Algeria’s reliance on oil and gas exports is a weakness in the current environment. But diversifying the economy would take a great act of political will.
The solutions are well known. Algiers needs to diversify the economy and encourage a bigger role for the private sector but it lacks the political will to carry them out. Reform is likely to be half hearted, with the government muddling through as best it can, as the political elite seeks to maintain the system that has served it so well.
The Algerian government has little choice but to diversify the economy because of low oil and gas prices and the impact of terrorist attacks on hydrocarbon infrastructure. Yet its enthusiasm for economic diversification has fluctuated in line with oil and gas prices over the past 30 years. There are signs that Algiers could be more serious this time around, but the government remains committed to the existing system, with the state continuing to dominate key sectors and the private sector held in some suspicion.
Algeria’s situation is not unusual. Many other big oil and gas exporters follow the same pattern, from Venezuela and Nigeria to Kuwait and Iran. They rely very heavily on their hydrocarbon exports and despite drawing up diversification plans on a regular basis, do relatively little to achieve them.
Oil and gas exports generate 94% of the country’s total export earnings, about the same level as in Nigeria and Angola, emphasising how little the non-oil economy has been developed or, perhaps more accurately, allowed to develop.
The downturn has forced the government to tap into its sovereign wealth fund. In three years the value of the Reserve Regulation Fund has fallen by 87%. Just as worryingly, state foreign exchange reserves have fallen by 35% over the past three years, according to figures from the Ministry of Finance. The 2015 budget deficit stood at a record 16% last year and the government aims to cut its spending by 9% this year.
Anthony Skinner, director at global risk advisory company Verisk Maplecroft, said: “The government is taking some measures to ensure that fiscal belt-tightening does not overly impact low-income earners, but the risk of social unrest is likely to increase over the coming 24 months. The government will have to continue cutting subsidies and raising taxes. State expenditure is projected by the government to fall 14% in 2017.”
Prospects for gas
If Algeria can encourage more investment in its gas industry, there is plenty of scope for greater exports to the European Union. It is one of Europe’s biggest piped gas suppliers and a significant liquefied natural gas (LNG) exporter but many European leaders are very concerned about their dependence on Russian piped gas imports.
They are keen to make the most of the steep increase in global LNG production over the next few years. However, Algeria must also bring domestic consumption under control.
A recent report by the Oxford Institute for Energy Studies concluded that domestic demand will rapidly eat into national production, leaving the country with export potential of just 15bn cubic metres a year by 2030. It stated: “As far as the supply side is concerned, we have established that declining (at best stagnating) gas production is, under prevailing conditions, an incontrovertible trend.”
Ali Aissaoui, a senior associate research fellow at the Oxford Institute for Energy Studies, commented: “Sustained government policies of low domestic prices have neither encouraged rationalisation of demand nor provided adequate incentives for upstream investment, ultimately resulting in a severe deterioration of national gas balances.”
Inward investment
The government has taken some limited steps to encourage diversification. New investment legislation has been passed, including tax cuts and incentives for the development of labour intensive sectors, such as agriculture, manufacturing and tourism.
However, it would be easy to argue that the measures are too little, too late. It is far better to undertake reform from a position of strength than weakness. Moreover, Algiers seemed to lose its nerve on plans to allow foreign banks to acquire majority stakes in state-owned banks.
Algiers still insists that foreign investors partner with local firms. At the end of November, Volkswagen announced that it had concluded a joint venture with Algeria’s SOVAC to set up a vehicle assembly plant producing Volkswagen, Skoda and SEAT models. However, the German company will only take a minority stake in the project.
Moreover, it will have production capacity of just 35,000 vehicles a year and so will only supply the domestic market. This contrasts poorly with Renault’s existing production of 250,000 vehicles in neighbouring Morocco, which are sold both in Morocco and further afield.
Also in November, the UAE’s Emarat Dzayer Group and Algeria’s Groupe Imetal set up the Emarat Dzayer Steel Company, which will produce steel in Annaba Province from early 2019. Again, the foreign partner will take a 49% stake. This seems an excellent way of making the most of the economic reality in Algeria, as the plant will be able to exploit low energy costs. It will produce 1.5m tonnes of reduced iron a year and 1m tonnes a year of steel products.
At the time of the launch, Ajay Sethi, the vice chairman of Emarat Dzayer Group, said: “We see a lot of demand from the local market because most of the steel is imported at the moment from places like the Gulf, Turkey and Spain. We will have an advantage as our costs will be cheaper because we will have gas concessions from the government and we have state-of-the-art technology.”
In May, IMF mission chief for Algeria, Jean-François Dauphin, told IMF Survey that “the prospects for the economy depend very much on the authorities’ policy response to the oil price shock. Thanks to savings accumulated in the past and very low debt, Algeria can afford to adjust to the shock and implement reforms gradually. But it cannot afford to let this moment pass without taking action. In the near term, growth is projected to slow as the government undertakes necessary fiscal consolidation.”
Outlook
Some commentators suggest that the country’s Arab Socialism could be watered down when President Bouteflika dies or leaves office, but continuity seems more likely. Skinner said: “It is unlikely that Algeria will witness a dramatic shift towards economic liberalisation when Bouteflika passes away.
“This is because le pouvoir – a clique composed of senior ministers, oligarchs and members of the top brass – has a vested interest in the current business environment. They do not want their crucial business interests to be jeopardised.”
The degree to which the government is willing to diversify the economy will depend on the extent to which we witness a recovery in oil and gas prices over the coming years. Opinion varies but on balance it seems most likely that oil prices will increase gradually to perhaps $60 a barrel by the end of 2017.
The fiscal break-even price for Algeria last year was $96.10 a barrel and there is little prospect of such a level returning in the foreseeable future, so it is clear that a structural change is required. Either oil and/or gas production must greatly increase or the non-oil economy has to grow.
Source: Can Algeria break the mould? – African Business Magazine
