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

2Energy Analytics & Consulting

Objectives and Methodology

• Objective– 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


Case studies

4

Countries Crude Oil Natural Gas Coal

Copper

Gold

Indonesia

Malaysia

Philippines

Vietnam

Cambodia

Timor Leste

Myanmar


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


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


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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


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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


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Case Studies: Details

Coal in Indonesia

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• 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


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.


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.


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.


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.


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,


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.


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.


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


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.


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.


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


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.


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


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.


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.


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.


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.


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


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


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


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.


Documents

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