Energy Analytics & Consulting

Energy Analytics & Consulting
Governance of Extractive Industries in Southeast Asia (scoping study for IESR) Jakarta, Indonesia 17 April 2013 Energy Analytics & Consulting

The “resource curse” and EI governance
Extractive industries (EI) a key source of income for many developing economies Yet resource-abundant countries often perform more poorly in economic terms: the “resource curse” High economic rents from EI lead to greater incentive for misappropriation and corruption EI windfall profits provide government with opportunity to derive political benefit of expanded public sector without the political costs of increasing tax rates Over-reliance on EI revenue can create weak political and economic institutions Governance is central to how effectively countries use their resources Growing emphasis on EI transparency by organizations such as the Extractive Industries Transparency Initiative (EITI) Energy Analytics & Consulting

Objectives and Methodology
Evaluate the governance of extractive industries in South-east Asian countries Methodology Develop a number of case studies from South-east Asian economies Apply assessment criteria for transparency and accountability, quality of regulatory framework and economic efficiency and equity considerations Energy Analytics & Consulting

Case studies Countries Crude Oil Natural Gas Coal Copper Gold Indonesia  Malaysia Philippines Vietnam Cambodia Timor Leste Myanmar Energy Analytics & Consulting

Assessment criteria Transparency and Accountability Transparency Accountability Corruption and Regulatory Capture Quality of regulatory framework Regulatory clarity, coherence and certainty Administrative Capacity Economic efficiency and equity Revenue sharing arrangements Incentives for investment Environmental and socio-political externalities Energy Analytics & Consulting

Key Challenges to EI Governance
Lack of regulatory clarity, uncertainty in interpretation and implementation of policies and regulations Poor administrative coherence, with overlapping jurisdictions between different levels of government and across different ministries and agencies Decentralization not matched by administrative capacity building at regional and local level Small scale mining and its attendant problems (externalities, H&S, sustainability) Regulatory agencies sometimes captured by interest groups (not unique to developing countries) Transparency and Accountability (“rule of law”) in Southeast Asia reflect political and social culture of each country Performance in economic efficiency (maximizing net present value of mineral resources) and equity (distribution and investment of resource rents) varies across countries in Southeast Asia Energy Analytics & Consulting

Political Economy of EI
Between Host Country (HC) and Foreign Investor (FI) Aspects of resource nationalism with unintended consequences, often a function of price cycles or political cycles (elections) HC subject to populist pressure to capture more of the resource rent than originally agreed with FI “Resource trap”: while HC can always extract short run gain, country is hurt in the long run as investment risk premium demanded by MNCs increases “Creeping nationalization” not only in non-OECD countries (such as Bolivia or Venezuela); also includes OECD countries (e.g. Britain in the North Sea, US in Prudhoe Bay) Within HC Resource rents reduces cost of poor governance, as transfers (both legal and illegal) can “buy” important constituencies and powerful interests Large resource rents can subvert rule of law and lead to the “resource curse” (Southeast Asia has generally avoided the worse symptoms) Economic efficiency and equity can be compromised at great cost to HC Energy Analytics & Consulting

Good EI Governance: Fundamentals
For HC-FI relations, encourage “self-enforcing” contracts for PSCs, leases, royalties, taxes and technology transfer regulations Contracts should flexibly allow for a change in the payoff structure such than neither party gets an “undue” share of windfall profits or adverse outcomes Other mitigation actions: political risk insurance, JV agreements to alleviate political pressure on FI Focus on long run benefits, despite electoral or commodity price cycles For economic efficiency in HC, promote stabilization of revenue streams Allow full operational autonomy to state-owned EI enterprises to run as commercial enterprises (e.g. Petronas) Establish sovereign wealth funds (SWFs) for large resource rents with transparency and credible commitments to economic development objectives Ensure policy coherence and clear jurisdiction guidelines across ministries of energy & mineral resources, finance, planning and trade & industry Practice equitable distribution of employment and resource rents across national, regional and local stakeholders Have separate and equitable regulations for the local, small-scale sector where possible, with local autonomy and self-governance guidelines Energy Analytics & Consulting

Case Studies: Details Energy Analytics & Consulting

Coal in Indonesia Largest exporter of thermal coal (with low calorific value) Comparatively small level of domestic consumption Decentralization program starting 1999 has created challenges for EI governance Transparency: Stakeholders required to play an active role in the regulatory process, but effectiveness of public consultation process in question Recent roll-backs in mineral policy, such as the mineral processing requirement, opposed by those outside government Indonesia’s decentralized governance structure has resulted in increased opportunities for regulatory capture as transparency and accountability are compromised. Overlapping authority and conflicts of interest exist in dealing with illegal mining problems Energy Analytics & Consulting

Coal in Indonesia(2) Quality of regulatory framework: Inadequate alignment between central governmental agencies and local governments High degree of uncertainty as to interpretation and enforcement of regulations Lack of institutional capacity at the local government level Economic efficiency and equity: Small-scale mining lacks economies of scale and hence needs to be curbed. A longer operation period would create incentives for maximizing resource value, but the new mining law has reduced the duration of mining leases. Recommendations An institution that coordinates extractive industry regulations should be set up Indonesia should raise the transparency with which regulations are formulated. There is a need for very clear guidelines as to the extent of the local government’s regulatory authority. Energy Analytics & Consulting

Coal in Vietnam Leading supplier of anthracitic coal in the Asia-Pacific region. Despite several reforms, the coal sector suffers from lack of transparency and inconsistency in the interpretation of regulations Transparency and Accountability There is evidence of stakeholder consultation but it is unclear whether their inputs were considered when formulating Vietnam's new mineral law New mineral law requires that exploration and mining rights are auctioned, improving transparency in how licenses are handed out Increasing illegalities in recent years, resulting from unclear laws, poorly equipped local governments, and collusion and corruption. Economic efficiency and equity Marginal cost pricing is an implicit subsidy to inefficient mines and could be manipulated as mining company is better informed of costs than regulator Vietnam has been experimenting with different tax formulae in an attempt to optimize on revenues, but frequent changes in taxation policy can have a detrimental impact of investor confidence in the sector. Energy Analytics & Consulting

Coal in Vietnam (2) Quality of regulatory framework: Regulations governing the extractive industry and coal often lack clarity Frequent lack of coordination amongst government entities which result in regulations that conflict in their objectives or duplicate effort. The Mineral Law 2010 does not address the issue of uncertainty brought about by the devolution of authority between the centre and the provinces. Regional governments lack the institutional capacity to administer their new responsibilities and lack of accountability for their actions. Recommendations: Vietnam needs to have a formal process for stakeholder consultation. Regulatory coherence can be improved by setting up a formal institution that aligns policies with Vietnam’s broader development objectives. Vietnam should clearly designate the extent of regulatory authority that local government regulatory authorities have. Raising the transparency of the regulatory process will reduce the potential for corruption and regulatory capture. Energy Analytics & Consulting

Natural Gas in Malaysia
Malaysia is a significant producer and exporter of natural gas PETRONAS has ownership rights of all gas resources in Malaysia Transparency and accountability Transparency has been increasing, but there remains very little transparency with respect to how the government spends the revenue. Accountability is very limited, since PETRONAS is not directly accountable to Malaysian citizens and enforces the same rules that it itself is bound by. The governance structure lends itself to a risk of regulatory capture, but the empirical evidence generally suggests that this has not occurred. Quality of Regulatory Framework PETRONAS generally has a good reputation for governance and has strong administrative and technical capacity. The absence of a distinct regulator has meant that many of the relevant procedures (e.g. the process for production-sharing) are not encoded in law Malaysia provides a favorable business environment with low levels of regulatory uncertainty, but this may entail a lack of regulatory flexibility. Energy Analytics & Consulting

Natural Gas in Malaysia (2)
Economic efficiency and equity Production-sharing contracts help maximize rent extraction from exploration and production, without noticeably diminishing incentives for investment. The revenue-sharing is lopsided in favor of the federal government Policies encouraging a high savings rate, macroeconomic and revenue management policies to counter the Dutch disease, and economic diversification policies have enabled Malaysia to avoid the resource curse. Recommendations Increased transparency is needed on spending of natural gas revenues A regulatory body that is independent from PETRONAS should be set up The Petroleum Regulations should include guidelines on many of the relevant procedures not encoded in law. This will increase regulatory clarity A more equitable revenue-sharing scheme between the federal and state governments is recommended e.g. by increasing the royalty rate The policy of using gas revenues to support fuel subsidies, which are distortionary and have resulted in a fiscal deficit, should be reconsidered, Energy Analytics & Consulting

Natural Gas in the Philippines
The Philippines consumes all of the gas it produces. Gas production has increased steadily since 2001 when the Malampaya gas project began operating. Transparency and Accountability Transparency is enhanced by the use of public bidding procedures, but transparency is lacking in the collection and disbursement of gas revenue. The regulatory process is characterized by a certain degree of accountability, with multiple stakeholders involved. Quality of the regulatory framework Lack of clarity is not generally an issue, but poorly defined property rights and territorial jurisdiction have sometimes been problematic. There exists a certain amount of regulatory coherence Delays and lags in policy formulation and implementation are problematic Regulatory certainty has been enhanced by broad stabilization provision in the model service contract but this has constrained the flexibility of the government to adjust and tweak regulations. Energy Analytics & Consulting

Natural Gas in the Philippines (2)
The service contracts allow the majority of proceeds to accrue to the government, but constrains the ability of the government to increase rent when profitability is high and has a high cost recovery limit of 70%. The provision of fiscal stability creates positive incentives for investment There is evidence to suggest that the management of the Malampaya funds has not always been socially optimal. An effective environmental impact assessment process exists The recent switch away from direct negotiations towards public bidding is likely to increase transparency and competition in the bidding process. Recommendations To increase transparency, the Malampaya Fund should be included in the National Budget and procedures for parliamentary oversight should be introduced. The stability assurance should be narrowed and limited only to fiscal laws. A progressive fiscal regime should be adopted, so that higher profitability leads to a higher government share of net proceeds. The cost recovery limit should be reduced Equity in revenue-sharing needs to be improved and the dispute over whether 25% or 40% of the Malampaya revenue should accrue to Palawan province should be rapidly resolved in accordance with the laws. Energy Analytics & Consulting

Oil in Timor-Leste Timor-Leste is ranked 52nd in the world in terms of oil production Timor-Leste is the 3rd country to be awarded EITI status, but the benefits of EI transparency have been eroded to an extent by high corruption Transparency and accountability Timor-Leste looks to public consultation before enacting laws, but many organizations lack the capacity to effectively critique government proposals The Open Budget Survey 2010 ranks Timor-Leste below average in terms of budget transparency and reporting on financial activities Timor-Leste has been having more frequent charges of corruption leveled against high-standing civil servants. Economic efficiency and equity Timor-Leste manages its petroleum wealth via a Petroleum Fund established in 2005, but in recent years has overdrawn from the fund The recent revision of the Petroleum Fund Law takes on more risk, weakening the sustainable spending rule Timor-Leste does not yet have a supreme audit institution Energy Analytics & Consulting

Oil in Timor-Leste (2) Quality of the regulatory framework Regulations governing Timor’s petroleum sector are quite intricate especially regarding revenue collection. Timor-Leste has not yet enacted a law on expropriation. The justice system is in transition so the legal foundations are an uncertain and changing mix of Portuguese, Indonesian, United Nations interim administration, and Timorese jurisprudence. Government employees often lack administrative experience. Recommendations Transparency should not be the only criterion to judge good governance. Timor-Leste needs to build up its regulatory capacity ensuring that personnel are technically adept The country needs to simplify its regulations to ensure that compliance cannot be circumvented due to lack of understanding Changes to the regulatory fund need to be deliberated over keeping in mind the guiding principles for creating the fund. Energy Analytics & Consulting

Oil in Cambodia Cambodia does not produce any oil and production is not expected to commence before at least mid-2013. The regulatory structure is highly centralized, with the Cambodian National Petroleum Authority (CNPA) in charge of all petroleum operations. Transparency and Accountability Details of the contracts, revenue-sharing arrangements and signature bonuses are not disclosed. Accountability in the governance of Cambodia’s oil industry is very limited, with the CNPA directly accountable only to the Prime Minister Corruption exists to a very severe degree in Cambodia, and there are conflicts of interest at the higher level of the governance of the oil sector. Economic efficiency and equity The model production-sharing contract is skewed in favor of the investing company and the guaranteed revenue is only 16% of gross production. Open bidding has not been conducted since the initial 1991 bidding round. Energy Analytics & Consulting

Oil in Cambodia (2) Quality of the regulatory framework The 1991 Petroleum Regulations are over 20 years old and outdated. It is uncertain when a new regulatory will be established Significant delays in the process for approval of production permits further increase uncertainty. There are legal and technical capacity constraints in the ability of the CNPA to directly regulate and govern the petroleum industry. Recommendations Increased parliamentary oversight and the use of public consultation procedures are recommended to increase accountability. Cambodia should accelerate the process for adopting and implementing of the new legislative framework to replace the 1991 Petroleum Regulations Cambodia should consider modifying the production-sharing contracts to capture a greater revenue share and reduce exposure to oil price volatility It is recommended that Cambodia return back to an open bidding process for awarding petroleum blocks Energy Analytics & Consulting

Oil in Myanmar Oil production in Myanmar has steadily increased in the last decade Since 2011 there has been growing foreign investor interest in the sector Transparency and accountability Details of the contracts and signature bonuses are not disclosed. Revenue transparency is absent and the technique for recording oil revenues in the national budget significantly understates the amount of revenue received. Accountability in the governance of Myanmar’s oil industry is very limited Corruption exists to a very severe degree in Myanmar and conflicts of interest have led to special provisions given to military spending of oil revenue. Quality of regulatory framework Petroleum regulations are very outdated and unlikely to be implementable. There is little regulatory clarity due to the absence of a workable Petroleum Act, which has been a key barrier to foreign investment in the oil sector. The absence of a comprehensive legislative framework and the general lack of transparency create regulatory uncertainty and increase risks for investors. Energy Analytics & Consulting

Oil in Myanmar (2) Economic efficiency and equity The model PSC in Myanmar is geared towards maximizing the rent accruing to the government through features such as progressive profit-sharing and limited cost recovery. It is not clear whether incentives such as tax holidays and exemptions from export duties are sufficient to encourage foreign investment There are legitimate concerns that the petroleum revenue generated is not always equitably shared within Myanmar. Recommendations Increased parliamentary oversight, greater public consultation and increased revenue transparency are recommended. A comprehensive and updated legislative package is urgently needed Given that considerable unexplored or partially explored petroleum resources still exist, Myanmar should consider increasing the revenue share of the contractor companies to encourage greater foreign investment Energy Analytics & Consulting

Copper in Indonesia Indonesia ranks as the eight largest copper producer globally and Asia’s second-biggest copper producer after China Transparency and accountability Indonesia has established a system whereby stakeholders are required to play an active role in the regulatory process. The decentralized governance structure has resulted in increased opportunities for regulatory capture Overlapping authority and conflicts of interest in dealing with illegal mining problems pose significant concerns Quality of regulatory framework Indonesia’s latest mineral regulations lack clarity on issues such as the basis for calculating the price to be paid to a divesting foreign investor While the Ministry of Energy and Mining Resources has overall responsibility, there are coordination problems with other ministries. Regulatory uncertainty is a major problem that investors face in Indonesia. Energy Analytics & Consulting

Copper in Indonesia (2) Economic efficiency and equity The new mining law has reduced the duration of mining leases to the detriment of efficient exploitation of resources Revenue from mining is shared between the central and sub‐national governments but it is unclear whether this arrangement is optimal. The blanket requirement for mineral raw materials to be processed in Indonesia rather than being exported in a raw state is economically inefficient. Recommendations Indonesia should raise the transparency with which the regulations are formulated. Staff involved in the regulatory process need to be adequately trained and compensated well enough to be prevented from gaming the system. An institution that coordinates the regulations that affect the extractive industry should be set up. There is a need for very clear guidelines as to the extent of the local government’s regulatory authority. Energy Analytics & Consulting

Copper in Myanmar Myanmar’s mining regulations have not produced the desired investment in the minerals sector, with copper output in 2010 nearly 69% of its 2006 level Transparency and accountability In the past, evidence of public consultations seemed missing but Myanmar has been seeking to make improvements in this area The vague nature of Myanmar's mining law allows for the mining sector to be plagued by several illegal practices. The poorly-worded mining law allows expropriation of privately-held land. The country’s mineral law allows the Chief Inspector of Mines to delegate her own powers to junior inspectors raising the possibility of regulatory capture. Economic efficiency and equity Given that the government has the discretion on deciding whether a project is small or large-scale leaves open room for negotiations and bribery and can reduce the economic efficiency of the extractive industry There is little evidence to suggest that the environmental impacts of copper mining have been accounted for. Energy Analytics & Consulting

Copper in Myanmar (2) Quality of regulatory framework Regulations often lack clarity or contradict each other. Myanmar’s mining law and its annexes are extremely short on standards of good mining practice, procedures to ensure their implementation and avenues for any public or individual recourse should practices fail. Myanmar does not seem to have a systematic mechanism to develop, monitor, and evaluate regulations. There is no centralized regulatory oversight body with ‘whole of government’ responsibility for policy, making for poor policy coordination Recommendations Myanmar needs to regularly revisit and update its regulatory policies. The country should set-up a formal institution that ensures alignment of regulatory policies. The environmental impacts of mining need to be taken into consideration. Myanmar should raise the transparency with which the industry is regulated. Energy Analytics & Consulting

Gold in the Philippines
The Philippines is well-endowed with gold, but remains a small producer. The key regulation for mining is the 1995 Mining Act, but this was suspended by a recent Executive Order pending new legislation Transparency and Accountability While there is some transparency, information on specific mining projects is confidential, fuelling local opposition to gold mining projects. Multiple stakeholders are involved but in practice decision-making is concentrated in the central government. However excluded groups have been able to challenge the regime through the courts, and civil society. Quality of the regulatory framework Att least twenty statutes and regulations govern various aspects of mining and property rights are often poorly defined, leading to a lack of clarity There is significant overlap of jurisdiction between the various agencies in mining, and regulations often overlap and contradict each other Regulatory certainty due to frequent policy lags has been cited by mining companies as a strong deterrent to investing in the Philippines Administrative capacity is limited Energy Analytics & Consulting

Gold in the Philippines (2)
Economic efficiency and equity The revenue-sharing arrangements in gold mining are skewed towards mining companies The direct contribution of gold mining (and mining in general) to the economy has been limited, and spillover benefits are comparatively low. Few of the benefits from gold mining accrue to local governments and indigenous communities affected by mining operations. There is evidence that the negative environmental and social externalities of mining are significant and not effectively taken into account Recommendations A more devolved decision-making process would lead to accountability A new legislative framework to replace the 1995 Act needs to be adopted The revenue-sharing arrangements in the Philippines should be modified so that the government captures a greater share of the mining revenue Equity in revenue-sharing should be emphasized to a much greater degree Energy Analytics & Consulting

Gold in Malaysia Malaysia is a tiny gold producer on the global stage The state governments possess all minerals within their territory Transparency and Accountability Transparency in revenue sharing between federal and local governments is very limited, but there is somewhat more transparency in other respects. Gold mining governance is characterized by decentralization, but provisions for direct public participation and consultation are weak/non-existent. Illegal gold mining operations have been an endemic problem in recent years in the jungles of Gua Musang and Jeli in the province of Kelantan. Quality of regulatory framework Federal laws and State Mineral Enactments are clear and coherent Policy alignment is a challenge, although Malaysia continues to attempt to resolve the issue (for instance by setting up a National Mineral Council). Regulatory uncertainty is limited, though there is some policy uncertainty since not all states are enthusiastic about encouraging gold mining Energy Analytics & Consulting

Gold in Malaysia (2) Economic efficiency and equity The flexible royalty regime allows the State government to extract the maximum rent possible, although it can increase investor uncertainty. Because state and federal revenue are clearly distinguished at the outset, equitable revenue distribution is much less of an issue Measures to encourage investment in gold mining have been effective There has been particular concern in recent times over the use of cyanide in gold mining and the consequent health effects. There is limited public participation in the Environmental Impact Assessment (EIA) process. Recommendations Provisions for direct public participation in governance should be improved to enhance accountability and to strengthen the EIA process Coordination issues could be addressed by setting up a consolidated governance regime applicable for the entire country A progressive royalty regime should be adopted to increase state rents from gold mining, and some guidelines should be introduced limiting the extent to which the royalty rate can be varied so as to address investor uncertainty. Energy Analytics & Consulting

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