Since Africa’s largest country split in two in July 2011, Sudan and South Sudan have been in dispute. Border clashes erupted into a full-scale conflict in April. At the heart of the disagreements is oil.

Most of the oil fields of the pre-partition, united country are now located in South Sudan. Khartoum was already struggling to balance its finances after a 75 per cent drop in oil income, and this latest conflict has made matters worse.

Oil revenues in Sudan

Sudan’s finances have been hit by disruptions to production in oil zones within its now reduced national territory. Revenues were already being squeezed because the two governments failed to reach a deal on transit and processing fees for oil exported by pipeline from the landlocked South.

The first three months of 2012 saw Sudan’s exports plunge by 83 per cent, compared with the same period last year. When Southern forces seized a disputed field in the border area, this shut down almost half the 115,000 barrels a day (b/d) produced in Sudan. South Sudan, which pumps 350,000 b/d, has suffered a total halt to exports and is under even greater pressure.

Many in the international community see the conflict as a reckless adventure by two governments that already have many other challenges. The UN Security Council has threatened both sides with sanctions if they fail to lay down their arms and negotiate.

Meanwhile, it will take months to restore production at Sudan’s main field, Heglig, although sufficient crude is now being pumped to keep the Khartoum refinery in operation.

Exact revenue projections cannot be made at this stage because of uncertainty over security conditions and the pace of repairs to damaged installations, but the government is at risk of losing hundreds of millions of dollars in revenue. This will put further pressure on the state treasury. Before partition, the 500,000 b/d oil sector generated more than half the government’s $25.5bn total receipts of revenue and grant aid.

The big Western donors have deep reservations about how Al-Bashir’s regime handled the Darfur crisis

The South’s secession has left Sudan with less than $4bn in oil income, but the net impact on state finances is slightly less because Khartoum no longer has to allocate public expenditure to the South. An agreement with the government in Juba on transit and refining fees would bring in a fresh source of revenue. Finance Minister Ali Mahmoud recently told parliament the lack of such an agreement had cost the government £Sud6.5bn ($2.4bn) in income in the first quarter this year.

Even assuming a deal on oil service fees can eventually be struck, there is no doubt that southern independence has had a negative net impact on Khartoum’s financial position.

But an end to the decades-old dispute over southern independence could in time turn out to be a burden lifted. Freed from preoccupation with the southern war, Khartoum could focus its energies on development, economic diversification and investment promotion. That, however, is a long-term opportunity and one that can only be fully realised once Sudan has resolved internal conflicts and neighbourly tensions.

Sudan’s funding deficit

The loss of oil income has left Khartoum with a funding shortfall, while Sudan’s trade balance has shifted from an annual surplus of $1.7bn to a deficit of $540m.

Hassan al-Turabi, leader of the opposition Popular Congress Party, has accused President Omar Hassan al-Bashir’s regime of allowing Sudan to become over-reliant on oil and neglecting agricultural production. The government countered by pointing to the progress of recent years, funded largely by oil. Opening May’s session of the Strategic Planning Council, Al-Bashir admitted Sudan faces difficulties, but insisted his administration had not failed.

Last year, in a report foreshadowing the impact of the South’s independence, the Washington-based IMF warned Khartoum that it would need to cut back on fuel subsidies and tax exemptions to offset falling oil income. The IMF also urged structural changes to stimulate growth and advised the government to do more to attract foreign budget aid.

That is a political challenge as much as an economic policy issue because the big Western donors have deep reservations about how Al-Bashir’s regime handled the Darfur crisis and its human rights record.

Sudan can count on significant assistance from friendly Arab governments, but this may not be enough to bridge the budget gap. With inflation well into double figures, the authorities could also come under growing domestic political pressure as living standards suffer.