World Bank background paper
	Mid-year Budget Update
	Sector Investment Plan for Timor Sea Oil

1. Domestic Revenues

The outlook for domestic revenue is brighter than visualised in the FY2003-04 CFET Budget. Revised estimates of domestic revenues and the original figures are presented in Table 3.2.

Table 3.2. Revised Estimates of Domestic Revenues ($million)

The domestic revenue outcomes for FY2002-03 and the revenue estimates for FY2003-04 and subsequent years have increased as a result of several factors, which include: (i) new revenue measures adopted by the Government, (ii) continued improvements in the administration of Customs and the ETRS, and (iii) the buoyancy of revenue collections in the first quarter of FY2003-04. The Automated System for Customs Data or ASYCUDA has been operationalised recently. It is combating fraud and evasion and bringing in significantly increased revenue collections from customs.

2. Timor Sea Revenues

The reductions in total revenue estimates arise largely from lower Timor Sea oil and/or gas revenues. The revised estimates of Timor Sea oil and/or gas revenues, based on application of a 15 per cent discount^[1] for future flows from FY2003-04 onward, are presented in Table 3.3.

Table 3.3. Revised Estimates of Timor Sea Revenues ($million)

The factors contributing to the projected decline and delay in the accrual of Timor Sea oil and/or gas revenues include the following:

1. The estimated start of full commercial production at the Bayu-Undan field has been delayed from April to November 2004 due to a delay in the installation of the drilling, production and processing platform; drilling problems encountered, which led to the abandonment of two wells; and lower availability of the facility than previously expected resulting in less downtime for maintenance;

2.  Due to the delay in the start of production, Conoco Phillips' production profile for 2004 shows a decrease in liquids production from 22 million to 12 million barrels. This is only about a third of the production estimate of 33 million barrels in 2004 anticipated at the time of the 2001 Bayu-Undan Understandings. This will result in a significant decline in the estimates of First-Tranche Petroleum (FTP) revenues from the Bayu-Undan field; and

3. The FY2003-04 revenues will be reduced because of the higher than expected prepayments of revenues from FY2002-03 under the Taxation of Bayu Undan Contractors Act, and the end of relatively high one-off income tax payments on production from the Elang Kakatua North (EKN) field.^[2]

While the projected Timor Sea oil and/or gas revenues for FY2005-06 and FY2006-07 have been significantly reduced, the revenue estimates for subsequent years have remained broadly unchanged. Thus, the major reductions in revenues are mostly in the next four years. The recent revisions to Timor Sea oil and/or gas revenues are illustrated in Chart 3.1.^[3]

The revenue estimates are based on information supplied by the Contractors and the Designated Authority, modeling by the Government, and revenue collections by ETRS. The near-term estimates are most influenced by ETRS revenue collections, while the medium-term estimates are based more on modeling. All the estimates are based on assumptions, which can change as new information becomes available and as conditions change.

3. First-Tranche Petroleum (FTP) Revenues and Savings

The delays in construction and production at the Bayu Undan field will also reduce the first-tranche petroleum (FTP) revenues. Interest received from Timor Sea FTP savings will also be lower because of lower interest rates on US dollar denominated assets. Revised estimates of the FTP revenues, interest received and savings are shown in Table 3.4.

Chart 3.1. Revisions to Total Timor Sea Revenues ($ million, undiscounted)

 Table 3.4. Revised Estimates of FTP Revenues, Interest and Savings ($million)

Accumulated FTP Savings at the end of FY2006-07 are now estimated to reach $91.6 million by the end of FY2006­07, as compared to $111.2 million presented in the FY2003-04 Budget.

D. Resource Gap in FY2003-04 and Actions Taken in MYBU

Although the lower Timor Sea revenues have widened the overall CFET budget deficit in FY2003-04 to around $10 million, no financing gap is expected for the current fiscal year, largely because of various developments (Table 3.5). The factors contributing to this result include (i) expenditure containment measures taken by the Government, (ii) higher than anticipated donor assistance resulting mainly from the depreciation of the US dollar, and (iii) drawdowns of larger amounts from the CFET savings/balances from previous years.

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 Table 3.5. FY2003-04 CFET Revenue, Expenditure and Financing Estimates ($million)

E. Emerging Resource Gaps in the Medium-Term (FY2004-05 to FY2006-07)

The downward revisions to the Timor Sea oil and/or gas revenue estimates increases the CFET financing requirement to $133.3 million over the three years, before any other adjustments. The medium-term CFET resource position is presented in Table 3.6. Data on the FY2003-04 situation under the MYBU is included in the Table for comparison.

Table 3.6. Medium Term CFET Revenue, Expenditure and Financing Estimates ($ million)

F. Potential Options to Bridge the Medium-Term Resource Gaps

As can be seen from the data in Table 3.6, the magnitude of the fiscal gap is relatively large. The Government is exploring various options to bridge the deficit. The potential options under consideration include the following:

(a) Extending the Transition Support Program (TSP) beyond FY2004-05: The Government intends to explore with Development Partners the feasibility of increasing the level of TSP contributions in FY2004-05 by $10 million, with the rest of the projected deficit of about $20.5m to be filled in the 2004-05 Budget through a combination of expenditure, revenue and asset sale measures; and continuing direct budgetary support for at least two more years (FY2005-06 and FY2006-07) at levels comparable to those under the present three-year TSP.

(b) Redirecting, as far as possible, bilateral and multilateral funds towards priority programs: This will be an important component of the Government's policy dialogue and discussions with Development Partners in the context of the forthcoming discussions on the Sector Expenditure Packages (SEPs) and how they fit in with the formulation by Development Partners of their medium-term country assistance strategies for Timor-Leste;

(c) Raising additional domestic revenue: The scope for any significant expansion in domestic revenue generation is limited given the low tax base.

(d) Raising additional revenue through asset sales: The assets may include parcels of urban land owned by the Government, confiscated goods such as sandalwood, and other equipment and supplies that are not essential for the Government operations.

(e) Constraining growth in CFET expenditures: The focus of CFET expenditures will be on consolidating and improving existing services with any increased funding directed to the highest priority areas in-line with the priorities in the NDP and the Road Map. This includes increased provisions in the forward years for the maintenance of existing capital assets, as well as adequate provisions for service delivery in Education, Health and Infrastructure (roads). Constraining CFET expenditure may have significant deleterious impact on the effectiveness of complementary development expenditures by bilateral donors off-CFET (in the combined sources budget). Also, it is likely to impact negatively on the economy, particularly in view of the fact that the multiplier effect of public expenditure through CFET on the domestic economy is higher than that through the off-CFET combined sources budget. (See also the discussion in Section VI on Some Systemic Issues.)

(f) Utilization of a portion of the Timor Sea (FTP) Savings: The Government will establish the Petroleum Fund for management of Timor Sea revenues, including the enactment of necessary legislation. Any change in the Government's FTP savings policy and procedures governing the utilization of the savings will be considered within the context of establishing the Fund, with the necessary regulations and safeguards incorporated in the legislation.

(g) Concessional loans: At the recent World Bank-IMF Annual Meetings in Dubai, the Prime Minister has requested the World Bank to assist the Government in undertaking a feasibility study to examine the pros and cons of concessional loans.

It is recognized that a combination of the options may be required to fill the medium-term budgetary gaps. The Government plans to explore the options in full consultation with Development Partners and review its policies on expenditure, revenue and asset sales in the FY2004-05 Budget. The outcome will determine if there will be need to consider other options such as drawing down of FTP savings and/or borrowing at concessional terms.

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Notes

Background Document from the World Bank (excerpt)

The Medium Term Fiscal Outlook and Financing Options

It has been confirmed that a substantial financing gap will transpire for FY05, FY06 and FY07. This is due solely to technical difficulties in the start-up phase of the Bayu-Undan oil and gas project which will not affect the lifetime earnings for the project, but will significantly change the production profile in the next three years. In FY05, the financing gap is estimated at USD 20 million over and above committed TSP grant contributions. In FY06 and 07, the financing gap would reach USD 60 million and USD 46 million, respectively. From FY08 on, the Government's budget is expected to be fully financed.^[4]

Table 4: Medium-Term Financing Gap (US$ m)

Source: Ministry of Planning and Finance and Bank Estimates

To bridge the financing gap, the Government is considering seven options which include: constraining growth in CFET expenditures; raising additional domestic revenue; selling assets; mobilizing augmented budget support for FY05 from development partners, and extended budget support in FY06 and 07; asking development partners to redirect grant assistance to priority programs; changing the savings policy for oil and gas revenues; and considering concessional loans from the International Finance Institutions. Given the magnitude of the financing gap, the Government recognizes it may need to rely on a combination of these financing mechanisms.

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The Government may consider using some of the oil and gas revenue savings. Two words of caution are in order here. First, being largely dependent on one oil and gas project, the Government's financing situation will remain very fragile and subject to risks of both technical and economic nature. Hence, it would be wise to maintain a precautionary savings balance at all times, such that at least one year of recurrent expenditures is safeguarded by the combination of domestic revenues and prudential savings. Second, in the NDP the Government had committed itself to maintaining the current FTP savings rule for the first three years following the restoration of independence, FY03-05. For transparency reasons it would thus be desirable to use oil and gas royalties only in the context of the upcoming Petroleum Fund Legislation, which is expected to establish a savings fund for future generations modeled after Norway's and taking a sustainable expenditure path as its point of departure. The Petroleum Fund Legislation will be the subject of an intense information campaign and to be submitted to Parliament in the course of FY05.