Why energy reforms are Algeria’s biggest challenge yet

Why energy reforms are Algeria’s biggest challenge yet
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Algeria has begun a series of energy reforms that have provoked deep social unrest in one of the last bastions of stability in North Africa.

Algeria, a country of 40 million, is one of the top three oil exporters in Africa and home to a large refining sector. The country is estimated to hold the world’s 10th largest gas reserves, with over 160 trillion cubic feet of natural gas. It is Europe’s third largest gas supplier and enjoys low operating costs. The country’s main oil export is a crude oil brand known as the ‘Sahara blend’ – a blend of crudes produced at Algeria’s largest fields in the Hassi Messaoud region.

However, production at the Hassi Messaoud field, along with other large, mature fields, has been gradually declining. Production in both oil and gas began to stall in the early 2000s, while domestic consumption has risen steadily. As a result, the welfare state fuelled by the country’s vast energy reserves has gradually eroded, until it recently reached a critical state. Now, the government says Algeria will need to inject over $100 billion dollars to modernize and extend its vast energy infrastructure, allocating $46 billion on existing fields alone. What is more troubling about this plan is that Algeria plans to finance over 90% of it alone.

Many experts doubt that this is even remotely possible given the country’s major economic shortfall. Despite the urgency of the situation, reform initiatives have thus far been extremely tepid; namely planning for the opening of new small scale fields and raising the value added tax.

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The gap between total oil production and domestic oil consumption has been narrowing over the past five years, leading to four consecutive budget deficits

Not only has the country stopped investing in new exploration, but its energy revenues, which support nearly two-third of the national budget, have been steadily decreasing. Facing an unparalleled crisis, Algeria has been surprisingly slow to react. Now, the country is faced with a few, highly ambitious options. At this rate, Algeria’s oil production will cover nothing more than its growing domestic demand, resulting in an economic crash.

The cost of inertia

Global oil prices have been floating around $50 a barrel since the beginning of 2015, yet Algeria still needs oil prices to be well over the $100 threshold in order to balance its budget. Hydrocarbons make up 58% of the country’s revenue. Facing both stagnant production and falling commodity prices, Algeria’s whole economic model has become unsustainable. Even before the oil price drop, the country has been running deepening budget deficits since 2009. The Revenue Regulation Fund, Algeria’s sovereign wealth fund, is also rumored to be fast depleting.

This economic slowdown is already showing its effects, as rampant inflation has led to major price hikes in basic food staples. Fresh fish and fruit have become three times as expensive since 2001, according to the country’s own official statistics. Algerians spend around 40% of their income on food and drinks. Major infrastructure projects, years in the planning, are routinely delayed, and corruption has been on the rise. Algeria’s East West Highway, a $6 billion project, eventually cost over $15 billion due to persistent graft, making it the most expensive road in the world.

The failing health of President Abdulaziz Bouteflika alone is a major source of instability, one that has consistently pitted the intelligence services and the army, two pillars of the Algerian political system against each other. Consequently, mutual suspicion in the country’s power ministries makes agreement on reform virtually impossible.

A few options ahead for Algeria

Algeria’s dual challenge is to divert the country’s economy away from oil and gas, while at the same time amortizing the social impact of energy reforms.

Algeria’s universal fuel subsidy affects the country’s economy in two ways: in addition to reducing export revenues, it represents an expense in and of itself. The IMF estimates the total cost of the subsidy to be around $45 billion a year. Last year, Algeria launched a series of reforms to reduce state support for domestic consumption, but bolder moves seeking the elimination of fuel subsidies pose a high political risk.

Energy subsidies are intimately intertwined with the country’s economy, which makes any reform extremely complex. Major price hikes during the oil crisis in 1986 were largely responsible for Algeria’s most violent crisis since its independence. Last year’s decision to raise the price of fuel by 35% triggered waves of protests across the country. Security experts fear the 1986 scenario could repeat itself should the planned austerity measures become too severe.

The government has taken steps to open its market to foreign investors, namely by amending its hydrocarbon law and inviting bidders to participate in the auctions for new exploitation in the south in 2013. Despite these efforts, political uncertainty and militant activity in the south are still a barrier to investment.

The main barrier to foreign investment remains Algeria’s national shareholding requirement, which stipulates that Sonatrach, the national energy company, must have a 51% share in all projects in the country. In the 2014 bid round, only 4 of the 31 blocks were awarded. The auction scheduled for late 2015 was canceled. Algeria’s oil and gas wealth has been the backbone of national growth and cohesion, yet in order to survive, the country needs to navigate a very fine line between effective reform and economic collapse.

 

Pierre-Olivier Bussières is an incident analyst with Intelligence Fusion and Associate Editor for Iaffairs Canada. He holds a graduate degree in Eastern European, Russian and Eurasian studies from Carleton University as well as a practical certificate in country risk analysis and geopolitical scenario planning from the Maastricht University. He has written a number of articles on political stability in Eastern Europe and Western Africa for the Diplomat, Iaffairs Canada and Republic of the East.

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