Local content requirements do not support wastage of public resources on an oil refinery

Today’s column, and the next, continues to evaluate the feasibility of a Guyana state-owned oil refinery, promoted by many as the leading edge of a local content requirements (LCRs) regime aimed at maximizing downstream domestic valueadded in the coming petroleum sector. I shall argue that my earlier economic assessment of LCRs (like refinery economics) does not lend economic justification for such a venture. For the purposes of today’s column, LCRs constitute the legislative and regulatory framework covering the petroleum sector’s value chain.

LCRs have evolved dramatically during the 2000s. While originally these were naïvely viewed as state measures to enable local producers to garner significant proportions of the petroleum sector’s inputs, today they are considered more analytically, as state policies promoting the localization of production, value added, and development potential of the petroleum sector inside the national economy. The earlier naïve view, however, persists and represents LCRs as the protected benefits flowing from government procurement and politically-mandated publicly-funded projects, of which, a state-owned, controlled and operated refinery is one.

This naïve and trivial view has elicited counter-arguments, which portray LCRs as disguised backdoor protectionism. And, in response, this has created strong national/international pressures seeking to constrain the anti-trade, anti-competitive, and state subsidies promoting the market distorting effects of LCRs. Such pressures have been reinforced by the mixed results which empirical evaluations of LCRs (both at the national and cross-country levels) have yielded.

Earlier assessment

My earlier assessment of LCRs had established: 1) petroleum LCRs have a long history (going back to the 1970s) and 2) the naïve focus on input restrictions and direct state intervention in the petroleum sector, has run its course. Today LCRs are framed as promoting policies from the standpoint of petroleum production seeking to generate economic benefits, beyond the direct contribution of the sector’s value added. These occur through sectoral linkages, both backward (through inputs) and forward (through value added outputs).

My earlier LCRs review had also focused on two empirical studies, namely, 1) S Silva’s study of South Africa’s experience, conducted on behalf of the United Nations Conference on Trade and Development (UNCTAD). Given Guyana’s goal of crafting a ‘Green State’, this study is intriguingly entitled: ‘LCRs and the Green Economy’; 2) the other study evaluated experiences of 48 countries, and was conducted on behalf of the World Bank. It is entitled ‘LCRs and the Oil and Gas Sector’. Both studies were recently completed in 2013.

Six features

Today, I briefly recap the main lessons learnt from the UNCTAD study. Upfront, however, it is worth noting both studies considered six dimensions of effective LCR regimes. First, to avoid ambiguity the meaning of local content (given its contentious history) was clearly defined. Second, based on the definition used, the extent of local content, as applied to the petroleum sector, was carefully delineated. Third, following on this, the relationship between furthering local content and securing enhanced development was carefully specified.

Fourth, the types of policies that promote local content were carefully categorized. Fifth, benefit/cost appraisals/impact assessments were indicated for policies listed at 4 above. Finally, clear pronouncements were given in regard to LCRs’ design, implementation, performance and monitoring.

Today’s column will not repeat in any detail my earlier extended analysis of LCRs. However, it would be useful to recall briefly the five main lessons that were drawn from the UNCTAD study. These strongly rebut the naïve/trivial version of LCRs, which I believe drives today’s calls for a Guyana state-owned refinery.

UNCTAD redux

The first finding is that the study supports my position that LCRs should be considered as promoting capacity/building, enhancing competitiveness, and providing value-added for domestic firms. In doing this, LCRs will avoid the naïve/trivial notion of simply meaning ‘locally owned’. Admittedly, those domestic firms whose capacity is being advanced should over the long term become localized in effect.

The second finding of UNCTAD’s study is the importance attached to the governance framework of LCRs. Great emphasis is placed on inclusiveness, openness, transparency and accountability in supporting a level playing field as well as the rejection of political and related factors in the administration of state support.

The third finding of the study stresses the importance of grounded realism in LCRs policies. Unfortunately, those who support state ownership of an oil refinery, as a necessary condition, have presented hyped-up expectations of benefits; some even suggesting the Haas’ study is rigged! Experience shows that hyped-up, overambitious, pie-in-the-sky expectations are often a prelude to humongous waste of state resources. As Rajendra Bissessar has observed in a shrewd letter, this could well become the equivalent of the poor decision-making that has plagued Skeldon.

The fourth finding also calls for a calibrated and orderly sequencing of LCRs, both as regards their timely phasing in and phasing out. Unless these timings are carefully specified, the risk is that special interests develop around individual LCRs. And there is a risk that, if they end up harming the economy, special interests would resist change. And indeed dig in to secure/protect their economic rents.

The final lesson drawn in the UNCTAD study is that naïve/trivial versions of LCRs are indeed naïve. Their greatest danger to sustainable development is that supporters literally advance LCRs in the petroleum sector as a panacea for all the systemic challenges Guyana faces However, as argued here, government’s primary interest is not to promote local ownership at all costs, but over the long term to secure reduced costs, increased competitiveness of domestic-based firms, more efficient/effective government, and the embedding of value-added along the entire petroleum value chain.

Schedule 1 (from the earlier review) summarizes UNCTAD’s findings, as described above.

Schedule 1: UNCTAD Main Findings on LCRs Item Main Findings (UNCTAD) in Oil & Gas Sector LCRs should be constructed as one element of a broad strategy promoting competitiveness, creating valueadded & capacity building for local firms. LCRs should be based on openness, transparency, accountability, and backed by strong and accountable institutions operating on a level playing-field. LCRs should embody realism in tar3 get setting, allowing for modification as conditions change. LCRs should be phased-in and phased-out orderly, catering for changed conditions and avoiding entrenchment of special interests in support of protectionism. LCRs should not be promoted as a panacea for every challenge facing the domestic economy. (Source: Adapted by author from S Silva, LCRs and the Green Economy, UNCTAD, 2013.)

Next week I wrap-up the discussion on LCRs and pinpoint the “lessons learnt” from the World Bank survey of 48 countries’ experiences with LCRs in the petroleum sector. 1 2 4 5

Conclusion