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Estimating the Sustainable Income

Prudence and Sustainability

13 March 2009

Liga ba pagina ida ne'e iha lian Tetum

The Estimated Sustainable Income (ESI) is a guideline for how much money Timor-Leste should spend from its Petroleum Fund each year. The 2005 Petroleum Fund Law defines it as "the maximum amount that can be appropriated from the Petroleum Fund in that Fiscal Year and leave sufficient resources in the Petroleum Fund for an amount of the equal real value to be appropriated in all later Fiscal Years." Follow these links for more information about:

According to the Petroleum Fund Law, Timor-Leste's annual withdrawal should be based on an Estimated Sustainable Income (ESI) calculated as three percent (3%) of the Petroleum Wealth -- that is, of the total of the money in the Petroleum Fund and the expected future revenues (after adjusting for inflation by calculating the Net Present Value) which will be received from oil and gas still in the ground. In theory, this enables the same number of dollars to be withdrawn from the fund every year for the indefinite future, even after Timor-Leste's oil and gas has all been extracted and sold.

In October 2008, the Ministry of Finance estimated this value for the 2009 State Budget based on Petroleum Fund (PF) opening balance of $4,215 million and expected future petroleum revenues of $9,379 million. Follow this link for the Government's explanation of these assumptions and how they calculate $13,595 as the Petroleum Wealth in the 2009 budget, 3% of which is $407.8 million.

ESI estimates depend on several assumptions (educated guesses), because nobody knows what oil prices on the world market will be in the future, exactly how much oil and gas will be extracted from underground and undersea reserves, or what future rates of inflation will be. The following table lists the assumptions the Government used to make their calculation, as well as some revised assumptions that La'o Hamutuk believes are more realistic and prudent than those used by the Government.

ItemAssumptions by Ministry of Finance (MF) in October 2008  Actual value or estimate by La'o Hamutuk in March 2009Impact on ESI
Balance in Petroleum Fund on 31 December 2008$4,215 million$4,197 million (actual value reported by BPA)Reduces ESI by $0.54 million every year.
Future petroleum production from Bayu-Undan (the only field with a development plan)Declining gradually since 2008, running out in 2023, based on information from ConocoPhillips. Follow this link for the numbers.Same as MF, as we have no access to data. 
Future petroleum prices$60/barrel until 2013, then declining to $49 in 2017 before rising slowly after that.  Follow this link for the numbers.The same trend as the MF, but starting with $40/barrel for the next five years. Click here for recent information about the price. On 3 March 2009, it was $41.65.Reduces 2009 ESI by $168.7 million, with similar reductions every year forever.
Short term spending above the ESIPetroleum Fund withdrawal of $589 million in 2009, and then staying at the ESI of about $400 million after that.Based on the Prime Minister's explanation that "2009 and future spending levels [will] exceed the Estimate of Sustainable Income," we use the MF number of $589 million for 2009 and assume $500 million/year for 2010-2012, and at the ESI level after that. Actual spending will probably be higher, as it's unlikely that the 2010 budget will be lower than 2009, which itself has increased 96% from 2008.Reduces ESI by $10.3 million every year after 2012.
Formula for ESI calculation3% of the total Petroleum Wealth, as specified in the Petroleum Fund Law.We agree that it should remain at 3%. However we have also modeled 5%, as some politicians are suggesting. If increased to 5%, ESI declines every year. By 2075, it will reduced by half.
Rate of return (interest) on invested Petroleum Fund3% real annual return -- that is, above the rate of inflation. In recent years, PF returns have been lower than that.Same as MF. However, the global financial crisis has sharply reduced interest rates, and could last for years. 
Discount rate (expected inflation)3%Same as MF. 


 Moving into equities?

The entire Petroleum Fund is currently invested in U.S. government bonds, which provides a safe, but fairly low, rate of return (interest). The Minister of Finance and others have suggested diversifying Fund investments into equities (corporate stocks). This might increase or decrease the rate of return, but will also greatly increase the risk that the principal could be lost.

If the Petroleum Fund had been invested in the stock market six months ago, Timor-Leste would have lost approximately half of its value, more than one billion dollars. The graph below shows how U.S. stock prices dropped during the past twelve months, and they may continue to decline.

During 2008, the Norwegian petroleum fund lost more than 40% of the money it had invested in equities, and it has continued to lose money since then. (Download their complete 8 MB annual report for 2008.)

The four graphs below were generated by an Excel spreadsheet which you can download to try out your own assumptions. All of them are based on the 2009 State Budget, ConocoPhillips' production projections, and estimates of 3% as the real interest rate on PF investments and as the discount rate for calculating the net present value of future oil revenues. They all use newer (actual) data for the Petroleum Fund balance at the end of 2008, as well as the LH interpretation of the Prime Minister's promise to spend more than the ESI for the next few years.

In each diagram below, the assumptions are shown in the yellow area at upper left, and some key results in the blue area at lower left. The graph to their right shows how much money will be available in each of the next 100 years. The Petroleum Fund is intended to provide revenues for longer than that, but looking four generations ahead gives a picture of the long-term consequences of different policies. (Similar graphs produced by the Government show only through 2023, which fails to consider the Petroleum Fund Law's mandate for "wise management of the petroleum resources for the benefit of both current and future generations."

In each graph, the red line represents oil revenues received from taxes and royalties paid by the companies to Timor-Leste each year, in millions of dollars. For now, La'o Hamutuk and the Government both include only revenues from Bayu-Undan, as it is the only field currently in production or under contract. When all other known fields (Kitan, Sunrise, and some others) are developed and included in the ESI calculation, the total future petroleum revenues (and ESI) will approximately double.

The blue line is the ESI for each year, based on the assumptions and withdrawals discussed above. The green line (which sometimes covers up the blue line) represents the actual amount of money withdrawn from the PF each year and transferred to the State Budget.

The dotted line is the withdrawal (green line), divided by the number of people who will be living in Timor-Leste, based on Department of Statistics projections from the 2004 census. It shows how many oil dollars (not millions) the Government will be able to spend for each citizen. Since the cost of government services (education, health, etc.) grows approximately proportionately with population, this provides a more meaningful indication of the results of spending petroleum money than the green line does. Over time, the dotted line decreases, and revenues will have to be found from other sectors, such as by taxing agriculture or tourism, to continue to provide schools and hospitals for Timor-Leste's people. Extrapolated census projections indicate that Timor-Leste will have about eight million residents in year 2100.

The first graph is based on the government assumptions in the 2009 budget, with the slight changes discussed above.

The second graph assumes a starting oil price of $40/barrel (instead of $60), which is more realistic and prudent given the current world market. The long-term ESI has dropped from $392 million to $202 million.

The third graph uses the Government's unrealistic oil price of $60/barrel. However, it illustrates what would happen if the Petroleum Fund Law was revised to allow a "sustainable" income withdrawal of 5% of Petroleum Wealth every year.

The fourth graph uses the more realistic oil price of $40/barrel, as well as an annual withdrawal of 5%. The income available from the Petroleum Fund a hundred years from now will be only about $100 million per year, or $12 for each person. Without strong development of other sectors of our economy, we will be far worse off than we are today.

The Timor-Leste Institute for Development Monitoring and Analysis (Lao 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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