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Saving us from ourselves

Planning begins for a sovereign wealth fund

by Jeremy Arbid

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.

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Jeremy Arbid

Jeremy Arbid is an energy and public affairs analyst specializing in Lebanon’s oil and gas industry. He was formerly a journalist covering economics and government policy for Executive Magazine in Beirut. His experience includes roles as a policy specialist in Chicago and with the United Nations in Geneva. Jeremy holds a Master's in Public Administration from the American University of Beirut and a Bachelor's in Political Science from Hamline University.

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