The Australian Financial Review

Thursday, June 19, 2008

Oil Bonanza Fails to Ease Timor's Woes

by Angus Grigg

JAKARTA

As soaring oil prices hit consumers and rattle global financial markets, one of the world's poorest nations, East Timor, is cashing in.

Thanks to the near-record cost of oil, East Timor has been transformed into a middle-income economy in just three years. Petroleum revenue has doubled and its sovereign wealth fund is on track to hit $US5 billion ($5.3 billion) by December and nearly $US50 billion in a decade.

That would make it the new Brunei. But money is not the island nation's problem. Social unrest and political instability have prevented the country from making the long march out of poverty.

A lack of skills in the bureaucracy means the government was able to spend just 30 per cent of its budget last year, a failure that has delayed critical infrastructure projects and job creation programs. In an interview with The Australian Financial Review, Energy Minister Alfredo Pires said the government would deploy its oil windfall this year, increase the national budget by 50 per cent to more than $US500 million and begin public works programs like upgrading Dili Airport, improving electricity infrastructure and building roads.

"The increased oil revenue raises expectations, especially since it has happened so quickly," Pires says from the capital, Dili. "But it does mean we have the money to solve some of our social issues." Pires says the government also plans to send 100 geology and engineering students overseas on scholarships this year.

"Next year we would hope to send more than 1000 students [across all disciplines] overseas to acquire skills and improve our human resources."

The surging price of oil means the government can now withdraw about $US400 million ($424 million) a year (up from $US270 million) from the Petroleum Fund, under a formula known as the estimated sustainable yield. Foreign aid will account for the remainder of the country's budget.

This formula, enshrined in the 2005 legislation that established the fund, means the government can spend only interest earned and a small amount of capital each year.

The fund, modelled on Norway's $US400 billion oil fund, aims to prevent East Timor falling victim to a so-called oil curse that has led many resource-rich African nations to squander their wealth.

Despite East Timor's oil wealth, its inability to spend the budget means the country remains the poorest in Asia, with most of its people living on less than $US1 a day.

The United Nations estimates 60 per cent of the population are illiterate and 40 per cent of children malnourished.

But with the high oil price, which was at $US133 a barrel yesterday, the country's oil revenue has doubled to $US200 million a month. As a result, its nominal gross domestic product per capita will double this year to $US4500 and to about $US38,000 in a decade, or even higher as new fields come online.

Australia's per capita GDP now stands at $US35,500 while Brunei ranks fifth in the world at nearly $US50,000 per person.

Former Victorian premier Steve Bracks, now an adviser to the East Timorese government, says executing this year's budget is the government's highest priority.

"There is a realisation that delivering the budget is a key defence against further instability," he said from Melbourne. "Great progress has been made, but spending the money will still be a challenge this year."

Bracks says Prime Minister Xanana Gusmao has been sparked into action by February's assassination attempt on himself and President Jose Ramos Horta. The Prime Minister was unhurt in the attacks, but Ramos Horta was shot three times and spent nearly two months in a Darwin hospital. He returned to East Timor last month, but has not committed to serving out his five-year term, which ends in May 2012.

February's attacks also highlighted the messy and factionalised politics of East Timor and the instability they foster.

It's a vicious cycle: political uncertainly slows down economic development and in turn causes resentment and further social unrest.

And then there's the many fault lines along which the tiny country is fractured. There's the geographic divide between those in the east and west of the country, between the young and old and between those who stayed and fought during Indonesia's occupation and others who went overseas.

Then there's the divide between those who went to Mozambique, Portugal and Australia.

Such geographic and age issues within the army led to riots and looting in 2006 and prompted the resignation of then prime minister Mari Alkatiri.

Violence erupted again in August last year when Alkatiri's Fretilin Party failed to win fresh elections and this swelled the number of people in Dili's already overflowing refugee camps.

In April, the International Crisis Group estimated 30,000 Timorese remained displaced in camps around Dili and a further 70,000 were living with family and friends.

Pires says the government will provide money and materials this year from oil revenue for these people to leave the camps and rebuild their houses. He says the government has already provided compensation and relocated 500 families from one refugee camp near the main hospital, but the two larger camps outside the port and airport remain.

These camps, where youth unemployment and boredom predominate, are havens for gangs and criminal activity.

Pires says the government has also agreed on pension plans for 300 petitioning soldiers to retire from the military. These soldiers and their grievances over promotion and discrimination sparked the 2006 political crisis. Many of these soldiers were also loyal to Alfredo Reinado, who was killed leading the attack on Horta.

But a further political and security crisis did not erupt in February, as many had feared.

This enabled the government to regain control within hours of the attacks and it has since acknowledged that economic development is the only solution to the country's lingering social problems.

Alan Dupont, a former Keating government adviser, worries, however, that East Timor does not have a comprehensive plan for its development and could squander its opportunity.

"It's yet to outline its strategic priorities," he says. "The oil revenue, which is more than anyone dreamed of, provides an increased temptation not to be fiscally disciplined and to implement ad hoc responses."

But he says higher oil revenue could ease tensions with Australia over the disputed maritime border and allow the country to fix some of its lingering social problems.

But Damian Kingsbury, head of international and political studies at Deakin University, questions East Timor's ability to spend this increased budget.

"The new government has promised to resolve budget bottlenecks and provide liquidity to the districts," he says. "But to be able to do this, it needs to skill up quickly."

Kingsbury says the government lacks the capacity to spend the money it had last year and he worries about corruption and inequality.

"Dili could very well become a boom town, but you could still have people living in grass huts in the hills," he says.

To counter fears of corruption, the government has pledged to establish an auditor-general for the public service and an anti-corruption body.

It has also appointed former Victorian public servant Greg Vines as head of its Civil Service Commission. Bracks says this commission will oversee the bureaucracy and help recruit public servants at director-general and director level.

"Part of this will be trying to encourage expatriates to return home to more secure and better-paying positions in the public service," he says.

Bracks has told The Australian Financial Review previously that oil could be used to broaden the economy, and the government should consider borrowing money to build the necessary infrastructure. No one is going to invest in East Timor unless the country can develop reliable infrastructure, he says.

"Better roads, electricity, sanitation are all bankable as is securing land title and they will all help to encourage foreign investment." But at present this lack of infrastructure, skills and instability is making it difficult to attract foreign capital.

The government is lobbying hard for the liquefied natural gas processing plant for the giant Sunrise gas field to be built in East Timor, as a means of up-skilling its population.

Australia's Woodside Petroleum, which will operate the Timor Sea resource, has yet to make a decision on the plant's location before the field coming into operation around 2013.

"We would like to make Timor a gas hub," says Pires. "We don't have the domestic pressure on supply that many other countries do, so we could become a major exporter."

But building the plant in East Timor would require a huge leap of faith in the country's political stability in the wake of February's attacks.

Gusmao's coalition government remains shaky amid calls from the opposition Fretilin Party for fresh parliamentary elections and there may also be a presidential election before 2012 if Ramos Horta does not serve out his term.

"I don't think you can calculate the political risk at present as there are just too many unknowns," says Dupont, who is now the director of the Centre for International Security Studies at the University of Sydney.

Table: WELL-GREASED

Year-end figures for East Timor's Petroleum Fund, established 2005.

2007 $US2 billion 2008 $US5 billion* 2009 $US10 billion* 2018 $US47 billion*

NB assumes oil price remains around $US120 a barrel, an interest rate of 5 per cent compounded and annual inflows of $US3 billion.

* estimates

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