LH submission on Petroleum Fund discussion paper

La’o Hamutuk
East Timor Institute for Reconstruction Monitoring and Analysis
1/1a Rua Mozambique, Farol, (P.O. Box 340) Dili, Timor Lorosa’e
Tel: +670-3325013 or +670-7234330
email: laohamutuk@easttimor.minihub.org
Website

Submission to the Petroleum Fund Steering Group
Ministry of Planning and Finance, Democratic Republic of Timor-Leste

regarding the Public Consultation Discussion Paper on
Establishing a Petroleum Fund for Timor-Leste

Summary

Introduction

The East Timor Institute for Reconstruction Monitoring and Analysis, La’o Hamutuk, appreciates the opportunity to submit our comments on the Public Consultation Discussion Paper on “Establishing a Petroleum Fund for Timor-Leste”^[1] (hereinafter the “Paper”). The issues discussed in the Paper are among the most critical for the long-term future of the people of our new nation, and we welcome the effort by the Government, the Prime Minister and the Ministry of Planning and Finance to invite civil society to participate in this discussion.

La’o Hamutuk is grateful to people in the government and other East Timorese institutions who helped us with information for this submission, especially Mr. Thomas Ekeli, Petroleum Fund Advisor in the Ministry of Planning and Finance and Mr. Abrão Vasconcelos, General Manager of the Banking and Payment Authority, for their patience and willingness to answer our many questions. In preparing this submission, La’o Hamutuk received invaluable expert advice from Global Witness, the Center on Globalization and Sustainable Development in the Earth Institute at Columbia University, the Open Society Institute, the Harvard Law Student Advocates for Human Rights and several individuals. Although we did not agree with all of their suggestions, we appreciate their support and their work to help Timor-Leste develop a Petroleum Fund that addresses its needs and reality. We have attached memoranda from Columbia and Harvard as Annex II and III of this submission.

Our submission is based on the assumption that this consultation is genuine, and that the drafters of the Petroleum Fund and other fiscal policy legislation approach this task with open minds. We hope you will seriously consider perspectives, approaches and information different from those proposed in the Paper, and we look forward to continuing dialogue and consultation as this legislation is drafted, revised and enacted.

This submission will discuss some broader issues than the Paper, as we believe it does not adequately consider many critical aspects of the problem. We will discuss some general concepts, and also suggest some specific measures which should be implemented in law. We also discuss aspects of long-term fiscal policy for Timor-Leste which, although not part of the Fund design, is discussed in the Paper as an important element of Timor-Leste’s long-term development. Unfortunately, we believe that the Paper does not express adequate attention to long-term planning for future generations of Timor-Leste citizens whose ancestors will have sold and depleted their nation’s petroleum birthright. We hope that the influence of International Monetary Fund (IMF) ideology in Timor-Leste will be tempered by others who don’t share the limited vision of international financial institutions, which rarely plan beyond one project or generation.

We share the Paper’s view that petroleum wealth can easily become a curse instead of a blessing. In the back-page editorial of La’o Hamutuk’s October 2004 Bulletin, we discuss how this damnation is prevalent in almost all petroleum-producing countries which weren’t rich before they started to develop petroleum, and how Timor-Leste has all the preconditions for this problem.

The description of the curse on page 8 of the Paper does not mention some of the worst manifestations of the “devil’s excrement.” Nearly all petroleum-revenue-dependent countries experience artificially high prices, substitution of imports for locally produced items, and neglect of non-oil sectors of the economy. Timor-Leste already suffers from all three of these conditions as a result of the large international presence here since 1999 and current free-trade market ideology. They will get much worse over the next decade, as petroleum revenues eclipse the rest of our economy. Any fiscal policy and effective management system for petroleum revenues must take steps to minimize these consequences, which will become devastating after the oil and gas are used up. If they are not dealt with, the good intentions behind the Petroleum Fund will come to nothing.

Unfortunately, good management of government petroleum revenues is not enough to avoid the resource curse. The problem also includes the petroleum companies, international financial institutions, systemic patterns of the petroleum industry, bad or short-sighted political decisions and powerful, industrialized buyers of oil and gas. As we discussed in our submission on the draft petroleum regime,^[3] environmental effects, possible conflicts, community consultation, human rights, long-term planning and other critical aspects of petroleum development must be carefully considered by any country which hopes to benefit from petroleum income.

One of the factors which may allow Timor-Leste to reduce its chances of following the resource curse pattern is that we are developing our oil and gas later than other nations. We can learn much from their experiences and actions, adopting best practices and avoiding some of the most dangerous pitfalls.

The government of Timor-Leste has chosen to follow Norway’s model, regarded by some as the world’s most successful. However, La’o Hamutuk believes that Timor-Leste is very different from Norway, so that some aspects of their model may not be appropriate for our situation. We also encourage Timor-Leste to look at the new Petroleum Law adopted by São Tomé and Príncipe, part of which is described in Annex I of this submission.

Norway was fully industrialized, with a high standard of living, before oil production began in 1970. Over the next twenty years, Norway experienced many problems related to oil revenues, including fluctuating oil prices, debt accumulation, and the contraction of non-petroleum sectors of the economy. Norway’s petroleum fund, created in 1990, was motivated by escalating inflation and debt. Although Norway’s oil and gas revenues continue to make up a large percentage of its total income, the country has managed to keep its economy diversified. In 2005, the Norwegian government expects^[4] net petroleum revenues of $33 billion, with non-oil revenues of $89 billion. They plan to use $12 billion of petroleum money to cover the non-oil budget deficit, and to deposit the remaining $21 billion in their Petroleum Fund. In other words, petroleum revenues will pay for about 11% of the Norwegian national budget.

By contrast Timor-Leste’s oil and gas revenues will pay for more than two-thirds of our national budget. At peak production, annual oil and gas income will be larger than our entire non-oil GDP. Without proper safeguards, our country’s struggle to diversify its economy will be made more difficult by oil and gas production.

Norway has an affluent, well-educated population with a long tradition of democracy, professionalism and integrity in government administration. La’o Hamutuk hopes that Timor-Leste will eventually attain that condition, but it will not happen for generations. In the meantime, our citizens’ grandchildren must depend on legal safeguards to preserve their petroleum wealth, even if Norway doesn’t need them.

Nevertheless, Timor-Leste can learn some important lessons from Norway. Unfortunately, the Paper does not incorporate some of the most important and relevant components of Norway’s system, leading us to wonder if “Norway Plus” has become “Norway Minus.”

La’o Hamutuk is not aware of many successful models of petroleum revenue management, and we have not been able to examine good practices other than Norway and São Tomé. Last January, however, we organized seven representatives of Timor-Leste NGOs to visit Nigeria to learn about the consequences of bad practice. They observed “corruption and repressive government, environmental and social damage, and human rights abuses” as a result of petroleum development, and concluded that “oil and gas revenues do not necessary lead to economic growth. Mismanagement of oil and gas revenues leads to poverty and lack of development.”

As the Paper mentions, oil and gas revenues are not “income” for Timor-Leste, but are really a conversion of the nation’s existing, non-renewable wealth from one form to another, from petroleum to cash. As Timor-Leste has no other significant resources which can readily be marketed internationally, our oil and gas have a key role in ensuring our nation’s economic independence and survival. They also are an essential commodity to industrialized countries, whose economy and lifestyles rely heavily on the planet’s finite petroleum reserves.

In the first sentence of the Executive Summary and on page 11, the Paper states that the Petroleum Fund is for oil and gas wealth “in the Timor Sea.” We hope that this is a misstatement, and that the Fund will be used for revenues from all of Timor-Leste’s petroleum wealth. The law which defines the Fund should specifically refer to revenues from the entire territory of RDTL, including terrestrial and maritime areas, the Exclusive Economic Zone, and any joint development areas, including the one defined by the Timor Sea Treaty. We also encourage the designers of this policy to consider how it would apply to other mineral and non-renewable resources this nation may exploit in the future, since such depletable resource extraction also converts mineral to financial assets.

The Paper assumes that oil prices will decline gradually to $27/barrel, but makes no allowance for inflation or the declining value of the U.S. dollar, so this assumption is that prices will continue to go down in real terms. In reality (as in the previous graph), oil prices will probably rise over the long term, even if there is a short-time decline from the current peak, and gas prices will follow the same trend. Oil and gas resources are globally limited, with new discoveries now happening more slowly than reserves are being depleted. As the world inevitably moves away from this environmentally damaging and increasingly expensive fuel, oil and gas still in the ground in fifty years from now could be even more valuable as a chemical feedstock.

Like everyone else, Timor-Leste will no longer use fossil fuels for electricity, transportation and fuel by the end of this century. If we begin now to convert to local, renewable energy sources, and base the development of our economy on such sources, we will save money, increase our energy independence (especially after our oil and gas are depleted), have a more sustainable economy and be more responsible global citizens.

The graphs and discussion in the Paper appear to assume that Bayu-Undan and nearly-depleted Elang-Kakatua are Timor-Leste’s only petroleum resources. While this is appropriately conservative, it is not consistent with the actual situation and could result in incorrect long-term planning. With a fair, legal determination of the Timor-Leste/Australia maritime boundary, Timor-Leste’s petroleum reserves are nearly three times as large as the Paper considers; even under the unfair Timor Sea Treaty and unratified International Unitization Agreement for Greater Sunrise, our proven offshore resources are much more than the Paper supposes. Onshore resources, unknown at present, could also be significant.

One decision which can help manage Timor-Leste’s petroleum wealth is to determine when and how rapidly to convert our oil and gas to dollars. As La’o Hamutuk has written in The Case for Saving Sunrise, developing our fields sequentially rather than simultaneously will help stabilize, prolong and probably increase revenues from our oil and gas; this applies to other fields as well. Although the current impasse with Australia may force the Government to follow our suggestion, we remain concerned that other decisions about petroleum development are being rushed to explore and exploit most fields as rapidly as possible. These decisions should be made in light of the long-term planning and “resource curse” concerns which motivate the Petroleum Fund.

Article 139 of the Constitution of Timor-Leste declares that undersea and underground resources belong to the State of Timor-Leste, not to a Government which holds office at a particular instant in time. The current consultation will lead to laws and policies that will be in place long after current government officials, advisors, contractors and political parties have faded from the scene. Since our current enlightened leadership will not be here forever, Timor-Leste needs to protect itself against potential abuses from hypothetical ill-intentioned, corrupt institutions and individuals who will be attracted by the many billions of dollars available from our resources.

During the Public Consultation, the Prime Minister was asked about the future, when another Government might not be as concerned as the current one about preserving petroleum revenues for future generations. He said that he was not responsible if the people voted for a future government, implying that re-electing his party forever was the best way to safeguard Timor-Leste’s petroleum birthright. La’o Hamutuk does not get involved in electoral or party politics, but we encourage the current Government to establish structures that protect the people of Timor-Leste regardless of who is in power in the future. This was the rationale behind writing a Constitution three years ago, and it should also underlie the Petroleum Fund and Fiscal Policy.

Timor-Leste will have converted all its oil and gas to cash within two or three generations, an irreversible process. The issues discussed in this Paper will largely determine the quality of life for our grandchildren. If we have not developed non-oil sectors of our society and economy to be self-sufficient in food and other basic necessities, and to generate enough foreign exchange to import what we cannot produce, Timor-Leste will soon revert to its current status as the poorest country in Asia, with unacceptable levels of disease, lack of services and poverty. We should learn the lesson of Nigeria, Africa’s largest oil producer, which can no longer feed its people – although they exported food before 1960, when the first of $300 billion worth of oil was extracted from their soil.

We are concerned that the proposed Fund design puts all decisions about the use of petroleum revenues into the annual budgeting process, which of necessity looks only at the next twelve months. In this environment, it will be virtually impossible to consider the impact on the post-petroleum part of Timor-Leste’s history. As we discuss later in this paper, we believe it is essential for binding restrictions to limit how quickly petroleum revenues are spent, and for what. Non-binding “guidelines” can be ignored or violated without anyone being aware. It would be better to establish lasting principles during the current deliberative process (even if they might be amended or repealed later), than to expect the budgetary process, inevitably influenced by short-term pressures for pork barrel projects, patronage and political gain, to make wise, long-term financial decisions year after year.

Fiscal policy

Some of the most important issues discussed in the Paper involve long-term fiscal policy for Timor-Leste: how much of the oil and gas revenues should be spent immediately, how much should be invested in physical and human assets which will help build Timor-Leste’s economy for a post-petroleum future, and how much should be invested in financial instruments to earn interest and provide revenues after oil and gas reserves are depleted?

We agree with the Government that the optimum fiscal policy for Fund at the present time is the one described as (a) on page 17 of the Paper – maintaining the value of Timor-Leste’s petroleum wealth. Our population is growing rapidly, and we should anticipate the expenses of educating and providing services for the many babies being born today and for their grandchildren’s grandchildren. Nevertheless, we believe the conservative assumptions about future petroleum prices and Timor-Leste’s total petroleum reserve limit spendable current petroleum income to an unacceptably low level under the more far-seeing guideline (b), maintaining fund withdrawals per capita. We also expect that physical investment over the next few years will provide a base to increase Timor-Leste’s economic output, resulting in an increase in non-oil tax revenues and a decline in the birth rate. This fiscal policy should be re-evaluated every two or three years, since over time we will have more accurate estimates of the factors in this paragraph.

Guidelines (a) and (b) involve estimating the total value of Timor-Leste’s petroleum wealth for all time, basing withdrawals on that estimate. But that calculation has a very high degree of uncertainty – not only because the size of the reserves is unknown and future oil prices are unpredictable, but because when the petroleum is sold will affect its price. The 2004-5 RDTL budget^[9] estimates the expected revenue from Bayu-Undan through 2008, and comes up with a range from $49.8 to $277.9 million. As the Budget Discussion Paper says, “There are very large risks to Timor Sea revenues over the next four years.” If projecting petroleum revenues for only four years is so uncertain, it is clearly not possible to make a reasonable estimate of what they will be for forty years or more.

We are not economics experts, but the formula illustrating a “Sustainable Fiscal Policy Guideline” in Appendix III of the Paper seems counter to common sense. It assumes that the value of money in the Petroleum Fund appreciates over time (and hence is discounted to adapt to inflation and the time value of money), but that oil and gas in the ground loses value over time (based on a constant price in dollars-of-the-day,^[10] which ignores inflation). But petroleum is a globally finite resource which will probably increase in price as worldwide supplies are depleted over the next decades. It is unlikely that U.S. dollars will appreciate – during the two and a half years since Timor-Leste became independent, the U.S. dollar declined 39% relative to the Euro. Given the precarious state of the U.S. economy and the large number of dollars loaned to the U.S. government by foreign creditors who may shift their investments to more stable currencies, the decline will probably continue.^[11]

These debatable assumptions could create an incentive to convert the petroleum to cash as quickly as possible. We hope that Timor-Leste’s actual fiscal policy, and any guidelines and/or laws which implement it, will use a model which more closely reflects real-world U.S. dollar and petroleum prices.

Countries with oil revenue windfalls have far more difficulty implementing sound fiscal policy than those without such income. A critical reason for a well-designed petroleum fund is to try to overcome this impediment, to encourage wise economic and financial planning which would have to be undertaken to survive if there were no oil money. Oil money makes it too easy to make bad short-term decisions; the negative consequences of those decisions become apparent only decades later, when a different government is in power. An effective petroleum revenue management system is one component of avoiding this problem.

A Petroleum Fund does not ensure solid fiscal policy, but it can encourage responsible planning and management, helping to shelter each year’s revenues from immediate political and economic demands, making it more likely that wise decisions will be made for long term. In many countries, oil income prevents sound financial decisions –a Fund can assist Timor-Leste’s future leaders in making decisions that are no worse than if we had no gas or oil. In order to accomplish this, we believe that the Fund structure should incorporate rules, not just non-binding guidelines or benchmarks, to limit how quickly the money can be spent. This will be discussed in more detail below.

When economists design fiscal policy, they often consider only economics in evaluating the benefits of different options.^[12] In this world view, everything is measured in dollars, including investment in human capital, and evaluated by its “rate of return.” This way of thinking does not consider people's quality of life, the health of non-workers, culture, recreation, environmental preservation, etc. Since the State of Timor-Leste exists to serve its citizens, not to satisfy the metrics of the IMF or other experts, we hope that a less materialistic evaluation of the results of different kinds of expenditures will be used.

We can group government expenditures (including money from petroleum revenues) into three categories:

Some of the discussions around the Petroleum Fund do not clearly distinguish between the first two types of expenditures.^[13] However, both are part of the government budget, whose deficit is proposed to be paid for with petroleum revenues. The automatic transfer of Petroleum Fund money to meet the annual budget deficit encourages excessive spending in category 1 (which will have the strongest popular demand), without adequate attention to category 2.

In the Prime Minister’s foreword to the Paper, he asks “How much should we spend of the petroleum wealth now, investing in infrastructure and human development, and how much should we save for the future?” But most current spending is not “investment in infrastructure and human development,” but operational costs of the government for the coming year, that will leave no lasting benefit.

La’o Hamutuk agrees with the Paper that both kinds of expenditures are needed, and that it is appropriate to use some petroleum revenues for current consumption and to invest some in physical assets, while saving the balance for the future. We concur that public services, especially health, education and infrastructure (such as roads) are urgent – but we are also concerned about intergenerational equity. We hope that the Government will also invest in human capacity, including education and training for Timorese workers and students, so that eventually we will not have to rely on foreign experts or contractors.

We believe that the transfer of money from the Petroleum Fund to the annual Government budget should not be automatic, invisible or effortless. Rather, as in Norway,^[14] we believe that the Council of Ministers and Parliament should have to enact a resolution – separate from approval of the budget – every time it wants to withdraw money from the Petroleum Fund. Such a 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. If our lawmakers debate and vote each time they use up part of our national patrimony, they will be more careful about squandering their children’s inheritance. This will also help make the Fund more transparent to the public, and elected officials can be held accountable for their decisions about spending Fund assets.

We agree that the Parliamentary budgeting process should be kept separate from the management of the Fund, and requiring such a resolution would not infringe on Parliament’s mandate. We also believe that the Fund can be a valuable tool to encourage sound fiscal management, and a mechanism to help implement it. To that end, as discussed in the next section, Timor-Leste should enact regulations to limit how much money can be withdrawn from the Fund and how it can be spent.

Because of the difficulties of managing petroleum wealth, and because the current deliberative and consultative process of designing the Petroleum Fund is less subject to narrow political pressures and lobbying by special interest groups than the annual budget process, we believe it is important to include rules in the Fund legislation to help protect against irresponsible decisions by future Governments and Parliaments. Such rules could take the form of law or of a provision in the RDTL Constitution. In either case, a future Parliament could amend them – but the public would know what their representatives were doing and hold them accountable. A non-binding benchmark or guideline, as proposed in the Paper, can be modified or violated at will.

We do not believe that these rules should define budgeting decisions in detail. We are also not proposing specific rules at this time, but rather advocating the concept of rules which could be developed over the next few months in consultation with the Government, civil society, international experts, Parliament and others, to be incorporated in the Fund legislation.

However, we would like to suggest a few examples of good rules which could be enacted. If the Petroleum Fund drafting committee decides to consider incorporating such rules, La’o Hamutuk would be glad to work with you to design them and to help ensure that civil society is consulted.

Article 95 of the RDTL Constitution gives our Parliament exclusive responsibility to make laws on “the budget system” and oversight responsibilities over the actual budget and its execution. It does not, however, assign to Parliament the responsibility to create the budget itself. Articles 115 and 145 give the Government responsibility to prepare the budget; all Parliament does is approve it. Article 140 assigns responsibility for promoting national and foreign investment to the State; one could argue that a petroleum fund would fall under this as well.

Timor-Leste struggled for decades against Indonesian occupation to create a democracy where actions of public officials are governed by the rule of law, not by the whim of individuals. This struggle is ongoing in various sectors of our and other societies – for example, Timor-Leste’s law on Domestic Violence is a positive move toward protecting the rights of women and children. During the public consultation, the Prime Minister mentioned many times that future generations of Timor-Leste have as much right to petroleum revenues as the present generation, and we agree. As with other rights, laws are the best way to protect these rights of future generations. Such legislation does not threaten the sovereignty of future Governments and Parliaments. Rather, it implements Article 139 of our Constitution that says that our petroleum resources belong to the State of Timor-Leste, not to any transitory government.

We were surprised by the view of some international advisors, including people designing the Petroleum Fund, that the current government should not adopt fiscal policy goals which constrain the options of future governments or attempt “to lock in ‘good’ fiscal policy.”^[15] During the UNTAET period, international advisors (including some from the IMF) had no such reluctance. Before Timor-Leste had even held an election, the IMF and UNTAET adopted the U.S. dollar as East Timor's currency, a decision with long-term consequences. In another example, UNTAET promised oil companies the same contractual terms they had received during the illegal Indonesian occupation, and then negotiated the Timor Sea Treaty (signed within hours of independence) which is binding on governments of Timor-Leste for thirty years. Although these undemocratic decisions may not have been wise, they illustrate that a government – especially an elected, representative one – should feel free to enact legislation which may constrain the decision-making space of future governments if it is in the long-term interests of the citizenry.

Of course, unforeseen circumstances – such as the discovery of large new petroleum reserves, long-term changes in the global petroleum economy, or an emergency facing our nation – could make it advisable or necessary for a future Government to change laws controlling how Fund monies are used, on either a one-time or permanent basis. This is of course possible under our Constitution; any regulation or law can be repealed or modified using the same process which enacted it in the first place. Even a Constitutional amendment can be undone with another amendment to the Constitution. We believe that this is a justifiable and reasonable level of “rigidity,” necessary to protect the rights of future generations.

At a seminar in Dili last March, an international advisor in the Ministry of Planning and Finance rejected a suggestion to give the Fund Constitutional status because it would take too long. But when we are establishing systems which must be effective for generations, the 120 days it takes Parliament to amend the Constitution is a blink of an eye.

The authors of Timor-Leste’s Constitution made it difficult to amend before May 2008, but it may still be appropriate to add an article institutionalizing the Petroleum Fund and the Council of Eminent Persons oversight mechanism. Furthermore, some of the rules suggested above may be appropriate to enshrine in the Constitution, as they are in Alaska and elsewhere. During this public consultation, our leaders repeatedly stated that broad public support for the Fund is essential if it is to be effective. Once that support has developed, many political parties would agree to incorporate it in the Constitution, making it easy to obtain the necessary four-fifths approval in Parliament.

Investing the Petroleum Fund

According to the Paper and speakers at the Public Consultation, the Fund will be invested in low-risk, high-liquidity financial assets outside Timor-Leste. We have several concerns about this recommendation, and also believe that there should be additional rules about how Timor-Leste’s future generations invest their inheritance.

As discussed above, the U.S. dollar is falling rapidly, and is likely to continue to do so as the U.S. economy increases its dependence on money borrowed from overseas. We believe that U.S. dollar-denominated securities are not the most secure or highest-returning investments Timor-Leste can make, and we encourage the Fund’s managers to be more creative. The Banking and Payments Authority (BPA) has invested the FTP money Timor-Leste has already received in U.S. Treasury Notes (although officials have refused to reveal where the money is invested, we believe this to be true.) In the public consultation, the Minister for Planning and Finance mentioned “USD denominated fixed income securities … (eg government bonds with short duration)”^[16] as the proposed Petroleum Fund investment strategy. We believe this decision has already cost the people of Timor-Leste a significant amount of money. Furthermore, we do not think that Timor-Leste’s citizens would want to loan our capital to help cover United States government deficits resulting from their invasion and occupation of Iraq in defiance of the United Nations.

La’o Hamutuk disagrees with the Fund designers’ inclination for short-duration, high-liquidity investments. Not only does this lower the rate of return Timor-Leste will receive, it also reinforces a mindset of withdrawing the money soon after it is deposited. Since the fiscal policy guidelines expect that most of the money in the Fund will be there for decades, it would be better to have a more diversified portfolio, with a significant number of longer-term securities to encourage saving.

One additional drawback of short-term, overseas investments is the necessity for frequent redemption and purchases of securities. This could result in a much money being paid in commissions to brokers or bankers in international financial centers. Since a 1% commission on the Fund will be more than ten million dollars, the incentives for mismanagement are large.

In view of the government’s stated commitment to follow the model of Norway’s petroleum fund, we hope that it adopts their Ethical Guidelines for investment of petroleum revenues.^[17] These include a negative screening and exclusion process of companies that engage in or contribute to unethical actions. A five-member “Council on Ethics” makes recommendations for exclusion. The Council’s recommendations are made public, which we feel is highly important in keeping information available, and if successfully implemented would increase the public’s sense of ownership of the Fund.

Timor-Leste may prefer investments which are consistent with our nation’s priorities and foreign policy, supporting our political and economic interests. For example, we should not invest in TNI-controlled businesses or Australian government securities (until that government respects our sovereign rights in the Timor Sea). We should also avoid investments with negative environmental or social consequences, or which contribute to war and repression. Using our investment money to promote democracy and human rights is one way that Timor-Leste can implement our moral and Constitutional^[18] duty of solidarity with those struggling against oppression. The principle of socially responsible investment should be added explicitly to the Fund’s “Key Principles” in Box 3 on page 15 of the Paper by inserting the words “socially conscious” after “low risk” in point #6; it should also be implemented in law.

In addition to the lucrative commissions mentioned above, there will be other pressures on the Fund managers to invest in particular companies or securities. The Paper proposes that the Ministry of Planning and Finance make the investment decisions, based on advice from an Investment Steering Committee (ISC). We are concerned that the Ministry will be vulnerable to short-term political pressures, since it is also responsible for collecting revenues, preparing Timor-Leste’s budget and managing money for government operations. The center of the Government’s daily financial operations is not the best place to make optimal long-term decisions, and our preference would be for an independent, non-political body to make investment decisions about the Petroleum Fund.

We support the Investment Steering Committee, which should includes members from civil society appointed independently of the Ministry and the BPA, perhaps by the President and/or Parliament. (São Tomé’s law has such a provision; see Annex I.) The ISC could help buffer the Ministry from political pressures by presenting its investment recommendations publicly and to the Parliament. This will help citizens feel a greater sense of ownership of the Fund, and will require the Ministry to explain if it declines to take the ISC’s advice. We also suggest that written guidelines for investment be developed, with public consultation, to help provide insulation against special interests or political manipulation.

Democracy and accountability

Timor-Leste is a Constitutional democracy, which means that the elected government is responsible to represent the wishes and priorities of the citizenry. La’o Hamutuk is concerned that the structure envisioned in the Paper assigns a large amount of power to the Banking and Payments Authority (BPA) and the Ministry of Planning and Finance (MoPF), neither of which is directly chosen by the voters. Both of these institutions have day-to-day financial and administrative responsibilities, and may not always have the generations-long perspective necessary to safeguard our great-grandchildren’s inheritance.

We are not proposing that operational and investment responsibilities be vested in another body. However, we feel that legal, structural and oversight components of this system need to be significantly strengthened. This is not undemocratic – these components will be implemented through the democratic legislative process, and could be changed by a future Parliament. But they are necessary if the Fund is to accomplish its stated objectives.

Independent oversight and supervisory bodies are not unusual around the world, or even in Timor-Leste. The Board of Governors of the Banking and Payments Authority (once it becomes functional) is one such body, as are the Constitutionally-mandated independent Electoral Commission and the Superior Councils for the Judiciary, Public Prosecution, and Defense and Security. Protecting future generations’ rights to the national patrimony is another responsibility which must transcend politics; it should be overseen by a similar body, with members representing various sectors of society and appointed by different organs of government and society. From the perspectives of sovereignty and democracy, such a body would be no less legitimate than, for example, the Ministry of Planning and Finance.

Indeed, the experience to date with the Banking and Payments Authority is not encouraging. The BPA was created three years ago by UNTAET Regulation 2001/30. Sections 16 of that Regulation defines a Governing Board to “formulate policies for the operations of the BPA and supervise their implementation.” The subsequent section enumerates fifteen specific powers of the Governing Board, many of which are essential prerequisites to the basic operation of the BPA. The seven members of the Governing Board include three BPA managers and four outside persons; five must be present to constitute a quorum. The UNTAET Transitional Administrator failed to appoint the necessary members; on 17 April 2002 he issued Executive Order 2002/6 temporarily restructuring the BPA Governing Board to eliminate all outside members; any two of the three top BPA staff would constitute a quorum. This order, which expired two months later, was retroactive to 30 November 2001, perhaps to legitimize extra-legal operations. Upon independence, the responsibility to appoint the BPA Governing Board passed to the Prime Minster, subject to Parliamentary approval. Two and a half years later, the Banking and Payments Authority continues to operate with only three members of its Governing Board, so it cannot conduct business in a legal meeting.^[19] Timor-Leste is fortunate that there not been significant apparent corruption or incompetence in the BPA, but it is unacceptable to rely on the personal integrity of individuals without any legal safeguards.^[20]

In the case of the BPA, laws exist (as no RDTL successor legislation has been enacted, UNTAET Regulation 2001/30 remains in effect) for an accountable structure, but they are not followed. As the Government considers structures to manage and oversee the Petroleum Fund, we hope they will be legally appointed before they receive millions of dollars in public funds.

Effective oversight is essential to any system managing large amounts of public money. We wish the Paper had further developed the Council of Eminent Persons concept and recommended its adoption, rather than merely suggesting it as a possibility. We do not agree that an independent institution to oversee oil wealth management is “dangerous.”^[21] In fact, the Council should have the scope and the authority to carry out its critically important role as trustees for future generations of Timor-Leste citizens.

When it establishes the Council, Timor-Leste should avoid structural mistakes made by other countries. Fewer than half of the Council’s members should hold any position in the Government or Parliament; they should represent various sectors of government, civil society and other institutions. Given the inter-generational responsibilities of the Petroleum Fund, the Council should include both young and elder members. A minority of the members could be appointed by the Prime and Finance Ministers, but others should be chosen by Parliament, the President, and other public institutions. In other countries where the Government appoints the entire oversight body, the body doesn’t even appear to be impartial or effective.

The Council should be able to initiate its own inquiries, as well as receive requests from citizens. It should have complete access to all information in the possession of the Ministry of Finance, the Banking and Payments Authority and the Petroleum Ministry.

We believe that the Paper’s suggestion that the Council report to Parliament does not go far enough. If it discovers situations which warrant further investigation or criminal prosecution, it must have a binding obligation to refer cases and present information to the Provedor and to the General Prosecutor.

The Council should review not only the legality of Fund operations, but also the wisdom of operational decisions. If members of the Council feel it appropriate, they should publish reports or findings in the media, and speak to the public. If the Fund managers fail in their duty of transparency, the Council should make information available to the media and the public about Fund balances, inflows, expenditures, and interest.

The Office of the Provedor should be filled before the Petroleum Fund commences, as the Council of Eminent Persons will probably not have the capacity to investigate Fund operations in detail. The Provedor’s mandate includes investigating anyone with responsibility for public funds or assets, which means not only the MoPF and the BPA, but also Fund operations outside Timor-Leste. During public information and socialization processes relating to the Fund, citizens should be encouraged to request the Provedor to look into any apparent corruption, but also into misguided investment decisions or other maladministration.

In addition to the Provedor, the Fund should be subject to independent, external, annual audits, the reports from which should be public documents. The audits should include any transfer and use of Fund monies inside and outside of Timor-Leste.

The Paper is not specific about what money goes into the Petroleum Fund, or about how it gets there. We believe that these principles should be legally binding not only on the government but on any oil companies, subcontractors, or their agents which make any kind of oil-related payments – taxes, royalties, FTP, bonuses, or anything else -- to any Timor-Leste public agency or official. All direct or indirect petroleum-related payments should go into the Fund; other oil-related payments should be prohibited by law. Although the Paper implies that all interest, dividends and other income earned by the Fund will be redeposited into the Fund, this is not explicitly stated, and should be.

At present, oil companies make pay their payments to the Timor Sea Designated Authority (FTP is subsequently transferred to a special account in the BPA) and to the Ministry of Planning and Finance (East Timor Revenue Service). We suggest that a special account, managed by the Fund’s managers, be established to receive petroleum-related payments directly from companies and their subcontractors or agents. Since no confidentiality should be applied to oil revenues (unlike to other taxpayers), and since oil revenues will be handled separately from other tax receipts, the revenue stream should be separated from the start. Petroleum-related payments should be required to go into this account managed by the BPA, subject to the same transparency and oversight regulations as the Petroleum Fund itself. Companies that make payments elsewhere should be prosecuted, which would discourage a common pathway to corruption in other countries. Contracts with oil companies should include provisions which render the contract invalid if a company makes illegal payments or fails to comply with transparency provisions.

Transparency

“Transparency” has become a cliché among people worldwide who are concerned about the resource curse. We agree that it is important, but it takes much more than repeating the word to create the situation where the public is fully informed, takes ownership and responsibility for Fund operations, and where corruption and misuse of funds are deterred. La’o Hamutuk strongly urges the Fund’s designers to implement transparency throughout this system. Articles 40.1, 41.1 and 53.1 of Timor-Leste’s Constitution guarantee the rights of media, citizens and consumers to information, which makes transparency a mandatory legal right, and not just a prerequisite for good Fund management.

There should be a presumption of transparency in every aspect of the Fund’s operation. Every item of information should be available to the public unless there is a compelling reason (such as national security or personal privacy, neither of which apply to institutional actions) to keep it private. The principle of commercial or other confidentiality that applies to other taxpayers and bank accounts is not appropriate for the Petroleum Fund. If Fund managers or others decide that certain information should not be available, they must explain their reasons in each case to Parliament and to the public.

In pages 4-6 of La’o Hamutuk’s submission reviewing the draft Petroleum Regime, we detailed how the Public Register should be made accessible and what information it should include. We will not repeat all those points here, but they are appropriate for the Petroleum Fund as well as for petroleum operations. We incorporate that section of our previous submission into this one by reference. If the Public Register in the Petroleum Laws is established consistent with our recommendations for accessibility,^[23] the same Register or a similar one could be used for the Petroleum Fund.

Some of our earlier recommendations for inclusion in the Register apply directly to the Petroleum Fund, including:

5. Full texts of every quarterly and annual Production Statement, Value of Production and Pricing Statement, Cost Recovery Statement, and Statement of Expenditure and Receipt.

6. All payments of $1,000 or more to the TSDA, the Government of Timor-Leste (or to any agency or agent of that government or Authority) in connection with petroleum development by any person, corporation or other business. This includes not only income and other taxes and royalties, but any other payments (including bonuses, finder’s fees, etc.) within or outside of Timor-Leste, for the purpose of facilitating or implementing Petroleum activities in Timor-Leste. Each payment report should include the date the payment was made, the amount, the payer, the payee, the purpose of the payment, and any services or goods received in return.

8. All contracts between the Operator and customers for sales of Petroleum from Timor-Leste.

9. Information on loans taken out by Timor-Leste, the Designated Authority or its agents in connection with petroleum development or in anticipation of petroleum revenues. At minimum, this should include dates, amounts, repayment schedules, actual repayments, conditions and collateral offered.

In addition to the documents listed above, the following should also be included on a timely basis in the Public Register in relation to the Petroleum Fund:

La’o Hamutuk is concerned about the current lack of transparency regarding the interim Petroleum Fund, the approximately $20 million already received in FTP money that is being held by the BPA, which will be transferred to the Petroleum Fund once it is established. Although the amount of money is periodically reported, we and others in civil society and the media have repeatedly asked where this money is invested. In response to a formal letter to the Prime Minister, we were told this information is in the annual government budget,^[25] however it is not. Other public officials told us to look in the annual report of the BPA, that report is confusing, with no specific information about where the FTP account is saved. We still have no clear answer, nor any explanation of why this information is not easily available to the public.

The Fund Discussion Paper (page 14) stresses the importance of a public “sense of ownership” of the Fund, and we agree. Ownership requires knowing not only how much is in the Fund, but where it is. If, as the Prime Minister has stated, only NGOs are interested in where the Fund invests its money, both government and civil society have much work to do.

Public consultation process

We appreciate the opportunity to provide our views on the issues raised in this discussion Paper, and hope that the Public Consultation will be a two-way communication. Unfortunately, most of what has been done thus far fits the pattern of socialization rather than consultation.

The invitation for the public consultation meeting on 16 November said “The agenda will include presentations by H.E. the Prime Minister, the Minister for Planning and Finance and the Director General for the Banking and Payments Authority, followed by a session of questions and answers.” Although this is what happened, there was no time to consult the public. Genuine consultation involves more than questions from the floor which can be answered – it includes alternative views, debates, and issues which require follow-up exploration. Unfortunately, the public is hardly ever asked for their views on pending legislation, which may explain why civil society attendance was so limited, and why there were so few questions that the meeting ended early. Although the Prime Minister’s opening of the Public Meeting appropriately signaled the critical importance of this issue for the future of Timor-Leste, his role as the primary presenter and responder to questions may have intimidated some people from speaking up.

The Petroleum Fund Discussion Paper (page 14) says that a “thorough public consultation” was recently conducted on the proposed petroleum regime. Although the consultation on this regime was more extensive than most others on Timor-Leste legislation, it is not yet over (the revised draft laws have not yet been made public) and was far from thorough. In La’o Hamutuk’s submission to that process, we suggested steps for a genuine public consultation; to our knowledge there is no plan to implement much of what we proposed. We notice a change from that August public meeting, where most of the presenters and speakers were internationals, to the one on the Petroleum Fund, where Timorese took the leading roles, and we hope it indicates that citizens of Timor-Leste are increasingly able to replace international “experts” in designing complex systems.

We would like to suggest the following steps for the continuation and completion of a public consultation on the Petroleum Fund and Fiscal Policy:

This is only the beginning

Establishing the Petroleum Fund and developing a fiscal policy and investment strategy are the first and easiest steps away from the resource curse. Far more difficult is to develop other sectors of Timor-Leste’s economy for the day – within the lifetimes of many people alive today – when all our oil and gas is used up.

As we did in our other submission, we strongly urge Timor-Leste to undertake a major long-term planning process, involving the public and others, to develop non-petroleum sectors of Timor-Leste’s economy over the next half-century. The National Development Plan prepared in 2002 looked only to 2020, when we are likely to be receiving maximum revenues from oil and gas. But thirty years after that, Timor-Leste may have no petroleum resources. If we have not developed other sectors of our economy, we will be condemned to perpetual poverty and dependence on imported energy.

If we do not begin this planning and prioritization process now, before large resource revenues flow into our treasury, we will be like people in so many other countries who lament that petroleum was ever discovered under their land and seas. In rich countries, investment managers, oil companies and oil consumers will have benefited from our resources, but their rightful owners, the people of Timor-Leste, will only have suffered.

Annex I: São Tomé e Príncipe: an example to learn from

São Tomé e Príncipe and Timor-Leste share similar history, geography and economic status. Both are small island countries, São Tomé with 182,000 people and Timor-Leste with about one million. Both are former Portuguese colonies whose liberation movements supported each other in the 1970s. São Tomé was one of the last countries in Africa to gain independence, in 1975. Timor-Leste was the last Portuguese colony to gain independence, due to the Indonesian invasion in that same year.

Both countries are in extreme poverty, unable to invest in programs to develop growth and improve living standards, largely dependent on foreign assistance. Agriculture is their main economic activity, in particular coffee developed during the Portuguese colonial period.

Both São Tomé and Timor-Leste have petroleum reserves under their territorial waters, shared in joint development zones with huge neighbors, Nigeria and Australia. The small countries see this as a chance for economic independence and to improve their people’s living standards. But the governments of both countries are also aware that oil revenues bring dangers. São Tomé experienced this last year, with oil greed underlying a bloodless coup attempt. In order to avoid the negative experiences of other oil-producing countries, both governments are currently writing laws and regulations to manage their petroleum activities and revenues, which are expected to increase markedly in the next few years.

São Tomé just enacted legislation for its Petroleum Fund, which differs significantly from the Norwegian model and the proposed model for Timor-Leste.

We are not suggesting that São Tomé’s model is perfect, or that it would be the perfect model for Timor-Leste. But we believe that Timor-Leste can improve its Fund design by learning from the best aspects of São Tomé’s legislation, especially given how similar the two countries are socially, historically and economically.

Unlike Norway, São Tomé e Príncipe is building a “strong” fund, one that specifies the maximum that can be withdrawn each year (the Annual Funding Amount) and the minimum that must be saved for future generations. Its legislation sets percentages, not amounts, adjusted depending on the stage of the exploration.

As with the proposed Fund for Timor-Leste, money withdrawn from the São Tomé fund – within the limits established – goes into the national budget. To make it clear how the money is to be allocated, there are two accounts:

The National Oil Account receives all petroleum revenues, some of which (the Annual Funding Amount) are then transferred to the government budget, with the balance being transferred to the Permanent Reserve.

The Permanent Reserve is intended to convert oil assets into permanent financial wealth, to benefit future generations of São Toméans. This money can only be used in exceptional situations.

This mechanism not only helps identify the petroleum revenue (as does Petroleum Fund proposed for Timor-Leste), but it protects the birthright of future generations of São Toméans.

Article 9 of their law prevents the Annual Funding Amount from being spent unwisely, such as for private projects or increasing military expenditures, and commits the money to development priorities that benefit the majority of the people: “The Annual Funding Amount must be essentially used for education, health, infrastructure, rural development and to enhance the institutional capacity of the State.”

São Tomé’s law also sets good examples in the areas of democracy and transparency.

As with the proposed Fund for Timor Leste, the Annual Funding Amount of the São Tomé’s oil money to be used for budget expenditures is decided in the budget process and approved by the National Assembly, within limits specified by law. But their law also creates two bodies to decentralize decision-making and promote broader participation:

Investment and Management Committee: comprised of the Ministry of Planning and Finance, the Governor of the Central Bank, one member appointed by the President, and two appointed by Parliament (one of whom is appointed by the opposition). Unlike the Investment Steering Committee proposed for Timor-Leste, this Committee is more than advisory. It presents an investment policy to the government, subject to Parliamentary approval, according to principles in the governing law. Those principles include a prohibition of investments in São Tomé’s territory or controlled directly or indirectly by São Tomé citizens.

Petroleum Oversight Committee: comprised of eleven people including representatives of the judiciary, NGOs and unions. This committee has administrative and financial autonomy, with power to investigate and monitor every aspect of the implementation of the Petroleum Fund law and to report to the competent bodies if the law is not respected. This independent committee also selects an international audit company to perform one of the two annual audits for the oil funds.

Both the São Tomé law and the Timor-Leste discussion Paper advocate transparency, but São Tomé implements clear principles to enforce the government’s responsibility to make information public and accessible. These include the requirement to publicize any contract, deal or operations relating to oil revenues within ten days of approval. They also restrict confidentiality clauses, and forbid confidentiality regarding financial aspects.

To involve the public in the design of São Tomé’s Petroleum Fund, the government held a National Forum to consult the people on how they wanted oil revenues to be invested. The National Forum was a unique experiment in participatory democracy and a chance to educate São Toméans about their country's anticipated oil revenues. It illustrates São Tomé’s determination to escape the closed-door politics too often associated with oil economies. The main purposes of the Forum were to give accessible information about the most pressing issues facing the country and help to align expectations between São Toméans and their national leadership, thereby facilitating governance, transparency and accountability.

The Forum included 55 public community meetings around the country, in which citizens were presented with a popular information Bulletin^[27] explaining the oil situation, and asked about their priorities for public investment. The Boletím de Informação Popular focused on imminent possible oil revenues, aiming to give a basic understanding of the country’s potential oil reserves, the new law through which revenues are to be managed, and how those revenues will interact with the national economy.

Citizens were given a questionnaire as a means to gather information for decision makers and create space for public dialogue. Groups of 20-40 people gave their answers, in a deliberative process. Citizens were asked how oil revenues should be used, as explained in the Bulletin, as well as demographic information. Groups were also asked their priorities in the areas of health, education, water and sanitation, energy sources, roads and transportation, and justice and internal order.

The results of the questionnaire were presented at a series of national-level meetings, providing a foundation upon which citizen delegates and political leaders could base their arguments.

Annex II: Comments from Dr. Martin E. Sandbu

La’o Hamutuk requested advice from the Center for Global and Sustainable Development at the Earth Institute, Columbia University, New York, USA to help us better understand the issues involved in the petroleum fund for Timor-Leste. Although we have incorporated some of the ideas we received from Dr. Martin Sandbu^[28] in our submission, we thought it would be helpful to the Timor-Leste Petroleum Fund Steering Group to have his entire memo.

Annex III: Memo from Harvard Law Students Advocates for Human Rights

La’o Hamutuk requested advice from a group at Harvard Law School, Cambridge, Massachusetts, USA^[29] on human rights issues which may be relevant to Timor-Leste’s Petroleum Fund. Although we did not feel that all of their points were appropriate to include in our submission, it may be helpful to the Timor-Leste Petroleum Fund Steering Group to have their entire memo.

Notes

Some of the footnotes in the printed and PDF versions have been replaced by hyperlinks in this web-posted version of this document. As a result, footnote numbers are not consecutive.

[1] RDTL Ministry of Planning and Finance, “Establishing a Petroleum Fund for Timor Leste: Public Consultation Strategy Paper” October 2004. Throughout this submission, we will refer to this document as the “Paper.” Available at http://www.mopf.gov.tp/download/tax_policy/PF-DiscPaper-Final.pdf

[10] This is not apparent in the formula but is stated explicitly on page 7 of the Petroleum Fund Discussion Paper, which assumes that petroleum prices fall gradually toward $27/barrel in dollars-of-the-day. Other estimates on that page also assume that petroleum prices decline at the rate of inflation over the long term.

This very conservative assumption may be appropriate for budgeting and to design the RDTL petroleum tax regime, but they lead to significant undervaluing of Timor-Leste’s Petroleum wealth.

[13] See, for example, the second paragraph on page 16 of the Paper which confuses current spending with saving in physical assets.

[14] Norway Act no. 36 of 22 June 1990, §3 (“The Fund’s capital may only be used for transfers to the central government budget pursuant to a resolution by the Storting (Norwegian parliament). The Fund’s capital may not be used in any other way, nor may it be used to provide credit to the central government or to private sector entities.”).

[15] “Establishing a Petroleum Fund for Timor Leste: Public Consultation Strategy Paper” October 2004, page 18 footnote 9.

“The Government Petroleum Fund is an instrument for ensuring that a reasonable portion of the country’s petroleum wealth benefits future generations. The financial wealth must be managed with a view to generating a sound return in the long term, which is contingent on sustainable development in the economic, environmental and social sense. The Fund’s financial interests should be consolidated by using the Fund’s ownership interests to promote sustainable development.

“The Government Petroleum Fund should not make investments that entail an unacceptable risk that the Fund is contributing to unethical actions or omissions, such as violations of fundamental humanitarian principles, gross violations of human rights, gross corruption or severe environmental degradation.”

[18] Article 10, RDTL Constitution: “1. The Democratic Republic of East Timor shall extend its solidarity to the struggle of the peoples for national liberation.”

[19] UNTAET Regulation 2001/30 says: “24.6 A quorum for the conduct of business at any meeting of the Governing Board shall consist of five members of the Governing Board.” The Board is required to meet at least monthly, but none of the meetings since June 2002 have had a legal quorum.

[20] This problem was described in the January 2004 La’o Hamutuk Bulletin (Volume 5, No. 1). After it was published, BPA General Manager Luis Quintaniero (who has since returned to Portugal) told us that we “didn’t understand” the situation, that he and his subordinates at the BPA were able to perform all the functions of the Governing Board. He was not disturbed by the lack of oversight, independent perspectives or legal legitimacy.

[23] As we wrote: “The Public Register should be available for inspection in Dili. No fees should be charged (except perhaps for photocopying at 5¢/page or less) of Timor-Leste citizens or institutions for inspecting it. The Register should also be available on the internet, similar to the Jornal da República. Most documents and reports can be in the original language or Portuguese, but the most important ones, such as Regulations and Authorizations, should also be available in Tetum and/or Bahasa Indonesia (at least for the next few years). Efforts should also be made to include explanations or summaries of these documents to make them more accessible to less technically trained citizens.”

[28] Postdoctoral Research Fellow, Center on Globalization and Sustainable Development, Columbia University Earth Institute, Columbia University, New York. Email: sandbu@post.harvard.edu

Contents