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Excerpts from
East Timor's National Development Plan
May 2002

3. THE DEVELOPMENT STRATEGY

"....the overriding goals for the development of the country (East Timor) are to reduce poverty......and to promote rapid, equitable and sustainable economic growth....."

Administration of Oil and Gas Revenues

3.25 The projected flow of significant oil and gas revenues currently expected to begin in 2004/05 or shortly thereafter, is a blessing to the people of East Timor. It will allow them to more fully address their development needs and priorities, further strengthen their human resources, consolidate the gains achieved so far, accelerate and sustain economic growth, reduce poverty and improve the welfare of all East Timorese. According to present indications, the flow of significant oil and gas revenues is expected to be of limited duration – between 20 to 30 years – depending on the types of petroleum products extracted, world prices and new discoveries.

Prudent management, saving, investment and utilization of the windfall in oil and gas revenues provides a valuable opportunity for East Timor to build its human, physical and economic capacities, and graduate to a middle-income country. The thrust will be to utilise the resources for the benefit of present and future generations of East Timorese, and curb the temptation to squander the windfall in ostentatious consumption. The Government is already benefiting from the advice and assistance of Norway on the latter’s experience in managing petroleum revenues in a sustainable way.

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Fiscal/Budget: Domestic Revenues

Timor Sea Oil and Gas Revenue

8.10 On July 5, 2001, East Timor and Australia signed the Timor Sea Arrangement (TSA) with the intention of converting this to a Treaty upon East Timor’s Independence. The TSA establishes a Joint Petroleum Development Area (JPDA) in the Timor Sea pending a final delimitation of seabed boundaries. Under the TSA, East Timor will receive 90% of petroleum from the JPDA and Australia 10%.

8.11 There is one small producing oilfield in JPDA, Elang Kakatu; although this is expected to close around the end of 2002.The Bayu Undan liquids project (condensate and liquid petroleum gas) was approved in 2002 and should begin production early in 2004. Full gas development at Bayu Undan depends upon Australian regulatory approval of part of the understandings on fiscal terms reached between East Timor and Bayu Undan contractors in December 2001. Meanwhile, in March 2002 the contractors announced a gas sales agreement with Japanese utilities for LPG from Bayu Undan Gas. The Greater Sunrise gas-condensate field lies partly within the JPDA as defined in the TSA. A development arrangement for this field has yet to be agreed among the joint venture partners.

8.12 There is still much uncertainty about revenue prospects from the Timor Sea. The main uncertainty relates to whether particular projects will proceed at all. Further uncertainty remains about the gas pricing method. Even if these uncertainties abate, East Timor will still be exposed to the risk of lower than expected world prices for oil and gas. It is therefore appropriate for East Timor to forecast Timor Sea revenues with caution.

8.13 If oil prices remain above US$18 per barrel (Brent Crude) then the Bayu Undan field is estimated to yield (in current prices) US$1.8 billion to US$ 3.2 billion to East Timor over the project life up to 2021. The higher figure assumes that full gas development occurs, while the lower assumes it does not. This is a "base" forecast, with an equal chance of a better or worse outcome. Accordingly, East Timor’s fiscal planning should use conservative estimates until there is confirmation of higher prices or new development outcomes.

8.14 The Bayu Undan Phase-2 project, if developed would be a dry gas project based around either a pipeline to Darwin or a floating manufacturing facility at the well site. Possible additional capital costs (extraction only) are around US$500 million. Gas reserves are estimated at 3 trillion cubic feet. The potential revenue to East Timor over a 20-year site life has been tentatively estimated at US$1.4 billion (current prices).

8.15 Annual revenues from Bayu Undan from FY 2006 to FY 2009 (oil and gas) are unlikely to exceed US$100 million; perhaps just sufficient to support planned public (budget) expenditures during those years. Thereafter, revenues are estimated to be higher for a decade or more. East Timor needs to finalise and implement a revenue smoothing and savings strategy well before then.

8.16 While there may be substantial uncertainty about Timor Sea revenue flows, it is clear that for the next three years at least such revenues under any scenario will be insufficient to finance government expenditure needs. There are also prospects that there will be shortfalls in revenue beyond FY 2005. The position may improve in the following years, but no substantial excess of revenue is likely until around FY 2010.

8.17 The long term implications of the oil and gas sector are covered in more detail later in this chapter. The remainder of this section concentrates on anticipated revenues to FY 2007, which are detailed in Appendix Table 2, Table 8.2 and Figure 8.6.

Table 8.2: Distribution of Timor Sea Revenues, FY 01 to FY 07

Figure 8.6: Components of Total Government Revenue, FY 2001 – FY 2007 (US$m)

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Two Critical Financing Issues

8.36 Arrangements for financing expenditure over the Plan period take on importance in East Timor. There are two significant issues for medium term financing, which are:

a) Proposed management approaches and outlook for oil and gas revenues.

b) Aid management policy and the preferred forward aid program.

Proposed Management Approaches and Outlook for Oil and Gas Revenues

Introduction

8.37 The short to medium term outlook for oil revenues has been set out at 8.10 above. It depends heavily on the outlook for Bayu Undan which is currently under construction. Apart from this approved petroleum liquids project (with approval on the gas phase still pending), there is one other highly promising site under consideration, but not yet approved for development. This is the Sunrise Troubador project, which if developed would be mainly (about 90%) a dry gas project, also based around either a pipeline to Darwin or a floating manufacturing facility at the well site. Based on the feasibility work undertaken the possible capital costs (extraction only) are around US$700 million. Gas reserves are estimated at a significant 10 trillion cubic feet, with potential production of 1,970 petajoules of gas and 70 million barrels of condensate. Potential total revenue to East Timor over a 20-year site life has been tentatively estimated at US$1.0 billion (current values).

8.38 Because no development contracts are yet in place for this potential project and because of engineering, commercial and international diplomacy uncertainties, no direct account has been taken of it in the current national planning exercise. However, it is current Government policy to pursue arrangements whereby these projects will come to full fruition in future years. This will depend on reaching agreement with potential developers on terms and conditions that are satisfactory for both the developers and the people and Government of East Timor.

8.39 The remainder of this section concentrates on the longer-term outlook and management approaches to the Bayu Undan Project. However, while the economic and commercial outlooks for different projects will vary, similar management approaches (as those set out below) are likely to be pursued for all future projects.

Proposed Management Approaches

8.40 Important elements and guiding principles of the management approaches that will be pursued are as follows.

a) The risks of Dutch Disease are now widely known and Government policy seeks to avoid such effects. Common elements of this disease include: (a) booming conditions in the oil sector can cause real upward movements in currency, price and wage levels, leading to diminished competitiveness and prospects for other sectors of the domestic economy, such as agriculture, industry and tourism; and (b) frequently, Government expenditure rises to levels above the effective absorptive capacity of the economy, leading to wastage in both recurrent and capital expenditures of the government budget.

b) Once higher oil revenues start to flow (currently expected to reach peak levels aroundFY 2010), oil revenues will not be taken directly into the budget, but will go initially into an offshore pool of foreign financial savings and investments. These investments will be of a secure nature (Investment Grade AAA only) and will aim to provide a secure stream of interest and dividends income, that can be brought into the budget without diminishing the real capital value of the Fund over time (after it reaches its projected peak level, around twenty years into the Bayu Undan project).

c) The precise mechanisms to implement the above savings goals are still being developed, partly in consultation with officials from the Norwegian Government Agencies responsible for similar mechanisms for supervising and managing oil revenues in Norway. While it is likely that a Norwegian type model and legislation will be introduced within the next 6 to 12 months it is still too early to be precise on all the fine details. However, important elements of the management approach are likely to be as follows:

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The approach will be backed by strong legislation, which will provide quite limited discretionary powers to Ministers to adjust legislated flows of finances either into or out of the Fund. In the first instance all funds received are likely to be deposited offshore.

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The legislation is likely to contain principles to apply to the collection and draw down of funds, with close integration with the budget processes. Some flexibility will need to be built into the principles to allow for changing circumstances and particularly during the early years, to allow for some draw down of capital until such time that the fund reaches its peak capital and earnings level. However, all significant matters affecting the flows of funds are expected to require legislative backing.

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After peak capital levels are achieved, a central principle is likely to be that the real capital value (value adjusted for price and currency movements) of the offshore fund will be at the very least maintained (hopefully it will grow) over time.

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Thus amounts drawn into the budget will be at levels that are sustainable in terms of maintaining the real capital value of the Fund. At the same time the aim will be to draw down amounts in a consistent and regular fashion each year, to allow medium term management of expenditures and the budget in smooth and predictable ways, without abrupt changes from year to year. Appropriate management of expenditures and the total budget from year to year will be critical for successful management of oil revenues.

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Offshore investments will be managed by a diversified range of AAA Grade Investment Funds. Regular monitoring of investment performance of individual Managers and the Total Fund will occur by the MoF and the BPA.

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The Timor Gap Authority (which regulates licensing, production sharing and other matters in joint areas of the Timor Sea) will maintain high standards and will be staffed only with people of high international standing, so as to fulfil properly its licensing and regulatory functions and also to undertake the important role of monitoring collection of tranche 1 and tranche 2 oil payments to East Timor.

bulletThe Revenue Service will be strengthened to ensure proper administration of the collection of oil revenues, using the highest international standards. Where necessary international technical assistance and the international contracting out of particular tasks will be undertaken. Regular and complete tax audits of oil operators will be a common feature of future tax administration.

8.41 Important elements of the financial outlook for Bayu Undan Project (both liquids and gas phases) are as follows:

a) Total of 370 million barrels of condensate and LPG and 3 trillion cubic feet of gas over the 20-year life of the project.

b) Estimated total revenue (from all sources) to East Timor of approximately US$3.2 billion over the course of the project (at current prices).

c) Recent modelling by both the Government and the IMF under quite conservative assumptions of the build up of the offshore savings fund indicate:

bulletThat the fund will achieve peak level in excess of US$1.3 billion (2000/2001 constant prices) in the early 2020s.
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That beyond this peak the Fund should be able to support regular drawings of around US$60 to US$70 million per year (2000/2001 values, but to be adjusted annually to approximately maintain the real value of drawdowns).

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Provided there is solid growth over time in the Non Oil domestic revenues to around 10 to 12% of GDP, the budget should be able to maintain annual total expenditures of around 25% of GDP (US$ 97 million in 2001 values), without recourse to CFET debt financing (though capital and technical forms of donor assistance are still sought over the longer term). This total level of expenditure is broadly equivalent to current plan estimates (where total CFET expenditure in 2006 / 07 levels out at around 25% of GDP – Appendix Table 3).

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In the event that the Bayu Undan phase-2 gas component did not eventuate a somewhat lower level of expenditures would be needed to sustain the real value of the offshore fund in perpetuity.

d) To the extent that oil prices are significantly above US$18 a barrel or that Sunrise Troubador and other prospective sites are developed at a later stage, then the situation presented would be even more promising. In these circumstances it is likely that the peak capital size of the Fund would increase sharply beyond the currently projected levels and that there would be scope for either higher annual levels of capital and development expenditures through the budget than are currently planned or for higher levels of savings for future generations, or a combination of both.

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Key Development Indicators

13.19 The key development indicators for each sub-sector are the following.

Department of Natural and Mineral Resources

  1. Establishment of a database on mining, minerals, oil and gas resources.

  2. Trained cadré of East Timorese to deliver all services to the sector.

  3. Development, promulgation and implementation of legislation and regulations for mining, oil and gas.

  4. Survey and mapping of the minerals, oil and gas resource base in East Timor.

Goals of Each Agency

13.21(d) Department of Natural and Mineral Resources will develop a suitable database, inventory of resources and resource mapping to support management of minerals, oil and gas and to develop promotional material for the sector. These materials will be in place by June, 2003.

Policies

13.22(c) DNMR will identify and join regional and global natural and mineral resources networks, develop strategic alliances that facilitate the appropriate exploitation of East Timor's mineral and natural resources, and promote the minerals, mining, oil and gas resources of the nation to the world.

Programs and Projects:

DEPARTMENT OF NATURAL RESOURCES AND MINERALS

13.24 The Department's development activities are driven by an overarching goal to plan, design and implement an efficient, effective and economic mining, oil and gas sector management and regulatory regime in East Timor. The following three programs will be implemented by the DNMR.

Program 2: Enabling Legal and Regulatory Framework

13.27 Indonesian mining and gas laws, technically, remain effective in East Timor. In reality they are, however, redundant as neither the organisational structure nor the sanctioning authorities are in place to enforce those laws. This comprises a substantial constraint on development in the sector, and one that discourages investors because of the uncertainty it implies. Assistance is needed to develop an appropriate legal and regulatory framework, with UNDP and ESCAP committing to providing such assistance. Once a legal and regulatory framework is established, management systems and procedures will be developed and implemented.

Program 3: Sectoral Development and Promotion

13.28 Reliable information about mining, oil and gas resources in East Timor is lacking. Consequently, the main activities in this program relate to surveying, mapping and the construction of an inventory of the nation’s minerals, oil and gas resources. A reliable resource inventory is needed to: (1) allow the Government, through DNMR, to understand the likely stock of resources and, therefore, be able to manage that stock in the best interests of the nation; and (2) allow potential investors to plan and assess opportunities in East Timor. Furthermore, the proposed remote sensing and GIS based survey and database development forms the main building block of the sectoral development and promotion strategy. Donor support will be sought for this program.

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Excerpt from East Timor Government Budget

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
email: info@laohamutuk.org    Web: http://www.laohamutuk.org    Blog: laohamutuk.blogspot.com