Cambodia’s Offshore Oil

An historic opportunity to achieve shared prosperity and secure long-term stability
By Douglas Gardner, United Nations Resident Coordinator and UNDP Resident Representative

The likelihood of significant oil and gas revenues being generated off the coast of Cambodia beginning sometime in 2010 presents a truly unique opportunity to secure the country’s long term growth, substantially reduce poverty, increase equity, and consolidate the country’s hared won stability. This opportunity is unique for several reasons.

First, because the oil and gas are offshore, no private land owner or group of land owners can claim to own it. As an offshore natural resource in Cambodia waters, it truly belongs to all Cambodian people.

Second, offshore oil and gas are newly discovered and relatively uncomplicated by recent history. As such, this oil and gas offers considerable flexibility and freedom for the Royal Government to improve the well being of the vast majority of the people.

Thirst, early indications are that the offshore oil and gas fields are likely to yield significant financial revenues for the government, sufficient to substantially improve access to quality health and education, fuel rapid progress towards the Cambodian Millennium Development Goals, help secure the economy’s long-term growth, and consolidate the country’s long-term stability.

How much oil is there?

The amount of commercial reserves I still to be confirmed, but preliminary evidence is promising. The amount of offshore commercial reserves in Block A are currently being assessed by Chevron. Solid estimates should become available around mid-year 2007. Very preliminary and tentative figures released last year suggested as much as 700 million barrels of oil in Block A alone.

At world oil prices averaging US$ 60 per barrel, this level of commercial reserves could annually generate net new revenues to the government budget in the order of US$1.7 billion. This latter amount represents some three times current ODA levels; nearly three times current budget revenues,; and more that 50 percent of merchandise export revenues.

But even under more cautious price and reserve assumptions with only half of such revenues generated, this would still leave some US$0.85 billion to be disbursed annually into the government’s general budgetary process. This in turn would contribute to a doubling of current budget revenues and expenditures, and allow for a near quadrupling of current expenditures on health and education, while still enabling significant growth in all other budget lines.

Blessing or Curse?

While expected oil and gas revenues present perhaps the single biggest emerging opportunity facing Cambodia, socio-economic research supported by UNDP in collaboration with SNEC and CNPA during 2005-2006 also strongly suggests that it may be the single biggest threat to the country’s well-being and long term stability.

These conclusions are also strongly reinforced by experiences in many other low income developing countries over the past forty years. More oil, gas and mineral rich developing countries than not have been negatively impacted by oil, gas and mineral revenues booms, and some even destabilized.

In general, available research indicates that long term growth rates of oil and mineral rich developing countries have been 30 to 50 percent lower than growth rates for oil and mineral poor developing countries. Moreover, mineral rich countries have underperformed mineral poor developing countries on a variety of other economic, social and political indicators.

Global Experience on the Resource Curse

A review of experiences by developing countries plagued by a resource curse over the past forty years reveals some of the main warning signs leading up to serious resou8rce curse outcomes.
These include a sudden surge of foreign currency revenues generated from the extraction of non-renewable natural resources combined with:

- lack of financial transparency;
- weak financial governance;
- fragmented and porous public finance systems;
- weak and narrow tax base;
- strong evidence of significant corruption;
- a predatory state where officials maximize personal gains
- through misuse of public office;
- weak macro-economic management resulting in “Dutch Disease”;
- significant borrowing against oil reserves;

Ingredients to a Blessing

The minority of oil/gas/mineral rich countries that achieved an oil blessing also share common features. These include an expected surge of oil revenues generated form extraction of non-renewable natural resources combined with:

- advance planning to effectively govern, manage and invest the resulting financial flows;
- a high degree of transparency;
- a high degree of participation and meaning decision making by the parliament or national assembly;
- well developed and effective public sector institutions;
- relatively low corruption with a functioning legal and judicial system;
- a healthy civil society;
- effective macroeconomic management capacity;
- aversion to debt accumulation;
- effective management and investment of the revenues to avoid over-evaluation of the exchange rate and promote economic diversification.;
- a rate of investment expenditure that ensures inter-temporal efficiency and equity within the capacity limits of the state and absorption capacity of the country (typically back stopped by a well-designed and transparent natural resource fund).

Outlook Cambodia?

Clearly achieving an oil blessing for Cambodia will not be automatic. Fortunately international experience provides valuable guidance.

Equally fortunate, Cambodia’s constitution provides an effective road map towards achieving an oil blessing. The constitution instructs that a ‘precise plan’ be devised by the state for managing such resources as oil and gas, and that such a plan be decided upon by the people through their voice in the National Assembly, Senate, Royal Government and Judiciary.

Such advance planning and broad participation of the people in the decision making process has proven to be an important ingredient to oil blessings in some of the more successful oil exporting countries.

Moreover, given the current institutional and development context of Cambodia, international experience would suggest that a number of important policy, legal and institutional safeguards will need to be put in place well in advance of oil revenues flows to ensure that Cambodia avoids an oil curse and enjoys an oil blessings.

On the policy front, there is a need for clearly defined policy on how potentially substantial future oil and gas revenues will be governed and managed; transparent policies on how oil and gas concessions should be allocated to maximize benefits to the country as a whole; transparency on the various types and amounts of financial payments and financial flows generated by oil and gas licensing, exploration, development and extraction; and more generally, clear policies on the degree of transparency in the sector as a whole.

Offshore oil and gas are the patrimony of all the people of Cambodia, so better informing and broadening the public debate on future use of oil and gas revenues would appear essential.

In order to miximise both efficiency and benefits accruing to the country as a whole, the allocation of oil and gas concessions to foreign companies would best be done through a competitive bidding process. While in order to better inform public debate, the broad term of Production Sharing Contracts outlining the various production sharing arrangements and various types of financial flows to the country should be made easily available to the general public (eg. gazetted or posted on a public website) to better inform public debate, related planning and effective decision making.

On the legal front, there is a need for a well designed petroleum law to govern the sector within the broader legal and institutional context of Cambodia based on a rational division of responsibilities within the state and between the state and the non-state sectors. There is also a need to ensure legal clarity and coherence with other laws (eg. on taxation, environment, etc.)
On the institutional front, given the current stage of institutional development in Cambodia, there is a strong case to be made for putting in place a well-designed and transparent petroleum fund to minimize the risk of Dutch Disease and other resource curse outcomes.

As is done in the most successful countries that have avoided the curse, financial flows generated by oil and gas could first be deposited in such a well designed transparent fund before being disbursed to and through the government budget process to finance planned investments within NSDP. Revenues from the fund to the budget would be disbursed at a rate that would enable efficient and effective investments within the limits of the country’s still developing institutional and absorption capacities.

Such a petroleum fund based approach would also better help ensure inter-temporal efficiency and equity of related investment expenditures.

In general, a further strengthening of public financial systems and management will clearly be important to avoid a resource curse. The government’s ongoing efforts in Public Financial Management Reform are even more critical in light of the potential for an oil and gas revenues surge beginning in 2010 and beyond.

There is also a need to ensure a rational division of institutional responsibilities and related capacities within the petroleum sector. The capacity of the Cambodian National Petroleum Authority (CNPA) needs strengthening in a wide range of technical areas, and the division of responsibilities with other government bodies may need further definition.

Investing in Shared Prosperity and Long-term Stability: Advancing the CMDGs

Another potential challenge facing Cambodia is how to effectively allocate expenditures through the budgetary process and NSDP so as to minimize the risk of a resource curse and maximize the likelihood of a blessing. Preliminary finding from ongoing UNDP supported research in collaboration with SNEC, CNPA and the Overseas Development Institute (ODI) are illuminating.
These findings generated by quantitative simulations of the Cambodian economy under varying oil and gas scenarios strongly suggest that the most effective way for Cambodia to minimize the risk of Dutch Disease and other resource curse outcomes would be to invest a substantial share of future oil and gas revenues into rural development. Rural investments in human resource development through much improved basic education training, and extension services as well as in rural infrastructure especially rural electrification, roads, and irrigation appear to generate the highest returns. These results are largely due to the existing low capital intensity in most of rural Cambodia.

Such rural based investments in human capital and infrastructure also appear to offer the greatest scope for economic diversification, generating jobs and incomes in the agricultural and manufacturing sectors, and sustaining healthy growth rates over the long-term.

Moreover, quantitative simulations also indicate strong positive impact on equity indicators, thereby, further underpinning long-term social stability.

In sharp contrast, the risks of Dutch Disease, and loss of competitiveness in agriculture, manufacturing, and tourism will rise as increasing shares of future revenues accrue to urban areas. In this scenario, equity indicators deteriorate rapidly boding ill for long-term social stability and human well being. Similarly, this scenario also tends to further exacerbate already high land concentration and related inequalities.

Similarly, early simulations strongly suggest that striking a safe balance between consumption and investment expenditures will also prove critical. Dutch Disease effects increase sharply as increasing shares of new revenues are used for consumption. The impact is especially negative on private sector competitiveness and investment. Imports would also rise to unsustainable levels.

Fortunately, the Government’s Rectangular Strategy and the National Strategic Development Plan (NSDP) both place heavy emphasis on rural development and achieving the Cambodia Millennium Development Goals. Effective implementation of the NSDP will be essential to ensuring that rural investments are sequenced up front.

While the NSDP does not specifically factor in the possibility of substantial oil and gas revenues, the realization of such revenues would allow for an NSDP + scenario fueling raid growth and poverty reduction in rural areas, as well as rapid advancement towards the other Cambodia Millennium Development Goals (CMDGs).

In short, substantial investments funded by future oil and gas revenues in rural people and rural infrastructure, coupled with needed governance reforms, would appear to be the most effective way to avoid a resource curse and ensure that the outlook for Cambodia and its people is truly blessed over the coming decades.

“Cambodia must learn from other countries, use oil revenues effectively and avoid an oil curse” Prime Minister Samdech Hun Sen speaking at the Cambodia Economic Forum