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Keith Rankin's Thursday Column: Lucky Strike?

Keith Rankin's Thursday Column
Lucky Strike?
23 March 2000

On Tuesday, US company Swift Energy announced that there is enough oil in its Rimu well, near Hawera, to make New Zealand self-sufficient in petroleum products. Further, a potentially larger nearby oilfield, Kauri, could make New Zealand into a substantial oil-exporting nation.

Could this oil strike turn out to be a cure for New Zealand's balance of payments problem?

Even if Kauri does not eventuate, Rimu offers significant opportunities for import replacement. If we can slash imports while maintaining exports at present levels, we should have the problem licked, shouldn't we?

Our balance of payments problem, however, is not caused by excessive commodity imports such as oil. It's caused by a net inflow of capital. When foreigners buy productive assets from New Zealand residents, or extend credit to New Zealand residents, or repay loans advanced in the past by New Zealand residents, that's an import of capital. If imports of capital into New Zealand exceed exports of capital from New Zealand, then we have a balance of payments current account deficit. That's arithmetic (subtraction and addition), not economics.

New Zealand could get rid of its balance of payments deficit today, simply by forcing a depreciation of the kiwi dollar. Nobody knows how far the dollar would have to fall. We only know that it is above its equilibrium price. (The equilibrium price of the kiwi is defined as the price in which current payments equal current receipts, which, by arithmetic, means the price in which capital imports equal capital exports.)

What effect can we expect the oil strike to have on capital imports and capital exports?

The oil strike is likely to make New Zealand in 2000 and 2001 more attractive to foreign capital than it would otherwise be. Hence the additional capital inflow will raise the value of the kiwi dollar, and increase the balance of payments deficit. A higher kiwi dollar will kill off some exports and raise the quantity of imports demanded.

Once the Rimu field is in production (say 2002), then oil imports will fall. But, if the flow of oil neither discourages capital imports nor encourages capital exports, the balance of payments deficit will not fall. Instead, oil imports will be replaced by other imports of equal value.

The discovery and operation of Rimu will enable New Zealand to run a balance of payments deficit at least as high as the deficit we have at present, while having a more highly priced kiwi dollar than we do now.

So is Rimu bad news then?

No. We can make it into good news. Under a floating exchange rate regime, the only way we can balance our payments without rationing capital imports is to regulate capital exports. That means, if the kiwi dollar price is above its equilibrium price (as it is now), then it should be government policy that the country should export more capital. One way to do that is to require the Reserve Bank to "print" money and use that money to purchase overseas assets or to extend credit to overseas debtors.

Under that scenario, if an oil strike or anything else led to an increased capital inflow, then the Reserve Bank could offset that by initiating a capital outflow. Were the RB to match capital imports with capital exports, then the exchange rate would be determined entirely by trade flows, interest and dividends.

Does it matter that Swift Energy is an American company?

Yes and no. The net profits of Rimu's production, whether retained or distributed to Swift's American stockholders, would constitute investment income outflows. Retained profits would reappear on our accounts as capital imports. The operation of Rimu would itself generate more of the capital imports that create our balance of payments deficit.

However the taxes, royalties, wages and local purchases paid by Swift will be additional income to New Zealanders. Such receipts will expand through a "multiplier effect", adding significantly to New Zealand's national income. That multiplier effect will be more substantial if the kiwi dollar value is kept low, meaning that more will be spent within New Zealand rather than on imports.

Thus, the benefits to New Zealanders of the Rimu oil strike will depend on the willingness of the Government and the Reserve bank to manage the exchange rate. That means that either the exchange rate must be fixed, or capital exports must be managed (my preferred approach), or capital imports must be restrained (eg through a "Tobin" foreign exchange tax).

If the exchange rate is not managed so as to ensure that New Zealand both pay for its imports and services its debts, we may come to suffer a national economic condition (a disease of conspicuous consumption) known as "Dutch disease", but which perhaps should have been called "Thatcher's canker".

Dutch disease was first identified following the development of natural gas fields in the North Sea in the 1970s. The ensuing rise in the market price of the Netherlands Guilder had a severely detrimental effect on Dutch manufacturing and agriculture.

North Sea oil in Britain provided a dramatic example of Dutch disease. The soaring pound cut huge swathes out of the manufacturing sector upon which Britain had hitherto depended. Britain, once the workshop of the world, became the warehouse of the world. The destruction of the British car industry (of which this week's giving away of Rover by BMW is a late episode) was classic Dutch disease.

If we can prevent the price of the kiwi dollar from rising as a consequence of the oil strike, then the Rimu oilfield can be effective in improving our country's balance of payments while also raising average material living standards.

While Rimu is probably not big enough to give us a large dose of Dutch disease, the Kauri field might be. Unless managed with much more care than Britain managed its oil, the Kauri field could destroy the present fabric of the New Zealand economy. An increase in oil exports would be accompanied by a matching decrease in non-oil exports.

Becoming self-sufficient in oil, or becoming an oil exporter, will not give us cheaper oil. Oil prices will continue to be fixed by supply and demand. In a competitive market, there is only one price, regardless of varying cost structures of supplying firms, and regardless of Jim Anderton or Linda Clarke's perceptions of what constitutes competition.

We can be sure that increased oil production in New Zealand will lead to increased levels of consumption by at least some New Zealanders. In Margaret Thatcher's Britain, a small number of people were able to consume much more, while a larger number of people were obliged to consume fewer goods and services than they did before the oil flowed. On the other hand, Norway was able to use its oil to enable all Norwegians to consume more goods and services than ever before, while running a balance of payments surplus.

Whether an oil strike is lucky or not depends on political choice, not chance.

© 2000 Keith Rankin

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