La’o Hamutuk

Bulletin  |  Surat Popular  |  Topic index  |  Reports & Announcements  |  Updates
Reference  |   Presentations  |  Mission Statement  |  LH Blog  |  Search  |  Home

Sunrise LNG in Timor-Leste: Dreams, Realities and Challenges

A Report by La’o Hamutuk
Timor-Leste Institute for Reconstruction Monitoring and Analysis

February 2008

Chapter 4. In Timor-Leste or For Timor-Leste

Link to Index and Table of Contents

A shorter version of this and the next chapter is in the La'o Hamutuk Bulletin.

Contents of this file

4.1 Economic consequences of an LNG facility

4.2 Fiscal effects: Government's tax revenues


What will be the results if we bring natural gas to Timor-Leste and construct and operate a gas liquefaction and LNG shipping facility here? As this section explains, the answer is “it depends.” To land natural gas from the Greater Sunrise field in Timor-Leste, the government will have to secure the agreement of Australia’s government and the Sunrise joint venture companies (see Figure 2) and find companies that can construct, operate, and responsibly decommission the pipeline and LNG facility. If things go well, such a plant could provide employment and training to Timorese workers, boost the economy of the country and the region where it is located, and provide tax revenues for the government, which can in turn be used for the benefit of all Timor-Leste’s people.

Box 7. Nigeria would be better off without oil and gas

 

Nigeria is well-endowed with natural resources, and was expected to be the economic tiger in Africa when it achieved independence 50 years ago. However, a corrupt military regime took power and supported the oil companies’ interests. Nigeria, the world’s sixth-largest oil exporter, has the economic capacity to make its citizens wealthy through transparent and accountable government and social investment. However, kidnapping, embezzlement, trafficking, bribery, collusion, nepotism and corruption have become deeply embedded.

Government policies that prioritize interests of foreign oil companies exacerbate the suffering of the people. Government is eager to maximize its revenues, the benefits to a few rich officials, and the profits of companies like ENI, Chevron and Shell. They fail to develop facilities or invest in their people, and the companies dominate politics, economy, and social and cultural life.

This policy directly impacts the community: gas explosions from leaking pipelines, burning coconut plantations, provoking ethnic conflict, and polluting residential and agricultural land, lakes and the sea. The ongoing violence in the Niger Delta region reflects these injustices, but the government uses the military to protect company facilities from the community. For example, the military repressed nonviolent activists, leading to the execution of Ken Saro-Wiwa from the Movement for the Survival of the Ogoni People.

Leaking pipelines demonstrate that the government has no power to compel the responsible companies to obey their contracts; the government covers up for the companies and denies the complaints of local communities. One community leader told us that “we would be happier if this country never had any oil and gas.”

By Julino Ximenes da Silva, HAK Association [43]

 

 

 

Box 8. Timika, West Papua

The U.S. company Freeport MacMoRan has been mining copper and gold in Timika, West Papua, since 1967. Freeport’s operations have repeatedly violated community rights (damaging subsistence and livelihoods, destruction of rainforest including hunting grounds and farmed areas), cultural rights (destruction of a mountain and other spiritually significant sites), human rights (torture, rape, indiscriminate and extrajudicial killings, disappearances, arbitrary detention, surveillance and intimidation, employment discrimination, and severe restrictions on freedom of movement). [2], [26]

But the situation could be much bleaker. The facility could become an enclave, physically situated on the coast of Timor-Leste, but with few or no jobs for Timorese citizens, no money going into the local community, and indeed no integration at all with the rest of society—neither economically, socially, or in terms of infrastructure such as road connections. In short, it could be “in” Timor-Leste, but not “for” Timor-Leste. The worst scenario is a plant that displaces the local population, impinges on their sacred places, and harms the natural environment, and is staffed by foreigners who live in self-contained housing with no positive interactions with the rest of the country. It is easy to see that this would cause deep grievances and frustrations among people who are already struggling with poverty and a history of colonialism and war.

Which scenario prevails will depend on the actions of everyone involved—the government, the petroleum companies, local authorities, local communities, traditional leaders, civil society and non-governmental organizations, and individual Timorese citizens—in preparing for the arrival of the pipeline, plant, and port; during the construction of the facilities; and throughout the life of the project. To maximize the benefits to the people of Timor-Leste and minimize the negative impacts, we all must prepare ourselves and each other for the opportunities and challenges that an LNG project will bring.

This report surveys these opportunities and challenges. They include the effects on the national and local economy (see Local economic activity below); the creation of jobs and infrastructure (Chapter 5); the project’s impact on the surrounding social and natural environment (Chapter 6); the effects on women and local communities (Chapter 7); and the consequences of an LNG project in Timor-Leste on the country’s domestic and international political situation (Chapter 8).

4.1 Economic consequences of an LNG facility

The lack of economic growth since the restoration of independence has disappointed many Timorese people, especially those who still suffer from poverty and unemployment. While the government has received billions of dollars from offshore petroleum, the non-oil economy has stagnated. It is not surprising that in discussions of the potential LNG project, most of the attention has focused on how it improve economic conditions. In this section, we discuss what economic effects an LNG plant could have and what is needed to ensure that they are as positive as possible. We start by looking at the potential for an LNG plant stimulating the national and local economy, rather than becoming an isolated enclave with no linkages to benefit the population. We then consider the amount of money the government could receive in tax revenue from the LNG project.

Local economic activity

There are great expectations that the LNG project will boost economic activity in Timor-Leste as a whole, particularly in the region where the facility is located. Virtually all the local administrators and elected and traditional leaders interviewed for this report expressed this hope. Most of all, people think that the project will create employment for the local population, either directly in constructing the plant and port complex, or indirectly through the increased demand for local goods and services that the project would spur. Since jobs are the first concern for many people, we address this topic in the next chapter, including how many and what kinds of jobs may be created. This section gives an overview of the possible consequences for parts of the local and national economy.

The first potential boost to the national economy would come in the construction phase. The construction of gas pipelines and liquefaction plants constitute enormous undertakings costing several billion dollars. How much of this will enter Timor-Leste’s economy and provide livelihoods for Timorese? Given the current state of development in Timor-Leste, virtually all of the materials and components required for the construction are likely to be produced abroad and shipped to the site, so any demand for local economic activity would have to come not from manufacturing but from the construction process itself, which has a slightly better chance of providing jobs for Timorese workers.

The construction process will involve purchases of at least three classes of goods and services. First, there is the construction work itself. Currently, no Timorese construction companies can provide more than very basic construction, and certainly most of the highly skill-intensive tasks will be carried out by foreigners. However, local companies may be able to gain subcontracts for certain low-skilled tasks, such as the administrative buildings for the plant, housing for workers and other ancillary facilities and infrastructure. Similarly, Timorese individuals may be hired by foreign contractors for lower-skill tasks, and a select few may secure higher-skilled jobs.

In addition to the construction services themselves, a range of other services will be needed during construction. These include security, drivers, transport, hospitality (food and housing), infrastructure, and clerical work. While these comprise a small part of the construction costs, they could provide a much-needed boost to the local economy. So would the demand for goods like food and basic construction materials, which will be required throughout the construction period. Again, the extent to which these ancillary services and consumer and producer goods will be sourced locally, depends both on the ability of the local market to supply them and the willingness of the contractors to purchase them locally rather than ship them in from abroad. This in turn will depend on the quality available, the ease with which the goods and services can be procured locally, and incentives for or requirements on the contractors. Again, policies are necessary to help local producers and service providers know which goods and services would be demanded, and provide training to prepare for that demand. In parallel, the infrastructure must be developed that would reduce the cost of buying locally, for example by improving the road connections between the site of the LNG facility and where the goods and services would be produced. The government and contractors would have to work closely with local authorities. Further, contractors and subcontractors should be required to source a high (but realistically feasible) proportion of their required ancillary goods and services locally. Note that these different policies—of improving the quality, quantity and access of the supply, and of requiring contractors to avail themselves of that supply—are highly interdependent. The contractors, for example, could be required to help upgrade the road connections between the construction site and nearby towns, so that food for the construction workers could be purchased without prohibitive transport costs.

Box 9. Local economic impact of UNTAET and UNMISET

    

Timor-Leste has already experienced a large international project in our country, and we can explore how much of the money spent entered the local economy. From 1999 to 2004, the UNTAET and UNMISET missions spent more than $1.7 billion, approximately one-third of the capital investment required to build an LNG plant.

Nearly 95% of the money spent on UN Missions did not come into the local economy. Local contracts and services were minimal, because Timor-Leste does not yet have a diversified economy with local manufacturers who can supply the needs of an international project. Local salaries constituted slightly over 1% of UN spending. Salaries for international staff were paid overseas, and staffers received allowances for local expenses. Surveys indicate that they typically spent half of their allowances on housing and a quarter on food.

About 5% of the five-year budget over the duration of UNTAET and UNMISET was spent locally. In comparison, over 80% was spent on military contingents, international civilian salaries, IT and communications infrastructure, and air transportation.

 

 

In comparison with LNG plant construction, the UN spent a much larger part on personnel and local activities, since the major components of the plant will be built outside Timor-Leste and shipped here.

Information from Economic Impact of Peacekeeping; Interim Report Phase I, by Peace Dividend Trust, April 2005. [64]

It seems inevitable that only a very small fraction of construction expenditures will be spent in Timor-Leste. In absolute numbers, however, they could still be significant. As our spreadsheet model (see http://www.laohamutuk.org/Oil/LNG/FiscalBenefits.xls) shows, if Timor-Leste secured 10% of the construction expenditures for Timorese workers or producers, that could amount to $100 million over a four-year construction period, or perhaps 7-8% of non-oil GDP. (By comparison, this is about three times Timor-Leste’s entire non-oil export income, which is almost all from coffee.) Achieving this will require judicious design and implementation of policies by the central and local governments, as well as cooperation from the contractors. Significant benefits can be reaped if the right preparations are made, as is shown by the experience of Trinidad and Tobago, where $235 million of the total of $1.3 billion spent to build the recently completed Train 4 was contracted locally. [11] Although Trinidad and Tobago is economically more developed than Timor-Leste, this high local content results from a concerted government policy.

After the construction period, the benefits of the LNG facility to the domestic economy will be small. Indeed it is entirely possible for the LNG plant to be almost entirely self-sufficient. Unless measures are taken to integrate the plant with the rest of the country, it could operate as an enclave, which would pump in gas, ship in necessary supplies, and ship out LNG, with few local employees and no linkages to the rest of the economy. While this scenario is not unavoidable, it is unfortunately a common pattern for the petroleum industry in poor countries. The authorities of Timor-Leste, the companies that operate the LNG plant and the local population face a difficult challenge in seeking to maximize the integration of the facility with the local and national economy. This can be measured by calculating the proportion of yearly operating expenses spent locally, as well as what that money is spent on. Our calculations estimate annual operating expenses of around $100 million, but only a small fraction of that is likely to enter the Timorese economy. There are two channels for this integration: Salaries paid to Timorese residents (and in particular those paid to Timorese nationals, since non-nationals will spend some of their income in their home countries or elsewhere), and purchases of locally sourced supplies. The bulk of the operating expenses, however, will go to purchases from abroad (of supplies such as mechanical parts or chemicals and other inputs into the liquefaction process, as well as specialized services for high-tech repairs and maintenance), and to a lesser extent, to remuneration to non-residents (such as foreign experts or expatriate staff on short-term assignments).

This observation for the construction phase also applies to the operations phase, although the much longer duration of the operations phase provides more opportunities for training local workers and developing local subcontractors. The most accessible way of integrating the facility with the local economy is through the employment of Timorese for tasks such as low-skill maintenance and cleaning, cooking, and security. With adequate preparation and training policies, coupled with realistic requirements on the companies, a few Timorese may also be employed at higher skill levels. It should be a goal for the government and the companies to steadily increase the proportion of Timorese employees at the facility over the lifetime of the project. We discuss the prospects for employment in more detail in Chapter 5.

The other connection the facility could have with the local economy is through locally sourced supplies. In addition to high-tech equipment and production inputs that would have to be procured from abroad, the facility would have a demand for goods that could be purchased locally. The most obvious is food, but this could include simple manufactures such as furniture. In the absence of government policy to discourage it, the facility always has the option of importing such supplies directly from abroad, so the right incentives need to be set up to maximize the share of local content—which again requires the right combination of facilitation from the government (in particular the relevant district administration, but also national policies), contractual requirements on the companies, and an efficient flow of communication about the nature of the goods and services required by the facility. The success of local content provision in the operations phase will be affected by how well local economy is integrated with the construction process. If during construction, roads and other infrastructure have been developed so as to connect the facility with local economic activity, it will be much easier to avoid the enclave problem once operations start. A further point is that one must pay attention not only to the quantity of locally sourced supplies, but also to their quality. Diversified economic development in Timor-Leste requires the growth of continuously higher-value-added productive activities, and local content policies should be designed with that goal in mind. While it must be the responsibility of local business to develop product of higher quality and higher value added (which can therefore command a higher price), the government can take steps to facilitate such a shift, and local content rules can be designed so as to secure a market for such products.

We must emphasize, however, that all this potential will not be realized by itself. It needs a combination of earnest effort from the companies (in their willingness to help promote local content), the national government (through wise polices implementing well-targeted regulation and incentives for the companies), and local government, communities and civil society organizations. Without this, the enclave model is very likely to be the reality of an LNG plant in Timor-Leste.

One of the simplest ways the plant can support the local economy is for Timorese businesses and people to provide food and housing for international plant workers. The Government, local communities and companies should work together to help Timorese companies start and grow so that the international companies and their workers can rent and buy housing, hotel rooms, restaurant food and groceries which are locally staffed and produced. This can include local content purchasing requirements, financing, teaching people how to start and run businesses, etc.

4.2. Fiscal effects: Government’s tax revenues

The most obvious advantage of processing natural gas in Timor-Leste is the fiscal benefit. The fiscal benefit is the revenue that Timor-Leste’s government will receive from the profits of the LNG facility, as well any taxes flowing from the jobs and economic activity the LNG facility may spur, in construction and during operation. We cannot predict the precise amount of these revenues, since they depend both on how much it would cost to build the pipeline and LNG facility, and on the future price of LNG. In addition, the LNG industry has recently seen rapidly increasing construction costs (see Box 12).

We present some very tentative estimates for several scenarios below, which should be taken with a great deal of caution. Before making a decision about whether to try to locate an LNG facility in Timor-Leste, the government must prepare more accurate and detailed estimates of the fiscal effects. However, even the most expert consultants and thorough data and methodology cannot predict LNG prices over the decades this project will be in operation or construction costs five years from now, so any estimate will be very approximate.

Box 10. “Upstream” and “downstream” project

 

Petroleum projects are often divided into “upstream” and “downstream” parts. The upstream project extracts the oil and gas from the ground or the seabed, while the downstream project includes everything that transports the raw petroleum, processes it, and brings it to market. In the case of Sunrise, the upstream project will be the facilities that pump the gas up from the seabed under the Greater Sunrise field. The downstream project will be the pipeline and the liquefaction plant the cools the gas and ships it off in tankers.

Even if the upstream and the downstream project are developed and managed by the same companies, the tax authorities will treat them as separate projects, because different tax rules apply to upstream and downstream activities. The upstream project will sell the gas to the downstream project, even if both projects belong to the same company. This is to make sure that profits at each level are calculated and taxed as the tax rules intend, and to prevent the companies from shifting profits to the level with the lowest taxes.

It is clear that any consideration of the fiscal benefits from such a project must include the possible tax effects on the upstream project as well (see Box 10). This is because what happens downstream will affect how much money the upstream project receives from the gas it sells downstream (the “netback price”), and that in turn affects company revenues, profits and tax revenues to Timor-Leste (through the JPDA and through Australia’s payments to Timor-Leste under CMATS) and Australia (directly and through the JPDA). There are several reasons why the increased tax revenue Timor-Leste’s government would receive from locating the LNG project here could be offset by reduced tax revenues from the Sunrise Unitized Area. The Australian government and Woodside have argued that it would cost more to build the LNG facility in Timor-Leste relative to the main alternative, which is either to expand the existing LNG facility in Wickham Point in Darwin or build a new plant on the Australian coast. (Other possibilities include floating plants and plants anchored to the seabed, but these are opposed by both Timor-Leste and Australia. Woodside is also not enthusiastic about untested mid-sea technology, although it continues to consider the floating option at the time of writing. This report compares the two onshore alternatives.) The pipeline route to Timor-Leste would have to traverse the deep Timor Trough, and could therefore be more expensive, even though Sunrise is much closer to Timor-Leste than to Australia. It is also possible that construction costs may be higher in Timor-Leste because of the lack of infrastructure, local contractors and skilled personnel. On the other hand, Timor-Leste could be a cheaper place to construct the LNG plant, as a pipeline crossing the Timor Trough may be cheaper because of the shorter distance. Moreover, modular construction methods that would not be used in Australia could be used in Timor-Leste, making the plant cheaper as well.

Another concern is that even if the Timor-Leste option is not more expensive than the alternative, the netback price paid for the gas could be lower, since Timor-Leste’s limited experience with self-government and stability may cause customers for the LNG to worry about possible supply disruption. This in turn could motivate them to bargain for a price discount to compensate for their additional risk exposure -- even if it is merely a perceived, not a real risk.

It is impossible to know how these variables will play out. In what follows, we consider five scenarios and two variations to derive some very simplified estimates of Timor-Leste’s tax revenues depending on where the downstream facility is located. (The assumptions and calculations are explained in Appendix 3, and can be examined in the spreadsheets available at http://www.laohamutuk.org/Oil/LNG/FiscalBenefits.xls.) In the first scenario, the Timor-Leste and Australia options can be done at the same “moderate” cost. In Scenarios 2 and 2a, the options are again equally costly, but more expensive than in Scenario 1. The next two scenarios we examine how fiscal revenues depend on the location of the plant if the construction costs are higher in one country than in another. Scenario 3 compares a moderate Timor-Leste option with an expensive Australia option, and Scenario 4 looks at the opposite. In Scenario 5, we go back to both options having the same moderate cost, but we see what happens if the Timor-Leste option receives a 10% lower LNG price because customers perceive it to be more risky. It is important to note that we are not suggesting which of these assumptions are correct. The scenarios simply make it possible to compare possible outcomes under different assumptions.

 

Box 11. Proposed tax “reform”

In September 2007, the Government proposed a major tax reform which they hope to enact in early 2008. [79] This would have a major impact on Timor-Leste’s tax revenue from a Sunrise LNG plant. For example, in our Scenario 1, the total fiscal revenue from the downstream project would fall from over $3.6 billion to about $1.1 billion – more than two-thirds less! Similar reductions would happen in the other scenarios with the LNG plant built in Timor-Leste. The scenarios in this chapter assume the current tax rules, as the current proposals may be modified or not even enacted, or a special tax law could be passed for the LNG plant. We have included Scenario 1a, which is the same as Scenario 1 with the new tax laws applied. Our modeling spreadsheet includes estimates with the current and the new tax rules, which show that the actual tax take would be significantly less if the new rules are enacted as proposed.

See also legislation, updates and analysis on this website.

The fiscal consequences of the downstream project depend very much on how the Timor-Leste government decides to tax it. Will it apply the normal domestic tax rules, or will it design a special tax system for the LNG plant? This could be an issue of negotiation between Timor-Leste and the oil companies. The government has not said anything about its plans, and we do not try to guess. The best we can do is to assume that the normal domestic tax laws will apply, and make our estimates based on that. In addition, in September 2007 the government proposed new domestic tax rules (see Box 11), and their effect on revenues is shown in Scenario 1a.

We discuss here the high-price scenarios, which assume a sales price for LNG of $7.50/MM BTU (about $44/BOE), based on the futures prices for natural gas at the NYMEX commodity exchange during 2006-2007. The low-price scenarios in the spreadsheet use a price of $3.50/MM BTU ($21/BOE). These show qualitatively similar results but are not shown as tables in this report. The other assumptions are explained in detail in Appendix 3.

The tax revenue from the downstream project can be divided into three main sources, as detailed in the spreadsheet accompanying this report. We have ignored indirect taxes (sales taxes), as these make little difference and would be too speculative to guess.

  1. Tax from the project itself. Once operations start, the income from the processing is liable to Timor-Leste’s general profit (income) tax at 30% after deductions, which in our Scenario 1 amounts to about $3.4 billion.

  2. Timor-Leste’s tax regime imposes a “withholding tax” on the purchase of “construction services” from residents at the low rates of 2-4%, and mandates the withholding of income tax at 20% for non-residents. Since a sizeable part of the construction costs of the LNG facility will be salaries and other compensation, this creates a large tax base for the country during the construction of the plant, which we estimate to generate $136 million in taxes for the government in Scenario 1.

  3. The incomes of those people locally employed during operation, and any money expended on locally sourced supply will enter the domestic economy and generate wage and income taxes during the operations phase. In Scenario 1, these are about $99 million over the life of the project.

Figure 15. How the profits and taxes from the Sunrise LNG project (upstream and downstream, not including liquids, after paying construction, debt service and operating costs) would be allocated among Timor-Leste (blue), Australia (pink) and the oil companies (green) for each scenario described below. Diagonal hatching is for downstream revenues, solid is for upstream, and horizontal strips are the small amount of secondary Timor-Leste taxes. The upper bar for each scenario is if the pipeline comes to Timor-Leste, and the lower one is if it goes to Australia.

Scenario 1. Base case

Table 3 below first includes our estimate of fiscal revenues to Timor-Leste over the lifetime of the project from the two plant locations under Scenario 1. The key figures show that even if the plant is built in Timor-Leste, about three-fourths of the revenues to the government of Timor-Leste (around $11.9 billion of a total $15.6 billion in Scenario 1) would come from the upstream Sunrise project, not from the pipeline/LNG plant facility. Notwithstanding, the potential tax revenues from the downstream facilities are also very large: on the order of $3.4 billion just from the plant itself (undiscounted except for inflation-adjustment), or an average of around $100 million per year. Income and withholding taxes discussed about would add about $235 million over the project’s lifetime. If the downstream facilities are located in Australia, but are otherwise identical from the perspective of project profitability, downstream tax revenue for Timor-Leste vanishes, as the downstream facilities become part of the domestic Australian tax base. Still, the upstream revenues would remain unchanged, at almost $12 billion over the projected period of Sunrise production.

All taxes from the downstream project would be lost to Timor-Leste if the liquefaction plant is located outside Timor-Leste’s tax jurisdiction. Instead, the downstream project’s profits would be shared between the companies and Australia. Our approximations of Australia’s company tax regime project that Australia will receive almost $3 billion more if the LNG plant comes to Australia than if it comes to Timor-Leste. The companies may also make more money with the Australian option, since taxes under Australian taxation rules are lighter than under current Timor-Leste laws. Some RDTL advisors suggest giving special tax incentives to make the project happen; which would also reduce tax revenues.

All figures in the tables below are in millions of U.S. dollars, except for LNG sales prices, which are in dollars per million BTU.

Table 3. Scenario 1: Base case

Location of LNG plant

Downstream project:

Timor-Leste

Australia

LNG sales price Freight on Board (F.O.B.)

$7.50

 

$7.50

 

Total fixed costs of downstream project

$2,075

 

$2,075

 

Net pre-tax income (total downstream net revenue)

$9,137

 

$9,137

 

Net post-tax income: Downstream private profits

$5,732

62.7%

$6,183

67.7%

Timor-Leste take of downstream net revenue

$3,405

37.3%

$0

0.0%

Other Timor-Leste tax revenue

$235

 

$0

 

Australia take of downstream net revenue

$0

0.0%

$2,954

32.3%

 

 

 

 

 

Upstream project (after CMATS redistribution):

 

 

 

 

Netback price to upstream project (real)

$5.26

 

$5.26

 

Total fixed costs of upstream project

$1,450

 

$1,450

 

Net pre-tax income of upstream project

$39,322

 

$39,322

 

Net post-tax income: Upstream private profits

$15,458

39.3%

$15,458

39.3%

Timor-Leste take of upstream profit

$11,932

30.3%

$11,932

30.3%

Australia take of upstream profit

$11,932

30.3%

$11,932

30.3%

 

 

 

 

 

Totals for project

 

 

 

 

Net total pre-tax income

$48,459

 

$48,459

 

Total Timor-Leste take of project profit

$15,338

31.7%

$11,932

24.6%

Total Australia take of project profit

$11,932

24.6%

$14,887

30.7%

Upstream private profit

$21,189

43.7%

$21,640

44.7%

Other Timor-Leste tax revenue

$235

 

$0

 

Total Timor-Leste tax revenue

$15,573

 

$11,932

 

Scenario 1a. New tax regime

As discussed in Box 11 above, Timor-Leste is considering major tax reform which would significantly reduce the fiscal benefits from an LNG plant in our territory. The following figures are is the same as the base case in Scenario 1, with the proposed new taxes applied. It is clear that the fiscal benefits for Timor-Leste are significantly less, and the companies’ profits are correspondingly larger.

Table 4. Scenario 1a: New tax regime

Location of LNG plant

Downstream project:

Timor-Leste

Australia

LNG sales price Freight on Board (F.O.B.)

$7.50

 

$7.50

 

Total fixed costs of downstream project

$2,075

 

$2,075

 

Net pre-tax income (total downstream net revenue)

$9,137

 

$9,137

 

Net post-tax income: Downstream private profits

$8,155

89.3%

$6,183

67.7%

Timor-Leste take of downstream net revenue

$981

10.7%

$0

0.0%

Other Timor-Leste tax revenue

$109

 

$0

 

Australia take of downstream net revenue

$0

0.0%

$2,954

32.3%

 

 

 

 

 

Upstream project (after CMATS redistribution):

 

 

 

 

Netback price to upstream project (real)

$5.26

 

$5.26

 

Total fixed costs of upstream project

$1,450

 

$1,450

 

Net pre-tax income of upstream project

$39,322

 

$39,322

 

Net post-tax income: Upstream private profits

$15,457

39.3%

$15,457

39.3%

Timor-Leste take of upstream profit

$11,932

30.3%

$11,932

30.3%

Australia take of upstream profit

$11,932

30.3%

$11,932

30.3%

 

 

 

 

 

Totals for project

 

 

 

 

Net total pre-tax income

$48,459

 

$48,459

 

Total Timor-Leste take of project profit

$12,914

26.6%

$11,932

24.6%

Total Australia take of project profit

$11,932

24.6%

$14,887

30.7%

Upstream private profit

$23,612

48.7%

$21,640

44.7%

Other Timor-Leste tax revenue

$109

 

$0

 

Total Timor-Leste tax revenue

$13,023

 

$11,932

 

Scenario 2. Higher construction costs for both options

Scenario 2 projects the same figures for a somewhat more costly LNG plant and pipeline. Our scenario amounts to 20% higher construction costs for the LNG plant and a 36% more expensive pipeline, an increase of $465 million over Scenario 1 assumptions for a 5.3 mtpa plant (for details about the cost assumptions, please see Appendix 3). The table shows that as long as the costs are the same in both locations, similar results hold in Scenario 2 as in Scenario 1.

Table 5. Scenario 2: Both options “expensive”

Location of LNG plant

Downstream project:

Timor-Leste

Australia

LNG sales price Freight on Board (F.O.B.)

$7.50

 

$7.50

 

Total fixed costs of downstream project

$2,540

 

$2,540

 

Net pre-tax income (total downstream net revenue)

$9,816

 

$9,816

 

Net post-tax income: Downstream private profits

$6,240

63.6%

$6,640

67.6%

Timor-Leste take of downstream net revenue

$3,576

36.4%

$0

0.0%

Other Timor-Leste tax revenue

$269

 

$0

 

Australia take of downstream net revenue

$0

0.0%

$3,176

32.4%

 

 

 

 

 

Upstream project (after CMATS redistribution):

 

 

 

 

Netback price to upstream project (real)

$5.13

 

$5.13

 

Total fixed costs of upstream project

$1,450

 

$1,450

 

Net pre-tax income of upstream project

$38,178

 

$39,178

 

Net post-tax income: Upstream private profits

$15,004

39.3%

$15,004

39.3%

Timor-Leste take of upstream profit

$11,587

30.3%

$11,587

30.3%

Australia take of upstream profit

$11,587

30.3%

$11,587

30.3%

 

 

 

 

 

Totals for project

 

 

 

 

Net total pre-tax income

$47,994

 

$47,994

 

Total Timor-Leste take of project profit

$15,163

31.6%

$11,587

24.1%

Total Australia take of project profit

$11,587

24.1%

$14,763

30.8%

Upstream private profit

$21,244

44.3%

$21,644

45.1%

Other Timor-Leste tax revenue

$269

 

$0

 

Total Timor-Leste tax revenue

$15,432

 

$11,587

 

Scenario 2a. Very high costs for both options

 

Box 12. Capital costs rising

In recent years, the cost of constructing LNG plants has been rising very rapidly, because a lot of countries currently want to build LNG plants. Only a few large companies are capable of doing it, and their resources are stretched. Raw materials have also become expensive. For example, a year or two ago, the commonly quoted cost of building a liquefaction “train” was $200 per ton-per-year capacity, but now prices of $600 per ton-per-year are seen. [48]

Our estimates assume costs around the levels that were expected before these recent increases. This is because these costs are not caused by fundamental physical or technological challenges, which have not changed in two years. Rather, they arise from tight conditions in the specialized engineering and construction market. Over the long term, as the construction industry expands its capacity (or fewer countries want to build LNG plants at the same time) we expect these prices to come back down to earlier levels. Additionally, Timor-Leste need not be in a hurry to build this plant (see Chapter 9.1) – this report argues that it takes time to prepare the public sector, private firms, civil society, and the population at large for the construction. And in any case, the government may not spend most of the revenues from Sunrise as they come in, because of the Petroleum Fund. So our estimates apply to a case where the government times the project wisely, including waiting until construction costs fall.

Nevertheless, we include one calculation based on much higher costs as Scenario 2a. When we assume that costs are three times higher than what we think is possible in the long term, total revenues obviously fall. But the qualitative conclusions in our main text which compare the two locations for the liquefaction plant are not changed much with higher costs. This is not surprising, since high construction costs would apply wherever the plant is built.

Recently, construction costs of LNG plants have been skyrocketing, as explained in Box 12. Although we believe it is unlikely that costs will remain this high for very long, we calculated a scenario with extremely high costs. The following results if exploration, construction, operating and decommissioning costs for both upstream and downstream are three times as high as in the base case described in Scenario 1. The project is still profitable for the companies, but both governments’ revenues are significantly reduced.

Table 6. Scenario 2a: Very high costs

Location of LNG plant

Downstream project:

Timor-Leste

Australia

LNG sales price Freight on Board (F.O.B.)

$7.50

 

$7.50

 

Total fixed costs of downstream project

$6,225

 

$6,225

 

Net pre-tax income (total downstream net revenue)

$13,976

 

$13,976

 

Net post-tax income: Downstream private profits

$9,316

66.7%

$9,316

67.0%

Timor-Leste take of downstream net revenue

$4,660

33.3%

$4,660

0.0%

Other Timor-Leste tax revenue

$705

 

$705

 

Australia take of downstream net revenue

$0

0.0%

$4,614

33.0%

 

 

 

 

 

Upstream project (after CMATS redistribution):

 

 

 

 

Netback price to upstream project (real)

$3.70

 

$5.13

 

Total fixed costs of upstream project

$4,350

 

$1,450

 

Net pre-tax income of upstream project

$14,460

 

$38,178

 

Net post-tax income: Upstream private profits

$5,491

38.0%

$5,491

38.0%

Timor-Leste take of upstream profit

$4,485

31.0%

$4,485

31.0%

Australia take of upstream profit

$4,485

31.0%

$4,485

31.0%

 

 

 

 

 

Totals for project

 

 

 

 

Net total pre-tax income

$28,436

 

$28,436 

 

Total Timor-Leste take of project profit

$9,145

32.2%

$4,485

15.8%

Total Australia take of project profit

$4,485

15.8%

$9,098

32.0%

Upstream private profit

$14,807

52.1%

$14,853

52.2%

Other Timor-Leste tax revenue

$705

 

$0

 

Total Timor-Leste tax revenue

$9,850

 

$4,485

 

Scenario 3. Timor-Leste more expensive

The comparisons in Scenarios 1 and 2 do not consider how the location of the downstream project might affect the upstream project if the Timor-Leste and the Australia option are not equally costly. Since we have assumed until now that the two downstream alternatives are financially identical, the netback price to the upstream is the same under both scenarios. This is an unrealistic assumption. We now look at two other scenarios in which building the downstream facilities in Timor-Leste costs more money (Scenario 3) or less money (Scenario 4) than building them in Australia (and therefore causes a lower or higher netback price, affecting the profitability of the upstream project). In Scenario 3 we compare an expensive Timor-Leste option with a moderate Australia option, as some argue that it would be more expensive to build a pipeline and a liquefaction plant in Timor-Leste.

In this scenario, the Timor-Leste option of course produces a lower overall net income for the whole value chain (reduced by $465 million for a 5.3 mtpa plant). In other words, locating the plant in Timor-Leste creates a slightly smaller “pie” to divide among the three parties: Timor-Leste, Australia and the companies. This loss is absorbed by the upstream level through a lower netback price. In fact it is more than absorbed. The rules guarantee a certain pre-tax rate of return to the downstream project, so that higher costs means more profit is allocated to the downstream to compensate. As a result, profits in the downstream project are higher in the high-cost option, whereas profits in the upstream project are lower by about $1,150 million – more than the extra cost. So all three parties lose at the upstream level with the more expensive option compared to the moderate option. The governments each get about $350 million less upstream tax revenue, while the companies get $450 million less.

The table also shows, however, that this effect is swamped by the zero-sum game over how the “pie” is divided. It is particularly significant where the downstream profits are taxed: Timor-Leste or Australia. At more than $9 billion, these profits are much bigger than the difference in construction costs. Therefore, Timor-Leste would get significantly higher government revenues with the more expensive plant in its territory than with the cheaper plant in Australia. Its projected tax revenues from the downstream amount to more than $3.8 billion, while its tax revenues from the upstream (due to lower overall profitability) only fall by about $350 million, leading to a net gain of about $3.5 billion. This is the additional tax revenue that we estimate Timor-Leste could gain from locating the plant in its territory rather than in Australia, even if that would come with higher costs of construction. Partly, this effect is because higher costs of construction (but also higher natural gas prices) are passed on to the upstream project through the lower netback price, and since tax revenues from the upstream project are shared equally with Australia, Timor-Leste’s government only bears part of the loss. (By the same token, downstream taxes are much less sensitive to oil and gas price fluctuations than are upstream taxes, provided prices stay high enough to make both downstream and upstream projects sufficiently attractive to investors.)  But mostly, the gain comes from the advantage of having the downstream project be part of Timor-Leste’s tax base, just as in Scenarios 1 and 2 where the cost was the same in both locations.

The other zero-sum game over who gets what share of the financial “pie” is between the companies and the governments. In Scenario 3, the companies get about the same amount of downstream profits in both the Australia and Timor-Leste locations. At the upstream level, however, they get less if the more expensive construction option is chosen, and would therefore be likely to favor the Australian location in this scenario.

Table 7. Scenario 3: Timor-Leste “expensive,” Australia “moderate”

Location of LNG plant

Downstream project:

Timor-Leste

Australia

LNG sales price Freight on Board (F.O.B.)

$7.50

 

$7.50

 

Total fixed costs of downstream project

$2,540

 

$2,075

 

Net pre-tax income (total downstream net revenue)

$9,816

 

$9,137

 

Net post-tax income: Downstream private profits

$6,240

63.6%

$6,183

67.7%

Timor-Leste take of downstream net revenue

$3,576

36.4%

$0

0.0%

Other Timor-Leste tax revenue

$269

 

$0

 

Australia take of downstream net revenue

$0

0.0%

$2,954

32.3%

 

 

 

 

 

Upstream project (after CMATS redistribution):

 

 

 

 

Netback price to upstream project (real)

$5.13

 

$5.26

 

Total fixed costs of upstream project

$1,450

 

$1,450

 

Net pre-tax income of upstream project

$38,178

 

$39,322

 

Net post-tax income: Upstream private profits

$15,004

39.3%

$15,458

39.3%

Timor-Leste take of upstream profit

$11,587

30.3%

$11,932

30.3%

Australia take of upstream profit

$11,587

30.3%

$11,932

30.3%

 

 

 

 

 

Totals for project

 

 

 

 

Net total pre-tax income

$47,994

 

$48,459

 

Total Timor-Leste take of project profit

$15,163

31.7%

$11,932

24.6%

Total Australia take of project profit

$11,587

24.6%

$14,887

30.7%

Upstream private profit

$21,244

43.7%

$21,640

44.7%

Other Timor-Leste tax revenue

$269

 

$0

 

Total Timor-Leste tax revenue

$15,432

 

$11,932

 

Scenario 4. Australia more expensive

Other observers (e.g. Imle [36], Lucon [49]) think that it would be cheaper to build the downstream project in Timor-Leste, as the pipeline would be shorter. We examine this possibility in Scenario 4. Here the Australia option is $465 million more expensive than the Timor-Leste option. At the upstream level, the difference between the two options is symmetrical to Scenario 3; here the Timor-Leste location generates the higher netback price and a larger “pie” to split. This means that Timor-Leste’s tax revenues from the downstream project would be boosted by a gain at the upstream level (relative to choosing the more expensive plant in Australia). In this scenario, Timor-Leste’s government would receive around $4 billion more if the plant were located in Timor-Leste than in Australia. But again, most of this gain is zero-sum: Australia would receive at least $2.8 billion less (not counting the taxes on employees and suppliers to the plant). The companies would also do better with the Australia option—in this case because Australia’s company taxation is lighter than Timor-Leste’s, at least under the current Timorese tax rules (but see Box 11).

Table 8. Scenario 4: Timor-Leste “moderate,” Australia “expensive”

Location of LNG plant

Downstream project:

Timor-Leste

Australia

LNG sales price Freight on Board (F.O.B.)

$7.50

 

$7.50

 

Total fixed costs of downstream project

$2,075

 

$2,540

 

Net pre-tax income (total downstream net revenue)

$9,137

 

$9,816

 

Net post-tax income: Downstream private profits

$5,732

62.7%

$6,640

67.6%

Timor-Leste take of downstream net revenue

$3,405

37.3%

$0

0.0%

Other Timor-Leste tax revenue

$235

 

$0

 

Australia take of downstream net revenue

$0

0.0%

$3,176

32.4%

 

 

 

 

 

Upstream project (after CMATS redistribution):

 

 

 

 

Netback price to upstream project (real)

$5.26

 

$5.13

 

Total fixed costs of upstream project

$1,450

 

$1,450

 

Net pre-tax income of upstream project

$39,322

 

$38,178

 

Net post-tax income: Upstream private profits

$15,458

39.3%

$15,004

39.3%

Timor-Leste take of upstream profit

$11,932

30.3%

$11,587

30.3%

Australia take of upstream profit

$11,932

30.3%

$11,587

30.3%

 

 

 

 

 

Totals for project

 

 

 

 

Net total pre-tax income

$48,459

 

$47,994

 

Total Timor-Leste take of project profit

$15,338

31.7%

$11,587

24.1%

Total Australia take of project profit

$11,932

24.6%

$14,763

30.8%

Upstream private profit

$21,189

43.7%

$21,644

45.1%

Other Timor-Leste tax revenue

$235

 

$0

 

Total Timor-Leste tax revenue

$15,573

 

$11,587

 

Scenario 5. Risk discount in Timor-Leste

 

Box 13. LNG spot markets

 

Most LNG is traded under long-term contracts, where one export liquefaction plant agrees with one or several customers to provide large and steady amounts of LNG for many years. The prices are determined separately for each such contract, depending on the negotiation between the LNG plant and the customer, and are often defined by formulas that link them to the oil price. This is different from the market for oil, which has a “spot market” and a “futures market.” In these markets, sellers and buyers can trade smaller quantities and agree to single trades at a time (either immediately—spot markets, or at a defined date in the future—future markets), so that oil tankers can be sent to where the demand is highest at any given time, rather than be committed to a long-term trading relationship. A small spot market is developing for LNG as well, and this trend seems likely to continue. Jensen shows that almost 12% of LNG traded in 2004 was sold under short-term contracts, rather than long-term relationships [39]:

 

The Sunrise International Unitisation Agreement (IUA) requires long-term sales contracts for at least some of the Sunrise gas before a development plan can be approved (see Figure 2). However, if a full-fledged LNG spot market develops, that would be an advantage to Timor-Leste, since it would alleviate the problem of perceived risks of supply disruption that would lead customers to try to negotiate a price discount. In a spot market, Timor-Leste could always sell its LNG at the prevailing market price, making it easier to resist customers’ requests for discounts.

As explained before, another reason locating the downstream in Timor-Leste may be less profitable than the alternatives is that the revenues may be lower, even if the costs are not higher. The reason is that with perceived political instability in Timor-Leste, the buyers of the LNG may worry about the possibility of supply interruptions. Even a record of many years of peace and stability may leave lingering doubts in the minds of purchasers, who may therefore demand a “risk discount” in their purchasing contracts. We examine this hypothesis in Scenario 5.

The size of such a risk discount would depend on many factors, including the perceived prospects for political stability in Timor-Leste when the contract is negotiated, but also the bargaining skills of the LNG plant and the customer, the availability to the customer of other supply options, and whether a larger and deeper spot market in LNG develops (see Box 13). All we can do is run our projections with a guess at a risk discount. We use 10%, which would be a large discount, cutting the F.O.B. price from $7.50 to $6.75/MM BTU (or from $3.50/MM BTU to $3.15/MM BTU in the low-price scenarios; the effects are similar). We use the moderate cost assumptions, so that Scenario 5 is identical to Scenario 1 except that the LNG fetches a 10% lower price in the Timor-Leste option.

As before, locating the downstream facilities in Timor-Leste brings with it the usual income taxes. But the lower price that the LNG can fetch in Scenario 5 also significantly reduces the netback price and therefore the profitability of the upstream project. Indeed in this comparison, the Timor-Leste option generates aggregate upstream profits that are $4.5 billion lower than the Australian option. This hurts Timor-Leste’s tax revenues from Sunrise upstream exploitation activities, which are about $1.35 billion lower than if the plant were built in Australia, under these assumptions. This goes a long way to cancel out Timor-Leste’s gain in tax revenues from the downstream project, although Timor-Leste’s government finances still gain — about $2 billion — from getting the plant rather than agreeing to locate the plant in Australia and benefiting from a higher netback price. However, the large upstream loss would be shared by Australia and by the companies, who would therefore likely put a lot of pressure on Timor-Leste to acquiesce in locating the downstream facilities in Australia. If the proposed tax rules are enacted (see Box 11 and Scenario 1a), then the taxes to Timor-Leste’s government from the LNG plant would be too small too compensate for a large reduction in its share of upstream profits.

Table 9. Scenario 5: Both “moderate,” lower LNG price for Timor-Leste

Location of LNG plant

Downstream project:

Timor-Leste

Australia

LNG sales price (F.O.B.)

$6.85

 

$7.50

 

Total fixed costs of downstream project

$2,075

 

$2,075

 

Net pre-tax income (total downstream net revenue)

$8,555

 

$9,137

 

Net post-tax income: Downstream private profits

$5,396

63.1%

$6,183

67.7%

Timor-Leste take of downstream net revenue

$3,159

36.9%

$0

0.0%

Other Timor-Leste tax revenue

$235

 

$0

 

Australia take of downstream net revenue

$0

0.0%

$2,954

32.3%

 

 

 

 

 

Upstream project:

 

 

 

 

Netback price to upstream project (real)

$4.74

 

$5.26

 

Total fixed costs of upstream project

$1,450

 

$1,450

 

Net pre-tax income of upstream project

$34,837

 

$39,322

 

Net post-tax income: Upstream private profits

$13,680

39.3%

$15,458

39.3%

Timor-Leste take of upstream profit

$10,579

30.4%

$11,932

30.3%

Australia take of upstream profit

$10,579

30.4%

$11,932

30.3%

 

 

 

 

 

Totals for project

 

 

 

 

Net total pre-tax income

$43,392

 

$48,459

 

Total Timor-Leste take of project profit

$13,738

31.7%

$11,932

24.6%

Total Australia take of project profit

$10,579

24.4%

$14,887

30.7%

Upstream private profit

$19,075

44.0%

$21,640

44.7%

Other Timor-Leste tax revenue

$235

 

$0

 

Total Timor-Leste tax revenue

$13,973

 

$11,932

 

Conclusion

It is important to understand the limitations of this analysis. Firstly, it is based on very uncertain estimates of the revenues from and costs of the Sunrise upstream and downstream developments. The scenarios are only educated guesses, meant more to convey qualitative judgments than precise quantitative projections. Secondly, the scenarios discussed above (except Scenario 1a) assume that Timor-Leste’s general domestic taxation regime in its current incarnation will apply to a downstream project located in Timor-Leste. But that taxation regime is not particularly attractive to investors, who may bargain with the government to secure more favorable tax treatment. Note that the IUA envisages (and these calculations assume) that the downstream project will earn a nominal 10.5% internal rate of return before taxes, the most important of which is the 30% income tax (under current tax rules; see Box 11). That leaves a very low after-tax return for private investors, who may choose not to invest in a Timor-Leste LNG project if they have lower-risk projects with similar or higher returns available to them. In other words, to attract investors who can finance such a multi-billion-dollar investment, the government may be obliged to grant special tax benefits. This would change the fiscal benefits in the above scenarios in the predictable way: the tax benefits from locating the downstream project in Timor-Leste would be smaller, and would not weigh up as much for falls in upstream tax revenues caused by possible higher downstream project costs (Scenario 3) or risk discounts (Scenario 5).

On the other hand, we have not included other possible revenues to the state from locating the downstream project in Timor-Leste. One obvious source of additional revenues would be land rent: since the Constitution prohibits foreigners from owning land, a liquefaction facility would likely need to lease land from the government. The Law on Leases of Government Land (Law No. 1/2003) provides legal tools for securing both the rent on the land and the maintenance of the natural environment (see Chapter 6). Leases of up to 50 years are available for major commercial and industrial uses, with provision for special cases for longer periods, as would likely be required for an LNG facility.

Keeping these qualifications in mind, we may draw some tentative conclusions regarding the fiscal consequences of the decision about where to locate the pipeline and liquefaction facilities:

  1. The downstream taxes are much smaller than the upstream taxes, but they are still economically very significant.

  2. All other things being equal (in particular the sales price of LNG and the costs of building and operating the pipeline and plant), the government of Timor-Leste would stand to receive large tax revenues from locating the downstream facilities in Timorese territory. This conclusion depends on the tax regime to which the pipeline and plant owners are subjected.

  3. Timor-Leste would benefit fiscally from locating the downstream facilities in its territory even if it entailed considerably higher costs of downstream construction and processing.

  4. Timor-Leste would benefit fiscally from locating the downstream facilities in its territory even if this entailed a small risk discount on the sales price of LNG to the customer, but if the risk discount becomes substantial; the benefit diminishes. In the tentative projections presented here, a risk discount of about 10% of the F.O.B. price of LNG still yields significant fiscal benefits to Timor-Leste from getting the plant, provided current taxation rules apply.

  5. A more lenient tax regime for the downstream facilities than current domestic taxation law would correspondingly reduce the fiscal benefits to Timor-Leste of locating the project in its territory.

Continue to Chapter 5. Employment and Infrastructure

Go back to Chapter 3. The Plant

Return to Table of Contents

 

The Timor-Leste Institute for Development Monitoring and Analysis (La’o Hamutuk)
Institutu Timor-Leste ba Analiza no Monitor ba Dezenvolvimentu
Rua dos Martires da Patria, Bebora, Dili, Timor-Leste
P.O. Box 340, Dili, Timor-Leste
Tel: +670-3321040 or +670-77234330
email: 
info@laohamutuk.org    Web: http://www.laohamutuk.org    Blog: laohamutuk.blogspot.com