Spreading the wealth: Reform reallocating royalty revenues from the mining and energy sectors comes into force

A combination of an improved investment environment from a security standpoint and rising international commodity prices have been the principal causes of the recent growth in the extractive industries. The booms experienced by the mining and hydrocarbons industries have in turn sparked a rapid increase in royalties collected and distributed to local governments. Having grown by roughly 70% from 2006 to 2011, with royalties from the extractive industries expected to double within the next decade, the current administration passed a royalty reform in June 2011 that will drastically alter the way funds are distributed.

Whereas commodity bearing regions once received all royalties from mineral and hydrocarbons extraction, under the new legislation they will be distributed throughout the country as part of the administration’s broader agenda to reduce inequality. As an example provided by the government, the four departments of the Pacific region – considered to be among the poorest in the region – received an average of $40m annually from 2002 to 2010, an amount which is expected to increase 20 times over to $852m under the new system of royalty allocation.

BROADER AGENDA: The World Bank ranks inequality in Colombia as the seventh highest in the world, a fact which has played a significant role in the ongoing battles against insurgency and narcotics. With improving security amidst an expanding macroeconomic environment, the government perhaps finally has the necessary conditions to effectively tackle social issues that have long plagued the country.

Effectively reducing inequality requires multiple solutions. The redistribution of royalties that were once narrowly concentrated in two of the 32 departments is one aspect of the administration’s agenda. Following the approval of royalty reform by Congress in 2011, fiscal tax reform was passed in December 2012 aimed at reducing poverty and inequality. Other reforms include the passing of a bill that will grant reparations and land restitution to victims of the war on narcotics and insurgency, a bill that criminalises racist acts, and the creation of new governmental agencies such as the Department for Social Prosperity.

REFORM: A new distribution system was created as a result of the legislation, known as the General System of Royalties, which replaced the old system that had seen roughly 80% of royalties distributed to commodity producing and transporting regions, with just 20% distributed on a broader national scale.

The reform itself will see the share of royalties in the largest mining and oil departments reduced gradually to 25% over time. The new system of distributing revenues will also allocate royalties from the extractive industries via six mechanisms identified by the administration. A savings and stabilisation fund will be created to allow the central government to eventually save up to 30% of royalties, which will be used to bolster reserves, help offset volatile global commodity prices and ensure general macroeconomic stability. A territorial pension fund is also being created to decrease the pension liabilities of departments, along with a specific mechanism to allocate funds directly to municipalities and departments where commodities (and their transportation infrastructure) are located.

Two funds will be created to address poverty and inequality in the poorest regions, known as the Regional Compensation Fund and the Regional Development Fund. The former will target populations in border regions and coastal areas, which are home to the poorest communities. The fund has a lifespan of 30 years, at which point it will roll over any remaining resources into the Regional Development Fund. The Regional Development Fund addresses poverty stricken areas according to population and unemployment criteria.

Finally, in an effort to improve innovation and combat the nation’s malaise in industrial development, the government has created a Science, Technology and Innovation Fund that will receive as much as 10% of royalty collections. The increase in government funding could expand the nation’s spending on scientific and technological projects by as much as 40% (see Research & Innovation chapter).

FINANCIAL IMPACT: According to projected figures from the administration, the average royalty windfalls will not actually decrease in any region over the next eight years from 2012 to 2020 in comparison with the 2002-10 period. This is primarily thanks to the continued expansion of the extractive industries, which are expected to double total royalties paid over the next decade. From 2002 to 2010 two departments, Meta and Casanare, received average annual royalties of more than $2.3bn. That figure is expected to quadruple as eight departments are now forecast to receive annual royalties of more than $2.3bn. Whereas no department received funds of between $1.8bn and $2.3bn from 2002 to 2010, five will receive average annual amounts in this range in the following period. Departments receiving $1.4bn to $1.8bn will also increase from two to six, while departments receiving between $900m and $1.4bn will remain unchanged at three, and departments receiving between $500m and $900m will increase from six to nine. Most importantly, where once more than half of the 32 departments (19) used to receive less than $500m, only one is expected to fall into this category now.

CHALLENGES: Though commodity producing regions are expected to receive roughly the same average windfall – if not a greater sum – in numerical terms from 2012 to 2020, as opposed to the previous eightyear period between 2002 and 2010, the percentage decrease has angered many local governments and communities in those departments. Fears also exist that competitiveness will suffer as a result, if local municipalities and departments are less eager (or even hostile) to welcome oil and mining firms. With mining and oil companies already facing issues such as slow environmental licensing processes, security concerns and an infrastructure deficit, adding hostile local communities to that list could be a deciding factor in investment decisions. So while the sum paid by the industry has not actually been increased, as has been done in other hydrocarbons-producing nations in the region, some are concerned about how the reform could impact investment at a crucial time when the country has a decidedly low reserve to production ratio. Other concerns focus on the ability of local governments to spend the increased sums effectively, though supervision from the central government should in theory keep financial corruption in check. By constitutional mandate the new System for Monitoring, Supervising, Control and Evaluation was created to monitor the process and combat corruption.

MACRO IMPACT: On a wider scale the reform is expected to increase competitiveness as specific issues limiting economic growth are addressed. In particular, a poor infrastructure network has created a ceiling for further economic growth. Despite possessing a wealth of large, urban centres scattered around the country, the large infrastructure gap severely limits the movement of goods and labour. Increased funding in commodity poor areas will necessarily be used to improve connectivity. However, it is perhaps increased spending on social infrastructure that could have the most impact in the longer term. Funding to improve standards of living in poor communities will also see the development of social infrastructure in the form of hospitals, schools and sanitation utilities.

Thus far since the reform was implemented in May 2012, the National Department of Planning has reported that over 2100 investment projects have been approved worth a total of $9bn, $5bn of which was directly funded by royalties with the remainder cofinanced using traditional departmental budgets. As the government continues to redistribute the vast wealth generated by the extractive industries, believed to be an average of $5bn annually over the next several years, there no doubt remains fairly staunch opposition in commodity producing areas. The reform’s impact on the extractive industries themselves remains to be seen. Nevertheless, such moves are necessary if the administration’s progressive agenda is to successfully address the social problems the country faces.