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Working paper

Resource Depletion,Dependence andDevelopment: Algeria

John Mitchell, Paul Stevens and Elisa Cassinadri

November 2008

Chatham House is independent and owes no allegiance to governmentor to any political body. It does not hold opinions of its own; the viewsexpressed in this text are the responsibility of the authors. Thisdocument is issued on the understanding that if any extract is used, theauthors and Chatham House should be credited, preferably with thedate of the event.

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Working paper: EEDP 11/08 Depletion, Dependence & Development Project Algeria

www.chathamhouse.org.uk 2

TABLE OF CONTENTS

MACROECONOMIC OVERVIEW ................................................................................................4

GROWTH......................................................................................................................................4FISCAL AND MONETARY POLICY ..................................................................................................... 6

BALANCE OF PAYMENTS................................................................................................................ 6

ENERGY.......................................................................................................................................6

SIMULATIONS ..............................................................................................................................8

ASSUMPTIONS..............................................................................................................................9

PHASES OF DEVELOPMENT.......................................................................................................... 10

A dependent phase .............................................................................................................. 10

A transition phase................................................................................................................. 11A sustainable phase ............................................................................................................. 11

SCENARIOS................................................................................................................................ 11

Table1: Scenario assumptions ............................................................................................. 12

REFERENCE SCENARIO........................................................................................................... 13

CONSUMPTION........................................................................................................................... 13

PRODUCTION ............................................................................................................................. 13

Government finance ............................................................................................................. 16

Current account .................................................................................................................... 17

Investment funds .................................................................................................................. 19

Key findings of the reference scenario................................................................................. 19

HYDROCARBON PRICE SCENARIOS...................................................................................... 20

HYDROCARBON PRICE ATUS$100 ............................................................................................. 21

Government finance ............................................................................................................. 21

CURRENT ACCOUNT.................................................................................................................... 22

GRADUALLY INCREASING HYDROCARBON PRICE........................................................................... 23

KEY FINDINGS OF THE HYDROCARBON PRICE SCENARIOS..............................................................24

OIL AND GAS RESERVES REPLACEMENT SCENARIO.........................................................24

PRODUCTION ............................................................................................................................. 25

GOVERNMENT FINANCE .............................................................................................................. 25

CURRENT ACCOUNT.................................................................................................................... 27

KEY FINDINGS OF THE OIL AND GAS RESERVES REPLACEMENT SCENARIO....................................... 27

CONSUMPTION SCENARIOS: ENERGY EFFICIENCY SCENARIO AND

LOW GROWTH SCENARIO ....................................................................................................... 27

SUMMARY OF SIMULATIONS...................................................................................................28

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GENERAL CONCLUSIONS........................................................................................................ 31

QUESTIONS FOR FURTHER DISCUSSION ...................................................................................... 33

BIBLIOGRAPHY.......................................................................................................................... 34

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ALGERIA - MACROECONOMIC OVERVIEW*

Hydrocarbons dominate the Algerian economy, providing 60 percent of

government revenue, 30 percent of GDP and 95 percent of exports. 45% ofgovernment expenditure in the non-hydrocarbon sector is paid for by oil and

gas revenues. Oil and gas exports pay for nearly 80% of imports of goods

and service, and other net payments by the non-hydrocarbon sector.

In the 1990s, the country went through a civil war in which some 100,000

people were killed. Although the security situation appeared to be improving,

last year there was a resurgence of violence.

The windfall revenues of the 1970s were largely wasted on large-scale,

state-controlled heavy industry projects which were not well-integrated into

the small domestic private sector or the international economy. Although they

attracted very strong state protection, these eventually proved too inefficient

to maintain and the country built up a huge external debt. This time there is a

much greater awareness of the dangers but corruption remains a problem

amongst the ruling elites. Regarding hydrocarbons policy, there is an

ambivalent attitude over whether greater oil and gas producing capacity is

required given the current very high levels of revenues. With $110 billion of

foreign reserves already in the bank and prices were expected (in early 2008)

to remain high for the foreseeable future, key decision makers were generally

of the opinion that Algeria does not necessarily need a massive expansion of

production.

Growth

In recent years, Algerias GDP has been growing driven largelyby the windfall hydrocarbon revenues. Thus GDP grew by 4.6

percent in 2007 compared to 2 percent in the previous year. On

a positive note the non-hydrocarbon economy has been

performing well growing in 2007 at 6 percent as a result of strong

growth in services, construction and public works. The IMF has

suggested this reflects a degree of success from the reform

programme aimed at promoting the non-hydrocarbon economy.

Indeed, the hydrocarbon sectors contribution to GDP actually

declined in 2007 (-1.0 percent) and in 2006 (-2.5 percent).

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However, the economy faces real problems. There is very highunemployment especially among the young and some 25 percent

of the 33.3 million population are living below the poverty line.

Although there has been a modest upturn in living conditions for a

majority of Algerians, and there is a strong feeling that money is

being better used than during previous periods of fiscal plenty,

the improvements are still minimal and the outlook for the

majority remains bleak.

In addition there are serious problems with the infrastructure.Especially, Algeria remains restricted by a lack of capacity to use

the funds that are available. Thus, although infrastructure

spending will rise, the authorities are unlikely to get carried awayas there is a realisation that Algeria lacks the capacity to reap the

full benefits. The state-spending outlook will therefore be

characterised by prudence rather than extravagance.

The whole economy is in urgent need of reform if the privatesector is to play a greater part in its development. Efforts aimed

at privatisation have largely failed and it remains very difficult to

start an SME, with influence-peddling still an integral part of

business. In particular the financial system needs urgent

attention. Attempts at reform are constantly thwarted by

corruption among the ruling elites and resistance from the

bureaucracy.

Attempts to attract FDI into the non-hydrocarbon sector have hadlittle success, not least because of the continued violence.

Much of the recent windfall in revenues has been used to pay offAlgerias external debt. In 2003, the total debt was 34.4 percent

of GDP. By 2007 this had been reduced to 3.5 percent of GDP

following deals with both the Paris and London Clubs. A large

sum will be kept in reserve to avoid any recurrence of oil debt

problems if and when oil prices fall.

Overall, the pattern of stop/start economic opening and glaciallyslow political change will continue. There remains too much

control from above and too little scope for individual initiative.

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Fiscal and monetary policy

The rising oil and gas prices have created a very strong fiscalposition for the country. Thus in 2007 hydrocarbon revenues

were estimated at $59 billion, up 87 percent on 2005. The budgetsituation is very unclear since the revenue estimates are based

upon a very low oil price ($19 per barrel for 2008) while the

expenditure is based upon a much higher price (thought to be

around $60 per barrel for 2008). There is some concern that

while inflation is currently low 4.6 percent in 2007 - increased

spending, especially on public investment and raising wages in

the public sector where some 32 percent of the workforce is

employed, could lead to higher inflation and an appreciation of

the real exchange rates threatening an attack of Dutch Disease.

Indeed higher spending in 2007 increased the non-hydrocarbon

fiscal deficit to 37.6 percent of GDP compared to 36 percent of

GDP in 2006.

The creation of a National Fund for Investment and Developmentis expected to play a key role in ensuring the quality of spending

under the public investment programme. Currently investment is

running at 31 percent of GDP but there is concern about the

quality of much of the spending.

Balance of payments

High hydrocarbon prices mean that the country is runningsubstantial trade surpluses. In 2007, the current account surplus

was over 20 percent of GDP.

The government is also building record foreign exchangereserves which, at the end of 2007 stood at $99 billion (In May

2008, $128 billion).

Energy

In terms of oil, the governments attitude is rather uncertain. Withsuch high existing oil revenues, there is concern that more will

simply generate a serious attack of resource curse. This

combined with growing sentiments of resource nationalism

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means that Algerias attitude towards IOC involvement is

becoming rather ambivalent. Recently there have been distinctly

hostile signals to the IOCs and in 2007, it was announced that

plans to increase oil-producing capacity to 2 million b/d by 2010

had been scraped. However, the official position is that thegovernment is entirely committed to sustaining oil predicting

levels and Sonatrach has announced plans to spend $48 billion

on the upstream and pipelines over the next five years.

Certainly the government appears to want to encourage greaterexploration, especially for gas. Thus recently the much delayed

7th

licensing round has been launched to offer 10 15 blocks in

gas prone areas for licensing.

There is some concern as to whether the reserves are largeenough to support the numerous gas export projects that are

under consideration. Thus in 2007 Algeria was exporting some 63

billion cubic metres per year (bcmy) with official plans to increase

this to 85 bcmy over the next few years and, to this end, a

number of gas pipelines and LNG plants are under consideration.

The official line is that there is plenty of gas but there is no doubt

that the domestic gas consumption is growing rapidly. In

particular, there are plans for 13 new desalination plants to come

on stream between 2005 and 2009 with a total capacity of 2.2

million cubic metres per day which will seriously strain Algerias

power supply system. In fact the completion date for these plants

was recently extended to 2011.

In the downstream, Sonatrach has ambitious plans to expanddomestic refining capacity. A new 300,000 b/d Greenfield refinery

is planned at Tiaret while there are plans to expand existing

capacity in the three other refineries by 20 percent in the next

three years. The budget for this is $28 billion over five years. All

this is to meet the very strong demand growth in Algeria for light

products, especially the transport fuels. However, these plans are

running into problems with rising costs and a serious shortage of

engineers in Algeria.

As the non-hydrocarbon economy starts to play a greater role,increasing domestic demand will raise demand for energy. This

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rising consumption could eventually lead to renewed current

account deficits and net hydrocarbon imports.

Officially there are plans to encourage the diversification of

energy consumption within Algeria. In particular there are plans toincrease power generating capacity from 7 GW to 12 GW by

2030 at a cost of $17 billion. This will further absorb oil and gas

away from the export market. Algeria is starting to consider

nuclear power and other alternatives. However, no firm policy

decisions have been taken yet.

*Note that this section was supplemented by information from the

Commentary on Algeria by Jon Marks, Environment & Development Working

Paper, Chatham House 2008.

SIMULATIONS

The aim of the research is to investigate the sustainability of Algerias

depletion policy and to determine the extent of the economic adjustments

needed once hydrocarbon production declines. The simple analysis of

scenarios is aimed at illustrating a general tendency, not at providing an exact

answer and precise numbers, given the numerous variables involved.

The reference scenario represents a baseline of hydrocarbon dependence

evolution and the need for eventual adjustments in the absence of major

changes in Algerias current hydrocarbon strategy or the fiscal and export

capabilities of the non-hydrocarbon economy. Alternative price and

production scenarios were developed to analyze the impact of such variations

on the size of necessary adjustment compared to the reference scenario.

Four indicators are used to compare the reference scenario with the

alternative scenarios:

1. The year when total hydrocarbon production is set to decline, given

proved reserves and current policies on maximum depletion rates

2. The year when Algeria is unable to continue exporting oil and gas;

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The overall fiscal deficit1

as a percentage of non-hydrocarbon GDP in

2025 (this indicates the fiscal adjustment increasing taxes or reducing

revenues, needed to balance the budget)

3. The overall current account deficit as a percentage of non-hydrocarbon

GDP in 2025 (this indicates the increase in exports or decrease in

imports necessary to balance the current account).

All scenarios are compared along a common timeline: 2006-2025, the same

as other countries in studied in this project.

Assumptions

A pivotal assumption in the simulations is the rate of growth of thenon-hydrocarbon economy from 2007 onwards. We assume real

non-hydrocarbon GDP (NHGDP) growth rates equal to 6 percent

from 2007 onward.

In the simulations the NHGDP growth rate is also the growth rateassumed for the non-hydrocarbon fiscal and current account

balance: non-hydrocarbon government revenue, non

hydrocarbon sector imports and exports of goods are set to grow

at the same rate as NHGDP from 2008.

Although the propensity of the non-hydrocarbon economy toprovide government tax income and generate export revenue is

in realty likely to improve in the long-term, in this analysis it is

assumed to remain fixed, in order to illustrate the size of

improvement required as hydrocarbon export earnings decline.

Government hydrocarbon revenue projections are obtainedassuming that the government hydrocarbon income as a share of

hydrocarbon production remains constant at 36%2.

For the 2004 to 2007 period, data was taken mainly from IMF3,EIA and BP. For the projections the exchange rate is kept

constant at the 2006 level and variables are dealt at 2006 prices.

1 Throughout the paper, the fiscal and current account balance is meant to include income frominvestments abroad of Algerian fiscal and foreign exchange surpluses. Therese are assumed toearn a real return of 3%2 Such a share is calculated from the IMF data referring to 2004-2007 and assumed to remainconstant

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Total energy consumption is projected to increase at 80% of non-petroleum economy growth rate.

Phases of development

The dynamics of depletion in the development of most hydrocarbon exporting

countries suggest three phases from the present state of dependence to

possible future sustainability:

A dependent phase

Like many oil exporters, dependence, measured as a ratio of the non-

hydrocarbon fiscal and current account deficits to non-hydrocarbon GDP (the

extent to which the latter depends on oil revenues), has slightly increased for

Algeria since prices rose in 2003. For Algeria, production and exports are

expected to rise up to about 2010. If international oil prices fall to $60,

Algerias oil revenues will not rise during this period faster than the historic

trend in the non-hydrocarbon sector of the economy.

Government oil revenues are being used to fund a growing fiscal deficit in the

non-oil sector and stimulate its growth. Foreign exchange earned by

hydrocarbon exports enables a rapid expansion of imports for the non-

hydrocarbon sector. It is not yet clear whether this explosive growth willcreate a non-hydrocarbon sector capable of supporting through taxation (or

through lower government expenditure) a higher proportion of the revenue it

now absorbs, or generating a higher proportion of exports to pay for the

imports it now absorbs. Our scenarios do not assume any change in the

propensity of the non hydrocarbon sector to run fiscal and current account

deficits0 The fiscal and current account deficits for 2025 are a measure of the

degree of change which will be required by that time.

To the extent the hydrocarbon revenues run ahead of the fiscal and currentaccount deficits of the non-hydrocarbon sector, surpluses are created which

are used to pay off debts, or are invested, usually abroad, in sovereign funds

and foreign financial assets. In 2000, Algeria created a stabilization fund

(Fonds de regulation des recettes, FRR) which is estimated to account for

$43bn as of December 2006. Such a fund, which is a sub-account of the

government at the central bank, collects hydrocarbon revenues above 19$

3 International Monetary Fund (2008), Country Report 2008 (08/103). For the other sources, seethe bibliography

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per barrel4. Outflows are aimed at amortizing the public debt and financing

the non-hydrocarbon deficit.5

A transition phase

In this phase, beginning with export revenues decline in 2012, essentially

unsustainable trends build up, leading to a permanent and growing deficit in

the government budget and in the country's current account on the balance of

payments. In the reference case fiscal surpluses would begin to decline in

2007, owing to the oil price assumptions, and deficits would begin in 2014.

Likewise, the external current account surplus is expected to decline from

2008 and turn negative in 2015.

A sustainable phase

When hydrocarbon production eventually declines, the non-hydrocarbon

economy must be sustained with rapidly diminishing hydrocarbon revenues.

In this longer term, the prosperity of Algeria will depend on the necessary

adjustments achieved in terms of increased productivity and growth of its non-

hydrocarbon sector.

According to the production level projected, Algeria wont experience any

plateau in the hydrocarbon production, which is expected to reach a

maximum level in 2011 and then immediately decrease. Decline in total

hydrocarbon exports would come along with decline in oil production level.

Thus, in Algerias case, transition and sustainable phases coincide.

Under the baseline assumptions, which are unsustainable in the long-term,

Algeria would cease to be self sufficient in oil in less than three decades: an

extrapolation which mirrors the unsustainable outlook for oil consumption in

the planet as a whole.

Scenarios

1. Reference scenario

2. Hydrocarbon price scenarios

3. Oil reserves replacement scenario

4This was the figure set for 2006: In our simulations we assume that all surpluses are invested .

5The Overall fiscal deficit reported in the simulations is net of the funds investment income

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4. Energy efficiency and Low growth scenario

The scenarios are designed to show the effect of variations in price,

production profile, and energy efficiency in the economy. The price variations

show prices rising at 2% per year from $60 in 2009, rising at 2% a year from

$75 in 2009, both to a limit of $100, and $100 flat price from 2009. Oil

production levels plateau at 2.3 mbd in 2010. Gas production is assumed to

cover domestic consumption increasing at a constant market share, plus 1

mbdoe of exports (roughly their current and short term future pipeline and

LNG capacity), but subject to the 20 year reserves-production constraint. A

peak in gas output would occur in 2027. Declines begin when necessary to

maintain a ratio of reserves to production of 20 to 1 for gas and 10 to 1 for oil.

The Reserve replacement scenario assumes that depletion is replaced until

10% and 20% has been added to the original (2006) reserves of oil and gasrespectively. There are two consumption variants: one with non-hydrocarbon

GDP growing at 5% instead of 6% after 2007, and one in which energy

consumption grows at 66% of the non-hydrocarbon GDP rate instead of 80%.

These assumptions are summarized in the table below:

Table1: Scenario assumptions

Reserves:oil (gas)

Oil price (BrenOil Productionplateau(2010-2011)

Energyconsumptiongrowth

Scenario

Bn Bbls oilequivalent

$ Bbl (2006)Mn Bbls oilequivalent daily

% of NHGDPgrowth rate

Reference 12 (29) 60 2.3 80%

price@100$ 12 (29) 100 2.3 80%gradual price 12 (29) $60-$100 2.3 80%Price

gradual price from 75$ 12 (29) $75-$100 2.3 80%

Hydrocarbon reserves replacement 13 (35) 60 2.3 (2010-2013) 80%

Energy efficiency 12 (29) 60 2.3 66%

Low economic growth 12 (29) 60 2.3 80%

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REFERENCE SCENARIO

Consumption

The largest role in meeting Algerias commercial energy demand is played byhydrocarbons. In 2004, gas accounted for nearly 62 percent of commercial

total primary energy demand, followed by oil (36 percent) and coal (1

percent). Hydro-electricity plays a negligible role while nuclear and other

renewables are planned to be part of the countrys future energy consumption

mix.

Under the reference scenario, Algerias energy mix is not assumed to vary

significantly over the long term. Hydro-electricity and alternative sources and

gas are assumed to remain a constant share of total primary energy demand:

as the surge in gas production over the medium-term allowed by the ongoing

projects would be sufficient to meet the rising domestic gas consumption, gas

share is expected to remain stable. In reality, depending on the evolution of

the electricity and renewables sector, there would be scope for further

substitution of gas and other fuels for oil.

Production

Oil and gas reserves are assumed to be those reported in 2007 in the BP and

EIA reports. The reference case does not allow for additions to reserves. It is

assumed that Sonatrach and the foreign hydrocarbon companies maintain a

policy of constraining production to preserve a 10-year and 20-year ratio of

reserves to production (a depletion rate of 10% and 5%) for oil and gas

respectively.

Under the reference scenario, at Brent oil price of $60 per barrel, oil

production is projected to be slightly rising until 2010, during the so-called

development phase. A maximum level of 2.3 Mbd of crude oil and natural gas

liquids in 2010 is assumed, in line with targets for 2010.6

This is held at a plateau for only two years and then declines in 2012 due to

the 10:1 reserve production assumption. The sharp decline thereafter (10%

per annum) is typical of what would occur under a 10% depletion constraint

and no additions to reserves. Faced with rising consumption, oil exports are

projected to start declining from 2011 and become unsustainable beyond

2023.

6 Calculated as sum of crude oil production target, set to 2 Mbd for 2010 as reported by Africa oiljournal, and 0.307 other hydrocarbon products obtained for 2006 from EIA

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Chart 1: Oil balance

Source: Authors calculations based on simulations and data provided by BP World

Energy Statistics 2006 and EIA

Gas production is assumed to cover domestic consumption increasing at a

constant market share, plus 1 mbdoe of exports (roughly their current and

short term future pipeline and LNG capacity), but subject to the 20 year

reserves-production constraint. After reaching a maximum in 2027, gas output

would decline to maintain a ratio of reserves to production of 20 to 1.

Notwithstanding the rising domestic gas consumption, the large gas reserves

would allow Algeria to export gas for almost other three decades. Chart 2

shows the resulting gas balance:

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Chart 2: Gas balance

Source: Authors calculations based on simulations and data provided by BP World Energy

Statistics 2006 and EIA

Taking oil and gas together, hydrocarbon production is forecast to increase

until 2011 and subsequently decrease. Decline in hydrocarbon production,

which should mark the start of the sustainable phase, is expected in 2012,

coinciding with a decline in exports. Hydrocarbon exports are projected to be

unsustainable beyond 2030.

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Chart 3: Total hydrocarbon production, consumption, and exports:

reference case

Source: Authors calculations based on simulations and data provided by BP World Energy

Statistics 2006 and EIA

Government finance

As oil revenue accounts for a major share of total government revenue

(almost 80%), the slightly increasing hydrocarbon production would allow

maintaining fiscal surpluses over the medium term.

Fiscal account balance during the transition and sustainable phases

When hydrocarbon production and exports decline, the overall fiscal surplus

is expected to start shrinking. The decline in production after 2011 will lead to

a steep decrease in oil revenue. This, in the reference case, presents an

immediate challenge to long-term sustainability of the trends in the non-

hydrocarbon economy.

A fiscal deficit is projected to arise in 2014 and to get worse throughout the

period considered in absence of fiscal adjustments: in 2025, three years after

hydrocarbon production declines, the fiscal deficit is expected to be 29.4% of

NHGDP. To correct this would require a reduction in government expenditure

in the non-hydrocarbon sector, or an increase in revenue from the non-hydrocarbon sectors. In reality, both income and expenditure would adjust:

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the simulation shows that the political and institutional mechanisms for such

adjustments need to be in place within the coming decade. Chart 4 shows this

development.

Chart 4: Fiscal balance as % of non-hydrocarbon GDP

Source: Authors calculations based on simulations and data provided by the IMF, Algeria

Country Report 2008

Current account

Over the next few years (the development phase), oil production and

hydrocarbon exports earnings are expected to slightly increase until 2011.

Nonetheless, the limited rise in output is not sufficient to cover the risingexternal payments. As a result, the current account surplus as a percentage

of the NHGDP would be decreasing.

As soon as hydrocarbon production declines and the volume of exports begin

to be eroded by both the rising domestic hydrocarbon consumption and

decreased output, the current account surplus as a percentage of NHGDP is

expected to decline steeply. The external balance would turn negative in

2015, three years after hydrocarbon production decreases. In 2025, the

external deficit is expected to be 38.4% of NHGDP. As chart 6 shows, the

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main problem is the combination of the continuing deficit of the non-

hydrocarbon sector with the decline in hydrocarbon earnings.

Chart 5: Current account balance


Country Report 2008

Hydrocarbon future: exporter into importer?

The combination of ever-rising consumption with restricted hydrocarbon

production has an inevitable arithmetical consequence. In our reference case

with no new reserve additions, hydrocarbon export earnings decline after

2011. Subsequently, the current account balance would steeply get worse. By

2023, if nothing is done to reduce the growth of domestic hydrocarbon

consumption, Algeria would be importing oil and exporting gas, the lower-

value fuel. The net effect, taking into account also the continuing import of

goods and services to maintain the hydrocarbon sector, would be in current

account deficit by about 2015 and net hydrocarbon imports by about 2030.

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Investment funds

In the reference scenario it is assumed that hydrocarbon fiscal revenues

above 19$ per barrel are invested in the stabilization fund (Fonds de

regulation des recettes, FRR), used to amortize the foreign debt and finance

the non-hydrocarbon fiscal deficit. This measure may be effective in

stabilizing budget expenditure, and in providing an emergency fund in case of

temporary oil price fluctuations. It has been assumed that fund assets will be

not be used to cover the non-hydrocarbon deficit. Under such a strict

hypothesis, the fund reserves would reach largest level, about 186 $bl in

2012. Under the reference case assumptions, the revenue from these

investments will mitigate the fiscal adjustments which will be necessary in the

non-oil sectors: the income will be 2-7% of non-hydrocarbon GDP.

Key findings of the reference scenario

Algeria is endowed with abundant hydrocarbon resources, whichmake the country the eighth largest gas producer in the world and

the second largest among OPEC-members. It is the third largest

oil producer in Africa (behind Nigeria and Libya) and the ninth

largest oil exporter in the world. It is highly dependent on the oil

and gas sector, key driver of the recent economic upturn. Oil and

gas revenues cover the fiscal deficit of the non-hydrocarbons

sector, equivalent to 35-45% of the non-hydrocarbon GDP, and

the non-hydrocarbon current account deficit, which under the

reference case assumptions will fluctuate around 40-50% of the

non-hydrocarbon GDP. Non-hydrocarbon exports cover less than

1% of Algerias imports of goods and services.

From the decline in total hydrocarbon production in 2011, theability of the hydrocarbon sector to support the fiscal and current

account deficits of the rest of the economy will decline.

An overall fiscal deficit would arise in 2014 and an overall currentaccount deficit in 2015.

By 2025 the economy will need to adjust its fiscal balance by 29% of the non-hydrocarbon GDP, and its current account balance

by 38%.

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Without the investment of surplus revenues (included in theabove) arising during the period of rising output (to 2011) the

adjustment would be greater. Under our assumptions funds

would reach a ceiling of around $186 billion: the income they

generate would be less than 2-7% if the non-hydrocarbon GDP.

The development of Algerias large gas and oil reserves has beenthe main driver of the economic upturn in recent years and

represents a unique opportunity to continue on the growth path.

The combination of buoyant oil revenues, market-oriented

reforms and decreased level of foreign debt policies, allow for a

positive medium term outlook. However, this opportunity will fade

rapidly after maximum hydrocarbon production is reached.

Algerias main challenge is to continue to sustain its recentfavourable economic performance so that the non-hydrocarbon

economy can adjust to declining support from the oil and gas

sector. It has to remain committed towards the path of effective

political and economic reforms and prudent macro-economic

policies. Oil revenues need to be managed efficiently and

transparently, without compromising price stability. In order to

spur the non-hydrocarbon growth in the long term, the large

public investment programme needs to generate a lasting

domestic supply response by improving productivity. Another

daunting challenge for the future is constituted by the growth in

the non-hydrocarbon sector, which is fundamental to support

Algerian economic development, once the hydrocarbon

production becomes unsustainable. As for all oil-exporting

countries, the main challenges are to reduce its vulnerability to

the resource curse and to combat the unemployment, which is

high particularly among the youth.

HYDROCARBON PRICE SCENARIOS

The reference scenario assumed a flat price of $60/bbl (Brent) ($2006) from

2008 onwards, representing a loosely based idea of a floor set by long-run

variable cost of supply of alternatives. $100 is used as a similarly loose

concept of a cap set by the full cost of a wide range if alternative energy

supplies and technologies in the demand system which would avoid energy

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and oil use. Variants look at $100 from 2008, and two scenarios of gradual

price increase, starting from $65 and $75 in 2008, and increasing at 2% per

year to $100 reached in 2033 and 2022 respectively. Gas prices are

changed proportionately to oil prices.

Hydrocarbon price at US$ 100

Variations in oil price affect the size of revenue the government will be able to

earn from the hydrocarbon sector. The scenarios assume production profiles

do not change in response to price, and that Algerias production choices do

not influence the long-term trend in world oil prices.

Government finance

If the Brent crude oil price was to settle at US$100 a barrel from 2008

onwards, government revenue would be expected to be significantly higher

than in the reference case throughout the period considered.

At $100 per barrel oil prices (and related gas prices) the overall fiscal balance

would improve while production was rising, until 2011. After the peak of

production in 2011 government hydrocarbon revenue would decline (as it

would at any constant price). The overall fiscal balance would, however,

remain positive until 2020, six years later than in the reference case.

Chart 6 compares the hydrocarbon revenues and fiscal balances at $100 and

$60, Despite the substantial improvement, there is n escape from an eventual

growing overall deficit in the face of continuous growth assumed in the fiscal

balance of the non-hydrocarbon sector.

The impact of adjustments to correct these deficits (by increasing revenues or

reducing expenditure in the non-hydrocarbon sector) is indicated by the

adjustment which would be required, as a percentage of the non-hydrocarbon

GDP. This is shown in Chart 6. In 2025, the overall fiscal deficit as a

percentage of non-hydrocarbon GDP would be expected to be equal to 24%

percent, significantly less than that of the reference case (46%).

Chart 6: Fiscal adjustment: a comparison between hydrocarbon price at

100$ scenario and reference case

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Country Report 2008

Current account

A higher level in oil prices would clearly benefit the current account balance,

allowing for higher export revenue.

If the Brent crude oil price were to settle at US$ 100 a barrel from 2008

onwards, the current account position as percentage of non hydrocarbon

GDP would be stronger as long as Algeria is a net hydrocarbon exporter. In

2025, the current account balance as a percentage of non-hydrocarbon GDP

would be negative, equal to nearly 30%, but smaller than in the reference

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case (38%).The higher level of export revenue would also delay the time

when the current account balance would turn negative, as Chart 7 shows.

While in the reference case the inversion would occur in 2015, if Brent crude

oil price was to settle at US$ 100 a barrel it would take place in 2019, four

years later. In the longer term, after 2030, when Algeria would be a netimporter in these simulations, the higher price would mean a worse current

account balance. The need to restrain consumption (and find more

hydrocarbons) would be more imperative for Algeria.

Chart 7: Current account adjustment: a comparison between

hydrocarbon price at US$ 100 a barrel scenario and reference case


Country Report 2008

Gradually increasing hydrocarbon price

If the Brent price was to increase (from $60/bbl in 2008) at an annual rate of

two percent up to a ceiling of US$ 100 a barrel, in 2025 the overall fiscal

deficit as percentage of non hydrocarbon GDP would be expected to be equal

to 23.2 percent, smaller than in the reference case and slightly higher then

the US$ 100 a barrel case, due to lower government oil revenue in early

years. Table 2 compares the key results of the different price scenarios.

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Table 2: price scenarios: results

Adjustment in 2025 NPV

Fiscal

Current

account

Governmenthydrocarbonrevenue

(Bn $)

Scenario Number of

years toadjust from2006

%expenditure % NHGDP % NHGDP

Reference 23 -48.18 -29.41 -38.42 39314

price@100$ 23 -37.62 -17.43 -30.46 60901

gradual price from $60 23 -40.10 -23.24 -34.82 48936Price

gradual price from $75 23 -37.62 -19.53 -32.56 54942

Key findings of the hydrocarbon price scenarios

Countries like Algeria which are net exporters experienceimprovements in the fiscal and current account balances as a

result of higher fuel prices. The challenge for these countries is to

use these revenue increases well. Net importing countries will at

the same time face increasing pressure on the current account

due to a rising import bill. In other words, if Algeria changes its

position from a hydrocarbon net exporter to a net importer, it hasto consider the reverse effect fuel price changes will have on its

fiscal and current account balance and consequently, on the

overall development of its economy.

A Brent crude oil price at US$ 100 a barrel from 2008 onwardwould benefit both the fiscal and current side by delaying the

emergence of negative balances by four years. As a result of

higher government oil revenues, the fiscal position would be

stronger throughout the period considered. Likewise, the current

account balance would be stronger for the next two decades, but

would be negatively affected once Algeria began importing oil.

OIL AND GAS RESERVES REPLACEMENT SCENARIO

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Production

In this variant we assumed that reserves of oil and gas were replaced up to

10% and 20% respectively of their 2006 levels7

thanks to new discoveries

and improved recovery. As a result, gas production would level, not decline,

after 2027. Oil production would enjoy a plateau of three years before

declining, and oil exports would continue for n extra 2 years, compared to the

reference case. Total hydrocarbon production would reach a maximum in

2013, two years later than in the baseline scenario. Hydrocarbon export

would turn negative in 2033, three years later than in the baseline scenario.

Chart 8 illustrates the difference for oil.

Chart 8: Oil Production, Consumption, Exports: oil reserves

replacement scenario compared to reference case

Source: Authors calculations based simulations

Government finance

Oil and gas reserves replacement over the next three years would greatly

increase the size of government revenue and fiscal balance during both the

development and transition phases, given that production profiles change.

The steeper decline in the government oil revenue, which is associated with

7 We assumed a 100% reserve replacement with a constraint that cumulative additional reservesare not greater than 10% of the oil reserves level as of 2006

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the decline in hydrocarbon production, would occur in 2015, i.e. two years

later than under the baseline scenario.

Chart 9: Fiscal adjustment: a comparison between oil reserves

replacement scenario and reference case

Source: Authors calculations and simulations based on data provided by the IMF, Algeria

Country Report 2008

In 2025, the favourable effect of the reserves replacement on the fiscal stance

is evident: the overall fiscal deficit as a percentage of non-hydrocarbon GDP

would be 22% compared to 29% in the reference case.

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The replacement hypothesis would also effect the time when the fiscal

balance is expected to turn negative, which would be postponed by four years

(2019 instead of 2014 in the reference case).

Current account

Oil and gas reserves replacement over the next years would also positively

affect the current account balance.

From the 2011, hydrocarbon export revenues would be higher than in the

replacement scenario and would turn negative in 2033, three years later than

in the reference case.

In 2025, the current account balance is projected to be significantly less weak

(-33% versus -38% of non hydrocarbon GDP in the reference case).

Key findings of the oil and gas reserves replacement scenario

The hydrocarbon reserves replacement scenario illustrates thefavourable effect of successful exploration and recovery

improvement for the next years on the economic sustainability of

Algerias depletion policy. However, success is uncertain and a

depletion or development policy which assumes it would be risky.

The decline in hydrocarbon production is expected to occur twoyears later, whereas the fiscal and current imbalances would

emerge five and four years respectively later than under the

reference case

In other words, under the oil and gas reserves replacementscenario the emergence of unsustainable imbalances would be

postponed by a few years.

CONSUMPTION SCENARIOS: ENERGY EFFICIENCY

SCENARIO AND LOW GROWTH SCENARIO

Our reference case optimistically assumes that energy use will grow at 80%

of the rate of growth in the non-hydrocarbon economy. This is a hazardous

assumption. Two scenarios change the level of hydrocarbon consumption in

this study: Energy efficiency, in which energy demand grows at 66% of rateof growth of non-hydrocarbon GDP, and Low economic growth, in which the

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non-hydrocarbon GDP grows at 5% instead of the reference cases 6% from

2007.

Both scenarios significantly reduce the external adjustment which would be

required in the non-hydrocarbon economy by 2025. Both delay the end of

hydrocarbon exports by two years and the onset of a current account deficit

by a year. Neither affects government hydrocarbon revenue, which is related

to neither production, and only the low growth case delays the onset of overall

fiscal deficit, yet not significantly. The lower growth scenario significantly

reduces the fiscal and current account adjustments required by 2025, as the

non-hydrocarbon fiscal deficit is smaller. As a result, the fiscal deficit is

delayed by one year. Table 3 shows the comparison with the reference case.

Table 3: results of consumption scenarios

Adjustment by 2025 NPV

Fiscal Current accountScenario

N. yearsto adjustfrom 200 %expenditure % NHGDP % NHGDP

Governmenthydrocarbonrevenue (Bn $)

Reference 23 -48.18 -29.41 -38.42 39314

Energy efficiency 25 -48.18 -29.41 -35.66 39314

Low economic growth 25 -45.62 -27.00 -35.78 38877

SUMMARY OF SIMULATIONS

Table 4 summarises the key results of the simulations, and Chart 10

illustrates their common pattern: Algeria faces a turnaround in its economy as

a result of limits to its hydrocarbon production and the government revenues

and foreign exchange earnings which result from it. Additional reserves will

defer the date at which surpluses turn to deficits, as will higher oil and gas

prices. By 2025 the adjustments required in the non-hydrocarbon economy

will be substantial, but not impossible. The challenge is begin the adjustments

in time: the nonhydrocarbon sector must begin to reduce its fiscal deficit by

generating more revenue for the government and spend less government

revenue. Non-hydrocarbon exports must increase, and imports reduce, all

relative to the non-hydrocarbon GDP.

Table 4: Summary of findings

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Chart 10: Fiscal balance trend: a comparison

Source: Authors simulations based on data provided by the IMF, Algeria Country Report 2008

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GENERAL CONCLUSIONS

Algeria is endowed with abundant gas and oil resources, which have

contributed to the recent economic upturn. Although the medium term outlook

is favourable, the country needs to address several issues to ensure a long

term high and sustained growth in the non-hydrocarbon sector. The key

challenges Algeria has to tackle are:

To manage oil wealth efficiently and transparently

To continue with prudent macroeconomic policies

Scrutiny over the quality of public expenditure

To broaden domestic supply to countervail inflationary pressuresby the extensive programme of public investment

To increase productivity

To lessen the unemployment rate, particularly among the youth

To develop non oil and non extractive sectors

Key points from the scenario analysis of the future dynamics of Algerias main

production and macroeconomic variables are:

Obviously, the higher price scenarios would be the mostfavourable. Higher levels of oil prices would greatly increase the

government revenues, lighten the burden of the adjustments and

put the country into a position of accumulating substantial foreign

assets. Adjustments to the non-hydrocarbon economy will

nevertheless eventually be necessary (early achievement ofthese will bring benefits).

Additions to reserves would improve all cases, and an aggressivepolicy of exploration and increased recovery techniques would

yield benefits under all price and growth scenarios. However, the

success of such policies is uncertain. From the reserves available

(and the investment in production and transportation facilities) the

government has no policy choice over the rate of depletion. The

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key policy choice is whether to leave the oil resources in the

ground to be produced later or to produce now, for export.

The future Algerian energy mix is worth considering, as any

introduction of nuclear and renewable energy consumption willaffect the entire hydrocarbon profile and as a result the overall

economy.

Whether the government decides to prioritize domestichydrocarbon consumption or exports will affect the dynamics of

the entire economy.

Considering just the proven oil reserves and a conservative pricescenario of $60 bbl, Algeria's hydrocarbon production profile

makes the adjustments necessary early in comparison with most

of the countries in this study. The absence of a plateau phase

anticipates the emergence of macroeconomic imbalances and

therefore requires earlier adjustments.

Given Algerias high dependence on oil and gas resources, thedecline in hydrocarbon output around 2012 will pose a major

challenge to the economy. To support long run economic growth,

Algeria must urgently promote growth in the non-hydrocarbon

sector to diversify the economy.

Without a successful transition to lower dependence onhydrocarbon, Algerias economy may lose the momentum of

growth which recent hydrocarbon developments are giving it:

without that development in the rest of the economy, political and

economic failure may threaten the development and maintenance

of the hydrocarbon sector itself, to the further detriment of Algeriaand those who hope to import oil and gas from it.

The complexity of the choices of depletion policy is enhanced bythe problem of uncertainty. The future trend of hydrocarbon

prices is uncertain, as is the rate of return of the recently created

reserve fund. Other variables like the size of proven hydrocarbon

reserves, which are a function of the status of science and

technology, will affect depletion preferences. In addition, the

Algerian governments uncertain future share of oil export

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revenues will affect the depletion pattern as impacts the private

sector investment decisions.

Questions for Further Discussion

Will reserves be added to sustain the possible production plateaus?

Will the growth in domestic energy consumption be reduced?

What policies will influence the fuel mix of domestic energy consumption?

Will the Algerian government adopt any energy and environmental policies?

How will Algeria find a strategy to increase the productivity of the non-

hydrocarbon sector so as to compensate the shortfall in oil related revenues

and export earnings?

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