Investing the money well

The danger of Lebanese politicians taking a cut is real

Lebanon’s progress to cultivate wealth from its offshore oil and gas resources has left us with more questions than answers. While the country will not extract any resources for at least five years, the agreements being negotiated in the next 12 months will determine whether Lebanon gets a good deal or not.

Over the course of six days, seven leading thinkers will discuss different aspects of the resources — from avoiding environmental destruction to how to spend the new wealth — each with the aim of helping provoke awareness about what is going on in this crucial period.

For our sixth segment, Paul Cochrane analyses how best Lebanon should invest the profits from oil and gas.

See also: Lebanon's Petroleum Administration makes a positive start

Avoiding a regional war over hydrocarbons

Transparency is not enough

Plan ahead to protect the environment

Will Lebanon's oil be Christian or Muslim?

 

If Lebanon manages to tap its offshore hydrocarbon reserves, the multi-billion dollar question is what to do with the revenues. How much is Lebanon looking to gain? Well, David Rowlands, chief executive officer of prospector British Spectrum Geo which has been carrying out seismic surveys on the country’s offshore resources, told The Times on March 4 that the value of Lebanon's oil and gas could be as much as $140 billion. Others have put it at anywhere from $40 billion to over $70 billion – much depends of course on commodity prices. With Lebanon's GDP at $40 billion, and public debt at $58.7 billion, any petrodollars are a major boon for the country's troubled finances.

In the 2010 Offshore Petroleum Resources Law, it is stipulated that Lebanon must form a sovereign wealth fund (SWF) into which the net proceeds of the government’s revenues will be invested. However, the law is deliberately unclear about how the money will be used once it is in the fund – leaving final decisions dependent on later negotiations.

Early last year, Prime Minister Najib Mikati proposed that the SWF should initially be used to reduce the public debt from 135 percent of gross domestic product (GDP) to 60 percent, but it was unclear whether he had government support for the proposal.

Given the government's less than stellar reputation in spending public money, the crony capitalism-style deals with Lebanese banks in financing the country's debt over the decades at highly lucrative interest rates, and the lack of accountability and transparency within the political process, how best to run a SWF?

Ups and downs

The primary rationale behind a SWF is to ensure the revenues generated from natural resources are appropriately utilized for the present and future generations – money put into the fund is invested, profits are generated and returns can be saved or re-invested for the future. Yet there are both positive and negative sides to SWFs.

On the plus side a SWF can handle greater investment risk than the central bank, domestic investment will boost the local economy, and strategic global investments can ensure a degree of economic and political security for a country.

On the negative side, SWFs are notoriously opaque. In the rankings of oil-based SWFs, only Norway scores well in the SWF Institute's Linaburg-Maduell Transparency Index, and notably Norway is the only democracy in the top 10 SWFs by value. As critics have pointed out, SWFs are popular with authoritarian and semi-authoritarian governments because they don't have to be transparent or accountable. Furthermore, oil and gas producing countries do not necessarily become more transparent if they set up a fund, while some energy producers do not have SWFs at all, such as Iraq and Saudi Arabia.

With Lebanon ranked 128 out of 176 countries in Transparency International Corruption Perception Index 2012, with a score of 30 out of 100 (zero means highly corrupt), hopes for transparency in handling hydrocarbon revenues are dim.

The real danger is that becomes a political tool. In Lebanon's political system, whom controls what ministry and handles the finances is hotly disputed, and no parties really trust one another, so the dangers for managing the SWF are clear.

Where will money be invested domestically that does not benefit one political party, movement or region over another? And if the fund invests internationally, where and what to invest in? Say a March 8 government wants to invest in Iran. Would the March 14 movement accept that? Probably not. Imagine then, hypothetically, if March 14 unseated March 8, would investments in Iran then be transferred elsewhere, such as to Saudi Arabia.

Seeking neutrality

Perhaps a better approach would be to give Banque du Liban (BDL) – the country’s central bank – control over the SWF. The BDL has handled foreign reserves well – certainly gold, with Lebanon ranked 19th globally by the World Gold Council (WGC) this year.

But BDL, like all central banks globally, is also not known for its transparency. Additionally, the recent appointment of Ahmad Safa as an Executive Director at the BDL's Banking Control Commission raises concerns, as he was fingered by the United States Treasury for his role in the money laundering scandal that took down Lebanese Canadian Bank in 2011.

Perhaps the best initial strategy would be to pay off the debt, and invest heavily – possibly through public-private partnerships for added transparency – in the country's dilapidated infrastructure and institutions. Only once that money is spent would it be truly worthwhile debating how best to organize and run a SWF, and where it could invest domestically and globally.

Alternatively, another idea would be to pay off some of the debt and then use the SWF to buy more gold, which could be held partly in Beirut and elsewhere. By holding physical gold the country would be on a solid foundation in terms of reserves and, if needed, to go to the markets for financing, while in the local political context this would arguably reduce the chances of misuse of funds.

Furthermore, in a period of quantitative easing with the US Federal Reserve printing money – some $1 trillion is to be added to the Fed's balance sheet per year, according to Forbes – holding gold is a way to hedge against any devaluation in the world's reserve currency, the greenback, which is crucial for Lebanon, given two-thirds of all bank deposits are held in US dollars and the Lira pegged to the dollar.

Additionally, there has been a growing move in recent years by governments (the US excluded) to buy gold as a hedge against inflation and currency devaluation, with official holds surging from $2 trillion in 2000 to $12 trillion in 2012, according to the WGC. Indeed, last year, central bank gold purchases were up 17 percent on 2011, to 534.6 tons, the highest level of buying since 1964. While buying gold would not be a panacea for what to do with hydrocarbon revenues, it should be considered as an option in these trying economic times, certainly to diversify the government's portfolio as well as to prevent political bickering.

Paul Cochrane

Paul Cochrane is the Middle East Correspondent for International News Services. He has lived in Beirut since 2002, and has written for some 70 publications worldwide, covering business, media, politics and culture in the Middle East, East Africa and the Indian subcontinent.

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