Lebanon is approaching a milestone nearly eight years in the making. In December, cabinet awarded two separate exploration licenses to a consortium of three companies: France’s Total (the operator), Italy’s Eni, and Russia’s Novatek. Contracts were signed at the end of January, leaving the consortium and the government about one year for preparatory work ahead of the first exploratory drilling in 2019. Executive met with Walid Nasr, president of the board of the Lebanese Petroleum Administration (LPA), the sector’s regulator, to find out what comes next.

E   At the end of January, the government signed exploration and production agreement (EPA) contracts. What happened between awarding the licenses and signing the contracts?

Finally, we have reached a point to start operations. After the approval of the cabinet to award the two blocks to the consortium, the companies are requested to provide the work commitment guarantee and parent company guarantee. These are two very important documents required to have [the] full commitment of the companies to actually implement their programs through the work commitment guarantees. And the parent company guarantee is very important because if anything goes wrong, the mother companies, who are fully in line with the prequalification requirements in terms of their financial capacities, would actually cover any losses or damages or anything coming up from operations. This is a safeguard to the government that we have such guarantees. The guarantees are uncapped.

E   Can you outline the aspects of the work commitment guarantee?

The consortium has proposed a technical offer with an exploration program with minimum work commitments, and the LPA has put in the tender protocol. It is published and known that there is a minimum commitment of one well for every exploration period. We have two exploration periods, [the] first one for three years and the second one for two years. So companies were required to drill at least one well in every period, and this is what the companies have actually submitted.

The companies need to estimate a budget to be able to implement their exploration program, and that budget will be covered by a work commitment guarantee issued by their bank. So in case, for any reason, the companies do not fulfill their work commitment as agreed upon in the offer, and then in the exploration plan that will be submitted soon, the government will have access to the money and the work commitment guarantee for the government either to implement it itself, or to bring another company to implement it. This would safeguard the targets set by the government to actually drill. So if the consortium fails to drill, the government has access to funds that would enable the government to do the work.

E   Have the guarantees been finalized and submitted?

The guarantees will be provided very soon. After that, it’s administrative work, but also a lot of technical work and preparing logistics, because the companies will have to prepare themselves to be able to drill in 2019. We have a firm commitment from the consortium to drill one well in Block 4 and one well in Block 9 in 2019, meaning a lot of additional assessment, studies on the geology, on the technical side, on where and how to drill. Then, logistically, because based on the regulations the companies need to operate from Lebanon, they will need to open offices in Beirut or [elsewhere] in Lebanon … [and] prepare all the logistics needed, including a supply base in. So 2018 will be a very busy year for the government and the consortium to make sure that all the preparations are done in terms of permitting administrative work, technical work, logistics, and all types of studies to be able to reach our goal of drilling two wells in 2019.

E   Did the companies offer to conduct more seismic surveys in their bids—would they need more data to narrow down exactly where they will drill?

In the offers themselves, the companies didn’t provide additional seismic surveys, and this [is] a very good indication that the seismic surveys conducted by the servicing companies [contracted in the past] by the Ministry of Energy and the LPA, were satisfactory for the companies. The companies were required to buy licenses to use the data of the seismic [surveys], and they have done so. They prepared the offers based on the interpretation of the seismic surveys that they have done before, and they were very satisfied with the quality of the survey and their coverage.

All our blocks are covered with 2D and 3D data. Accordingly, they have done their assessment and the prospect of our offshore [fields]. That is why they applied and provided an offer for that. And they even provided details on how they want to drill and where. The companies did not commit to seismic surveys because they assessed they don’t need them. Now they still have the option to do seismic surveys if they think they’re needed to have a better exploration program. When they submit the exploration plan in the coming 60 days, then they will identify what type of studies they are doing and whether they need to do seismic surveys or not.

E   In December, Executive incorrectly reported that the strategic environmental assessment (SEA) was to be completely redone, and also incorrectly reported how it was to be contracted and carried out. Can you explain what is happening with the SEA in terms of an update and its expected completion?

The SEA was completed in 2012, before an SEA decree was [completed] by the Ministry of Environment, standardizing how an SEA should be done. The SEA has identified different scenarios [for] what may happen during the development of the petroleum sector in Lebanon, and it had a set of recommendations [for] what needs to be done next after preparing the SEA. The LPA had taken the recommendations of that study and has done a lot of work to actually implement these recommendations, for example, preparing a national oil spill contingency plan. Now, in 2017 and 2018, we thought it was time to update the SEA with anything new since 2012—most importantly, to include any additional environmental data available in our analysis. This will be done soon. It will also include environmental management plans for the sector.

E   A draft law for a sovereign wealth fund (SWF) has been submitted to a parliament subcommittee for debate. What role does the LPA have in contributing to this draft law?

The concept of the SWF is laid down in the Petroleum Resources Law 132, which says that all revenues coming from petroleum activities need to be put in the SWF. Now, the LPA is not an institution mandated to establish the SWF, nor to manage [it]. Our role is to basically give guidance to other institutions in the government related to the technical part of the input needed for the petroleum sector. So what we’ll be doing is that we’ve been coordinating with the Ministry of Finance and now, as you mentioned, this will be discussed in the Parliament and specialized committees. So the LPA will take part in those discussions in those parliamentary committees to provide any technical advice or input needed for the parliamentarians to discuss the SWF.

E   Are there specific revenues that have already incurred?

The revenues incurred so far are the revenues from sales of the licensing of the seismic data. And this is now put in a separate account in the central bank, [and] again this is a decision of the Parliament of how to use this fund, and whether this can be seed money for the [SFW].

In the midst of Lebanon’s first offshore oil and gas licensing round, the Lebanese Oil and Gas Initiative (LOGI), an independent NGO aiming to develop a network of Lebanese oil and gas experts, commissioned a study about the 52 companies that had prequalified to bid. This research allowed LOGI to evaluate the companies based on six criteria covering two main areas: corruption track records and anti-corruption policies, and environmental track records—critertia not assessed by the government.

The licensing round ended in October, and a consortium made up of three companies—France’s Total (the operator), Italy’s Eni, and Russia’s Novatek—was the only bidder, submitting two separate offers (Block 4 and Block 9). The Council of Ministers awarded the bids in December and tasked the energy minister with signing contracts by the end of January. In this one-bidder scenario, it is crucial to revisit the findings of our report, with regard to these three companies. We found that none have a completely clean record.

The report found that while Total discloses its beneficial owners—the entities or individuals that ultimately own the company—there are still transparency issues that the company must address. Our research found that Total was involved in a number of bribery incidents, such as one in Iran in 2013 where the company admitted guilt in return for a deferred prosecution agreement with the US Department of Justice for paying third-party bribes for work. Total is also listed in the TRACE corruption database as engaged in anti-bribery lawsuits. On the environment, Total were fined after failings led to a gas leak in one of its plugged wells in the North Sea.

Eni, for its part, has a publicly available anti-corruption policy, yet in 2010, the US Securities and Exchange Commission brought corruption charges against the company related to a bribery scheme in Nigeria involving construction contracts. It also has  other ongoing corruption lawsuits according to TRACE.

Novatek, a Russian firm, does not disclose its beneficial owners. But a review of available literature revealed that one is Gennady Timchenko, a Russian billionaire and member of Putin’s inner circle. For a country such as Lebanon, where foreign political players have substantial influence on all internal political dynamics, it is critical to know whether politically exposed people are associated with international oil companies working in Lebanon.

Based on these findings, LOGI proposes that Lebanese regulatory authorities publish the signed EPA contracts, establish a monitoring mechanism for negotiations between the government and the companies that includes a civil-society watchdog, and publish the outcomes of the negotiations to select a final winner.

In addition, LOGI strongly recommends that the Extractive Industry Transparency Initiative, a tool to facilitate the disclosure of information, be implemented as soon as possible, and that the draft law presented by MP Joseph Maalouf entitled “Strengthening Transparency in the Oil and Gas Sector in Lebanon” be passed. The main aim of the due diligence report was to push the Lebanese government to adopt criteria that LOGI included in its evaluation of companies applying to prequalify for bidding in subsequent licensing rounds, both offshore and onshore.

LOGI also recommends that Novatek’s beneficial owners—both actual and economic beneficiaries—is published by the government.

Further, LOGI recommends that the current Strategic Environmental Assessment, a policy prepared in 2012, be updated as soon as possible so that newly available data can be used as a baseline for future Environmental Impact Assessments. These assessments should be mandatory during the exploration phase because critical environmental planning, as well as health and safety measures, need to be put in place prior to the start of any exploration activity.

The oil and gas industry worldwide has been, and will continue to be, among the top industries associated with corruption, conflicts, and increases in poverty and unemployment rates. Managing these resources, from awarding rights to sustainable use of revenues, in a transparent and accountable manner will render prosperity to its owners, the Lebanese people. For Lebanon to ensure good governance at the early stages of awarding licenses it must adopt stricter criteria for the prequalification of companies, and better hold contractees to account.

Five years ago, Lebanon was ready to invite companies to explore for oil and gas offshore. A law organizing offshore exploration had been passed, an environmental study—known as a Strategic Environmental Assessment (SEA)—to study and mitigate the effects of exploration on the environment had been prepared, a regulator had been appointed, and the bid round announced. Then politics got in the way. The government could not agree on issuing needed decrees to move forward, and the licensing round was, effectively, put on ice.

Around this time last January, the bidding round was awoken from its cryogenic slumber. The needed decrees were issued and a roadmap to accepting bids laid out. By December 2017, the government awarded two separate exploration licenses, for Block 4 and Block 9, to a consortium of companies made up of France’s Total, Italy’s Eni, and Russia’s Novatek. At the end of January, contracts were signed.

Environmental concerns set oil and gas back

But during the licensing round’s four-year hibernation, the factors affecting oil and gas exploration changed. New exploratory data became available, and the Ministry of Environment issued new rules requiring and standardizing SEAs.

In May 2017, an analysis of the SEA found that it contained too many problems to be an effective planning tool. The report, published by the Lebanese Oil and Gas Initiative (LOGI), urged the government to overhaul the SEA, and to do so in parallel with the licensing round. Its author, environmental consultant Klemen Strmšnik, summarized the report’s findings in a January email to Executive: “The SEA was not fully implemented and was based on a lack of data. Stakeholder involvement was limited, and the SEA report was not presented to the public through public consultations. Additionally, national legislation on SEAs was substantially changed, and the current SEA report simply does not satisfy the standards set by new environmental legislation. [Therefore], it does not provide all needed answers and cannot represent a sound decision-making tool.” (Full disclosure: The author of this article is a co-founder of LOGI and sits on its board of directors.)

Given Lebanon’s track record on other national environmental problems, such as waste management, water pollution, and the destruction of wildlife habitats, it is easy to doubt the state’s capabilities to regulate and enforce environmental measures on large multinational oil and gas companies. And it is worth remembering that inadequate regulation can have huge financial costs for petroleum companies, and catastrophic consequences for ecosystems. BP, which was responsible for the Deepwater Horizon spill in the Gulf of Mexico in 2010, has had to pay a total of $67 billion for the spill, the Financial Times reported in January. According to the National Ocean Service, a US government agency, the Deepwater Horizon disaster killed 11 workers and spilled 134 million barrels of oil into the Gulf over nearly three months, killing thousands of marine mammals and sea turtles. LOGI’s SEA critique painted a portrait of a regulator unconcerned with environmental protection, and its recommendation was clear: Plug the data gaps, address new environmental rules, implement recommendations found in the original SEA, and do more to get the public’s feedback.

Assem Abou Ibrahim, head of the Lebanese Petroleum Administration (LPA)’s Quality, Health, Safety, and Environment Department, told Executive that some recommendations have already been addressed: In 2013, the government issued decrees as part of the Petroleum Activities Regulations, defining the SEA’s scope in line with the new environmental rules, and, in 2016, the LPA published a National Oil Spill Contingency Plan—a guideline to prevent and respond to oil spills.

In December, Executive incorrectly reported that the government would be commissioning a new SEA from scratch and that such a contract would be directly awarded. This is not the case. Some sections of the SEA will be updated and the work carried out by the LPA with support from the European Union. “Based on our assessment of all these developments and their expected implications on the SEA study, the Ministry of Environment agreed with the LPA’s evaluation for not modifying the scope of the existing SEA but rather to implement some updates to sections affected with the current information availability and to integrate the various management and planning initiatives into a comprehensive plan,” says Abou Ibrahim, “The SEA will as well be an opportunity to further engage with affected stakeholders. We are currently assessing the possibility for initiating the SEA update work through a technical assistance project implemented at the LPA and funded by the EU.” He added that the SEA update should take around four months to finish, with an expected completion date toward the end of Q2 2018, ahead of exploratory drilling beginning in 2019.

Jeremy Arbid is the co-founder of the Lebanese Oil and Gas Initiative (LOGI) and a member of its board of directors , in addition to Economics and Policy Editor at Executive Magazine.

Lebanon signed oil and gas exploration contracts on January 29, and officials hope to one day save and invest proceeds from selling and taxing the resources, if commercial quantities are found. It could take time to find oil and gas deposits off the coast of Lebanon, and even more time to extract and bring them to market. But if Lebanon finds itself sitting on a pile of cash, that money would need to be protected and invested in public goods, services, and infrastructure for the benefit of future generations.

As debate over a sovereign wealth fund (SWF) begins to take shape, lawmakers are receiving advice from a range of SWF experts. Executive corresponded by email with Vidar Ovesen, a Norwegian consultant on petroleum revenue management, on the basics of timing, design, and fund management.

E   If Lebanon makes a commercial discovery of oil or gas, some estimates show a several-year period before revenues from their sale pour in. When should the legal framework be put in place to organize a sovereign wealth fund?

Establishing a SWF should be considered an integrated part of the overall policies for managing petroleum revenues in a country. It is important to be well prepared to get the most out of the revenues, and the design of the SWF’s legal and institutional framework is one key milestone, in particular if a significant amount of the petroleum revenues are to be saved in an SWF. On the other hand, petroleum exploration and development normally takes many years, and major revenues to the government would, in most cases, first materialize when the investment costs are recovered, i.e. some years after production commences. Starting the planning for an SWF too early has, in some cases, raised unrealistic and overly optimistic expectations, which have resulted in increased public spending, rent-seeking, and loss of attention to other economic sectors that might be even more important for the country’s long-term economic development.

E   You mention that poorly designed funds could be very harmful. Can you give general examples of design flaws?

Lack of transparency is often a major reason for poor management of SWFs around the world. A good governance model for an SWF includes mechanisms for regular disclosure of information about in- and out-flow of revenues, the performance of the investments, and other aspects that may be relevant to the broader public. Transparency enables Parliament and civil society to hold the government accountable for how petroleum revenues are managed. It is important to ensure that common assets for future generations are managed well, and the only way to do this is to ensure maximum transparency on all key aspects of how the SWF is managed. Moreover, it is paramount to establish a clear division of responsibilities between the owner, i.e. the government, and the operational manager of the SWF to avoid any political interference in the day-to-day management. The government should establish the overall policies and leave the implementation of these policies to the professionals. Lack of oversight mechanisms such as independent audits may also harm the performance of the SWF.

E   In Lebanon’s case, your advice at a workshop for members of parliament was that it might be best to stabilize or reduce public debt before investing oil and gas revenues. Is that a common strategy of other jurisdictions and SWFs?

It is important to strike the right balance between debt repayments, SWF investments abroad, and domestic spending through the budget. In countries with significant foreign debt, it should be considered whether paying down foreign debt would be a better strategy than saving budget surpluses in an SWF. Although building up a portfolio of liquid assets is beneficial, particularly in tight global liquidity conditions, the opportunity cost of holding such assets is high when the cost of servicing that debt is high. It is important to bear in mind that what matters for future generations is the net fiscal position of the government, and not the size of the SWF that can be inherited. In Norway, all foreign debt was paid down before the first financial savings were allocated to the SWF in 1996.

Along the coastal highway in Batroun, north of Beirut, is a billboard that reads “Lebanon is now an oil producer.” For now, that is optimism, not reality. Offshore wells will not be drilled before 2019, and until they are, the extent of Lebanon’s oil and gas reserves—if they exist—will remain unknown. But with an answer finally on the horizon, a draft law has been introduced in Parliament to decide how to spend the dollars that could eventually come gushing forth. 

In December, the Council of Ministers awarded two offshore exploration licenses to search for oil and gas, and the consortium of companies that won both bids signed exploration and production agreements at the end of January.

The award has invigorated expectations that Lebanon is set for a windfall. Politicians looking to make a big splash ahead of the parliamentary elections scheduled for spring are claiming credit for ushering Lebanon to “day one” of exploration, and may already be attempting to stake claims over the oil and gas proceeds that could come some years down the road.

Uncharacteristically ahead of schedule, Parliament may soon begin debating a draft law that would set up a sovereign wealth fund (SWF) into which possible oil and gas riches will be deposited. Created in principle by a 2010 law that lays the foundations of Lebanon’s offshore oil and gas sector, the sovereign wealth fund needs its own law to detail how it would be managed and operate: who would oversee revenues, for example, and how they would be spent or invested.

Slow and steady

It may still be too soon to legislate a SWF—the first exploratory wells will not be drilled until next year and, if oil and gas are found, it may take several more years to extract and successfully bring them to market—but experts Executive spoke to agree that it is better to begin fleshing out the legal framework earlier rather than later.

At the same time, they expressed caution, because the draft law would set out important rules for managing any future proceeds. Vidar Ovesen, a Norwegian consultant on petroleum revenue management who briefed lawmakers on SWFs last year, explained in an email to Executive that creating a SWF should be a well thought-out process that manages expectations and considers the long-term health of the economy (see SWF Q&A). Andrew Bauer, an expert on natural-resource revenue management with the Natural Resource Governance Institute who reviewed the draft law for the Lebanese Oil and Gas Initiative, advises that now would be too early to legislate a SWF. “There is absolutely no rush to get this passed now. If oil is produced, [revenues are] is years away.”

Into the piggy bank

The draft law, introduced by Member of Parliament Yassine Jaber, proposes both a savings account and a development account. Most of the revenues generated from royalties and production sharing would be deposited in the savings account, and the development account would receive revenue from the 20 percent corporate income tax that oil and gas companies will pay in accordance with the sector-specific tax law that Parliament passed in October 2017.

The rules for spending money from the two accounts are complicated by design, an economist familiar with the draft law tells Executive. Money can be withdrawn from the savings account in a specific year only if Parliament has approved a budget allocating the money for a specific purpose. And that withdrawal is conditioned on whether the Treasury has reached a debt-sustainable primary surplus, meaning that enough non-petroleum revenue is flowing to the Treasury to cover interest payments on public debt and stop the national debt from increasing. (As of November 2017, the debt stood at almost $80 billion, $30 billion denominated in foreign currencies and nearly $49 billion in Lebanese lira, according to Ministry of Finance figures).

To create a debt-sustainable primary surplus, Lebanon needs to generate a primary surplus that equals about 5 percent of the national GDP, says the economist, who requested anonymity because he was not authorized to speak with press. Lebanon would have to generate an extra $2.5 billion in revenue to cover its debt-interest payments and keep the national debt from increasing—a nearly impossible task, the economist says, without introducing major reforms to public spending, like cutting back on the billion-dollar subsidy to the failing public utility, Electricité du Liban.

Tapping into the development account would only be allowed once a budget is in place and the debt-to-GDP ratio is stabilized. A portion of the money in the development account (up to 2 percent of GDP, according to the draft law) can be spent to reduce public debt denominated in foreign currencies in order to ease pressure on the national budget. Once foreign-currency debt is paid down to 20 percent of GDP, funds in the development (up to 3 percent of GDP) account can be used for capital investments in education, health, research, development, and renewable energy.

The experts Executive spoke with differed on the draft law’s requirement that the government first pay down its foreign currency-denominated public debt. The economist familiar with the law describes this as a necessary and good strategy. “It is very important to only pay foreign currency debt instead of spending money on local currency-denominated government debt, which is held by Lebanese banks. If the state were to pay down lira-denominated public debt, that would create more space for borrowing in the future. But the point is not to worry about paying down local currency debt, because the government could theoretically print as much Lebanese lira as they want,” the economist says.

Martin Skancke, a former director of Norway’s sovereign wealth fund and now an asset-management consultant advising other countries setting up SWFs, wrote in an email to Executive that Lebanon should deliberate the pros and cons of saving versus paying down debt. “The first question you need to ask is, ‘Would it make sense to spend some of this money to reduce the overall debt level rather than building up a fund?’ If you have high debt and you start saving in the fund, you have a relatively leveraged balance sheet and you can be hit on the balance sheet both by losses on your assets and of course by disruptions in external finances. This is about managing the risks of the overall sovereign wealth fund balance sheet in a good way,” Skancke wrote.

Bauer says the draft law’s rules for spending on public debt are not strong enough. “There is nothing preventing the government from using oil revenues to pay down the debt then borrow separately, essentially moving money into one pocket then out the other. What would be needed is a rule that limits government debt accumulation in general, such as an expenditure growth rule (as in Peru), a structural balanced-budget rule (as in Chile or Norway, though I’m unconvinced this would work in Lebanon), or a debt ceiling (as in Indonesia),” he wrote to Executive in an email.

Oversight of the sovereign wealth fund will be a crucial challenge. An economist formerly based in Beirut with an international public-finance institution tells Executive that the state would need to set up multiple layers of auditing to optimize fund performance and limit mismanagement. “The government or the Parliament should set performance targets. The minister of finance and Parliament, alongside external auditors, must do the due diligence and make sure there is no fraud,” says the economist, who asked not to be named because he was not authorized to speak with reporters. “You want to have checks and balances and separation of powers so that everybody is not conflicted by interests.”

Skancke wrote to Executive that in other jurisdictions, it is the role of the finance ministry to oversee management of a SWF. He also wrote that the whole governance structure, including reporting requirements, must be enshrined in legislation as part of the SWF law.

The draft law calls for the appointment of a board of directors to oversee the operations of the SWF, and it implements spending and investment strategies. The strategies are prepared by a subunit of the board, a petroleum-assets management unit, which is overseen by the finance minister. The minister submits the strategies to the Council of Ministers for approval before sending orders back to the unit to implement. Control over investment strategy is vested in the finance minister.

Bauer wrote to Executive that the prescribed governance structure is weak, and that it was unusual to have the finance ministry circumventing the board of directors through the subunit. He wrote that the draft law does not clearly spell out several controls, and he criticized the law’s “lack of independent external audit to be made public; lack of independent board members; and [lack of] clear qualifications for board members.” He recommends adjusting the text of the draft law to clarify the required qualifications for board members and to allow Parliament to name at least two of the board members, with a focus on strong audit and financial-analysis skills. He also recommended implementing a requirement to publish the external auditors’ reports in full.

Though it may be years away, there is potentially a big chance for Lebanon to score some serious cash if oil and gas is discovered. To avoid botching this big opportunity, it is important to take the development of these wealth-management frameworks slowly and carefully. With drilling not scheduled until 2019 and hoped-for proceeds years ahead, there is still plenty of time to improve the draft law.