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Published: February 23, 2010
 / Spring 2010 / Issue 58

 
 

How to Manage a Highly Volatile Asset

Through good governance, oil-exporting countries can shield themselves from the effects of oil-price volatility.

Title: Oil Prices and Real Exchange Rate Volatility in Oil-Exporting Economies: The Role of Governance
Authors: Johanna Rickne (Uppsala University)
Publisher: Research Institute of Industrial Economics, Working Paper No. 810
Date Published: September 2009 

Why are a few oil-rich nations — such as Norway or Saudi Arabia — able to keep their real exchange rates from rising with the price of oil while others fail and the competitiveness of their economies suffers? This paper analyzes 33 oil-exporting countries between the years 1985 and 2002 by seven criteria, including the price of oil, the cost of goods and services, the level of corruption, and the degree of government stability. The author found that governance plays a crucial role in determining whether the natural resource is a blessing or a curse.

The paper’s key conclusion is that countries that have carefully crafted policies to protect against the risks of being overly dependent on oil are able to make good use of their oil revenue — often by investing in other industries and maintaining appropriate currency reserves — regardless of the fluctuations in oil prices. For example, Norway maintains a US$455 billion fund (known as the Petroleum Fund) to stockpile surplus oil revenue, which can be used both to keep the nation’s currency on an even keel, independent of oil prices, and to provide a source of cash should oil revenues drop. Other good governance characteristics, including strong legal systems, low rates of corruption, equitable distribution of income, and stable democratic institutions also help weaken the relationship between a nation’s real exchange rate and the price of oil, the author found. 

Bottom Line: Through good governance, oil-exporting countries can shield themselves from the effects of oil-price volatility.  

Author Profile:

  • Matt Palmquist was a founding staff writer and is currently a contributing editor at Miller-McCune magazine. Formerly, he was an award-winning feature writer for the San Francisco–based SF Weekly.
 
 
 
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