Global Agenda: The Dutch disease

There is risk in the recent gas find.

After several decades in which Israel’s “energy sector” comprised a bunch of half-baked local companies (legally structured as partnerships, but let’s skip the niceties) in the “oil-exploration sector,” Israel is on the way to becoming an energy producer and an energy exporter. The process began in 1999, when deposits of natural gas were discovered offshore by the Yam Thetis group. Those fields have now been developed and will soon be exhausted; they were not big enough to be a game changer at the macro level.
In January 2009, an Israeli syndicate, headed by companies owned by Yitzhak Tshuva and partnered with the veteran American exploration company Noble Energy, made a major discovery in the Mediterranean off the Haifa shore. The Tamar field was, even on initial estimates, a major find – apparently the third biggest in the world last year and potentially enough to supply Israel’s needs for 15-20 years. Its immediate impact was to save the Tshuva group from being dragged down to Davy Jones’s locker by the deadweight of debts used to finance his global real-estate empire. But that is a side issue (unless you happen to be a shareholder or bondholder in the Tshuva group).
Tamar and the wells being drilled in its general area have spurred a massive speculative boom in the local oil-exploration sector, and the relevant companies have become the darlings of the local stock exchange, with every item of information and misinformation about them scrutinized as if it was holy writ. That is also nice, but also a side issue, unless you are a speculator on the Tel Aviv Stock Exchange. What really matters is that there is no longer any doubt that the Israeli energy sector – mostly natural gas, but maybe some oil too; mostly offshore, but maybe some onshore, too – has become a big deal.
The myopic and bean-counting response of some Israeli government officials has been to propose changing the rules governing taxation and royalties of oil and gas discoveries. If this is done retroactively, as some of the stupider and more intensely obtuse proposals suggest, then the golden goose will be slaughtered while still a chick (or whatever baby geese are called). If it is done sensibly, in a graduated manner and with future effect, there should be enough profit for everyone, including the taxpayer. But even that is not the point.
The prospect of Israel generating most, or all, of its energy requirements from its own resources is truly a game changer, with massive implications for the entire economy and, even more critically, for the country’s geostrategic position. These implications will be realized gradually, as the process of bringing “onstream” the fields that have been, are being and probably will be discovered will take several years and cost many billions of dollars. Changing the energy infrastructure of the country from being based on oil or coal to natural gas – starting with the Israel Electric Corporation, where the process is already under way – will also take years but ultimately will be highly worthwhile economically and ecologically.
The primary macroeconomic impact of this change will be in Israel’s trade. Energy imports are by far the largest single factor influencing the country’s balance of trade and, by extension, its balance of payments. In late 2008, when oil prices collapsed, the chronic trade deficit evaporated and, for months, Israel ran a trade surplus. Ideally, the new vista is of a permanent trade surplus and an even bigger surplus on the balance of payments than we have been running in recent years.
But there is another side to the impending energy bonanza. The darkside of the force, in the context of natural resources riches, iscalled “the Dutch disease.” In the late 1960s, Holland – the epitome ofa hard-working, Protestant-ethic, sober and no-nonsense industrializedEuropean economy – made major offshore discoveries of natural gas. Theresult was that Holland “struck it rich,” the Dutch currency soared invalue, Dutch labor and Dutch products became uncompetitive – a fataldevelopment for a small trading economy such as Holland – and thecountry’s economic and social fabric suffered serious damage. A decadelater, the process repeated itself in the UK, when North Sea oil beganto flow and sterling became a “petro currency” during the second oilshock of 1979-80.
In Israel’s case, the shekel is already overvalued and the decline ofthe euro is rapidly exacerbating this problem. The dreaded Dutchdisease is a real threat in the medium term, when the investments havebeen made and the gas comes ashore. Thus, while large-scale discoveriesof energy sources are a tremendous boon, it is important to rememberthat they are a mixed blessing.
At the macroeconomic level, the government needs to start thinking veryseriously not just abut how much revenue it can rake in, which is theremit of the recently appointed committee headed by Prof. EitanSheshinki, but about the very varied and diverse impacts that Tamar,Leviathan and our other offshore assets will have across the board.Ironically, this might prove easier to do after this week’s events, inwhich Israel made another important offshore discovery: that if youmake waves out at sea, they can come ashore as a tsunami.