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Lebanon’s O&G wealth

How a sovereign wealth fund can keep the government honest

by Jeremy Arbid

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.

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Jeremy Arbid

Jeremy is Executive's former economics and policy editor.

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