Oil Benchmark As Developing Nations' Budget Indicator

Published on 22nd October 2012

An oil rig                                               Photo courtesy
Whether a nation is developed, underdeveloped or developing, one thing common to all - is revenue. When the revenue is primarily [single] commodity driven as is the case with developing and under-developed nations, it comes down to the price of that commodity and its fluctuation in the world market. For developed nations whose revenue sources are primarily taxation driven, it comes down to the employment base and other economic taxable activities that kick in the revenue.

While in US, oil is a private resource whose revenue is taxed, in Nigeria, oil is a public resource whose revenue is based on the price of the commodity sold. In US, the oil produced on federal land is based on lease and royalty payments using complex calculations linked to indices. US has no national oil company like NNPC.
For Nigeria a single commodity revenue nation - oil/gas, its budget is benchmarked on oil price. Benchmark price is basically a price expectation hinged on the volume to be produced/sold with the projected revenue to be realized, forming basis for the nation's budget. In a quota/benchmark driven formula, when prices go up, lower production occurs. It is vice versa when the price is low, production goes up. This is intended to compensate for any shortfall.

Given the politics business of oil, developed nations play games with this balancing act, stifling single commodity nations in the process. Here is the kicker: When developing nations fall short of their budget expectation/projection, it forces them to cut deals and borrow on short term basis to make up for the gap. This places them in a 'catch 22' situation. Given the worldwide business politics that affects oil price beyond the control and influence of any given nation, Nigeria, without a budget shortfall cushioning provision in its national fiscal policy is exposed to wide and wild swings. With a benchmark price, the government projects its budget and spending plans.
The danger in a single commodity budget revenue system is the fluctuation. Therefore, when the price falls below the benchmark, the government is left with a [huge] shortfall and gap. The gap can be closed with supplements or spikes in price, assuming conditions make the price jump. The national assembly and executive arm debates as to where to peg the benchmark is typical. However, what matters most is how a nation cushions its shortfalls.
In some nations, there is provision for Rainy Day account - a mandatory savings and statutory provision to set aside a percentage of annual budget in a safe risk free account. The savings that accrue is used to cover gaps withdrawn at a scale. Such provision is not mandatory in US federal system but some states have such provisions as well as local governments. US federal government budget is a deficit system; allowing/calling for line of credit increases or borrowing coupled with/out tax increases to cover budget shortfalls. That is why there is a push in some quarters for balanced budget amendment; simply spending what is collected and no more. With a deficit system, shortfall is addressed with debt - IOUs issued by the government as a charge/pledge against future revenue. But with shrinking revenue, the deficit increases as the debt widens.
Given that Nigeria’s federal budget is the majority source of spending for the entire nation, negative fluctuations in the oil benchmark set off conditions that paralyze the economy. Nigeria needs to enhance and improve other sources to cushion its single revenue stream. Although Nigeria is a major oil producer, it does not control the politics that set the crude price. And given that Nigeria does not barter oil for say infrastructure as an off balance sheet transaction, its revenue either IOU or cash, is severely impacted when the business politics oil unduly kicks in.
As a pay-as-you-go budget system with weak Naira, and lower than 25% derived benefits from every budgeted Naira, the oil revenue is hardly sufficient in addressing national needs. Money is never enough. What matters in the case of money is its elasticity enabled by legislation and fiscal policy that enhances and caps, reduces and eliminates certain expenditures. Extension of credit by instruments complements government spending powers and influence. But in a cash-only economy, Nigeria budget is never at a point to address needs. Although nations borrow internally and internationally but without strict spending cuts and provisions to minimize waste, no amount of money in the system cures shortfalls.
Setting a benchmark is a good political exercise. It is however futile because Nigeria does not control the world oil price and without a strong Rainy Day Account and balanced budget constitutional provision, the wide and wild swing in revenue expectations keeps the economy in a 'no-one-knows-what-to-expect' scenario.
By Ejike Opka II
Dallas, Texas.

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