The Papua New Guinea government’s proposal to move to production sharing agreements in resource projects may not solve the government’s financial problems and there is a risk it will harm the country’s reputation for being a good place to invest, according to the industry itself.

The LNG tanker ‘Papua’ loading at the PNG LNG project’s marine terminal. Credit: ExxonMobil/Richard Dellman

Back in August, the Minister for Petroleum and Energy, Kerenga Kua, told an industry event that PNG’s present royalty tax system (RTS) obligates the government to borrow money to acquire an interest in resources projects. With the PNG government’s debt-to-GDP ratio close to the maximum permitted level, he said the government did not have the capacity to borrow to participate as an equity partner.

One way to mitigate a perceived loss of resource ownership by the state, Kua said, was to move to a production-sharing contract (PSC) arrangement, which the government is now actively pursuing.

John Chambers, General Manager PNG at Santos acknowledged during an industry webinar last week that maintaining a low debt-to-GDP ratio is ‘important to a developing country’. He said there are two ways of handling it: paying off debt or growing GDP, arguing that the latter is ‘the preferable way to do it’.

‘Every country in the world has this debate. It is a complicated one.’

‘It is very hard to pay off debt if your economy is not growing and, to grow GDP, you have to get investment in your country.’

Chambers said Australia, Singapore and Indonesia have been able to do it, adding that debates over ‘getting the split right’ in resources projects go on everwhere.

‘Every country in the world has this debate. It is a complicated one.’

Factoring in assets

Arthur Somare. Credit: PNG Chamber of Commerce/Linkedin

PNG already has ways of participating in projects without incurring higher levels of debt, according to Arthur Somare, the former Public Enterprise Minister who was heavily involved in the negotiations for the ExxonMobil-led PNG LNG project.

He told the same industry event last week that, when the PNG LNG project was being developed, the State had an asset available: Oil Search shares trading on the Australian Securities Exchange.

‘The State, with Treasury, decided it was feasible to leverage such an asset to find the appropriate finance mechanism to move forward,’ Somare said. ‘We used Oil Search shares, through an exchangeable bond, to raise the necessary financing: US$1.2 billion to take up a 19.4 per cent interest in the project.’

‘It is possible to use what [law] we already have in PNG to work out the state funding piece’

Somare said the investment into the PNG LNG project made a lasting impact on the economy.

‘There was US$20 billion capital spend into the economy that created a multiplier effect. We still enjoy some of the impact of that US$20 billion today, in infrastructure. That was a direct consequence of the foreign direct investment. Today, if we do not convert on the next big project, where will PNG be?’

‘If we were to leverage the Kumul companies today, as we leveraged the business trust and Oil Search shares in 2009, we would be able to finance these projects fairly easy: P’nyang, Papua LNG and Wafi-Golpu.’

Production sharing no ‘panacea’

Santos’s John Chambers. Credit: Linkedin

John Chambers warned that the government’s aim of moving towards production-sharing contracts (PSCs) would not be a ‘panacea’ to solve its fiscal problems.

‘In most pure PSCs, contractors are not be taxed. The big advantage to the State is that, in the royalty tax system, the State has to pay its share of exploration costs and, on top of that, project development costs along the way.

‘It is critical that PNG strengthens existing laws that it has to woo foreign investment into PNG.’

‘I think as an industry we need to recognise that this is an issue for PNG. But the Kutubu oil field was a royalty tax system and the PNG share was paid out by the developers anyway. It is possible to use what [law] we already have in PNG to work out the state funding piece; it can be done through future production.’

Chambers noted that PSCs are not ‘particularly efficient vehicles’, and so tend to be less profitable. ‘Overall take is reduced and the splits between developer and state are reduced.’

He said in a PSC structure the entity is seen as spending future state earnings whenever it invests funds, which creates the wrong incentives.

‘Every bit of capital you spend is effectively taking that [state] share out, so the state becomes very incentivised to reduce expenditure.’

In addition, there is an increased amount of auditing and complex compliance that slows production down, he said. ‘It is very hard to do things quickly. In Indonesia, what takes three-to-four years in Australia takes three-to-four months. As time moves on, investors are losing on their rate of return.’

International reputation

Arthur Somare also noted that PNG’s existing resource laws had given the country a good reputation as a place to invest.

‘We have a predictable and certain regime that gives us absolute clarity for investors so they will appreciate they will get a return on their investment. It is critical that PNG strengthens the existing laws that it has to woo foreign investment into PNG.’

Until the legal framework was clear, Chambers said he could not go to his board and be able to answer questions about the project’s rate of return.

‘Until the PSC has been defined, we won’t be able to invest. And, when it is defined, it will be very difficult to administer. It can be done in petroleum, but will be far harder in the mining industry.’