The PNG LNG project could have a big impact on the local economy

With 2015 growth predictions ranging from 6.9% to 21%, Papua New Guinea may end the year as the fastest-growing economy in the world or as simply another fast-growing economy. The country may be able to spend as planned, make the necessary and desired investments and build for a sustainable future, or it may find itself scrambling to maintain its momentum and keep its fiscal situation from deteriorating. Given the direction of commodity prices and the cost of financing, as of early 2015 officials were expecting the possibility of the latter and calling for some major adjustments in spending.

“For 2015, economic growth will reflect a full year of liquefied natural gas (LNG) production and export. However, lower net inflows than earlier envisaged are expected from LNG exports. This may be compounded by the lower prices of other export commodities,” the central bank wrote in early 2015.

2017

Analysts anticipated that money from the LNG project would hit government accounts in 2014, but they added that the funds would not start to build up in the coffers until 2017. Furthermore, they argue that even then the government will have very little additional funds to work with. The Lowy Interpreter noted that in the original best-case scenario, when LNG prices were expected to remain high and steady, the LNG project was supposed to do little more than replace revenue from declining minerals sector revenues and help the government reduce its deficit. There was not much extra to work with in the first place.

The money that does become available needs to be spent wisely. The group advises that equity purchases (except when they are for the sovereign wealth fund) and low priority capital projects should be avoided. Recent history suggests that this may be a challenge. While economic activity was on the upswing as a result of the construction phase of the PNG LNG project, little of that prosperity trickled down.

A February 2015 Lowy Interpreter article suggested focusing in the future on areas such as health, vital infrastructure, and safety and security. It also advised the building of appropriate capacity and improving transparency and accountability so that funds are managed well and with the right sort of oversight.

The Interpreter article noted that a failure to address some of these issues and properly prioritise spending will leave the country where it was after the last boom in the 1990s, which ended abruptly and was followed by more than a decade of stagnation. “Major budget increases have been directed to most of these priorities, but weak policy conception, planning and implementation capacity, and even poorer accountability has handicapped achievement of the objectives. Progress is now further threatened by the recent drop in global energy prices,” the author, Paul Barker, wrote.

Not As Planned

The PNG LNG Economic Impact Study, which was published by ACIL Tasman in 2008, indicated that the project would have a great and positive impact on the economy. Its predictions through the construction phase were quite accurate. According to the report, employment would spike in 2011 and 2012, and then quickly drop off after the construction phase was complete. That is exactly what transpired and why the country experienced a boom and then a sharp slowdown.

The report also modelled expected returns to the government over the life of the project. It predicted that PNG would receive, in the form of taxes, levies and royalties, about PGK2bn ($756.8m) a year by 2014, almost PGK3bn ($1.1bn) by 2023 and PGK3bn a year by 2029. It calculated a low case, which tops out at about PGK1.6bn ($605.4m) a year, and a high case, with a maximum payout of nearly PGK4bn ($1.5bn) a year. According to the report, the vast majority of those payouts (56%) would be generated by government equity in the project. That is followed by company tax (34%), the development levy and royalties (both 5%), and personal income tax (1%).

Ultimately, Barker argues that the money generated by the project flowing into the economy will provide a wide range of benefits in the form of general economic growth, payments to employees and landowners, and investment in vital sectors.

“The project has the potential to transform the economy of PNG, boosting GDP and export earnings, providing a major increase in government revenue, royalty payments to landowners, creating employment opportunities during construction and operation, and providing a catalyst to further gas-based industry development,” Barker stated. “The benefits from the project would spread throughout the economy as the government applies the earnings from its substantial share of the project revenues to social and economic programmes. These programmes have the potential to improve the quality of life of Papua New Guineans by providing essential services and enhancing the country’s productivity,” he added.

The PNG Treasury also saw the project greatly benefitting the economy. In a 2011 assessment it recognised that much of the value would go offshore right away. Most of the gross operating surplus is repatriated in dividends and debt repayments. It also saw a good deal of value remaining within the country over the life of the project as taxes and royalties are paid out. In its analysis, the Treasury predicted that about one-third of the surplus would leave the country in payments of capital costs and interest payments; one-third would leave as dividends; and one-third would stay within the country. Of the last third, about 10% would be paid out as operational expenses.

Circuitous Payout

It is not yet clear how much of this will come to pass. The original structure as outlined in the assessment has been altered considerably as a result of cost overruns and changes in the financial structure due to loans undertaken. Analysts add that it is difficult to get a handle on the cash flows because most of the proceeds from the project going to the government come out as dividends or tax payments related to profits. These cannot be precisely estimated without knowing the operating costs and financial position of the project. The other problem is one of transparency on the government’s side. Some resource revenues have been taken off budget in 2015, while the government has off-budget liabilities, such as a UBS loan, to contend with, according to Paul Flanagan, a visiting fellow at the Development Policy Centre at the Australian National University.

The central bank indicated in its March 2015 monetary policy statement it would be some time before the project had an impact on government financials, at least from a cash flow basis, “In 2016 and 2017, the repayments of external loans by the LNG project and government will more than offset the net inflows of foreign exchange from LNG and other commodity exports, reducing the level of international reserves.”

Benefits Overall

Despite falling commodity prices and a less-than-ideal structure, the project could have a significant impact on the economy. In the construction phase, the World Bank noted that local companies and employees benefitted from the experience in terms of capacity and organisational ability. LNG PNG brought in contractors from an international oil major, and the business carried out with domestic companies likely resulted in the transfer of some technology. The World Bank also believes this may have a positive residual effect on the companies.

Even if PNG LNG is a break-even proposition for a few years, the project will help the country from descending further into debt. If the cash flows can help the national balance sheet, it will have an impact on local interest rates and inflation.

Most significantly, the project has burnished the reputation of PNG as a place where massive projects can get done. While PNG LNG was over budget, it started production early and has met all its major benchmarks. The project has underperformed mainly because of the price of the underlying commodity and the choices made by the government in terms of financing. This has not gone unnoticed and has been cited as a reason for others to attempt similar large-scale ventures. Total E&P, for example, is leading the development of the Elk-Antelope field, with the first production expected around 2021. The company has said that the success of ExxonMobil in completing such a large project influenced its decision to make a significant commitment to PNG.

Long Term

In the longer term, the benefits of LNG to the economy rest almost entirely with the government. The effect on GDP directly is small once the construction phase ends, as very little money will go into the economy from payments to local citizens and companies. Rather, the majority of funds will flow via the government. What happens during production is almost completely a matter of policy. In the past, the government has not done well in this respect. This time, the government has been caught flat-footed. Its countercyclical spending to help the country through the slow point between construction and production has not been followed by the expected rebound, and it will take some effort to pull back on spending until proceeds finally begin to impact government finances.