Friday, February 07, 2014

Part 5: Papua-New Guinea SWF--Reimaging the State in the Global Sphere: An Inventory of Sovereign Wealth Funds as Regulator and Participant in Global Markets

(Pix (C) Larry Catá Backer 2014)

This Blog Essay site devotes every February to a series of integrated but short essays on a single theme. For 2014 this site introduces a new theme:  Reimaging the State in the Global Sphere: An Inventory of Sovereign Wealth Fund as Regulator and Participant in Global Markets.

There have been a number of studies that have sought to provide an overarching structure for understanding SWFs. The easiest way to to this is to find the largest and most influential funds and then extrapolate universal behaviors or characteristics from them.  This is a useful enterprise, it may erase substantial nuance that itself might provide the basis for a deeper understanding of SWFs within globalization and in the context of a state system in which not all states are created equal.  In this sense, while the large SWFs are better known, they do not define the entire field of emerging SWF activity. This study provides a brief critical inventory of the emerging communities of sovereign wealth funds. Each post will consider a different and less well known SWF.  Taken together, these brief studies might suggest the character and nature of the emerging universe of SWFs, and their possible rationalization.

This Post considers the the Papua New Guinea Sovereign Wealth Fund.

Like a number of other smaller funds established by developing states, the Papua New Guinea SWF (PNGSWF) consists of a number of coordinated funds.  They were established in 2011 as a (1) Development Fund; (2) Futures Fund; (3) Stabilization Fund; (4) Management Fund; and (5) Other (Sovereign Wealth Fund Institute Papua New Guinea).  The PNG SWF are expected to come on line in 2015.

Like other SWFs established in countries facing similar challenges, these funds are meant to serve as a disciplinary tool to help the state protect and manage its resources--perhaps mostly against itself.  Human Rights Watch noted for 2012 that "Papua New Guinea has abundant natural resources, but poor governance and corruption have prevented ordinary citizens from benefiting from this wealth. The government has failed to safeguard environmental concerns in mining operations, and the continued dumping of mine waste into rivers poses potentially severe health risks." But, if well managed, the SWFs may also protect the state against the vagaries of macroeconomic patterns against which they have little alternative ability to engage in effectively.

At the center of the SWF funding are revenues form Papua New Guinea's extractive industry. Unfortunately, as in similarly situated states, the government itself has tended to give over control of its rich natural resources to others. Again Human Rights Watch:
Extractive industries are the main engine of the economy, but the government has long failed to adequately regulate them, with devastating consequences to the environment. Papua New Guinea’s sprawling Porgera gold mine, 95 percent owned by Canadian company Barrick Gold, has produced more than 16 million ounces of gold since opening in 1990, worth more than US$20 billion today. The mine dumps 16,000 tons of liquid waste into the Porgera River every day, a controversial practice that is out of line with current industry standards. Critics worry it could pose serious health risks to communities downstream.

A protracted legal battle over the Ramu Nickel mine, set to begin operations in late 2011, involves Ramu Nico Management (MCC), the Chinese company that owns the majority of the mine, and landowners raising compensation discrepancies and environmental concerns. In July the National Court dismissed an application that landowners had brought for a permanent injunction preventing the mine from dumping waste into the sea. The Supreme Court was hearing an appeal at this writing.

Exploration drilling as part of a projected $15 billion Liquid Natural Gas (LNG) project is set to expand at the end of the year. Disputes between local landowners and LNG contractors have been common since the project was sanctioned in 2009, and unresolved disputes over compensation for landowners, outstanding business development grants, and inadequate benefits for employees continue to generate protests and occasional violence. In August local villagers attacked two employees at the LNG site in Komo, a proposed airfield, forcing Exxon Mobile to temporarily halt operations. ((Human Rights Watch World Report 2012 Papua New Guinea).

In a sense, as in some other states, SWFs appear to be an integral part of the economics of the global economics of extractives industries. States might well justify their relationships with foreign companies, including those owned by other states, as well the terms under which national resources are alienated both on the basis of free movement of capital and goods, but also on the "tax" that revenues flowing to SWFs may represent--tax both in the sense that it reoresents part of the price of permitting exploitation by foreigners but also a tax on the state itself by segregating funds it might otherwise use immediately. "PNG has been at the forefront of policy-institutional innovation aimed at managing the problems of resource-based development. It was among the first developing countries to put in place a resource-rent taxation regime." (Peter Drysdale, Can Papua New Guinea capitalise on its Asia boom?, East Asia Forum, 21 Jan. 2013)

Yet corruption and lack of discipline may substantially weaken the effectiveness of the PNG SWF.  Corruption remains a difficult issue that has impeded aid from foreign states (e.g., Liam Cochoran, Australia withdraws funding from Papua New Guinea health programs over corruption, fake drug concerns, Australia Network News, 26 Dec. 2013). This from Public Enterprises Minister Sir Mekere Morauta in 2012:
“Transforming resource wealth into better living standards is the biggest single challenge facing our country,” Morauta said.

“If we can set up the SWF properly, keep sticky fingers off the money and channel funds into the right public investments, then the future is bright.

“We need leaders, organisations and the will to make this happen.

“Yes, it (SWF) will help to insulate the economy from Dutch Disease and inflation, and it will smooth out volatile revenue flows,” Morauta said.

“And if it is established properly, the SWF will also keep sticky fingers off the revenues and financial investments.

“But if the money to be drawn down from the SWF flows into an unreformed budget, then we are likely to see a repeat of the same old story: No discipline, no capacity to implement, no accountability; and thus no real development, no improvement in services for our people.

“If the Budget disperses money as it does now over a million and one so-called ‘priorities’, then what can we do to ensure that top priorities, such as maintaining national infrastructure, don’t miss out?

“If the public coffers are vulnerable to corruption and theft, then what can we do to put in place strong governance and accountability mechanisms and regimes?

“If government departments lack capacity and accountability, then what can we do to restructure the service delivery model to deliver results?” (Malum Nalu, Morauta concerned about sovereign wealth fund, Papua New Guinea Mine Watch, June 7, 2012).
 Lastly a sensible view form Australia:
Stephen Howes asks how can Papua New Guinea do a better job of converting growth into development?

Howes reckons that five issues will make the difference. At their core is the issue of how to capture revenue from the resource boom and transform it into effective development spending. As Australians know, it’s an issue that is certainly not unique but there are some aspects particular to Papua New Guinea. What’s not unique is the challenge of putting in place a taxation regime that captures resource rents and smooths expenditure growth without distorting investment incentives. What’s a special challenge in the PNG setting is directing the revenue take to economic and social development purposes rather than wasting it as ‘grease’ money. In a small resource-dependent developing country the case in principle for using a sovereign wealth fund (SWF) instrument for smoothing expenditure patterns is strong. The government has moved to establish an SWF to manage the flows of dividends and tax revenue that will come on stream in 2015 from the massive LNG project currently under development ((Peter Drysdale, Can Papua New Guinea capitalise on its Asia boom?, East Asia Forum, 21 Jan. 2013)).
 Lastly the PNGSWFs evidences the way in which SWFs have begun to intertwine around the revenue producing sources to which they are tied.  Consider in this context the connection between the Abu Dhabi Fund, PNG exptractives and potential revenues to the PNG SWF.

In late 2008, PNG under former prime minister Michael Somare agreed to a deal with one of Abu Dhabi’s sovereign wealth funds to raise A$1.68 billion to pay for its share of the cost of developing the US$19 billion PNG LNG gas-export project, operated by Exxon Mobil Corp.XOM +0.87% The agreement involved a five-year exchangeable bond covering the PNG government’s entire 17.6% stake in Oil Search, since diluted to 15%.

That deal was completed in March 2009, at which point the clock began ticking on when the fund, known as International Petroleum Investment Co., or IPIC, could exchange its bond for the shares.

The catch is that IPIC’s bond has a strike price of A$8.55 a share. If Oil Search’s stock is trading below that level when the bond matures in March this year, then Papua New Guinea’s leaders will have to tap the country’s coffers to make up the difference. For example, if Oil Search trades at A$8 on that date, then the PNG government must bridge the 55-cent gap per share out of its own coffers.

As a result, issuing new shares at a discount to fund a deal with InterOil and Total is problematic—especially for a company like Oil Search, which has most of its operations in Papua New Guinea. Oil Search’s shares would likely fall when trading restarts to accommodate the additional stock.

PNG’s government, led by Prime Minister Peter O’Neill, isn’t likely to want to drain valuable cash reserves to make up a bigger discount to the A$8.55 strike price when IPIC’s bond matures. Indeed, the government would prefer to eliminate the bond altogether by buying it back from IPIC so it can retain its stake in Oil Search, according to a person familiar with the matter. Papua New Guinea has been courting lenders to enable it to do so. (David Winning, Odds Are Against Oil Search Joining Gas Project, Money Beat, January 24, 2014).
In this regard consider generally:
Today another scenario may appear equally unlikely: a Norwegian government agency managing Algeria’s sovereign-wealth fund; German police overseeing security in the streets of Mumbai; and Dubai playing the role of the courthouse of the Middle East. Yet such outlandish possibilities are more than likely if a new development fulfils its promise. Ever more governments are trading with each other, from advising lawmakers to managing entire services. They are following businesses, which have long outsourced much of what they do. Is this the dawn of the government-to-government era? (Unbundling the Nation-State, The Economist, February 8, 2014).

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