Algeria, a country of 40 million people, is a key member of the committee which monitors the wide OPEC+ agreement reached last year, and one of the last bastions of stability in North Africa. Despite the 2011 Arab Spring, which swept across the region, the country has maintained relative peace in the face of multiples waves of change.

Algeria is one of the top three oil exporters in Africa, with a large refining sector and the world’s 10th largest gas reserves (over 160 trillion cubic feet). The country’s main oil export is a blended crude oil brand produced in the Hassi Messaoud region known as ‘Sahara blend’.

However, there are challenges. Crude oil prices have declined sharply since mid-2014, from $120 per barrel to $27, before recovering to reach the current price of around $50. This compares to the over $100 threshold which is required for Algeria to present a balanced budget. Even before the oil price drop, the country had been running a series of deepening budget deficits since 2009. Also, since 2007, Algeria’s consumption of O&G has risen by more than 50% while its oil production has fallen by 25%. With less oil available for export, the government’s revenues have been hit hard

Therefore, faced with both low commodities prices and stagnant production, Algeria’s whole economic model has become unsustainable. There are also rumours that the Revenue Regulation Fund (RRF), the country’s sovereign wealth fund, is being depleted. Algeria’s FX reserves, held in the RRF, are also rapidly depleting, from $177bn in 2014 to around $112bn this year and dropping to $76 billion in 2018 (according to IMF forecasts). The money has been used to pay national bills and support the Algerian currency, the dinar, with an unfortunate side-effect of boosting inflation.

Algeria has two main challenges:

1) To divert the economy away from O&G, and
2) To minimise the social impact of energy reforms

Economic Diversification

Algeria depends on hydrocarbons for 94% of its exports (mostly to Europe) and 60% of its budgeted revenues. It also still holds massive oil wealth, boasting a high GDP per capita, and this income keeps state industries and large social programs afloat. It also allows high defence spending, motivated by a long-term rivalry with neighbour Morocco.

However, the country has been draining its reserves lately to pay for imports, pushing its budget deficit to a record high of 16.4% of GDP in 2015. The low oil prices, lower demand from Europe and decreased output from Algeria’s energy sector are all factors.

In order to grow long-term, the country has recognised that it will have to funnel some of its oil wealth into diversifying the economy.

Political & Energy Reforms

O&G production at the larger mature fields, such as Hassi Messaoud, has gradually been declining since the early 2000s, while domestic consumption has risen steadily. Therefore, the welfare state built on the income from these assets is no longer sustainable. Algeria provides a universal fuel subsidy, which represents a large expense and reduces export revenues. The IMF estimates the total cost of the subsidy to be around $45 billion a year.

The government is now trying to cautiously reshape the economy, but any cuts carry political risk. Major price hikes during the 1986 oil crisis were largely responsible for the most violent crisis in the country since independence. Security experts fear a repeat of this scenario if planned austerity measures become too severe. Algerian citizens are already unhappy with the effect the cutbacks from a series of reforms in 2016, which raised the price of fuel by 35% and increased the national sales tax from 15% to 17%. The moves triggered waves of protests across the country.

The cuts added to the negative effects of the wider economic slowdown. The recent rampant inflation in Algeria has led to major price hikes in basic food staples, with fruit and fresh fish tripling in price since 2001. Algerians now spend around 40% of their income on food and drinks. For now, the Algerian leaders seem willing to implement unpopular reforms. They recently slashed spending by 14% (vs a 9% commitment in last year’s budget). In 2017, Algeria is aiming to reduce imports by an additional $5bn.

In the longer term, diversification and investment are needed to spur growth. The potential for social unrest must also be managed. Some popular pressure is now building to ease up on austerity measures.

Algeria has been a relatively stable country in the two decades since its civil war ended. The country is headed by President Abdulaziz Bouteflika, whose failing health is seen as a major source of instability. The Algerian political system has two pillars – the army and the intelligence services. The mutual suspicion and distrust between these will likely slow down the passage of reforms.

Asking For Help

Algeria will need to inject over $100 billion dollars over the coming years to modernise and extend its vast energy infrastructure, allocating $46 billion on existing fields alone. It currently plans to finance over 90% of this alone. Many experts doubt this is possible given the country’s major economic shortfall. Faced with a potential crisis and economic crash, the country has been slow to react.

For the first time in decades, Algeria has turned to the international community for help. The country is seeking foreign investment into both its lucrative but suffering energy sector and its agricultural industry, which was once a significant economic driver.

The government has taken steps to open the domestic market to foreign investors – by amending the hydrocarbon law and inviting bidders to participate in auctions for new E&P in 2013. The country’s updated constitution explicitly prohibits the formation of new monopolies, but its power has yet to be tested.

Despite these efforts, political uncertainty and reports of militant activity in the south still form barriers to foreign investment. The other main barrier 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. Corruption and delays are also issues. Algeria’s East West Highway, a $6bn project, cost over $15 billion (triple the $6bn expected cost) due to persistent graft, making it the most expensive road in the world.

The country’s outdated banking sector is also struggling to keep pace, while Algeria’s neighbours’ branch out into new Islamic financing instruments (e.g. Sukuk bonds) to finance projects. And, as the government attempts to modernise the energy sector, it risks clashes with the ruling elite, who benefit from entrenched patronage networks around Sonatrach, the national O&G company.

Algeria’s O&G wealth is the backbone of the national economy, but the country is now navigating a divide between effective reform and economic collapse.