The Government has made a very significant contribution of $40.5m to closing the 2003-04 MYBU financing gap from policy and administrative measures on domestic revenue and expenditure. This has been achieved by focussing on measures which reduce cost overheads (efficiency savings) but do not impact on services delivered to the community.

The Government’s contribution is almost as large as the contribution of $53.8m from improved Timor Sea developments. While part of this arises from improved compliance with tax laws, most comes from higher world oil prices, improved production volumes and changes in the commencement of depreciation deductions for tax purposes. Higher contributions from development partners arising from greater commitments and exchange rate adjustments have also reduced the fiscal gap by $6.2m. Despite these significant improvements a financing gap of $30.3m remains.

Timor Sea taxation revenues are highly volatile and difficult to forecast. They are influenced by factors beyond the control of Timor-Leste. This leaves Timor-Leste significantly exposed to shifts in its CFET budget. Table 2.4 shows the impact on the CFET fiscal gap as a result of scenario analysis of Timor Sea revenues, using a high case scenario and a low case scenario.

Table 2.4
Fiscal Gap Under Different Scenarios ($m)

If the high case scenario for Timor Sea revenues eventuated then there will be no financing gap in any future year and $90.0m would be available for savings or additional expenditure. In this case, the Government would be inclined to save the additional revenue in its petroleum fund and spend any unused budget support on capital and development projects agreed with development partners.

If the low case scenario for Timor Sea revenues eventuates then the financing gap will increase to $138.1m over the next four years. This is well beyond the scope of Timor-Leste’s current resourcing to manage unassisted. This possibility is one of the reasons that Government is requesting an extension of the budget support provided by TSP beyond 2004-05 and into 2005-06 and 2006-07.

The very real possibility that Timor Sea revenues are substantially (over $100m) lower than those contained in the 2004-05 Budget also supports the Government’s strong savings policy. Timor Leste needs to plan to keep sufficient reserves to fund core CFET expenditure against the possibility that Timor Sea revenues could be very low. Table 2.5 shows the Budget estimates of the balance of FTP savings under current policies and the balance of CFET reserves.

Table 2.5
Estimates of Timor-Leste Savings

These reserves would also include any potential to fund spending from petroleum fund savings and concessional loans. While no decisions have yet been taken, this suggests that these options be held in reserve and not used at this stage .

Policy on saving or spending the FTP petroleum savings will be made in the context of the establishment of a petroleum fund. A petroleum fund advisor is expected to provide advice in early 2004-05 and leading to the establishment of the fund in law by the end of 2004-05. Decisions about concessional loans will be made after the Government has received a feasibility study that was requested from the World Bank on IDA loans in September 2003.

As reported in the 2003-04 MYBU, decisions on petroleum savings and concessional loans will also be contingent on the decision by development partners about their contributions to filling the CFET financing gap, whenever these are less costly than other options in regard to public investment.

...

TIMOR SEA DEVELOPMENTS AND RISKS

The Timor Sea revenues are based on many assumptions, including for world oil prices and production quantities. As reported in the 2003-04 MYBU, “the appropriate assumptions to use for forecasting change as new information becomes available and as conditions change”.

For the 2004-05 Budget, the key changes in assumptions have been:

	an increase in assumed world oil prices (West Texas Intermediate basis) to an average of about $24 dollars over the rest of the decade (increases revenue estimates);
	an increase in production volumes in 2004 from 11.8 mmbl to 15.5 mmbl (increases revenue estimates);
	a delay in the commencement of tax depreciation from January 2004 to April 2004 (increases revenue estimates); and
	an increase in construction costs largely associated with a weaker US dollar (decreases revenue estimates).

The 2004-05 Budget estimates of Timor Sea revenue are for $157.6m over the next four years. However, if the high case scenario eventuates then Timor Sea revenues will be $277.9m. In contrast, if the low case scenario eventuates then Timor Sea revenues will be only $49.8m over the next four years.

There are very large risks to Timor Sea revenues over the next four years. Revenue could be over $100m lower than the 2004-05 Budget estimates or it could be over $100m higher. In addition, these scenarios are not the maximum or minimum for revenue – the variation in revenue could be greater than that shown in the scenarios. For example, the low case scenario is based on an assumed price of $22 per barrel, but oil prices could be much lower – they have varied between $18 and $36 over the last five years and averaged about $19 from 1986 to 1999. Timor-Leste must manage these very large risks by putting in place appropriate policies, such as building up a sufficient level of reserves. Timor-Leste seeks assistance from development partners to enable it to do so.

...

Relations with Immediate Neighbours

The excellent communications with Indonesia continued during the period, with commitment to good relations at the highest political level on both sides. However, progress on resolving a number of pending bilateral issues has been slow. Some 16,000 former refugees remain in West Timor. Also, a durable solution is yet to be found for the outstanding cases of East Timorese children separated from their families. The target date of 30 November 2003 for the two governments to finalize a provisional border demarcation line was not met, although technical work continued in spite of some logistical and other difficulties. There is a continuing need for communication and dialogue between the security agencies of Timor-Leste and Indonesia to guard against misunderstandings and undesirable unilateral actions.

The first round of negotiations with Australia on the maritime boundaries concluded on 22 April 2004.
Timor-Leste presented significant material in support of its position, but there was little progress. Although Timor-Leste proposed the next round of discussions in May 2004, the Australian delegation preferred to wait until September 2004 to resume the talks. A fair delineation and just distribution of the Timor Sea mineral resources would strengthen the relations between the two countries and contribute to the improved economic well-being of Timor-Leste. Australia, however, continues to promote and emit licences for oil and gas exploration in zones that are situated in areas of overlapping claims and recognised as areas joint exploration by Dili and Canberra

...

JOB CREATION (TSP II) ...

Government continued its efforts, as part of its normal exchanges with the Timor Sea operating companies, to encourage investment by those companies in onshore non-oil and gas sectors. Currently, the petroleum code and the Law of Mineral Exploration are currently being drafted and are in their concluding stages.

...

PROPOSALS UNDER TSP III (2004-05)
Petroleum Fund

During 2004-05, the Government plans to establish a petroleum fund. The fund which will be created
after ample consultation, will be established on the principle of inter generational justice, would go to implement adequate governance provisions for proceeding with investments.

The fund will have to implement adequate governance and policy arrangements for Timor Sea revenue. The Government has been consistent with the principles of the so called “Extractive Industries Transparency Initiative”. The Government anticipates utilising these very same principles after the fund has been created.

The Government is conscious that it will be obliged to divulge completely the effective payments by operators to the Government. The IMF and the Government of the Norway are providing technical support in regard to the establishment of these arrangements In this context, the establishment of the petroleum fund is foreseen in TSP III.

...

PART 6 – REVENUE

Revenue estimates in the 2004-05 Budget for the next four years show an increase if compared with the 2003-04 MYBU. This expected increase in revenue is due to:

	an increase in the market price of oil;
	better than expected progress in the development of the Bayu Undan project; and
	improved administrative management of the Timor Leste Revenue Service (TLRS), Customs Service and other agencies.

The aforementioned increase in total revenue for Timor-Leste for the 2004-05 Budget includes First Tranche Petroleum (FTP) and revenue from autonomous agencies, and is compared with the estimates made in the 2003-04 MYBU.

Table 6.2
Timor Leste Total Revenue ($m)

The Timor Sea revenue is subject to large risks and Timor-Leste will face challenges in relation to the receipts of revenue. This could mean a reduction in revenue of $100m over the next four years due to risks such as oil prices, quantity of oil production etc. However, revenue could be over $100m higher than the estimates in the 2004-05 Budget if prices and production quantities are high. The magnitude of these effects on Timor Sea revenue is illustrated in the Table 6.3.

Table 6.3
Revenue Estimates for Timor Sea –Sensitivity Analysis ($m)

...

TIMOR SEA REVENUE

The methodology used to generate numbers for the Timor Sea revenue estimates for the 2004-05 Budget over the next four years (2004-05 to 2007-08), was to meet with the project operator, in order to get information about their production estimates, and to consider world oil prices and the fall of the exchange rate of the US dollar. Also meetings were held with the Timor Sea Designated Authority, Timor Sea Office and the TLRS in order to analyse the information obtained from the operator to generate estimates that are as accurate as possible. Information given by the operator became an important base for Estimates on Timor-Leste revenue.

The Timor Sea forecasts were updated using the latest information for Bayu Undan from the operator on;

	higher oil prices;
	revised upstream investment costs;
	revised tax on upstream investment;
	revised LNG plant investment cost (including changing exchange rates);
	revised pipeline investment costs;

	2004 $25.41
	2005 $24.03
	2006 $23.49
	2007 $23.35
	2008 $23.26
	2009 $24.43 (Thereafter increasing 2.5% per annum).

Estimates in the annual 2004-05 Budget for value added tax (VAT) from investors over the next few years is expected to decline, as the volume of investment activities for Bayu Undan is completed. Income tax is yet to display signs of an increase as production on the Bayu Undan Project has only just begun. At this stage the product of Bayu Undan has not yet been sold on international markets. In addition, tax depreciation will significantly reduce taxable income for the next five years. The EKKN project is expected to experience a decline in production for the current year and next year and cease its production in 2006.

Income Tax is expected to experience an increase in revenue for 2005 caused by Bayu Undan starting to achieve its full production and being sold to the international market. Income tax collections are therefore expected to rise. They will also rise when the pipeline commences operations. The large effect of the risks and uncertainties on Timor Sea revenue estimates is best illustrated by scenarios.

The high case scenario and low case scenario are based on better or worse outlooks than the assumptions used for the budget estimates. From the start of 2000, world oil prices (West Texas Intermediate) on the international market have ranged between about $18 and about $36 per barrel. For the previous period between 1986 and 1999 the average price was about $19 per barrel. This can provide reference points for the current status of world oil prices. The revenue of Timor-Leste could be higher than that indicated in the high case scenario, or could be lower than that illustrated in the low case scenario.

There are several scenarios for revenue from Bayu Undan, namely the:

	high case scenario;
	low case scenario; and
	the 2004-05 Budget scenario.

FIRST TRANCHE PETROLEUM (FTP) FOR THE LONG TERM

The Government of Timor-Leste has adopted a policy to save all First Tranche Petroleum (FTP), which is the royalty component of Timor Sea revenue. The policy aims to secure savings for development in the future. This policy was implemented several years ago, and the latest estimates are shown in Table 6.8.

Table 6.8
FTP and savings from FTP ($m)

Higher oil prices and the faster than expected development of Bayu Undan will contribute to a higher level of revenue for FTP from the Timor Sea for the Timor-Leste Government in the 2004-05 Budget compared to the 2003-04 MYBU. Interest generated by the FTP savings from the Timor Sea are expected to increase due to an increase in FTP savings. Also the bank interest is expected to increase annually.

Estimates indicate that savings accumulated from the FTP at the end of 2006-07 will reach $96.3m, in comparison with the 2003-04 MYBU of $91.6m. It is likely that Timor-Leste will have fluctuations in revenue. Timor-Leste could use its FTP savings to maintain desired levels of Government spending at some future time.

TSP ANNEX 2

Draft FY2005 Action Matrix for Third Transition Support Program (TSP-III)

TSP ANNEX 3

12. Two years into Timor-Leste’s existence the Government clearly emerges as the country’s strongest institution. It has established core planning and resource management functions that are effective and transparent, and compare very favorably with those of other low income countries. Prominently, and consistent with world-wide best practice, the Government has adopted a transparent savings rule for oil and gas revenues, and has consistently applied this rule (Box 2). A more permanent rule will be established in the context of the Petroleum Fund Law which is under preparation. Yet the system is vulnerable in the face of decreases in international advisors, as indicated by a recent assessment of the Ministry of Planning and Finance, and will need to be supported by continuous institution building efforts to enhance the credibility and sustainability of rules and practices.