Another nice article, from Euromoney, on the LNG and other plans affecting Papua New Guinea’s future

Papua New Guinea’s pipeline to change
by Chris Wright

The exploitation of natural gas resources looks set to transform Papua New Guinea’s wealth profile and social structure. The downside is the possibility that its undeveloped infrastructure and institutions will be unable to cope with rapid change. Chris Wright reports.

OCTOBER WILL BE be a big month for Papua New Guinea. It doesn’t sound much on paper: it’s the deadline for the final investment decision on a liquefied natural gas and pipeline project. But it’s a project that will change the country dramatically – economically and socially. In fact, it’s hard to think of another example anywhere in the world where so much, good and bad, might depend on a single investment decision.

The project is known as PNG LNG, and it is an attempt to commercialize undeveloped petroleum and gas resources in the highlands and western provinces of Papua New Guinea. The gas has to pass through a 470-kilometre pipeline across rugged terrain to a liquefied natural gas facility 20 kilometres outside Port Moresby, the capital, for liquefaction. Once there, about 6.3 million tonnes of LNG product a year will be loaded into tankers to be shipped to gas markets worldwide. ExxonMobil, with its Esso Highlands subsidiary as operator, is the driver of the project with a 41.5% interest; also in there are Australia’s Oil Search (34%) and Santos (17.7%) and Japan’s Nippon Oil (5.4%) among others, with the PNG state expected to join as an equity participant at a later date.

The numbers attached to this project are extraordinary in any context, but particularly so in an economically small country where 85% of the population is engaged in subsistence agriculture. The development costs are put at between $11 billion and $14 billion, figures confirmed to Euromoney by the Investment Promotion Agency (IPA). Once completed in 2013 or early 2014, the project is expected to double Papua New Guinea’s approximately $12 billion GDP.

The consortium signed a gas agreement with the Papua New Guinea government in May and has since moved to what is known as the front end engineering and development (Feed) part of the project – a sufficiently big step to persuade many observers that the project’s development is now a foregone conclusion. “They are spending $400 million on Feed, so it would be silly to spend that kind of money and not have the project go ahead,” says Ivan Pomaleu, who heads the IPA. One foreign banker says he senses “100% certainty among local people that it’s going to happen”. But it won’t be until October that the deal is confirmed. “That’s basically the point where we say yes, no or defer,” says Pomaleu. “That’s the moment when we can say: ‘Yep, we have a project; no, we don’t have a project; or we will have a project but not immediately’. It’s a big project and we want to be sure.”

So big that those involved tend to use great understatement in describing it. “The scale [financially] will depend on commodity prices but if it doubles our current GDP, that’s quite big,” says Simon Tosali, secretary for the department of treasury. “It will be the biggest project this country has ever undertaken in its 34 years of independence. So it’s going to be quite big.”

The knock-on effects will be varied, and not entirely to the good. An increase in wealth on this scale obviously has enormous potential for budget revenues and the ability to fund badly needed spending on schools, hospitals and roads, among other things. There’s also the demonstration effect to consider: if a project like this is shown to be not only possible but practicable then a host of other possibilities come to the surface in this remarkably resource-rich country.

But there are real questions about Papua New Guinea’s ability to cope with this sudden influx of money and development. “There is already a strain on all infrastructure: telecoms, security, power, skilled labour,” says one banker. “There are lots of business opportunities but the capability of the local market to provide that support is already sorely tested.” Foreign banks – there are three of note, the Australians Westpac and ANZ and the Malaysian Maybank (Malaysia is the most active foreign nation in Papua New Guinea, particularly in such areas as forestry and palm oil) – should stand to do remarkably well out of the development of Papua New Guinea, using their own global or regional networks to help serve the multinational companies that are coming in.

But it’s the on-the-ground presence, from the 7,500 construction workers required for PNG LNG, to the hotels and schools they will need and the roads they will drive on and the power for their businesses, to the local accountancy and legal professions, that are going to be under stress.

Absorbing growth

Pomaleu sees this clearly. “The doubling of GDP is almost a frightening prospect for us when you think about the possible implications,” he says. “Everyone is quite aware of the Dutch disease [the sense that an influx of wealth from natural resources can actually be bad for a country]. Our challenge as a country is to have the structures in place to be able to absorb the growth: the challenges it will have on our existing capacity, and its demands on government services, infrastructure, everything we have.” He mentions wharves, roads, housing, airports, customs and immigration services. “The numbers that are being quoted we are excited about: we could use a few more million dollars in our budget. But we have to have the capacity to absorb the growth.”

And it could get bigger still. Towards the end of last year InterOil, a company with petroleum licences covering about 8.7 million acres of land, started to talk about strong finds in its Antelope natural gas field. In March, it went further, announcing a flow of 382 million cubic feet of natural gas a day with 5,000 barrels of condensate a day – a flow test that set a new record for Papua New Guinea, and a figure that InterOil believes to be a world record. It also believes the well contains the largest vertical hydrocarbon column head in any single onshore field of its type. Now InterOil wants to build an LNG plant next to its refinery and start talking with potential stakeholders about taking equity or setting offtake contracts.

Consequently, as Pomaleu puts it, “prior to December I thought we had one project. Now we have two.” Development here is in a much earlier stage, and Tosali speaks of it with some caution. “It’s being negotiated,” he says. “We want them to prove their research.” But already build costs of $5 billion are being quoted and there is a real chance of PNG’s sudden windfall – and the associated drain on resources and infrastructure – being magnified still further.

All this is happening in a country that, for various reasons, has not had the best reputation as a place to come to and do business. There are clearly still big problems to be addressed and they start with security. Port Moresby regularly turns up in surveys from groups such as the Economist Intelligence Unit as one of the world’s least liveable, and most dangerous, cities. Local opinions on the true level of lawlessness vary: some feel aggrieved that this is the only impression foreigners have of Port Moresby; others feel that, despite a recent improvement, the problem is intense, with gangs of what are known locally as raskols robbing and sometimes kidnapping with apparent impunity. The consensus seems to be that it’s a place to be careful rather than to live in fear. But whatever one’s opinion of the scale of the problem, there is no question that the costs of arranging security are a necessary consideration for any foreign enterprise seeking to do business in Papua New Guinea.

Bureaucracy is a frequent complaint of foreigners too: not corruption necessarily but a certain stodginess of process that impedes efficient business. Another complaint, reminiscent of Manila about 10 years ago, is power failures. “Everyone has to get a generator set up to back up the main power,” one foreign businessman says. “It’s not such a big deal, you get used to it, but it becomes another cost.”

Enforceability of contracts also gets mentioned, with the court system slow. “They say whenever you go to court there is a 51/49 rule,” says one businessman. “There is never more than a 51% chance that you will win. But there is never less than a 49% chance that you will lose. It is not the most predictable of systems.” Here, development banks are involved in trying to improve the process.

There are, though, some major positives that should be put on the credit side of the ledger. First among them is relative political stability. When Sir Michael Somare’s government lasted an entire electoral term from 2002 to 2007 and then got re-elected it was the first time ever – in the country’s entire independent history – that a term had been served without the government being ousted or the prime minister damned in a vote of no confidence. Few would bemoan a robust democracy but it is only with a sense of political continuity and predictability that foreigners have begun to show more interest in getting involved.

“It’s a strong contributing factor to ensure that policy is stabilized,” says Tosali. “When you have continuous change the system is unstable. This is the only government that was there in the last term and has continued to rule.” And so one begins to see long-term policy being effected: a fiscal responsibility act, a continuous and more predictable attitude towards energy and resources, and the implementation of five-year fiscal frameworks.

Also, Tosali rankles at the idea of Papua New Guinea as a difficult place to do business. “Papua New Guinea has always got a very bad press overseas. People still ask if it is one of the hardest countries to do business in. But if you look at some of the laws currently, especially in terms of the fiscal incentives we have for foreign investors in this country, it is very robust and very competitive. For a long time we were being told our fiscal regime has not been the best, but in some of the latest reports we see it has improved quite dramatically. We have changed a lot.” Legal codes in the commercial sphere tend to be modelled on Australian approaches.

Bringing down public debt

Fiscal discipline will be vital as the money starts rolling in, and the best illustration of the present administration and central bank’s ability to be prudent with it comes with some real achievements in the field of national debt. In 2002 the debt to GDP ratio stood at a crippling 70%; it is now down to 30%. “I think that is a remarkable achievement we have made in the last five years or so,” Tosali says. The aim now, over the five-year medium-term fiscal strategy that runs out in 2012, is to get it down to about 20%. As the strategy document says: “Bringing public debt down to near the 20% level would represent a major fiscal achievement. It would make it more likely that according to the measure used by the IMF, PNG’s public debt would be assessed as sustainable.” It would also likely improve rating agencies’ assessment of sovereign debt, and in turn promote investor confidence.

Additionally, as commodity prices rose last year, PNG found itself, as Tosali puts it, with “so much money floating around in the system the problem was how best to manage it.” Indeed, while subsequent commodity price falls have clearly had an impact on the country, it doesn’t look remotely like any other nation in the grip of a global financial crisis: it has been putting interest rates up, not down, most recently to 8%.

While PNG hasn’t gone quite so far as some other commodity windfall nations – most notably East Timor, which is putting almost all of its newfound oil and gas bounty into a sovereign wealth fund for the next generation and only drawing off replaceable quantities for spending today – Papua New Guinea has tried to set a similar policy of sorts for its incoming revenues, and this will become more and more important as more money comes in in future. From now on, once mineral revenues go above 4% of GDP, the additional income over that level is then drawn off. It is then split 70-30 between public investments and paying down public debt. (Tosali had wanted the whole lot for public debt, but this ended up being the compromise.)

Although that looks prudent, the country is still wrestling with problematic double-digit inflation that is surely only going to get worse as the big projects get rolling. Oil price falls have brought it down a touch, from 13.5% mid last year to 11.5% at the end of December but those are still worryingly high levels. “We are still very worried about inflationary pressures on the economy,” says Tosali.

And although political stability, fiscal strength and simplification of business processes are all positive, there is still not yet much sign in the numbers of growing foreign direct investment: in fact it peaked in 2004. This maintains the sense that Papua New Guinea is a country in which things are about to happen from a foreign investment perspective, rather than one where they are already happening. That said, there are also good signs of foreign engagement: both Australian airlines, Qantas and Virgin Blue, now run code-share arrangements and other partnerships with local PNG airlines, while a particularly interesting deal came in a big Chinese investment in Madang, in the country’s north. It’s a $1.4 billion nickel and cobalt mine that will employ 4,000 people; Chinatowns are now emerging in the wilderness. China is already the third most active foreign country in PNG and it might be that ventures with the People’s Republic, rather than western nations such as Australia, is where the country’s future lies. “There has been a special effort on our part to encourage Chinese investment,” Pomaleu says.

For foreign banks, there is a lot of potential ahead. They tend to see four areas: advising multinationals before they come in to PNG, through other offices; commercial business on the ground, helping international companies once they come in; the landowners’ groups, very powerful in Papua New Guinea, which increasingly need banking services; and the retail side as more and more expatriates come in. If law and order could be brought under control the country ought to have a burgeoning tourism industry too, with world-class diving, hiking, scenery, surfing and the attraction of PNG’s stunningly multicultural nature (more than 800 distinct languages are spoken). “It’s almost totally unexploited and it should be the tourism centre of the Pacific,” says one expatriate. “Fiji’s got nothing on this.”

So when October comes, the country will find itself at a watershed moment: continue as it was or take a big step forward that will at once enrich the country and put it under substantial strain. There’s a lot to do. “We have our challenges in Papua New Guinea and I would be the first to admit that,” says Pomaleu. “But I also think we have addressed a lot of issues.”