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COMMENT

Natural gas discovery: a Pandora’s Box for Cyprus?

27 June, 2011 | Posted By: Theodore Panayotou

Dr Theodore Panayotou
Cyprus International Institute of Management

For Cypriots who always had an Arab-envy, seeing their neighbors drawn in oil while they have to import every drop of it, has been frustrating if not intoxicating. Loren Steffy, the business columnist for the Houston Chronicle, reports: “Just as the Israeli discoveries may transform that country from an energy importer to an exporter, a similar find off the coast of Cyprus could turn the island nation into a major European energy hub”.
Terry Gerhart, the Vice President for international operations of Houston-based Noble Energy declares: “Cyprus could be on the verge of a natural gas revolution. Gas will strengthen the Cypriot economy for decades to come. Cyprus will become the Mediterranean’s energy hub”.
The discovery of new fossil fuel deposits in the midst of high and rising energy prices is celebrated as salvation for an energy-hungry world and a panacea for a resource-poor country in the midst of economic crisis and unsustainable budget deficits. Yet, experience teaches us that it is neither. It is at best a mixed blessing or rather a double-edged sword, at worst, a Pandora’s box.
But surely, fossil fuel discoveries can not possibly be bad for the country that successfully claims them as its own. Especially when they are located well offshore, there is hardly any opportunity cost for the area and any environmental costs are easily externalised into the marine environment. Suddenly, out of nowhere, a huge amount of cash will begin to be injected into the economy from royalties and revenue sharing arrangements; this would certainly help a country facing a high budget deficit and rising foreign debt like Cyprus.
Yet, the risks are equally compelling though conveniently ignored, if perceived at all. First, the funds may be squandered to maintain and expand an over-bloated, overpaid and profligate public sector; to give out subsidies to interest groups and to raise social spending to unsustainable levels. Easy money will encourage governments to undertake more high-cost, low-return public projects with high environmental impact such as the planned Paphos-Polis four-lane highway.
Worst, easy money will reduce the pressure and put off the restructuring of the economy and the public sector which is badly needed to regain international competitiveness.

The Resource Curse

A second well known risk goes by the name of “resource curse” which is defined as the paradox that countries with an abundance of non-renewable natural resources like oil and natural gas tend to have lower levels of development than countries with fewer natural resources due to many reasons:
• A decline in the competitiveness of other sectors;
• Volatility of revenues from the natural resource sector due to exposure to global commodity market swings; and,
• Government mismanagement of resources, or weak, ineffectual, unstable or corrupt institutions (possibly due to the easily diverted actual or anticipated revenue stream from extractive activities).
The resource curse goes also by the name of “Dutch disease”, a term coined in 1977 by The Economist to describe the decline of the manufacturing sector in the Netherlands after the discovery of a large natural gas field in 1959. The Dutch experience was repeated time and again by Mexico, Venezuela, Saudi Arabia, and most other oil and natural gas exporters. As the Venezuelan politician Perez Alfonzo, one of the founders of OPEC, prophetically stated when Venezuela first discovered oil. “Ten years from now, twenty years from now, you will see: oil will bring us ruin … Oil is the Devil’s excrement”. Indeed, Venezuela has been literally ruined politically and economically.
The most pernicious and lasting effect of the resource curse is the retardation of the country’s human and institutional development. The flow of easy revenues from resource extraction lessens the pressure to develop a knowledge-based economy, an entrepreneurial and innovation culture and robust institutions of public finance and macroeconomic management. Furthermore, the newly found wealth creates demands for more jobs and salary increases in the public sector, subsidies to failing enterprises, and to organised interest groups.
As a result, economic growth slows down and political development gets retarded. From 1965–98, in the OPEC countries, GDP decreased on average by 1.3% per annum, while in the rest of the developing world, per capita growth was on average 2.2%. The current social unrest and political crisis throughout the Arab world is not unrelated to the resource curse.

Turning the Curse into a Blessing

Only few resource exporters such as Malaysia, Norway, Kuwait, Botswana, New Zealand and the province of Alberta in Canada managed to contain the resource curse by taking deliberate measures to neutralise the effects of natural resource discoveries on their economic, political and institutional development. They save part of the revenues in special funds and bring them into the economy slowly to reduce the spending effect and to stabilise the revenue stream which otherwise varies widely as a result of commodity market swings.
By saving the boom revenues, these countries are sharing their exhaustible resource with future generations. Invariably, these prudent and provident countries have created sovereign wealth funds such as the Alberta Heritage Savings Trust Fund, Kuwait’s Future Generations Fund and the Norway Government Pension Fund, which save and invest the resource revenues in education, research and development, and environmental restoration.
Opportunity to Accelerate Reform

Thus, instead of allowing the revenues from natural gas and oil discoveries to derail and retard the country’s institutional and economic development, we can sterilise them and use them creatively to accelerate the process of reform to regain international competitiveness:
• reform the public sector to reduce its size and improve its productivity and efficiency;
• reform and capitalise the pension fund to make it solvent;
• invest in educational reform and human resource development and knowledge creation;
• invest in research and development and promote entrepreneurship and innovation;
• invest in renewable energy technology development to exploit the country’s abundant solar energy and to export solar technology;
• establish an insurance fund for future adversities, natural disasters, and economic crises;
• establish a Future Generations Fund for long term investments in sustainable development.
In this way we would be converting the non-renewable fossil fuel resources into renewable knowledge resources, education, research and innovation which will continue to be generating wealth even when the newly discovered resources are long gone.

Look before you leap

Cyprus should not rush, like the all-gifted but foolish Pandora, to open gods’ glistening gift box with the promise of vast deposits of fossil fuels, without first deciding how to use the flow of natural gas revenues. Unlike Israel, a mighty technological machine, that will put its resource revenues to good use, Cyprus is at risk of distorting its economic priorities and forgoing the development of its most abundant resources, the sun and its people.
While the hope that the worst can be avoided remains still locked in Pandora’s box, it is not prudent to embark on this journey without a road map and a compass. Prometheus, the god of forethought and resourceful counsel, not Epimetheus the god of afterthought and lame excuses, should guide our actions. Without a well thought-out strategy, tapping our newly found natural gas deposits is tantamount to playing with fire. With the right strategy, cognizant of both opportunities and risks, our newly found wealth can launch Cyprus into economic reform, investment in research and innovation, development of our solar energy potential, and the creation of sovereign funds for adverse times and future generations.


Theodore Panayotou is Director of the Cyprus International Institute of Management (CIIM) and Professor of Environmental Economics, Business Ethics and Corporate Social Responsibility. He taught at Harvard University for the past 25 years. He studied economics at the Universities of Athens (Greece) and York (Canada) and holds a PhD in Economics from the University of British Columbia. He advised many governments including Brazil, China, Indonesia, Mexico, Russia, Thailand, and the USA and consulted with the World Bank and the UN. He has an extensive research and publication record in the areas of Environmental Economics, Climate Change and Sustainable Development. Professor Panayotou was recognised as contributor to the 2007 Nobel Peace Prize won by the Intergovernmental Panel on Climate Change (IPCC). He can be contacted at:
theodore.panayotou@ciim.ac.cy