The Government of Sri Lanka signed agreements with France’s Total EP and Norway’s Equinor ASA last month, for the exploration of oil and natural gas off the eastern coast.
This is not a shot in the dark because it is now known that Sri Lanka does have gas deposits. An Indian subsidiary of Cairn Energy, a small independent oil and gas exploration company discovered natural gas in 2011. It found gas in two wells which are estimated to have a trillion cubic feet of natural gas and 10 million barrels of condensate according to the Petroleum Resources Development Secretariat.
Cairn did not persue development following falling global oil prices so the government has now signed up with two much larger companies to continue exploration.
The idea that the discovery of oil is the panacea for all of Sri Lanka’s economic ills is an attractive one; we can become rich with little effort and our people will be happy.
Unfortunately, for countries with poor governance the discovery of natural resources often ends in tears. History has shown; repeatedly, that unless a proper framework is set in place the discovery of substantial natural resources is a curse that leaves a country improverished, indebted and often ravaged by conflict.
Juan Pablo Pérez Alfonso, Venezuela’s Oil Minister in the early 1960s and one of the founders of OPEC, complained in 1975: “I call petroleum the devil’s excrement. It brings trouble...Look at this locura waste, corruption, consumption, our public services falling apart. And debt, debt we shall have for years”.
Academic research has confirmed this view, The Open Society Institute, a foundation financed by George Soros, points out that resource-poor countries grew two to three times faster than resource-rich countries between 1960 and 1990 (even after adjusting for differences in population, initial income per head and other variables). Tellingly, resource-rich countries began to lag only after the 1970s- only after oil wealth started to pour in.
If the discovery is commercially viable how does a responsible government go about exploiting it? The Natural Resource Charter provides a set of 12 principles prepared by a group of high-profile economists, lawyers and political scientists, including Michael Spence, 2001 laureate of the Nobel prize in economics; Robert Conrad, an expert on natural resources economics at Duke University, and Tony Venables and Paul Collier, professors of economics at Oxford University.
“We want to provide a policy toolkit,” says Collier, who is also the author of the 2008 book The Bottom Billion: Why the Poorest Countries Are Failing and What Can Be Done About It. “We are not here to tell the government off. We are saying to them: ‘If you want to turn national assets into broad-based development, these are the key steps that you need to get right. These steps are not obvious, as governments and societies have got them wrong over the years.”
The principles of the charter are summarised below:
1. Resource Management should secure the greatest benefit for citizens through an inclusive and comprehensive national strategy, clear legal framework and competent institutions.
2. Resource governance requires decision makers to be accountable to an informed public.
An essential prerequisite for accountability is transparency. However, piecemeal information is not sufficient. The government should disclose information about the whole chain of decisions. For instance, revenue data might be accompanied by information on the applicable tax rates and taxable income. Authorities should make available data and reports on licenses, geological surveys, cadastres and reserves, as well as economic, environmental and social impact assessments. Critically, authorities should also publish contracts and make them readily available online. The government should disclose not only payments and spending, but also the relevant rules across the whole decision chain. In many cases, governments write large parts of these rules into complex contracts hidden from public inquiry. As far as possible, governments should write terms within legislation, which observers can scrutinize more easily than a contract.
3. The government should encourage efficient exploration and production operations and allocate rights transparently. This must start with thorough understanding of their country’s resource base—both the quantum of resource and its geographic distribution. The quantum of the resource base informs key decisions on the rate of exploitation and potential future revenues. A proper assessment if environmental risks are worth the potential reward is needed. Where resources are to be extracted clear property rights must be established and allocated through open porcesses – competitive auctions being the best.
4. Tax regimes and contractual terms should enable the government to realize the full value of its resources consistent with attracting necessary investment, and should be robust to changing circumstances. One of the best types of tax is a royalty which assures the government of a revenue stream from the beginning of production, and also ensures that the country receives some minimum payment for the resource and to cover the social costs of extracting it. If a project cannot sustain a reasonable royalty to cover these costs, it is highly unlikely that the project is a good deal. To work, royalties require accurate measurement of output, well-defined timing rules and good measures of market value for example by tying the royalty to some international and publicly quoted price.
Investors often request that governments with potential or newly discovered resources provide special incentives in the form of tax holidays, accelerated recovery of capital expenses, or reduced royalty or profit rates. A government should resist offering such incentives. If a project cannot bear the royalty or a normal tax on equity investment, the investment is unlikely to be a good deal for the country.
5. The government should pursue opportunities for local benefits and account for, mitigate and offset the environmental and social costs of resource extraction projects. Resource management requires minimizing the costs for affected communities, while enhancing the benefits. Where these costs cannot be eliminated, the government should arrange adequate compensation for those affected. As a general rule, the aim of compensation should be to improve the livelihoods of those most adversely affected by extraction.
6. Nationally owned companies should be accountable, with well-defined mandates and an objective of commercial efficiency. State entities may appeal for a number of reasons: to capture rent for the state in cases where taxation of private companies is considered insufficient; to facilitate transfer of technology and business practices to local companies but carry great risks if governed poorly. At the extreme these companies can destroy rather than create value for citizens, a phenomenon of which there are many historical examples, including most recently Venezuela.
7. The government should invest revenues to achieve optimal and equitable outcomes, for current and future generations. In the event of a windfall there is a great temptation to squander it. The government should consider two overriding objectives: promotion of equity, both between generations, and across society; and efficient use of revenues to maximize welfare. Putting the revenues into a long term reserve fund that is transparent and independently managed is a must.
8. The government should smooth domestic spending of revenues to account for revenue volatility. This is related to the above, if the budget depends on oil prices, every dip in prices puts the budget under pressure.
9. The government should use revenues as an opportunity to increase the efficiency of public spending at the national and sub-national levels. This is also related to the two above, high expenditure of resource revenues can affect the wider economy, causing inflationary pressures, and thus may reduce the value of the revenues. Resource extraction may increase inequality and poor transparency results in corruption.
10. The government should facilitate private sector investments to diversify the economy and to engage in the extractive industry. Large capital inflows may lead to an appreciation in the domestic currency, resulting in reduced competitiveness and a deterioration of domestic manufacturing and export sectors—a phenomenon known as “Dutch disease.” This can leave the country highly dependent on the main natural resource.
11. Companies should commit to the highest environmental, social and human rights standards and to sustainable development. This is one of the most serious criticisms of private sector companies in extractive industry projects. They must take steps that go beyond minimum legal requirements to respect the highest environmental, social and human rights standards; avoid corruption; contribute to sustainable development outcomes; and make public and accessible relevant project information.
12. Governments and international organizations should promote an upward harmonization of standards to support sustainable development. Governments and international organizations that finance, or influence, the policies affecting extractive industries play a vital role in supporting the decisions made by resource-rich governments.
The writer is an independent consultant
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