La’o Hamutuk
East Timor Institute for Reconstruction Monitoring and Analysis
 1/1a Rua Mozambique, Farol, (P.O. Box 340) Dili, Timor Lorosa’e
Tel: +670-3325013 or +670-7234330
email: laohamutuk@easttimor.minihub.org
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Submission to the Petroleum Fund Steering Group
Ministry of Planning and Finance, Democratic Republic of Timor-Leste

from La’o Hamutuk

regarding the Timor-Leste Petroleum Fund Draft Act

1 March 2005

Contents

Summary

Introduction

The East Timor Institute for Reconstruction Monitoring and Analysis, La’o Hamutuk, appreciates this second round of public consultation on the Petroleum Fund for Timor-Leste, and we hereby submit our comments on the draft Act. We are also attaching an annotated copy of the Act, with our observations and suggested changes section-by-section.

This public consultation on the Petroleum Fund is significantly better than other processes for public consultation in Timor-Leste, such as the one on the Petroleum Regime. We appreciate the Ministry of Planning and Finance’s interest in community views, and the efforts you have made to incorporate some of them in the Fund Act. Nevertheless, we believe the current Act is still inadequate to achieve “wise management of the petroleum resources for the benefit of both current and future generations.”[1]

We agree with your observation that most countries in Timor-Leste’s situation fall victim to the “resource curse,” and that far-seeing, effective measures must be taken to avoid that situation. We also agree that no law can substitute for good governance, sound fiscal planning and long-term perspective. Nevertheless, laws are the best instrument to protect people’s rights in a democratic society, and we encourage every legislative effort to make poor governance and short-sighted decisions more difficult and less likely. A Petroleum Fund by itself cannot avoid the resource curse, but a fund well-designed for the realities and necessities of Timor-Leste will help avert and minimize some of the poor decisions and devastating consequences that oil and gas development often brings to newly-democratic, impoverished nations like ours.

In our previous submission[2] on the Petroleum Fund discussion paper,[3] we discussed many issues which are still relevant. Although you have incorporated several of our suggestions completely and others partially, a number of the most important ones have not been incorporated in the draft Act. We will not repeat our entire arguments in this submission, and encourage you to refer our earlier one for additional documentation and elaboration.

Thank you for adopting some of our earlier suggestions, including:

We also appreciate that you have partially incorporated some of our recommendations, even though improvements are necessary to make them completely effective:

The draft Act:

It should also:

Prohibits using the Fund as collateral for borrowing (Art. 11).

Disallow the use of Fund money for debt service.

Provides information for more informed and extensive discussion in Parliament prior to approving transfers from the Fund (Art. 7).

Require Parliament to pass specific legislation, in addition to the State Budget, for each transfer from the Fund.

Creates a Petroleum Fund Consultative Council (CC formerly the Council of Eminent Persons, Art. 15-17).

Expand the CC to include a broader range of society, and empower it to publish reports and refer cases to investigatory or prosecutorial authorities when appropriate.

Defines a principle of transparency (Art. 18).

Eliminate obstacles to transparency such as “confidential information” and “adaptation for public information.” A Public Register should be created to contain explicitly named reports and information in a timely manner, without censorship or editing.

Defines a single account for all petroleum-related payments (Art. 6).

Require oil companies to make all petroleum-related payments into the Fund, and to publicly report such payments, with sanctions for non-compliance.

Unfortunately, you did not incorporate our ideas in a number of critical areas, including:

Protecting our children’s inheritance

As La’o Hamutuk has said many times, the petroleum industry is one of the world’s most widespread, profitable and powerful. Many industrialized nations are addicted to vast quantities of inexpensive energy. This addiction, magnified by huge profits available to transnational oil companies, motivates decision-makers so forcefully that it takes extraordinary, unified efforts to protect the citizens of poor, oil-producing countries. No government is immune to this manipulation, and Timor-Leste cannot rely on the possibility of being an exception.

Our petroleum wealth will have been entirely transformed into money before the middle of this century. Although most of that money will go to oil companies, Timor-Leste will receive a significant share. If we have not saved and invested it wisely, preparing for our post-petroleum future, our grandchildren’s children may endure worse poverty, unemployment, maternal mortality, illiteracy, disease and lack of services than we live with today. This is the experience of people all over the world, and the current draft Petroleum Fund Act and Petroleum Regime will not put Timor-Leste on a different path.

Our Government is bypassing legal processes in its haste to issue petroleum licenses by this November, rushing the Petroleum Regime legislation through without adequate consultation or discussion. The Government has contracted for seismic exploration and is soliciting oil companies to explore in Timor-Leste territory before laws to regulate such activity have been submitted to Parliament or released to the public.

This has set an unfortunate precedent for the power of petroleum over democracy. In the future, Timor-Leste needs to protect itself against potential abuses from any ill-intentioned, corrupt institutions and individuals made greedy by the many billions of dollars available from our resources.

Fiscal policy

Countries with oil revenue windfalls have far more difficulty implementing sound fiscal policy than those without such income. A well-designed petroleum fund is needed to help overcome this impediment and to encourage the same wise economic and financial planning which would have to be undertaken if there were no oil money. Oil money makes it too easy to make bad short-term decisions; the negative consequences of those decisions often only become apparent decades later, when a different government is in power. An effective petroleum revenue management system is one component of avoiding this problem.

A Petroleum Fund does not guarantee solid fiscal policy, but it can encourage responsible planning and management, helping to shelter each year’s revenues from immediate political and economic demands, making it more likely that wise decisions will be made for long term. A Fund can assist Timor-Leste’s future leaders in making decisions that are no worse than if we had no gas or oil.

At the 14 February public consultation in Dili, Government officials stated[6] that they recently enacted a policy on savings and expenditures (although we have not been able to obtain a copy). A policy guideline is not a substitute for law. Please refer to our previous submission for specific suggestions and examples of how this can be implemented in law – there is much to learn from practices of both Norway and São Tomé.

The draft Petroleum Fund Act says six times that the Fund exists “for the benefit of current and future generations.”[7] This is a very vague standard, which will be impossible to assess until it is too late. A more useful goal would be sustainability for the indefinite future, providing for Timor-Leste’s people in our post-petroleum era beginning about 50 years from now. There should also be goals covering human rights, building human and physical infrastructure, moving toward renewal energy, developing non-oil sectors of our economy and other objectives to prepare our nation for the future.

Budgetary process

The draft law puts the decision of how much Fund money to spend into the annual budget process. As we wrote before, this process is unavoidably influenced by many short-term, political and special-interest pressures. We continue to recommend that the Fund Act or other legislation establish clear, binding rules limiting how much of the Fund may be spent each year. These rules should also direct Fund revenues toward particular human and physical investment, and away from boondoggles and militarism.

In the attached section-by-section commentary, we suggest improvements to how money is withdrawn. The Council of Ministers and the Parliament should enact a separate resolution for each transfer from the Petroleum Fund. This resolution should specify the amount of money, what it will be used for, its relation to current Fund income and its impact on future dividends. Such a provision would promote broader debate in Parliament before the approval of any withdrawal from the Fund, and avoid entangling the withdrawal discussion with controversies relating to other items in the State Budget. It would make the Fund more transparent to the public, who can hold elected officials accountable for spending Fund assets.

If the transfer is above sustainable levels, extraordinary reasons should be specified, as well as a forecast as to whether such high transfers will be required in subsequent years. Non-sustainable withdrawals for more than two consecutive years should be prohibited.

The Government of Timor-Leste repeatedly says it wants to safeguard future generations’ petroleum birthright. To do that effectively we need structures to protect those assets no matter who holds power in the future. Timor-Leste’s government has signed treaties and contracts which last for decades, constraining future governments to meet the requirements of international oil companies and foreign governments. Why can’t we take similar action to help secure the well-being of our own grandchildren?

The Ministry of Planning and Finance (MoPF) believes that Parliament should not legislate rules governing Fund transfers, and rejects requiring a Parliamentary act for each transfer out of the Fund. They ask “Who is supposed to decide funding to areas of priority if not Parliament elected by the people?”[8] However, Parliament’s powers are not respected if unrestricted discretion for use of Fund money is placed in the State Budget which, according to our Constitution, is “prepared by the Government.”[9]

For reasons we do not understand, the Ministry of Finance argues[10] defensively against empowering Parliament to make a more deliberate decision on withdrawing money from the Fund. Similarly, many of the reasons given by the Ministry for rejecting rules guiding the use of Fund assets seem specious. This is curious, especially in light of the high respect that document pays to Parliament’s ability to represent the needs of the citizenry. Is there some non-obvious reason why the drafters are so resistant to this idea?

The Ministry of Planning and Finance (MoPF) says that “A bad government will almost always find a way to implement bad policies.”[11] To us, this is an odd reason not to legislate good policies. A determined murderer will almost always find a way to kill his victim, but is that a reason not to have a law against murder? Even with a good law, there will still be some murders – but fewer than there would have been without law enforcement. With strong and effective protection and oversight of Timor-Leste’s petroleum revenues, our future generations are more likely to receive their fair share of our petroleum wealth.

We appreciate the intention behind Article 7, providing Parliament with information to make informed decisions about Fund sustainability and transfers, with additional information if the proposed transfer exceeds the sustainable amount. We agree that avoiding unsustainable transfers is important.

We welcome the prohibition of the use of the Petroleum Fund as collateral for borrowing. We agree with the current Government that Timor-Leste should not borrow with one hand while saving with the other, but are concerned that Article 11 may not provide adequate protection.

If a future Government decides to borrow money, the lender would expect interest and principal to be paid out of the budget. Since the Fund automatically pays for any budget deficit, it is in effect guaranteeing the loan, as collateral without encumbrance. The best course is not to borrow at all, so the Fund should be designed not to facilitate debt. Fund money should be prohibited from paying for debt service. Furthermore, the Estimated Sustainable Income could be lowered by the annual debt service payments, and the calculated Petroleum wealth reduced by the outstanding debt.

Investment Rules and Advisory Board

The draft Act does not incorporate La’o Hamutuk’s prior suggestions about how the Fund should be invested. Article 9 says that the Fund must be invested in low-risk, high-liquidity financial assets in U.S. dollars outside Timor-Leste. Our concerns abut this are detailed in our previous submission.

With the U.S. dollar likely to continue to fall,[12] U.S. dollar-denominated securities are probably not the most secure or highest-returning investments Timor-Leste can make. More specifically, we object to Article 9.2(b)(ii), which gives the United States Federal Reserve an exemption from the credit rating requirement specified in Article 9.2(b)(iii). We also suggest more flexible rules regarding currency, liquidity and duration of the investments.

We also urge the government to legislate Ethical Guidelines for investment of petroleum revenues, as Norway has done. We believe that the people of Timor-Leste do not want their money invested in military activities or governments that violate human rights or illegally occupy other countries. We doubt that Timor-Leste’s citizens would choose to lend their money to indirectly support the United States occupation of Iraq. This is discussed in our proposed new article 9½ in the attached annotated Fund Act.

La’o Hamutuk supports the creation of an Investment Advisory Board (IAB), but the draft Act falls short in several areas. This board has no power and no independence. It has no civil society or independent representatives – all of its members are appointed by the Prime Minister or the Minister of Planning and Finance; most work for the Central Bank or the Finance Ministry. Since those institutions are responsible both for managing the Petroleum Fund and preparing the annual budget, it would be better to have some IAB members outside those institutions, who can be more objective. People with experience in socially responsible investing and public accountability would be welcome additions to the IAB, as would representatives appointed by civil society. The 1997 Asian financial crisis painfully demonstrated the fallibility of “investment experts,” and we prefer some members more grounded in reality.

Article 10.10 provides for the Minister to release edited IAB advice to the public when required by Parliament. The IAB should be able to publish its own reports, including recommendations and debates, in a timely manner – not only when the Annual Report is published, after decisions have already been taken. As we discuss below, there is no “confidential information” in such reports that might require censorship – this is the public’s money, and the public has the right to know how it is invested, and why.

Article 8.2 says “the Minister shall not make any decisions in relation to the investment strategy or management of the petroleum Fund without first seeking the advice of the IAB in accordance to Article 10.” But Article 10.2 says “if the IAB does not provide the advice requested in a timely manner … the Minister shall make the decision.” There is no requirement for the Minister to make his request in a timely manner, and no definition of what a timely manner is. Article 10.3 allows the Minister to ignore the IAB entirely. The board could be completely ineffective and nobody would know.

Democracy and accountability

The power to manage the Fund is largely vested in the Central Bank (currently the Banking and Payments Authority, BPA) and the Ministry of Planning and Finance (MoPF), institutions which are responsible for day-to-day financial operations and annual budgets, and they may not have the long-term perspective required to safeguard our great-grandchildren’s inheritance.

We agree that these are the appropriate institutions for budget, investment and finances, but the Petroleum Fund Act should create legal and structural oversight, checks and balances. Effective oversight will strengthen those institutions, as envisioned in the Petroleum Fund Executive Summary.[13] Functioning, independent and representative oversight is essential not only for transparency and accountability, but also to build a democratic and participatory system.

As we discussed in our previous submission, the BPA continues to operate illegally. Since its Governing Board has only three members, it has never had a valid meeting, which requires five for a quorum.[14] This ongoing disregard for law is not a hopeful sign. If the BPA does not obey its own organic statute, how can it be relied on to obey the laws governing the Petroleum Fund? We hope the Governing Board will be legally constituted before the BPA is handed millions of dollars more in public funds. We also suggest that the “outside members” of the BPA Board of Governors include an independent investment advisor.

Article 8.8 requires that the Central Bank reports to the public on the Fund within 40 days after the end of each quarter, which is good, but it does not specify what must be in the report. Since the draft Act has no Public Register, there is no mechanism for making this report and other information accessible to the public. Currently, other Central Bank reports are “public” but a person must have access to internet or go to the BPA office and ask for a copy. Making information accessible means ensuring that everyone is aware of it and taking active steps to distribute it. Saying it is “public” and keeping it in a cabinet in someone’s office is not enough.

Oversight

Effective oversight is essential to any system managing large amounts of public money, especially when a government is as inexperienced as that of Timor-Leste, having recently wrested itself from a regime rife with corruption and secrecy.

The Petroleum Fund Consultative Council (CC) is a step toward oversight – but only takes us part of the way there. This is a “watchdog” without powers; when it barks nobody will come. We strongly recommend broadening and empowering the CC to make it a guard dog, an oversight body with teeth:

  • The CC must publish its own reports and advice promptly, both for the public and for Parliament.

  • When Parliament receives advice from the CC, Parliament should disclose whether or not it followed the advice, with a clear explanation if the advice was rejected.

  • The CC members representing of civil society, business sector and religious organizations should be chosen by those sectors, not by the government.

  • Additional CC members should be included to represent youth, opposition political parties, popular organizations and people in rural areas.

  • The CC should have the power to investigate evidence or allegations that the law is not being followed by an individual or institution, and to refer the case and provide information and assistance to the Provedor or General Prosecutor. Such referral must be allowed without the intervention of the Finance Ministry or the Central Bank.

  • As part of its public consultation function (Article 17.4) and at other times, citizens should be able to bring information to the CC for further action. This is not only for advising Parliament, but for overseeing Fund management.

  • The CC should have access to all information in the possession of the Ministry of Finance, the Central Bank, the Investment Advisor and the Petroleum Ministry.

  • The CC (and the Independent Auditor) should have access to information from the petroleum companies about all payments they make to Timor-Leste for oil and gas operations, and how those amounts were derived (see below).

  • The CC should review not only the legality of Fund operations, but also the wisdom of operational decisions. If members of the CC feel it appropriate, they should publish reports or findings in the media and speak to the public, especially if the Fund managers fail in their duty of transparency.

We urge that the Office of the Provedor be operational before the Petroleum Fund commences. The Provedor’s mandate includes investigating anyone with responsibility for public funds or assets, which means not only the MoPF and the Central Bank, but also Fund operations outside Timor-Leste.

Audit

Independent, external, annual audit reports of the Fund should be made public in full. If the Auditor finds any irregularity, he/she should be able to refer the case to the Provedor or the General Prosecutor.

We are concerned that the Act does not provide for appointment of an Independent Auditor until several parts of the judiciary are operational – which could be a long time given the scarcity of qualified judges. This position needs to be filled before July 2005, when the Fund will begin operation. To ensure independence, the Auditor should be selected by the Consultative Council, not the Government.

Audits should include receipts, transfers and investment of Fund monies inside and outside of Timor-Leste, as well as payments by petroleum companies. When the Auditor certifies the Government’s “amount of the estimate of sustainable income” to Parliament (Articles 7.3(c) and 7.4(c)), the Auditor should also evaluate and report on the assumptions and models underlying the estimate, verifying their validity against globally-accepted projections of fuel prices, inflation rates, and interest income.

Transparency and access to information

We welcome Article 18 “Transparency as a Fundamental Principle,” and Article 14 requiring a public Annual Report. We hope that the principle and the spirit of transparency will be implemented throughout the Fund. The Petroleum Fund is a public trust, derived from publicly owned resources. There is no justification for secrecy regarding any aspect of the Fund’s operation. The Act proclaims “the highest standard of transparency” (Article 18.1) – but that standard is lowered throughout the Act.

Loopholes for censorship

The drafters seem obsessed with disclosure of “confidential information,” mentioned six times in the Petroleum Fund Act,[15] nearly every place the Act discusses providing information to the Public. This invitation to censorship should be removed. Public institutions and public servants have no excuse for confidentiality in relation to the Fund, and any private firm, such as an investment advisor, can be informed in their contract that Timor-Leste practices genuine transparency.

Every item of information should be available to the public unless there is a compelling reason (such as national security or personal privacy, neither of which apply to institutional actions) to keep it private. The concepts of commercial or other confidentiality that apply to other taxpayers and bank accounts are not appropriate for the Petroleum Fund.

If the drafters reject our suggestion and insist on “confidential information,” this phrase must be clearly and narrowly defined and time-limited. Every time a document is redacted for confidentiality this must be disclosed, with an explanation of the deletion. Otherwise it’s a blindfold which will be abused by those with something to hide.

We are also concerned about four provisions[16] which require that reports or information be “adapted for public information” before being released. It is indeed helpful to publish clearer versions so that people can understand them more easily, but this is no reason not to release the original. The Act should be changed so that the uncensored, unedited document or report is public in each of these cases, in addition to versions adapted for wider accessibility. All versions of the Annual Report should be published in several languages.

Public Register

Although the Fund Act does not provide for a Public Register, we urge that one be created. Our proposed new Article 18½ in the section-by-section portion of this submission includes a list of information which should, at minimum, be included, uncensored, in a timely manner.

We do not know if an effective Public Register is included in the Petroleum Act as passed by the Council of Ministers. If that Act includes a well-structured, accessible Public Register, the Fund might be able to utilize it.

Information from companies

The Petroleum Fund Act primarily defines functions internal to the government of Timor-Leste, but there is one important area where it needs to apply to companies involved in petroleum exploration and production. In order for the CC, the independent auditor and the public to have confidence that reports of Fund receipts (Article 6.1) are accurate and complete, they need information from the companies about payments they have made. This is in keeping with the growing international movement for transparency within extractive industries. Verification of the Estimated Sustainable Income may also require information from the companies.

The Petroleum Act and Production-Sharing Contracts should also contain this requirement, but the orientation of the drafters of that legislation, as well as earlier versions, give us concern that requirements in those documents may not be sufficient. Consequently, we urge that the Petroleum Fund require companies to cooperate with the CC, the Auditor, the Provedor and the Parliament in providing information about all payments they make to Timor-Leste and the TSDA. This information should also include how the amounts of each payment were determined. The companies will be required to provide such information to the Petroleum Ministry on a regular basis;[17] these statements should be public as part of the Petroleum Fund management.

La’o Hamutuk’s submissions on the Petroleum Regime and Petroleum Fund Discussion Paper proposed that the Public Register include:

“All payments of $1,000 or more to the TSDA, the Government of Timor-Leste (or to any agency or agent of that government or Authority) in connection with petroleum development by any person, corporation or other business. This includes not only income and other taxes and royalties, but any other payments (including bonuses, finder’s fees, etc.) within or outside of Timor-Leste for the purpose of facilitating or implementing Petroleum activities in Timor-Leste. Each payment report should include the date the payment was made, the amount, the payer, the payee, the purpose of the payment, and any services or goods received in return.” [18]

Although some oil companies may not welcome this requirement for transparency, they will obey the law – especially if there are penalties for non-compliance. Representatives of the two oil companies most involved in the Timor Sea have recently said that they will comply with whatever disclosure law Timor-Leste adopts, even if they do not like it.

Some existing contracts and regulations governing Timor-Leste’s relations with oil companies do not practice transparency. When the Petroleum Fund Act requires companies to provide information, its provisions should explicitly override existing provisions in laws, contracts or mining codes which might be cited as a reason not to disclose information.

The government of Timor-Leste has announced it will implement the principles of the Extractive Industries Transparency Initiative (EITI), and one of the basic ones is that the companies should publish what they pay. Embedding this requirement in the Petroleum Fund Act not only carries out our Prime Minister’s public promise, but enables the managers and overseers of the Petroleum Fund to do their jobs.

Conclusion

This part of our submission discusses La’o Hamutuk’s main concerns regarding the draft Petroleum Fund Act. Some additional and more detailed concerns and changes are described in the attached annotated copy of the Draft Act.

We appreciate the efforts of the Ministry of Planning and Finance and others involved in designing Timor-Leste’s Petroleum Fund to solicit and consider input from many perspectives, including civil society. We hope that our participation in this process will help strengthen the Petroleum Fund, to buttress the Government’s stated determination to safeguard our petroleum wealth and protect our people from the environmental, economic, political and societal curses that oil and gas development has brought to so many.

Unfortunately, we have yet to see Government actions, including this draft Act, which adequately respond to the dangers of the “paradox of plenty.”

La’o Hamutuk urges every one in Timor-Leste – including the Government, interim Petroleum Ministry, Ministry of Planning and Finance, TSDA and Timor Sea office – to increase their recognition of the dangers facing our people if we don’t handle petroleum development properly. We also hope that Parliament, NGOs and other civil society organizations will work constructively and with determination not only to safeguard our petroleum revenues, but to save our people from the war, pollution, corruption and economic ruin that so often plagues countries like Timor-Leste.
 

Section-by-section comments and suggested changes

This document is the second part of our submission on the Petroleum Fund Draft Act, and should be read together with the narrative part of our submission.
 

Executive Summary

La’o Hamutuk comments

This purpose of this Act is to establish a Petroleum Fund for Timor-Leste. The provisions in the Act reflect the discussion paper on the key policy issues that was released on 18 October 2004, as well as submissions received during the ensuing period of broad public consultations.

 

The objective of the public consultation is to get comments from civil society and the public at large on this draft Act by 1 March 2005. After considering the submissions the Government will submit the Act establishing the Petroleum Fund to Parliament. Subject to the approval by Parliament and promulgation by the President, the Petroleum Fund can be operational from 1 July 2005 (the start of the 2005-2006 fiscal year).

This draft Act should be revised, and the revisions released to the public, before it is submitted to the Council of Ministers and the Parliament.

Also, regulations must be written and positions filled before the Fund is operational. It’s hard to see that happening in two months.

The design of the Petroleum Fund is based on the following key principles:

  

  • The Petroleum Fund shall be a tool that can contribute to the wise management of Timor-Leste’s petroleum resources, for the benefit of both current and future generations.

The phrase “for the benefit of both current and future generations” occurs often in this Act, but it is vague, especially as to how far into the future it applies. The Act should have a goal of providing sustainable income for Timor-Leste for the indefinite future, including after our petroleum reserves have been exhausted.

  • The Petroleum Fund builds on international best practice and reflects the circumstances of Timor-Leste. It is based on the petroleum fund used in Norway, one of the few models internationally that are generally seen to function well and contributing to a wise management of the petroleum wealth. The proposed model for Timor-Leste is currently referred to as the ”Norway Plus” model, reflecting additional accountability, transparency and information features that are judged appropriate for Timor-Leste’s circumstances.

As we discussed earlier, São Tomé e Príncipe is a more appropriate and relevant model for Timor-Leste. Furthermore, several of the best elements of Norway’s Fund are omitted from the proposal for Timor-Leste, making this “Norway Minus.”

  • The Petroleum Fund builds on the Constitution. The Petroleum Fund Act lays down the key parameters for the operation and management of the Fund in accordance with article 139 in the Constitution, which states that the petroleum resources shall be owned by the State, shall be used in a fair and equitable manner in accordance with national interests, and that the petroleum extraction should lead to the establishment of mandatory financial reserves. The proposed Petroleum Fund builds on the constitutional framework, giving to the Parliament and the Government the powers that correspond to their competencies.

 

  • The Petroleum Fund allows for a strengthening of the responsibilities, powers and capacity of key public sector institutions, such as Parliament, the Government, the Ministry of Planning and Finance and the Central Bank. There will be an Investment Advisory Board advising the Minister of Planning and Finance to enhance the quality of advice preceding decision-making. There will also be an independent Consultative Council to advise Parliament on the operations of the Fund, acting as a “watchdog” and contributing to an informed public debate and a sound management of the petroleum wealth.

The independence of the Investment Advisory Board and Consultative Council needs to be strengthened, and they need to be able to invoke investigatory and prosecutorial authorities when appropriate, on their own initiative, and to freely share their findings and opinions with the public.

  • The Petroleum Fund is to be a tool that contributes to sound fiscal policy, and thereby help deliver on a sustainable basis strong economic growth and improved public services. The design of the Petroleum Fund acknowledges that good planning and execution of public sector budgets are key to avoiding the resource curse found in so many petroleum producing countries. The Petroleum Fund is to be coherently integrated into the budget process, supporting a fiscal policy framework that strikes the right balance between current consumption, investing in physical assets (infrastructure and human development) and investing in financial assets.

This Act and the Fund should encourage planning for our nation’s post-petroleum era. This would include long-term planning, development of non-petroleum sectors, and investing in human and physical infrastructure.

  • The Petroleum Fund is to be prudently managed, invested securely in low-risk financial assets abroad.

 

  • The management of the Petroleum Fund shall be carried out with the highest standard of transparency and accountability. This is a key element in building public confidence and support for a wise strategy of managing the petroleum resources. This can allow Timor-Leste to avoid the negative experiences found in so many petroleum producing countries, where petroleum has proved to be a curse instead of a blessing.

“Highest” is not a relative term. There are many ways transparency in this Act could be improved and made more effective.

The draft Petroleum Fund Act has the following key features:

 

  • The Petroleum Fund’s income: all revenues emanating directly or indirectly from Timor-Leste’s petroleum resources will flow into the Fund, as well as the return on the Fund’s investments (net of management expenses). All the income of the Fund shall flow into an ‘earmarked receipts account’. The Fund’s opening balance on 1 July 2005 will be the accumulated First Tranche Petroleum payments, plus an amount to be determined by the Government to take into account the large petroleum revenues during the current fiscal year. [Articles 5 and 6]

 

  • The Petroleum Fund’s expenditure: transfers from the Fund can only be made to a designated State Budget account, and the sum of all transfers in a fiscal year can not exceed a ceiling set by Parliament when approving the State Budget. This ceiling will as a general rule correspond to the amount necessary to finance the deficit on the State Budget excluding petroleum revenues. The Budget approved by Parliament decides the level of domestic tax revenues and spending – be it on current public consumption or on investment in infrastructure and human capital. Since it is the Budget’s financing need that determines the outflow from the Petroleum Fund, the Budget also decides the net allocation to the Petroleum Fund that gets invested in financial assets. This creates a direct link between the Budget approved by Parliament and the development of the Fund, and the Petroleum Fund will give a good representation of the Government’s rate of savings and net financial asset position. [Article 7]

The Parliament should pass a separate annual resolution authorizing a set amount, not a ceiling, for transfers from the Fund.

  • The Government has separately adopted a savings/expenditure policy of maintaining the real value of the petroleum wealth, which will serve as a reference to determine the amount of money that should flow out of the Fund. This policy translates to spending the estimated sustainable income from petroleum, which is the amount that can be spent each year forever and therefore can be said to strike a good balance between the interests of current and future generations. On current calculations, this policy allows for a significant increase in Government spending in the medium term.

We have been unable to obtain a written document describing this policy. Is it a public document? How has it been adopted, and who has approved it? How will it be reviewed and revised?

  • The Act has specific reporting requirements imposed on the Government and the Consultative Council if the State Budget proposes to withdraw from the Petroleum Fund more than the estimated sustainable income from petroleum. While there at times may be good reasons to spend more than the estimated sustainable income, the provisions in the Act should contribute to making sure that such decisions are transparent and well informed. [Articles 7 and 17]

 

  • The management of the Petroleum Fund: The Government has responsibility for the overall management of the Fund, and the Minister of Planning and Finance will exercise key functions and competences. The operational management will be delegated to the Central Bank in accordance with a management agreement, and it is envisaged that other investment managers will be appointed. [Article 8]

 

  • The Investment Advisory Board is an expert body that shall advise the Minister on any matter relating to the management of the Petroleum Fund. Members of the Board will include the Director of the Treasury, the Head of the Central Bank, two persons with significant experience in investment management and one other person. [Article 10]

This Board needs to be expanded to insure independence from the Government, the Finance Ministry and the Central Bank.

  • The investment of the Petroleum Fund: The Fund’s savings will from the beginning be invested securely in low risk financial assets abroad. The Act stipulates that investments must be USD denominated debt instruments with a low credit risk (a minimum credit rating of Aa3 by Moody’s or AA- by S&P). This will in practice mean investments mostly in government bonds, which means that the financial risk is seen to be limited and the expected investment return moderate. The investment strategy shall be reviewed within five years, when a larger Fund and improved institutional capacity may suggest a different asset allocation. [Article 9]

 

  • There will be independent, external audits carried out by an internationally recognized accounting firm to bolster confidence that money going to, from or remaining in the Petroleum Fund are not misappropriated. The external auditor will also certify the calculation of the estimated sustainable income, and prepare a report on payments made by companies as Petroleum Fund receipts. [Articles 1, 7, 14, 20 and 23]

The audit report should also validate and explain the assumptions on which the sustainable income calculation is based. It should look at investments, not just income and expenditures. Audit reports should be made public in full.

  • There will be an independent Consultative Council. The Council is to advise Parliament on the operations of the Fund, acting as a “watchdog” and contributing to an informed public debate and a sound management of the petroleum wealth. Members of the Council will be appointed by the President, Parliament, Government and civil society, and there will in addition be seats for former Presidents, Speakers of Parliament, Prime Ministers, Ministers of finance and Heads of the Central Bank. [Articles 15, 16 and 17]

The Consultative Council should include representatives from a broader range of civil society. These appointments should not be made by the Minister, but by the sectors of society they represent, to ensure that they are accountable to the people whom they represent.

  • There are accountability, transparency and information features to contribute to a wise management of the petroleum wealth. There will be a high degree of transparency of operations, including comprehensive and accessible reporting requirements – both on the management of the Fund and on whether the spending of petroleum revenues is consistent with long-term considerations. There are also information requirements on payments made by companies as Petroleum Fund receipts, which is a core element of the Extractive Industries Transparency Initiative. [Articles 7, 10, 14, 17, 18 and 20]

There is room for a great deal of improvement in these areas, as discussed elsewhere in this submission.

 

Draft Act

La’o Hamutuk comments

This Act establishes a Petroleum Fund which seeks to meet with the constitutional requirement laid down in Article 139 in the Constitution of the Republic. This provision states that the petroleum resources shall be owned by the State, shall be used in a fair and equitable manner in accordance with national interests, and that the petroleum extraction should lead to the establishment of mandatory financial reserves.

 

The Petroleum Fund shall contribute to a wise management of the petroleum resources for the benefit of both current and future generations. The Petroleum Fund shall be a tool that contributes to sound fiscal policy, where appropriate consideration and weight is given to the long-term interests of Timor-Leste’s citizens.

The Act and its implementers need to go beyond the vague “for the benefit of both current and future generations.” The Fund Act should specify goals involving transition to the post-petroleum era, human rights, building human and physical assets and capacity, moving towards renewable energy. It should also discourage use of Fund money for military expenditures, weapons, one-time projects, etc. Since the preamble of the Act will be the standard by which the Investment Advisory Board, Consultative Council and others judge whether the Fund is being properly managed, it needs to be explicit, detailed and carefully thought out.

Efficient planning and proper execution of public sector budgets are key components of a sound management of the petroleum wealth. The Petroleum Fund is to be coherently integrated into the State Budget, and shall give a good representation of the development of public finances. The Petroleum Fund shall be prudently managed and shall operate in an open and transparent fashion, within the constitutional framework.

As discussed below and in our narrative and earlier submissions, the Act should include binding rules to improve the ability of Timor-Leste officials to properly plan and execute their budgets. In the absence of such rules, windfalls of petroleum revenue, magnified by short-term pressures, almost invariably lead to bad policy.

This Act lays down the key parameters for the operation and management of the Petroleum Fund. The Act governs the collection of and management of receipts associated with the petroleum wealth, regulates transfers to the State Budget, and provides for Government accountability and oversight of these activities.

 

Therefore, pursuant to Article 139 of the Constitution and for the purpose of establishing a fund of income from the exploitation of non-renewable petroleum resources for the needs of both current and future generations, The Government presents to the National Parliament, pursuant to paragraph c), item 1, Article 97, and paragraph a), item 2, Article 115, of the Constitution of the Republic, the following draft law:

 

Chapter I – General Provisions

 

Article 1: Citation

 

This Act may be cited as the Petroleum Fund Act.

 

Article 2: Definitions

  

1.1 In this Act, unless the context requires otherwise:

 

“Central Bank” means the authority to be established under Section 143 of the Constitution of the Republic or, until such authority is established, the Banking and Payments Authority;

 

“Code” means the Petroleum Mining Code agreed and adopted by Timor-Leste and Australia under Article 7 of the Treaty, as amended, varied, modified or replaced from time to time, and regulations made and directions given under it;

This is referenced only once, in the definition for petroleum authorization.

“estimated sustainable income” for a fiscal year means the amount determined in accordance with the formula set out in Schedule 1;

 

“Exchange of Notes” means:

This is referenced only once, and this Act would be clearer if it were spelled out in Article 6.2, rather than here.

(a) Exchange of Notes Constituting an Agreement between the Government of Australia and the United Nations Transitional Administration in East Timor, of 10 February 2000; or

 

(b) Exchange of Notes Constituting an Agreement between the Government of Timor-Leste and the Government of Australia, of 20 May 2002.

 

“fiscal year” means the period of twelve (12) months from 1st July to 30th June;

 

“independent auditor” means the auditor appointed, from time to time, for the purpose of auditing the Government accounts as set out in the Timor-Leste law, or an internationally recognised accounting firm appointed pursuant to Article 23;

 

“investment manager” means the Central Bank and any person appointed as investment manager under Article 8;

 

“Minister” means the Minister in charge of finances;