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Excerpts from
World Bank Background Paper for the Timor-Leste and Development Partners Meeting

Dili, 18-19 May 2004

Executive Summary (excerpts)

The projected financing gap for the next 4 years has been reduced from USD 126 million to about USD 30 million, as the result of Government efforts, and a projected increase in oil and gas revenues. A small portion of this reduced gap (USD 1.7 million) comes from increased contributions from development partners, including exchange rate changes. The Government has improved tax administration and proposes much reduced growth in expenditures, together contributing about USD 40.5 million to the reduced gap. Bayu-Undan oil and gas production has accelerated, and combined with a surge in oil prices, this  results in projected oil and gas revenues that are about USD 53.8 million higher than those presented at the December TLDPM. However, oil and gas revenues are subject to tremendous uncertainties in the range of USD 100 million, both on the upward and the downward side. Hence a low and high case scenario for FY05-08 are associated with a financing gap of USD 138 million and a surplus of USD 90 million, respectively. In face of these uncertainties, the Government would like to maintain its request for extending TSP to FY06 and 07 at levels similar to the current contributions by development partners.

DEVELOPMENTS SINCE LAST MEETING AND PLANS FOR THE FURTHER IMPLEMENTATION OF THE NATIONAL DEVELOPMENT PLAN

...
Governance
...

With respect to public expenditure management, the Government is finalizing the Budget and Financial Management Law and expects to submit it to Parliament together with the FY05 Budget Law. The Government is also finalizing a Procurement Decree Law. These legislative pieces are crucial for establishing the basic framework for transparency and accountability in the use of public resources, including oil and gas revenues.

These laws will be complemented by a set of la ws specifically governing the exploitation of petroleum and the use of oil and gas revenues, expected to be submitted to Parliament in the course of FY05. These will include: the Petroleum Mining Code and the associated model production sharing contract for the Joint Petroleum Development Area; a code and model contract for the petroleum production areas outside the JPDA; the Petroleum Taxation Law; and the Petroleum Fund Law. The Petroleum Fund Law will establish a savings policy and governance arrangements for a savings fund. It will be important to hold broad-based consultations on the mechanisms through which the nation’s petroleum revenues will be managed and saved for the benefit of future generations. Timor-Leste is already applying sound principles to the management of oil and gas revenues; the Government has indicated its support of the Extractive Industries Transparency Initiative (EITI) and participated in the London EITI Conference on June 17th 2003. The Government is currently adhering to EITI guidelines in its financial reporting, and may wish to become one of the first countries to receive assistance under the initiative.

...

The Medium Term CFET Outlook and Financing Options

At the time of the December TLDPM it was projected that there would be a financing gap of about USD 126 million over FY05-07, and the Government issued a call to donors for augmented TSP support in FY05 as well as an extension of TSP support to FY06 and 07. Due to several developments, and assuming that all oil and gas royalties will continue to be saved, the financing gap for FY05 -08 has now been revised downward to about USD 30 million in the base case scenario (Table 4).

However, oil and gas revenues are subject to very large uncertainties related to potential variations in both price and production, illustrated by a “low case” scenario with a deficit of USD 138 million to a “high case” scenario generating a surplus of USD 90 million . Hence, while programmed TSP support for FY05 will be sufficient to finance the deficit, mindful of the magnitude of uncertainties, the Government maintains its request to donors for an extension of TSP financing to FY06 and FY07 at levels similar to the current annual TSP financing.

Several factors are contributing to the reduced financing gap. First, projected oil and gas tax revenues have increased for FY05-08, reaching USD 158 million, as opposed to USD 104 million at the time of the FY04 MYBU. Forward estimates for the price of oil have increased since December, and average about USD 24 per barrel for the next four years. Moreover, production is expected to reach 15.5 million barrels of petroleum in 2004, as opposed to 12 million barrels as projected in December. Two additional factors are also expected to have a positive effect on oil and gas revenues over the next four years: a delay in the scheduled depreciation of taxable capital assets, and improved tax administration.Second, the Government has made impressive efforts to reduce the financing gap both by increasing domestic revenue and by constraining expenditure growth. These efforts amount to a total reduction in the projected deficit of about USD 40.5 million. Following improved administration of customs and other domestic taxes, domestic revenue forecasts have been revised upward from USD 88 million to USD 98 million for the FY05-FY08 period. Moreover, the Government proposes to follow a very conservative expenditure path, with proposed CFET spending totaling USD 320 million as compared to USD 350 projected at MYBU. It will focus on consolidating and improving existing services with increased funding directed only to the highest NDP priorities. It will also seek more efficiency in spending, for example by improving the procurement of fuel for the power sector. The proposed cut in expenditure growth is large and any further reductions in projected expenditures would be detrimental to Timor-Leste’s
sustainable development. In fact, Government may wish to consider whether the proposed reduction in expenditure growth would jeopardize achieving the highest NDP priorities, especially the delivery of services most urgently needed in districts and rural communities.

It is important to underline that tremendous upward and downward risks may affect medium term oil and gas revenues. First, as the Bayu-Undan project is in its start up phase, small changes in the price can have a very large effect on revenues since profit taxes disappear below a certain price level. In other words, changes in price do not always have a proportional effect on tax revenues. Second, there are considerable technical risks especially for a country that relies on one project only, Bayu-Undan, and hence production volumes are uncertain.4 Finally, there are marketing risks.

These uncertainties are best illustrated by presenting high and low case scenarios for revenue projections (Table 5). The high case scenario assumes an average world oil price of USD 28 per barrel as well as production levels that are about 18 percent higher than those for the base case. Under the high case scenario, there is no longer a financing gap over the medium term, but rather a surplus of USD 90 million. As oil prices have been well above USD 30 for several months recently, this case is not implausible. The low case scenario is based on an average world oil price of USD 22 per barrel, and production levels that are about 16 percent lower than those for the base case. In the low case scenario, the projected deficit is USD 138 million, which would be extremely difficult for Timor-Leste to absorb given that the re is no room for further cutting projected expenditures. Again, this scenario is not implausible; oil prices averaged USD 19 per barrel from 1985 to 2000.

Table 5: Fiscal Gap Under Different Scenarios ($m)

4 As an illustration of production uncertainties, in 2001 it was estimated that the 2004 Bayu-Undan production would reach 33 million barrels of petroleum. At the time of the FY04 budget presentation the expected production was 22 million barrels. In December 2004, following protracted drilling problems production estimates were again revised downward to 12 million barrels . Today 2004 production is expected to reach about 15.5 million barrels.

The Timor-Leste Institute for Development Monitoring and Analysis (La’o Hamutuk)
Institutu Timor-Leste ba Analiza no Monitor ba Dezenvolvimentu
Rua D. Alberto Ricardo, Bebora, Dili, Timor-Leste
P.O. Box 340, Dili, Timor-Leste
Tel: +670-3321040 or +670-77234330
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