Where do the proceeds from petroleum production in developing nations go?- A closer look at Nigeria

Notwithstanding the fairly recent discourse around the transition towards cleaner sources of energy away from fossil fuels, oil is still the lifeblood of the modern world. The jury is still out as to how long the status quo will persist.

Many economies globally rely predominantly on oil. For example, more than 50% of the GDP of Saudi Arabia (which together with the USA is the largest producer of oil in the world); is reliant on oil production.[1] Throughout the 20^th Century, the Kingdom of Saudi Arabia firmly established itself as a high income economy and is presently the only Arab nation that is a member of the G-20 major economies. Its position in the global economy has been attributed to its substantial petroleum revenues. This is a testament of its management of petroleum revenues.

Conversely, there are a number of developing countries that are major producers of petroleum, for example Nigeria, Angola, Libya etc. These nations have not derived as much economic success as compared to Saudi Arabia and other resource-rich developed countries like Qatar[2], a phenomenon that has  been termed as the ‘resource curse.’

The establishment of Sovereign Wealth Funds (SWFs) has been proposed as a measure to aid in the  management of petroleum resources, especially in Africa. It is argued that African countries first need to put conditions in place to facilitate or justify the establishment of SWFs, because they are currently not ready for such an endeavour.

This article investigates where the proceeds from petroleum revenue goes to in the specific context of Nigeria. Some parallels will also be drawn with other African countries. In doing so, the article contends that strict controls are necessary to ensure that such revenues are utilised to promote the economic growth and development, not only of Nigeria, but also of other resource-rich African countries. This is in an effort to combat the resource curse.

Nigeria is Africa’s largest oil producer, which is the government’s biggest source of revenue. The country is also a member of the Organization of the Petroleum Exporting Countries (OPEC), the most powerful cartel in the global petroleum industry. In spite of the sizeable oil reserves and its extensive services sector,[3] Nigeria’s economy has been struggling, and according to a World Bank report in 2018, almost half of the population of slightly over 200 million is living below the international poverty line. This is as a result of inter alia: income inequality, ethnic conflict and political instability.

With all the revenue that accrues from oil, why is the rate of poverty in Nigeria so high? Where does all that money go to? These are the questions that the article briefly addresses.

A major problem is the fact that the government of Nigeria is heavily dependent on oil for approximately 75% of its revenue, meaning that whenever the global prices of oil plummet, countries with such high dependence on this natural resource, will go into recession.[4] This situation manifested in 2014 after the global oil prices plunged, causing the Nigerian economy into a recession, that it is still struggling to escape from today.[5] A typical example of the adage, ‘putting all your eggs in one basket.’

However, even when the global prices of oil are favourable, it is concerning that a large percentage of revenue does not trickle down to the people. Experts assert that majority of the proceeds from oil are used by the government to pay off the country’s massive international debts, coupled with using it to cover its operational costs like paying salaries to its civil service and public officials. Therefore, there is hardly much revenue that remains for the growth and development of the country.

Furthermore, another major challenge is the insufficient refining capacity of Nigeria, which is a concern for other African countries. Oil that is extracted from the ground is in crude form, implying that it requires to be refined in order to convert it into usable form. With the insufficient capacity to refine, the crude oil is exported to western countries with the requisite capacity, to be refined, and it is then sold back into Nigeria at often exorbitant prices by multinational oil companies, thus explaining where some of the revenue from oil goes to.

Fortunately, the above might not be the situation any longer, since Africa’s wealthiest businessman, Aliko Dangote, is presently constructing at least three refineries around Nigeria, with one scheduled to be completed and be commissioned by the end of 2020.

Additionally, corruption and lack of transparency are other reasons explaining why proceeds from petroleum in Nigeria do not trickle down to the general population. The country has a state-owned body named the Nigerian National Petroleum Corporation (NNPC), headquartered in Abuja, which plays the role of the national oil regulator as well as being a separate legal entity as a corporation operating in the industry.[6]

The corporation side of the NNPC concludes contracts with the multinational companies that operate mostly in the upstream stages of the oil cycle.[7] These companies pay to the corporation costs for licenses, permits and profit taxes.[8] The NNPC then delivers that money to the country’s exchequer, the National Treasury. An issue arises because the regulator that is intended to monitor these payments, is the NNPC itself. Therefore a lot of the transactions with multinational companies in the sector are clouded with secrecy.[9] Such lack of transparency has created rampant corruption, where billions of Naira “disappear” mysteriously. In 2016 for example, it was reported that $16 Billion oil revenues went missing and was not received by the Treasury.

The above instances of misappropriation of funds have become commonplace not only in the Nigerian oil industry, but also in other African countries. For example in Kenya, it has been reported that the massive investments that have been made by the British company, Tullow Oil in the oil-rich region of Turkana, are misappropriated and end up in the hands of politicians and other wealthy elite, as the majority of the population in the region languish in poverty. 

Additionally, the lack of appropriate mechanisms to foster transparency motivates these multinational companies to engage in other economic and financial malpractices e.g. relating to taxation. Companies are alleged to report lower profits so as to pay less taxes (tax evasion). Others are infamous for engaging in transfer mispricing, where they sell the crude oil to their own subsidiaries in a tax haven and then sell the oil to other buyers at full price. They also engage in inflating the cost of oil to maximize revenues, as well as underreporting the quantity of oil that they produce, for the same purpose of maximizing profit. Countries with weak regulatory mechanisms and financial safeguards, facilitate such financial crimes, thereby explaining how revenues “disappear.”

Lastly, the oil-rich Niger Delta region of Nigeria is infamous for having militias, who among other things, damage oil pipelines and syphon the crude oil in large volumes.[10] At times, these militias have elaborate and organized international supply chains that enable them to sell the crude oil to buyers all over the world. The problem of militias around the mines is an issue that is not unique to Nigeria. It was reported earlier this year that various stakeholders in the mining industry of South Africa are calling upon the government to intervene and provide security, amid killings by armed gangs, and other forms of organized crime around the mines.

The aforementioned are not the only reasons explaining where the proceeds from oil in Nigeria go to, but are potentially the ones with the most adverse effects. Some solutions to the stated problems include: Nigeria diversifying its economy as a long-term solution to alleviate the overdependence on oil revenue and guard against what has been described as the ‘Dutch Disease’;[11]  accelerating efforts to promote the refining capacity around the continent, strengthening the regulatory mechanisms in the country especially on taxation, and prioritizing transparency and accountability, as the key pillars of good governance. Also, the corporate arm of the NNPC should be split from the regulatory arm, and they ought to exist as different entities to enhance, not only transparency and openness, but also efficiency in monitoring the chain from the point that multinationals pay for operating in the country, to the money being delivered into the Treasury’s coffers. 

Oil-rich countries and other consumers of oil (and its constituent products) may be forced to seek alternative sources of energy/ substitutes in the coming years as the global demand for oil reduces, as the emphasis shifts to alternative sources of energy. This would have catastrophic effects on countries like Nigeria that are over reliant on their petroleum industries, hence the urgent need to diversify their economic portfolio. Even OPEC is beginning to feel the pinch, as it begins to lose it influence on oil prices and supply, because of several factors including the expansion of alternative energy sources.

Written by Kennedy Chege.