economy benefits suddenly from rents (such as mineral resources) or other external financing (such as foreign aid) that cause real exchange rate appreciation (by pushing up the price of nontradables in relation to tradables), which harms the traditional export sector.

These results are also consistent with findings by Kinda (2011) indicating that rainfall, foreign prices, public investment, and exchange rate movements were the main determinants of consumer price inflation in Chad during 1983–2009. Shocks to rainfall were found to exert the most persistent impact on inflation, which has historically been moderate, averaging 4.2 percent during 1983–2010. During the oil years (2004–10), inflation averaged 2.2 percent, but exhibited sizable year-to-year fluctuations, also driven mostly by the impact of variable rainfall on agricultural output.

Chad ranked last (183) in 2010 and 2011 on the World Bank’s Doing Business Index and on the World Economic Forum’s 2010–11 Global Competitiveness Index. It is near the bottom of Transparency International’s 2010 Corruption Perceptions 2010 Index (171 out of 178).

Levy (2007) uses a computable general equilibrium model calibrated for Chad and shows that oil-financed public investment, in the form of roads and irrigation infrastructure, need not lead to Dutch disease (real exchange rate overvaluation and decline of traditional sectors) because it can be successfully mitigated by a strong agricultural output response.

See Daban and Lacoche (2007a and 2007b) for a comprehensive discussion of the experience with the PRMP.

For instance, under a framework proposed by Daban and Hélis (2010), Chad could adopt a fiscal rule that delinks expenditure from oil revenue to ensure both fiscal and debt sustainability and the quality of spending, by treating oil revenue as a “source of financing” of the sustainable non-oil deficit. The government could then adhere to a spending path designed through a medium-term expenditure framework aligned with its poverty reduction strategy.

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