Petroleum Fund Act

La’o Hamutuk comments

Preamble

This Act establishes a Petroleum Fund which seeks to meet with the constitutional requirement laid down in Article 139 in the Constitution of the Republic. Pursuant to this provision, petroleum resources shall be owned by the State, be used in a fair and equitable manner in accordance with national interests, and the income derived therefrom should lead to the establishment of mandatory financial reserves.

The Petroleum Fund shall contribute to a wise management of the petroleum resources for the benefit of both current and future generations. The Petroleum Fund shall be a tool that contributes to sound fiscal policy, where appropriate consideration and weight is given to the long-term interests of Timor-Leste’s citizens.

The Act and its implementers need to go beyond the vague “for the benefit of both current and future generations.” The Fund Act should specify goals involving transition to the post-petroleum era, human rights, building human and physical assets and capacity, moving towards renewable energy. It should also discourage use of Fund money for military expenditures, weapons, one-time projects, etc. Since the preamble of the Act will be the standard by which the Investment Advisory Board, Consultative Council and others judge whether the Fund is being properly managed, it needs to be explicit, detailed and carefully thought out. This applies to a number of articles below.

Efficient planning and proper execution of public sector budgets are key components of a sound management of the petroleum wealth. The Petroleum Fund is to be coherently integrated into the State Budget, and shall give a good representation of the development of public finances. The Petroleum Fund shall be prudently managed and shall operate in an open and transparent fashion, within the constitutional framework.

As discussed below and in our earlier submissions, the Act should include binding rules to improve the ability of Timor-Leste officials to properly plan and execute their budgets. In the absence of such rules, windfalls of petroleum revenue, magnified by short-term pressures, will almost inevitably lead to bad policy.

This Act lays down the key parameters for the operation and management of the Petroleum Fund. The Act governs the collection of and management of receipts associated with the petroleum wealth, regulates transfers to the State Budget, and provides for Government accountability and oversight of these activities.

Therefore, pursuant to Article 139 of the Constitution and for the purpose of establishing a fund of income from the exploitation of non-renewable petroleum resources for the needs of both current and future generations,

This Act and the Fund should encourage planning for our nation’s post-petroleum era. This would include long-term planning, development of non-petroleum sectors and energy sources, and investing in human and physical infrastructure.

The Government presents to the National Parliament, pursuant to paragraph c), item 1, Article 97, and paragraph a), item 2, Article 115, of the Constitution of the Republic, the following draft law:

Chapter I – General Provisions

Article 1: Citation

This Act may be cited as the Petroleum Fund Act.

Article 2: Definitions

2.1 In this Act, unless the context requires otherwise:

(a)     “Central Bank” means the authority to be established under Section 143 of the Constitution of the Republic or, until such authority is established, the Banking and Payments Authority;

(b)     “Code” means the Petroleum Mining Code and the Interim Petroleum Mining Code agreed and adopted by Timor-Leste and Australia under Article 7 of the Treaty, as amended, varied, modified or replaced from time to time, and regulations made and directions given under it;

(c)     “estimated sustainable income” for a fiscal year means the amount determined  in accordance with the formula set out in Schedule 1;

(d)     “Exchange of Notes” means:

(i)     Exchange of Notes Constituting an Agreement between the Government of Australia and the United Nations Transitional Administration in East Timor, of 10 February 2000; or

(ii)    Exchange of Notes Constituting an Agreement between the Government of Timor-Leste and the Government of Australia, of 20 May 2002.

(e)   “fiscal year” means the period of twelve (12) months from 1st July to 30th June;

(f)    “independent auditor” means an internationally recognised accounting firm appointed for the purpose of auditing the Government accounts as set out in the Timor-Leste law until the administrative, tax and audit courts is established, or thereafter an internationally recognised accounting firm appointed pursuant to Article 34;

(g)   “investment manager” means the Central Bank and any person appointed as external investment manager under Article 12;

(h)     “Minister” means the Minister in charge of finances;

(i)       “Parliament” means the National Parliament of Timor-Leste;

(j)     “payer” means any entity on whom there is an obligation pursuant  to this present Act to make a payment into the Petroleum Fund;

(k)     “petroleum” has the same meaning given to it in the Petroleum Act;

(l)       “Petroleum Act” means the Petroleum Act, 2005, as amended, varied, modified or replaced from time to time, and regulations made and directions given under it;

(m)   “petroleum authorisation” means:

(i)    an access authorisation, a petroleum contract, a prospecting authorisation or a seepage use authorisation, or any agreement made in respect of such an authorisation or contract, granted or entered into under the Petroleum Act; or

(ii)   an authorisation or production sharing contract, or any agreement made in respect of such an authorisation or contract, granted or entered into under the Code;

(n)     “Petroleum Fund” means the Petroleum Fund for Timor-Leste established under Article 5;

(o)     “Petroleum Fund receipts” has the meaning given to it in Article 6;

(p)     “petroleum operations” means authorised activities under a petroleum authorisation;

(q)     “State Budget” means the State Budget referred to under Section 145 of the Constitution of the Republic;

(r)      “tax revenue” means any tax or duty imposed under Timor-Leste law;

(s)      “Timor-Leste” means the Democratic Republic of Timor-Leste; and

(t)      “Treaty” means the Timor Sea Treaty between the Government of Timor-Leste and the Government of Australia signed on 20th May 2002, as amended, varied, modified or replaced from time to time.

2.2 All terms in the present Act that are defined in the Timor-Leste law on budget and financial management have the same meaning given to it in that law.

There should be a specific reference to that law.

Article 3: Scope of the Act

This Act shall provide for the establishment and management of the Petroleum Fund, and the procedural rules relating thereto.

Article 4: Inconsistencies

For the purposes of this present Act, in the event of any inconsistency between the provisions of the Act and the provisions in the law of Timor-Leste on budget and financial management, or between the provisions of the Act and the terms of a petroleum authorization, the provisions of the present Act shall prevail.

Chapter II – The Petroleum Fund for Timor-Leste

Article 5: Petroleum Fund for Timor-Leste

5.1 There is hereby established a fund known as the Petroleum Fund for Timor-Leste.

5.2 The Petroleum Fund shall have an earmarked receipts account, held by the Central Bank in compliance with Articles 14 and 15, into which the Petroleum Fund receipts set out in Article 6 are credited.

5.3 Transfers from the Petroleum Fund shall be made only in accordance with Articles 7 to 10.

5.4 The details concerning the account referred to in Article 5.2, and the State Budget account referred to in Article 7.1, shall be made public through the publication of the operational management agreement to which Article 11.3 refers.

Article 6: Petroleum Fund Receipts

6.1 The following amounts are Petroleum Fund gross receipts:

The Act should forbid any petroleum-related payments, by any party, to places other than the Fund. There should be penalties for companies not complying with the Act, including for making payments outside of the Fund. This should be inserted either in this Article or as a new Article in Chapter VII – Penalties.

(a)     the gross revenue, including tax revenue, of Timor-Leste from any petroleum operations, including prospecting or exploration for, and development, exploitation, transportation, sale or export of petroleum, and other activities relating thereto;

This should include all revenue from the sale of seismic or other data.

(b)     any amount received by Timor-Leste from the Designated Authority pursuant to the Treaty;

(c)     any amount received by Timor-Leste from the investment of Petroleum Fund receipts;

(d)     any amount received from direct or indirect participation of Timor-Leste in petroleum operations; and

(e)     any amount received by Timor-Leste relating, directly or indirectly, to petroleum resources not covered in paragraphs (a) to (d) above.

This should explicitly include money paid by Australia according to the March 2003 “Memorandum of Understanding Between the Government of the Democratic Republic of Timor-Leste and the Government Of Australia Relating to the Exploitation of the Sunrise and Troubadour Petroleum Fields in the Timor Sea” if the IUA comes into effect.

It should also include money to be paid by Australia in compensation for Timor-Leste forgoing downstream development rights or boundaries, as is envisioned in the proposed “creative solution” to the boundary dispute.

Also revenues and compensation to be recovered from Australia for revenue they already collected from illegal exploitation of Laminaria-Corallina and other fields, or from escrow accounts relating to such revenue. Also fines or interest collected on this – plus any damages awarded by a court in connection with these activities.

6.2 In the event that Timor-Leste participates in petroleum operations indirectly, as provided for in paragraph (d) of Article 6.1, through a national oil company, the receipts of the Petroleum Fund shall include the following:

(a)     any amount payable by the national oil company as tax, royalty or any other due in accordance with Timor-Leste law; and

(b)     any amount paid by the national oil company as dividend.

6.3. From the amount received in accordance with Article 6.1, the Central Bank shall be entitled to deduct, by direct debit of the Petroleum Fund account, any reasonable management expenses, as provided for in the operational management agreement referred to in Article 11.3.

Article 7: Transfers

Rules should set binding limits on the amount which can be withdrawn from the Fund in a given year. Otherwise, Parliament could decide to spend the entire Fund in a single year.

7.1 Subject to Article 6.3, the only debits permitted to the Petroleum Fund are electronic transfers made in accordance with this present article, as well as Articles 8 to 10, to the credit of a single State Budget account.

If debits not permitted by this article are made, penalties should be specified in Chapter VII.

7.2 The total amount transferred from the Petroleum Fund for a fiscal year shall not exceed the appropriation amount approved by Parliament for the fiscal year.

This should not be a ceiling, but a fixed amount like the rest of the budget. Unspent money can be carried over to the following year’s budget, reducing the amount needed from the Fund for that year.

This Act should require a specific resolution by the Council of Ministers and the Parliament for each transfer from the Fund to the budget, as in Norway. The resolution should specify the amount of money, what it will be used for, its relation to current Fund income and its impact on future dividends.

All authorizations of transfers, actual transfers, budget resolutions and related reports should be promptly recorded in the Public Register. See proposed new article 32½ below.

7.3. Subject to Article 8 to 10, transfers from the Petroleum Fund by the Central Bank in the fiscal year, shall only take place after publication of the budget law, or any subsequent changes thereto, in the Jornal da República, confirming the appropriation amount approved by Parliament for that fiscal year.

Article 8: Requirements for Transfers

No transfer shall be made from the Petroleum Fund in the fiscal year unless the Government has first provided Parliament with reports:

All of these reports, unedited, should be made public at the same time they are given to Parliament.

(a)     specifying the estimated sustainable income for the fiscal year for which the transfer is made;

The report needs to explain how these figures are calculated, not just the amount, and what assumptions were made.

(b)     specifying the estimated sustainable income for the preceding fiscal year; and

The report should also specify the estimated sustainable income (ESI) for future years, based on the proposed amount of the transfer (if it is less than the sustainable income, future ESI will increase).

(c)     from the independent auditor certifying the amount of the estimated sustainable income in paragraphs (a) and (b).

The auditor should certify the assumptions and models which the ESI is derived from, not only the amount.

Article 9: Transfers Exceeding the Estimated Sustainable Income

No transfer shall be made from the Petroleum Fund in a fiscal year in excess of the estimated sustainable income for the fiscal year unless the Government has first provided Parliament with:

(a)     the reports described in paragraphs (a) and (b) of Article 8;

(b)     a report estimating the amount by which the estimated sustainable income for fiscal years commencing after the fiscal year for which the transfer is made will be reduced as a result of the transfer from the Petroleum Fund of an amount in excess of the estimated sustainable income of the fiscal year for which the transfer is made;

This report should also indicate the impact of exceeding the ESI on the total amount which can be withdrawn from the Fund over time, not only on the reduction of the ESI. If Parliamentarians realize that an excess transfer of $10 this year will cost Timor-Leste $44 over the next 50 years, they might be more reluctant to do it.

(c)     a report from the independent auditor certifying the estimates of the reduction in estimated sustainable income in paragraph (b); and

(d)     a detailed explanation of why it is in the long-term interests of Timor-Leste to transfer from the Petroleum Fund an amount in excess of the estimated sustainable income.

This explanation should include whether or not withdrawals larger than the ESI are anticipated for each of the next few years, and why.

There should be a prohibition on exceeding the ESI level for more than two consecutive years.

Article 10: Transfers for Purposes of Refund of Tax

If required under the law of Timor-Leste, transfers from the Petroleum Fund are exceptionally permitted for purposes of refund of tax, in the event of overpayment of tax under paragraph (a) of Article 6.1. This amount represents a reduction of the Petroleum Fund receipts, and shall not be considered as part of the appropriation approved under Article 7.2.

Does this only apply to Supplemental Petroleum Tax? From our reading of the public consultation drafts of the Petroleum Tax Act and Model PSC, other tax overpayments are credited to the following year rather than refunded. This article should reference relevant articles of other acts.

Each tax refund should be timely and publicly reported as a negative receipt, including the date, amount, payee and reason for the transfer.

Chapter III – Petroleum Fund Investment and Protection

Article 11: Management of the Petroleum Fund

11.1 The Government is responsible for the overall management of the Petroleum Fund.

The February 2005 draft of this Act (8.1) also said: “In the exercise of any management functions and competences entrusted thereto, the Minister shall be accountable before the Prime Minister, and they both shall be accountable before the Council of Ministers and before Parliament".

This should be put back in, to give Parliament the authority it may need to exercise effective oversight.

11.2 The Minister shall not make any decisions in relation to the investment strategy or management of the Petroleum Fund without first seeking the advice of the Investment Advisory Board in accordance with Article 16.

11.3 The Minister shall enter into an agreement with the Central Bank for the operational management of the Petroleum Fund and the Central Bank shall be responsible for the operational management of the Petroleum Fund.

The agreement should be public and subject to approval by the Council of Ministers, the Board of Governors of the Central Bank and Parliament.

The Central Bank (BPA) Board of Governors must be legally constituted so that it can achieve a quorum, which it has not been up to now.

11.4 The Petroleum Fund shall be managed prudently in accordance with the principle of good governance for the benefit of current and future generations.

Article 12: External Investment Managers

12.1 The Central Bank may propose to the Minister, either of its own motion or at the request of the Minister, the appointment of one or more external investment managers to be responsible for managing the investment of amounts in the Petroleum Fund.

The appointment of investment managers should be public.

If they are to be paid from the assets or revenues of the Petroleum Fund, that must be included in the public announcement, auditor’s reports, and estimates of sustainable income.

12.2 The Central Bank may select and appoint an external investment manager proposed under Article 12.1 only if the Minister is satisfied that:

(a)     the external investment manager is a legal person with sufficient equity capital and adequate guarantees and insurances against operational risks;

In addition to the characteristics listed in (a-c), investment managers should have familiarity and experience with ethical investing, as well as long-term asset management.  They must be free of conflicts of interest.

(b)     the external investment manager has a sound record of operational and financial performance; and

(c)     the references and reputation of the external investment manager in the field of fund management are of the highest standard.

They should have an excellent record of integrity and be committed to following Timor-Leste’s principle of the highest level of transparency, willing to forego any predilection they might have to keep information confidential.

12.3 The Central Bank shall be responsible for the tendering procedures required for any appointment made pursuant to Article 12.1, as well as for the contracting of any other professional services under the operational management agreement referred to in Article 11.3, and shall in doing so comply with the substantive provisions of Timor-Leste law.

12.4 The procedures for terminating a contract with an external investment manager shall be laid down in the operational management agreement referred to in Article 11.3.

12.5 The duty of the investment manager is to maximise the return on the Petroleum Fund investments having regard to appropriate risk as indicated by the investments permitted under Articles 14 and 15, any subsidiary legislation under this Act, any instructions by the Minister and the operational management agreement referred to in Article 11.3.

The investment and management of the Petroleum Fund should include ethical guidelines, as in Norway. Maximizing the rate of return is important, but it should not be done at the costs of violating human rights, financing unsustainable development, or profiting from war or occupation.

The Fund should be invested according to socially responsible principles that should be included in this Act, and the investment managers should act according to those principles as well. See proposed new article 15½.

All instructions by the Minister referred to in this article should be public.

Article 13: Quarterly Reports on the Petroleum Fund

13.1 The Central Bank shall present to the Minister quarterly reports on the performance and activities of the Petroleum Fund no later than twenty (20) days after the end of each quarter.

There should be specific requirements for the contents of such reports, including all income, expenditures, and investments made to, from and by the Fund during the reporting period, as well as other information. All management fees and commissions paid should also be reported.

13.2 The Central Bank shall provide for the publication of its reports no later than forty (40) days after the end of the quarter.

There is no need for a 20-day delay between when the report is presented to the Minister and when it is published. In many places in this law, there is a long time after a report is finished before it has to be released or published. Since this involves very little work, it should be reduced to 5 days or less everywhere it exists (see article 32.5 for another example).

13.3 The Central Bank shall ensure that in releasing, or allowing access to, such reports measures are taken to prevent the disclosure of confidential information.

“preventing disclosure of confidential information” which appears here and in many other places is still a problem, even though confidential information is better defined than in earlier drafts. See comments below on article 32.2.

Article 14: Investment Rules

14.1 Not less than ninety per cent (90%) of the amounts in the Petroleum Fund shall be invested only in qualifying instruments described in Article 15.

The Fund is protected against risky investment, but not against unsafe spending. This seems incomplete; it is like locking a window while leaving the door wide open.

14.2 Not more than ten per cent (10%) of the amounts in the Petroleum Fund may be, in accordance with all procedures laid down in this present Act, invested in financial instruments other than those mentioned in Article 15.1, provided that such instruments are:

(a)     issued abroad;

(b)     liquid and transparent;

(c)     traded in a financial market of the highest regulatory standard.

14.3 The range of instruments included as qualifying instruments in Article 15.1 shall be reviewed by the Government, and approved by Parliament, at the end of the first five (5) years of the Petroleum Fund existence, having regard to the size of the Petroleum Fund and the level of institutional capacity.

This review should also include the 90%/10% allocation of instruments allowed under 14.2.

This review and consequent recommendations should be made public. If it results in changing the qualifying instruments listed in 15.1, an act of Parliament should be required to amend this Act.

Article 15: Qualifying Instruments

15.1 Subject other provisions of this present article, a qualifying instrument is:

(a)     a debt instrument denominated in United States Dollars that bears interest or a fixed amount equivalent to interest, that is:

(i)       rated Aa3 or higher by the Moody's rating agency or rated AA– or higher by Standard & Poor’s rating agency; and

(ii)     issued by or guaranteed by the World Bank or by a sovereign State, other than Timor-Leste, provided the issuer or guarantor is rated Aa3 or higher by the Moody's rating agency or rated AA– or higher by Standard & Poor’s rating agency; or