Why we need financial modeling

Prices of oil and minerals can go really high. A country may benefit given the right fiscal regime. During the boom cycle in the latter half of the previous decade, many resource-rich countries saw their budgets swelling (and their dictators happy). Along with it came their spending as well. Then the unexpected happened. Prices reached all-time lows since 2011. Resource-dependent countries are now struggling with a fiscal crisis caused by their lack of diversification and prudence in spending in the past. What can governments do about this? Plan for the long-term. ​

There are lots uncertainties and risks that could happen in the life of a resource project. Expectations can be set too high, in some cases. Financial models are simplified projections of these possible scenarios. Why should governments and civil society organizations do financial modeling? Here are three of the many reasons why.

1. Prices are volatile and outcomes vary per scenario

Just when you thought you were the moodiest person in the room, then you haven't met oil and mineral prices. They change. A lot. When governments are not prepared for the worst case scenarios, their budgets suffer. Their expenditures including social services, debt servicing, and infrastructure spending are put at risk. This is true not just at the national level but more so for local governments who are dependent on extraction of natural resources.

2. Natural resource extraction rakes in tons of money and timing is key

Governments can only spend so much but when big money starts to kick in, they end up spending on the closest thing they can put their hands on when unprepared. It's like you binge online shopping when you get (or are expecting) a raise. This is where long-term planning is important. If governments can't tell (roughly) how much money is coming at which year, they fail to plan for where the money should go. Civil society organizations (CSOs) and communities should also be able to compare the projected and actual amounts of extraction and payments. Did the government receive what companies claim to pay at year x? If not, what could explain the deviation? Was it because of lower prices or something else? This holds governments and companies accountable to the citizens.

3. Tons of money invites bad temptation

Kleptocrats lurk around where it is darkest. If watchdogs including CSOs and communities do not know how much money a resource project would generate at given year x, corrupt government officials can easily operate in a veil of secrecy.

Should we do financial modeling?

An important caveat, however, is this: financial models operate under many assumptions. Hence, should be used with caution. A financial model can aid in projecting government revenue from a resource project at a given period. It can also provide affected communities and CSOs an opportunity to better monitor resource projects operating near their community. They are not the sole solution to the resource curse but they make a whole lot of difference. Government has a lot to lose when benefits from resource projects are not maximized. Communities lose a one-time opportunity to improve their living conditions when benefits are enjoyed by the very few. Hence, governments and communities have the most to gain when projects are better planned for and monitored.