Local Content Policies in the Oil and Gas Sector
A number of countries have recently discovered and are developing oil and gas reserves. Policy makers in such countries are anxious to obtain the greatest benefits for their economies from the extraction of these exhaustible resources by designing appropriate policies to achieve desired goals. One important theme of such policies is the so-called local content created by the sector—the extent to which the output of the extractive industry sector generates further benefits to the economy beyond the direct contribution of its value-added, through its links to other sectors. This paper provides a detailed description of the policy context, objectives, implementation tools, and metrics used in a select group of petroleum-producing countries, including Angola, Brazil, Indonesia, Kazakhstan, Malaysia, and Trinidad and Tobago. The information is further analyzed in the paper on Local Content in the Oil and Gas Sector, World Bank Studies, Washington D.C., 2013.
W O R L D B A N K P U B L I C A T I O N Local Content in the Oil and Gas Sector: Case Studies Silvana Tordo and Yahya Anouti Copyright ÂŠ 2013 The International Bank for Reconstruction and Development/The World Bank 1818 H Street, NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org World Bank papers are published to communicate the results of the Bankâ€™s work to the development community with the least possible delay. The manuscript of this paper therefore has not been prepared in accordance with the procedures appropriate to formally edited texts. Some sources cited in this paper may be informal documents that are not readily available. This paper is a product of the staff of the International Bank for Reconstruction and Development/The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. 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Queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: email@example.com. Contents Acknowledgments ............................................................................................................................................. xii Abbreviations and Acronyms ........................................................................................................................... 13 1. Angola ....................................................................................................................................................... 14 1.1 Structural Context ............................................................................................................................... 15 1.1.1 Economy ....................................................................................................................................... 15 1.1.2 Taxation ........................................................................................................................................ 16 1.1.3 Population and Labor Force ...................................................................................................... 16 1.1.4 Education ..................................................................................................................................... 17 1.1.5 Business Environment ................................................................................................................ 18 1.2 The Petroleum Sector .......................................................................................................................... 20 1.2.1 The Petroleum Sector in the Economy ..................................................................................... 20 1.2.2 Petroleum Geography ................................................................................................................ 22 1.2.3 Reserves, Production, and Consumption ................................................................................ 22 1.2.4 Sector Institutional Framework ................................................................................................. 23 1.2.5 Market Structure and Local Capabilities ................................................................................. 24 1.2.6 Management of Petroleum Wealth ........................................................................................... 25 1.3 Local Content Policies ........................................................................................................................ 26 1.3.1 Policy Objectives ......................................................................................................................... 26 1.3.2 Policy Tools .................................................................................................................................. 27 Angolanization of the Workforce ......................................................................................................... 27 Domestic Sourcing of Goods and Services .......................................................................................... 29 Preferential Treatment............................................................................................................................ 31 1.3.3 Legislative Channels ................................................................................................................... 31 1.3.4 Institutional Responsibilities ..................................................................................................... 32 1.3.5 Interlinks ...................................................................................................................................... 32 1.3.6 Monitoring and Measuring Tools ............................................................................................. 32 1.3.7 Policy Impact on Local Content Levels .................................................................................... 33 Angolanization ........................................................................................................................................ 33 Domestic Sourcing and Preferential Treatment .................................................................................. 35 2. Brazil ......................................................................................................................................................... 40 2.1 Structural Context ............................................................................................................................... 41 2.1.1 Economy ....................................................................................................................................... 42 2.1.2 Taxation ........................................................................................................................................ 43 2.1.3 Population and Labor Force ...................................................................................................... 44 2.1.4 Education ..................................................................................................................................... 46 2.1.5 Business Environment ................................................................................................................ 46 2.2 The Petroleum Sector .......................................................................................................................... 48 2.2.1 The Petroleum Sector in the Economy ..................................................................................... 48 2.2.2 Petroleum Geography ................................................................................................................ 49 2.2.3 Reserves, Production, and Consumption ................................................................................ 50 2.2.4 Sector Institutional Framework ................................................................................................. 51 2.2.5 Market Structure and Local Capabilities ................................................................................. 52 2.2.6 Management of Petroleum Wealth ........................................................................................... 53 iii 2.3 Local Content Policies ........................................................................................................................ 54 2.3.1 Policy Objectives ......................................................................................................................... 54 2.3.2 Policy Tools .................................................................................................................................. 55 Regulatory Requirements ...................................................................................................................... 55 Fiscal Incentives ...................................................................................................................................... 57 Program for the Mobilization of the Oil and Gas Industry (PROMINP) ........................................ 57 2.3.3 Legislative Channels ................................................................................................................... 60 2.3.4 Institutional Responsibility for Policy Design and Monitoring of Implementation .......... 60 2.3.5 Interlinks ...................................................................................................................................... 62 2.3.6 Monitoring and Measuring Tools ............................................................................................. 63 2.3.7 Policy Impact on Local Content Levels .................................................................................... 63 3. Indonesia .................................................................................................................................................... 69 3.1 Structural Context ............................................................................................................................... 70 3.1.1 Economy ....................................................................................................................................... 70 3.1.2 Taxation ........................................................................................................................................ 72 3.1.3 Population and Labor Force ...................................................................................................... 73 3.1.4 Education ..................................................................................................................................... 75 3.1.5 Business Environment ................................................................................................................ 76 3.2 The Petroleum Sector .......................................................................................................................... 77 3.2.1 The Petroleum Sector in the Economy ..................................................................................... 77 3.2.2 Petroleum Geography ................................................................................................................ 79 3.2.3 Reserves, Production, and Consumption ................................................................................ 80 3.2.4 Sector Institutional Framework ................................................................................................. 81 3.2.5 Market Structure and Local Capabilities ................................................................................. 82 3.2.6 Management of Petroleum Wealth ........................................................................................... 83 3.3 Local Content Policies ........................................................................................................................ 84 3.3.1 Policy Objectives ......................................................................................................................... 84 3.3.2 Policy Tools .................................................................................................................................. 84 Local Content in the Labor Force .......................................................................................................... 84 Domestic Procurement of Goods and Services ................................................................................... 85 3.3.3 Policy Channels ........................................................................................................................... 90 3.3.4 Institutional Responsibilities ..................................................................................................... 90 3.3.5 Interlinks ...................................................................................................................................... 91 3.3.6 Monitoring and Measuring Tools ............................................................................................. 91 3.3.7 Policy Impact on Local Content Levels .................................................................................... 93 4. Kazakhstan ............................................................................................................................................... 101 4.1 Structural Context ............................................................................................................................. 102 4.1.1 Economy ..................................................................................................................................... 102 4.1.2 Taxation ...................................................................................................................................... 103 4.1.3 Population and Labor Force .................................................................................................... 104 4.1.4 Education ................................................................................................................................... 105 4.1.5 Business Environment .............................................................................................................. 106 4.2 The Petroleum Sector ........................................................................................................................ 108 4.2.1 The Petroleum Sector in the Economy ................................................................................... 108 4.2.2 Petroleum Geography and Geology ....................................................................................... 109 4.2.3 Reserves, Production, and Consumption .............................................................................. 109 iv 4.2.4 4.2.5 4.2.6 Sector Institutional Framework ............................................................................................... 111 Evolution of Local Capabilities and Market Structure ......................................................... 111 Management of Oil Wealth ...................................................................................................... 113 4.3 Local Content Policies ...................................................................................................................... 113 4.3.1 Policy Objectives ....................................................................................................................... 113 4.3.2 Policy Tools ................................................................................................................................ 115 Localization of Petroleum Workforce ................................................................................................ 115 Target Quotas for Foreign Staff Employed by Subsoil Users ...................................................... 115 Limitations on Granting of Work Permits ..................................................................................... 116 Minimum Budget Dedicated to Training of Local Workforce .................................................... 116 Domestic Sourcing of Goods, Works, and Services .......................................................................... 116 Goods, Works, and Services Procurement Rules .......................................................................... 116 Ministry of Oil and Gas KC Development Programs .................................................................. 117 KMG (National Oil Company) Local Content Development Efforts ......................................... 117 4.3.3 Legislative Channels ................................................................................................................. 119 4.3.4 Institutional Responsibility for Policy Design and Monitoring of Implementation ........ 119 4.3.5 Interlinks .................................................................................................................................... 120 4.3.6 Monitoring and Measuring Tools ........................................................................................... 120 Local Content in the Labor Force ........................................................................................................ 121 Local Content in the Procurement of Goods, Works, and Services ................................................ 121 4.3.7 Policy Impact on Local Content Levels .................................................................................. 122 5. Malaysia .................................................................................................................................................. 131 5.1 Structural Context ............................................................................................................................. 131 5.1.1 Economy ..................................................................................................................................... 132 5.1.2 Taxation ...................................................................................................................................... 133 5.1.3 Population and Labor Force .................................................................................................... 134 5.1.4 Education ................................................................................................................................... 136 5.1.5 Business Environment .............................................................................................................. 137 5.2 The Petroleum Sector ........................................................................................................................ 139 5.2.1 The Petroleum Sector in the Economy ................................................................................... 139 5.2.2 Petroleum Geography .............................................................................................................. 140 5.2.3 Reserves, Production, and Consumption .............................................................................. 140 5.2.4 Sector Institutional Framework ............................................................................................... 142 5.2.5 Market Structure and Local Capabilities ............................................................................... 142 5.2.6 Management of Petroleum Wealth ......................................................................................... 144 5.3 Local Content Policies ...................................................................................................................... 144 5.3.1 Policy Objectives ....................................................................................................................... 144 5.3.2 Policy Tools ................................................................................................................................ 145 Building Local Capabilities in the Petroleum Sector ........................................................................ 145 Domestic Sourcing of Goods and Services ........................................................................................ 147 Incentives for the Manufacturing Sector ............................................................................................ 147 Developing a Domestic OFSE Industry ............................................................................................. 148 5.3.3 Policy Channels ......................................................................................................................... 150 5.3.4 Institutional Responsibilities ................................................................................................... 150 5.3.5 Interlinks .................................................................................................................................... 150 5.3.6 Monitoring and Measuring Tools ........................................................................................... 152 5.3.7 Policy Impact on Local Content Levels .................................................................................. 152 v 6. Trinidad and Tobago................................................................................................................................ 156 6.1 Structural Context ............................................................................................................................. 157 6.1.1 Economy ..................................................................................................................................... 157 6.1.2 Taxation ...................................................................................................................................... 158 6.1.3 Population and Labor Force .................................................................................................... 159 6.1.4 Education ................................................................................................................................... 160 6.1.5 Business Environment .............................................................................................................. 161 6.2 The Petroleum Sector ........................................................................................................................ 162 6.2.1 The Petroleum Sector in the Economy ................................................................................... 162 6.2.2 Petroleum Geography .............................................................................................................. 163 6.2.3 Reserves, Production, and Consumption .............................................................................. 163 6.2.4 Sector Institutional Framework ............................................................................................... 164 6.2.5 Market Structure and Local Capabilities ............................................................................... 165 6.2.6 Management of Petroleum Wealth ......................................................................................... 166 6.3 Local Content Policies ...................................................................................................................... 167 6.3.1 Policy Objectives ....................................................................................................................... 167 6.3.2 Policy Tools ................................................................................................................................ 168 6.3.3 Legislative Channels ................................................................................................................. 170 6.3.4 Institutional Responsibilities ................................................................................................... 170 6.3.5 Interlinks .................................................................................................................................... 171 6.3.6 Monitoring and Measuring Tools ........................................................................................... 171 6.3.7 Policy Impact on Local Content Levels .................................................................................. 171 Tables Table 1.1 Key Economic Indicators of PostCivil War Angola, 1985–2010 ________________________ 15 Table 1.2 Angola’s Labor Force Indicators Compared to Select Countries, 2010 ___________________ 17 Table 1.3 Angola’s Educational Indicators Compared to Select Countries, 2010 ___________________ 18 Table 1.4 Indicators for Doing Business in Angola, 2011_______________________________________ 19 Table 1.5 Snapshot of Angola’s Oil Sector Reserves and Production (2010) _______________________ 23 Table 1.6 Angola: Company Share and Operator (in Gray), by Producing Blocks (%) ______________ 25 Table 1.7 Domestic Sourcing of Goods and Services in Angola: Objectives, Rationale, and Instruments __________________________________________________________________________________ 26 Table 1.8 Angolanization Targets Outlined by the Decree of 1982 ______________________________ 27 Table 1.9 Angola: Annual Contributions to the Training and Development Fund _________________ 28 Table 1.10 Key Angolanization Regulatory Requirements and Fines in Case of Noncompliance ____ 29 Table 1.11 Angola: List of Goods and Services by Mode of Preferential Treatment ________________ 30 Table 1.12 Angola: Tendering Rules as per Decree No. 48/06 ___________________________________ 30 Table 1.13 Summary of Local Content Policy Tools in Angola __________________________________ 31 Table 1.14 Labor Distribution and Angolanization Rate by Occupation along the Oil Value Chain, 2002 __________________________________________________________________________________ 34 Table 1.15 Angolanization Rate in Administrative versus Technical Occupations, 2002 ____________ 35 Table 1.16 Number of Graduates from High-Skilled Programs at the INP, 19832008 _____________ 35 Table 1.17 Angola: A Selection of Sonangol Joint Ventures in Upstream Oil and Gas Services, 1984– 2002 ______________________________________________________________________________ 36 Table 2.1 Key Economic Indicators of Brazil, 1980 –2010_______________________________________ 42 Table 2.2 Snapshot of Taxes in Brazil (2010) _________________________________________________ 44 vi Table 2.3 Brazil’s Labor Force Indicators Compared to Select Countries, 2010 ____________________ 45 Table 2.4 Brazil’s Educational Indicators Compared to Select Countries, 2010 ____________________ 46 Table 2.5 Indicators for Doing Business in Brazil in Comparison to OECD Average, 2012 __________ 47 Table 2.6 Snapshot of the Brazilian Petroleum Sector in 2010 __________________________________ 50 Table 2.7 Brazil: Local Content in the Bidding Process, 1999–2007 ______________________________ 56 Table 2.8 Brazil: Schedule of Fines in Case of Noncompliance with Local Content Requirements ____ 56 Table 2.9 Brazil: An Activity Map of PROMINP’s Local Content Stakeholders ___________________ 62 Table 2.10 Brazil: PROMINP’s Methodology for Calculating Local Content ______________________ 63 Table 2.11 Brazil: PROMINP Targets Versus Achieved Participation of Domestic Industry in Investments, 2003–10 _______________________________________________________________ 64 Table 2.12 Brazil: Cumulative Total and Local Investment (in $ million) and Percentage Local Content, 2011 ______________________________________________________________________________ 64 Table 3.1 Key Economic Indicators for Indonesia, 1980–2010___________________________________ 71 Table 3.2 Indonesia’s Labor Force Indicators Compared to Select Countries, 2010 _________________ 74 Table 3.3 Indonesia’s Educational Indicators Compared to Select Countries (2010) ________________ 75 Table 3.4 Indicators for Doing Business in Indonesia Compared to OECD Average _______________ 76 Table 3.5 Snapshot of the Oil and Gas Industry in Indonesia 2011 ______________________________ 81 Table 3.6 Indonesia: Definition of Goods and Respective Procurement Strategy __________________ 86 Table 3.7 Indonesia: Procurement Requirements for Services __________________________________ 87 Table 3.8 Indonesia: Summary of Price Preferences Based on Local Content (LC) Level and Company Status ____________________________________________________________________________ 88 Table 3.9 Indonesia: Example of Calculating a Bid Evaluation Price for the Supply of a Good ______ 88 Table 3.10 Indonesia: Activities, Criteria, and Weights for the Local Content Level Achieved _______ 89 Table 3.11 Indonesia: Calculating the Penalty Given for Unachieved Local Content, and Rank Changes __________________________________________________________________________________ 89 Table 3.12 Indonesia: Local Content Levels for Work Tools ____________________________________ 92 Table 3.13 Indonesia: Local Content of Value of Service of Equipment Use in Implementation of Physical Work and Other Services ____________________________________________________ 93 Table 3.14 Indonesia: APDN Distribution of Goods by Category _______________________________ 94 Table 3.15 Indonesia: Snapshot of Domestic Suppliers of Compressors and Vacuum Pumps _______ 95 Table 4.1 Key Economic Indicators of Kazakhstan, 1990–2010 _________________________________ 102 Table 4.2 Kazakhstan’s Labor Force Indicators Compared to Select Countries, 2010 ______________ 104 Table 4.3 Kazakhstan’s Educational Indicators Compared to Select Countries, 2010 ______________ 106 Table 4.4 Indicators for Doing Business in Kazakhstan in Comparison to OECD Average, 2012 ____ 107 Table 4.5 Tengiz and Kashagan: A Comparison _____________________________________________ 109 Table 4.6 Snapshot of the Oil and Gas Sector in Kazakhstan (2011) ____________________________ 110 Table 4.7 Kazakhstan: Quotas for Foreign Staff Employed by Subsoil Users _____________________ 115 Table 4.8 Kazakhstan: Local Content Targets and Attained Levels in 2011 ______________________ 117 Table 4.9 Kazakhstan: Breakdown of the Planned KMG Agreements by Value (million KZT) ______ 118 Table 4.10 KMG’s Kazakh Content in Purchased Goods, Works, and Services: 2010 and 2011______ 119 Table 4.11 Kazakh Content in Subsoil Personnel ____________________________________________ 122 Table 4.12 Kazakh Content in Goods, Works, and Services: 2010–11 ___________________________ 123 Table 4.13 Kazakh Content by Product Group and Local Suppliers, 2011 _______________________ 126 Table 5.1 Key Economic Indicators for Malaysia, 1980–2010 __________________________________ 133 Table 5.2 Malaysia Labor Force Indicators Compared to Select Countries, 2010 __________________ 135 Table 5.3 Malaysia’s Educational Indicators ________________________________________________ 137 Table 5.4 Indicators for Doing Business in Malaysia _________________________________________ 138 vii Table 5.5 Snapshot of the Oil and Gas Industry in Malaysia (2010) _____________________________ 141 Table 5.6 Companies and Universities Engaged in the Malaysian Government’s Internship Program _________________________________________________________________________________ 147 Table 5.7 Malaysia: Industry Strategy, Expected Contribution to GNI, and Jobs to be Created _____ 148 Table 5.8 Malaysia: OFSE EPPs, KPIs, and Targets for 2011 ___________________________________ 152 Table 5.9 Malaysia: OFSE-related EPP Progress over 2011, and Target for 2012 __________________ 152 Table 6.1 Key Economic Indicators for T&T, 1980–2010 ______________________________________ 158 Table 6.2 T&T Labor Force Indicators Compared to Select Countries, 2010 ______________________ 160 Table 6.3 T&T Educational Indicators, 2010 ________________________________________________ 160 Table 6.4 Indicators for Doing Business in T&T in Comparison to OECD Average, 2012 __________ 162 Table 6.5 Snapshot of the Oil and Gas Industry in T&T 2011 __________________________________ 164 Table 6.6 T&T: Capacities and Shareholders of LNG Plants (1999, 2002, 2003, 2006) ______________ 165 Table 6.7 T&T: Energy-Intensive Industrial Base by Company ________________________________ 166 Table 6.8 T&T: Vision 2020, Goal 1 for the Energy Sector _____________________________________ 167 Table 6.9 Total and Local Content Expenditure on Platform Fabrication in T&T _________________ 172 Figures Figure 1.1 Angola’s Exports by Commodity, 1980–2010 ($ billion) ............................................................ 15 Figure 1.2 Comparison of Angola’s Tax Revenues and Corporate Tax Rate to Other Countries, 2009 and 2010 ..................................................................................................................................................... 16 Figure 1.3 Evolution of the Angolan Population and Labor Force over Time (in millions of people) ... 17 Figure 1.4 Governanced Indicators in Angola Compared to the OECD Average ..................................... 20 Figure 1.5 Contribution of Angola’s Extractive Sector to Value-Added, 1970–2010 (in $ billion and as share of GDP) ............................................................................................................................................ 20 Figure 1.6 Breakdown of Value-Added in Angola by Economic Activity, 2010 ($ billion) ...................... 21 Figure 1.7 Angola: Percentage of Oil’s Contribution to GDP, Oil Export Revenues ($), and Total Government Revenues, 2002–10 ............................................................................................................. 21 Figure 1.8 Employment in the Angolan Oil and Oil Services Sector, 2004–09 ........................................... 22 Figure 1.9 Angola: Actual and Estimated Oil Production According to Field Depth, 19902020 ........... 23 Figure 1.10 Achieved Angolanization Rate versus Target, 1990 .................................................................. 33 Figure 1.11 Angola: Production ........................................................................................................................ 34 Figure 1.12 Angola: Framework and Initiatives for Approaching Domestic Sourcing Challenges ......... 36 Figure 2.1 Key Challenges for Brazilian Companies, Percentage of Respondents (total = 77) ................. 42 Figure 2.2 Brazil’s Exports by Commodity, 1980–2010 ($ billion) ................................................................ 43 Figure 2.3 Comparison of Brazil’s Tax Revenues and Corporate Tax Rate to Other Countries, 2009 and 2010 (%) ...................................................................................................................................................... 43 Figure 2.4 Evolution of the Brazilian Population and Labor Force over Time, 1950–2050 (in millions of people) ........................................................................................................................................................ 44 Figure 2.5 Breakdown of Labor Force by Category, 2000 and 2007 (in millions of people)...................... 45 Figure 2.6 Governance Indicators in Brazil Compared to the OECD Average .......................................... 48 viii Figure 2.7 Brazil: Breakdown of Value-added by Economic Activity, 2010 ($ billion).............................. 48 Figure 2.8 Brazil: Contribution of Mining, Manufacturing, and Utilities to Value-added, 1970–2010.... 49 Figure 2.9 Brazil: Geographical Distribution of Main Oil and Gas Reserves – 2010 (Number in Parentheses Indicates Percentage Onshore) .......................................................................................... 49 Figure 2.10 Brazil: Evolution of Production by Water Depth (in billion boe) ............................................. 50 Figure 2.11 Brazil: Forecasted Domestic Oil Demand and Supply, mmbpd .............................................. 51 Figure 2.12 Brazil: Evolution of Petrobas’ R&D Spending (to the left) in Comparison to IOCs and NOCs (to the right), 1998–2008 ............................................................................................................... 53 Figure 2.13 Brazil: Forecasted Investment, 2010–20 ($ billion) ..................................................................... 54 Figure 2.14 Brazil: Number of Jobs to be Created in the Oil And Gas Value Chain, in Thousands ........ 55 Figure 2.15 Brazil: Progredir Program Workflow .......................................................................................... 59 Figure 2.16 Brazil: Gaps and Challenges in Domestic Supply (Red Cells Indicate Areas of Challenges/Gaps) ...................................................................................................................................... 59 Figure 2.17 Brazil: PROMINP Strategic Subjects, Areas, and Projects ......................................................... 60 Figure 2.18 Brazil: PROMINP Governance Structure .................................................................................... 61 Figure 2.19 Brazil: Average Local Content Commitment Resulting from Bidding Rounds, 1999–2008 . 64 Figure 2.20 Brazil: Local Content in the Procurement of Goods (left) and Services (right) Sourced by Petrobras, 2005–08 .................................................................................................................................... 65 Figure 3.1 Indonesia’s Exports by Commodity, 1980–2010 ($ billion) ......................................................... 72 Figure 3.2 Comparison of Indonesia’s Tax Revenues as Percentage of GDP and Corporate Tax Rate to Other Countries, 2009 and 2010 .............................................................................................................. 72 Figure 3.3 Evolution of the Malaysian Population and Labor Force over Time, 1950–2050 (in millions of people) ........................................................................................................................................................ 73 Figure 3.4 Breakdown of Indonesia’s Labor Force by Sector, 2000–08 ........................................................ 74 Figure 3.5 Governance Indicators in Indonesia Compared to OECD Average .......................................... 77 Figure 3.6 Indonesia Compared to Select Countries: Breakdown of Value-added by Economic Activity in 2010 ($ billion) ....................................................................................................................................... 78 Figure 3.7 Indonesia: Contribution of Mining, Manufacturing and Utilities to Value-added, 1970–2010 ..................................................................................................................................................................... 78 Figure 3.8 Oil and Gas Production and Consumption in Indonesia, 1990–2011 ........................................ 80 Figure 3.9 Indonesia: Evolution of Upstream Investments and Local Content Levels, 2006–11 .............. 93 Figure 3.10 Indonesia: Local Content Procurement of Goods and Services, 2006–11 ($ billion) .............. 94 Figure 3.11 Indonesia: Distribution of Companies by Local Content Value Achieved ............................. 95 Figure 3.12 Indonesia: Distribution of Local Content Value by Segment of Activities ............................. 96 Figure 3.13 Indonesia: Distribution of Companies by Category of Certificate of Business Ability ......... 96 Figure 3.14 Evolution of Indonesianization in Exploration (left) and Production (right) Activities (in thousand workers) .................................................................................................................................... 97 ix Figure 3.15 Number of Indonesians Engaged in Capability Development Programs, 2008–11............... 97 Figure 4.1 Kazakhstan’s Exports by Commodity, 1995–2010 ($ billion).................................................... 103 Figure 4.2 Comparison of Kazakhstan’s Corporate Tax Rate to Other Countries, 2009 and 2010 (%) .. 103 Figure 4.3 Kazakhstan: Population by Age Group from 1950 to 2050 ....................................................... 104 Figure 4.4 Kazakhstan: Breakdown of Labor Force by Sector, 2001–07..................................................... 105 Figure 4.5 Governance Indicators in Kazakhstan Compared to the OECD Average .............................. 106 Figure 4.6 Kazakhstan: Contribution of Mining, Manufacturing, and Utilities to Value-added, 1990– 2010 ........................................................................................................................................................... 108 Figure 4.7 Kazakhstan: Breakdown of Value-added by Economic Activity in 2010 ($ billion) .............. 108 Figure 4.8 Evolution of Oil and Gas Production and Consumption in Kazakhstan, 1991–2011 ............ 110 Figure 4.9 Kazakhstan: Reports Filed by Subsoil Companies, 2008–11 ..................................................... 123 Figure 4.10 Evolution of Kazakh Content in Monetary Presentation for the Purchase of Goods, Works, and Services, 2009–11 (in KZT billion) ................................................................................................. 123 Figure 4.11 Kazakh Content in Goods Purchased for Offshore Operations, 2011 ................................... 124 Figure 4.12 Kazakh Content in Goods Purchased for Onshore Operations by Depth, 2011 .................. 124 Figure 4.13 Kazakh Content in Works and Services Purchased for Offshore Operations, 2011 ............ 125 Figure 4.14 Kazakh Content in Works and Services Purchased for Onshore Operations by Depth, 2011 ................................................................................................................................................................... 125 Figure 5.1 Malaysia’s Exports by Commodity, 1980–2010 ($ billion) ........................................................ 133 Figure 5.2 Malaysia’s Tax Revenues and Corporate Tax Rate Compared to Select Countries, 2009 and 2010 ........................................................................................................................................................... 134 Figure 5.3 Evolution of the Malaysian Population and Labor Force over Time, 1950–2050 (in millions of people) ...................................................................................................................................................... 135 Figure 5.4 Malaysia: Breakdown of Labor Force by Sector, 2000–08 (millions) ....................................... 136 Figure 5.5 Governance Indicators in Malaysia Compared to OECD Average ......................................... 138 Figure 5.6 Malaysia and Select Countries: Breakdown of GDP by Economic Activity in 2010 ($ billion) ................................................................................................................................................................... 139 Figure 5.7 Malaysia: Contribution of Mining, Manufacturing, and Utilities to GDP, 19702010 .......... 140 Figure 5.8 Evolution of Oil and Gas Production and Consumption in Malaysia, 19912011................. 141 Figure 5.9 Malaysia: Forecasted Contribution of the Energy Sector to the 2020 Gross National Income (RM billion) .............................................................................................................................................. 145 Figure 5.10 Malaysia: Number of Scholars Sponsored by Petronas, 1975–2005 ....................................... 146 Figure 5.11 Malaysia: Skills Gap in the OFSE Industry ............................................................................... 149 Figure 6.1 T&T’s Exports by Commodity, 1980–2010 ($ billion) ................................................................ 158 Figure 6.2 T&T’s Tax Revenues and Corporate Tax Rate Compared to Other Countries, 2009 and 2010 ................................................................................................................................................................... 159 Figure 6.3 Evolution of the T&T Population and Labor Force over Time)................................................ 159 x Figure 6.4 Governance Indicators in T&T Compared to the OECD Average ........................................... 161 Figure 6.5 T&T: Contribution of Mining, Manufacturing, and Utilities to Value-added, 1970–2010 .... 163 Figure 6.6 T&T and Select Countries: Breakdown of Value-added by Economic Activity in 2010 ($ billion) ...................................................................................................................................................... 163 Figure 6.7 T&T: Evolution of Oil and Gas Production, 1970–2010 (in million tons of oil equivalent) .. 164 Figure 6.8 T&T: Evolution of Petrotrin .......................................................................................................... 165 Figure 6.9 T&T: Evolution of Funds, September 2001–September 2010 ($ billion) .................................. 167 Figure 6.10 T&T: Approach to Maximizing Local Content and Participation .......................................... 169 Figure 6.11 T&T: Survey of Domestic Services Companies ........................................................................ 172 xi Acknowledgments Local Content Policies in the Oil and Gas Sector is part of a wider research effort aimed at gathering existing knowledge and data on local content policies, with a view to develop guidelines for the design and monitoring of implementation of local content policies. This paper contains detailed case studies on the local content policies in selected countries and is intended as background document for the paper on Local Content Policies in the Oil and Gas Sector, World Bank Studies, 2013. The case studies were coordinated by Silvana Tordo (lead energy economist, Sustainable Energy Department, World Bank). The main author was Yahya Anouti (consultant). The comments of peer reviewers Maria Vagliasindi (lead economist, Sustainable Energy Department, World Bank), Graham Davis (professor, Division of Economics and Business, Colorado School of Mines), Fredric Manuel Cegarra Escolano (senior adviser, Sustainable Energy Department, World Bank) and Gary McMahon (senior mining specialist, Sustainable Energy Department, World Bank) are gratefully acknowledged. Helpful comments were also received from Alexander Huurdeman, David Santley, and Kristina Svennson, all from the Sustainable Energy Department, World Bank, and Havard Halland, from the Poverty Reduction and Economic Management Department, World Bank. Special thanks go to Dino Andrian (BP MIGAS) for his assistance with the preparation of the Indonesia case study, and Fayre Makeig, who edited the paper. xii Abbreviations and Acronyms ASEAN Association of Southeast Asian Nations CAGR compound annual growth rate CAs concession agreements E&P exploration and production EOR enhanced oil recovery FDI foreign direct investment GATS General Agreement on Trade in Services GATT General Agreement on Tariffs and Trade GDP gross domestic product GWS goods, works, and services HSE health, safety, and the environment HRW Human Rights Watch IMF International Monetary Fund IOC international oil company KPI key performance indicator LCP local content policy LNG liquefied natural gas MNC multinational company NAFTA North American Free Trade Agreement NCO national oil company NGO nongovernmental organization OECD Organisation for Economic Co-operation and Development OFSE oil field services and equipment OPEC Organization of the Petroleum Exporting Countries PPPs public-private partnerships PSA production sharing agreement or similar contractual arrangement R&D research and development SADC Southern African Development Community SMEs small- and medium-sized enterprises TRIMs Trade-Related Investment Measures UN United Nations WEF World Economic Forum WTO World Trade Organization 13 1. Angola Oil has been the lifeblood of the Angolan economy since its independence from Portugal in 1975. In 2009 the oil sector constituted over 44 percent of Angola’s gross domestic product (GDP), over 95 percent of exports value, and around 65 percent of government revenues (World Bank 2012). Shortly after independence, the political administration instigated local content policies (LCPs) in the country’s petroleum sector. At the end of the 27year civil war, a socioeconomic development agenda renewed these policies. Upon the nation’s independence in 1975, the Popular Liberation Movement of Angola (MPLA) led the political and economic scene. Supported by Cuba, the MPLA had a Marxist outlook with a strong presence in Luanda and the oil-rich urban coastal areas. The MPLA president Agostinho Neto nationalized colonial properties in Angola and introduced a centralized planning economy in the capital and the coastal areas that were controlled by the MPLA (Oliveira 2007; Warner 1991). The nationalization agenda had a different path in the oil sector. As a starting point, there was a smooth appropriation of the colonial oil company, Angol, followed by the creation of the state oil company, Sonangol. The company was granted sole concessionaire rights over petroleum resources and mandated with regulatory and operational activities (CRES 2008). Aware that international oil companies, vital for the transfer of knowledge and for future production, would be discouraged to invest in Angola should Sonangol follow the socialist agenda, Sonangol was allowed to partner with international companies (Oliveira 2007). Albeit, the government introduced a local content agenda, calling for transfer of knowledge and Angolanization of the petroleum sector workforce. Institutionally this was mainly championed by Sonangol (Council of Ministers 1982). Shortly after independence, the country underwent a 27-year civil war that engaged three main political parties,1 neighboring countries, and international allies. The battles took place mostly in the underdeveloped areas, causing the migration of the local population and the destruction of the country’s infrastructure (Cihlar 2010; Oliveira 2007). During this period, Sonangol appeared to operate in isolation, unaffected by the overall destitute situation of the economy and its institutions (Morais 2012). By the end of the civil war the Angolan society was shattered, the country’s human capital was lost, and the non-oil economy was almost nonexistent (Oliveira 2007). In response to these socioeconomic conditions, the government revived the Angolanization of the workforce and launched new policies directed toward the domestic sourcing of goods and services, which were extended beyond the petroleum sector (National Assembly 2003). Today Angola remains an oil economy, with Sonangol establishing itself on the international oil scene by branching outward into many countries and ventures. The country consists of 18 provinces that are governed by a centralized pyramid structural hierarchy. The MPLA’s José Eduardo dos Santos, who took office in 1979, still exerts a strong grip on the ministries under his constitutional rule (Morais 2012), and particularly on the oil sector through the Ministry of Petroleum, and Sonangol by proxy (Cihlar 2010). In this context, LCPs are expected to be pursued across most of the country’s sectors. The MPLA and two other parties: (i) the National Union for the Total Independence of Angola, supported by South Africa, which controlled the majority of inland areas that were dependent on diamond extraction and agriculture; and (ii) the National Front for Liberation of Angola, a more ethnic-based party drawing the majority of its supporters from local tribes and ethnicities, backed by neighbouring Zaire. 1 14 1.1 Structural Context As previously noted, the 27-year-long civil war destroyed the country’s infrastructure and human capital— apart from the petroleum sector, the Angolan economy was left barely functioning. In its Global Competitiveness Report 2011, the World Economic Forum (WEF) placed Angola 139th out of a total of 142 countries, dropping one position from the previous year’s report. The country joins the bottom 10 of the list with 7 other SubSaharan African countries (WEF 2011). In addition, the country is ranked near the bottom of the United Nations (UN) Human Development Index. Today, Angola suffers from several structural problems including inequality in income distribution, a noneducated growing labor force, lack of infrastructure, high bureaucracy, and corruption. 1.1.1 Economy Backed by high oil prices, Angola’s GDP and per capita income have been growing since the end of the civil war. Today, the country is the second-largest economy among the Southern African Development Community (SADC) countries. This performance is mixed with high inequality in income distribution and poverty levels. In 2010 the country’s GINI index was 58.6, and 54.3 percent of the population lived below $1.25 per day (UNDP 2010). Angola’s real interest rate has been always among the lowest in the world. By the end of the civil war the government started controlling the inflation rate that reached 14.5 percent in 2010, still among the highest in the world. The country’s currency, Kwanza, has been depreciating against the U.S. dollar. Table 1.1 provides a brief overview of Angola’s key economic indicators. The country’s overall exports have been on an increase. As shown in Figure 1.1, the basket of exports is increasingly dominated by petroleum and mining products. Table 1.1 Key Economic Indicators of PostCivil War Angola, 1985–2010 1985 GDP (constant 2000 $, billion) GDP per capita (constant 2000 $) 1990 1995 2000 2005 2006 2007 2008 3.9 3.0 4.2 6.7 8.0 9.9 11.2 11.5 11.9 362.5 372.8 251.9 298.4 404.3 473.1 563.0 622.6 619.8 623.2 2,671.8 325.0 23.0 13.3 12.2 12.5 13.7 14.5 -84.7 -60.8 25.2 4.2 13.0 -6.0 22.8 -0.5 0.0 10.0 87.2 80.4 76.7 75.0 79.3 91.9 152.5 128.7 109.9 117.5 127.5 98.5 100.2 Real interest rate (%) Exchange rate (LCU per $) Trade (% of GDP) 0.0 0.0 61.1 59.8 Source: World Bank 2012. Note: CPI = consumer price index; GDP = gross domestic product; LCU = local currency unit. Figure 1.1 Angola’s Exports by Commodity, 1980–2010 ($ billion) 1.9 2.2 3% 3.9 97% 1980 1985 Source: Adapted from WTO 2012b. 9% Manufactures 13% Fuels and mining products 78% 2010 3.3 Inflation, CPI (%) Agricultural products 2009 3.6 7.8 24.1 1% 1% 3% 2% 8% 53.4 1% 100% 97% 91% 97% 99% 1990 1995 2000 2005 2010 15 100% 1.1.2 Taxation Compared to other Sub-Saharan African countries, such as Tanzania and Uganda, Angola leads the pack in levying the highest corporate tax. For a select group of companies, the rate is in line with that of the United States. The tax “is levied on all profits derived from Angola, [and] all the income obtained by an Angolan company operating overseas” (PKF 2011). In addition, Angola levies high taxes on the mining and petroleum sectors. For instance, Angola’s petroleum industry tax regime taxes—on “the income obtained from the exercise of petroleum transactions and any other income derived from other activities of a non-commercial or industrial nature”—can reach 65.75 percent for joint ventures (PKF 2011). As shown in Figure 1.2, tax revenues in Angola as a percentage of GDP are among the highest in the world. Figure 1.2 Comparison of Angola’s Tax Revenues and Corporate Tax Rate to Other Countries, 2009 and 2010 Tax Revenues as % of GDP, 2009 Corporate Tax Rate, 2010 Angola 43% Norway Angola 35% 27% Brazil Trinidad and Tobago 26% Australia 30% United Kingdom 26% India 30% South Africa 26% Uganda Netherlands 23% Australia 22% Malaysia 16% Chile 16% Brazil 13% Canada 12% Uganda Indonesia India Kazakhstan 12% 30% Canada 28% Norway 28% South Africa 16% Russia 34% 28% Indonesia 25% Malaysia 25% Netherlands 25% Trinidad and Tobago UK 11% 10% 8% 25% 24% Chile 20% Kazakhstan 20% Russia 20% OECD 14% Source: based on data from CIA 2012; Deloitte 2012; World Bank 2011. Note: For Angola and Tanzania, tax revenues reflect 2011 levels and include social contributions (such as payments for social security and hospital insurance), grants, and net revenues from public enterprises. OECD = Organisation for Economic Co-operation and Development. 1.1.3 Population and Labor Force Population has been growing at a double-digit pace since the 1980s, totaling 19 million in 2010. This trend is expected to continue for the coming decade, but at a slower rate. As a result, the country is characterized by a young population—more than half of the labor force aged 15 to 64. By 2030 the youth share of the working-age group is projected to increase to around 60 percent (UN 2010). Figure 1.3 presents the evolution of Angola’s population by age group and expected growth. 16 Figure 1.3 Evolution of the Angolan Population and Labor Force over Time (in millions of people) 45 70% 40 60% Million People 35 60+ 50% 50 to 59 25 40% 40 to 49 20 30% 30 30 to 39 15 10 to 19 10% 0 to 9 10 5 0 20 to 29 20% 0% % 15 to 64 Source: Adapted from UN 2010. While the overall unemployment rate is at 25 percent, Angola’s skilled-labor market is very tight; the labor force’s mean years of education is 4.4 years, in line with that of other countries with low human development (4.2 years). Minimum wage is $127 a month, and the average wage is $211 per month in a country whose capital is the second-most expensive city in the world (Mercer 2012). Table 1.2 presents a snapshot of Angola’s labor market in comparison to select countries. Table 1.2 Angola’s Labor Force Indicators Compared to Select Countries, 2010 Educational attainment (% of total) Labor force (million) Angola Australia Primary Secondary Mean years of education Tertiary 7.1 — — — Unemployment, total (% of total labor force) Minimum wage ($ per month) 4.4 127 25 11.8 27.3 38.9 33.8 12 1,597 5.2 101.6 — — — 7.2 300 8.3 19.0 13.5 40 46.5 12.1 1,903 8 8.8 — — — 10.4 — 6.6 Malaysia 12.0 18.3 56 21.1 9.5 — 3.7 Norway 2.6 19.9 43.5 35.8 12.6 3,609 3.6 South Africa 18.2 15.8 74.2 5.2 8.5 543 23.8 Tanzania 22.1 — — — 5.1 59 10.7 0.7 25.3 63 11.1 9.2 — 5.38 Uganda 13.4 — — — 4.7 3 4.2 United Kingdom 31.8 19.2 44.4 35.4 9.3 1,655 7.8 Brazil Canada Kazakhstan Trinidad and Tobago Source: Based on data from World Bank Group 2012; UNDP 2010. Note: Educational attainment data for Australia, Canada, Malaysia, South Africa, and Trinidad and Tobago are from 2008; unemployment data for Brazil, Kazakhstan, Malaysia, South Africa, and Uganda from 2009. — Not available. 1.1.4 Education Finding a skilled workforce is a challenge in Angola, partly due to a weak educational system that suffers from low enrollment rates. While enrollment in primary education is relatively low, enrollment in tertiary education 17 is among the lowest in the world. In addition, the literacy rate among adults and youth is near 70 percent, and government expenditure on education is well below the Organisation for Economic Co-operation and Development (OECD) average of 5 percent. As per the 2011 budget, primary and preprimary education constitutes over two-thirds of spending on education. Table 1.3 summarizes key educational indicators in Angola in comparison to select countries. Table 1.3 Angola’s Educational Indicators Compared to Select Countries, 2010 Literacy rate (%) Adult (15+) Angola Australia Brazil Canada Kazakhstan Malaysia Norway South Africa Tanzania Trinidad and Tobago Uganda UK 70.1 — 90.3(1) — 99.7 93.1 — 88.7(c) 73.2 98.8 73.2 — Youth (1524) 73.1 — 98.1(a) — 99.8 98.4 — — 77.3 99.6 87.4 — School enrollment (%) Primary Secondary Tertiary 85.7 97.1 94.1(b) — 89.5 — 99.1 85.1(a) 98.0(b) 93.9 90.9 99.6(a) 11.5(a) 85.5 82.0(b) — 88.2 67.9(a) 93.9 — — — — 96(a) 3.7 79.9 36.1(a) — 38.5 40.2(a) 74.4 2.1 4.2(a) 58.5(a) Public expenditure on education (% of GDP) 3.6 5.1(a) 5.4(b) 4.8(b) 3.1(a) 5.8(a) 6.5(b) 6.0 6.2 3.8(d) 3.2(a) 5.4(b) Source: Based on data from Gomes and Weimer 2011; UNDP 2010; World Bank 2012. Note: (a) year 2009; (b) year 2008; (c) year 2007; and (d) year 2006 data. The situation is exacerbated by the low quality of secondary and higher education, and the restricted entry to vocational and specialized engineering education. Among multiple factors, absenteeism of faculty, lack of libraries, and nonexistence of an accreditation system contribute to the weakness of university-level educational. As stated by Gomes and Weimer (2011), universities in Angola do not adequately prepare their students—a situation acknowledged by Sonangol, which established its own university. The national company education plan has still not been approved by the Ministry of Education. To close the educational gap, most international companies operating in Angola have established internal programs and rely on partnerships and external support, in-country and abroad, to train their local staff (Gomes and Weimer 2011). 1.1.5 Business Environment Bureaucracy and corruption remain key issues in Angola, and the centralized bureaucratic system suffers from low capabilities and regulations from the colonial era (Kirk 2011). In fact, it takes 68 days and up to 8 procedures across different government bodies to start a business in Angola. The World Bank has ranked Angola as one of the most difficult countries in the world to do business in. Further indicators on doing business in Angola in comparison to the OECD average are presented in Table 1.4. 18 Table 1.4 Indicators for Doing Business in Angola, 2011 Angola OECD 1. Starting a business 6. Protecting Investors Procedures (#) Time (days) Cost (% of income per capita) Paid-in min capital (% income per cap) Rank (Change in rank from 2011) Extent of disclosure index (0-10) Extent of director liability index (0Ease of shareholder suits index (0Investor protection strength (0-10) Rank (Change in rank from 2011) 8 68 118.9 25.3 167 (-3) 5 12 4.7 14.1 11 321 180.3 115 (+4) 14 152 45.7 8 48 890.5 120 (+5) 5 103 92.8 7 184 3.2 129 (+45) 5 31 4.4 3 4 2.4 0 126 (+4) 7 5 9.5 63.9 2. Dealing with Construction Permits Procedures (number) Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) Payments (number per year) Time (hours per year) Profit tax (%) Labor tax and contributions (%) Other taxes (%) Total tax rate (% profit) Rank (Change in rank from 2011) Documents to export (#) Time to export (days) Cost to export (US$ per container) Documents to import (#) Time to import (days) Cost to import (US$ per container) Rank (Change in rank from 2011) 5. Getting Credit Strength of legal rights index (0-10) Depth of credit information index (0-6) Public registry coverage (% of adults) Private bureau coverage (% of adults) Rank (Change in rank from 2011) 5 6 6 5.7 65 (-5) 6 5 7 6 31 282 24.6 9 19.5 53.2 149 (-4) 13 186 15.4 24 3.2 42.7 11 48 1850 8 45 2690 163 (-1) 4 10 1032 5 11 1085 1011 44.4 46 181 (0) 518 19.7 31 6.2 22 6.9 133 (+6) 1.7 9 68.2 8. Trading across borders 4. Registering Property Procedures (number) Time (days) Cost (% of property value) Rank (Change in rank from 2011) OECD 7. Paying Taxes 3. Getting electricity Procedures (number) Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) Angola 9. Enforcing Contracts Time (days) Cost (% of claim) Procedures (number) Rank (Change in rank from 2011) 10. Resolving Insolvency Time (years) Cost (% of estate) Recovery rate (cents on the dollar0 Rank (Change in rank from 2011) Source: World Bank 2012. Note: Ranking is out of 183 countries. OECD = Organisation for Economic Co-operation and Development. Despite some efforts to improve the situation, corruption and weak governance remain major hurdles in Angola (as shown in Figure 1.4). In fact, the country is perceived to have one of the highest levels of corruption in the world (CRES 2008). In relation to domestic sourcing policies in the petroleum sector, many questions are being raised around the conflict of interest arising from Sonangolâ€™s role as operator and shareholder in oilservice companies (IEA 2006). 19 Figure 1.4 Governanced Indicators in Angola Compared to the OECD Average Voice and Accountability 100 80 Political Stability/Absence of Violence 60 Control of Corruption 40 20 Angola 2010 0 Angola 2000 OECD 2010 Government Effectiveness Rule of Law Regulatory Quality Source: Adapted from Kaufmann, Kraay, and Mastruzzi 2011. 1.2 The Petroleum Sector 1.2.1 The Petroleum Sector in the Economy The later pre-independence days of Angola were characterized by a relatively diversified economy with strong agricultural and manufacturing sectors. Since independence in 1975, the country gradually increased its economic reliance on extractive industries, particularly oil and diamonds—with extractive industries contributing around 35 percent of GDP. In 2010 that share increased to over 50 percent, most of which came from oil. Figure 1.5 presents the evolution of the extractive industry value-added and its share of GDP. Angola’s oil intensity in GDP is among the highest in the club of the resource-rich and Organization of the Petroleum Exporting Countries (OPEC) countries Figure 1.6). Figure 1.5 Contribution of Angola’s Extractive Sector to Value-Added, 1970–2010 (in $ billion and as share of GDP) 60 80% 70% 50 50% 30 40% 30% 20 20% 10 10% 0 0% 70 72 74 76 78 80 82 84 86 88 90 92 Contribution to GDP 94 96 98 00 02 04 06 Percentage Share Source: UN Statistics 2010. Note: GDP = gross domestic product. 20 08 10 Share of GDP GDP (Bn $) 60% 40 Figure 1.6 Breakdown of Value-Added in Angola by Economic Activity, 2010 ($ billion) 85 1,296 2,066 1,637 159 304 402 377 24 17 22% 23% 2,236 22 100% 7% 25% 15% 20% 33% 38% 39% 43% 45% 5% 11% 6% 13% 8% 18% 6% 8% 9% 50% 14% 7% 2% 5% 5% 19% 19% 7% 10% Australia Brazil 5% 7% 8% 12% 8% 8% 4% 6% 1% 12% 6% 2% 21% 33% 6% 24% Canada Kazakhstan Malaysia Norway South Africa Trinidad & Tobago 27% 10% 36% 20% 8% 12% 8% 0% 13% 1% 8% 7% 8% 3% 32% 6% 16% 6% 3% 4% 30% Angola 5% 11% 8% 14% 19% 20% 13% 11% 51% 12% 10% 9% 23% 1% 12% 14% 14% Uganda UK Tanzania Other Activities Transport, storage and communication Construction Wholesale, retail trade, restaurants and hotels Manufacturing Agriculture, hunting, forestry, fishing Mining, Manufacturing, Utilities Source: Based on data from UN Statistics 2010. Note: UK = United Kingdom. During the past decade, Angola shifted from its dual resource dependency to a predominantly oil economy. In fact, the diamond sector’s contribution to GDP diminished from 5.7 percent in 2005 to 1.2 percent in 2008 (Teka 2011). In 2008 oil constituted over 56 percent of GDP, over 96 percent of exports value, and around 80 percent of government revenues, as a result of upward trending prices and increased production. Oil export revenues increased from $7.57 billion in 2002 to a peak of $67.12 billion in 2008 (Cihlar 2010). Figure 1.7 shows the percentage of oil’s value-added contribution to the country’s main economic indicators. Figure 1.7 Angola: Percentage of Oil’s Contribution to GDP, Oil Export Revenues ($), and Total Government Revenues, 2002–10 2.0 100 Oil Price (Brent $/bbl) 1.8 90 1.6 80 1.4 70 1.2 60 1.0 50 0.8 40 0.6 30 0.4 20 0.2 10 0.0 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 Export. Rev. ($ Bn) 7.57 8.76 13.24 22.37 30.72 43.07 67.12 41.85 - Share in GDP (%) 54.2 54.7 62.9 55.7 55.8 56.9 44.4 - - Source: Based on data from BP 2011; Morris, Kaplinsky, and Kaplan 2011. Note: bbl = barrel; GDP = gross domestic product; mmbpd = million barrels per day. 21 $/bbl mmbpd Production (mmbpd) In 2004 the oil industry employed 12,296 people directly through operators and 12,886 people indirectly through supporting service companies. Fueled by exploration and development activities, the workforce in the oil services sector almost tripled in 2009, increasing the total workforce over 1.5 times. As shown in Figure 1.8, overall employment in the oil sector reached 64,677 workers in 2009, which included the 5,174 registered expatriates working in oil services (Skills Shortages II). Figure 1.8 Employment in the Angolan Oil and Oil Services Sector, 2004–09 64,808 64,677 CAGR 2004 - 2009 55,061 48,818 77% 76% Service Provider 31% Operator 5% 74% 25,182 27,173 74% 51% 52% 49% 48% 26% 26% 23% 24% 2004 2005 2006 2007 2008 2009 Source: Based on data from CRES 2008. Note: CAGR = compound annual growth rate. 1.2.2 Petroleum Geography Angola has a 1,980-kilometer (km) coastline on the Atlantic Ocean stretching from Cabinda, a small separate province north of the general borders of Angola, to the Namibian borders in the south. Along the coastline are three major sedimentary basins: the northern Lower Congo Basin, the Kwanza Basin, and the southern Namibe Basin. The Lower Congo Basin has the largest proven reserves and the most-developed base for production, particularly in Cabinda (CRES 2008). It is divided into onshore and offshore blocks that are in their exploration and production phases. The Kwanza Basin was the first discovered in Angola (CRES 2008) and constituted the majority of production before the 1990s. It is also divided into onshore and offshore blocks. The onshore blocks have mostly matured and their production was highly affected by the civil war; the offshore blocks are in both production and exploration phases. The third basin, Namibe, is located in the south and has identified reserves that remain largely untested by drilling. Exploration efforts there have been discouraged after several failures in that area. Overall, Angola’s petroleum resources extend from onshore to ultra-deep waters. To date, most exploration efforts have primarily focused on offshore areas (CRES 2008). The offshore formation is divided into 51 blocks, of which only 9 are currently in production. The blocks are distributed as follows: 14 in shallow waters with depths below 500 meters; 17 in deep waters between 500 meters and 1,500 meters; and 20 ultradeep blocks below 2,500 meters. 1.2.3 Reserves, Production, and Consumption Angola experienced significant exploration activities after the 1990s, when Sonangol opened up the country’s deep-water areas. Proven oil reserves increased from 1.6 billion barrels in 1990 to 13.5 billion barrels by 2010. Proven reserves in 2010 constituted 1 percent of the world reserves, positioning the country in 16th position 22 worldwide and in 3rd position among African countries, behind Nigeria (37.2 billion barrels) and Libya (46.4 billion barrels) (UN Statistics 2010). In 2007 Angola became a member of the OPEC (Cihlar 2010). The majority of recent discoveries were made in deeper waters. The first of these discoveries was made by French ELF in 1996 (CRES 2008). Since then, deep-water exploration efforts ramped up. Between 2004 and 2011, subsea spending on infrastructure and equipment more than tripled, from $1.27 billion to $4 billion. In 2011 cumulative offshore EPC spending reached $21.4 billion (Rystad Energy 2010). Angola was a small player in the oil market, with moderate and stagnant production figures, between 1970 and 2002, as the civil war hindered production from onshore fields. Additionally, prior to 1990, offshore reserves were not discovered and did not surface on the government’s agenda until 1996. Since the end of the civil war in 2002 daily production picked up, doubling from 0.9 million barrels per day (bpd) in 2002 to over 1.8 million bpd in 2010 (BP 2011) to constitute 2.3 percent of the world production. Oil production in Angola peaked in 2012, with future discoveries coming onstream to replace depleting reserves. Table 1.5 provides a snapshot of the oil sector with annual productions and estimates, and Figure 1.9 shows oil production since 1990 and the estimated production until 2020 as reported by Sonagol. Table 1.5 Snapshot of Angola’s Oil Sector Reserves and Production (2010) 2010 Level Share of world % Oil proven reserves, billion boe 13.5 1.00 Oil production, mmbpd 1,851 2.32 Percentage change Global rank 16 1 yr % 0.0 3 yrs % 0.0 5 yrs % 49.4 10 yrs % 107.7 15 3.78 -1.3 30.3 149.5 Source: Based on data from BP 2011. Note: boe = barrel of oil equivalent; mmbpd = million barrels per day. Figure 1.9 Angola: Actual and Estimated Oil Production According to Field Depth, 19902020 3.0 Ultra-deep Water Deep Water 2.5 2.0 1.5 1.0 0.5 0.0 1990 1995 2000 2005 2010 2015 2020 Source:Based on data from Sonangol 2012. Angola’s oil consumption remains low; the country exports most of its oil. In 2009 the country exported 98 percent of its production, the main export markets being China and the United States. 1.2.4 Sector Institutional Framework Although the Council of Ministers and the Ministry of Petroleum are the constitutional overarching bodies overseeing the oil sector (Teka 2011), Sonangol retains the upper hand in decision making within this structure (Oliveira 2007). Upon its establishment in 1976, Sonangol was granted sole concessionary rights and mandated to manage the exploration of Angolan hydrocarbon resources. Today, the company: o o o Identifies exploration areas Negotiates and manages production contracts Collects, validates, monitors, and archives all petroleum activity data in Angola (CRES 2008). 23 As per the law of 2004, petroleum activities can be only carried out under a prospecting license or a concession. Historically, Sonangol has engaged foreign companies through production sharing agreements (PSAs). Operationally, Sonangol’s influence over its upstream joint ventures is translated through venturespecific operating committees. A joint-venture operating committee advises, supervises, and oversees exploration, development, and production activities. The committee, constituting four members (two appointed by Sonangol and two by the contractor), approves work programs and budgets. Decisions within the committee are taken by a simple majority, and the tie-breaking vote is reserved for the Sonangol-nominated committee chairman. Provisions for the operating committees are established in the PSAs. Sonangol was established prior to the ministry, and its top executives are closely affiliated with the ruling elite, providing more power and control for Sonangol (Oliveira 2007). Furthermore, some argue that Sonangol reports directly to the president (Lwanda 2011). Nevertheless, the Ministry of Petroleum is mandated with policy development and some regulatory activities, including: o o o o o Issuance of exploration permits Formulation of sectoral policies Approval of work plans Regulation of production levels Design and enforcement of the petroleum tax regime in coordination with the central bank and the Ministry of Finance. The mandate extended Sonangol’s activities to export crude oil and identify exploration areas. Furthermore, Sonangol manages the bidding process, and negotiates for new concessions and ventures in partnership with operators. In practice, Sonangol's participation has taken a variety of forms. In many contracts signed to date, Sonangol holds a working interest through exploration and concession agreements (CAs); in others, it only participates in the development of commercial discoveries in PSAs (CRES 2008). 1.2.5 Market Structure and Local Capabilities Historically, before independence, the major oil company operating in Angola was Cabinda Gulf Oil, an American subsidiary of Gulf Oil. When the Marxist MPLA took power in 1975, Gulf Oil closed its operations out of fear of nationalization, and the MPLA was not able to secure the transfer of the company’s technology and knowledge acumen (Oliveira 2007). But this was not the case for another oil company operating in Angola called Angol, a subsidiary of Sacor of Portugal. In 1975 the MPLA took over Angol, but did not nationalize it. Instead the existing Portuguese employees were preserved (Oliveira 2007), and new cadres of Angolan2 executives were introduced. Since then, Sonangol has developed its capabilities through external training of its personnel, reliance on consultants, and partnerships with international oil companies. Upon its establishment, Sonangol was the sole concessionaire, regulator, and tax collector of the oil industry. Since then, the company has relied on external consultants to complement its capacities in all its operations (Oliveira 2007). The company received close guidance and advice from the Italian oil company, ENI. A first wave of Sonangol-sponsored employees who received training at ENI’s facilities in Milan took on leadership positions when they returned to Angola by the end of 1970s (Sonangol 2012). A second, larger group went to Algeria and received training from the Algerian state company, Sonatrach (Sonangol 2012), which had the trust and confidence of the MPLA leaders (Oliveira 2007). Moreover, the former colonial advisors and auditors of the Angolan oil sector, the U.S. consulting firm Arthur D. Little, played a role in the shaping and development of Sonangol (Oliveira 2007), by handling Angola’s negotiations with international oil companies from 1977 (Neigus 1981). On another front, Sonangol relied on the capabilities of international operators to carry out upstream 2 The key figures in Sonangol’s core team were well-networked MPLA party members who enjoyed the confidence of President Neto (Oliveira 2007). 24 activities, by partnering with leading international oil companies through PSAs. Table 1.6 presents the shareholders and operators by producing block. With time, Sonangol began expanding its activities beyond Angola. The first subsidiary was established in London in 1983; Sonangol Limited was responsible for direct trading of nearly 40 percent of the production (Oliveira 2007). In 1991 the company undertook a restructuring of its growing business. A holding was created, and the principal line of business became subsidiaries. Overall, Sonangol has emerged from a postcolonial era and a 27-year-long civil war to drive the country’s oil sector economy into 29 joint ventures and multiple subsidiaries (Lwanda 2011), with more than 8,000 employees across the globe in 2008 (CRES 2008). The company has ventured into drilling, fabrication, transportation, industrial supplies and infrastructure, distribution, storage services; banking, food retail, and catering; and civil engineering and real estate development. Table 1.6 Angola: Company Share and Operator (in Gray), by Producing Blocks (%) Sonangol Block 3 Block 0 Block 2 3/05 Sonangol P&P 41.00 25.00 25.00 Total 10.00 3/85 and 3/91 6.25 50.00 Canuku Block 14 100.00 20.00 20.00 BP IOCs Block 15 39.20 ENI 9.80 20.00 16.67 12.00 15.00 20.00 20.00 40.00 20.00 Sonangol Sinopec 50.00 China Sonangol 25.00 STATOIL PETROBRAS 13.33 23.33 27.50 AJOCO Independents 50.00 31.00 Esso NOCs Block 18 40.00 26.67 Chevron Block 17 20.00 SOMOIL 9.30 POLIEDRO, S.A. 9.10 KOTOIL, S.A. 9.10 12.50 10.00 NATGAS 4.00 5.00 INA-NAFTA 4.00 5.00 GALP 9.00 SVENSKA 6.25 Source:Based on data from Sonangol 2012. Note: IOCs = international oil companies; NOCs = national oil companies. 1.2.6 Management of Petroleum Wealth Angola’s oil wealth has not been efficiently managed to the benefit of the economy and the population at large. The country has so far not instituted an oil fund, nor has it publicly designated a methodology for the management of oil revenues. In fact, the management of oil revenues has been characterized as illusive, lacking transparency, often fraudulent, and endowed with a certain degree of political motivation. High poverty levels in addition to the country’s overall poor infrastructure are visible proof of the poor management of oil revenues. Over the years, several issues have been brought to the limelight by international economic and monitoring bodies such as the International Monetary Fund (IMF) and Human Rights Watch (HRW), which claim the unlawful appropriation of oil revenues. Issues include Sonangol’s unaccounted-for sums between 1996 and 2001, which totaled $10 billion, and unlawful donations by oil companies to the Fundacao Eduardo dos Santos (Foundation of Eduardo Santos) to maintain a good relationship with the authorities (Andre 2010). 25 In addition, Sonangol did not have to publicly disclose receipts from oil companies as per Tax Law 13 of 2004 (Republic of Angola 2004), thus increasing the possibility of shadow operations to take place unnoticed. 1.3 Local Content Policies 1.3.1 Policy Objectives The Angolan government has been following two routes to achieve its local content objectives: (i) Angolanization of the workforce and (ii) domestic sourcing of goods and services. These are primarily legislated through a series of official decrees. In addition, the PSA administered by Sonangol includes local content rules and regulations that build on the governmental legislations. Angolanization of the workforce started in 1979, with Law10/79 giving Sonangol exclusivity over the country’s petroleum rights. The law mandated that the national oil company must employ locals and provide them with the necessary technical-professional training, allowing it to hire foreign workers only in case of a shortage of qualified Angolan workers. Three years later, an official decree was issued on the Angolanization of the petroleum industry workforce. As it appears in the introduction of the decree 20/82 of 1982, the objective was “to endow the People's Republic of Angola with national personnel able to assure the functioning of the economic key sectors” (Council of Ministers 1982). This objective remained unchanged 27 years later in the law of 2009. Angolanization of the workforce was stated as a government priority with the necessity “to provide the Republic of Angola with national workers capable of ensuring the functioning of this sector of national economy” (Council of Ministers 2009). In 2003 a backward link was introduced to Angola’s local content strategy in the oil and gas sector as well as other sectors.3 Decree 13/03 promoted the sourcing of domestic goods and services in petroleum-related activities. The introductory notes of the decree imply that there are two overarching objectives behind such policies: (i) achieving socioeconomic development and (ii) fairness in the distribution of national wealth. Here, the government argues that the first objective can be only achieved by development that is led by an Angolan citizen. Operationally, this can be through direct economic activity or through ownership of rights to production of goods. Achieving the second overarching objective is a consequence of such a development. Building on that, the government offers a rationale for its intervention through LCPs: (i) to reduce inequalities faced by domestic investors when competing against foreigners; and (ii) to encourage synergies between these agents. An analysis of the introduction to the decree of 2003 is presented in Table 1.7. Table 1.7 Domestic Sourcing of Goods and Services in Angola: Objectives, Rationale, and Instruments Overarching objective Strategy Rationale for state intervention Local content policies and objectives Instruments The economic and social development and fair distribution of well-being and quality of life in a market economy can never be complete until that development is carried out and led predominantly by Angolan citizens’ families and public and private institutions, either in terms of economic initiatives or the ownership of the right to produce goods. Therefore, one of the pillars of development shall be based on national free private initiative of Angolan citizens’ families and institutions. For that purpose it shall be the duty of the State, according to the principle of more favorable priority or preferential treatment. Contribute toward reducing inequalities in competition with foreign investors and encouraging synergies between national and foreign private investors. Create and offer the legal, material, and institutional conditions. Source: Based on data from National Assembly 2003. The decree specifically covers the following activities: crops and livestock, extraction and processing, commerce, finance, fishing, food industry, public works, civil construction, transport, and services. 3 26 1.3.2 Policy Tools Angolanization of the Workforce Decree 20/82 of 1982 laid out the foundation for local content in Angola’s oil and gas workforce. Policy instruments outlined by the decree covered the recruitment, training, and career progression of the local workforce. On recruitment, any company operating in the Angolan petroleum sector must: o o o Hire locals whenever their qualification and experience meet the requirements Submit annual recruitment plans to be approved by the Ministry of Petroleum Get the ministry’s approval for hiring any foreigner. In addition, Angolans and foreign workers of the same grade must enjoy equality in compensation and benefits.4 On training, the law mandated the provision of capacity-building programs by operating companies. To this end, companies had to develop annual training plans and get the Ministry of Petroleum’s approval before implementation. In addition, companies had to contribute annually to a training fund accessed by the Ministry of Petroleum, to the tune of 15 cents for every dollar per barrel produced. Appraisal and exploration companies had to pay $200,000 yearly; for companies engaged in other activities, the amount was decided by the ministries of petroleum and finance on a case-by-case basis. Funds could be used by the Ministry of Petroleum for the provision of training programs, research activities, and purchase of books and equipment for training purposes. On career progression and replacement of the foreign workforce, the law set out Angolanization targets specific to groups of job grades for the years 1985, 1987, and 1990 (outlined in Table 1.8). The targets were reviewed in 2002 and new ones set for the year 2010. Table 1.8 Angolanization Targets Outlined by the Decree of 1982 Example of occupations Unskilled staff (up to grade VI) Midlevel staff (grades VII to XI) Upper-level staff (grades XII and XIII) Drivers, janitors Technicians, accountants Managers, geologists, engineers 1985 % 1987 % 1990 % 2010 % 100 50 — 100 60 50 100 70 80 100 80 70 Source: Based on data from Council of Ministers 1982; MENAS, Angola 2008. — Not available. Noncompliance with the plan of recruitment and training could result in cancellation of the contract. In addition, the Ministry of Petroleum could impose monetary fees that were double the value of what would have been spent to comply with the plan. In case companies could not achieve the Angolanization target, they had to pay a monetary fine for every percentage point missed from the target. On January 1, 1980, the value of the fine was the U.S. dollar equivalent of 3 million kwanzas. The fine was to be updated every quarter based on the UN index of the prices of manufactured products exported by developed countries. Driven by technological developments in the industry and new policy options for the use of human resources, Angola launched a new system of the recruitment, integration, training, and development of Angolan personnel and the regulation of the hiring of foreign personnel in 2009, 27 years after the initial law. The new system reformulated aspects of the 1982 law and included a new regulatory framework. On recruitment, the law reinforced the need to hire Angolan citizens at all job grades. Equity between local and foreign workers was reiterated. In 2010 decree No. 13/10 gave Angolans “legal protection against Any kind of discrimination between national and foreign workers with respect to the conditions of employment (including accommodation and other benefits) is prohibited by law, without prejudice to the right of the employer to provide compensatory measures for foreign workers to defray the cost of their presence in a foreign country, including periodic trips to their home country (Council of Ministers 1982). 4 27 discrimination in employment and working conditions, salary, allowances and social benefits, embodied in perks and benefits granted by companies as an additional increment to the salary and of medical care, medication and othersâ€? (Ministry of Petroleum 2010). Foreign workers could still be admitted only upon authorization of the Ministry of Petroleum. Albeit, getting the approval required companies to submit evidence that no qualified Angolan was found for the vacant position. On training and development, every operating company must conclude an annual contract with the Ministry of Petroleum, which includes the: o o o o Organizational structure of the company and foreseen evolution Roles, responsibilities, and wages of personnel Career development plans for Angolan workers Goals to be achieved in terms of integration of the Angolan workforce (Council of Ministers 2009). As part of the annual contract, the Ministry of Petroleum must approve a plan for training and development, which includes: o A definition of the knowledge and expertise to be transferred to the Angolan workforce o A detailed manpower plan o A career path and succession plans o Training plans. An additional modification to the 1982 law was the amendment of the training and development contributions, accessed by the Ministry of Petroleum (outlined in Table 1.9). These contributions became taxdeductible5 and their spending channels were expanded to include benefits to the National Petroleum Institute and other educational institutions, internship-related expenses, and funds committed for projects in higher and vocational education. Table 1.9 Angola: Annual Contributions to the Training and Development Fund Companyâ€™s scope of activities Annual contribution Holding a prospecting license $100,000 Appraisal or exploration $300,000 Production, processing, or refining 15 cents per barrel produced Storage, transmission, distribution, and marketing of petroleum products 0.5% of annual revenues Services 0.5% of the value of the contract Source: Based on data from Council of Ministers 2009. Typically, 9 of the 15 cents per barrel received from oil companies go to the Ministry of Industry and Petroleum (MINPET), while the rest are used by operators on training their staff. Of the 9 cents, 3 cents go to local universities (Gomes and Weimer 2011). The new law does not mention Angolanization targets, but companies not complying with Angolanization regulatory requirements become subject to the monetary fines outlined in Table 1.10. In addition, noncomplying companies are banned from entering into new contracts relating to the petroleum sector in Angola. A second offense to the regulatory requirements is punishable by three times the value of the fine. Collected fines are equally distributed between the state budget and the Social Fund of the Ministry of Petroleum. 5 For the purpose of calculating profit taxes. 28 Table 1.10 Key Angolanization Regulatory Requirements and Fines in Case of Noncompliance Regulatory requirement Get the approval of the Ministry of Petroleum for hiring any foreign worker. Offer local and foreign workers equal rights. Submit a list of service providers. Conclude a training and development contract with the Ministry of Petroleum. Get approval from the Ministry of Petroleum on the annual human resources development plan. Get authorization from the Ministry of Petroleum for any modification on the training and development plan. Submit a training and development status update report. Contribute annually to a training and development fund at the Ministry of Petroleum. Category Training and development Fine in case of noncompliance 25 percent of the annual contribution to training and development. 2.5 percent of the annual contribution to training and development. Immediate repatriation of workers improperly admitted. 10 percent of the annual contribution to training and development. Immediate repatriation of workers improperly admitted. 25 percent of the annual contribution for training and development. Training and development 20 percent of the annual contribution for training and development. Training and development 25 percent of the annual contribution for training and development. Training and development 10 percent of the annual contribution for training and development. Training and development 10 percent of the annual contribution for training. Recruitment Recruitment General Source: Based on data from Council of Ministers 2009. Finally, the decree recognizes temporary workers in the industry, and requests the Ministry of Petroleum to create a database of these workers to facilitate their integration into future projects. A secondary source for the Angolanization of the workforce is the PSA entered by any contractor group with Sonangol. A specific article in the agreement refers to the above legislations and adds the following: o o o o o o o The contractor group shall train its Angolan personnel to reach the level of knowledge and qualifications enjoyed by foreign personnel. The training shall enable Angolan personnel to use the latest technologies, including proprietary and patent technologies.6 The subcontractors offering services to the contractor group for more than one year shall be required to comply with the training requirements of their personnel. The contractor group shall be responsible for monitoring their compliance. Recruitment, training, and integration plans for Angolan personnel shall have a span of three years, and be submitted to Sonangol for approval by the Ministry of Petroleum. Contracting external specialists for the delivery of training programs shall be approved by Sonangol. The contractor group shall incur all costs associated with training of Angolan personnel it employs. Training costs shall be recovered as production expenditures. Domestic Sourcing of Goods and Services As per the Order 127/03 of 2003, national, private (that have at least 51 percent of their capital being owned by Angolan citizens), or state companies enjoy preferential rights over foreign companies for sourcing of goods and services. As per the law, exclusivity to Angolan businesses is given for the sourcing of goods and services that require limited capital and nonspecialized know-how. Activities requiring a reasonable level of capital and limited level of specialized capabilities fall under semi-compliance preferential treatment and require joint ventures between domestic and international companies. Other activities are open for competition. The decree Here the terms of the PSA mention that this shall happen to the extent permitted by applicable laws and agreements, subject to appropriate confidentiality agreements 6 29 does not outline capital and skill-level triggers for preferential treatments, but outlines the list of goods and services under exclusivity and semi-compliance treatments (Table 1.11). Table 1.11 Angola: List of Goods and Services by Mode of Preferential Treatment Group I (Nonspecialized, low CAPEX) Pressure tests for storage tanks and oil and/or gas pipelines Transport of equipment, materials, or drilling and production platforms Supply of industrial and drinking water Catering and foodstuffs Supply of technical materials General cleaning and gardening General maintenance of equipment and vehicles Supply post operators and managers (airports, ports, and service stations) Retail sales of kerosene, gas, and lubricants Quality inspection of products distributed and marketed (oil products and derivatives) Transport of products from terminals to supply posts Group II (Higher level of know-how, not necessarily specialized, moderate CAPEX) Acquisition and/or processing of Drilling production materials and geographical data equipment Geographical or geodesic surveys Well cleaning and maintenance work Vertical, directional, and/or horizontal drilling of wells Geological control of drilling (mud logging) Production tests Laboratories for geological, geochemical, and fluid analysis Specialized consultancy services Operation and maintenance of production facilities, including oil and gas pipelines Calibration of storage tanks and measuring equipment Construction and assembly of mechanical and electrical structures, and production and drilling facilities Inspection and supervision of the loading of petroleum or natural gas Transport in tankers of petroleum or natural gas Cement and conventional (drilling) mud products Supply of conventional (drilling) mud Supply of seismic materials, including explosives Well cementing and/or completion work Transport of crude oil to the refinery Electricity and instrumentation Terminal operators and managers Pressure tests on storage tanks and measuring equipment Maintenance engineering for terminals and supply posts Inspection of distribution and supply facilities Manufacture and assembly of ovens and lighting Manufacture and assembly of electric generators Assembly of selected makes of vehicle for the oil industry Manufacture of plastic for the petroleum industry, as well as synthetic fibers and rubber Manufacture of fertilizers Production of detergents Source: Based on data from Ministry of Petroleum 2003. Note: CAPEX = capital expenditure. In addition, national private or state companies receive preferential rights if their proposal is no more than 10 percent higher than what is proposed by other companies.7 The law mandates all companies operating in the oil sector to launch public tendering for contracting and subcontracting the provision of goods and services. A subsequent decree in 2006, No. 48/06 on Petroleum Tenders Rules and Procedures, specified tendering rules (outlined in Table 1.12). Here it must be noted that the state company has a strong influence over the final contract award decision. These rules are reiterated in the terms of the PSAs entered into with Sonangol. Table 1.12 Angola: Tendering Rules as per Decree No. 48/06 Contract value Below $250,000 Exceeding $250,000 and below $750,000 Exceeding $750,000 o o o o Tendering process Sole sourcing is allowed as long as operators inform Sonangol of the contracts they enter into on a quarterly basis. Operators must hold public tenders. Sonangol must be informed of the results of the tender. Subsequently, the state company can object to the results within 30 days In addition to the above, operators must obtain the approval of Sonangol of the prequalified firms invited to bid. Source: Based on Decree No. 48/06. Note: Direct contracting can only take place in case of technical urgency or lack of local suppliers after approval of the Ministry of Petroleum. 7 This provision existed in PSAs prior to the law of 2003. 30 To facilitate the engagement of local suppliers in any bidding process, the Ministry of Industry annually publishes a list of domestic suppliers of goods used in oil activities, and the Chamber of Commerce and Industry publishes a list of service providers contracted by oil operators (Ministry of Petroleum 2003). Preferential Treatment As per the law passed by the National Assembly in 2003, preferential treatment must be given to national private companies. In the case of the petroleum sector, Sonangol is mandated to grant local companies: o o o o Fiscal incentives including the exemption from or reduction of industrial, income, import, and other taxes Financial support in the form of subsidies, loans, promotional venture capital, access to agreed private management funds, and financial guarantees Technical support Special rights privileges in awarding concessions. In addition Sonangol is mandated to support the creation of professional training centers (National Assembly 2003). Here it must be noted that the government offers exemptions from customs duties on goods8 used in petroleum operations in case the good supplied in the Angolan market cannot ensure â€œsimilarâ€? quality, timely delivery, or a price of not more than 10 percent above the cost of the imported good before customs duties. A summary of the local content policy tools adopted in Angola is presented in Table 1.13. Table 1.13 Summary of Local Content Policy Tools in Angola Ministry of Petroleum to approve the recruitment of any foreign worker. Angolanization Recruitment Ministry of Petroleum to approve annual recruitment plans. Companies to offer capability-building programs, to be approved by Ministry of Petroleum Training Companies to contribute to a training and development fund managed by the Ministry of Petroleum. Replacement of foreign workforce Companies to meet Angolanization targets by job grade set by the Ministry of Petroleum. Exclusivity to Angolan businesses for sourcing of goods and services that require limited capital and nonspecialized know-how. Semi-compliance for goods and services requiring a reasonable level of capital and limited level of specialized capabilities, requiring joint ventures between domestic and international companies. National private or state companies receive preferential rights if their proposal is no more than 10 percent higher than what is proposed by foreign companies Domestic sourcing of goods and services Local companies, with at least 51 percent of the capital being owned by Angolan citizens, to be offered: Fiscal incentives including the exemption from or reduction of industrial, income, import, and other taxes. Financial support in the form of subsidies, loans, promotional venture capital, access to agreed private management funds, and financial guarantees. Technical support. Special rights privileges in awarding concessions. Source: Authorsâ€™ compilation. 1.3.3 Legislative Channels In Angola LCPs are mainly legislated through: o o Law 10/79 mandating Sonangol to employ and train nationals Decree 20/82 on the Angolanization of the petroleum industry workforce A list has been attached to the 2004 Law on the Customs Regime for the Petroleum Sector, http://www.sonangol.co.ao/wps/wcm/connect/e1c39000455a61ebb93aff8cae8691b3/law_petroleumCustoms_en.pdf?MOD=AJPERES andCACHEID=e1c39000455a61ebb93aff8cae8691b3. 8 31 o o o o o Law 14/03 establishing a framework for the promotion of Angolan private enterprises in all sectors of the economy Decree 127/03 on domestic sourcing of goods and services in petroleum-related activities Local content provisions in PSAs Decree 13/10 granting protection to nationals against discriminatory hiring and remuneration practices Petroleum-sharing agreements that set forth specific requirements in terms of level and area of training for Angolan workers, and extends training requirements to subcontractors providing services to the contractor for more than one year. 1.3.4 Institutional Responsibilities Institutional responsibilities for LCPs are mainly split between the Ministry of Petroleum and Sonangol. The ministry is responsible for the formulation of LCPs and regulation of their Angolanization aspects, as detailed above. Meanwhile, Sonangol: o o o Provides input to the Ministry of Petroleum on policy design. Teka (2011) argues that the Sonangol’s Local Content Department is currently in the process of defining a new local content plan in coordination with the ministry. Negotiates PSA terms in relation to local content, led by the Negotiations Directorate of the state company. Manages the procurement aspects of local content through the approval of sourcing activities and influence over the selection of sourcing companies. Annually, the Ministry of Industry publishes a list of domestic goods suppliers, and the Chamber of Commerce and Industry of Angola publishes a list of service providers. 1.3.5 Interlinks LCPs in the Angolan petroleum sector are part of a national industrial plan. In fact the law of 2003 on preferential treatment of domestic suppliers covers “all sectors of economic activity in particular crops and livestock, the extraction and processing industry, commerce, finance, fishing, food industry, public works and civil construction, transport, and services.” As for international trade, Angola has been a member of the World Trade Organization (WTO) since 1996. Considered as a least-developed country, Angola’s grace period of seven years of domestic market protectionism, under the Trade-related Investment Measures (TRIMs), has expired. Angola’s policies on the domestic sourcing of goods thus violate TRIMs’ provisions that ban measures requiring enterprises to purchase domestic products. It must be noted that under the General Agreement on Trade in Services (GATS) Schedule, Angola has specific commitments in the areas of banking, money lending, and money-transfer services; hotels and restaurants; and recreational and sporting services. Angola is not a signatory to the Plurilateral WTO Agreement on Government Procurement, and no complaints have been filed against the country (WTO 2012a). On another front, the country had signed a trade protocol with the SADC in 2003, which calls for the facilitation of trade among member countries through reduction of tariffs and harmonization of trade policies. Implementation of this protocol is expected to harm Angola’s non-oil exports and increase the country’s imports, especially from South Africa. As such, Angola has been delaying the implementation of this protocol in the hope of reviving its local industries. 1.3.6 Monitoring and Measuring Tools Monitoring of local content regulations is done through approval processes by the Ministry of Petroleum for Angolanization of the workforce and direct control of Sonangol for the sourcing of domestic goods and services. 32 Regarding the recruitment of foreign workers, it was not until 2010 that a well-established monitoring system was laid out. Under the new monitoring system, companies wishing to hire foreign workers must submit evidence to the Ministry of Petroleum that no qualified Angolan was found for the vacant position. Support documents include a detailed job description, public announcements on the job vacancy, and an official letter from the Centers for Employment and Vocational Training of the Ministry of Public Administration, Employment and Social Security stating that no Angolan citizen is available for the position (Ministry of Petroleum 2010). As for recruitment plans and training programs, these have to be approved on a yearly basis by the Ministry of Petroleum. Monitoring of these plans is done through the review of an annual implementation report submitted to the Ministry of Petroleum,9 which documents progress against the plan, the challenges faced, and proposed solutions to overcome these challenges. Upon review, the Ministry of Petroleum informs the operating companies in case of noncompliance, and the appropriate measures to be taken to overcome reported challenges (Council of Ministers 2009). Usually these plans are approved by the Ministry of Petroleum without comments. The budgets and effectiveness of training funds allocated to universities, however, are not monitored by the Ministry of Petroleum (Gomes and Weimer 2011). Monitoring of domestic sourcing of goods and services is carried out through the direct involvement of Sonangol in the procurement process of any operator, as outlined earlier in Table 1.12. No evidence has been found of a formalized system measuring local content in goods and services procured by operators. 1.3.7 Policy Impact on Local Content Levels Angolanization In 2002 the Advisory Council of the Ministry of Petroleum carried out a review of the Angolanization efforts against set targets across all operators. As shown in Figure 1.10, the review revealed that the 1990 targets were met for unskilled workers, exceeded for midlevel staff, and came short by 46 percentage points for higherskilled staff. Overall, the Angolanization rate was 77 percent. In 1999 the total number of workers increased to 10,061, and Angolanization rates remained similar to the 1990 levels. In 2002 the total number of workers increased by around 35 percentage points from the 1999 levels. Compared with 1990, the overall Angolanization rate increased to 88 percent (Mangueira 2004). The highest increase occurred with reference to upper level staff, likely as a result of the increased level of investment and raising production levels (Figure 1.11). Figure 1.10 Achieved Angolanization Rate versus Target, 1990 3,107 7% 8,099 2,427 14% 46% +166% +239% +323% 1,167 93% 86% 715 1,913 20% 54% 66% 80% 1990 2002 Unskilled staff (up to grade VI) 1990 34% 2002 Mid-level staff (grades VII to XI) Source: Based on data from Mangueira 2004. 9 It used to be on quarterly basis as per the decree of 1982. 33 1990 2002 Upper level staff (grades XII and XIII) Figure 1.11 Angola: Production 2.0 mmbpd 1.5 1.0 20… 20… 20… 20… 20… 20… 19… 19… 19… 19… 19… 19… 19… 19… 19… 0.0 19… 0.5 Source: Based on data from BP 2011;. Note: mmbpd = million barrels per day. One problem with the above targets and measurement mechanism is that it does not consider the Angolanization rate by occupation. Triggered by that and upcoming petroleum developments, in 2002 the Ministry of Petroleum launched the first study in the country that looked at the labor demand across the oil value chain by occupation. Findings from the study showed that Angolanization rates are lower in upstream engineering occupations, and that the overall rate was 91 percent (Table 1.14). Table 1.14 Labor Distribution and Angolanization Rate by Occupation along the Oil Value Chain, 2002 Upstream Downstream Total % Angolan 15 7,105 84 5 2,166 87 23 o 564 62 119 4 824 83 90 6 684 77 Angolan Expatriates Angolan Expatriates Technical 5,373 1,147 570 Operations 1,550 273 338 Marine operations 327 214 Mechanical 563 138 Electrical/Instruments. 434 154 Welding/Piping 2,023 348 0 0 2,371 85 Construction 476 20 0 0 496 96 Engineering 695 783 86 6 1,570 50 Operations 71 190 59 3 323 40 Marine operations 7 85 3 0 95 11 Mechanical 62 77 11 1 151 48 Electrical/Instruments. 97 81 13 2 193 57 Engineering 171 94 265 65 Geology/Geoscience 187 111 298 63 100 145 245 41 1,631 183 2,152 91 Surveying Finance and administration 336 2 Other 3,427 394 932 16 4,769 91 Total 11,126 2,507 1,924 39 15,596 84 Source:Adapted from Mangueira 2004. A view of the Angolanization rates in upstream operations between administrative and technical occupations by job grade, presented in Table 1.15, shows that administrative occupations achieved higher rates.10 The rates across the various administrative occupations are consistent with the average by job grade. 10 For details on Angolanization rates by occupation, refer to Mangueira (2004). 34 Table 1.15 Angolanization Rate in Administrative versus Technical Occupations, 2002 Total Administrative staff Technical staff Workforce % Angolan Workforce % Angolan Workforce % Angolan Unskilled staff (up to grade VI) 3,107 93 350 100 2,757 92 Midlevel staff (grades VII to XI) 8,099 86 1,404 98 6,695 83 Upper-level staff (grades XII and XIII) 2,427 54 725 64 1,702 49 13,633 82 2,479 89 11,154 80 Total Source: Based on data from Mangueira 2004. In 1983 the National Petroleum Institute (INP) was instituted to promote the educational and skill levels of the national working force in the oil industry. The INP cooperated with the Norwegian RKK center for vocational and professional training and the Stavanger Offshore Technical College (SOTS), mainly in the training of instructors for the INP itself. It offered three training programs: o o o The Technical Training Program (high skilled) is a three-year program provided at the secondary level with courses in technical industrial maintenance, geology and mining, drilling, and production as well as petroleum operations. The Professional Training Program (medium skilled) is for candidates with secondary-level qualifications. It has additional 12-month and 18-month courses in electrical engineering, production operations, mechanics and maintenance, refrigeration, instrumentation, English, and information technology. The Petroleum Engineering Program (PEP), established in 2002, is a continuing specialized postgraduate program of mining, steel, chemistry, and civil engineering and graduates around 20 engineers annually (Teka 2011). Between 1990 and 2003 the INP trained 1,581 high-skilled professionals and 1,111 medium-skilled professionals through its programs (CRES 2008); by 2008 the number of high-skilled graduates reached 1,790 (Teka 2011). Table 1.16 presents the INPâ€™s training programs and the number of Angolans who graduated between 1983 and 2009. Table 1.16 Number of Graduates from High-Skilled Programs at the INP, 1983ď€2008 Study program Geology and prospection Drilling and production Mechanical engineering Geology and mining Subsea technology Other Total Number of graduates 33 705 395 425 100 132 1,790 Source: Teka 2011. Among oil companies, training and development efforts were diversified and varied according to the level of the beneficiaries and the spending value. For instance, Chevron concentrated on students and provided outstanding ones with scholarship grants in engineering, information technology, and health and safety studies, whereas Total E&P concentrated its efforts on training existing staff through tailored programs and rotations, often on projects outside Angola. ExxonMobil also provided on-the-job and off-the-job training to existing employees, although mostly to improve soft skills. In addition, the company funded Angolans to study in the United States (Skills Shortage II). British Petroleum (BP) developed trainings within the company and implemented the leadership programs used in other countries to Angola, to identify and develop leadership potential within its ranks. Domestic Sourcing and Preferential Treatment Driven by the preferential treatment legislated in the decree of 2003, Sonangol developed over 20 joint ventures with international companies to supply core and noncore goods and services to the oil and gas industry. An 35 overview of a selection of these joint ventures is presented in Table 1.17. In 2003 the Ministry of Finance commissioned KPMG to audit the activities and roles of the key stakeholders in the petroleum sector. In relation to local content, the auditor’s report raised the issue of conflict of interest since Sonangol acts as a concessionaire and contractor at the same time. No evidence was found on work being awarded to any of Sonangol’s joint ventures without being the lowest in price, as demanded by the tendering process. But the report highlighted that “the possibility for Sonangol to exert pressure on operators to award contracts to a Sonangol Joint Venture must exist.” In addition, the report recommended that payments to “Sonangol's joint venture companies should be made in local currency into bank accounts in Angola. Any foreign exchange payments made by the joint venture should be made through the Bank of Angola in the normal way,” suggesting that it was not the case at present (MENAS, Angola, 2008). Table 1.17 Angola: A Selection of Sonangol Joint Ventures in Upstream Oil and Gas Services, 1984–2002 Sonangol Company shares Partners (shares) Year Key activities (%) Sonamer 49 Pride International (51%) 1998 Drilling Petromar 30 Saipem (70%) 1984 Construction of facilities Sonamet 40 Acergy (55%) and Wapo International (5%) 1998 Fabrication Sonadiets Project management, technical assistance, and 30 Dietsmann (70%) 1999 professional training Sonaid Supply, storage, and management of tubular 30 FORAID (55%) and KITONA (15%) 2002 equipment Angoflex Manufacturing of umbilicals and pipelines for 30 Technip (70%) 2002 underwater production Source: Based on data from Sonangol 2006a AfDevInfo 2008. Foreign oil companies operating in Angola have faced a challenge in coexisting with an inexperienced sector of domestic firms and suppliers. As a result, there is a move toward public-private partnerships (PPPs) to define the challenges hindering the integration of LCPs in sourcing goods and services. The challenges rest within four main categories: o o o o Infrastructure and engineering equipment inadequacy Insufficient financial resources to drive change Low level of technical expertise Lack of collaborative efforts (Sonangol 2006b) To counter the challenges, a framework involving five subgroups led by oil companies and coordinated by Sonangol has been launched Figure 1.12). Figure 1.12 Angola: Framework and Initiatives for Approaching Domestic Sourcing Challenges Ministry of Petroleum Feeds into a government action plan Sonangol Coordination of Efforts Total ESSO Chevron BP Micro-Finance Bidding Process Local Capacity for SMEs Professional Training Source: Adapted from Sonangol 2006b. Note: BP = British Petroleum; SMEs = small and medium-sized enterprises. 36 In 2002 Chevron pioneered the formation of the Angola Enterprise Program (AEP) to develop local capacity of small- and medium-sized enterprises (SMEs) and maintain a business environment that can provide reliable and quality-driven products and services. The program, funded by the Spanish International Cooperation Agency for Development (AECID) and Chevron, was budgeted at $4 million and implemented with the involvement of a number of development agencies and governmental institutions. The program started in 2004 and was initially set to be finalized by 2007, but later extended until 2013. The AEP provided technical and financial support and assistance to local companies through funding the Luanda Business Incubator, which provided the premises and the delivering of training seminars in finance, management knowledge, human resources skills, and technology networking. The incubator also facilitated the business networking necessary for later operations. In 2009 the incubator graduated 6 entrepreneurs who went on to establish companies that created 69 jobs and were expected to generate $378,000 per year (Chevron CSR Report 2009). BP launched the Centro De Apolio Empresarial (CAE) in 2005 in partnership with Sonangol, Chevron, Esso, Total, and CDC Development Solutions (formerly Citizens Development Corps). The CAE provided core courses and training sessions to local SMEs in the fields of human resource management, supply-chain management, health safety and environment, quality management, and finance. BP coordinated and financed the program along with its partners, while CDC monitored the progress and implementation of the CAE program. By February 2010 the CAE had trained 1,455 companies engaging 2,478 participants. In addition, the CAE facilitated the engagement of local companies in 289 contracts with the total value of $206 million, creating 4,194 jobs (CAE 2010). On the other hand, Total E&P moved to promote microfinance through the creation of the Zimbo Fund11 in 2005. Total partnered with Banco Totta de Angola to create a joint guarantee fund increasing SMEs’ access to capital and reducing the bank’s lending risks. Projects were selected by executives from Total and Banco Totta, according to the capital and developmental return on investment by the candidate SMEs. The loan ceiling per project was set at $20,000 and the whole program aimed to finance around 60 projects and create 100 jobs (Total 2005). The fund was estimated to have created 300 jobs via the creation of dozens of local companies including a textile workshop, an Internet café, and a farm cooperative (E-biz guides). Esso, a subsidiary of ExxonMobil, concentrated its efforts on the facilitation of bidding processes and promotion of the CAE programs. Between 2008 and 2009, its trainings encompassed 78 local suppliers of which 56 companies were provided from the CAE’s database and 22 others from Esso’s list of suppliers. The companies received technical assistance on accessing the electronic bidding system e-RFX (CAE 2010), which is used by ExxonMobil worldwide to reduce time consumption and eliminate paper work in the bidding process. The attendees came from various oil supply sectors including security and transportation, fuel and chemical production, office furniture, information technology (IT) and telecommunications, and water supply. 11 Named after a type of shell that was once used as money. 37 References AfDevInfo. 2008. Online Database. AfDevInfo. Andre, G. 2010. The Management of the Angolan Oil Revenues: Are There Any Chances to Change Course of the “Resource Curse”? University of Dundee. BP (British Petroleum). 2011. BP Statistical Review 2011. London: BP. CAE. 2010. CAE Newsletter. Luanda. CIA (Central Intelligence Agency). 2012. The World Factbook. https://www.cia.gov/library/publications/theworld-factbook/fields/2221.html. Cihlar, J. 2010. Policy of the IMF and WB in Angola. Implementation of the Strategic Poverty Reduction Plan and the Influence of Foreign Powers on the Development of the Country after the End of Civil War in 2002. Czech Republic: Brno Joštova, Department of International Relations and European Studies. Council of Ministers. 1982. “Mandatory Hiring and Training of Angolans by Foreign Companies Operating in the Angolan Oil Industry.” Official Gazette (Diário Da República) I Series No. 90, Angola. ———. 2009. “Rules and Procedures to Observe in Recruitment, Integration, Training and Development of Angolan Personnel in the Oil Industry and Hiring Foreign Personnel for the Execution of Oil Operations.” Decree-Law No. 17/09 of July 26, Council of Ministers, Luanda. CRES (Centre De Recherches Enterprises Et Societe). 2008. Skills Shortages in the Global Oil and Gas Industry, How to Close the Gap. CRES. Geneva, Swistzerland. Deloitte. 2012. “Corporate Tax Rates 2008-2012.” Deloitte Global Services Limited. http://www.deloitte.com/assets/DcomGlobal/Local%20Assets/Documents/Tax/Taxation%20and%20Investment%20Guides/matrices/dttl_cor porate_tax_rates_2008_2012.pdf. E-biz guides. n.d. http://ebizguides.com/ebizpartners_see.php?id_country_sponsors=17andebizpartnersid=858. Gomes, E., and M. Weimer. 2011. Education in Angola: Partnership Opportunities for the UK. London: Chatham House. IEA (International Energy Agency). 2006. Angola: Towards an Energy Strategy. Paris: IEA. Kaufmann, D., A. Kraay, and M. Mastruzzi. 2011. “The Worldwide Governance Indicators (WGI) Project.” http://info.worldbank.org/governance/wgi/index.asp. Kirk, R. 2011. 2011 National Trade Estimate Report on Foreign Trade Barriers. Office of the United Stated Trade Representative. Lwanda, G. C. 2011. “Oiling Economic Growth and Development: Sonangol and the Governance of Oil Revenues in Angola.” Working Paper Series No. 21, Development Bank of Southern Africa. Mangueira, J. P. 2004. “Educational policies and endogenization of human capital in developing countries. The case of the oil industry in Angola.” Universidade Técnica De Lisboa Instituto Superior Técnico. Portugal. MENAS. 2008. Angola. MENAS Local Content Online. http://www.menas.co.uk/localcontent/home.aspx?country=6Mercer. 2012. 2012 Cost of Living Rankings. Mercer.: http://www.mercer.com/costoflivingpr#City_rankings Ministry of Interior. 2010. “application of recruitment, integration, training and Angolan personal development and the hiring of foreign personnel for the execution of oil operations in Angola.” Executive Decree No. 13/10 of February 10, Luanda. Ministry of Petroleum. 2003. “General Regulatory Framework for Hiring of Services and Goods from National Companies by Companies in the Oil Industry.” Decree No. 127/03, Ministry of Petroleum, Luanda. 38 Morais, R. M. 2012. Understanding President Dos Santos Rule and the Gaming of His Succession. Maka Angola. Morris, M., R. Kaplinsky, and D. Kaplan. 2011. “Commodities and Linkages: Industrialisation in Sub Saharan Africa.” MMCP Discussion Paper No 13, University of Cape Town and Open University. National Assembly. 2003. Law on the Promotion of the Angolan Private Business Community. Luanda: National Assembly. Neigus, D. 1981. “The Government Haig Calls a "Soviet Surrogate" is Signing Sweet Deals with Gulf, Boeing, and More.” Multinational Monitor: http://www.multinationalmonitor.org/hyper/issues/1981/08/neigus.html. Oliveira, R. S. 2007. Business Success,Angola-Style: Postcolonial Politics and the Rise and Rise of Sonangol. Oxford: Cambridge University Press. PKF. 2011. Angola Tax Guide 2011. http://www.pkf.com/media/386978/pkf%20angola%20tax%20guide%202011.pdf. Republic of Angola. 2004. National Assembly Law No. 13/04. Translated by Miranda, Correia, Amendoeira and ASSOCIADOS. Angola. Rystad Energy . 2010. INTSOK Annual Market Report. Oslo, Norway. Sonangol. 2006a. Sonangol Universo. Luanda: Sonangol. http://www.sonangol.co.ao/sonangolEP/publications/sonangolUniverso/su11.pdf. ———. 2006b. “Sonangol’s Experience on Promoting Local Content.” Local Content Summit for Oil and Gas. London. ———. 2012. Sonagol Webpage. http://www.sonangol.co.ao. Teka, Z. 2011. Backward Linkages in the Manufacturing Sector in the Oil and Gas Value Chain in Angola. Centre for Social Science Research. The World Bank Group. 2012. Doing Business: http://www.doingbusiness.org/. Total. 2005. Sharing Our Energies, Corporate Social Responsibility Report . Total. http://www.total.com/MEDIAS/MEDIAS_INFOS/1052/EN/Total-2005-CSR-en.pdf UNDP (United Nations Development Programme). 2010. Human Development Index. UNDP. United Nations (UN). 2010. Department of Economic and Social Affairs. Population Division, Population Estimates, and Projections Section: http://esa.un.org/unpd/wpp/unpp/panel_indicators.htm. UN Statistics. 2010. National Accounts Main Aggregates Database. New York: United Nations. Warner, R. 1991. Angola : A Country Study edited by Thomas Collelo. Library of Congress , Federal Research Division. Washington, DC: U.S. G.P.O. World Bank. 2011. World Bank Development Indicators. Washington, DC: World Bank. http://data.worldbank.org/indicator/IC.TAX.TOTL.CP.ZS/countries/1W-TT-ZJ?display=graph. ———. 2012. World Development Indicators and Global Development Finance. Washington, DC: World Bank. WEF (World Economic Forum). 2011. The Global Competitiveness Index 2011-2012 Rankings. http://www3.weforum.org/docs/WEF_GCR_CompetitivenessIndexRanking_2011-12.pdf. WTO (World Trade Organization). 2012a. Angola and the WTO. World Trade Organization. ———. 2012b. Statistics Database. http://stat.wto.org/StatisticalProgram/WSDBStatProgramSeries.aspx?Language=E. 39 2. Brazil Brazil’s first oil discovery dates back to 1864, six years after that of the United States. But it was not until 1939 that oil was discovered in commercial quantities. Since then, political and economic conditions have shaped the country’s position toward the protection of the domestic petroleum value chain. In the earlier days of the industry and during the rule of Getulio Vargas, several decrees 12 were issued providing the state with full ownership of all existing oil and gas fields in the country and monopolizing all the rights for exploration, transport, distribution, and trade of oil and oil-related products. Dictator Vargas was overthrown in 1945, and General Dutra became president. During his first year in office a new constitution was declared, which provided local and foreign oil companies established in Brazil the right to obtain oil concessions. This fueled a major debate between the liberal and nationalist camps that carried on for years. On one hand, the liberals, in office at the time, argued that nationalization would damage relations between Brazil and the United States and would hinder the development of the domestic industry due to the limited availability of domestic capital and capabilities. On the other hand, nationalists saw that oil was crucial to the national economy and felt that the government should control all aspects of the sector. Nonetheless, the sector remained liberalized, and the dispute was not settled until Vargas was reelected in 1953. During that year, state control over the oil sector was reinstated (through Law number 2004) creating Petrobras, the sole concessionaire that held monopoly rights over all upstream operations. The government was the major shareholder in the company.13 Promotion of domestic sourcing of goods and services used by the petroleum industry started with the establishment of Petrobras. In 1954 the local industry supplied only 5 percent of the equipment and material consumed by Petrobras. But stimulated by the state company, a number of domestic suppliers were established and by 1960 they supplied more than 60 percent of the material and equipment sourced by Petrobras. Following a period of consolidation among suppliers, this share increased to 80 percent in 1979. That period was characterized by a strong growth in Petrobras’ investments as well as the overall economy (Brandao 1998). But by 1980 Petrobras had shifted its investments to offshore developments, where the domestic industry was lacking capabilities, and the industry’s share in goods consumed by Petrobras fell to 52 percent. In parallel, the country’s economic growth started plummeting and inflation rates swelled. Two years later, import restrictions—put in place as a result of the debt crisis—enabled the domestic industry to raise its share of goods sourced by Petrobras to 83 percent, increasing further to 91 percent by 1989 (Brandao 1998). The period that extended to the 1990s was characterized by low investments from Petrobras, and a shrinking domestic supply base. Overall, the domestic chain developed to meet Petrobras demands (ONIP 2010). In the early 1990s reforms and liberalization of external trade were introduced during the rule of Fernando Collor and his vice president, Itamar Franco, who later took office. The reform process was carried on by subsequent presidents. During Fernando Cardoso’s term the Real Plan was introduced in 1995 mainly to fight rising inflation rates, and its implementation began to place the economy on a growth path. Brazil’s gross domestic product (GDP) witnessed a growth rate of 4.3 percent in year 2000, up from 0.3 percent in 1999 (World Bank 2012b). During this regime, an Oil Bill was passed in 1997 liberalizing the oil sector and transferring all regulatory activities to an independent entity linked to the Ministry of Mines and Energy 12 13 Decrees 336 of 1937 and Decree 395 of 1938 nationalized the oil sector in Brazil. No foreign company was allowed to own shares in Petrobras 40 (MME). The bill did not expressly include any statements on the local sourcing of goods and services used by the petroleum industry. Instead, these were managed in piecemeal until the arrival of the Workers Party (PT) president, Lula da Silva, to office in 2002. Upon its foundation in 1980, the PT united an assortment of Marxists, liberation Catholic activists, moderate intellectuals, and union and social movement leaders. Although a homogenous mixture, PT constantly defined itself as socialist and assumed many radical stands. In 1988 the party advocated rejection of external debt, nationalization of banks and mineral wealth, and radical land reform. In 1994 it further committed to anti-monopolist and anti-imperialist change as part of a long-term strategy to build an alternative to capitalism (Samuels 2004). But as a result of failure at the 1989 and 1994 election polls and the fall of the Soviet camp, PT began a process of revaluation looking inward at the party’s objectives and way forward. During Lula’s third presidential campaign in 1998, PT changed its socialist proposals and silenced any intention to transition Brazil to a socialist society. The clear shift, however, was only visible in the 2002 elections, when interparty polls saw moderate candidates gaining ground over radical candidates. During these elections, Lula and PT emphasized a “respect for the country’s contracts and obligations” and expressed “opposition to radical and unilateral solutions.” Although the PT dialogue toned down the socialist slogans of the 1980s, it kept its stand on developing the working class and increasing local capacity of Brazil as a nation. These objectives were directly translated into multiple legislations as PT rose to office. The Oil Bill of 1997; the Buy Brazilian Law of 2010, which led to the Bigger Brazil Plan of 2011; and multiple other initiatives have been spearheaded by President Dilma Rousseff, who herself moved from the ranks of the National Petroleum Agency (ANP) to become the Minister of Energy, until taking over office in 2010. The subsequent sections provide in-depth analysis of local content policies (LCPs) related to the oil and gas industry and the context surrounding them. 2.1 Structural Context In its 2011 Global Competitiveness Report, the World Economic Forum (WEF) placed Brazil in 53rd position among 142 countries, enhancing the country’s rank by five positions from 2010 and 19 positions from 2007. Brazil comes in behind two of the BRICS14 (that is, China and South Africa), and multiple Latin American countries such as Chile and Panama (Sala-i-Martin 2011). According to the report, Brazil enjoys a large domestic market, high level of sophistication of business, efficient financial markets, and high rates of innovation and technological adoption. On the other hand, multiple structural factors hinder the progress of the country. These include poor infrastructure, high interest rates, a complex fiscal system, and heavy bureaucracy, in addition to a shortage of skilled labor and a weak educational system. In its 2010 competitiveness analysis of the Brazilian oil and gas sector, the National Organization of the Petroleum Industry (ONIP) argued that raw material costs, labor costs, and taxes make production of petroleum-related goods in Brazil more expensive than in emerging economies such as China, Mexico, and Southeast Asia.15 On the other hand, when compared to developed economies, Brazil suffers from lower productivity, lack of scale, and higher cost of capital, taxes, and logistics costs. The exchange rate is also a challenge. The same study reports that structural factors are the main hurdles to the sector competitiveness. On top of the list of challenges reported by oil and gas suppliers in Brazil (Figure 2.1) are high taxation, lack of qualified labor, and high cost of capital (ONIP 2010). Following is a discussion of these major constraints. 14 Brazil, Russia, India, China, and South Africa. The study included a competitiveness analysis for establishing domestic production facilities for a selection of oil- and gas-related equipment (that is, valves, pumps, flanges, naval boilers, heat exchangers, and naval steel plates). 15 41 Figure 2.1 Key Challenges for Brazilian Companies, Percentage of Respondents (total = 77) High Taxation 76% Qualified Labor 55% High Cost of Capital 40% Business Bureaucracy 35% Technology Access /… 29% Credit/Assurance Access 28% Cost of Local Raw Materials 26% Source: Adapted from ONIP 2010. 2.1.1 Economy Brazil GDP continues to experience an overall upward sloping trend in growth (World Bank 2012b). The country enjoys a strong internal market that immunized it against the global recession in 2008. In 2010 the country achieved a growth rate of 7.2 percent, three points above the world’s average. This growth is expected to slow down over the coming five years (IMF 2012). The 2010 per capita GDP in Brazil reached $10,710, showing a compounded real average growth rate of 2.2 percent from year 2000. Despite the growth, Brazil has had a troubled history with inflation nearing 3,000 percent in 1990. More recently, between 2000 and 2010, the country maintained a relatively stable inflation rate (which varied between 3 and 7 percent), with the exception of 2003, when inflation hit 14.7 percent. Compared to other countries, Brazil ranks 104 out of 163 countries. After a long period of depreciation and backed by high commodity prices, the Brazilian real has been appreciating vis-à-vis the dollar starting in the year 2002. This trend is expected to continue in the future, making imports relatively cheaper. The year 1994 marked the start of a wave of foreign direct investment (FDI) in Brazil. Net FDI reached $39 billion in year 2000, though the trend reversed between 2001 and 2005. Then, post-2006, Brazil experienced another surge in FDI inflows, though the level was still lower than that of 2000. On the external front, despite Brazil’s relatively high debt-to-GDP ratio, 54.4 percent (CIA 2012), the country’s debt profile has been improving and current account imbalances are seen as manageable. Currently, Brazil enjoys a net creditor position, and its foreign exchange reserves more than enable the country to offset its external debt. Since 2002 Brazil has been enjoying a trade surplus, as exports experienced a compounded annual growth rate (CAGR) of 22 percent between 2002 and 2008. In 2010 the country overcame the slowdown of 2009, and surpassed the 2008 exports level to reach $201.9 billion; imports experienced a similar trend, reaching $191.5 billion. This led to a trade surplus of $10.5 billion in 2010. Brazil’s trade is also quite diversified. In 2010, 80 percent of the imports came from 21 major partners, and less than 80 percent of exports were directed to 25 major partners (UN Comtrade 2010). Table 2.1 provides a historical view of Brazil’s main economic indicators from 1980 through 2010. Table 2.1 Key Economic Indicators of Brazil, 1980 –2010 1980 1985 1990 1995 2000 2005 2006 2007 2008 2009 2010 430.4 454.2 501.8 583.6 644.7 739.6 768.9 815.7 857.9 855.1 919.5 GDP per capita (constant 2000 $) 3,536.0 3,334.0 3,353.0 3,606.0 3,696.1 3,976.6 4,090.6 4,297.8 4,478.8 4,424.8 4,716.6 Inflation, CPI (%) — 226.0 2,947.7 66.0 7.0 6.9 4.2 3.6 5.7 4.9 5.0 Real interest rate (%) — — — — 47.7 44.9 42.1 35.8 35.9 36.8 30.4 Exchange rate (LCU per $) 2.3E-11 2.7E-09 3.0E-05 0.9 1.8 2.4 2.2 1.9 1.8 2.0 1.8 Trade (% of GDP) 20.4 19.3 15.2 16.0 21.7 26.6 25.8 25.2 27.1 22.3 23.3 GDP (constant 2000 $, billion) Source: World Bank 2012. Note: CPI = consumer price index; GDP = gross domestic product; LCU = local currency unit. — Not available. 42 The real interest rate in Brazil has declined since the late 1990s, but is still among the highest in the world. As shown in Table 2.1, the real interest rate reached 30.4 percent in 2010, placing Brazil in the second place after Madagascar in the list of 28 countries reported by the World Bank (2012b). Looking at the basket of commodities exported (Figure 2.2), petroleum-related commodities contributed to 10 percent of total exports in 2010. Upon achieving self-sufficiency in oil production, the country became a net exporter of crude oil in 2007. Figure 2.2 Brazil’s Exports by Commodity, 1980–2010 ($ billion) 20.1 25.6 31.4 46.5 55.1 118.5 201.9 17% 20% 19% 15% 11% 8% 6% 6% 6% 9% 7% 7% 6% 4% 34% 45% 11% 2% 4% 11% 1% 19% 2% 10% 16% 28% 26% 16% 18% 10% 14% 100% 10% 10% 28% 30% Other Iron and steel Chemicals Fuels 50% 39% 34% 31% 34% Machinery and transport equipment Mining products Agricultural products 1980 1985 1990 1995 2000 2005 2010 Source: Based on data from WTO 2012. 2.1.2 Taxation The overall tax burden in Brazil is among the highest in the region and the world (Figure 2.3); the same applies to the country’s corporate tax rate. This has led to the establishment of a large informal economy. In addition, the tax system in Brazil is complex, characterized by a long list of federal and state taxes (Table 2.2 presents a snapshot). This issue has been recognized by successive governments, but reform remains slow. During her 2010 electoral campaign, President Rousseff promised to lead a tax reform that would reduce the socially regressive effects of the existing taxation system. The pledge was reiterated in her inaugural speech in January 2011. Figure 2.3 Comparison of Brazil’s Tax Revenues and Corporate Tax Rate to Other Countries, 2009 and 2010 (%) Tax Revenues as % of GDP, 2009 Corporate Tax Rate, 2010 Angola 43% Norway Angola 35% 27% Brazil Trinidad and Tobago 26% Australia 30% United Kingdom 26% India 30% South Africa 26% Uganda Netherlands 23% Australia 22% Malaysia 16% Chile 16% Brazil 16% Russia 13% Canada 12% Uganda 12% Indonesia India Kazakhstan 30% Canada 28% Norway 28% South Africa 28% Malaysia 25% Indonesia 25% Netherlands 25% Trinidad and Tobago UK 11% 25% 24% Chile 20% Kazakhstan 20% Russia 20% 10% 8% 34% OECD 14% Source: Based on data from CIA 2012; Deloitte 2012; World Bank 2011. Note: For Angola and Tanzania tax revenues reflect 2011 levels and include social contributions—such as payments for social security and hospital insurance—grants, and net revenues from public enterprises. OECD = Organisation for Economic Co-operation and Development. 43 Table 2.2 Snapshot of Taxes in Brazil (2010) Tax Rate (%) Corporate 15% CSLL 9% Interest 15% FGTS ICMS IPI 8% on monthly salary 025% 26.8%28.8% on monthly salary paid by employer and 7.6511% paid by employee 0%330% II 0%35% Import tax. IR ISS IOF top rate 27.5% 2%5% 0%25% Personal income tax. Municipal service tax. Financial operations tax (on loans and foreign investment). INSS Description The basic rate of 15% is increased by a surtax of 10% on annual taxable profits exceeding 240,000 reals Social contribution on net profits The rate for interest payments on loans can increase to 25% for residents of tax havens. Fund for the guarantee of length of service. State value-added tax (VAT). Social security contribution. Tax on industrial products. The national average is about 10%. Source: Based on data from KPMG 2012 and Deloitte 2012. Note: II = import tax; IPI = tax on industrial products; II = Import tax; IR = Export tax; ISS = Personal income tax; ISS = Municipal service tax; IOF = Financial operations tax. — Not available. 2.1.3 Population and Labor Force Brazil’s population is the largest in Latin America and has been steadily growing since 1950. As shown in Figure 2.4, the country’s labor force will peak early next decade, returning to current levels toward 2040. This is paralleled by an exploding generation of the elderly. PT came into power after a period of growing unemployment, which reached 12.3 percent when Lula took office in 2003. Since then, unemployment has been trending toward historically low rates on the back of a growing economy. Figure 2.4 Evolution of the Brazilian Population and Labor Force over Time, 1950–2050 (in millions of people) 250 80% 70% Million People 200 60% 150 100 50 50-59 50% 40-49 40% 30-39 30% 20-29 20% 10-19 10% 0-9 0% % 15 - 64 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 0 60+ Source: Based on data from UN 2010. The mean years of education of the Brazilian labor force averaged at 7.2, lower than resource-rich and developed economies averages. In terms of labor compensation, the real average labor wage has been rising, with a sharp increase in the minimum wage (which reached $300 in 2010). While this presents a positive development internally, it might affect the country’s competitiveness in the global arena. Table 2.3 presents a summary of key labor-related indicators. 44 Table 2.3 Brazil’s Labor Force Indicators Compared to Select Countries, 2010 Labor force (million) Angola Australia Brazil Canada Indonesia Kazakhstan Malaysia Norway South Africa Tanzania Trinidad and Tobago Uganda United Kingdom 7.1 11.8 101.6 19.0 11.8 8.8 12.0 2.6 18.2 22.1 0.7 13.4 31.8 Educational attainment (% of total) Primary Secondary Tertiary — 27.3 — 13.5 — — 18.3 19.9 15.8 — 25.3 — 19.2 — 38.9 — 40 — — 56 43.5 74.2 — 63 — 44.4 — 33.8 — 46.5 — — 21.1 35.8 5.2 — 11.1 — 35.4 Mean years of education Minimum wage ($ per month) Unemployment, total (% of total labor force) 4.4 12 7.2 12.1 5.8 10.4 9.5 12.6 8.5 5.1 9.2 4.7 9.3 127 1,597 300 1,903 133 — — 3,609 543 59 — 3 1,655 25.0 5.2 8.3 8.0 7.1 6.6 3.7 3.6 23.8 10.7 5.4 4.2 7.8 Source: Based on data from World Bank 2011; UNDP 2010. Note: Educational attainment data for Australia, Canada, Malaysia, South Africa, and Trinidad and Tobago are from 2008; unemployment data for Brazil, Kazakhstan, Malaysia, South Africa, and Uganda from 2009. — Not available. Industry accounted for 22 percent of the total employment in 2009, in line with the Organisation for Economic Co-operation and Development (OECD) average. Agriculture’s share has been on a downward trend, accounting for a historically low 17 percent. The remaining workforce is in the growing services sector (World Bank 2012b). Despite the increase in the absolute level, employment in the knowledge-intensive manufacturing remains lower than in mature economies, as shown in Figure 2.5. Figure 2.5 Breakdown of Labor Force by Category, 2000 and 2007 (in millions of people) 61.2 84.5 20.2% 20.1% 3.9% 50.6% 2.3% 2.2% 4.0% 50.6% 1.3% 1.4% 19.4% 19.6% 2000 2007 100% 2.1% Mature economy average, 2007 (% of total employment) Total change in employment, 2000 - 2007 (Million jobs) Primary Resources 3 4.6 Labor-intensive manufacturing 2 0.3 Capital-intensive manufacturing 6 1.0 2.2% Knowledge-intensive manufacturing 5 0.6 Labor & Capital intensive services 42 11.8 Knowledge-intensive services 17 0.4 Health, education and public services 26 4.7 Source: Based on data from MGI 2012; UNIDO 2012; ILO 2012. Note: The number of employees engaged in manufacturing activities is based on the United Nations Industrial Development Organization’s (UNIDO’s) statistics, while the rest are based on International Labour Organization (ILO) data. Overall, Brazil is characterized by rigid labor laws and well-organized unions. Strikes occur frequently in private sector companies where the labor force is commonly demanding for an increase in its share of profits— a requirement of the Brazilian law. Currently, labor courts are responsible for concluding decisions on most labor disputes, as opposed to being the outcome of negotiations between management and labor. The São Paulo Federation of Industries claimed that labor reform would make it easier for companies to hire workers, and that it could potentially integrate some 27 million workers from the informal to the formal market, and open another 8 million job opportunities. 45 2.1.4 Education Education in Brazil offers ample room for improvement. The country’s enrollment figures are lower than neighboring and developed economies, especially in tertiary education. As for the quality of higher education, out of the 183 universities, only 6 show up in the world’s list of top 500 (Academic Ranking of World Universities 2010), most of them ranking above 200. Literacy among adults is another issue—it was 90 percent in 2008 for adults above 15 years old. This number is set to increase as literacy rate among youth is around 98 percent and multiple programs are in place to combat that (World Bank 2012a). Public expenditure on education reached 5.7 percent of GDP in 2009, an increase from 4.5 percent in 2005. Table 2.4 shows the educational indicators of Brazil in comparison to that of other countries. Table 2.4 Brazil’s Educational Indicators Compared to Select Countries, 2010 Literacy rate (%) Adult (15+) Angola Australia Brazil Indonesia Kazakhstan Malaysia Norway South Africa Tanzania Trinidad and Tobago Uganda United Kingdom 70.1 — 90.3(a) 92.2(b) 99.7 93.1 — 88.7(c) 73.2 98.8 73.2 — Youth (1524) 73.1 — 98.1(a) 99.5(b) 99.8 98.4 — — 77.3 99.6 87.4 — School enrollment (%) Primary Secondary Tertiary 85.7 97.1 94.1(b) 95.9 89.5 94.1(e) 99.1 85.1(a) 98.0(b) 93.9 90.9 99.6(a) 11.5(a) 3.7 79.9 36.1(a) 23.1 38.5 40.2(a) 74.4 — 2.1 40(b) 4.2(a) 58.5(a) 85.5 82.0(2) 67.3 88.2 68.7(5) 93.9 — — — — 96(a) Public expenditure on education (% of GDP) 3.6 5.1(a) 5.4(b) 3.5(b) 3.1(a) 5.8(a) 6.5(b) 6.0 6.2 3.8(d) 3.2(a) 5.4(b) Source: Based on data from Gomes and Weimer 2011; UNDP 2010; World Bank 2012b MSTTE 2011. Note: (a) year 2009; (b) year 2008; (c) year 2007; (d) year 2006; and (e) Global Competitiveness Report data. 2.1.5 Business Environment The overall business environment in Brazil is promising, offering diversified opportunities and prospects. The country enjoys a stable political system and a developed financial sector. The country has been undergoing reform initiatives on tax (to change the rigid tax system), regulatory, and structural frameworks to encourage investment in the country. Despite the increased privatization and constitutional reform over the past decade, corruption and bureaucracy in business and government remain overly high in Brazil and improvements need to be made, along with reforms of the legal framework. The World Bank’s annual “Doing Business Survey” shows that Brazil ranks toward the bottom of the list with an average of 119 days to establish a new business. In other aspects too—such as registration of property, dealing with construction permits, and enforcing contracts (Table 2.5)—procedures are long and time consuming. This occurs despite some recent legislative efforts to ease up tax procedures for small- and medium-sized enterprises (SMEs) through the implementation of the “Super Simples” tax regime, which aims to save the time needed to file tax reports. Moreover, a recent presidential decree in 2009 took effect prohibiting public officials from requesting new paperwork in cases where a similar document is held by another government agency. 46 Table 2.5 Indicators for Doing Business in Brazil in Comparison to OECD Average, 2012 Brazil OECD 1. Starting a business Procedures (#) Brazil OECD 6. Protecting Investors 13 5 Extent of disclosure index (0-10) 6 6 Time (days) 119 12 Extent of director liability index (0-10) 7 5 Cost (% of income per capita) 5.4 4.7 Ease of shareholder suits index (0-10) 3 7 Paid-in min capital (% income per cap) 0.0 14.1 Investor protection strength (0-10) 5.3 6 Rank (Change in rank from 2011) 79 (-5) Rank (Change in rank from 2011) 120 (+5) 2. Dealing with Construction Permits Procedures (number) Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) 7. Paying Taxes 17 14 9 13 469 152 Time (hours per year) 2600 186 40.2 45.7 Profit tax (%) 22.4 15.4 Labor tax and contributions (%) 40.9 24 3.8 3.2 67.1 42.7 127 (+6) Payments (number per year) Other taxes (%) 3. Getting Electricity Procedures (number) Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) Total tax rate (% profit) 6 5 34 103 130.3 92.8 51 (+2) 4. Registering Property Rank (Change in rank from 2011) 150 (-2) 8. Trading Across Borders Documents to export (#) 7 4 Time to export (days) 13 10 2215 1032 Cost to export (US$ per container) Procedures (number) 13 5 Documents to import (#) 8 5 Time (days) 39 31 Time to import (days) 17 11 2.3 4.4 Cost to import (US$ per container) 2275 1085 Rank (Change in rank from 2011) 121 (-5) Cost (% of property value) Rank (Change in rank from 2011) 114 (-5) 5. Getting Credit 9. Enforcing Contracts Strength of legal rights index (0-10) 3 7 Time (days) 731 518 Depth of credit information index (0-6) 5 5 Cost (% of claim) 16.5 19.7 Public registry coverage (% of adults) 36.1 9.5 45 31 Private bureau coverage (% of adults) 61.5 63.9 Rank (Change in rank from 2011) Procedures (number) Rank (Change in rank from 2011) 118 (0) 98 (-2) 10. Resolving Insolvency Time (years) 4.0 Cost (% of estate) 12 9 17.9 68.2 Recovery rate (cents on the dollar0 Rank (Change in rank from 2011) 1.7 136 (+1) Source: The World Bank Group 2012. Note: Ranking is out of 183 countries. OECD = Organisation for Economic Co-operation and Development. After three decades of underinvestment, the Brazilian government put forth the Growth Acceleration Program (Programa de aceleração do crescimento, PAC) in 2007. As per the plan the government intended to invest 646 billion reals on infrastructure projects in transport, energy, sanitation, housing, and water. Former president Lula da Silva, in an effort to promote close integration within the region, was active in lobbying developed countries (in particular the United States) to seek funding and direct investments in infrastructure projects. Frequent disputes have, however, delayed these projects (especially in the energy sector), challenged mostly as they are by the trade-off between the need to accelerate licensing processes of new operations and to protect environmental and social factors. The country’s overall governance indicators show the stability of the political environment and the improvement in the rule of law (Figure 2.6). 47 Figure 2.6 Governance Indicators in Brazil Compared to the OECD Average Voice and Accountability 100 Control of Corruption Political Stability/Absence of Violence 50 2000 Brazil 2000 0 2010 Brazil 2010 2010 OECD 2010 Government Effectiveness Rule of Law Regulatory Quality Source: Adapted from Kaufmann, Kraay, and Mastruzzi 2011. 2.2 The Petroleum Sector 2.2.1 The Petroleum Sector in the Economy In 2010 the mining, manufacturing, and utilities sector contributed 19 percent to Brazil’s GDP; oil and gas constituted half of that (Azzoni and others 2007). Recent presalt 16 discoveries are set to boost the sector’s share in the country’s GDP to 20 percent by 2020 (Panassol 2009). Figure 2.7 compares the breakdown of Brazil’s GDP by activity to other countries in 2010, and Figure 2.8 shows the evolution of the contribution of mining, manufacturing, and utilities sector to GDP over time. Figure 2.7 Brazil: Breakdown of Value-added by Economic Activity, 2010 ($ billion) 85 1,296 2,066 1,637 883 159 304 402 377 39% 38% 24 17 22% 23% 2,236 100% 7% 14% 25% 15% 5% 33% 43% 45% 11% 5% 6% 13% 8% 20% 18% 9% 9% 8% 6% 50% 7% 2% 14% 12% 10% 5% 5% Angola Australia 19% Brazil 5% 8% 12% 7% 3% 8% 8% 4% 1% Indonesia Kazakhstan Malaysia 6% 21% 6% Norway South Africa Trinidad & Tobago Other Activities Transport, storage and communication Construction Wholesale, retail trade, restaurants and hotels Manufacturing Agriculture, hunting, forestry, fishing 12% 14% Uganda UK Note: UK = United Kingdom. Deposits located under thick layers of salt at a depth of around 18,000 feet below the ocean’s surface. 48 1% Mining, Manufacturing, Utilities Source: Based on data from UN Statistics 2010. 16 10% 24% 20% Canada 2% 12% 12% 36% 33% 32% 8% 0% 13% 3% 6% 7% 8% 6% 1% 30% 16% 6% 11% 4% 29% 19% 19% 20% 8% 8% 51% 12% 5% 10% 13% 11% 20% 11% Figure 2.8 Brazil: Contribution of Mining, Manufacturing, and Utilities to Value-added, 1970–2010 450 30% 400 GDP (Bn $) 300 20% 250 15% 200 150 10% 100 Share of GDP 25% 350 5% 50 0 0% 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Contribution to GDP Percentage Share Source: Based on data from UN Statistics 2010. Note: GDP = gross domestic product. Today, the industry creates around 500,000 jobs along the supply chain—80,000 by Petrobras itself. With presalt discoveries and LCPs, Brazilian authorities plan on creating 2 million jobs across the oil and gas supply chain by 2020. 2.2.2 Petroleum Geography Brazil has 29 sedimentary basins spread across the north, coastal regions, and deep waters, of which onshore reservoirs account for less than 10 percent. As shown in Figure 2.9, the state of Rio de Janeiro is endowed with most of the country’s oil and gas reserves and is home for most major companies. Specifically, 150 kilometers (km) north of the state’s capital is the port city of Macaé, which is considered the capital of offshore operations in Brazil. Presalt discoveries will draw further attention to the state. Most of the country’s inland natural gas reserves, however, are unexploited due to limited transportation capacity. Figure 2.9 Brazil: Geographical Distribution of Main Oil and Gas Reserves – 2010 (Number in Parentheses Indicates Percentage Onshore) São Luís AM CE RN SE BA SP North North-east Midwest South-east South Source: Adapted from OSEC 2011. 49 2.2.3 Reserves, Production, and Consumption Brazil is endowed with 15.1 billion barrels (bbl) of proven oil reserves, making its reserves the second largest in South America after Venezuela (BP 2012). Recent presalt discoveries will potentially move the country’s worldwide rank in oil reserves from 15th to 5th (Center for Global Energy Studies 2010), increasing the country’s reserves to 114 bbl. The majority of Brazilian reservoirs are of heavy oil, characterized by an API17 gravity in the lower 20s (Marathon 2012; Rigzone 2012). Brazil’s proven gas reserves are 16 trillion cubic feet (tcf) (BP 2012). Table 2.6 provides a snapshot of Brazil’s oil and gas landscape. Table 2.6 Snapshot of the Brazilian Petroleum Sector in 2010 15.1 Share of world % 0.9 Oil production, mmbpd 2,192.9 Oil refinery capacities, mmbpd 2,115.9 Oil consumption, mmbpd 2,652.7 Gas proven reserves, tcf 16 Gas production, bcfd 2011 Oil proved reserves, billion boe Gas consumption, bcfd Primary energy consumption, million toe Global rank Percentage change 3 yrs 5 yrs % % 16.9 19.2 14 1 yr % 5.6 10 yrs % 53.5 2.9 11 2.5 8.1 19.7 46.3 2.3 8 1.1 1.1 9.4 14.2 3.0 7 2.3 9.8 18.7 32.3 0.2 31 8.6 25.1 25.9 87.9 1.6 0.5 6 16.2 43.2 49.3 80.7 2.6 0.8 29 -0.3 35.0 26.3 89.4 266.9 2.2 8 3.5 13.9 18.3 43.4 Source: Based on data from BP Statistical Review 2011. Note: bcfd = billion cubic feet per day; boe = barrel of oil equivalent; mmbpd = million barrels per day; tcf = trillion cubic feet; toe = tons of oil equivalent. In 2010 Brazil was listed as the world’s 11th-largest producer of oil and 8th-largest oil refiner (BP 2012). The country’s oil production has experienced steady growth, with a CAGR of 7.3 percent between 1997 and 2010, reaching over 2 million barrels per day (mmbpd) (BP 2012). Production from onshore and shallow water basins is at a plateau or decline, and most of the foreseen growth in production will be from deep-water basins (Figure 2.10). Figure 2.10 Brazil: Evolution of Production by Water Depth (in billion boe) 16 14 12 Deep Water (>300 meter) Shallow Water (0-300 meter) Onshore 10 8 6 4 2 0 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Source: Based on data from Offshore Center Denmark 2009. Note: boe = barrel of oil equivalent. 17 American Petroleum Institute. 50 In 2006 Brazil announced self-sufficiency in oil consumption, and soon after became a net exporter of oil.18 Over the coming decade, the plan is to increase production to over 5 mmbpd, directing most of the increase to export markets. Figure 2.11 presents the forecasted domestic oil demand and supply. Figure 2.11 Brazil: Forecasted Domestic Oil Demand and Supply, mmbpd 6 5 Historical Production Forecasted Production Historical Demand Forecasted Demand 4 3 2 1 2020 2019 2018 2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 0 Source: Based on data from ANP 2011b. Note: mmbpd = million barrels per day. For natural gas the picture is reversed—despite the growth in domestic production, Brazil relies heavily on liquefied natural gas (LNG) imports, mainly from Bolivia. In 2010 the country imported around 45 percent of its consumption, as it plans to boost the supply of natural gas through two new offshore LNG facilities. Currently, over 80 percent of the domestic natural gas supply is produced from offshore fields, 60 percent coming in the form of associated gas. 2.2.4 Sector Institutional Framework Since 1953 state-controlled Petrobras has held a monopoly over the oil and gas value chain (expect for retail and wholesale distribution) and used to act as the regulator and operator of the sector. In 1997 the Oil Bill liberalized the value chain, separated governance roles, and freed oil prices from state control. Among the long list of reforms, the new bill: Separated policy, regulatory, and operational roles Established concession contracts for oil and gas exploration, development, and production activities Decreased the government ownership stake in Petrobras Granted Petrobras the right to enter into joint ventures with private companies without congressional approval19 Obliged Petrobras to set up an independent oil and gas transportation company (Transpetro) and mandated open access to pipelines and terminals. Under the new governance model, the National Congress (Congresso Nacional) is the legislative body responsible for passing new laws and amending existing ones. Since policy making resides with the executive arm of the country led by the presidency, an intergovernmental arm, the Conselho Nacional de Politica Energetica (CNPE), was established to advise the presidency on the formulation of national energy policies.20 Despite that, Petrobras continues to import light oil for its refineries and exports its heavy crude. Investment plans are still to be approved by Congress. 20 The CNPE includes members from the MME and the ministries of planning and budget, finance, environment and industry, as well as the Secretary of Strategic Affairs of the Presidency, representatives from the states and federal district, and a Brazilian citizen specialist in the energy sector. 18 19 51 The CNPE is also responsible for defining the blocks to be included in any bidding process. In addition to implementing the CNPE’s recommendations, the MME is responsible for sectoral planning 21 and management of government interests in state-owned companies. The minister of mining and energy is the chairman of the CNPE and sits on the board of Petrobras. The ANP was created to regulate the sector. Under the MME, the agency enjoys administrative autonomy and is governed by a board of four directors that are appointed by the president upon approval of the senate (Article 11 of the 1997 Oil Bill). The ANP’s key responsibilities include contracting of oil and gas licenses, monitoring of activities, and management of technical data. All of the ANP’s regulatory decisions are made upon public hearings22 and are published on its Web site (www.anp.org.br). Today, the ANP has over 800 civil servants distributed across different states. Environmental licensing of offshore activities is carried out by the Brazilian Institute of Environment and Natural Resources (IBAMA), which is a federal agency under the Ministry of Environment. Despite the opening of the sector more than 10 years ago, Petrobras remains predominant in all segments of operations. The company controls approximately 97 percent of production, 96 percent of the refining capacity, 100 percent of the transport structure, and 46 percent of refined-products distribution. Upstream, the situation is expected to change with presalt activities. Today, the company is recognized for its deep-water capabilities and operates in 27 countries, holding a top quartile position in petroleum reserves, production, refining capacity, and market capitalization. For presalt discoveries, the country recently launched a new regulatory framework composed of four bills that were approved by the Congress in 2010 (Beaubouef 2012). The new framework includes: Adoption of a production sharing regime. Under this contractual regime, Petrobras is the operator with a minimum 30 percent stake with all production belonging to the federal government. Participating companies receive a fix share of generated revenues. Creation of a new state-run company, Petrosal, to manage exploration and production (E&P) contracts and carry out negotiations on behalf of the government for presalt discoveries. The company will not have any operations. Capitalization of Petrobras through granting it 5 bbl of unlicensed presalt oil reserves in exchange for a larger government-ownership share. Creation of a sovereign wealth fund to manage the government’s wealth from presalt discoveries (Langevin 2010). In line with the new reforms, the government decreased its ownership stake in Petrobras to 48 percent, while maintaining control over the company through 54 percent of its voting shares. In 2010 Petrobras performed the largest shares offer in history raising almost $70 billion. 2.2.5 Market Structure and Local Capabilities Upon its creation, Petrobras relied heavily on external contractors to deliver upstream activities such as seismic and drilling. Over the years, the company built internal capabilities through knowledge transfer from foreign experts, training programs, and in-house research activities. Specifically on research and development (R&D), in 1955 the company established its research center, Cenepes, which has been closely integrated within Petrobas’ operations and strategic objectives. Throughout the years, the center enabled Petrobras to achieve major breakthroughs such as: o First offshore oil discovery in the Guaricema field in 1968 Geological mapping of the national coast in 1978 Either directly or through state-owned companies. The Companhia de Pesquisa de Recursos Minerais (CPRM) is a state-owned company that carries out the functions of the Geological Survey of Brazil, under the auspices of the MME. Its mission is to “produce and divulge the basic geological and hydrological knowledge required for sustainable development in Brazil.” 22 For regulations that might affect rights. 21 52 Setting the new world record of deep-water oil in 1999 Designing of a new concept of building floating platforms on a single column in 2005 Presalt discoveries in 2007. Between 1998 and 2008 Petrobras increased its R&D spend by more than four times, placing the company in third position among major international oil companies (IOCs) and national oil companies (NOCs) (Figure 2.12). Today the center has a diverse portfolio of research projects covering 15 areas linked to Petrobras’ activities. Figure 2.12 Brazil: Evolution of Petrobas’ R&D Spending (to the left) in Comparison to IOCs and NOCs (to the right), 1998–2008 1,000 941 R&D Spend by Company in 2008 ($ Mn, grey represents IOCs and blue NOCs) 900 800 Shell R&D Spend ($ Mn) 1,266 1,122 PetroChina 700 Petrobras 600 941 Total +401% 900 500 ExxonMobil 847 400 Chevron 835 399 803 Gazprom 300 200 BP Sinopec 152 100 495 StatoilHydro Eni 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 595 ConocoPhillips 395 318 209 Source: Based on data from Herold 2010. Note: IOCs = international oil companies; NOCs = national oil companies; R&D = research and development. Upstream, Petrobras holds over 90 percent of oil and gas production. For natural gas, a series of licensing rounds that started in 1999 introduced competition in the upstream sector by increasing the level of foreign participation, but Petrobras still remains the dominant player. In 2009 the company owned 92 percent of the production of natural gas, but upcoming local private firms are expected to gain a significant share. IOCs (such as ExxonMobil, Chevron, Shell, and Total) as well as other countries’ national oil companies also participate in oil and gas exploration and production. Transportation has been always highly regulated. As per the 1997 Oil Bill, Petrobras established an independent oil and gas transportation company, Transpetro, which owns most of the existing pipeline assets. The bill also mandated open access to pipelines and terminals. The country has a network of 8,000 km of oil and a similar network for gas. Historically, distribution has been the most competitive part of the fossil-fuels value chain in Brazil. In 2000 Petrobras’ market share in fuels distribution was 26 percent, with the rest split across the private sector. Over the past few years the market has experienced a lot of acquisition activities, resulting in the increase of Petrobras’ market share to 46 percent in 2009.23 2.2.6 Management of Petroleum Wealth It wasn’t until recently that Brazil set up a fund for the management of its oil wealth. Prior to 2010 oil revenue allocation was often characterized as region preferential, unequally distributed among governorates, and not providing a return for future generations in terms of social and economic well-being. Oil revenues of royalties, taxes, and dividends were allocated mostly to states, municipalities, and unions (Gobetti 2009) in the areas 23 This accounts for around 80 percent of total fuel sales in Brazil. It includes ethanol but not natural gas for transport. 53 where production occurred (Pereira, Olbertz, and Rost 2012). Following the major presalt discoveries, the government made a leap in the management of its wealthy and new oil resources. The Social Fund of Pre-Salt (Fundo Social do Pre Sal) was enacted by means of Law 5940 in December 2010 (Baker and McKenzie 2010) to manage the new presalt oil revenues to continuously finance social development in the country and reduce inequalities. This was to be carried out through programs aimed to develop the areas of education, culture, public health, science, and technology, in addition to poverty reduction and environmental sustainability (Gobetti 2009). The fund would allocate investments across the nation, thus reducing the concentration of investment in producing areas. Funding is raised from signing bonuses and royalties, petroleum marketing, and the income earned from investing those sources. Fund governance is the responsibility of two newly founded bodies. First, the Financial Management Committee of the Social Fund (CGFFS), which acts as a portfolio manager defining risks and allocating funds for investment. The second, a separate Advisory Board of the Social Fund (CDFS), describes priorities and sets parameters for the CGFFS. The fund is directly subordinate to the Presidency of the Republic, as are the two bodies. 2.3 Local Content Policies 2.3.1 Policy Objectives Brazil is set to double its oil production over the coming decade, which requires massive investments across the oil and gas value chain. By 2020 the decade’s cumulative demand for oil-and-gas-related goods and services is forecast to be around $400 billion. Figure 2.13 presents the cumulative forecasted investments and split by category. Figure 2.13 Brazil: Forecasted Investment, 2010–20 ($ billion) 33.6 2% 6% 30.3 2% 6% Vessels and supporting boats Seismic 25.1 4% 6% 17% 22.3 4% 8% Driller construction 14% 16% 16% 15% 18% 19% 30% 32% 29% 15% 30.1 2% 7% 16% 27% Exploration and Evaluation 33.8 1% 7% 29% 25% 19% Production development 24% 12% Construction of productive units 21% 30% 2010 2012 30.5 86.1 30% 31% 30% 2014 2016 2018 2020 155.1 231.4 311.8 399.6 31% Cumulative Investment* Source: Based on data from ONIP 2010. Note: (*) Includes operating costs. Instigated by these plans, President Lula de Silva argued that the development of Brazil’s oil and gas resources should be viewed through the broader lens of development, and that Petrobras should be used as a development platform with objectives that reflect national interests. To this end, the government launched policies to maximize the share of domestic industry participation in supplying goods and services to the oil and gas industry (defined as local content). Through LCPs, the government aims to develop a competitive base for local suppliers, generate income, and create job opportunities. A review of the Brazilian government literature on local content shows limited 54 explanation of the rationale behind these aspirations and policies. Officially, the ANP states the following four objectives: Increase the participation of the national industry on a competitive basis Improve national technological development Improve the level of capabilities Create job opportunities for nationals and achieve growth in income (ANP 2009). Over the coming decade, the government expects the creation of over 2 million jobs in the oil and gas value chain. As shown in Figure 2.14, this will be induced by organic growth in demand, increased participation of the local industry, and exports. Figure 2.14 Brazil: Number of Jobs to be Created in the Oil And Gas Value Chain, in Thousands 2,110 – 2,500 130 - 170 940 – 1,150 620 - 760 410 - 420 Actual Current Increase in Demand Increase in Supply Participation Increase in Exports Aspired Total Source: Adapted from ONIP 2010. 2.3.2 Policy Tools LCPs are enabled by an integrated set of tools that includes regulations, fiscal incentives, and support programs. Regulatory Requirements Local content requirements were not expressly laid out in the Oil Law of 1997 (Law number 9.478/97). The topic was briefly mentioned under the law’s main principles of the National Energy Policy (Redo 2010). To achieve the policy objectives, the ANP made local content commitment a provision in concession contracts and a component of the bidding process for oil and gas licenses. Accordingly, operators were asked to bid for the total percentage of equipment and services they were committed to source locally. Commitment value is phase specific (that is, for exploration and development). In the first four bidding rounds, no minimum requirement was set,24 and bids were evaluated based on a formula that weighed the bidders’ value of cash bonus and local content commitments. Cash bonus was given 85 percent and local content was given 3 percent for the exploration phase and 12 percent for the development phase. The total score was over 100 points, and points from local content commitments were calculated based on the following formula: % of local content offered by bidder Local Content Weight of Local Content by Phase Maximum offered value A maximum value for local content was set at 50 percent for exploration and 70 percent for development. Starting from the fifth bidding round in 2003, the ANP introduced a minimum local content requirement to the Brazilian E&P licensing process. The local content requirement is location specific (that is, it depends on For evaluation purposes, domestic investments for a class of systems and production units count three times their value. Such systems include subsurface lifting systems, production gathering systems, and fixed platforms. Details are available in the Tender Protocol document of each bidding round. 24 55 whether the block is onshore, in shallow water, or in deep water) and varies between exploration and development phases. Minimum requirements were made item and subitem specific. In addition, the bidding evaluation formula was modified introduce a minimum local content requirement. The mandatory minimum requirement and evaluation formula were amended in later bidding rounds. By 2017 minimum local content requirements are expected to gradually increase to as high as 95 percent. Table 2.7 summarizes the local content requirements and bidding evaluation process for bidding rounds one through nine. Table 2.7 Brazil: Local Content in the Bidding Process, 1999–2007 Bidding Round Year 1 2 3 4 5 6 7 8 9 1999 2000 2001 2002 2003 2004 2005 2006 2007 30% for class A blocks*. Exploration phase None. 50% for class B blocks. 70% for class C blocks. Minimum local content requirement 30% for class A blocks. Development phase None. 60% for class B blocks. 70% for class C blocks. 37% for deep water and shallow water starting at 100 million. 51% for shallow water up to 100 million. 70% for onshore blocks. 55% for deep water and shallow water starting at 100 million. 63% for shallow water up to 100 million. 77% for onshore blocks. Maximum value for local content allowed 50% for exploration and 70% for development. 85% signature bonus. Bid evaluation weights 12% local content in development phase. 3% local content in exploratory phase. Ten points over the minimum percentage. 30% signature bonus. 40% signature bonus. 15% local content in exploratory phase. 5% local content in exploratory phase. 25% local content in development phase. 15% local content in development. 30% minimum in exploratory program. 40% minimum in exploratory program. Source: Based on data from ANP (http://www.anp.gov.br/brnd/round5/english/guia_julgamento.asp). Note: (*) These classes represent an operational classification where class A are unrestricted operators, class B are restricted to shallow water and onshore blocks, and class C are restricted to onshore and mature basins. In case a higher local content level is achieved in the exploration phase, the incremental value achieved can be transferred to the development phase upon approval by the ANP. In case of noncompliance, upon award of contract, a fine is applied. The fine is based on a schedule linked to the nonrealized value of local investment (NR). Table 2.8 presents the schedule of fines from the seventh bidding round. Table 2.8 Brazil: Schedule of Fines in Case of Noncompliance with Local Content Requirements % of the Value of Unrealized Local Content (%NR) Fine as a % of the Value of Unrealized Local Content Below 65% From 65% to 100% 60% 1.143 x %NR – 0.14285 Source: Based on data from MENAS 2009. In addition to these regulations, the concession contract includes provisions such as: “Include Brazilian Suppliers in the companies invited to submit proposals”; “Grant access to a Portuguese or English version of the same technical specifications for all companies invited to submit proposals, and be disposed to accept equivalent specifications in accordance with the 56 Best Practices of the Oil Industry, in such a way that does not restrict, inhibit, or impair the participation of Brazilian suppliers”; “Send to the Brazilian suppliers a Portuguese version of all the nontechnical documents and correspondence”; and “Require no technical qualifications or certifications from the Brazilian suppliers, besides those required from foreign suppliers” (ANP 2007). It must be also noted that the concessions agreement allows the concessionaire to request the ANP to waive local content requirements on items in case of excessively high prices, delays in delivery, or absence of technology. As stated in the concession contract template “excessively high prices for the acquisition of local goods and services when compared to international market conditions” was a condition for waiving local content requirements (ANP 2007). Some operators may also elect to set higher local content requirements on their suppliers. In addition, financing institutions, such as the Brazilian National Development Bank (BNDES), impose minimum local content requirements to offer financing facilities. Additionally, operators must invest 1 percent of each field’s gross revenues in oil-and-gas-related R&D (Filho 2000). Up to half of this investment can be used in the operator’s research facilities in Brazil and the rest has to invested in research to be carried out by local universities or research institutes accredited by the ANP, in line with regulations published in year 2005.25 The ANP’s Web page features the 57 institutions that were accredited between 2008 and 2011, and the $5 million that was raised and invested between 1998 and 2010. Being the dominant operator, Petrobras is responsible for over 99 percent of this amount (ANP 2011b). Fiscal Incentives Fiscal incentives to promote local content include tax reductions and subsidized financing. Following is a selection of such incentives: REPERTO. In 1999 a federal tax exemption regime (REPERTO) was launched offering tax benefits to imports and exports of oil-and-gas-related goods, which included suspension of COFINS, II, IPI, and PIS.26 REPERTO is scheduled to last until 2020 and its benefits apply to a family of items defined by the Revenue and Customs Secretariat (Secretaria de Receita Federal). These include wet Christmas trees, families of vessels, floating cranes, and remote operation submarine vehicles.27 BNDES financing. Backed by the government, the bank offers subsidized financing to local suppliers. The Merchant Marine Fund. Launched by the government in December 2009, the over $5 billion fund is set to finance the construction of 17 new shipyards and the expansion of 5 existing ones. Governmental direct assistance and tax reliefs are given to qualifying R&D projects. Despite the existence of multiple incentive packages, importers report that the regime is complex to take advantage of, and some companies have found difficulties in benefiting from the exemptions (MENAS 2009). Program for the Mobilization of the Oil and Gas Industry (PROMINP) At the end of 2003 the federal government launched the multistakeholder program PROMINP to “maximize goods and services national industry content, within competitive and sustainable basis, in the implantation of oil and gas projects in Brazil and abroad” (PROMINP 2011b). The program is coordinated by the MME and engages most industry stakeholders. The use of funds and accreditation of institutions are governed by the ANP resolutions 33 and 34/2005 and NPA Technical Regulations 5 and 5/2005. 26 As a reminder, contribution for the financing of the social security system (COFINS), import tax (II), tax on industrial products (IPI), and social integration plan (PIS). 27 The list of items is available at: http://www.receita.fazenda.gov.br/legislacao/ins/2008/in8442008.htm. 25 57 PROMINP intervenes in three strategic areas: (i) qualification, (ii) industrial policies, and (iii) industry performance. Within each, the program has specific areas where it (i) identifies gaps and (ii) structures initiatives to close these gaps. In the first area, PROMINP launched a professional qualification plan assessing the demand for labor by professional category and by state. Then, a training program was launched involving 71 educational institutions and comprising 953 courses targeting over 100,000 professionals across 17 states between 2006 and 2010. In addition, and to boost the development of domestic suppliers, the program invested $27 million in 24 projects along the oil and gas value chain for competitive import substitution. Under the second strategic area, in 2005 the program published a manual for the assessment of local content. This followed confusion on reporting and monitoring local content. The manual outlined and formalized the definitions related to local content and presented a methodology for local content calculation. Within the same strategic subject, PROMINP engineered a frame agreement in 2004 between Petrobras and a national small business support association, Sebrae, for the inclusion of small- and medium-sized enterprises (SMEs) in the petroleum supply chain. The agreement aimed at mapping potential business opportunities for SMEs, training them, and fostering interaction through business rounds. The first phase of the agreement was accomplished in 2007. A total of $32 million was investedâ€”$12 million offered by Petrobras and Sebrae and $20 million funded by partner companies. The agreement encompassed 12 states and resulted in over $113 million in transactions between oil and gas companies and SMEs (Jenkins 2007). In 2008 the agreement was renewed for another three years, and additional funds were raised and more states included. Between 2004 and 2010, 3,000 SMEs were trained to become suppliers in the oil and gas value chain. The 65 business rounds organized in this period resulted in around $2.6 billion in transactions between oil and gas companies and SMEs. The agreement was renewed yet another time in 2011 (PROMINP 2008). Under the third area, PROMINP carried out a national competitiveness diagnostic study. The study forecast oil and gas operatorsâ€™ demand for goods and services by family. Then it looked at domestic supply capacity and identified gaps and challenges for each family of goods and services. The gaps and challenges were grouped into eight categories combined under three areas. Subsequently, a series of technological, infrastructure, capabilities, and financing initiatives were designed based on the competitiveness of the sector and challenges it faced. Figure 2.16 provides a snapshot of the diagnostic and action plan proposed by the study. As such, multiple initiatives were launched in the areas of technology, infrastructure, and supply chain management. On the technological front, a plan was developed defining the technology agenda and implementation model. A fund of $80 million was raised and 38 projects launched to close technological gaps in the manufacturing of valves, flanges and connection, boilers, and naval construction in addition to instrumentation and measurement. On the infrastructure front, an expansion plan was outlined calling for fostering partnerships with international companies and the mobilization of these companies especially in sectors were domestic competiveness is limited. To date multiple joint ventures have been signed, especially in shipyard manufacturing. On the supply chain front, PROMINP engineered the creation of the Petrobras Supply Chain Financing Program, Progredir, offering competitive financing to suppliers contracted by Petrobras. The program involves the six largest banks in Brazil and is managed on an online platform (PROMINP 2011b). Figure 2.15 offers an overview of the workflow in Progredir. 58 Figure 2.15 Brazil: Progredir Program Workflow 1 2 3 Buyers validate information and Suppliers are allowed to request a loan 4 Banks see the loan request and make a proposal respecting the deadlines previously agreed 6 Suppliers select bank and request their buyer the confirmation of the banker padlock 7 8 After the deliver (goods or services), buyer liquidates its obligations, according to the banker padlock â‰ˆ After supplier assumes its obligation as a buyer, bank releases the money 5 Buyers confirms the supplier contract banker padlock at the Portal 9 Bank checks if there is any notice of default against the supplier, before releases the money paid by the buyer Bank releaser resources for the supplier, after they liquidate their loans and occasional defaults Source: Adapted from Bonesio 2011. Figure 2.16 Brazil: Gaps and Challenges in Domestic Supply (Red Cells Indicate Areas of Challenges/Gaps) Technology Insufficient Production Capacity Sectors Infrastructure Incomplete Production Portfolio Technology Low Local Content Low R&D Activity Process Technology Human Resources Basic Industrial Technology Engin eering Professional Qualification Steel Mills Metallurgical Pipelines Flanges and Connections Boiler Works Rods and Sucker Rod Pumps Subsea Pumps Mechnical Compressors Gas / Diesel Engines Turbines Cranes and Hoists Valves and City Gates Generators and Electric Engines Electrical Substations and Transformers Automation and Instrumentation Services Engineering Construction and Assembly 1 7 High 13 Medium Competitiveness 8 14 15 6 17 19 18 8 16 10 20 Sectors 2 5 3 4 7 9 Low 21 22 24 23 Low High Productive Capacity Note: Size of Bubble indicates level of dependency of the oil and gas industry on these goods (low, medium, high) 1.Telecommunication 2. Substation and transformers 3. Generators and Motors 4. Electrical Distribution Panels 5. Automation 6. Pipelines 7. Winches 8. Valves 9. Flanges and Connections 10. Boilers Works 11. Mills 12. Steam Turbines 13. Subsea - Equipment 14. Subsea - Umbilical and Flexible Pipes 15. Pumps 16. Alternative Compressors 17. Engines 18. Cranes (Onshore) 19. Engineering Services 20. Construction and Assembly 21. Instrumentation and Measurement 22. Gas Turbines 23. Centrifugal Compressors 24. Electrical Motors (large size) Action Plan Mobilize foreign companies Enable technology transfer Promote articulation between buyers and sellers Invest in production capacity Consolidate demand and promote technological upgrading Promote technological upgrading Instigate production and commercial changes Invest in production capacity Technological innovation Source: Adapted from PROMINP 2010. Note: R&D = research and development. 59 â‰ˆ Buyers upload the pre-registration and Suppliers insert their contracts information into the portal Figure 2.17 provides a summary of PROMINP’s strategic subjects, areas, and key projects. 28 Figure 2.17 Brazil: PROMINP Strategic Subjects, Areas, and Projects 1 Qualification Strategic Areas Technological Qualification 2 Industrial Capacity Projects Professional Qualification Industrial Policy 3 Industry Performance Financing Regulation Sustainability Tax Policy Foster micro and small companies HSE Professional Qualification Plan Manual for Assessment of Local Content Competitive import Substitution Petrobras x Sebrae Frame Agreement Competitiveness Competitiveness Study Industry of Oil and Gas market Source: Adapted from PROMINP 2010. Note: HSE = Health, Safety and Environment. 2.3.3 Legislative Channels In Brazil, LCPs are legislated through: The petroleum law number 9478/97, which sets out general local content principles Minimum local content requirements that are established in the licensing round for the award of oil and gas E&P rights; these change over time and for different types of acreage (based on relative maturity and location) Specific commitments that are set out in petroleum contracts The ANP Regulation No. 6/2007 Resolution No.36/2007, which specifies the criteria and procedures for the calculation and certification of local content The ANP Regulation No. 8/2007 and Resolution No. 38/2007, which specifies the procedure for audit of local content certification The ANP Regulation No. 9/2007 and Resolution No. 39/2007, which specifies the reporting procedure and format. 2.3.4 Institutional Responsibility for Policy Design and Monitoring of Implementation The governance of LCPs is distributed among several entities. Policy design is led by the CNPE (National Energy Policy Council) that establishes guidelines for LCPs, in coordination with the MME. Regulatory activities fall under the responsibilities of the ANP and it: Sets the minimum local content requirements Defines criteria, accredits and audits certification entities Accredits R&D institutions Issues templates for local content reporting Checks local content commitments and applies penalties in case of noncompliance Runs training programs, funded by revenues from royalties. Operators may elect to local content requirements that are higher than what they have committed for in their respective bids. In addition, financing institutions (for example, the BNEDS) set minimum local content requirements. For certification of local content, 21 entities are featured on the ANP’s Web page. These entities: 28 Details and results of projects undertaken by PROMINP are available in Portuguese at http://www.prominp.com.br. 60 o Issue local content certificates, in line with the template provided by the ANP, for goods and services, stating the percentage of local content based on the local content primer developed by PROMINP Issue a quarterly certification report to the ANP, detailing certification activities. o The leading certifier is the ONIP, a nongovernmental organization (NGO) engaging 2,000 companies working in the Brazilian oil and gas value chain (Heller Redo Barroso 2010). In addition to certification of local content, the NGO: Proposes actions for improvement of industrial policy and the development and competitiveness of domestic industry Proposes joint actions and actors for the removal of bottlenecks on factors of competitiveness of the domestic industry Develops and disseminates sectoral knowledge and understanding of national and international markets Promotes interactions and contributes to the development of business in favor of domestic suppliers. Several other NGOs and associations are engaged in similar activities. The other major enabler of LCPs is PROMINP. The program is a multistakeholder initiative, composed at the steering committee level of the minister of mining and energy; minister of development, industry, and trade; president and services director of Petrobras; president of the BNDES; president of the ONIP; and the president of the Brazilian Petroleum Institute. Reporting to the steering committee is an executive committee and four sectoral committees (Figure 2.18). Figure 2.18 Brazil: PROMINP Governance Structure Steering Committee CEO / President ONIP President BNDES President Brazilian Petroleum Institute (IBP) Minister of Mining and Energy (MME) Minister of Development, Industry, and Trade (MDIC) President of Petrobras Director of Services of Petobras Executive Committee MME – O&G and Renewable Fuels Secretariat MDIC – Secretariat BNDED – Director Petrobras – Director PROMINP – Engineering Executive Manager ONIP – Director IBP – Director Associations – President / Director (ABCE, ABDIB, ABEMI, ABIMAQ, ABINEE, ABITAM, SINAVAL e CNI) Sectoral Committee E&P Maritime Transp. G&P and Pipelines Downstream Source: Adapted from PROMINP 2011b. Note: BNDES = Brazilian National Development Bank; E&P = exploration and production; G&P = gas and processing; ONIP = National Organization of the Petroleum Industry; PROMINP = Program for the Mobilization of the Oil and Gas Industry. The steering committee is mainly responsible for strategy development, approval of portfolios of projects, and the budget and funding sources. The executive committee shall mainly: Implement PROMINP’s guidelines Coordinate sectoral committees and appoint their coordinators Prepare the annual budget and indicate sources of funds Validate, prioritize, monitor, and evaluate the portfolio of projects. Sectoral committees are responsible for the implementation of projects and management of resources (Decree No. 4925, 2003). PROMINP’s day-to-day activities are mainly funded by the government and Petrobras. As for the projects launched by the program, these are mostly funded on a project-by-project basis. To summarize the landscape of local content institutional responsibilities, Table 2.9 maps key local content activities to the different stakeholders. 61 Table 2.9 Brazil: An Activity Map of PROMINP’s Local Content Stakeholders Activities Policy Design local content policies Regulation CNPE MME x x ANP Set minimum local content requirements Issue templates for local content reporting Define criteria and accredits certification entities x x NGOs x x x Audit certification entities x Check local content commitments x Apply penalties in case of incompliance x Implementation Issue local content certificates Support Financing Certifying Operators Suppliers PROMINP Institutions Entities x Voice industry concerns to government Identify challenges to meeting policy objectives Propose and lead the implementation of local content x Offer training programs x x x x Source: Based on data from ANP 2009, BNDS 2011, ONIP 2010, PROMINP 2011a. Note: ANP = National Petroleum Agency; CNPE = National Energy Policy Council; MME = Ministry of Mines and Energy; NGO = nongovernmental organization; PROMINP = Program for the Mobilization of the Oil and Gas Industry. 2.3.5 Interlinks LCPs became a pillar of Brazil’s petroleum sector plan. These policies are linked to Brazil’s overall industrial strategy, which is aimed at protecting the domestic industry and increasing its competitiveness. The overall direction was put in place during the presidency of Lula da Silva and carried on by his successor, Dilma Rousseff. From the country’s industrial policy of 2008 (the Policy for Productive Development) to the 2011 plan of Bigger Brazil, the government has been offering fiscal incentives and support programs to domestic industries.29 On the financing front, the BNDES has been a catalyst for Brazil’s industrial policies. Overall, the Bank has been offering programs that emphasize consolidation to increase the competitiveness of Brazilian production in the international arena. Within the scope of the Bigger Brazil industrial plan, the bank launched the Support Program for the Development of Oil and Natural Gas Goods and Services Supply Chain (BNDES 2011). The program aims to: Expand the productive capacity of businesses Support merger and acquisition activities that increase competitiveness Fund projects aimed at expanding production capacity, modernization, and optimization of industrial units as well as the search for technologies abroad Support R&D activities. 29 For instance, as per the later industrial plan, the government is guided to purchase goods and services produced domestically that cost up to 25 percent more than imported ones, as long as they meet technical requirements. 62 2.3.6 Monitoring and Measuring Tools In Brazil the measurement of local content is based on an expenditure philosophy. Prior to the seventh bidding round, measurement and reporting of local content was not formalized. Operators were asked to provide a statement of origin of their sourced goods and services without providing supporting evidence (Maya 2011). In 2005 PROMINP published a local content primer, which formalizes definitions related to local content and details methodologies for calculating the level of local content, specific to equipment and goods, equipment and goods for temporary use, 30 services, systems, and subsystems (Table 2.10).31 Table 2.10 Brazil: PROMINP’s Methodology for Calculating Local Content Goods, Systems, and Subsystems X LC 1 100 Y Formula Services ILS Value of goods directly imported by the operator or main contractor, including import tax. Value of imported goods purchased by the operator or main contractor in the local market, excluding internal tax. X Y Total price of goods and systems excluding IPI and ICMS taxes. X 100 Y Total cost of local manpower Total manpower cost Source: Based on data from PROMINP 2005. Note: ICMS = state VAT; ILS = local content of services; IPI = tax on industrial products. To facilitate and standardize calculation and reporting of local content, PROMINP developed templates specific to types of goods and services. Starting from the seventh bid round, the primer was annexed to the concession agreements. In 2007 the primer was made part of a series of the ANP regulations that introduced major changes related to the fulfillment of local content clauses to be applied as of the seventh bidding round. As part of these regulations, a certification system was put in place. The system included the setup of certification entities that are accredited by the ANP based on predefined criteria. These entities issue local content certificates in line with the manual and standardized templates published by PROMINP in 2005. Under the new regulations: Local content reporting happens on a quarterly basis Reporting is block specific for the exploration phase and area specific for the development phase Templates are provided by the ANP and are standardized for each phase (that is, exploration and development) Auditing takes place at the end of the exploration phase as well as the development phase. To date, over 5,000 local content certificates have been issued, multiple audits carried out, and notifications of noncompliance fees issued to some operators (ANP 2011b). 2.3.7 Policy Impact on Local Content Levels As part of the bidding process, concessionaires committed themselves to local content requirements in the exploration and development phases. Figure 2.19 presents the average local content commitment by concessionaires achieved over the bidding rounds. Goods and equipment used under rental, chartering, leasing, or operational / financial leasing. A system that is an integral part of a greater system. This could be, for example, a MODULE of an oil rig, a tanker, offshore supply, or other type of offshore vessel. 30 31 63 Figure 2.19 Brazil: Average Local Content Commitment Resulting from Bidding Rounds, 1999â€“2008 Exploration Phase Development Phase 86% 79% 81% 74% 80% 73% 7 (2005) 8 (2006) 77% 69% 84% 79% 54% 48% 42% 40% 39% 28% 25%27% 1 (1999) 89% 86% 2 (2000) 3 (2001) 4 (2002) 5 6 (2003) (2004) Bid Round (Year) 9 (2007) 10 (2008) Source: Adapted from BG 2012. The inception of PROMINP is believed to be the driver behind the boost in the participation of the domestic industry in investments from 57.3 percent in 2003 to 74.3 percent in 2010 (Table 2.11). Table 2.11 Brazil: PROMINP Targets Versus Achieved Participation of Domestic Industry in Investments, 2003â€“10 2003 % 2004 % 2005 % 2006 % 2007 % 2008 % 2009 % 2010 % Target LC Index 57.3 59.7 63.1 59.9 64.0 66.0 67.2 68.5 Achieved LC Index 57.0 62.2 70.0 74.3 75.4 75.6 75.4 74.3 Year Source: Based on data from PROMINP 2010. Note: LC = local content. At a more granular level, the ANP reports the value of investment and local content achieved at the item level. Table 2.12 presents the cumulative value of total investment, domestic portion, and percentage local content by item. In addition to these indicators, Petrobras has reported multiple success stories. Table 2.12 Brazil: Cumulative Total and Local Investment (in $ million) and Percentage Local Content, 2011 Total investment 509.0 88.0 1,059.0 231.1 6.5 7.8 3.7 0.1 1.0 3.7 0.0 0.5 2.4 0.0 43.4 16.3 18.7 1,991.3 Geology and geophysics Drilling rigs Logistics and operational support Well drilling, completion, and assessment Basic engineering and detailing Management, construction, assembly, and commissioning Electrical, control, instruments, and measurement systems Telecom systems Oil and gas pipelines, storage tanks Compression units Steam generation and injection units Subsea equipment and control systems Oil-processing and treatment systems Natural gas-processing and treatment systems Platform and ship building HSSE Civil works and utilities Total Source: Adapted from ANP 2011b. Note: LC = local content; HSSE = health, safety, security and environment. 64 Local investment 328.8 38.2 747.5 196.4 6.1 7.0 3.6 0.1 0.8 3.0 0.0 0.3 2.0 0.0 27.6 14.6 18.4 1,394.5 Average LC % 65 43 71 85 93 90 99 99 77 82 99 63 86 100 64 90 98 70 For goods and services sourced by Petrobras, the level of domestic sourcing has been on an increase but fluctuating (Figure 2.20). Figure 2.20 Brazil: Local Content in the Procurement of Goods (left) and Services (right) Sourced by Petrobras, 2005–08 7,011 International 38,170 Domestic International Domestic 34,599 19% 22% 5,240 32% 18% 4,026 12% 16,767 2,886 11% 81% 78% 30% 68% 82% 8,528 31% 88% 89% 70% 69% 2005 2006 2007 2008 2005 2006 2007 2008 Source: Based on data from Rittershaussen 2010. On the other hand, local content policy trade-offs are being directly felt by the oil and gas industry. On multiple projects, this has led to higher costs and delays in delivery. In fact, José Sergio Gabrielli, former CEO of Petrobras, mentioned that the cost of building a midrange tanker in Brazil is twice the cost of building it in China (Leahy 2012). As for delays, Petrobras missed its production targets last year due to delays in receiving rigs (Millard 2012). Overall, LCPs are believed to hinder Petrobras from achieving its production and financial targets. The company did not meet its production targets for the last three years and its stocks have been underperforming. Some analysts are watching for the new CEO of Petrobras to seek some breathing space on local content requirements to achieve the company’s growth targets (Leahy 2012). 65 References Academic Ranking of World Universities. 2010. Academic Ranking of World Universities—2010. http://www.arwu.org/ARWUStatistics2010.jsp. ANP (National Petroleum Agency). 2007. Concession Agreement for the Exploration, Development and Production of Oil and Natural Gas. Rio de Janeiro: ANP. ———. 2009. 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WTO (World Trade Organization). 2012. Statistics Database. http://stat.wto.org/StatisticalProgram/WSDBStatProgramSeries.aspx?Language=E 68 3. Indonesia Indonesia’s history in the petroleum sector dates back to the end of the 19th century, when the country was still a Dutch colony. Since then, foreign oil companies have played a pivotal role in exploring, developing, and operating the country’s resources. After a shaky sectoral history following World War II, the framework engaging these companies has undergone a major change marked by the formation of the country’s national oil company (NOC) in 1957, and the government’s decision in 1966 to secure state interests through production sharing agreements (PSAs).32 A few years before these major changes, mainly in the early 1950s, the local content agenda in the oil and gas sector appeared in the Indonesianization of the petroleum sector workforce. Since then, the local agenda has evolved over time and is undergoing several major milestones. Toward the early 1950s, the country witnessed aggressive Indonesianization of foreign oil company personnel. Surprisingly, this was initiated by the companies33 themselves in a move to improve their position in tough negotiations with the government. The negotiations were taking place in a rising nationalistic/socialist environment. Indonesianization efforts were highly successful for disciplines requiring a low to medium level of capabilities. For higher technical positions, the foreign oil companies established training schools and offered scholarships to send Indonesian staff abroad to leading technical schools. Indonesianization efforts at the managerial levels were limited. By 1963 Indonesianization of the workforce was formalized in the working contracts entered by the foreign oil companies and Pertamin, the NOC at that time (Hunter 1966). Under the PSA, contractors have been mandated with a domestic market obligation that requires them to sell a share of their production entitlement to the domestic market at a discounted price. This, coupled with the overall government fuel subsidies and the NOC’s aspirations, instigated the development of a well-established forward link. As for the local content agenda related to backward links from the oil and gas sector, policies were initiated in the late 1970s, when the government envisioned driving technology transfer in oil field services and equipment (OFSE) from foreign companies to domestic ones by forcing partnerships between multinationals and local firms operating in the OFSE segment. This policy was complemented by a set of import tariffs on certain OFSE. Overall, the government aimed at reaching local content levels of 35 percent. Failing to reach this target required production sharing (PS) contractors to receive an exemption from the Ministry of Industry and Trade. During this period Pertamina enjoyed a monopoly in the oil and gas sector as it was mandated with regulatory and operational powers. The adopted approach to develop a backward link proved to induce a limited impact. By the turn of the century, the achieved local content levels were believed to be in the range of 10 to 20 percent (Nordas, Vante, and Heum 2003). In 2001 the oil and gas sector underwent a major restructuring process. In that year, the Indonesian government published a new Oil and Gas Law that primarily aimed at improving the governance of the sector and introducing competition. As per the new law, upstream regulatory roles were transferred from Pertamina to three regulatory bodies: Directorate General of Oil and Gas (DGOG) under the Ministry of Energy and Mineral Resources (MEMR), acting as the policy and concession management body BPMIGAS, upstream regulatory body Under the PSA, production-sharing contractors incur all capital expenditures during exploration and development, to recover them over the production phase. 33 At that time, Royal Dutch Shell, Stanvac Petroleum, and Caltex Pacific were the main companies operating in Indonesia. 32 69 BPHMIGAS, downstream regulatory body. The restructuring process also marked a new milestone for the local content agenda that was driven by a national need to increase domestic production, create jobs, and reduce the need for foreign exchange (MoI 2005). To this end, the law of 2001 stipulated the development of local capabilities that enable domestic companies to compete in the national, regional, and international landscape of OFSE. To this end, the upstream regulator was envisioned to be an engine “mobilizing different economic and industrial activities.” Here, BPMIGAS was to “prioritize domestic/regional human resources roles, and utilization of goods and services in oil and gas industry” (BPMIGAS 2011b). To achieve its local-content-related aspirations, the regulator published in 2009 a set of procurement rules around the domestic sourcing of goods and services in upstream activities. These rules were further developed and clarified in the second revision of the manual published in 2011. Today, local content policies (LCPs) are also applied in the mining and extractive industry, government procurement, as well as other sectors. Going forward, policy makers in Indonesia have to deal with two main sectoral priorities: (i) meeting the growing domestic demand for natural gas in light of a shortage, and (ii) managing the depletion of oil reserves. Despite that, LCPs are expected to remain on top of the development agenda for the coming years, with aspirations to reach a 50 percent level (MOEMR 2009). 3.1 Structural Context Indonesia, a lower-middle-income country, is the largest economy in Southeast Asia (RSM 2012). It is in the transition phase between stage one and two on the scale of global economic development (Schwab 2011) and has a large multiethnic population of 242.3 million. Its GDP per capita in 2011 was above Southeast Asia’s average, at $3,495, for a total of $846.8 billion (World Bank 2012b). The highest contributor to the economy’s GDP is manufacturing, with a 45 percent share, followed by services, with a 38 percent share. Indonesia’s GDP has been on an increasing trend, with an average growth rate of 56 percent. Foreign direct investment (FDI) in Indonesia was vital to the country’s economic development, particularly during the period of the 1970s (Satiotomo 1999). Exports have also been on an increasing trend over the years, with fuels and mining as the dominating export commodities with a 39 percent share. The business environment in Indonesia is now undergoing a fast pace of reform coupled with high levels of optimism. In fact, the country has been moving from the planned market economy toward a decentralized economy and lately enjoys a stable political and economic outlook (World Bank 2010b). But despite the reforms and the impressive growth rates, Indonesia is still facing challenges posed by the legacy of 32 years of centralized authority, corruption, and weak governance of the Suharto rule. Indeed, Indonesia’s governance indicators remain well below the Organisation for Economic Co-operation and Development (OECD) standards, and corruption is still one of the key obstacles to doing business in Indonesia. This is coupled with the low quality of infrastructure that suffers from multiple bottlenecks. The country is also struggling with other challenges such as the low tax revenue as a percent of GDP, mounting pressure on cities driven by increased urbanization, shortage in skilled workers, and the low quality of its educational system. 3.1.1 Economy Indonesia gained its independence in 1945 toward the end of World War II, after more than three centuries of Dutch colonial rule (Bey 2012). The Indonesian economy was in poor condition, and it wasn’t until 1966, when the Communist government was overthrown, that Indonesia began to follow a sound economic track. By the end of the 1960s and similar to its northern neighbor, Indonesia began to set economic targets and develop five-year national plans (Repelita) in an effort to achieve those targets. Driven by revenues from mineral and petroleum resources, the country achieved considerable economic growth, attained food security from being a rice importer to exporter, and developed abilities in manufacturing and higher technology industry (Satiotomo 1999). In fact the country’s GDP was set on an increasing trend as of the late 1960s. GDP growth has been momentous, achieving an average of 8.1 percent from 1968 through 1978 (World Bank 2011). The only years 70 witnessing steep drops in GDP growth were 1982 (1 percent), following the decrease of oil prices, and 1998 (-13 percent), as a result of the Asian economic crisis. The economy recovered shortly after the 1998 contraction, as the country regained growth levels in 1999 at 1 percent and a 5 percent growth rate in 2000. Over the past decade, GDP growth rate has been steady, between 5 and 6 percent. Today, Indonesia is a member of the G-20 countries (RSM 2012). Indonesia’s economy has witnessed a structural change since the 1960s, a scenario similar to its neighbors, Malaysia and Thailand, where a shift from agricultural dependence toward service and manufacturingoriented activities was achieved. In 1970 agriculture contributed to nearly half of the country’s GDP, while in 2008 the agriculture share of GDP reached 13 percent (ILO 2010). Additionally, in the early 1990s, a nationalistic tendency, adopted by a group of economists with close ties to President Suharto, envisioned a shift of the economy away from traditional sectors such as agriculture and light manufacturing into knowledge-intensive manufacturing such as light aircrafts, helicopters, ship building, and communication satellites (Amuzegar 1999). Indonesia was ranked sixth in terms of GDP per capita adjusted for PPP in Southeast Asia (CIA 2012). Across the world, Indonesia ranked 154th out of 226 countries. The key contributor to Indonesia’s 2011 GDP of $846.8 billion (World Bank 2012b) was manufacturing, with a 45 percent share of GDP, followed by services with a 38 percent share. Agriculture contributed the least, with a 17 percent share of GDP in 2011 (World Bank 2011). Table 3.1 reveals additional key economic indicators for Indonesia. Table 3.1 Key Economic Indicators for Indonesia, 1980–2010 1980 1985 1990 1995 2000 2005 2006 2007 2008 2009 2010 GDP (constant 2000 $, billion) 58.8 77.4 109.2 159.4 165.0 207.9 219.3 233.2 247.3 258.7 274.7 GDP per capita (constant 2000 $) 390.0 460.1 592.1 799.3 773.3 914.6 953.9 1003.4 1052.4 1089.7 1145.4 Inflation, CPI (%) 18.0 4.7 7.8 9.4 3.7 10.5 13.1 6.4 9.8 4.8 5.1 — — 12.2 8.3 -1.7 -0.2 1.7 2.3 -3.9 5.7 4.8 Exchange rate (LCU per $) 627 1,111 1,843 2,249 8,422 9,705 9,159 9,141 9,699 10,390 9,090 Trade (% of GDP) 54.4 42.7 49.1 54.0 71.4 64.0 56.7 54.8 58.6 45.5 47.6 Real interest rate (%) Source: World Bank 2012b. — Not available. FDI in Indonesia was vital to the country’s economic development particularly during the period of the 1970s (Satiotomo 1999). But the strongest records of FDI inflows have been achieved in recent years. In 2011 FDI reached over $18.9 billion, an increase from 2010 of $13.8 billion and a leap from 2009 inflows of $4.9 billion (OECD 2012). FDI inflows have increased due to factors such as the lower cost of labor, tax incentives, and reduction in bureaucratic procedures, as well as the country’s overall economic stability (DBS 2011). The country’s exports value has increased over the years. In 2008 the value of total exports reached $147.6 billion, increasing from $65.4 billion in 2000 (OPEC 2011). Fuels and mining were the dominating export commodities during the last decade, reaching a 39 percent share in 2010, followed by agriculture products with a 23 percent share. On the other hand, labor-intensive industries, such as textiles, have maintained a low share of exports reaching 3 percent between in 2010, as shown in Figure 3.1. 71 Figure 3.1 Indonesia’s Exports by Commodity, 1980–2010 ($ billion) 21.9 1% 18.6 8% 2% 22% 16% 25.7 45.4 87.0 158.1 25% 21% 18% 4% 5% 5% 7% 3% 11% 4% 6% 8% 5% 100% 1% 21% 25% 5% 6% 6% 2% 7% 5% 16% 76% 65.4 5% 18% 73% 3% 4% 3% 3% 4% 5% 23% 16% Other Textiles Telecommunications equipment 12% Clothing Office and telecom equipment 48% 31% 29% 39% 37% Chemicals Agricultural products Fuels and mining products 1980 1985 1990 1995 2000 2005 2010 Source: Based on data from WTO 2012b. 3.1.2 Taxation The tax system in Indonesia has three components: national taxes, regional taxes, and custom taxes. The national taxes are enforced on income, stamps, and property and cover sales tax on luxury goods. Regional taxes include taxes on development, motor vehicles, households, roads, and media advertising. The third category includes custom taxes, levied on cross-border trade and on select goods such as tobacco, sugar, alcohol, and gasoline (RSM 2012). Compared to neighboring countries (such as Thailand, the Philippines, Australia, and Singapore), Indonesia levies a lower corporate tax of 25 percent. In fact, corporate taxes were lowered in 1995 from 35 percent to 30 percent, to be lowered again in 2010 to the current level of 25 percent. Indonesia offers a 5 percent corporate tax incentive, depending on the company’s minimum public offering (PKF 2012). The government also levies capital gains taxes and branch profits taxes. Capital gains taxes exclude transactions made on the local market and on private property (PKF 2012). In terms of tax revenue as a percentage of GDP, Indonesia ranks considerably low at 11 percent, as shown in Figure 3.2. Corporate taxes are extended to construction and mining sites; however, goods used for the purpose of executing mining contracts are excluded from value-added taxes. Figure 3.2 Comparison of Indonesia’s Tax Revenues as Percentage of GDP and Corporate Tax Rate to Other Countries, 2009 and 2010 Tax Revenues as % of GDP, 2009 Corporate Tax Rate, 2010 Norway 27% Brazil Trinidad and Tobago 26% Australia 30% India 30% United Kingdom 26% South Africa 26% Netherlands Australia 22% 16% Chile 16% Brazil 16% Russia 13% Canada 12% Uganda 12% Indonesia India Kazakhstan Uganda 23% Malaysia 30% Canada 28% Norway 28% South Africa 28% Malaysia 25% Indonesia 25% Netherlands 25% Trinidad and Tobago UK 11% 25% 24% Chile 20% Kazakhstan 20% Russia 20% 10% 8% 34% OECD 14% Source: Based on data from Deloitte 2012; World Bank 2011. 72 3.1.3 Population and Labor Force Indonesia is a multiethnic and multilingual populous nation. The country encompasses nearly 300 ethnic groups that speak over 700 local languages and dialects (Idris 2012) and constitute a large population of more than 242.3 million. Population in Indonesia has been growing steadily since 1950. Historically, the majority of the population resides in rural and agricultural areas. This, however, has been changing, with around 40 percent of the population currently residing in urban locations (ILO 2010). Urbanization in Indonesia is on the rise and it is expected that the urban population will constitute half the nation in 2040 (around 170 million people). This places increasing pressure on the main cities, which are already struggling with issues such as growing illegal housing settlements, heavy congestion, and the consequential degradation of the environment (World Bank 2012a). The working-age population is increasing, a trend that is expected to continue over the next decades (DBS 2011). This is driven by a growing portion of the population aged 15 to 64, leading to around 2.5 million new entrants to the workforce each year (RSM 2012). In 2010, 29 percent of the population was aged below 30 (UN 2010). This has been exacerbating the historic problem of child labor, which is expected to have a serious impact on the country’s social fabric if no policies are enforced. Figure 3.3 illustrates the evolution of Indonesia’s population by age group from 1950 to 2050. Figure 3.3 Evolution of the Malaysian Population and Labor Force over Time, 1950–2050 (in millions of people) 350 80% 300 70% 60% Million People 250 50% 200 40% 150 30% 100 20% 50 10% 0 0% 60+ 50 to 59 40 to 49 30 to 39 20 to 29 10 to 19 0 to 9 % 15 - 64 Source: Based on data from UN 2010. The labor force in Indonesia is in the low-cost category, characterized by an overall shortage of skilled workers (World Bank 2012a) and rigid labor market regulations (DBS 2011). The total number of the Indonesian workforce has been on the rise. In 2010 the total workforce reached 117.9 million, growing from 76.8 million in 1990 (World Bank 2012b). The agricultural sector has the larger share of the working force in the country. Although at a decreasing rate, agriculture employed 38 percent of the labor force in 2008, a decrease from the 66 percent achieved in 1970 (ILO 2010). Other sectors such as wholesale, retail, and trade employed 16.7 percent and manufacturing employed 12.2 percent of the total workforce in 2008 (ILO 2010). The overall unemployment rate in 2010 was higher than neighboring countries at 7.1 percent, but showed a drop from 2005 levels when unemployment was at 11.2 percent (Table 3.2). Indonesia’s labor force primary education attainment is on par with that of developed countries. But in terms of secondary and tertiary attainment, Indonesia has plenty of room for improvement. Its mean years of education are half that of developed countries such as the United States and Australia, and Indonesia’s gross enrollment as a percentage of the total for tertiary education is at 22.4 percent. This has placed Indonesia as the 73 fourth lowest in the region in terms of tertiary education attainment as well as in terms of labor compensation per worker per year. Table 3.2 Indonesia’s Labor Force Indicators Compared to Select Countries, 2010 Educational attainment (% of total) Labor force (million) Mean years of education Minimum wage ($ per month) Unemployment, total (% of total labor force) Primary Secondary Tertiary Angola Australia Brazil Canada Indonesia Kazakhstan Malaysia Norway South Africa Tanzania Trinidad and Tobago Uganda 7.1 11.8 101.6 19.0 11.8 8.8 12.0 2.6 18.2 22.1 0.7 13.4 — 27.3 — 13.5 — — 18.3 19.9 15.8 — 25.3 — 38.9 — 40 — — 56 43.5 74.2 — 63 — — 33.8 — 46.5 — — 21.1 35.8 5.2 — 11.1 — 4.4 12 7.2 12.1 5.8 10.4 9.5 12.6 8.5 5.1 9.2 4.7 127 1597 300 1903 133 — — 3609 543 59 — 3 25.0 5.2 8.3 8.0 7.1 6.6 3.7 3.6 23.8 10.7 5.4 4.2 UK 31.8 19.2 44.4 35.4 9.3 1655 7.8 Source: Based on data from World Bank 2011; UNDP 2010. Note: Educational attainment data for Australia, Canada, Malaysia, South Africa, and Trinidad and Tobago represent year 2008 level. Unemployment data for Brazil, Kazakhstan, Malaysia, South Africa, and Uganda represent year 2009 levels. — Not available. Another look at the breakdown of labor force by activity reveals that the largest share for workers is in primary resources sectors. In 2008 workers in primary resource sectors reached 45 percent, followed by laborand capital-intensive services with 38.3 percent. As shown in figure 3.4, knowledge-intensive manufacturing employed 0.9 percent of the labor force in 2008, which is significantly below mature economies’ average of 5 percent (Figure 3.4). A recent World Bank (2010b) report on skills in Indonesia suggests that the limited availability of qualified local capabilities hinders the development of the manufacturing sector. According to the report, 69 percent of surveyed executives in the manufacturing sector face difficulties in recruiting skilled capabilities, and 84 percent face difficulties in filling management positions (World Bank 2010b). Figure 3.4 Breakdown of Indonesia’s Labor Force by Sector, 2000–08 82.4 94.2 45.0% 49.9% 2.0% 2.4% 100% 1.8% 0.8% 38.3% 35.3% 1.7% 0.9% Mature economy average, 2007 (% of total employment) Total change in employment, 2000 - 2008 (Million jobs) Primary Resources 3 1.3 Labor-intensive manufacturing 2 -0.4 Capital-intensive manufacturing 6 0.4 Knowledge-intensive manufacturing 5 0.1 Labor & Capital intensive services 42 7.0 Knowledge-intensive services 17 0.2 Health, education and public services 26 3.3 0.7% 0.6% 9.1% 11.4% 2000 2008 Source: Based on data from MGI 2012; UNIDO 2012; ILO 2012. Note: The number of employees engaged in manufacturing activities are based on the UNIDO statistics while the rest are based on the ILO. 74 3.1.4 Education Following independence in 1957, and as a result of the economic development plans during recent decades, Indonesia succeeded in increasing overall access to education. Since the 1970s, Indonesia was keen on maximizing school enrollment through building schools across the country. The national targets regarding education were to maximize primary enrollment, ensure equal school admission opportunities between economic classes, and improve the quality of education while considering economic and societal needs (World Bank 2004). But several challenges have slowed the government’s efforts in achieving such objectives. The main challenge rests in the quality of education. The schooling facilities are generally worn out and in low-quality condition, especially in poorer regions of the country. Additionally, the schooling system suffers from a lowerquality teacher base with an overall skills gap between teachers and the set curriculum. Another challenge facing education is a result of the rapid expansion experienced in the early 1970s, which aimed to maximize enrollment levels but in fact concentrated on increasing the number of schools rather than controlling the productivity and quality of the schools. This was coupled with relatively low government spending on education, which ranged between 2.5 percent to 3.5 percent of GDP over the past decades. The highest level of government spending in recent years was 3.5 percent of GDP in 2009, which was still lower than neighboring countries such as Malaysia and Thailand (UN 2010). In 1997 the Asian economic crisis hit Indonesia, and resulted, among other things, in raising the inflation rates especially in food commodities (Pradhan 2001). Household expenditure as a result was affected severely and this caused household budgets on education to be reduced, thus threatening to ruin the educational progress (in enrollment levels) that Indonesia had made in the previous decade. Household expenditure on education declined by nearly one-third from 1998 to 2000. The government was successful, however, in making a quick recovery to avoid the possible threats of such a crisis by launching a scholarship program for poor families and creating a school grant program to diminish the negative effects of the situation. Looking at the education indicators, shown in Table 3.3, literacy rates are quite high in Indonesia, at 99.5 percent for youth aged between 15 and 24 years. Enrollment levels as mentioned above were also high at 95.9 percent, while secondary and tertiary showed lower levels, at 67.3 percent and 23.1 percent respectively. On the quality of primary education, Indonesia ranked 55 out of 139 countries. According to the Global Competitiveness Report, in 2011 the quality of the educational system in higher education and training revealed a competitive advantage and was ranked at 40 points. Table 3.3 Indonesia’s Educational Indicators Compared to Select Countries (2010) Literacy rate (%) 70.1 — 90.3(a) 92.2(b) 99.7 93.1 — 88.7(c) 73.2 98.8 73.2 Youth (1524) 73.1 — 98.1(a) 99.5(b) 99.8 98.4 — — 77.3 99.6 87.4 — — Adult (15+) Angola Australia Brazil Indonesia Kazakhstan Malaysia Norway South Africa Tanzania T&T Uganda UK School enrollment (%) Primary Secondary Tertiary Public expenditure on education (% of GDP) 85.7 97.1 94.1(b) 95.9 89.5 94.1(e) 99.1 85.1(a) 98.0(b) 93.9 90.9 11.5(a) 85.5 82.0(b) 67.3 88.2 68.7(5) 93.9 — — — — 3.7 79.9 36.1(a) 23.1 38.5 40.2(a) 74.4 — 2.1 40(b) 4.2(a) 3.6 5.1(a) 5.4(b) 3.5(b) 3.1(a) 5.8(a) 6.5(b) 6.0 6.2 3.8(d) 3.2(a) 99.6(a) 96(a) 58.5(a) 5.4(b) Source: Based on data from Gomes and Weimer 2011; UNDP 2010; World Bank 2012b; MSTTE 2011. Note: T&T = Trinidad and Tobago; UK = United Kingdom; (a) year 2009, (b) year 2008, (c) year 2007, (d) year 2006 data. — Not available. 75 3.1.5 Business Environment The current business environment in Indonesia can be characterized by the fast pace of reform coupled with general high levels of optimism. The country has been moving from the planned market economy toward a decentralized economy, and currently enjoys a stable political and economic outlook (World Bank 2010a). The business environment has also been positively affected by the country’s fast recovery from the global economic slowdown, together with the overall reforms and decentralization policies that improved the economic growth and outlook. Several issues, however, remain, with the most problematic factors being government bureaucracy and corruption (Schwab 2011), following the low quality of the country’s infrastructure. Reforms have successfully reduced the startup time for a new business by 70 percent, from 151 days in 2006 to 45 days in 2011. Additionally, the number of procedures required was also reduced from 12 in 2006 to 8 in 2011. The time spent to get construction permits was reduced by 15 percent from 186 days in 2005 to 158 days in 2011 (World Bank 2012a). But Indonesia remains well below the OECD average, which requires only 5 procedures to start a business, taking around 12 days. Table 3.4 provides a snapshot of doing business indicators in Indonesia. Table 3.4 Indicators for Doing Business in Indonesia Compared to OECD Average Indonesia OECD 1. Starting a Business Indonesia OECD 6. Protecting Investors Procedures (#) 8 5 Extent of disclosure index (0-10) 10 6 Time (days) 45 12 Extent of director liability index (0-10) 5 5 Cost (% of income per capita) 17.9 4.7 Ease of shareholder suits index (0-10) 3 7 Paid-in min capital (% income per cap) 46.6 14.1 Investor protection strength (0-10) 6 6 Rank (Change in rank from 2011) 46 (-2) Rank (Change in rank from 2011) 155(+1) 2. Dealing with Construction Permits 7. Paying Taxes Procedures (number) 13 14 51 13 158 152 Time (hours per year) 266 186 Cost (% of income per capita) 105.3 45.7 Profit tax (%) 23.7 15.4 Rank (Change in rank from 2011) 71 (0) Labor tax and contributions (%) 10.6 24 0.1 3.2 34.5 42.7 Time (days) Payments (number per year) Other taxes (%) 3. Getting Electricity Total tax rate (% profit) Procedures (number) 7 Time (days) 5 108 103 Cost (% of income per capita) 1,379.0 92.8 Rank (Change in rank from 2011) 161 (-3) 4. Registering Property Rank (Change in rank from 2011) 131 (+3) 8. Trading Across Borders Documents to export (#) 4 4 Time to export (days) 17 10 644 1032 Cost to export (US$ per container) Procedures (number) 6 5 Documents to import (#) 7 5 Time (days) 22 31 Time to import (days) 27 11 10.8 4.4 Cost to import (US$ per container) 660 1085 Rank (Change in rank from 2011) 39 (-1) Cost (% of property value) Rank (Change in rank from 2011) 99 (-3) 5. Getting Credit 9. Enforcing Contracts Strength of legal rights index (0-10) 3 7 Time (days) Depth of credit information index (0-6) 4 5 Cost (% of claim) Public registry coverage (% of adults) 31.8 9.5 Private bureau coverage (% of adults) 0 63.9 Rank (Change in rank from 2011) Procedures (number) Rank (Change in rank from 2011) 570 518 122.7 19.7 40 31 156 (-2) 126 (-10) 10. Resolving Insolvency Time (years) 5.5 Cost (% of estate) 18 9 13.8 68.2 Recovery rate (cents on the dollar0 Rank (Change in rank from 2011) 1.7 146 (+3) Source: World Bank 2012a. Note: Ranking is out of 183 countries. Despite the reforms and impressive growth rates, Indonesia’s business environment is still weighed down by the 32 years of centralization of authority, corruption, and weak governance of the Suharto rule. In 1997 it 76 was estimated that corruption cost Indonesians 63 percent of GDP (Idris 2012). Between 1999 and 2003, several legislative efforts were adopted to combat corruption. The Clean Government Act and the Commission for the Eradication of Corruption (KPK) have been successful in prosecuting numerous corrupt officials in highranking positions, and have legally won all law suits in the anti-corruption courts; however, the fight for a clean transparent economy is still ongoing, and corruption levels remain of concern (Idris 2012). In a recent survey done by PricewaterhouseCoopers (PwC), it was revealed that the recent high-profile arrests in relation to corruption had made a positive impact on the perception of Indonesia’s commitment to fighting corruption (PwC 2012b) Indonesia’s governance indicators over the past decade reveal that progress has been achieved in the country’s political stability and its fight over corruption. Despite such progress, Indonesia remains well below the OECD standards as shown in Figure 3.5. Figure 3.5 Governance Indicators in Indonesia Compared to OECD Average Voice and Accountability 100 Control of Corruption Political Stability/Absence of Violence 50 0 2000 Indonesia 2000 2010 Indonesia 2010 2010 OECD 2010 Rule of Law Government Effectiveness Regulatory Quality Source: Adapted from Kaufmann, Kraay, and Mastruzzi 2011. As for the state of Indonesia’s infrastructure, it also poses obstacles to the overall country’s efficiency. The Global Competitiveness Report of 2011 ranked the inadequate supply and quality of infrastructure as the third problematic factor for doing business in Indonesia (Schwab 2011). With a vast area and regional differences, the country had a poor ranking in the quality of its infrastructure. Road facilities were ranked 82 among 139 countries and ports infrastructure was ranked 96th. Electricity supply was also of concern as it was rated worldwide in the lower quartile with 97 points out of 139. Other facets of the country’s infrastructure such as telephone lines and air transport revealed a better standing, but remain in poor condition in relation to other countries. 3.2 The Petroleum Sector 3.2.1 The Petroleum Sector in the Economy The petroleum sector has been a major pillar in the country’s economy, contributing to its development for over a century. A key feature of this sector is the increasing role of gas, which is replacing oil as the key natural resource in Indonesia. With declining oil outputs and increasing gas exploration and discoveries, gas is becoming the primary major hydrocarbon resource in Indonesia. The mining, manufacturing, and utilities sector has been a leading contributor to the country’s GDP in the past decades. In 1970 the government began to reap the benefits of its industrial and economic plans set during the 1960s. In fact, the mining, manufacturing, and utilities sector’s contribution to GDP increased to reach 17 percent in 1970. The sector continued to contribute an increasingly higher share of GDP to reach 34 percent in 1990 and about 40 percent in 2000 (UN 2010b). In 2010 the contribution decreased to nearly 36 percent, but still constituted the largest share among other economic activities. Figure 3.6 shows the breakdown of GDP by 77 economic activity in 2010, and Figure 3.7 shows the share of the mining, manufacturing, and utilities sector to GDP. Within this framework, the petroleum sector plays a key role in Indonesia’s economy. The sector accounts for 7 percent of the country’s GDP and contributes over 25 percent to state budget revenues (IPA 2012a), while being a main source for foreign currency. In 2011 the petroleum’s sector contribution to state revenues reached $34.4 billion and oil and gas investment reached $12.8 billion (PwC 2012b). Figure 3.6 Indonesia Compared to Select Countries: Breakdown of Value-added by Economic Activity in 2010 ($ billion) 85 1,296 2,066 1,637 883 159 304 402 377 39% 38% 24 17 22% 23% 2,236 100% 7% 14% 20% 25% 15% 33% 43% 45% 5% 11% 11% 5% 6% 13% 8% 20% 18% 20% 6% 9% 50% 14% 7% 2% 7% 12% 10% 5% 5% Angola Australia 19% Brazil 3% 8% 8% 4% 1% 6% 1% 12% 8% 0% 13% 12% 6% 2% 10% 21% 36% 33% 32% 6% 24% 20% Canada 7% 8% 3% 30% 6% 16% 6% 4% 29% 19% 12% 11% 8% 8% 8% 5% 8% 13% 11% 19% 10% 9% 51% 12% 5% Indonesia Kazakhstan Malaysia Norway South Africa Trinidad & Tobago Other Activities Transport, storage and communication Construction Wholesale, retail trade, restaurants and hotels Manufacturing Agriculture, hunting, forestry, fishing 12% 14% Uganda UK 1% Mining, Manufacturing, Utilities Source: Based on data from UN 2010a. 300 35% 250 30% 25% 200 20% 150 15% 100 10% 50 Share of GDP GDP (Bn $) Figure 3.7 Indonesia: Contribution of Mining, Manufacturing and Utilities to Value-added, 1970–2010 5% 0 0% 70 72 74 76 78 80 82 84 86 88 90 92 Contribution to GDP 94 96 98 00 02 04 06 08 10 Percentage Share Source: Based on data from UN 2010a. Petroleum exports fluctuated during the past years due to several domestic and macroeconomic factors. In 1990 petroleum exports contributed to 27.6 percent of total exports, after which production levels began to decline as a result of depleting reserves and maturing basins. Indeed, the share of petroleum exports declined to 14.8 percent of total exports in 1994 (OPEC 2011), and to 8.1 percent in 1998, following the Asian economic crisis. Despite this declining share of exports, the country’s total earnings from petroleum exports remain sizeable, reaching $166 billion between 1974 and 1994 (Amuzegar 1999). In 2004 Indonesia became a net importer of oil and the country began shifting toward dependency on gas, particularly for power generation. This shift has been demonstrated by the relative increase in the number of 78 gas wells drilled. For instance, 439 gas wells were completed in 2008—a significant increase from the 2003 level of 23 wells (OPEC 2008). Several attempts to culminate the effect of oil depletion were applied, including deepwater exploration, enhanced oil recovery incentives,34 and the offering of new exploration bids.35 This shift toward gas resources was mostly evident in exports, and less so in the local market where the dependency on oil remained relatively high. Until 2002 oil satisfied 75 percent of the local need for energy (Suryantoro and Manaf 2002). This dependency on oil, however, declined in 2010 to reach 58 percent, indicating a shift to natural gas. This drove down gas exports, leading Indonesia to lose its number-one rank as the world’s largest exporter of liquefied natural gas (LNG) and it become the world’s second-largest exporter in 2010 (PwC 2012b). In terms of employment, the oil and gas sector employed over 300,000 Indonesian workers (IPA 2012b). 3.2.2 Petroleum Geography Indonesia is an archipelago composed of a collection of islands located between the Asian continent and Australia. The overall Indonesian territory consists of 13,700 islands and has a total land area of 1,919,317 square km (Satiotomo 1999). The islands are grouped according to their proximity to the five main island groups. In the east there is Sumatra Island. The capital, Jakarta, is located on the central Java Island, and to its north rests the central Kalimantan—the region of Indonesia sharing borders with Malaysia’s Sabah in the north. Sulawesi is the smaller island located east of Kalimantan, and New Guinea is toward the far eastern section bordering Papua New Guinea. Petroleum basins are spread across the whole country and are intertwined on both onshore and offshore locations. The main basins are: North Sumatra Basin Central Sumatra Basin South Sumatra Basin The Natuna Sea Sunda and Asri basins Northwest Java Northeast Java Barito Basin Kutei–Mahakam Delta Basin Tarakan Basin Eastern Indonesia: Bula (Seram), Salawati, Bintuni, and East Sulawesi Basins. The large oil basins are the North and Central Sumatra basins located north of Sumatra Island, and the Kutei basin located in the east coast of the Kalimantan region. Basins with oil reservoirs of between 1 and 5 billion barrels are the Southern Sumatra basin, the Northern Java basins, the East and West Natuna island basins located in the South China Sea, and the Bintuni basin in the east shore of New Guinea. The rest of the basins contain oil deposits below 1 billion barrels, and there are around 18 basins spread across the country. The largest in terms of deposits within the smaller category below 1 billion barrels are the Timor Sea basin in the south east, the Ceram and Sarawati basins located east of New Guinea, and the Barito and Tarakan basins located east of Kalimantan (Dousta and Noble 2007). Gas basins, on the other hand, are located in North, Central, and Southern Sumatra, in addition to Southern Java, Kalimantan Sulawesi, and Northern New Guinea (Yusgiantoro 2012). The largest in terms of reserves are the Sumatra and New Guinea gas basins. Most oil and gas fields are located onshore and in offshore shallow waters (Nordas, Vante, and Heum 2003). 34 Removal of taxes on capital goods involved in the process. Thirty-one offshore blocks were released for bidding in October 2009. The majority of the new releases were in deep-water basins. 35 79 3.2.3 Reserves, Production, and Consumption Oil and gas reserves followed different trajectories over the past decades. While oil reserves have decreased in recent years, gas reserves continued to rise. Oil reserves have reached 4 billion barrels in 2011, enduring a slow decline since the early 1980s when oil reserves consisted of around 11 billion barrels. On the other hand, gas reserves increased from 0.8 trillion cubic meters (tcm) in 1980 to 2.9 tcm in 1990. Proven gas reserves dropped heavily to 1.8 tcm in 1991 and remained below the 2 tcm level until 1996, when the upward trend regained momentum until today's levels of 3.1 tcm (BP 2011). Commercial oil production in Indonesia dates back to 1885; East Java was the first producing basin. Production of oil during the first half of the 20th century was limited. Oil did not pick up until the new government order was in place a decade after independence. Production increased significantly and an oil boom was experienced during the 1960s, to peak in the 1970s. In 1965 oil production reached 486,000 barrels per day (bpd) and continued increasing to reach a peak of 1.68 million barrels per day (mmbpd) in 1977 (BP 2011). Indonesia joined the Organization of the Petroleum Exporting Countries (OPEC) in 1962 and was one of the main producers during the 1970s. Oil production in the 1980s was also significant; however, as of 1991 it became more difficult to produce due to maturing reserves. Production began a descending trend to reach a break-even point toward the turn of the century. Indonesia became a net importer of oil in 2004, leading the country to temporarily withdraw its membership from the OPEC in 2008. Indonesia’s gas production did not start until 1967 and has quickly shown strong potential since 1975. Today Indonesia is one of the world’s most important gas exporters (Thieme, Lujala, and Rød 2007). The largest gas reserves are found in North Sumatra’s Arun and East Kalimantan’s Badak. LNG exports to the industrial East Asian centers primarily come from these two producing areas (IPA 2009a). The gas production scenario has shown impressive increases beginning in the late 1970s. In 1980 gas production reached 18.5 tcm. Year by year, gas production increased and more than doubled in one decade to reach 43.9 tcm in 1990 (BP 2011). With Indonesia’s steadily growing population, gas consumption has increased but unlike oil consumption, it remains well below production levels. In 1982 gas consumption accounted for 35 percent of production, and a decade after consumption reached 41.6 percent of production. In 2010 consumption levels reached 40.3 tcm constituting nearly half of the country’s production in that year (BP 2011). Table 3.5 provides a snapshot of the oil and gas sector and Figure 3.8 shows the progression of oil and gas consumption in Indonesia. Figure 3.8 Oil and Gas Production and Consumption in Indonesia, 1990–2011 mbpd bcfd 1,800 8 1,600 7 1,400 6 1,200 5 1,000 4 800 3 600 2 400 1 200 0 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Oil Consumption (mbpd) 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Oil Production (mbpd) Gas Consumption (mbpd) Source: Based on data from BP 2011. 80 Gas Production (mbpd) Table 3.5 Snapshot of the Oil and Gas Industry in Indonesia 2011 % Change Oil proved reserves, billion bbl Oil production, mmbpd Oil refinery capacities, mmbpd 2011 % of World Global rank 1 yr 3 yrs 5 yrs 10 yrs 4.0 0.2 28 -4.5 -6.1 1.3 -14.4 941.7 1.1 45 -5.6 -4.9 -3.1 -27.0 1141 1.2 22 0.2 5.2 -0.8 4.5 1,430.5 1.6 16 -1.1 8.7 12.6 20.8 104.7 1.4 14 0.0 -2.5 -1.2 16.0 Gas production, bcfd 7.3 2.3 44 -7.8 5.1 11.8 8.5 Gas consumption, bcfd 3.7 1.2 24 -5.9 1.5 21.1 15.4 148.2 1.2 16 -0.4 10.9 14.5 37.9 Oil consumption, mmbpd Gas proved reserves, tcf Primary energy consumption, million toe Source: Based on data from BP 2012. Note: bbl = barrels; bcfd = billion cubic feet per day; boe = barrel of oil equivalent; mmbpd = million barrels per day; tcf = trillion cubic feet; toe = tons of oil equivalent The region of Java, where the capital Jakarta is located, and the extended Madura-Bali series of islands have the largest population in Indonesia (around 80 percent) (OECD/IEA 2008) and certainly constitute the largest petroleum-consuming region of the country (IPA 2009c). Indonesia’s refining capabilities are distributed over nine plants, some of which are aging with very limited output. The total refining capacity of Indonesia is estimated at 1 mmbpd (OECD/IEA 2008). The Cilacap refinery, the largest in the country, is located in the central Java region and has a capacity of 348,000 bpd. 3.2.4 Sector Institutional Framework The governance of Indonesia’s petroleum sector has undergone several changes for over a century, from the colonial period through independence and until the recent structural reforms were assumed. Overall, the sector is characterized by strong government control over the sector’s activities. During the colonial period, petroleum-related activities in Indonesia were governed by the mining law of the government of the Netherlands (Pertamina 2011). Toward the later part of the colonial era, the United States of America’s interest in the oil and gas sector in Indonesia was evident and collaborations were made with several companies. Companies such as Standard Oil of New Jersey, Standard Oil of California, Gulf Oil, and Standard Oil of New York (today ExxonMobil) have been operating in Indonesia under joint ventures and agreements with several Dutch companies, mainly with Royal Dutch Shell. Upon independence, the government took over all operating Dutch enterprises in the country 36 (Pertamina 2011) and in 1957 the Indonesian government merged the two state-owned companies—Permina for oil and gas and Pertamin for distribution—to create Pertamina. The new fully owned state company was assigned with the full spectrum of responsibilities in exploration, production, processing, refining, transportation, and marketing of oil and gas products. By means of the Oil and Gas Law no. 44 of 1960, and the later Law No. 8 of 1971, the NOC became solely responsible for all petroleum activities in the country. The government’s interests in the oil and gas sector were carried out by Pertamina prior to 2001. With the enacting of the legislative reforms after 2001, particularly with the issuing of the Oil and Gas Law No. 22, the duties were segregated. The petroleum policy design, licensing, and regulatory functions were granted to the DGOG of the MEMR (OECD/IEA 2008). The DGOG has thus become the sole concessionaire, responsible for the preparation and management of petroleum contracts bidding process. By means of Law 22, the Executive Agency for Upstream Oil and Gas Business Activities (BPMIGAS) was created to regulate the upstream sector and act as a government body responsible for implementation of 36 The Royal Dutch Shell was the only exception, reportedly due to its wide international equity. 81 agreements. BPMIGAS effectively took over its duties after regulation 42 of 2002. BPMIGAS reports directly to the president of the republic, but it coordinates with the MEMR and DGOG and considers their recommendations before the semiannual reporting period. BPMIGAS recommends policies, signs contracts on behalf of the government, and is also responsible for monitoring the work of the contracting parties (OECD/IEA 2008). As for downstream activities, recent government regulations have also changed the institutional framework. In 1997 the government allowed local companies to partner with Pertamina in setting up refineries in an effort to increase investment in the segment and to meet the ultimate goal of supplying the domestic demand for fuel (EEPC 2002). Until 2001 Pertamina remained the regulator and distributor of fuel in the domestic market. Law 22 created the Executive Agency for Downstream Oil and Gas Business Activities (BPHMIGAS) to be the regulator and supervisor of all distribution and trading activities. BPHMIGAS supervises and regulates the availability, allocation, transportation, and marketing of natural gas for domestic and international needs. Both BPMIGAS and BPHMIGAS are state-owned enterprises whose heads are appointed by the president. The most common form of contractual agreements for petroleum activities with oil companies is PSAs, which were first signed during the 1960s. In 2001 supervision over signed PSAs with international oil companies (IOCs) was transferred from Pertamina to BPMIGAS, and was set for a 30-year ceiling (exploration phase for 6 years), with the government share set at 80 percent of the output (Nordas, Vante, and Heum 2003). Less common agreements can be enforced, including technical assistance contracts (TACs), and enhanced oil recovery contracts (EORs), which are a version of PSAs. In addition, technical evaluation agreements (TEAs), joint operating agreements (JOAs), and loan agreements (EEPC 2002) are applied. 3.2.5 Market Structure and Local Capabilities During the colonial era, the Dutch initially carried out petroleum development. The pioneering petroleum activities date back to the 19th century when Dutch geologists carried out exploration activities, following the industrial revolution in Europe (Suryantoro and Manaf 2002). The Dutch involvement was also crucial in understanding and mapping the complex geological characteristics of the Indonesian archipelago. As a result, crude oil, among other energy and mineral resources, was discovered. The first commercial oil field was found in the North Sumatra Basin in 1885, after 14 years of exploration. The discoveries continued and oil was found on Java in 1888, Kalimantan in 1898, and in the South Sumatra Basin in 1904 (Thieme, Lujala, and RĂ¸d 2007). But most of the countryâ€™s petroleum resources remained untapped until the national development days following independence. With independence following World War II, all oil resources and Dutch assets including oil fields and existing refineries were returned to the Indonesian government. The state then constitutionally took ownership and control of all natural resources including petroleum, with the objective for natural wealth to be utilized toward the welfare of the people (IPA 2009b). Exploration activities were continuously carried on after Indonesian independence. Government plans for developing oil and gas were enforced, and leveraged the technological capabilities of international oil and gas companies to further explore and develop petroleum resources in the country. As a result, the 1960s and 1970s witnessed large increases in reserves and production. The discovered oil and gas became the catalyst for further development funding. Upstream exploration and production (E&P) activities were dominated by the IOCs in the early periods. Although the early days were under Dutch colonial control, joint ventures and mutual understandings with American companies were realized during that period. As mentioned above, companies such as Standard Oil of New Jersey, Standard Oil of California, Gulf Oil, and Standard Oil of New York have been the major players in Indonesia. Toward the 1960s, Shell/BPM, STANVAC, and Caltex (Standard Oil and Texaco) dominated E&P (IPA 2009b). In later periods, after the national reclaiming of Dutch assets, the American firms with PSAs with Pertamina have dominated the scene (Nordas, Vante, and Heum 2003). It was estimated that nearly 45 percent 82 of the country’s oil was carried out under Chevron’s E&P wing—triple the oil output of Pertamina (Pillai 2010). In 2000 only 3.3 percent of oil production was attributed to Pertamina as an operator (Nordas, Vante, and Heum 2003). Today, and with over 200 active PSAs, Indonesia enjoys a diverse base of upstream PS contractors that include IOCs, NOCs37 from other countries, and local and international independents. As for the downstream sector, the legal framework has played a significant role in its development. Prior to the new oil and gas law, Pertamina had complete monopoly over the sector. The national company owned and operated the refineries in the country, the franchising of gasoline stations, and the retail trade. In 2001 Law 22 substantially changed the role of the national oil and gas company. The law liberalized the downstream business and the 2003 Decree no. 31 converted Pertamina from a state-owned enterprise to a limited liability company called PT Pertamina with the majority of the shares owned by the state, and with an outlook for privatization to occur in the near future (Nordas, Vante, and Heum 2003). PT Pertamina became an equal to private sector commercial oil and gas companies (Twomey, Watkins, and Galuh 2004), and is similarly required to contract with BPMIGAS. The United States and Japan account for 60 percent of the imported oil and gas field equipment to Indonesia. Since most of the petroleum fields are onshore and require average sophistication and technology, a transfer of knowledge to local capabilities was evident. Indonesia was able to cater to the downstream sector through developing oil field services and equipment. The value of oil and gas field equipment was $459 million in 2000, estimated close to half the total market for OFS in 2000 (Nordas, Vante, and Heum 2003). Local capabilities exported to the international market as well—161 million worth of OFS equipment were exported to Malaysia, Thailand, Brunei, and China. By 2003 around 200 local firms were operating in the downstream sector (Nordas, Vante, and Heum 2003). Although there are many local companies, their capability to supply for upstream activities of E&P was limited to the large local companies (EEPC 2002). The biggest share goes, however, to the IOCs, especially U.S.-based companies, due to the high-level technological advantage of their equipment and to the American common industry standards adopted by Indonesia in most of its oil gas operations (EEPC 2002). 3.2.6 Management of Petroleum Wealth Unlike other hydrocarbon-rich countries such as Kazakhstan, Norway, or neighboring Malaysia, Indonesia has not introduced a national oil fund to manage its oil wealth. Petroleum wealth, and particularly oil, was instead spent toward internal development (Eifert, Gelb, and Borje Tallroth 2003). With the exception of Pertamina’s government bailout of 1974, the windfall of oil revenues in the 1960s, 1970s, and onward were for the most part allocated to economic development programs of vital importance for the country and the people of Indonesia. Achieving national food security and reducing poverty was the government’s priority during the era following independence. Poverty levels during the 1970s period were high, estimated at the time to be close to 40 percent of the population (more than 50 million people) (Asian Development Bank Institute 2005). As a result, the government was keen to invest oil windfalls in improving social and economic conditions primarily in the formation of human capital and development of the country’s poor infrastructure, especially in the lessdeveloped and remote rural areas (Amuzegar 1999). Poverty levels were successfully reduced to nearly 11 percent of the population in 1996 (Asian Development Bank Institute 2005). In addition, the country’s abundant gas reserves were utilized to drive forward links in the country (Eifert, Gelb, and Borje Tallroth 2003). The following Repelitas concentrated the oil windfalls on diversifying the resource-based industries and substituting lighter industry into heavier manufacturing such as petroleum refining, steel and aluminum processing, LNG development, fertilizers, paper, and cement (Amuzegar 1999). The tides changed for Indonesia, as the country became a net importer of oil in 2004. The government was often criticized in later years for its poor management of petroleum wealth and for its failure to encourage 37 CNOCC of China and INPEX of Japan. 83 investment in further exploration of oil resources. Oil prospects in offshore Natuna were left untapped (Hertzmark 2011). Reportedly, the market lacked, among other things, the sufficient and accurate data to motivate investments in oil exploration (Natural Gas Asia 2012). To counter this position, and in an effort to extend the life of oil resources, Indonesia is considering establishing a petroleum fund. The fund will be stipulated for in the new oil and gas law that is being drafted. The petroleum fund will be set to receive approximately 5 percent of nontax state revenues from the oil and gas sector to finance the construction of core infrastructure as well as for research and development. As a result, the government aims to offer big investors sufficient data on oil and gas reserves (PT. Bina Media Tenggara 2012). 3.3 Local Content Policies 3.3.1 Policy Objectives As stipulated by the law of 2001, the main objective behind LCPs is to develop local capabilities that enable domestic companies to compete in the national, regional, and international landscape of OFSE. This is to be achieved in a transparent and competitive way (DGOG 2011a). Another source reflecting objectives behind LCPs are the vision and strategic directions of BPMIGAS. The regulator’s vision is to “be a proactive and trustworthy partner in optimizing the benefits of the upstream oil and gas industry for all stakeholders while becoming one of the Nation’s engines in mobilizing different economic and industrial activities” (BPMIGAS 2011b). To this end, a pillar of BPMIGAS strategy is to “prioritize domestic/regional human resources roles, and utilization of goods and services in oil and gas industry.” More specifically, the head of BPMIGAS set the aspired level of local content at 50 percent by stating in 2009 that “half of the total budget of oil and gas projects must be spent domestically in order to increase local content” (MOEMR 2009). 3.3.2 Policy Tools To achieve the above-mentioned objectives, BPMIGAS has launched a holistic set of policy tools based on a detailed assessment of domestic capabilities. Next, we discuss LCPs aimed at raising the level and participation of local upstream capabilities, increasing domestic sourcing of goods and services, and raising the contribution of the domestic banking sector in financing procurement transactions. The following LCPs apply to upstreamrelated activities, noting that only Indonesian entities can engage in downstream activities (OSP 2011). Local Content in the Labor Force In 2005 BPMIGAS published a set of guidelines on the management of human resources in PSAs. The guidelines aimed at accelerating the development of local capabilities and increasing the share of spend on Indonesian personnel to 75 percent by 2010.38 The guidelines were extended and reviewed in 2008. Overall, BPMIGAS deploys a set of regulations related to the recruitment, training, and career progression of the workforce engaged in upstream activities. All PS contractors need to get the approval of BPMIGAS on the size and structure of the operating organization. In addition to that, the recruitment of any domestic or foreign workforce requires the approval of the regulator. In general, foreign manpower can be recruited only in case no domestic capabilities can be found. It is noted that BPMIGAS imposes targets for the recruitment of Indonesian workforce by skill level and by phase of development (that is, targets differ between development phase and production phase). Under some contracts this is done at the regional level for villages directly affected by the oil and gas operations. Similarly, companies operating in the downstream sector must give preferences to local employment. More specifically, recruitment shall be done in coordination with regional governments and priority must be given to people residing in the area of operations. Concerning the salaries and benefits extended to national staff, 38 Taking into account the costs and benefits of such actions. 84 BPMIGAS imposes caps for cost-recovery purposes (PwC 2012a). Here, industry advocates are calling for removing the caps and shifting to a market-based competitive salary setting for both expatriate and local workers (IPA 2012b). Under the contractual agreements, PS contractors are required to establish and deliver capability development programs for local personnel. Among the various programs, PS contractors deploy: Structured mentoring system that allows junior Indonesian personnel to be taught, coached, and counseled by more senior staff39 Educational and training programs International career development programs that include swap and technical development exchange between the PS contractor Indonesian employees and expatriate ones in different geographies Internationalization of Indonesian personnel (that is, recognizing that Indonesian personnel capabilities are in line with the PS contractor’s global competencies) Overseas and domestic on-the-job training (BPMIGAS 2005). These programs are part of the annual work plan and budget-reviewing process carried out by BPMIGAS. Incurred costs are cost recoverable. Concerning career progression, all expatriate positions should include a succession plan that lays out the Indonesianization plan for the position. Violating any of the above stipulations subjects the related incurred cost to be excluded from cost recovery. Concerning providers of OFSE, PS contractors are encouraged to offer training programs about the operating procedures of the PS contractors, procurement regulations, as well as health, safety, and environmental issues (BPMIGAS 2011c). Domestic Procurement of Goods and Services In 2009 BPMIGAS launched a new set of procurement guidelines reflecting a holistic approach to achieving local content objectives. The guidelines were reviewed and extended in 2011. Under the procurement guidelines, PS contractors must give priority to domestic sourcing of goods and services such that they “use, maximize or empower domestic products that meet criteria of quantity, quality, handover time and price” (MoI 2011). The left-hand side of the policy statement is translated into specific actions in three categories of domestically produced goods40: Mandatory goods. Primary goods for exploration and production where there exists at least one domestic manufacturer who enjoys a minimum local content plus Company Benefit Weight (BMP)41 level of 40 percent. Maximized goods. Primary goods that have been produced domestically where there exists at least one domestic manufacturer who enjoys a minimum local content level of 25 percent and no domestic manufacturer with a local content plus BMP of 40 percent. Additionally, this category includes supporting goods where there exists at least one domestic manufacturer who enjoys a minimum local content level of 25 percent. Empowered goods. Goods where there exists at least one domestic manufacturer who enjoys a minimum local content level of 5 percent and no domestic manufacturer with a local content of 25 percent. The list of goods by category as well as details on domestic suppliers (names and addresses of the producers, specification, standard, capacity, value of local content) are provided annually in the Buku Apresiasi Produksi Dalam Negeri (APDN) book published by MIGAS (MoI, 2011).42 The procurement of mandatory goods is carried out via a limited bidding process where all domestic manufacturers with a minimum local content of 15 percent are invited. To optimize the procurement of Every expatriate should act as a mentor. A domestic company is one with at least 50 percent of its shares being owned by an Indonesian citizen, the state, or a regional government. 41 Discussed below. 42 Information can be found on http://www.migas.esdm.go.id/apdn/. 39 40 85 mandatory goods across all upstream operations, BPMIGAS may elect to carry out the procurement process on behalf of PS contractors43 through a joint contract strategy. For maximized goods with contract value greater than $100,000, procurement is done by inviting all domestic manufacturers with a minimum local content level of 10 percent. This is done via a limited bidding process for primary goods and a public one for supporting goods. For empowered goods with a contract value above $100,000, procurement is done by engaging all domestic manufacturers with a minimum local content level of 5 percent. Like maximized goods, this is done via a limited bidding process for primary goods and a public one for supporting goods. A summary of the definition of the three groups of goods and respective procurement strategies is presented in Table 3.6. It must be noted that in case the number of registered bidders for maximized or empowered goods is less than three, then the bid is extended and ultimately open to all suppliers (BPMIGAS 2011c). Table 3.6 Indonesia: Definition of Goods and Respective Procurement Strategy Category Mandatory Goods Maximized Goods Primary Supporting Empowered Goods Primary Supporting Local content (LC) requirements At least one domestic manufacturer has LC + BMP ≥ 40% At least one domestic manufacturer has LC ≥25% and no domestic manufacturer has LC+ BMP ≥ 40% Contract value Procurement method Any Limited Bidding > $100,000 Limited Bidding Public Bidding At least one domestic manufacturer has LC < 25% and no domestic manufacturer has LC ≥ 25% > $100,000 Limited Bidding Public Bidding Invited bidders Domestic manufacturers with minimum LC achievement of 15% Domestic manufacturers with minimum LC achievement of 10% Domestic manufacturers with minimum LC achievement of 5% Source: Based on data from BPMIGAS 2011c. For the procurement of services, bidders must commit to a minimum local content level of 35 percent 44 for contracts with a value more than $100,000. Domestic companies45 get a priority such that they are extended the privilege to form a consortium with national companies46 or foreign ones when in-house capabilities are not adequate. In case no domestic company participates in the bid, this privilege is extended to national companies. Additional procurement rules concerning the mode of delivery, share of contract value going to a domestic company,47 amount of physical work to be carried out in Indonesia, and subcontracting rules are determined based on the type of the service procured. To this end, BPMIGAS splits services into two types: engineering, procurement and construction (EPC) services, or other/combined services. Additional factors affecting the procurement rules include the contract value and type of asset. To illustrate the rules, consider the procurement of a non-EPC service; in case no domestic company possesses required capabilities, the company is suggested to partner with another domestic company, a national, or a foreign one. Under the latter two modes of partnership, at least 30 percent of the contract value must be carried out by the domestic company and at least 50 percent of the work must be carried out in Indonesia. A summary of the procurement requirements across the different types of services is provided in Table 3.7. In that case, PS contractors are represented on the procurement committee. Or as determined by BPMIGAS. 45 A company with more than 50 percent of its shares being owned by an Indonesian citizen, state, or regional government. 46 A company with less than 50 percent of its shares being owned by an Indonesian citizen, state, or regional government. 47 Or consortium of domestic companies. 43 44 86 Table 3.7 Indonesia: Procurement Requirements for Services Service type Other/ Combined Contract value (CV) Any EPC 100,000 < CV ≤ $5 Mn Asset type Any Onshore Offshore Onshore $5 Mn < CV ≤ 200 Mn 200 Mn < CV Privileged modes of delivery for domestic companies (in case of no adequate local capabilities) Min share of CV going to DC Consortium with NC or FC 30% Consortium with NC, DC acting as lead 50% Consortium with NC, DC acting as lead Offshore Consortium with NC or FC, DC acting as lead Onshore Consortium with NC or FC, DC acting as lead Offshore Consortium with NC or FC Min share of physical execution in countrya Max value of subcontr act to FC — 50% 70% 50% 50% 50% 50% 50% 50% 50% Source: Based on from BPMIGAS 2011c. Note: DC = domestic company; NC = national company; FC= foreign company. (a) If not met, this is reduced to 30 percent. — Not available. Any of the requirements (that is, local content, value of contract implemented by domestic company, amount of physical work carried out in Indonesia) may be compensated by a loan from a state-owned enterprise (BUMN) or a regional government-owned enterprise (BUMD).48 This action aims at increasing the role of local banks in financing procurement transactions given their historically limited role in that, underpinned by limited competitiveness, compared to international banks. Going back to the overarching policy statement, the right-hand side of the statement mentions four criteria that domestic suppliers must meet for the procurement strategies to apply. The quantity criterion refers to the ability of domestic manufacturers to meet the demand given installed capacity. This said, PS contractors should include “reasonable” handover and delivery schedules in their procurement plans. The quality criterion requires local manufacturers to meet Indonesian National Standards 49 or minimum industry requirements. As for the price criteria, upon meeting quantity, quality, and handover time requirements, suppliers of goods and services gain a price preference based their local content levels as well as their company status. A price preference is given for goods that include a minimum of 25 percent of local content. For services, a price preference is given in case of a promise or commitment to achieve a minimum of 30 percent of local content. For goods, the maximum price preference given is 15 percent applied proportionally on the local content level. For services, the maximum price preference offered is 7.5 percent, calculated proportionally to the local content commitment. In addition to the price preferences based on local content, companies can gain a higher level of price preferences based on the company status (that is, whether the company is a domestic one or not). The schedule of requirements and associated price preferences is summarized in Table 3.8. These are business entities with at least 50 percent of capital or shares owned by the Government of the Republic of Indonesia/regional government. Additional rules on the loan are laid out in the procurement manual. Additional rules related to the cap on the loan are outlined in the procurement guidelines. 49 Mainly derived from U.S. industry standards. 48 87 Table 3.8 Indonesia: Summary of Price Preferences Based on Local Content (LC) Level and Company Status Category Minimum LC Goods 25% Company status Other requirements Price preference Any None A maximum of 15% Proportional to LC Domestic None Additional 2.5% Flat Any None A maximum of 7.5% Proportional to LC At least 50% of the service is Additional 7.5% performed by a Domestic Domestic acting as Company; and a lead of a At least 50% of the service is Additional 5% consortiumb carried out in Indonesia Domestic Services 30%a Schedule Flat Flat Source: Based on data from BPMIGAS 2011c. Note: (a) Promise/commitment to achieve 30 percent; (b) Consortium with national company that has a status of foreign investment and/or with foreign company. The local-content-related price preference (Pb) is applied on the direct production cost of the goods (HPb). For instance, the price preference does not apply on the transportation and handling component of the cost (TH). As such, the evaluation price reflecting the price preference for local content is expressed as: EP L C 1 HP b 1 Pb As for the company status price preference (PSp), that is applied on the total cost components, which includes a noncost component (NC). To this end, the bid evaluation price (BEP) can be defined as: BEP 1 EPL CTH NC 1 PSp An example for the evaluation of a bid price in comparison to the contract value is presented in Table 3.9. Table 3.9 Indonesia: Example of Calculating a Bid Evaluation Price for the Supply of a Good Component A Direct production cost (HPb) Transport and handling (TH) Total cost components Company status Noncost component Total Local Content Contract Value ($ Mn) Value ($ Mn) % B c d=c/b 25.00 7.00 28.00% 1.50 26.50 Manufacturer has domestic company status (55% of shares owned by Indonesian) 2.00 28.50 Price Preference % f=d*15% 4.20% 2.50% BEP ($ Mn) g 23.99 1.50 25.49 24.87 2.00 26.87 Source: Based on data from BPMIGAS 2011c. Suppliers can gain a value of appreciation on the local content level achieved, called BMP, in case a company’s investment in Indonesia is directed toward the development of a domestic industry. BMP allows PS contractors (through their suppliers and service providers) to increase the level of achieved local content by up to 15 percent. As shown in Table 3.10, companies can gain a BMP through four activities. Each activity has defined criteria that are translated into weights applied on the maximum BMP level of 15 percent. A maximum weight limit applied also to each activity (BPMIGAS 2011c). 88 Table 3.10 Indonesia: Activities, Criteria, and Weights for the Local Content Level Achieved # I II Local industry development activities Empowering micro and small businesses as well as small cooperatives by means of partnerships Certificate owning: - Health and work safety (SMK3/OHSAS 18000) (30%) - Environmental management (ISO 14000) (70%) III Community development IV After sales service facilities Criteria Weight Minimal Rp 500 Mn 5% Any multiples of Rp 500 Mn 5% None 0% Available 6% None Available Minimal Rp 250 Mn Any multiples of Rp 250 Mn Minimal investment of Rp 1 Bn Any multiples of Rp 1 Bn 0% 14% 3% 3% 5% 5% Maximum weight limit BMP values 30% 4.5% 20% 3.0% 30% 4.5% 20% 3.0% Source: Based on data from BPMIGAS 2011c. On another front, the new procurement rules include stipulations offering small- and medium-sized enterprises (SMEs) with cash advances based on the financial conditions of the PS contractors. Here it must be noted that the procurement rules outline caps on the contract values that SMEs can bid for. Failing to deliver the local content targets specified in the contract subjects the goods or services provider to administrative and financial penalties. Administratively, a goods or services provider is prohibited to bid for future contracts under the relevant PS contract over the following year. Furthermore, in case the goods or services provider fails in delivering local content commitments under other contracts within the year of administrative sanctions, the provider is placed on the blacklist. As for the financial penalty, this is defined based on the results of the original bid evaluation process: In case the achieved lower local content level does not change the rank of the winning bidder, the penalty is the difference between the BEP of contract realization and the original BEP In case the rank changes, then the difference between the contract value of the winning bid and that of the first-rank bid under the local content level upon implementation is added to the above If realization of local content goods is less than that stated in the contract, and the goods/service provider changes source of procurement of goods partially or entirely from a domestic source to a foreign source then the PSA contractor must use imported facilities, the relevant goods/service provider is imposed with additional sanctions as much as the value of import duty (ID) plus a charge for the purpose of import (CPI) from the value of domestic components that cannot be fulfilled. Considering the example of Table 3.11, in case the winner of the bid (provider A) achieves a local content level of 22 percent upon implementation then it is no more eligible for the price preference. In that case, and considering the bid evaluation results outlined in Table 3.113.13, the monetary penalty is equivalent to $2.13 million ($1.63 million being the difference between the BEP of contract realization and the original BEP, and $0.5 million being the difference between the contract value of the winning bid and the second-rank one). Table 3.11 Indonesia: Calculating the Penalty Given for Unachieved Local Content, and Rank Changes Bid phase Implementation phase Goods/ service provider Value ($ Mn) LC BEP ($ Mn) Ranking LC BEP ($ Mn) Ranking A B C 28.5 27.5 28.0 28% 0% 25% 26.87 27.5 27.10 I II III 22% 0% 25% 28.50 27.5 27.10 III II I Source: Based on data from BPMIGAS 2011c. Importing goods and services requires the approval of BPMIGAS. For goods, the approval is granted in any of the following cases: Goods are not yet produced domestically 89 Domestic production capacity does not enable timely delivery or does not meet minimum quality standards Price of domestic sourcing, including local content preference, is not competitive with imports (that is, higher than the lowest price of cost, insurance, and freight [CIF] of imported products) (BPMIGAS 2011c). For IT software, BPMIGAS’ approval is granted in case of intellectual property requirements when there is no local representative agent for the supplier. To complement the above policies, MIGAS issues OFSE companies certificates for business ability. The certificates are issued based on a formula that weights ownership status, production ability (output, standard/quality, capacity, and local content and company benefit weight values), management (quality/environment/work safety and health), marketing network, and after-sales service. Based on the evaluation process, companies are categorized as follows: Incompetent in case the evaluation value is below 40 (here a certificate is not issued) Competent with one star in case the evaluation value is equal or above 40 and below 60 Competent with two stars in case the evaluation value is equal or above 60 and below 80 Competent with three stars in case the evaluation value is equal or above 80 (DGOG 2011a). At this stage, the rating of the companies is not part of the tendering process. Concerning the aggregation and splitting of procurement packages, BPMIGAS allows the aggregation of procurement packages given three criteria: (i) it is done based on technical and economic considerations, (ii) it is not a type of work that should be carried out by small-scale enterprises including small cooperatives, and (iii) it does not hinder the utilization of domestic capabilities. On the other hand, splitting of procurement packages is permitted in case, among other criteria, it intends to increase the level of local content or it offers business opportunities to small-scale enterprises including small cooperatives. 3.3.3 Policy Channels Today, LCPs are legislated via the: Oil and Gas Law No. 22/2001 segregating regulatory roles and commercial operations Supply Chain Management Manual PTK 007/2009 as revised in 201150 Ministry of Industry Regulation No. 16-16/2011 on local content calculation Investment Law No. 25/2007 (applicable only to limited liability companies domiciled in Indonesia and owned by Indonesian investors) Regulation No. 258/PMK.011/2011 on caps applicable to expatriate costs Company Law No. 40/2007 The 2005 Guidelines for Human Resource Management of BPMIGAS and revision of 2008 Joint cooperation contracts for upstream activities.51 3.3.4 Institutional Responsibilities Local-content-related responsibilities are mainly split between the MEMR, BPMIGAS, PS contractors, and the Department of Industry. Overall, there is no clear split of responsibilities between the ministry and BPMIGAS. The DGOG, under the MEMR, is responsible for formulating policies and laws related to local content. The directorate also engages in the execution of some aspects of the laws as it assures compliance with the issued laws. To this end, the Subdirectorate for Home Potential Empowerment is mainly tasked with: 50 51 Developing policies, norms, and criteria for local empowerment Launched in 2004 the first edition was published in 2009, and the second revision published in 2011. Local content is not a parameter in awarding PSAs. 90 Collecting and reviewing information related to domestic procurement of goods and services Crafting work procedures and guidelines for importing goods and the expatriate workforce Preparing plans for employment nationals and the expatriate workforce Publishing the APDN book for goods and services. In addition, the subdirectorate engages in labor productivity improvement initiatives (DGOG 2012). BPMIGAS is tasked with representing government interests in PSAs. In relation to LCPs, BPMIGAS leads the implementation of laws issued by the DGOG as it issues guidelines to facilitate implementation of laws. Among the various responsibilities, BPMIGAS: Reviews and approves work plans and PSA annual budgets (these include procurement plans) Regulates the implementation of local-content-related policies issued by the DGOG Approves goods and services procurement bid plan and award for contract values of $5 million and above Carries out post-implementation audits for procurement activities with contract value below $5 million Approves cost-recovery items Develops and implements procurement guidelines Monitors and reports local-content-related performance. In driving the local content agenda, BPMIGAS coordinates with the Department of Finance, Department of Manpower and Transmigration, Department of Industry as well as multiple industry players. For instance, the Department of Industry is responsible for issuing local content certificates to goods manufacturers. PS contractors are responsible for the implementation of recruitment and procurement activities in accordance with sectoral procedures and regulations. 3.3.5 Interlinks Indonesia joined the World Trade Organization (WTO) in January of 1995. Under the General Agreement on Trade in Services (GATS), Indonesia has commitments for professional and business services, telecommunications, construction and engineering services, educational services, financial services, health services, tourism, and maritime cargo handling. In October 2010 U.S. and European Union (EU) representatives raised their concerns around the LCPs pursued by Indonesia in the mining sector.52 The U.S. commission filed a list of four questions requesting clarifications on the LCPs pursued by Indonesia (WTO 2010). The answers provided by Indonesia were followed by a new series of questions filed by the U.S. commission in 2012. In a nutshell, the U.S. questions were centered on violations of LCPs with terms under the GATS. Indonesia’s response denied that the country’s commitments violated any of the terms. For instance, concerning the country’s commitment for civil engineering under the GATS, Indonesia stated that any foreign engineering firm shall establish a joint venture with a domestic company in case it wants to engage in business in Indonesia (WTO 2012a). 3.3.6 Monitoring and Measuring Tools BPMIGAS monitors the level and evolution of Indonesianization through annual reviews of the organization structure and the recruitment rules put in place. In addition, the regulator deploys an integrated online system allowing it to monitor compensation spending, delivered educational and training programs, and succession plans put in place. Concerning the domestic sourcing of goods and services, PS contractors must agree with BPMIGAS on local content targets over a certain period or work package, as part of the procurement planning process. To this end, a BPMIGAS template must be filled by PS contractors specifying details related to procurement 52 Relating to backward and forward links. 91 activities and targeted local content levels. Subsequently BPMIGAS monitors the achievements of PS contractors against set targets for the year under consideration as well as the previous five years. PS contractors must submit monthly reports to BPMIGAS on the procurement activities of goods and services. The reports are standardized based on forms developed by BPMIGAS and made available in the revised version of the procurement guidelines.53 Among other information, PS contractors must report on the local content level and contribution of SMEs. Local content levels for goods are demonstrated either via the APDN book published by the DGOG, or through certificates that are issued by any “government agency that deals with the industry”54 (BPMIGAS 2011c). For services, this is done via a statement letter specifying the level of local content to be achieved over the implementation of the service. The value of local content in goods resulting from verification is valid for two years (MoI 2011). The local content in goods is measured as the ratio of the price of the finished product excluding the price of foreign-made components and the price of the finished product. The prices should reflect direct material and labor costs in addition to indirect factory overheads. 55 For services, the local content is calculated as the ratio of the whole service costs excluding foreign services costs and whole service costs. The costs should reflect labor, tool/facility, and general services costs. The local content is defined based on the following criteria: Country of origin for material Ownership and country of origin for work tools and facilities—for work tools the local content level is defined based on the geography of production an ownership status of the producer, as outlined in Table 3.12 Citizenship for labor force Table 3.12 Indonesia: Local Content Levels for Work Tools Geography of production Local Local Local Foreign Foreign Foreign Ownership status of producer Domestic Foreign Joint Domestic Foreign Joint Local content level 100% 75% 75% + SODS1 x 25% 75% 0% SODS Source: Based on data from MPRI 2011. Note: Portion of stocks owned by domestic supplier (SODS). It must be noted that the calculation of local content for goods and services traces down to the second level of production of goods and provision of services. At the second level, the local content is 100 percent in case: The second-level good is produced locally The cost of the second-level good constitutes less than 3 percent of the first-level good’s production cost The accumulation of the second-level good’s cost is 10 percent, at most, of the first-level good’s production cost. In case second-level goods and services make use of third-level ones, than these are considered to be 100 percent local if supplied by a local company. For the service of equipment used in the implementation of physical work and other services, the local content level is defined as per Table 3.13. For consultancy services, the value of local content is “calculated based on value of service of the use of domestic workers, including value of cost of goods/services to support the workers’ activity.” It must be noted that imported goods sold by local companies are not considered as http://www.bpmigas.go.id/blog/2011/05/02/ptk-no-007-revisi-iiptki2011/. It is reported by the Ministry of Trade and Industry. 55 The prices should not include profits, company overheads, and output taxes. 53 54 92 domestic goods. In addition, foreign workers employed in Indonesia are not considered as domestic components (BPMIGAS 2011c). Table 3.13 Indonesia: Local Content of Value of Service of Equipment Use in Implementation of Physical Work and Other Services Geography of production Domestic Abroad Ownership status LC level 100% 100% Domestic company or Indonesian citizen National company with more than 50 percent of shares owned by a foreign citizen or foreign company National company with more than 50 percent of shares owned by foreign citizen or foreign company Domestic Abroad 75% 0% Source: Based on data from BPMIGAS 2011c. Originally, a domestic manufacturer was considered as one who produces goods on Indonesian territories regardless of the ownership status (Nordas, Vante, and Heum 2003). Today, a domestic company is one with at least 50 percent of the shares being owned by an Indonesian citizen, the Republic of Indonesia, a regional government, a state-owned enterprise (BUMN), or a regional government-owned enterprise (BPMIGAS 2011c). 3.3.7 Policy Impact on Local Content Levels Prior to the implementation of the new LCPs on procurement of goods and services, local content levels in procurement were believed to be in the range of 10 to 20 percent (EEPC 2002). As reported by Nordas, Vante, and Heum (2003), earlier policies related to the domestic sourcing of goods and services were not seen as successful. For instance, the late 1970s policy that required international companies to partner with domestic ones in delivering OFSE has led to the establishment of multiple joint ventures. While the objective of the policy is to drive knowledge transfer, it is reported that limited transfer has been achieved. Looking at the drilling sector, 48 drilling companies were registered; however, still all offshore drilling has been led by the foreign partner of the joint venture (Nordas, Vante, and Heum 2003). Today, despite the strong monitoring system in place and the strong regulatory grip of BPMIGAS over the sector, the regulator does not formally publish metrics and analysis on local content levels achieved in the procurement of goods and services. The only publicly available sources that enable the analysis of current local content levels are the 2011 annual report by BPMIGAS and the APDN book of 2011 published by the DGOG. As per BPMIGASâ€™ numbers, local content levels have increased by 18 percentage points between 2006 and 2011. But and as shown in Figure 3.9, this is coupled with a nearly 50 percent reduction in upstream investments. BPMIGAS presents the value of procurement of goods and that of services that qualify as local content, Figure 3.10, without the split in total values. Figure 3.9 Indonesia: Evolution of Upstream Investments and Local Content Levels, 2006â€“11 Bn $ % LC LC % Investment 63% 40 36.8 61% 60 54% 35 55 49% 30 43% 65 50 43% 45 25 40 20 18.5 18.3 19.4 17.1 35 30 25 15 12.2 20 10 15 10 5 5 0 0 2006 2007 2008 2009 93 2010 2011 Source: Adapted from BPMIGAS 2011a. Figure 3.10 Indonesia: Local Content Procurement of Goods and Services, 2006â€“11 ($ billion) 15.8 37% 11.8 10.8 9.0 8.0 65% 6.6 69% Services Goods 60% 63% 72% 2006 82% 28% 18% 2007 2008 40% 35% 31% 2009 2010 2011 Source: Adapted from BPMIGAS 2011a. As per the classification used in the APDN, 10 segments of goods fall under the mandatory category where at least there exists one Indonesian supplier enjoying a local content plus BMP level of 40 percent. Only two segments of supplies fall under the maximized goods category and the 28 remaining segments fall under empowered goods. Table 3.14 lists the segments of goods by local content category. Table 3.14 Indonesia: APDN Distribution of Goods by Category Mandatory Casingâ€”Tubing Wire, Cables, and Accessories Tubular Goods Marine and Offshore Installations Wellhead and X-Mas Tree Accessories Electric Power Sources Chemicals Pumps Centrifugal and Rotary Valve Fittings Oil and Oil Products Maximized Cementing Equipment and Liner Hanger Systems Wellhead Equipment and Accessories Empowered Boilers and Accessories Oil and Oil Products Building Material and Hardware Paints and Varnishes Building Material, Metals, and Hardware (Bolts and Nuts) Plant Elements and Parts Building Structure and Tanks Production Well Test and Monitoring Instruments Casing, Tubing, and Accessories Pumps, Centrifugal, and Rotary Cementing Equipment and Liner Hanger Systems Pumps, Reciprocating Chemicals Pumps, Other Types Compressor and Vacuum Pumps Switch, Control Gear, and Electrical Instruments Drilling Tools and Retrievable Production Tools Transportation Drilling Machinery, Mud Equipment, and Accessories Tubular Goods Fire, Safety, and Environmental Conservation Equipment Valve Fittings Jointing (Gaskets), Insulating Materials Wellhead Equipment and Accessories Machinery Accessories and Transmissions Wireline Tool Box and Unit Complete with Power Pack Marine Offshore and Installations Wire, Cables, and Accessories Source: Based on data from DGOG 2011b. Within each segment, the APDN lists the standards and available local suppliers with their respective characteristics (that is, local content levels, BMP rating) by subproduct type. A snapshot of compressors and vacuum pumps suppliers is provided in Table 3.15. Out of the 97 companies featured in the APDN book of 2011, only 18 companies seem to benefit from BMP appreciation. Of these companies, only one company took the maximum BMP appreciation of 15 percent while most of the remaining companies achieved BMP levels below 6 percent. 94 Figure 3.11 presents the distribution of companies by BMP value and Figure 3.12 presents the distribution by segment of activities. Table 3.15 Indonesia: Snapshot of Domestic Suppliers of Compressors and Vacuum Pumps Product # Code Type 1 2 B-24 B-24 Specification Instrument Air Compressor Package Air Compressor Package Oil Free/Oil Lubricated Air Compressor Air Compressor Package Supplier Rating Local Content (%) BMP Capacity Standard Consist of 2x100% Air Compressor on Skid 2x100% Air Dryer on Skid, 2 unit of air receiver, Interconnecting Pipe, Valve and Instrumentation, PLC Based Lead/Lag Controller Client Spec. Kota Minyak Internusa, PT 2 — — 4 Units/year Pressure range : up to 13 Bar, Capacity 1.5 kW-500 kW (6 cfm2988 cfm) •1 to 8, 61 508-1 to 7 • NAS 1638 • ISA S 5-1, 52, 5-3, 18-1, 20, 51-1, 75-1, 7517 • ISA SP 84 • SP-INS-000, 010, 015, 020, 100, 101, 120, 140, 240, 900 • SP-COR-181 Kota Minyak Internusa, PT 2 19,30 — 5 Units/year Source: Adapted from DGOG 2011b. Figure 3.11 Indonesia: Distribution of Companies by Local Content Value Achieved 8 7 1 1 1 0 BMP=15 15<BMP≤12 12<BMP≤9 9<BMP≤6 6<BMP≤3 Source: Based on data from DGOG 2011b. 95 BMP≤3 Figure 3.12 Indonesia: Distribution of Local Content Value by Segment of Activities 9 3 7 1 1 1 3 3 2 1 1 1 1 1 1 1 1 BMP=15 15<BMP≤12 12<BMP≤9 9<BMP≤6 2 1 1 2 2 1 1 6<BMP≤3 BMP≤3 Casing, tubing & accessories Oils and oil products Wellhead equipment and accessories Chemicals Paints, varnishes Wire, cables and accessories Drilling tools and retrievable production tools Pumps, centrifugal and rotary Drilling, machinery, mud equipment & accessories Transportation Fire, safety and environmental conservation equipment Tubular goods Source: Based on data from DGOG 2011b. As for the certificate of business ability, 68 companies are featured as competent ones. As shown in Figure 3.13, out of these companies, 34 companies enjoyed a rating of three stars, 30 companies enjoyed two stars, and four companies received one star. Figure 3.13 Indonesia: Distribution of Companies by Category of Certificate of Business Ability 34 30 Competent with one star in case the evaluation value is equal or above 40 and below 60; Competent with two starts in case the evaluation value is equal or above 60 and below 80; Competent with three stars in case the evaluation value is equal or above 80 4 Source: Based on data from DGOG 2011b. Concerning the involvement of the domestic banking sector in financing OFSE procurement transactions, BPMIGAS reports that state-owned banks have financed a total of $14 billion between 2009 and 2011. Looking at the local content levels in the upstream workforce, the level of Indonesianization has been maintained between 96 and 97 percent in producing PSAs between 2006 and 2011. Looking at exploration PSAs, the Indonesianization level appears to be lower, though there is a five percentage points improvements between 2006 and 2011. Figure 3.14 presents the evolution of employment in E&P PSAs by nationality. Here we note that no information is available on the Indonesianization levels by discipline. 96 Figure 3.14 Evolution of Indonesianization in Exploration (left) and Production (right) Activities (in thousand workers) Exploration PSC Contractors Production PSC Contractors 2.5 2.4 27.6 4% 10% 10% 24.7 22.2 22.2 22.5 4% 3% 3% 3% 96% 96% 97% 97% 97% 2006 2007 2008 2009 2010 4% 1.8 13% 1.6 22.1 21.3 1.9 3% 1.6 9% 1.5 17% 12% 12% 96% 90% 90% 87% 91% 83% 88% 2006 2007 2008 2009 2010 2011 97% 88% 2012E Expatriate 2011 2012E Local Source: Based on data from BPMIGAS 2011a. Looking at the development of local capabilities, the number of Indonesian employees engaged in technical development exchange, job swapping, job assignment, and internationalization has increased from 212 employees in 2008 to 396 in 2011. The evolution of engaged Indonesian workers by type of development program is presented in Figure 3.15. Figure 3.15 Number of Indonesians Engaged in Capability Development Programs, 2008â€“11 Job Swapping Technical Development Exchange 30 70 55 55 2009 2010 44 18 14 10 2008 2009 2010 2011 2008 Job Assignment Internationalization 72 69 36 2011 204 41 224 128 85 2008 2009 2010 2011 2008 Source: Based on data from BPMIGAS 2011a. 97 2009 2010 2011 References Amuzegar, J. 1999. Managing The Oil Wealth: OPEC's Windfalls and Pitfalls. I. B. Tauris. Asian Development Bank Institute. 2005. Poverty Targeting in Asia. (J. Weiss, Ed.) Cheltenham, UK: Edward Elgar Publishing Limited. 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During the Soviet era, petroleum-related policies and activities were controlled by the central government, and Kazakhstan’s hydrocarbon resources were not a priority (Johnston and Johnston 2001). Upon independence, the petroleum sector was central to Kazakhstan’s economic activity and following the major discoveries of year 2000, the sector became a catalyst for economic growth. The governance of the petroleum sector evolved in a way that reflected the country’s learning curve, and size of discoveries in addition to the political and economic environments. In this context, local content policies (LCPs) were marked by three main periods postindependence. The first period was when the country began the transition phase from 1991 to 2000, the second period began in 2000 and extended till 2010, and the third was 2010 onwards. During the Soviet era, petroleum-related knowledge and human capital used to be maintained and managed at the central level. Upon independence, Kazakhstan had to develop its own capabilities. As a first step, the country relied on international oil companies (IOCs) to develop employment and local capabilities by including obligations to this effect in the contractual agreements with these companies. In addition, IOCs were required to carry out social development programs especially in the vicinity of operations (Domjan 2004). Over this period, LCPs were regarded as corporate social responsibility (CSR) activities and were often pioneered by the companies themselves (Kalyuzhnova 2008). LCPs were lenient and not clearly defined by authorities. Additionally, during the 1990s, authorities were more interested in developing the country’s hydrocarbon resources and maximizing the government revenues from taxes (Luong 2010). As a result IOCs had regularly eluded local content requirements, procuring their goods and services from international sources and hiring locals according to their own discretion, mostly in lower-skilled personnel and trainees (Kalyuzhnova 2008). Toward the turn of the century, the local content scene began to witness some changes, marked by the introduction of the term “Kazakh content” (KC) in 2004, a term that refers to the origin of goods and services used in any resource or subsoil project, including oil and gas (MENAS 2009). But there was a lack of monitoring system and methodology for calculating KC. The period from 2000 until 2010 was marked by several trends. First, the oil discoveries in offshore fields in the North Caspian dramatically increased the country’s reserves, especially the Kashagan oil field, which is considered the fifth largest in the world. This has afforded the state a stronger ground to renegotiate contracts with IOCs and to increase its control over the sector, through the creation of a single-state oil company with monopoly equity rights and regulatory responsibilities. The government policy was also evidenced by several legal and regulatory changes that raised the bar for local content deliverables by the oil companies. On the political front, the period from the late 1990s to early 2000 saw a rise in dissent against President Nazarbayev’s rule. The year 2010 marked the start of a new era for local content characterized by well-defined policies that were strongly enforced and monitored. In fact, LCPs became central to the development of the country’s resources and overall development plan. This new local content scene cannot be understood in isolation from economic and political factors. During 2010 and subsequent years, the economic scene was recovering from the fallouts of the 2009 global crisis, which affected the country’s gross domestic product (GDP) growth and the influx of new foreign investment to both the economy and the oil sector (Ernst and Young 2011). Higher inflation and a rising unemployment rate were also observed in the period leading to 2010 (World Bank 2010). These conditions were later reflected through labor strikes that led to brutal confrontations in the oil sector (EoN 2011). 101 Kazakhstan authorities nonetheless were in the process of forming new and formalized local content measures, drawing from experiences and success stories from other countries (Yerkebulanov 2012). The surge in upstream investments encouraged positive trickle-down effects to the country’s economy. In addition, there was a stronger public sentiment toward a better utilization of oil resources. This was supported by continuous media efforts shedding light on cases where potential businesses were lost to foreign enterprises while local capabilities existed. Over the near future, more stringent enforcement of LCPs is likely to be observed. 4.1 Structural Context For over 20 years, Kazakhstan has been in a gradual transition from Soviet influence to independent governance. Although political independence was granted in 1991, a Soviet legacy carries on in several fronts of the country’s social and economic scene. Despite the growth and development achieved on the back of the discovery of natural resources, mainly oil and gas, the country still faces a number of structural difficulties. Limited access to capital, lack of adequate education, corruption, and bureaucracy are among the top challenges facing businesses in Kazakhstan (WEF 2011). 4.1.1 Economy Upon receiving its independence, Kazakhstan launched a reform plan centered on liberalization of prices and privatization. This was followed by macroeconomic stability measures upon leaving the ruble currency in 1993. Despite these efforts, the 1990s era was characterized by hyperinflation and limited growth that was highly impacted by the Russian financial crisis of 1998 (Kalyuzhnova 2008). Driven by currency devaluation and oil market dynamics, Kazakhstan’s GDP steadily increased from 1999 to 2008. Following the global recession, the country’s GDP dropped by 1.2 percent in 2009 before returning to it precrisis growth path. In 2010 Kazakhstan’s GDP per capita was approximately $9,070, the highest it had been since 1990 (World Bank 2012b). Upon leaving the ruble zone in 1993, the country experienced a period of hyperinflation (Kalyuzhnova 2008). In fact the inflation rate did not come under control until recently. In 2000 the inflation rate reached 13.2 percent, which was a significant drop from the 170 percent experienced in 1994. In 2004 Kazakhstan’s real interest rates became positive, but have since “gradually decreased from very high levels at the beginning of reforms” (Craig and others 1999). In 2010 the International Monetary Fund (IMF) directors “agreed that real interest rates should be kept positive to maintain depositor confidence, and cautioned against the use of subsidized interest rates” (IMF 2010). Projections show inflation rates in the range of 6 percent until 2017 (IMF 2012). Table 4.1 presents key economic indicators for Kazakhstan. Table 4.1 Key Economic Indicators of Kazakhstan, 1990–2010 1990 GDP (constant 2000 $, billion) 1995 2000 2005 2006 2007 2008 2009 2010 26.3 16.2 18.3 30.0 33.2 36.1 37.3 37.8 40.5 1,611.7 1,022.9 1,229.0 1,977.7 2,166.3 2,332.3 2,380.1 2,345.9 2,481.7 176.2 13.2 7.6 8.6 10.8 17.2 7.3 7.1 Exchange rate (LCU per $) 61.0 142.1 132.9 126.1 122.6 120.3 147.5 147.4 Trade (% of GDP) 82.5 105.7 98.3 91.6 92.2 94.4 75.9 73.2 21.6 7.0 5.9 5.3 6.3 9.5 10.2 GDP per capita (constant 2000 $) Inflation, CPI (%) Government debt (% of GDP) Source: Based on data from World Bank 2012b. Note: CPI = consumer price index; GDP = gross domestic product; LCU = local currency unit. Compared to neighboring countries and developed economies (for example, the United Kingdom and Canada), Kazakhstan relies more heavily on exports. Between 1992 and 2010, 4060 percent of Kazakhstan’s GDP was derived from exports of goods and services.56 In 2009 total exports were comprised mostly of 56 Over the same period the UK share of GDP from export of goods and services ranged from 20 to 30 percent. 102 merchandise (92 percent), but also commercial services (8 percent). As shown in Figure 4.1, petroleum products have increasingly dominated the basket of goods exported by Kazakhstan. In fact the share of petroleum products in the total value of exports increased from 25 percent in 1995 to 70 percent in 2010 (WTO 2012). Figure 4.1 Kazakhstan’s Exports by Commodity, 1995–2010 ($ billion) 5.3 6% 8.8 4% 5% 2% 1% 12% 13% 27.8 2% 2% 7% 59.5 2% 5% 6% 14% 13% 1% 1% 10% 100% 20% 18% Other Machinery and transport equipment 24% 70% 70% 52% Agricultural products Chemicals Iron and steel 25% Mining Products Fuels 1995 2000 2005 2010 Source: Based on data from WTO 2012. Net foreign direct investment (FDI) was $2.9 billion for 2010, ranking it the highest among its neighboring countries. From a GDP percentage point of view, about 7.2 percent was FDI inflow and 5.2 percent was FDI outflow. Kazakhstan is receiving FDI primarily to improve infrastructure to facilitate business activity. 4.1.2 Taxation The overall tax burden in Kazakhstan is among the lowest in the world, as shown in Figure 4.2. Corporate tax rates depend on whether a company is considered resident or nonresident. In the case of a resident company, taxes are based on worldwide income; a nonresident company simply pays tax based on its income “sourced in Kazakhstan.” In addition, overseas companies permanently situated in Kazakhstan are not only required to pay corporate tax but also a branch tax, which depends on the nationality of the parent company. Small and medium businesses are subject to special tax regimes. The standard corporate tax rate for Kazakhstan in 2011 was 20 percent. This is a dramatic decrease from 2008 rates, when corporate taxes reached 30 percent. Figure 4.2 Comparison of Kazakhstan’s Corporate Tax Rate to Other Countries, 2009 and 2010 (%) Tax Revenues as % of GDP, 2009 Corporate Tax Rate, 2010 Norway 27% Brazil Trinidad and Tobago 26% Australia 30% India 30% United Kingdom 26% South Africa 26% Netherlands 23% Australia 22% Malaysia 16% Chile 16% Brazil 16% Russia 13% Canada 12% Uganda 12% Indonesia India Kazakhstan Uganda 10% 30% Canada 28% Norway 28% South Africa 28% Malaysia 25% Indonesia 25% Netherlands 25% Trinidad and Tobago UK 11% 8% 34% 25% 24% Chile 20% Kazakhstan 20% Russia 20% OECD 14% Source: Based on data from CIA 2012; Deloitte 2012; World Bank 2011. Note: For Angola and Tanzania tax revenues reflect 2011 levels and include social contributions—such as payments for social security and hospital insurance—grants, and net revenues from public enterprises. OECD = Organisation for Economic Co-operation and Development. 103 4.1.3 Population and Labor Force Kazakhstan’s population steadily increased from 1950 to 1990. Postindependence and until 2000, the country’s population dropped by approximately 5 percent. Following 2000 and as forecasted until 2050, growth in total population is expected to increase, but at a slower rate than that observed from the period 1950 to 1990, while the country’s labor force (aged 1564) is expected to follow a downward trend (Figure 4.3). Compared to neighboring countries such as Turkmenistan, Uzbekistan, and Russia, Kazakhstan has a higher labor force as a percentage of the total population (UN 2010b), and relatively low unemployment rates. Figure 4.3 Kazakhstan: Population by Age Group from 1950 to 2050 25.0 80% 70% Million People 20.0 60+ 60% 50-59 50% 15.0 10.0 40-49 40% 30-39 30% 20-29 10-19 20% 5.0 0-9 10% 2050 2045 2040 2035 2030 2025 2020 2015 2010 2005 2000 1995 1990 1985 1980 1975 1970 1965 1960 1955 0% 1950 0.0 % 15 - 64 Source: Based on data from UN 2010b. As of 2009, the minimum wage in Kazakhstan was set around $147 per month. This is equivalent to approximately 23 percent of the country’s average wage (Klaveren and others 2010). It is worth noting that a joint treaty was signed between the three Customs Union countries (Kazakhstan, Russia, and Belarus) allowing citizens of each country to work in the other treaty countries without a work permit as of January 2012 (Baker and McKenzie 2011). Table 4.2 presents an overview of the Kazakh labor market in comparison to a select group of countries. Table 4.2 Kazakhstan’s Labor Force Indicators Compared to Select Countries, 2010 Labor force (million) Angola Australia Brazil Canada Indonesia Kazakhstan Malaysia Norway South Africa Tanzania T&T Uganda UK 7.1 11.8 101.6 19.0 11.8 8.8 12.0 2.6 18.2 22.1 0.7 13.4 31.8 Educational attainment (% of total) Primary n.a. 27.3 n.a. 13.5 n.a. n.a. 18.3 19.9 15.8 n.a. 25.3 n.a. 19.2 Secondary n.a. 38.9 n.a. 40 n.a. n.a. 56 43.5 74.2 n.a. 63 n.a. 44.4 Tertiary n.a. 33.8 n.a. 46.5 n.a. n.a. 21.1 35.8 5.2 n.a. 11.1 n.a. 35.4 Mean years of education Minimum wage ($ per month) Unemployment, total (% of total labor force) 4.4 12 7.2 12.1 5.8 10.4 9.5 12.6 8.5 5.1 9.2 4.7 9.3 127 1,597 300 1,903 133 n.a. n.a. 3,609 543 59 n.a. 3 1,655 25.0 5.2 8.3 8.0 7.1 6.6 3.7 3.6 23.8 10.7 5.4 4.2 7.8 Source: Based on data from The World Bank Group 2012; World Bank 2011; UNDP 2010; Klaveren and others 2010. Note: Educational attainment data for Australia, Canada, Malaysia, South Africa, and T&T represent year 2008 levels. Unemployment data for Brazil, Kazakhstan, Malaysia, South Africa, and Uganda represent year 2009 levels. n.a. Not applicable. 104 Looking at the employment levels by sector, Kazakhstan’s labor force is largely concentrated in resources and service industries; both constituted over 95 percent of employment as shown in Figure 4.4. Between 2001 and 2007 employment in primary resources industries decreased from 38.5 percent to 34.5 percent. Employment in the knowledge-intensive manufacturing remains much lower than mature economies. Figure 4.4 Kazakhstan: Breakdown of Labor Force by Sector, 2001–07 6.6 7.5 Mature economy average, 2007 (% of total employment) Total change in employment, 2001 - 2007 (Million jobs) Primary Resources 3 0.0 Labor-intensive manufacturing 2 0.0 Capital-intensive manufacturing 34.5% 38.5% 4.2% 100% 0.6% 1.7% 3.8% 37.3% 34.2% 0.7% 1.2% 20.0% 21.5% 2001 2007 0.3% 1.4% 6 0.0 Knowledge-intensive manufacturing 5 0.0 Labor & Capital intensive services 42 0.5 Knowledge-intensive services 17 0.0 Health, education and public services 26 0.3 Source: Based on data from MGI 2012; UNIDO 2012; ILO 2012. Note: The number of employees engaged in manufacturing activities are based on the UNIDO statistics while the rest are based on the ILO data. 4.1.4 Education During the Soviet era, the Central Committee controlled the educational system in Kazakhstan. Over that period, educational programs were designed to produce workers in various fields according to the Soviet central plan (Burkhalter and Shegebayev 2012). By the time of independence, the country inherited a strong primary and secondary educational institution system from the Soviet Union, especially with the compulsory education policy that was effective until the age of 15. As a result Kazakhstan’s literacy rate reached very high levels that continued over the years, but the Soviet legacy exhibited some qualitative educational issues. Among the issues lately identified were the general absence of independent thinking among students, lack of initiative and creativity, as well as fear-based behavior (Burkhalter and Shegebayev 2012). A recent educational assessment review recently published by the United Nations Children’s Fund (UNICEF) concludes that there is a shortage of schools in Kazakhstan mainly due to poor maintenance since the Soviet era. The review also points to a deficiency in trained teachers, especially in remote rural areas. Additionally, most of the current Kazakh curriculum and instructional materials date back to the Soviet period (UNICEF 2008). Public spending on education and research is low by international levels. In fact, 12 percent of government expenditure in 2000 was designated to the educational sector, which is 10 percent lower than Azerbaijan’s allocation during that year (UN 2010a). The percentage of GDP spent on education rose from 3.2 in 1990 to 3.7 in 2001 (Kalyuzhnova and Kaser 2005). In 2011 public expenditure on education as a percentage of GDP reached 3.1 percent, and on research and development (R&D) was 0.2 percent; however, there is a lack of information on the allocation of that spending (UNICEF 2008). In terms of enrollment, while primary and secondary education show strong performance, the percentage of gross enrollment in tertiary education (38.5 percent) is quite low relative to neighboring countries such as Iran and Russia. As for the quality of higher education, none of the 97 universities in Kazakhstan made it to the top 500 listing in the 2010 Academic Ranking of World Universities (Academic Ranking of World Universities 2010). In addition, research facilities are generally worn out with poor IT and knowledge infrastructures 105 (Whitman 2008). Table 4.3 contains select indicators on education in Kazakhstan in comparison to other countries. A survey on the quality of education and local staff in the oil and gas sector conducted among IOCs’ executives suggested a number of shortcomings, including lack of proactivity, poor English-speaking abilities, and a lack of familiarity with Western business practices (Kalyuzhnova 2008). Table 4.3 Kazakhstan’s Educational Indicators Compared to Select Countries, 2010 Literacy rate (%) Adult (15+) Angola Australia Brazil Indonesia Kazakhstan Malaysia Norway South Africa Tanzania T&T Uganda UK 70.1 n.a. 90.3(a) 92.2(b) 99.7 93.1 n.a. 88.7(c) 73.2 98.8 73.2 n.a. Youth (1524) 73.1 n.a. 98.1(a) 99.5(b) 99.8 98.4 n.a. n.a. 77.3 99.6 87.4 n.a. School enrollment (%) Primary Secondary Tertiary Public expenditure on education (% of GDP) 85.7 97.1 94.1(b) 95.9 89.5 n.a. 99.1 85.1(a) 98.0(b) 93.9 90.9 99.6(a) 11.5(a) 85.5 82.0(b) 67.3 88.2 67.9(a) 93.9 n.a. n.a. n.a. n.a. 96(a) 3.7 79.9 36.1(a) 23.1 38.5 40.2(a) 74.4 n.a. 2.1 40(b) 4.2(a) 58.5(a) 3.6 5.1(a) 5.4(b) 2.8(b) 3.1(a) 5.8(a) 6.5(b) 6.0 6.2 3.8(d) 3.2(a) 5.4(b) Source: Based on data from Gomes and Weimer 2011; UNDP 2010; World Bank 2012b; MSTTE 2011. Note:(a) year 2009, (b) year 2008, (c) year 2007, (d) year 2006 data. n.a. Not applicable. Overall, higher education and vocational training in Kazakhstan would seem to offer room for improvements. A revised version of the Law on Education was approved in 2007 with the objective of developing a more competitive educational structure and improving the country’s regulatory systems on education (UNICEF 2008). 4.1.5 Business Environment Weak governance remains one of the key problems facing Kazakhstan. Although the country has shown some improvement along the six pillars of governance since 2000, it remains well behind the Organisation for Economic Co-operation and Development (OECD) levels, as shown in Figure 4.5. Corruption and accountability levels have barely improved since 2000, and improvement in the rule of law and overall regulatory quality has been minor. Figure 4.5 Governance Indicators in Kazakhstan Compared to the OECD Average Control of Corruption Voice and Accountability 100 80 60 40 20 0 Political Stability/Absence of Violence 2010 Kazakhstan 2010 Government Effectiveness Rule of Law 2000 Kazakhstan 2000 Regulatory Quality Source: Adapted from Kaufmann, Kraay, and Mastruzzi 2011. Note: OECD = Organisation for Economic Co-operation and Development. 106 2010 OECD 2010 Several surveys and corruption indices have labeled the country with corrupt flags. The Transparency International’s Corruption Perception Index (CPI), which ranks countries according to perceived levels of public sector corruption, scored Kazakhstan at 2.757 points in 2011 (CPI 2011), although it fares better than its neighboring countries (Russia at 2.4, and Uzbekistan and Turkmenistan at 1.6). Bureaucracy remains one of the issues that Kazakhstan inherited from the Soviet era. The centralized leadership structure of the public sector and the rotational program of key public sector personnel have resulted in a general lack of transparency and accountability of institutions and government officials (Arkhipov and others 2010). According to the 2011 Doing Business survey of the World Bank, dealing with construction permits and cross-border trading are two of the most problematic issues in doing business in Kazakhstan. For instance, the costs of import or export of a single container was more than triple the OECD average, and the estimated time to complete cross-border transactions is at 76 days for export and 62 days for import is far above the OECD average (of 10 and 11 days, respectively) and requiring more than double the documentations. Table 4.4 provides a snapshot of the latest “doing business” indicators for Kazakhstan. Table 4.4 Indicators for Doing Business in Kazakhstan in Comparison to OECD Average, 2012 Kazakhstan OECD 1. Starting a Business Kazakhstan OECD 6. Protecting Investors Procedures (#) 6 5 Extent of disclosure index (0-10) 9 6 Time (days) 19 12 Extent of director liability index (0-10) 6 5 Cost (% of income per capita) 0.8 4.7 Ease of shareholder suits index (0-10) 9 7 Paid-in min capital (% income per cap) 0.0 14.1 Investor protection strength (0-10) 8.0 6 Rank (Change in rank from 2011) 10 (+34) Rank (Change in rank from 2011) 57 (-8) 2. Dealing with Construction Permits 7. Paying Taxes Procedures (number) Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) 32 14 7 13 189 152 Time (hours per year) 188 186 93.2 45.7 Profit tax (%) 15.9 15.4 Labor tax and contributions (%) 11.2 24 1.6 3.2 28.6 42.7 147 (+1) Payments (number per year) Other taxes (%) 3. Getting Electricity Total tax rate (% profit) Procedures (number) 6 Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) 5 88 103 88.4 92.8 86 (+1) 4. Registering Property Rank (Change in rank from 2011) 13 (+13) 8. Trading Across Borders Documents to export (#) 9 4 Time to export (days) 76 10 3130 1032 Cost to export (US$ per container) Procedures (number) 4 5 Documents to import (#) 12 5 Time (days) 40 31 Time to import (days) 62 11 0.1 4.4 Cost to import (US$ per container) 3290 1085 Rank (Change in rank from 2011) 176 (0) Cost (% of property value) Rank (Change in rank from 2011) 29 (-2) 5. Getting Credit 9. Enforcing Contracts Strength of legal rights index (0-10) 4 7 Time (days) 390 518 Depth of credit information index (0-6) 5 5 Cost (% of claim) 22.0 19.7 36 31 Public registry coverage (% of adults) 0.0 9.5 Private bureau coverage (% of adults) 37.6 63.9 Rank (Change in rank from 2011) Procedures (number) Rank (Change in rank from 2011) 27 (-1) 78 (-3) 10. Resolving Insolvency Time (years) 1.5 Cost (% of estate) 15 9 42.7 68.2 Recovery rate (cents on the dollar0 Rank (Change in rank from 2011) 1.7 54 (-5) Source: The World Bank Group 2012. Kazakhstan is considered to have a strong infrastructure in terms of automobile and railway routes, and is one of four international transport corridors between Asia and Europe, but its transportation infrastructure is deteriorating at a fast pace (UN 2006). Since the country’s independence, most of the investments were directed 57 This is measured on a scale of zero to 10, zero being highly corrupt. 107 toward the country’s telecom and energy infrastructures connecting the country to Western markets through Russia. It is expected that $25 billion will be invested through 2011 to 2030 in infrastructure—out of which 40 percent will be allocated to the railway system, 23 percent to highways, 25 percent to telecommunications, and 12 percent to water transport (RoK 2010b). 4.2 The Petroleum Sector 4.2.1 The Petroleum Sector in the Economy In 2010 the oil sector accounted for 11.5 percent of the country’s GDP, and about 46.5 percent of government revenues (Coronel, Rozhkov, and Al-Eyd 2011). The value of oil exports reached $37 billion, which represented 57 percent of total exports of goods and services in 2010. According to the IMF, oil exports values are expected to reach $56 billion in 2016 (IMF 2012). Figure 4.6 shows the evolution of the contribution of mining, manufacturing, and utilities to GDP over time, and Figure 4.7 compares the breakdown of Kazakhstan’s GDP by activity to other countries in 2010. On the employment front, the mining and quarrying activity in Kazakhstan—which includes oil and gas extraction—employed on average 2.7 percent of total employment between 1999 and 2008. In 2008 over 200,000 workers were employed in the sector, representing around 2.5 percent of the total labor force—a drop from 4.2 percent in 1999 (UN 2012). 60 35% 50 30% 25% 40 20% 30 15% 20 10% 10 Share of GDP GDP (Bn $) Figure 4.6 Kazakhstan: Contribution of Mining, Manufacturing, and Utilities to Value-added, 1990–2010 5% 0 0% 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Contribution to GDP Percentage Share Source: Based on data from UN 2010a. Figure 4.7 Kazakhstan: Breakdown of Value-added by Economic Activity in 2010 ($ billion) 85 1,296 2,066 1,637 883 159 304 402 377 39% 38% 24 17 22% 23% 2,236 100% 7% 14% 25% 15% 5% 33% 11% 43% 45% 11% 5% 6% 13% 8% 20% 18% 9% 8% 8% 6% 8% 9% 50% 7% 2% 14% 12% 10% 5% 5% Angola Australia 19% Brazil 5% 12% 7% 3% 8% 8% 4% 3% 32% Indonesia Kazakhstan Malaysia 2% 12% 12% 6% 21% 36% 33% 10% 6% 24% 20% Canada 8% 0% 13% 1% 6% 7% 8% 6% 1% 30% 16% 6% 11% 4% 29% 19% 19% 8% 20% 51% 12% 5% 10% 13% 11% 20% Norway South Africa Trinidad & Tobago Other Activities Transport, storage and communication Construction Wholesale, retail trade, restaurants and hotels Manufacturing Agriculture, hunting, forestry, fishing Source: Based on data from UN 2010a. 108 12% 14% Uganda UK 1% Mining, Manufacturing, Utilities 4.2.2 Petroleum Geography and Geology The country is endowed with 15 sedimentary basins that spread over 60 percent of its area. But most of onshore and offshore oil and other mineral deposits are located in the North Caspian Basin. Some oil reserves are also located in Southern Kazakhstan but the prospects for new discoveries there are limited (Deutsche Bank 2010). The North Caspian basin is spread over Russian and Kazakh territory. On the Kazakh side (northern Caspian), the offshore Kashagan, located near Atyrau city, and onshore Tengiz are by far the largest Kazakh fields. To the north of the country, close to the Russian borders, rests the Karachaganak field. Kashagan, Tengiz, and Karachaganak are referred to as the three whales (Yerkebulanov 2012), which suggests the massive reserves they hold. The North Caspian basin is bound by the Hercynian Ural Mountains to the east and by other orogenic belts to the southeast and south. In the north, the basin is separated by the Voronezh Massif in the west and by the Volga-Urals Platform in the north (Talwani, Belopolsky and Berry 1998). The basin is divided into 15 licensed blocks that include 20 different offshore fields in shallow water. Most fields are under appraisal or development. Tengiz and Kashagan, the two major fields in the country, are considered as twins because they both possess similar geological characteristics with reservoir rocks, fluid properties, pressure gradients, reservoir depths, and sulfur content as shown in Table 4.5. Recoverable reserves are rated at 69 billion barrels of light oil (out of 24 billion barrels in place) with associated gas reserves of 64 trillion cubic feet (tcf). Table 4.5 Tengiz and Kashagan: A Comparison Kashagan Tengiz Discovered Location 2000 1979 Onshore 100,000 Crude characteristics 42-45° API Gravity 18-20 mol % H2S Pressure gradient Assumed to be roughly the same as Tengiz—very high 1,9002,200 from KE-1 and KW-1 tests Offshore 1022 feet of water Size of potential productive area (acres) 320,000 Reservoir depth (feet) 13,00014,000 Gas oil ratio (cubic feet per barrel) Likely 14,000 (data not available) 48.2° API Gravity 12.5 mol % H2S Very high, approximately 0.82 psi/ft Likely high (data not available) Source: Based on data from Johnston and Johnston 2001. 4.2.3 Reserves, Production, and Consumption Kazakhstan is a resource-rich country that ranks first in terms of quantity of subsoil minerals among the Commonwealth of Independent States (CIS) other than the Russian Federation (Yerkebulanov 2012). The country sits on large reserves of metallic ores, industrial minerals, and hydrocarbons. In terms of the explored reserves of uranium, chrome, lead, and zinc, Kazakhstan ranks number two in the world; it is number three in manganese, and number five in copper. As for the reserves of coal, iron, and gold, Kazakhstan is among the world’s top 10 countries. Kazakhstan’s petroleum sector went through several stages of development. During the period following independence in 1991, Kazakhstan’s petroleum industry witnessed stagnant growth and limited production. But since the late discoveries of offshore reserves, petroleum suddenly became the most abundant resource in the country. Today, Kazakhstan's oil resources are the largest of all the former Soviet republics apart from the Russian Federation. Oil reserves at the end of 2011 were estimated at 30.0 billion barrels representing 1.8 percent of world reserves, and 28.5 percent of total reserves in Europe and Eurasia, increasing from 5.4 billion barrels in 2000 (BP 2012). The Tengiz, Kashagan, and Karachaganak fields contain over 50 percent of the country’s reserves, while Uzen, Zhetybai, Zhanazhol, Kalamkas, Kenkiyak, Karazhanbas, Kumkol, North 109 Buzachi , Alibekmola, Central and Eastern Prorva, Kenbai, and Korolevskoye contain nearly 40 percent (Ernst and Young 2011). Gas reserves on the other hand were estimated at 66.4 tcf at the end of 2011, and represented less than 1 percent of world reserves (BP 2012). Table 4.6 provides a snapshot of the oil and gas sector in Kazakhstan. Table 4.6 Snapshot of the Oil and Gas Sector in Kazakhstan (2011) Oil proved reserves, billion boe Oil production, mmbpd Oil consumption, mmbpd Gas proved reserves, tcf Gas production, bcfd Gas consumption, bcfd Primary energy consumption, million toe 2011 30.0 1,840.7 212.4 66.4 1.9 0.9 50.5 % of World 1.8 2.1 0.3 0.9 0.6 0.3 0.4 Global Rank 12 13 51 19 15 43 36 1 yr 0.0 0.9 7.6 0.0 9.6 13.0 0.5 % Change 3 yrs 5 yrs 0.0 0.0 5.4 20.0 11.9 -9.0 0.0 0.0 8.3 15.6 18.6 10.1 0.6 -3.6 10 yrs 455.6 74.4 25.4 2.6 112.4 6.1 23.4 Source: Based on data from BP 2012. Note: bcfd = billion cubic feet per day; boe = barrel of oil equivalent; mmbpd = million barrels per day; tcf = trillion cubic feet; toe = tons of oil equivalent. The Kashagan field holds the largest oil reserves in Kazakhstan with an estimated potential for 38 billion barrels, of which 79 billion barrels (and up to 13 billion barrels if gas injections is used) are recoverable. Its prospectivity was cited by the Soviets in the early 1970s but was not officially discovered until 2000 (Campaner and Yenikeyeff 2008). Tengiz, the country’s second-largest field, was discovered in 1979 and has an estimated 69 billion barrels that are recoverable. The Tengizchevroil (TCO) partnership has been developing the Tengiz field since 1993. Chevron holds 50 percent equity, ExxonMobil holds 25 percent, the national oil company (NOC) KazMunayGas (KMG) holds 20 percent, and the remaining 5 percent is held by Russian/US LUKArco (Ernst and Young 2011). Oil production has picked up steadily as of 2000 and has increased from 744,000 barrels per day (bpd) to over 1.7 million bpd in a decade. The increase in production was driven by offshore fields, as most of the Kazakh onshore oilfields have matured and production has reached a plateau (Gizitdinov 2011). Similarly, gas production showed a steady increase since 2000. The country produced 33.6 billion cubic meters (bcm) of gas in 2010, almost triple the production in 2000. Gas consumption has shown the same trend increasing from 9.5 to 25.3 bcm between 2000 and 2010 (BP 2012). The increase is transforming the country from a net importer to a net exporter. But gas resources remain less developed than oil reserves due to the lack of a domestic gas pipeline infrastructure to transport gas from the production regions in the west to the consumption regions in east. The Kazakhstan-China gas pipeline due in 2014 is expected to transport gas to the eastern industrial regions. Figure 4.8 presents the evolution of oil and gas production and consumption in Kazakhstan. At current production levels, oil proved reserves are forecasted to last for 44.7 years and gas reserves for 97.6 years (BP 2012). Figure 4.8 Evolution of Oil and Gas Production and Consumption in Kazakhstan, 1991–2011 2.0 2.0 Oil Production Oil Consumption 1.8 1.6 1.4 1.4 1.2 1.2 BCF 1.6 1.0 Gas Production Gas Consumption 1.0 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 0.0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 0.8 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Million bpd 1.8 Source: Based on data from BP 2012. 110 In the downstream sector, Kazakhstan has three processing plants. They had a capacity of 130 million barrels in 2009, showing an increase of 17 percent relative to 2008 (KMG, 2011c): The Atyrau refinery was the first refinery in Kazakhstan, put into operation in 1945 (KMG, 2011c). During the Soviet era the refinery received a major technical upgrade that included all refinery technological equipment. This enabled the refinery to increase the capacity to 31.5 million barrels per year. The Shymkent refinery was put into operation in 1985. The estimated capacity of the plant amounts to 43.9 million barrels per year. The Pavlodar petrochemical Plant (PPCP) started operations in 1978. A new joint venture between KMG and ENI took over the plant with plans for upgrading it, which included increasing refining capabilities to 54.9 million barrels per year and increasing petroleum product output and quality (EoN 2011). Transport is carried out through the main active export routes—the Atyrau-Samara pipeline, CPC pipeline, and Atasu-Alashankou. 4.2.4 Sector Institutional Framework Today, the Ministry of Oil and Gas (MOG) is the executive body that carries out policy design. The ministry also acts on behalf of the state, or mandates a competent body in contracts and agreements for exploration and/or production with subsoil companies (MOG 2012a). On the operations front, the national oil company KMG, is a joint venture established in 2002 between two former state-owned enterprises, KazakhOil NC CJSC and Oil and Gas Transportation NC CJSC (the national transportation company). KMG is a fully state-owned operator responsible for services for exploration, development, production, processing, transportation, and marketing of oil and gas in Kazakhstan (KMG 2010). During the past decade, a series of legislations were enforced and have provided the NOC with additional mandates. The Petroleum Law of 2005 authorized KMG to act as a regulator for monitoring and controlling of compliance of subsoil companies in accordance to their subsoil use contracts. Additionally, the Petroleum Law provided KMG with further mandates namely: Taking part in strategy formation for the use petroleum resources Representing the state in contracts and agreements Organizing tenders for subsoil operations Exploring and producing of oil and gas (KMG 2010). One of the major mandates given to the NOC was via the amendment to the industrial development law in 2004, the PSA Law of 2005 that required all production sharing agreements (PSAs) to include KMG with a minimum of 50 percent equity in oil and gas projects (Tordo, Tracy, and Arfaa 2011). Exploration contracts in Kazakhstan are valid for up to six years and may be extended twice for a two-year period. The typical duration of PSAs is 25 years and they can be extended to 45 years for hydrocarbon deposits with more than 100 million tons of crude oil and/or more than 100 bcm of natural gas. Extensions may not be granted on the same terms and conditions of the original petroleum contract (Utegenova 2010). In line with industry practices, the Kazakh authorities may terminate a contract in case the company fails to comply with material obligations or to remedy previously identified violations (National Regulation of the Hydrocarbon Industry, n.d.). 4.2.5 Evolution of Local Capabilities and Market Structure The extent and evolution of Kazakhstan’s experience and capability in the petroleum sector have been affected by the country’s political and economic history. During the Soviet era, Kazakhstan’s oil and gas activities (that is, policy, operation, production, and transportation) and knowledge capital were under the central control of the Soviet state. Subsoil exploration and energy matter were not a priority. Following independence in 1991, 111 the country proceeded to form its own institutions as it had to fully govern its assets and resources (KMG 2012). During the 1990s there was no expectation that the oil and gas would become a prominent sector: production was stagnant, and offshore reserves had not been discovered yet. At the time, the authorities were more interested in generating tax revenues in the short term. Some have attributed this approach to the president’s need to obtain political gains over his opposition (Luong 2010). During this period the government was open to foreign investment, and, in the early 1990s, it often stood in a weaker negotiation position with IOCs. The government was aware that lack of technology, funding, and offshore expertise were the main challenges for the development of a local petroleum industry (World Bank 2012a). Thus authorities were relying on the transfer of knowledge from the IOCs. Since 1992 the authorities mandated IOCs with training activities and educational and social initiatives marking the beginning of LCPs (Kalyuzhnova 2008). The Petroleum Law of 1995 and the Law on Subsoil and Subsoil Use 1996 were the main laws governing the petroleum sector. The majority of agreements in the 1990s was under concessionary contracts and had taken place in Tengiz (the highest producer and third-largest reserve holder) and other fields (Aktobe, Emba, Kumkol, and Uzen) that had much smaller reserves but collectively accounted for 50 percent of production (Luong 2010). After its creation in 2002, KMG was mandated to act on behalf of the state in PSAs and relevant agreements, and was provided increasing authority over the years. The large and promising discoveries in Kashagan and the north Caspian, and the resurgence of resource nationalism in the country, helped to change Kazakhstan’s relative bargaining power and underpinned the development of a new governance model (Buchannan and Anwar, 2009). This was further motivated by the global financial crisis and the country’s pressing need for development and growth. In addition, the country was going through a reverse privatization trend, which may have contributed indirectly to the general inclination toward more control even in the oil and gas sector. This shift began around a decade ago and was clear in the new legislative framework that reshaped the country’s outlook and governance of oil and gas until today. The state began increasing its grip over the sector through extending KMG’s authority (Kalyuzhnova 2008). The Petroleum Law of 2005 introduced two crucial reforms. First, PSAs became the preferred contractual model; second, a minimum equity participation of KMG in all new projects was mandated. Given the already existing option for the state to acquire majority stakes in existing projects, KMG emerged as the main player and the majority owner in the country’s petroleum sector. Coupled with the state’s increased control was the trend to fortify the weak local content requirements at the time (World Bank 2012a). This policy approach was further consolidated in the new Subsoil Law of 2010, which replaced the Law on Petroleum of 1995 and the Law on the Subsoil and Subsoil Use of 1996, and was aimed to ensure economic growth and protect the interests of Kazakhstan and its natural resources. Kazakhstan has a relatively complex value chain. The upstream segment is dominated by IOCs who compete in exploration and production (E&P) activities, while local companies who enjoy local content protection dominate the downstream segment. Kazakh companies within the oil and gas value chain are dominated by state-owned enterprises, particularly KMG, and other companies reportedly enjoying certain ties to the president (Arkhipov and others 2010). Capacity building in the upstream segment is challenged by the lack of engineering expertise and financing and managerial skills particularly needed for the future offshore projects. KMG’s management team was cited as relatively dynamic and competent (Kalyuzhnova 2008), but its talent pool is still limited. KMG intends to address capacity building via continued PSAs with the IOCs, and through strategic alliances particularly with Russian oil companies (expectations of a joint venture with Russian Gazprom) (EoN 2011). Nonetheless, KMG’s strategy going forward can be summarized according to each segment of the oil and gas value chain: 112 Upstream. To increase production, upgrade to novice and promising fields, and acquire strategic onshore and offshore E&P companies. Joint ventures with IOCs to develop more complex fields are also on the future agenda. Midstream. To improve its transportation systems with new routes and additional capacity (develop the Asia Gas Pipeline, operate and expand the Kazakhstan-China and CPC pipelines, and develop a gas logistics infrastructure west to south of the country). Downstream. To modernize refineries to fit Euro 5 fuel standards and improve marketing reach for the retail end consumer in Kazakhstan and abroad (European countries) (KMG 2011a). 4.2.6 Management of Oil Wealth Presidential Decree No. 402 of August 23, 2000, created the National Fund for the Republic of Kazakhstan (NFRK). Within four years the fund accumulated $5 billion, 13 percent of the country’s GDP in 2004, and by early 2010 the fund reached approximately $25 billion (Faizuldayeva 2010). The fund’s objective is to preserve resources for future generations and to evade economic difficulties on the economy through a stabilization function (Kalyuzhnova 2006). Kazakhstan’s international reserves along with assets in the oil fund were boosted by nearly $11.5 billion to reach $73 billion by the first quarter of 2011 (IMF 2011). The fund is run by a management council consisting of high-profile members of the state and state institutions. In addition to the president, the council comprises the prime minister, the heads of the two chambers of parliament, the chairman of the National Bank of Kazakhstan, and the minister of finance. The fund’s operations, revenues, expenditures, and annual independent audit reports are published in the national press (Kalyuzhnova 2006). The NFRK’s capital consists of contributions from government income from the oil sector, which includes taxes (corporation tax, value-added tax), in addition to royalties, bonuses, and revenue from PSAs (Kalyuzhnova 2006). The NFRK invests in liquid foreign equities and has a long-term investment function (75 percent) and a smaller stabilization function (25 percent). But the fund is “bottlenecked by inefficient domestic capital markets limiting financing opportunities for SMEs” (Arkhipov and others 2010). 4.3 Local Content Policies 4.3.1 Policy Objectives Kazakhstan’s LCPs first appeared with the postindependence law governing petroleum activities, the Petroleum Law of 1995. Following that, multiple local-content-related amendments and laws were introduced leading up to a significant regulatory change in 2010, represented by the introduction of the new Law on Subsurface and Subsurface Use. LCP regulations since 1995 have been driven by the government’s objectives of altering the investment climate in the oil sector toward increased use of local goods, services, and personnel and enhancing its governance of natural resources (IIED 2011). Toward the early days of independence, provisions on LCPs aimed at increasing the use of local goods and services, and the employment of Kazakh personnel and developing their capabilities through training and educational requirements. These requirements fell more under CSR (Kalyuzhnova 2008) and were only broadly described. The 1995 Petroleum Law included only high-level provisions requiring that subcontractors in the oil sector be “largely” Kazakh owned. This was followed by the 1996 Law on Subsurface and Subsurface Use, which required that companies propose, at an early stage, their own local content commitments. More specifically, this included: Employing a specific percentage of local workers Procuring products and services of Kazakh origin 113 Improving infrastructure and contributing to economic and social development objectives in the region of operation58 (MENAS 2009). This approach allowed subsoil users to easily elude local content requirements and didn’t result in a significant improvement in the use of local content in the oil sector. Consequently, the government launched a review of the local content policy framework. More specific policies were laid out in the 2005 Law Concerning Production Sharing Agreements when Conducting Offshore Petroleum Operations. The law required that KMG hold at least 50 percent share of new PSAs and determined specific requirements to ensure purchase of local goods and services. These requirements were further detailed in the 2007 rules for procurement of goods, works, and services (GWS). The rules detailed the procurement process of all subsurface operations and included a “positive” discrimination rule in favor of Kazakh contractors (IIED 2011). The 2007 law made local content a mandatory requirement, outlined a monitoring and measurement procedure, and developed a clear definition of local content, as follows (MENAS 2009): Localization of the labor force. “The percentage of Kazakhstan personnel engaged in the implementation of a contract, broken down by category of personnel, indicating separately the percentage for each individual category in relation to foreign personnel, whose quantity must be reduced over years as mandatory training and qualification improvement programs are implemented for Kazakhstan personnel.” Goods. “Equipment, final product and other material and technical values, purchased for direct use in subsoil operations and for the activity, which is specified as auxiliary in the contract.” Works. “Carrying out activities on a paid basis on creating (producing) goods, equipment assembly, construction of facilities and other sites, required for direct use in subsoil operations and for the activity which is specified as auxiliary in the contract.” Services. “Carrying out activities on a paid basis, required for direct use in subsoil operations and for the activity, which is specified as auxiliary in the contract, not aimed to create (produce) goods or other material objects.” More recently, LCPs, while still focused on increasing use of local goods, services, and personnel, shifted toward the overarching objective of economic diversification and the reduction of economic dependency on the oil sector. Since the petroleum sector is at the heart of Kazakhstan’s economy, the government aimed to boost local industrial and service capacity through the development of links. During 2010 new regulations on local content were introduced in which the main concepts and objectives of previous regulations were preserved. In addition clear targets, procurement rules, and strict measurement procedures were introduced. This may be attributed to economic and industry-related factors. In summary, the government’s rationale since 1995 has been to intervene and secure its link with the oil and gas sector and thus improve employment and turn the economic wheel to the domestic advantage. A number of fiscal and regulatory tools have been introduced to achieve the government’s local content objectives in localization of the petroleum workforce and domestic sourcing of goods and services. Current LCPs are legislated through the decrees below: Law No. 291-IV of 24 June 2010 on subsoil and subsoil use Decree No. 1139 of 2007 on the rules of procurement of GWS for subsoil use operations Decree No. 965 and Decree No. 1018 of 2010 that regulate reporting forms of subsoil users Decree No. 367 and Decree No. 964 of 2010 that regulate and set the calculation methods for KC in GWS. As per the laws, local companies were allowed to sue any foreign company in the oil and gas sector that did not show preference to domestic sources. 58 114 As per the law on subsoil and subsoil use, all regulations apply retroactively (MOG 2012b). These mandate that local content requirements59 be included in the bids for subsoil use and be negotiated or assessed by the authorities as part of the bidding process (RoK 2010c). Specific local content obligations are then stated in the contractual agreement between the government and the subsoil user, and are decided on the basis of the needs of the area where the project is located. 4.3.2 Policy Tools Local content policy rules and regulations cover a set of provisions focused primarily on localization of the labor force and domestic sourcing of GWS. Localization of Petroleum Workforce Localization of workforce policy tools are: Target quotas for foreign staff employed by subsoil users Limitations on granting of work permits Minimum budget dedicated to training of the local workforce. Target Quotas for Foreign Staff Employed by Subsoil Users Resolution No. 71/2011 contains a schedule limiting the share of foreign employees in oil and gas operations. This is defined according to three job categories, as outlined in Table 4.7. Table 4.7 Kazakhstan: Quotas for Foreign Staff Employed by Subsoil Users Employee category Target % foreign personnel Description 2011 2 Senior managers, deputy managers, financial and technical directors and certain engineers, metallurgists, architects, geologists, and geophysicists. Managers and highly educated specialists. 3 Highly educated workers. 1 2012 and beyond 50 30 30 10 30 10 Source: Based on data from RoK 2011; Baker and McKenzie 2011. These targets do not apply to the following: Certain designations within the company, such as company directors of major investment contracts with the government, branch heads of foreign companies and of representative offices of foreign companies, and foreigners who have obtained a permanent residency certificate. Employees working in the major fields of Karachaganak, North Caspian (Kashagan), and Tengiz as well as their operators, contractors, and subcontractors for 3 years until January 2015 (Yerkebulanov 2012). To obtain the benefit of this exemption, the employer (subsoil user in any of the foregoing projects) must provide evidence of participation in the implementation of one of the three projects when applying for an employee work permit (Baker and McKenzie 2011). Small companies as defined according to the Law on Private Entrepreneurship as companies having no more than 50 employees, and with average annual assets less than $600,000 (Nisengolts 2011), unless Kazakhstan becomes a member of the World Trade Organization (WTO) (Baker and McKenzie 2011). The first category of jobs (the high-level jobs) were later redefined to include a larger sample of professionals to which the above regulations and ratios apply. The designations were: chief executives, deputy chief executives, financial and technical directors, chief structure engineers, production engineers, power Subsoil users must initially offer their local content commitment in relation to goods, works, services, training, and retraining as well as R&D financing (RoK 2010). 59 115 engineers, metallurgists, architects, geologists, and geophysicists (KPMG 2011).60 In addition, subsoil users and their subcontractors must grant equal conditions and rewards to local and foreign personnel. Limitations on Granting of Work Permits Resolution 71 also introduced the geographical ring-fencing of work permits. In Kazakhstan subsoil work permits must be requested from and are valid in the administrative-territorial units of issuance. This entails that any relocation of foreign employees among the territories of Kazakhstan or any geographical job rotation program is bound by certain limitations. For example, the duration of business trips to administrativeterritorial units other than that in which a work permit has been issued was reduced from 120 to 60 calendar days during a calendar year (RoK 2011). In case foreign employees are seconded to other companies in the country, or if foreign staff limits are violated, work permits are cancelled. If a violation occurs, the authorities can impose a 12-month bar on obtaining new work permits. Minimum Budget Dedicated to Training of Local Workforce In addition, the new law on subsoil use—Law No. 291/2010—mandates subsoil users to commit to a minimum amount of money to be allocated to education and training activities, as part of other requirements such as social programs. This includes education, training, and retraining of Kazakh workers and personnel involved in the execution of the contract. Subsoil users are also required to train and finance the training of other personnel, specified by the MOG (RoK 2010c). Domestic Sourcing of Goods, Works, and Services Three key categories of policy tools are being used by the Kazakh government to increase domestic sourcing of GWS in the oil and gas sector: Specification of GWS procurement rules for subsoil users MOG Kazakhstan Content Development Programs KMG (National Oil Company) local content development efforts. Goods, Works, and Services Procurement Rules The permissible methods for procurement of local content GWS are specified in Resolution No. 1139 of November 2007 on Procurement Rules for Subsoil Users. The rules also define the monetary fines a subsoil user is subject to in case of noncompliance. In particular, the procurement of GWS shall be carried out through one of the following procedures: Open tenders giving potential contractors at least 30 days of notice A restricted bidders list based on a request for proposal An online purchasing system managed by the Kazakhstan Contract Agency (KCA) A commodities stock exchange. Upon technical evaluation, winning contractors shall be chosen on the basis of the lowest price across all relevant procurement methods. Under the procurement rules, subsoil users are required to publish announcements of forthcoming purchases, tender documentation, draft procurement agreements, and results onto an online registry of GWS.61 Subsoil users should also publish such information in company periodicals in both the Kazakh and Russian languages. The bid evaluation criteria provides for the inclusion of a 20 percent price premium for the following categories of suppliers: 60 61 The above-mentioned individuals must fulfil certain criteria of higher education and experience of five years in relevant positions. This is publicly accessible at http://www.report.camng.kz/Default.aspx. 116 Suppliers of goods who possess a CT-KZ certificate62 Suppliers of works and services with over 95 percent of their employees as Kazakh. The CT-KZ certificate is a legal confirmation that goods were produced in Kazakhstan, and that the producer is considered a domestic company. To issue a CT-KZ Certificate, the authorities assess the origin of the goods and expertise employed in production to then compute the rate of KC. The certificate is valid for one year and entitles its holder to the 20 percent price premium. The incentive was provided to domestic companies in previous regulations and confirmed in the 2010 regulatory. It denotes that each Kazakh company that is registered within the Unified Register of Domestic Producers and Foreign Investors (discussed later) will have the right to be awarded a bid, provided that the price is not 20 percent higher than that of the foreign supplier. In case of noncompliance with the procurement rules of Resolution 1139, subsoil users are subject to a monetary fine or termination of the contract depending on the amount in violation, as follows: For violations below 50 percent of the annual financial obligations, 63 a subsoil user is subject to a monetary fine equivalent to 30 percent of the amount in violation. For violations above 50 percent of annual financial obligations, companies are subject to contract termination (MOG 2011). The Kazakh authorities have also set specific local content aspirations for 2014, which are shown in Table 4.8 together with local content achievements. Table 4.8 Kazakhstan: Local Content Targets and Attained Levels in 2011 Kazakh Content in: Goods Works Services Achieved in 2011 % 12.2 58.0 69.1 Targets for 2014 % 16 85 85 Source: Based on data from Yerkebulanov 2012; Decree 1135 of 29/12/2010. Ministry of Oil and Gas KC Development Programs In addition to setting procurement rules for subsoil users, additional local content policy tools were developed by the MOG. These include: Identifying the most demanded goods and services and mapping those with potential Kazakh manufacturers Supporting Kazakh companies’ involvement as coexecuters/subcontractors in foreign suppliers’ contracts Introducing long-term contracts for commonly procured GWS Transitioning to online procurement Training contractor and subcontractor Kazakh employees Supporting companies in acquiring local content certification Offering interest-free loans and advance payments for KZ-contractors’ equipment and personnel mobilization and technology transfer activities (KMOG 2011). KMG (National Oil Company) Local Content Development Efforts In addition to the procurement rules and the MOG measures to support local manufacturers in the oil and gas sector, the national oil company (KMG) has been actively involved in efforts aimed at increasing the share of CT-KZ is issued (for a period of one year) by the Technical Regulation and Metrology Committee and provided to Kazakh manufacturers of goods who are interested in working with subsoil companies. It is not mandatory to obtain a CT-KZ certificate to supply for subsoil companies; however, it is necessary for subsoil companies to purchase from CT-KZ holders so that local content will be calculated within the subsoil investment quota. 63 As per the Subsoil Law, all subsoil users must commit to an annual investment obligation considered as a financial obligation. 62 117 local content in its procurement of GWS in the oil and gas sector since 2009. In 2009 and throughout 2010, KMG took several measures to increase the share of KC in procurement of GWS, covering: Provision of information for Kazakhstan suppliers of GWS on KMG’s procurement plans and provision of catalogs of the goods scheduled for purchase. Signing cooperation memoranda and contracts for the supply of GWS with local suppliers. In 2009 memoranda for the total amount of 44 billion Kazhaki tenge (KZT) were signed with local suppliers in more than 15 different areas in Kazakhstan. Launching of the NC KazMunayGas JSC (joint stock company) Promotion Program of the Oil and Gas Machine Building Development in the Republic of Kazakhstan for 20102012. Creation of the Coordination Council for the oil and gas machine-building sector including specialists from the NC “KazMunayGas” JSC, and major Kazakh machine-building companies. In 2011 KMG consolidated its local content support efforts into a holistic program called the Program of the NC KazMunaiGaz JSC for the Development of Kazakhstan’s Content for 2011–2015. The program focused on the following key objectives: To increase the volume of purchases of locally produced goods To assist local commodity producers in producing new commodities that are currently imported To increase overall KC in large oil and gas projects To build service and machinery-building assets. KMG has also set the following quantitative targets to be achieved through the program by 2015: Increase production of oil equipment by 23 percent from the 2010 level Increase the share of local content in commodities purchases of the KMG Group to 50 percent Increase the share of local content in work purchases of the KMG Group to 90 percent Increase the share of local content in purchases of operators of large oil and gas projects Set up new joint production, service, and machinery-building assets of the KMG Group. KMG has already started working toward achieving the above goals. In fact, long-term agreements with a total value of KZT 53.6 billion are planned for 201115 between KMG’s affiliates and subsidiaries on the one hand and domestic commodity producers on the other. Table 4.9 shows the breakdown of the planned agreements value (in million KZT). Table 4.9 Kazakhstan: Breakdown of the Planned KMG Agreements by Value (million KZT) Name of KMG subsidiaries and affiliates KazMunaiGaz EP JSC KazTransOil JSC KazTransGaz Group Total 2011 2012 2013 2014 2015 Total 8,019 1,357 3,981 13,357 8,243 1,357 3,937 13,537 8,499 1,598 1,598 7,779 1,356 3,393 12,528 32,540 4,070 17,026 53,636 4,117 12,616 Source: Based on data from KMG 2011b. In addition, KMG has set specific targets for share of local content in procurement of GWS. The group’s objective for the 2011 share of local content was set at 55 percent. Indeed, in the first half of 2011, the KMG Group purchases of locally produced GWS reached 48 percent. More specifically, the local content share of the volume of goods purchased amounted to 40 percent, while the share of KC in purchased work comprised 66 percent and 57 percent of the volume of purchased services. Table 4.10 shows the actual figures for 2010 and the targets for 2011. 118 Table 4.10 KMG’s Kazakh Content in Purchased Goods, Works, and Services: 2010 and 2011 Goods Work Services Year KZT billion KC % KZT billion KC % KZT billion Kazakh content % 2010 (achieved) 2011 (plan) First half of 2011 (achieved) 608 735 725 36 40 40 396 320 189 56 60 66 434 400 300 72 75 57 Total in KZT billion KC % 1,438 1,455 1,214 52 55 48 Source: Based on data from KMG 2011b. Note: KC = Kazakh content. KMG has also initiated its support programs for oil and gas machinery building in Kazakhstan through cofinancing of plants and provision of long-term orders for overhauling, servicing, and troubleshooting. In fact, such programs have been in place since November 2010, when KMG signed a technological agreement for production of new oil and gas equipment with the Ministry of Transport. The agreement required that the JSC Center of Engineering and Technologies Transfer of the Ministry of Transport provide technical and technological documentation to local machine-building companies for enhancing the production of products demanded by KMG and arranging for testing procedures after production of prototypes. Shortly after this agreement, the oil and gas machine-building support program, JSC NC KMG Promotion Program of the Oil and Gas Machine Building in the Republic of Kazakhstan, was launched. The program continues to be a key pillar of KMG’s overall local content support project, the Program of the NC KazMunaiGaz JSC for the Development of Kazakhstan’s Content for 20112015. Since program implementation, local oil and gas machine-building companies have been expanding their capabilities to produce different types of oil and gas equipment. Today, these companies have the capabilities to produce more than 320 different types of highquality oil and gas equipment (KMG 2011b). 4.3.3 Legislative Channels KC-related policies are legislated through: Law 291-IV/2010 on subsoil and subsoil users Law 156-IV/2009 on public procurement Decree 1139/2007 on the rules for the procurement of GWS for subsoil users Decrees 965/2010 and 1018/2010 on reporting forms Decree 1135/2010 on state program for local content development Decrees 367/2010 and 964/2010 on the measurement of local content and the unified calculation method Decree 45/2012 on expatriates’ workforce quotas and work permit rules PSAs containing local content obligations specific to the project/area of operation. 4.3.4 Institutional Responsibility for Policy Design and Monitoring of Implementation Four entities govern Kazakhstan’s petroleum sector local content policy design and implementation: the MOG, Ministry of New Technologies, KCA, and Expert Council on Local Content. While the two ministries lead policy design, the KCA is responsible for facilitating local content policy implementation. More specifically, KCA’s mission is to: Promote local content through the involvement of Kazakhstan producers of GWS into the oil and gas supply sector Manage, document, and analyze local content operations in the procurements of subsoil users and update the Unified Register of Domestic Producers and Foreign Investors (KCA Register) Assist local manufacturers in meeting industry standards and requirements (KCA 2012a). 119 The KCA Register was created to fulfill transparency and complete disclosure in the procurement process. Subsoil users are required to upload all procurement information and documents through the Subsoil User Report Acceptance System (SURAC) for each tender (MOG 2012b). The SURAC is responsible for planning the procurement process, and maintaining the register of local content requirements and the GWS procurement plan. Via the SURAC, companies are able to upload all required information constituting the whole procurement process from the initial call for supply of GWS, to GWS specifications, until the awarding of the contract and the uploaded information are authenticated through electronic digital signatures (EDS). By adopting this methodology, disputes related to noncompliance with the regulations and/or the contract can be promptly solved through a transparent process. 64 Additionally, subsoil users and their subcontractors are mandated to publish in the KCA Register their procurement calendars for all upcoming and planned requests for GWS, and as well as past awards. In 2012 the KCA announced that 99 percent of subsoil users have performed reporting procedures on GWS in 2011 using the new system compared to 50 percent in 2008. Moreover, 98 percent of subsoil users reported on their procurement plans using the new system compared to 45 percent of the companies in 2008. Investments in procurement of GWS in 2011 were around $8.3 billion, nearly double that of 2010 ($4.7 billion) and increasing from $2 billion in 2005. In 2010 the KCA, with the cooperation with MOG, established the Expert Council on Local Content. The council incorporates delegates from all major stakeholders in the oil and gas sector, including: Associations and unions of entrepreneurs Suppliers of goods and services Subsoil users Government and policy experts. The council, which operates under the supervision of the MOG, is responsible for participation in the assessment of local content of major projects; the development of working programs in Kashagan, Tengiz, and Karachaganak; and communication and ensuring of the interests of domestic suppliers and contractors. 4.3.5 Interlinks LCPs in Kazakhstan extend to other sectors such as mining, agriculture, and manufacturing. Concerning international agreements, Kazakhstan has been an observer member of the WTO since its submission to join the organization in 1996. Currently, the country is undergoing the final stages of negotiations toward becoming a member of the WTO. During negotiations, the Kazakh team has been facing challenges on preserving local content requirements in subsoil activities. As per a statement by the Kazakh minister of economic integration, the government succeeded in preserving the country’s rights in preserving local-content-related policies in subsoil activities (Gazeta 2012). On September 3, 2012, President Nazarbayev requested the government to reshape the deployed LCPs in the agriculture, manufacturing, and financial sectors in light of joining the WTO (KCA 2012c). 4.3.6 Monitoring and Measuring Tools Subsoil users are required to file a Quarterly Kazakh Content Monitoring Report and an Annual Procurement Plan in the KCA Register. Specifically, subsoil users and their subcontractors are mandated to report on: 64 The medium- and long-term procurement calendar Local content in terms of GWS on a quarterly manner Status on employment of the Kazakh workforce Performance of training and retraining obligations of local workforce (own staff, supplier, students) (MOG 2012b). Settlement can be drawn to the judicial system should any side of the dispute consider the KCA verdict as unlawful. 120 To standardize measurement and reporting on local content, the Kazakh authorities have developed specific formulae for the calculation of use of local content by subsoil users. Local Content in the Labor Force Local content in the petroleum workforce is monitored via work permits and through the periodical reports submitted by subsoil users on the status of their employment obligations. As for educational commitments, the MOG represented by the KCA is responsible for monitoring educational contracts execution and detection of any breaches. In case of a breach, subsoil users are sent notices for their violations, and any amount that remains unspent is considered as “educational debt” that must be carried out by the subsoil user before the end of the contract. Local Content in the Procurement of Goods, Works, and Services The measurement of KC in the procurement process is a two-way process that varies by GWS. The percentage of KC in goods is stated in the CT-KZ certificate65 issued by the Technical Regulation and Metrology Committee66 to the Kazakh manufacturer. The percentage of KC in goods procured by a subsoil user that utilizes the goods produced by a holder of CT-KZ certificate is identical to the percentage indicated on the certificate. In March 2009 the Kazakh Government approved Decree No. 367 that formalized the measurement of local content in GWS. The decree became effective in 2010. In accordance with the Decree No. 367/2010, the KC in goods (KCT) is measured as follows: n Equation 1 KCT 100% CT K i i 1 i S Where: n is the total number of goods purchased by a supplier and its subcontractors for the execution of a contract for the provision of goods to a subsoil user. СТi is the cost of good i. Ki is the share of KC in goods indicated in the СТ-KZ certificate. S is the total cost of goods purchases. The KC in works and services (KCp/y) is measured as follows: CT K CA n Equation 2 KC p / y 100% i 1 m i i j 1 j CT j CCA j R j S Where: n is the total number of goods purchased by the suppliers and subcontractors for the execution of a contract for provision of works (services) to a subsoil user CTi and Ki are as per the definitions above m is the total number of contracts for provision of works (services) signed by a subsoil user and its contractors СAj is the value of jth contract To understand Kazakh content in goods produced by local producers, a CT-KZ certificate was introduced. CT-KZ is issued (for a period of one year) by the Technical Regulation and Metrology Committee and provided to Kazakh manufacturers of goods who are interested in working with subsoil companies. It is not mandatory to obtain a CT-KZ certificate to supply for subsoil companies; however, it is necessary for subsoil companies to purchase from CT-KZ holders so that local content will be calculated within the subsoil investment quota. 66 Issuance, verification, and registration of CT-KZ are performed by the territory departments of the Committee of the Technical Regulation and Metrology of the Ministry of Industry and Trade. 65 121 СТj is the total cost of goods purchased under the jth contract ССAj is the total value of subcontracting agreements signed under the jth contract Rj reflects the share of Kazakh staff payroll in total compensation S is the total value of the contract for provision of works (services). For quarterly reporting purposes, Kazakh content is calculated as: n KC 100% CA KC i 1 i i S Where: n is the total number of contracts signed by a subsoil user with suppliers of GWS СAi is the value of each contract for the purchase of GWS КСi is the Kazakhstani content of a supplier of GWS under each procurement contract S is the total cost of GWS purchased by a subsoil user in the relevant reporting period (RoK 2010a). Information on local content so collected by the government is used for monitoring purposes, as well as to measure the level of involvement of local enterprises and the assessment of domestic competitiveness (RoK 2010a). 4.3.7 Policy Impact on Local Content Levels Levels of local content in employment and GWS improved significantly after the introduction of the unified methodology and certification process; however, some violations and drivers for subsoil users’ inability to comply with requirements remain, suggesting room for improvement in LCPs. Prior to the publication of the unified methodology and the introduction of the certification process, each company reported local content levels using its own formulas. Some reported committed expenditure while others used actual spending. This inconsistency led to difficulty in accounting for the impact of LCPs. The introduction of the unified calculation methodology and certification process, however, eliminated the inconsistency in accounting for local content leading to improved reporting and local content levels. In fact, in the first quarter of 2012, the KCA reported an overall level of 96.6 percent local content in employment, well above the regulator’s targets (see tables 4.7 and 4.11). In general, local content across all categories has shown improvement from the Q1 2011 levels. Table 4.11 Kazakh Content in Subsoil Personnel Category I Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Category II Category III Total Total (#) % Kazakh Total (#) % Kazakh Total (#) % Kazakh Total (#) % Kazakh 3,495 3,756 3,627 3,639 3,696 77.2 79.7 81.3 82.5 83.1 18,837 24,937 24,359 24,615 24,793 91.2 92.9 93.5 93.8 94.0 36,267 41,447 40,414 41,209 42,847 98.8 99.1 99.1 99.2 99.3 58,599 70,140 68,400 69,463 71,336 95.8 96.4 96.7 96.9 96.6 Source: Based on data from KCA 2012a. In 2011 a total of $10.4 million allocation was set by subsoil users for education and training, which secured the training of 1,068 Kazakh citizens involved in the oil and gas sector (KCA 2012a). According to the MOG, over 83 percent of the trainees will be employed gradually by subsoil users. Looking at GWS, the level of reporting has dramatically increased upon the enforcement of the reporting system in 2010, as shown in Figure 4.9. In addition, the number of violations has decreased in value from KZT 158 billion in 2010 or 25.4 percent of annual investments, to KZT 113 billion or 17.8 percent of the investments. 122 Figure 4.9 Kazakhstan: Reports Filed by Subsoil Companies, 2008–11 Reports on Commodites and services 50% Yearly Purchase Plans 95% 95% 99% 98% 2010 2011 59% 59% 42% 2008 2009 Source: Based on data from MOG 2012c. Additionally, the level of local content in GWS in 2011 is showing an increase compared to 2010 (Figure 4.10). More specifically, the level of local content in goods increased by 2 percentage points in 2011, while local content in works and services increased by 8 percentage points each (Table 4.12). Figure 4.10 Evolution of Kazakh Content in Monetary Presentation for the Purchase of Goods, Works, and Services, 2009–11 (in KZT billion) % Change 2009 - 2011 2,207 44% Imported 553% 56% KC 309% 1,505 +390% 54% 450 33% 46% 67% 2009 2010 2011 Source: Based on data from MOG 2012c. Note: KC = Kazakh content. Table 4.12 Kazakh Content in Goods, Works, and Services: 2010–11 Goods Works Services 2010 Total spend (KZT billion) 354 405 746 % KC 10.3 50.0 60.6 2011 Total spend (KZT billion) 352 889 967 % KC 12.2 58.0 69.1 Source: Based on data from MOG 2012c. Note: KC = Kazakh content. In purchases of goods in offshore operations, the share of local goods was highest in development activities compared to exploration and operations activities, where the share of local goods didn’t exceed 9 percent. More specifically, the highest share of local goods purchases was in development activities such as foundation construction purchases (83 percent), followed by tank farm-system purchases (71 percent), and offshore fixedplatform-construction-related purchases (46 percent). On the other hand, the lowest share of local goods purchases was at 7 percent in development-related software products and nitrogen units and operationsrelated spare parts (Figure 4.11). 123 Figure 4.11 Kazakh Content in Goods Purchased for Offshore Operations, 2011 Exploration Well construction 9% General marine systems 20% High pressure and low pressure compressors 9% Software products 7% Nitrogen units and instrumentation units 7% Power generation system Development 9% Power system and communications 20% Cofferdam foundation construction 83% Flare system 14% Offshore fixed platform construction 46% Tank farm system 71% Fuel gas system Operations Other 10% Process system maintenance Spare parts, tools and accessories 9% 7% Software products 9% Source: Based on data from KCA 2012b. Note: KC = Kazakh content. In onshore operations, however, the share of local goods reached 70 percent in development as well as operations and abandonment activities, as shown in Figure 4.12. More specifically, in development activities, the share of local goods purchased for supra salt fields tank farm separators and tanks was 70 percent, followed by a 60 percent share in supra salt oil flowlines/pipelines purchases, and 50 percent of supra salt power supply system purchases. In operations, the share of local goods purchases was highest in primary hydrocarbon treatment systems (70 percent). On average, however, local goods purchases lagged in subsalt field activities, covering exploration, development, and operations such as production, well construction, and production simulation systems (the share didnâ€™t exceed 10 percent). Figure 4.12 Kazakh Content in Goods Purchased for Onshore Operations by Depth, 2011 Exploration 42% Exploration well construction 10% Production well construction 10% 45% 21% 22% Power system and communications Power supply system 50% 51% Oil flowlines / pipelines 51% Tank farm (separators, tanks) 50% Development Production automation systems 60% 70% 10% 6% 41% Spare parts, tools and accessories 21% 30% 31% Chemicals for production/transportation Operations Production simulation systems Abandonment 20% 7% Primary hydrocarbon treatment systems 70% 71% Well suspension 70% 71% Suprasalt fields (up to 2,500 m) Source: Based on data from KCA 2012b. Note: KC = Kazakh content. 124 Subsalt fields (up to 2,500 m) Purchases of local works and services in offshore operations were significantly high in support activities, such as environmental surveys, insurance services, and legal services, where their share reached 95 percent of purchases. But in more technical offshore activities, the share of local works and services is significantly lower at 6 percent in EPCM (engineering, procurement, construction and management and reaches a maximum of 46 percent in offshore fixed-platform construction (Figure 4.13). Figure 4.13 Kazakh Content in Works and Services Purchased for Offshore Operations, 2011 Seismic operations 20% Environmental surveys Exploration 93% Geological, geophysical surveys and other research Drilling operations Drilling services 40% 8% 10% Oil spill response and clean-up 18% Offshore fixed platform construction Development 46% Cofferdam foundation construction 43% Preparation of technical documents 20% Air conditioning and ventilation system Equipment maintenance and repair Operations 27% 10% Fixed equioment maintenance and repair 40% Rotating equipment maintenance and repair 30% Start-up 22% Industrial waste management 30% Insurance services 95% Emergency consultantsâ€™ services / medical treatment Other 80% Design / feasibility study, permits and approvals EPCM 84% 6% Customs clearance, transport and forwarding 84% Legal services 95% Transportation services 55% Source: Based on data from KCA 2012b. Note: KC = Kazakh content; EPCM = Engineering, procurement, construction and construction management. In purchases of works and services in onshore operations, the level of local content was comparable in supra and subsalt fields activities as well as across exploration, development, operations, and abandonment activities (Figure 4.14). Figure 4.14 Kazakh Content in Works and Services Purchased for Onshore Operations by Depth, 2011 80% Seismic acquisition 69% 76% Exploratory drilling Exploration 40% 80% Geotechnical studies 69% 60% 59% Analyses and research 76% Construction and installation 59% 70% Well drilling and construction Directional drilling Development 40% 40% 30% 76% 75% 76% 75% Power supply Pipeline construction Design 50% 40% 70% 69% Oilfield equipment maintenance 76% Well workover Operations Enhanced oil recovery 60% 40% 39% 87% 86% Waste management 50% 49% Oil / gas transportation 80% 80% 80% 80% Rig-down operations Abandonment Well suspension 90% 90% EIA (ecology) Suprasalt fields (up to 2,500 m) Source: Based on data from KCA 2012b. Note: KC = Kazakh content; EIA = Environmental impact assessment. 125 Subsalt fields (up to 2,500 m) Looking at overall KC by product group in 2011 (Table 4.13), the share of KC is highest in petroleum, oil, and lubricants (44 percent), followed by transformers (28.8 percent), pump products (24.4 percent), and tabulators (21.1 percent). But with the exception of tabulators, these products represented a low share of 2011 total spend. Petroleum oil and lubricants were only 3.1 percent of 2011 total spend while transformers and pump products represented 4.6 percent and 0.6 percent respectively. The highest share of procurement spend was in “other goods” where KC represented only 8 percent. Table 4.13 Kazakh Content by Product Group and Local Suppliers, 2011 Procurement spend ($ million) % of total spend Average KC (%) Kazakh manufacturers Total Kazakh 270.2 68.6 19.7 21.1 88.2 13.6 6.4 2.2 87.6 17.6 6.4 11.6 63.1 21 4.6 24.4 50.2 4.1 3.7 4 44.1 2 3.2 4.1 Petroleum, oil, and lubricants 42.1 27.2 3.1 44 Almaty Heavy Engineering Plant, Petropavlovsk Heavy Engineering Plant, Aktau Oil Electronic Company (ANEK) RauanNalco, Almatyneftekhim-А, Global Chemicals Company Aktyubinsk Oil Equipment Plant, Munaimash, ANEK, Caspian Machine-Building Complex Kazneftegazmash, Munaimash, Ust-Kamenogorsk Valve Plant Kazelektromash, Kazenergokabel, Tola—stroy SK, AktauEnergoKabel Kazakhstan vendors Sucker rods 36.7 17 2.7 17 AZNO, Munaimash Work clothes 25.8 6.8 1.9 15 Zhanarys, KazSPO-N LLP, Symbat LLP 21 3.4 1.5 12.6 8.8 3.4 0.6 28.8 634.8 67.2 46.3 8.2 1,372.7 251.2 100 13.2 Tubulars Drilling equipment Chemicals Pump products Wellhead equipment, valves Wires and cables Separators, tanks Transformers Other goods Total LLP KSP Steel West Kazakhstan Machine-Building Company, JV Byelkamit, Buran Boiler Kentau Transformer Plant, Alageum Electric Source: Based on data from KCA 2012b. Note: KC = Kazakh content. Despite the overall increasing share of local content in the oil sector, some violations remain due to difficulties faced by subsoil users preventing them from meeting their local content targets. In 2010 the MOG reported that 122 violations of the Procurement Rules were identified, and 34 notices for termination of contracts were sent out (Ospanova 2010). Overall, the local industry found difficulty in complying with the new local content requirements. Among the challenges faced were: Shortage of suppliers with specialized capacity to construct products in demand by subsurface users Growth in technological capacity among local suppliers is lower than industry demand Lack of qualified local workforce, which is challenged by the long-term nature of the training and education developments Lack of sufficient investments directed toward the development of small- and medium-sized enterprises (SMEs) (Ospanova 2010). 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GRATA Law Firm, Oil, Gas and Energy Law Intelligence. http://www.gratanet.com/en/publications/466. 130 5.Malaysia Malaysia’s history in the hydrocarbon sector dates back to 1910, when Shell discovered oil in Sarawak. Historically, international oil companies (IOCs) have played a key role in the country’s hydrocarbon landscape. A major milestone related to the mode of IOC engagement was the foundation of Malaysia’s national oil company (NOC), Petronas, in 1974. The event was driven by a confluence of political and economic factors and a growing sense of nationalization (Bank Pembangunan 2011). Since then, IOCs have been engaged under production sharing agreements (PSAs). The establishment of the NOC came along with a local content agenda that looked at developing local capabilities, gaining further control over the sector, and driving links to the industry. More recently, the government’s Economic Transformation Program (ETP) of 2010 marked a turning point in relation to local content and backward links from the petroleum sector. The ETP aims at transforming the nation into a high-income country by 2020. Through this program the country plans on growing its gross national income (GNI) by 6 percent every year, allowing it to grow its GNI per capita from the 2009 level of $6,700 to $15,000 by 2020. Under the new program the petroleum and energy sector is the first of the 12 National Key Economic Areas.67 Three of the 12 sectoral ETPs fall under local content policies (LCPs), all aiming at the creation and strengthening of value creating activities along the oil and gas value chain. Indeed, the government aims at increasing the competitiveness of its domestic oil field services and equipment (OFSE) industry to become a regional hub by 2017. Drivers for these aspirations are centered on: A growing regional market for OFSE (but no current regional hub) A growing domestic petroleum industry that is exposed to a complex geology (as Malaysia’s reservoirs become depleted, future discoveries are expected to be more technically challenging) The country’s geographical proximity to resource rich-countries in Asia and the Middle East Existence of a domestic competitive local workforce. At this stage and in coordination with Petronas, the government has defined specific initiatives, targets, and an implementation road map that is being closely monitored (Pemandu 2012). 5.1 Structural Context In 2010 Malaysia had the 37th-largest gross domestic product (GDP) and 39th-largest population in the world. The country enjoys a well-developed infrastructure, which was classified 23rd out of 142 countries worldwide, out-ranking the United States by one spot in 2010. As per the World Economic Forum (WEF) classification, Malaysia’s economy is in its second stage of development and is considered as an efficiency-driven economy. The GDP per capita in 2011 was $9,656, the highest among its largely populated neighbors (World Bank 2012c). The country’s constitutional monarchy, with a democratically elected parliament along with its well-developed infrastructure system, provides a favorable and stable business environment. In fact, Malaysia ranked 21st out of 142 in global competitiveness, improving five spots from last year. Despite that improvement, the country ranks behind neighboring Singapore (second position) and Hong Kong (eleventh position). Malaysia ranked in the low 20s among other countries on basic requirements, efficiency enhancers, and innovation subindices. According to the Global Competitiveness Report, Malaysia ranks high due to its efficient and sound financial 67 For a detailed overview, visit http://etp.pemandu.gov.my. 131 sector, highly efficient goods market, and a transparent and relatively well-developed tax system. The country also witnessed significant improvement in education over the past two decades with a significant increase in the percentage of secondary- and tertiary-educated workers, and adult literacy rate reaching 92.5 percent (WEF 2011). Nonetheless, the country is faced with several challenges. In fact, the country’s depleting natural resources are largely affecting current and future of government revenues. In addition, the fuel subsidy burden is also mounting as oil reserves are depleting and the country is turning into a net importer. The maintained high growth in population experienced and expected for the next decades also applies pressure on unemployment levels, and there is a growing tendency for brain drain. On the other hand, the macro challenges include competition from neighboring countries with lower-cost labor and resources (such as China, India, Indonesia, and Vietnam). 5.1.1 Economy Malaysia’s 2011 GDP was at $278.6 billion and its growth rate was at 7 percent in 2010, and 5 percent in 2011 (World Bank 2012c). Its GDP per capita in 2011 was at $9,656, the highest among its largely populated neighbors, and significantly higher than the South Asian average GDP per capita of $1,371 (World Bank 2012c). In fact, Malaysia was ranked 4th in terms of GDP per capita adjusted for purchasing power parity in Southeast Asia in 2011, and across the world it was ranked 77th of 226 countries (CIA 2012). The 1970s were a turning point for the Malaysian economy, which witnessed momentous growth in GDP, as growth rates reached a record high of 12 percent in 1973 and 1976. Malaysia’s GDP growth was interrupted by the Asian financial crisis in the late 1990s, during which its GDP contracted to 7 percent in 1998. Malaysia’s economy, however, demonstrated resilience as it started growing shortly after this contraction with growth rates reaching 6 and 9 percent in 1999 and 2000. In doing so, the economy recorded a faster recovery than its neighboring countries such as Thailand, Philippines, and Indonesia. Since independence in 1957, the Malaysian authorities began to take a proactive role in the development and industrialization of the economy. Traditionally, successive governments have adopted five-year plans each with set targets for developing the country’s key economic, social, and environmental segments. These plans focused primarily on diversifying the country’s economic base by transforming it from an agriculturedominated economy to a more industrial and export-oriented economy (Mun 2007). Indeed, the agricultural sector’s annual contribution to GDP did decline to 15 percent in recent years compared to a 30 percent in the early 1960s. On the other hand, the contribution of the manufacturing sector has risen from below 10 percent during the 1960s to 28 percent during the past five years (World Bank 2012c). Along with the manufacturing base and the export sector, Malaysian governments have also focused on foreign direct investment (FDI) promotion. In fact, during the past decade, FDI in Malaysia steeply increased to reach over $10 billion in 2011. Promoting FDI as a government policy began in the late 1960s when authorities introduced the first investment incentive regulations. Later in 1971, the Free Trade Zone Act was issued and in 1972 the first free trade zone was launched. It was then that FDI began to play a significant role in the country’s development (Athukorala and Waglé 2011). From the late 1980s to 2000 FDI in Malaysia made a leap, increasing from annual levels below $2 billion to above $4 billion. But the financial crisis of 199798 disrupted Malaysia’s remarkable record of attracting FDI, which contracted from $5 billion in 1996 to $2.1 billion in 1998. Table 5.1 presents key economic indicators for Malaysia. The country’s trade as a percent of GDP has also increased over the years. Exports in particular have increased since 1990 by nearly six-fold, with manufacturing goods being the chief export commodity. Malaysia is a leading exporter of electrical appliances, electronic parts, and components, in addition to palm oil and natural gas (World Bank 2012b). Among total merchandise exports (imports), about 15 percent (10 percent) were agricultural products, 16 percent (15 percent) were fuels and mining products, and 67 percent (73 percent) were manufactured products. Malaysia’s largest trade partner in exports in 2010 was Singapore, and Japan in 132 imports. For total commercial services exports (imports), about 15 percent (37 percent) represented transportation, 56 percent (25 percent) represent travel, and 30 percent (38 percent) represent other services (WTO 2012a). The evolution of Malaysia’s exports by commodity is shown in Figure 5.1. Table 5.1 Key Economic Indicators for Malaysia, 1980–2010 1980 1985 1990 1995 2000 2005 2006 2007 2008 2009 2010 GDP (constant 2000 $, billion) 26.4 33.9 47.2 74.2 93.8 118.2 124.8 132.7 139.1 137.0 146.8 GDP per capita (constant 2000 $) 1,909.6 2,149.4 2,592.5 3,581.9 4,005.6 4,529.6 4,695.2 4,905.1 5,057.8 4,901.5 5,168.7 Inflation, CPI (%) 6.7 0.3 2.6 3.5 1.5 3.0 3.6 2.0 5.4 0.6 1.7 Real interest rate (%) — — 4.8 4.9 -1.1 1.3 2.5 1.4 -3.9 12.9 -0.1 Exchange rate (LCU per $) 2.2 2.5 2.7 2.5 3.8 3.8 3.7 3.4 3.3 3.5 3.2 Trade (% of GDP) 111.0 103.2 147.0 192.1 220.4 212.1 210.5 199.4 183.2 171.2 176.8 Source: World Bank 2012c. Note: CPI = consumer price index; GDP = gross domestic product; LCU = local currency unit. — Not available. Figure 5.1 Malaysia’s Exports by Commodity, 1980–2010 ($ billion) 13.0 29.5 73.9 98.2 141.0 198.6 25% 29% 24% 28% 27% 13% 1% 5% 10% 2% 6% 7% 21% 16% 100% 10% 10% 1% 1% 0% 46% 2% 2% 11% 2% 25% 8% 25% 1980 3% 1% 4% 1% 17% 10% 16% 8% 15% Chemicals Telecommunications equipment 19% 17% 7% 10% 13% 16% 1995 2000 2005 2010 18% Other Manufactures Mining Products 15% 15% 18% 1990 9% 12% Electronic data processing and office equipment Agricultural products Integrated circuits and electronic components Fuels Source: Based on data from WTO 2012a. 5.1.2 Taxation Malaysia’s tax system is transparent and relatively well developed; it is based on the UK and Australian tax systems. The tax burden is moderate and generally in line with those of other neighboring countries. Taxes are levied on yearly income accumulated inside or derived from Malaysia. The tax burden is composed of direct and indirect obligations. Direct taxes are levied for income, real property gains, petroleum income,68 as well as stamp duty. On the other hand, indirect taxes are levied on excise duty, cross-border trade, sales, and services tax (UHY 2011). Corporate tax is at 25 percent,69 a lower bracket compared to neighboring countries such as Australia, and the Philippines, but in line with Indonesia and Thailand. Sales tax is between 5 to 10 percent, and service tax is at 6 percent (KPMG 2012). In terms of tax revenue as a percentage of GDP, Malaysia ranks above average against neighboring countries. Malaysia also levies ad valorem import duties that range from zero to 60 percent. Duties on raw materials and machinery are generally lower. Figure 5.2 presents a comparison of 68 69 Petroleum income tax is at 38 percent. This is a reduction of 1 percentage point from the 2010 corporate tax rates. 133 Malaysia’s revenues from taxes and the country’s corporate tax rate to other countries. Figure 5.2 Malaysia’s Tax Revenues and Corporate Tax Rate Compared to Select Countries, 2009 and 2010 Tax Revenues as % of GDP, 2009 Corporate Tax Rate, 2010 Angola 43% Norway Angola 35% 27% Brazil Trinidad and Tobago 26% Australia 30% United Kingdom 26% India 30% South Africa 26% Uganda Netherlands 23% Australia 22% Malaysia 16% Chile 16% Brazil 13% Canada 12% Uganda 12% Indonesia India Kazakhstan 30% Canada 28% Norway 28% South Africa 16% Russia 34% 28% Indonesia 25% Malaysia 25% Netherlands 25% Trinidad and Tobago UK 11% 10% 8% 25% 24% Chile 20% Kazakhstan 20% Russia 20% OECD 14% Source: Based on data from CIA 2012; Deloitte 2012; World Bank 2011b. Note: For Angola, tax revenues reflect 2011 levels and include social contributions—such as payments for social security and hospital insurance—grants, and net revenues from public enterprises. Malaysia offers a basket of tax incentives to promote investments in selected industries. Tax incentives are offered for foreign investments in the following business categories: manufacturing, tourism, agriculture, environment protection, training, research and development (R&D) as well as transport and communication (UHY 2011). Some industries that may qualify for tax incentives also include biotechnology industries, venture capital companies, and operation headquarters. Malaysia also has extended tax incentives to companies generating renewable energy to “promote the advancement of green technology and efficient utilization of energy” until December 31, 2015 (PKF 2012). In addition, Malaysia is signatory to a wide network of more than 70 treaties, which may indicate possible further reductions to tax rates in the future.70 5.1.3 Population and Labor Force The Malaysian population totaled 28.8 million in 2011 and is composed of three main ethnicities. Approximately 53 percent are Malay Muslims, while the other two main ethnic groups are Chinese, constituting 26 percent, and Indians, constituting 7.7 percent. The Chinese mostly follow Buddhism and Confucianism while the majority of Indians follow Hinduism (Khader 2012). The population in Malaysia has been growing steadily since 1950; it is expected to still increase, but at a slower rate (UN 2010). More specifically, Malaysia is expected to have a growing workforce driven by growth in the population aged 1564. Figure 5.3 illustrates the evolution of Malaysia’s population by age group from 1950 to estimates for 2050. 2012 Investment Climate Statement – Malaysia, US State Department, Bureau of Economic and Business Affairs, June 2012 Report. http://www.state.gov/e/eb/rls/othr/ics/2012/191191.htm 70 134 50 45 40 35 30 25 20 15 10 5 0 70% 60% 50% 40% 30% 20% 10% 0% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 Million People Figure 5.3 Evolution of the Malaysian Population and Labor Force over Time, 1950–2050 (in millions of people) 60+ 50 to 59 40 to 49 30 to 39 20 to 29 10 to 19 0 to 9 % 15 - 64 Source: Based on data from UN 2010. Malaysia’s total workforce amounted to 11.7 million people in 2010, of which around 21 percent had attained tertiary education. Malaysia’s net tertiary enrollment is higher than its neighboring countries, with the exception of Australia (a more-developed country) and Thailand. The country also has one of the highest mean years of education, outperforming that of the United Kingdom. But quality of education has been an issue, with the inadequately educated workforce being the fifth-most problematic factor for doing business in 2011 in Malaysia (Schwab 2011). The overall unemployment rate in Malaysia is relatively low. In 2009 unemployment stood at 3.7 percent, lower than the Organisation for Economic Co-operation and Development (OECD) average of 8.3, and below the levels for some regional countries such as Philippines and Indonesia (as shown in Table 5.2). In fact, unemployment rate has been below 4 percent since 2000, and it is ranked third in compensation per year per worker in Southeast Asia, behind Australia and Singapore. Table 5.2 Malaysia Labor Force Indicators Compared to Select Countries, 2010 Labor force (Million) Angola Australia Brazil Canada Indonesia Kazakhstan Malaysia Norway South Africa Tanzania T&T Uganda UK 7.1 11.8 101.6 19.0 11.8 8.8 12.0 2.6 18.2 22.1 0.7 13.4 31.8 Educational attainment (% of total) Primary Secondary Tertiary — 27.3 — 13.5 — — 18.3 19.9 15.8 — 25.3 — 19.2 — 38.9 — 40 — — 56 43.5 74.2 — 63 — 44.4 — 33.8 — 46.5 — — 21.1 35.8 5.2 — 11.1 — 35.4 Mean years Minimum wage of education ($ per month) Unemployment, total (% of total labor force) 4.4 12 7.2 12.1 5.8 10.4 9.5 12.6 8.5 5.1 9.2 4.7 9.3 25.0 5.2 8.3 8.0 7.1 6.6 3.7 3.6 23.8 10.7 5.4 4.2 7.8 127 1,597 300 1,903 133 — — 3,609 543 59 — 3 1655 Source: Based on data from World Bank 2011b; UNDP,2010. Note: T&T = Trinidad and Tobago. Educational attainment data for Australia, Canada, Malaysia, South Africa, and T&T represent year 2008 levels. Unemployment data for Brazil, Kazakhstan, Malaysia, South Africa, and Uganda represent year 2009 levels. In terms of the sectoral distribution of the Malaysian labor force, the services sector continues to be the largest recruiter of Malaysians, followed by health, education, and public services. Knowledge-intensive manufacturing activities, on the other hand, recruited 6.6 percent of the labor force in 2008, which is above the mature economies’ levels for the year 2007. As for primary resources, the share of labor force has declined by over 5 percentage points between 2000 and 2008 to reach 14.7 percent. Figure 5.4 shows the breakdown of the Malaysian labor force by sector for the years 2000 and 2008. 135 Figure 5.4 Malaysia: Breakdown of Labor Force by Sector, 2000–08 (millions) 8.9 10.5 16.2% 14.7% 3.8% 6.3% 3.1% 7.1% 9.3% 44.6% 100% Mature economy average, 2007 (% of total employment) Total change in employment, 2000 - 2008 (Million jobs) Primary Resources 3 0.1 Labor-intensive manufacturing 2 0.0 Capital-intensive manufacturing 6 0.2 Knowledge-intensive manufacturing 5 -0.1 Labor & Capital intensive services 42 1.0 Knowledge-intensive services 17 0.1 Health, education and public services 26 0.4 6.6% 47.4% 2.5% 2.6% 17.3% 18.5% 2000 2008 Source: Based on data from MGI 2012; UNIDO 2012; ILO 2012. Note: The number of employees engaged in manufacturing activities are based on the UNIDO statistics, while the rest are based on the ILO data. 5.1.4 Education Education has witnessed significant developments and increased attention from policy makers in Malaysia since the 1970s. A number of legislative acts, institutions, committees, and initiatives for the development of education standards and levels have been active over the past decades. Despite measurable improvements in education and enrollment levels, a number of issues remain. These issues include: the mismatch between supply and demand, national brain drain (Fleming and Søborg 2012), as well as a relatively high unemployment rate among fresh graduates (Woo 2006). A closer look at the country’s achievements in education over the past two decades shows a significant increase in the percentage of secondary- and tertiary-educated workers. In 2010 the share of secondaryeducated workers in the total workforce reached 56 percent, an increase from 36 percent in 1982. A similar increase was achieved in tertiary education levels. Graduates with tertiary education constituted 6 percent of the total labor force in 1982; two decades later, the percentage reached 24 percent of the total labor force (Fleming and Søborg 2012). This can be potentially credited to an increase in government spending on education. In 2009 Malaysian expenditure on education reached 5.8 percent of GDP, higher than the 2008 U.S. estimates of 5.5 percent and higher than other regional countries such as Thailand with 4.1 percent and Indonesia with 3.5 percent of GDP (as shown in Table 5.3). Although, the overall quality of education remains a challenge for doing business in Malaysia (Schwab 2011)—the quality of primary education was rated 5 out of 7 in the Global Competitiveness Report of 2010. The enrollment rate was 94.1 and 68.7 percent for primary and secondary education, respectively (WEF 2011). The mean year of schooling of adults over 25 years was 9.5 years and adult literacy rate was 92.5 percent (UNDP 2011). The country’s facilities for higher education are located predominantly in the Peninsular Malaysia surrounding the urban area of the capital and main cities (MOHE 2012). Currently, there are 20 public universities and 26 private universities (Fleming and Søborg 2012). 136 Table 5.3 Malaysia’s Educational Indicators Literacy rate (%) School enrollment (%) Angola 70.1 Youth (1524) 73.1 85.7 11.5(a) 3.7 Public expenditure on education (% of GDP) 3.6 Australia — — 97.1 85.5 79.9 5.1(a) Brazil Indonesia Kazakhstan Malaysia Norway South Africa Tanzania T&T Uganda UK 90.3(a) 98.1(a) 94.1(b) 82.0(b) 36.1(a) 5.4(b) 3.5(b) 3.1(a) 5.8(a) 6.5(b) 6.0 6.2 3.8(d) 3.2(a) 5.4(b) Adult (15+) 92.2(b) 99.7 93.1 — 88.7(c) 73.2 98.8 73.2 — 99.5(b) 99.8 98.4 — — 77.3 99.6 87.4 — Primary Secondary Tertiary 95.9 89.5 94.1(5) 99.1 85.1(a) 98.0(b) 93.9 90.9 99.6(a) 67.3 88.2 68.7(5) 93.9 — — — — 96(a) 23.1 38.5 40.2(a) 74.4 — 2.1 40(b) 4.2(a) 58.5(a) Source: Based on data from Gomes and Weimer 2011; UNDP 2010; World Bank 2012c; MSTTE 2011. Note: T&T = Trinidad and Tobago; UK = United Kingdom; (a) year 2009, (b) year 2008, (c) year 2007, (d) year 2006 data, (5) Global Competitiveness Report. 5.1.5 Business Environment The business environment in Malaysia is competitive. The country’s constitutional monarchy, with its democratically elected parliament and well-developed infrastructure system provide a favorable and stable business environment (PKF 2009). Despite its overall competitive and favorable business environment, businesses in Malaysia still face several obstacles, with the most problematic ones being corruption, inefficient government bureaucracy, followed by access to financing. Malaysia ranks well on the “ease of doing business” and “competitiveness” indices, and has relatively easy procedures for business startups compared to its neighbors. The Doing Business Report of 2011 ranked Malaysia 21st among 183 countries on ease of doing business. Malaysia was ranked 4th out of 24 countries in the East Asia and Pacific region for doing business, after Singapore, Hong Kong, and Thailand (World Bank 2011a). The Global Competitiveness Index of 2011–12 ranked Malaysia 21st among 142 countries, and the cost for crossborder trade in Malaysia is also among the lowest in Southeast Asia. The cost of export per container was $450 in 2011 and cost of import, $435. Despite this favorable ranking, governance and corruption remained among the most problematic aspects of doing business in 2011 (Schwab 2011). The government has acknowledged corruption as an obstacle to doing business since the 1970s, and has taken various steps in that regard. Several anti-corruption regulations have been passed and the Anti-Corruption Agency along with other administrative programs such as the Public Complaints Bureau have been established. Despite these initiatives, corruption has increased, with Malaysia’s Corruption Perception Index decreasing in 2011 to 4.3 points from 5.3 points in 2003. The country, however, still has a better standing than its neighbors in Southeast Asia, with Indonesia’s Corruption Perception Index at 3 points, Thailand’s at 3.4, Vietnam’s at 2.9, and Philippines’ at 2.6 points71 (Transparency International 2012). Ethnic and political motivations were considered as reasons for corrupt conduct in Malaysia; however, these are thought to affect local companies more frequently than international firms. Table 5.4 shows a snapshot of indicators on Malaysia’s business environment and doing business, and Figure 5.5 shows how governance indicators in Malaysia have been stable during the past decade but remain below the OECD indicators. 71 A Corruption Perception Index ranking of 1 point implies highly corrupt. 137 Table 5.4 Indicators for Doing Business in Malaysia Malaysia OECD 1. Starting a Business Malaysia OECD 6. Protecting Investors Procedures (#) 4 5 Extent of disclosure index (0-10) 10 6 Time (days) 6 12 Extent of director liability index (0-10) 9 5 16.4 4.7 Ease of shareholder suits index (0-10) 7 7 0.0 14.1 Investor protection strength (0-10) 8.7 6 Rank (Change in rank from 2011) 4 (0) Cost (% of income per capita) Paid-in min capital (% income per cap) Rank (Change in rank from 2011) 50 (+61) 2. Dealing with Construction Permits Procedures (number) Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) 7. Paying Taxes 22 14 13 13 260 152 Time (hours per year) 133 186 7.1 45.7 Profit tax (%) 17.0 15.4 Labor tax and contributions (%) 15.6 24 1.4 3.2 34.0 42.7 113 (-2) Payments (number per year) Other taxes (%) 3. Getting Electricity Total tax rate (% profit) Procedures (number) 6 Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) 5 51 103 95.5 92.8 59 (+1) 4. Registering Property Rank (Change in rank from 2011) 41 (-2) 8. Trading Across Borders Documents to export (#) 6 4 Time to export (days) 17 10 450 1032 Cost to export (US$ per container) Procedures (number) 5 5 Documents to import (#) 7 5 Time (days) 48 31 Time to import (days) 14 11 3.3 4.4 Cost to import (US$ per container) 435 1085 Rank (Change in rank from 2011) 29 (-1) Cost (% of property value) Rank (Change in rank from 2011) 59 (0) 5. Getting Credit 9. Enforcing Contracts Strength of legal rights index (0-10) 10 7 Time (days) 425 518 Depth of credit information index (0-6) 6 5 Cost (% of claim) 27.5 19.7 Public registry coverage (% of adults) 49.4 9.5 29 31 Private bureau coverage (% of adults) 83.4 63.9 Rank (Change in rank from 2011) 1 (0) Procedures (number) Rank (Change in rank from 2011) 31 (+29) 10. Resolving Insolvency Time (years) 1.5 Cost (% of estate) 15 9 44.6 68.2 Recovery rate (cents on the dollar0 Rank (Chang+F14e in rank from 2011) 1.7 47 (+10) Source: World Bank 2012c. Note: Ranking is out of 183 countries. Figure 5.5 Governance Indicators in Malaysia Compared to OECD Average Control of Corruption Voice and Accountability 100 80 60 40 20 0 Political Stability/Absence of Violence 2000 Malaysia 2000 2010 Malaysia 2010 2010 OECD 2010 Government Effectiveness Rule of Law Regulatory Quality Source: Adapted from Kaufmann, Kraay, and Mastruzzi 2011. 138 5.2 The Petroleum Sector 5.2.1 The Petroleum Sector in the Economy Malaysia is a resource-rich country with geographical proximity to dynamic economies that are dependent on imported fuels—such as Japan, South Korea, Singapore, and Taiwan. Historically, and as can be implied from Figures 5.6 and 5.7, the petroleum sector never played a dominant role in the Malaysian economy; however, it has been a driver of the economic expansion for decades. This is especially true for the well-established downstream clusters that rely heavily on the country’s gas resources (Nordas, Vante, and Heum 2003). Looking at the sector’s contribution to GDP, the mining manufacturing, and utilities sector accounted for 32 percent of the country’s GDP in 2010, followed by the manufacturing sector with a 20 percent share of GDP, as shown in Figure 5.6. In subsequent years, the petroleum and energy sector contributed 1620 percent of the country’s GDP (Pemandu 2010). Petroleum exports constituted a large portion of the country’s external trade. Exports of crude oil slightly decreased from 236,000 barrels per day (bpd) in 2009 to 234,000 bpd in 2010, constituting around 35 percent of Malaysia’s crude oil production. Imports during 2010 reached 205,000 bpd of lower-cost crude oil for processing at local oil refineries (EIA 2011). Petronas is the single-largest contributor to the country’s revenue. In 2009 the company earned nearly half of government revenues by means of taxes and dividends (PetroMin 2011). In 2008 Petronas’ payment to the federal government represented 44 percent of total revenues (Fleming and Søborg 2012) and over 40 percent in 2010 (EIA 2011). Figure 5.6 Malaysia and Select Countries: Breakdown of GDP by Economic Activity in 2010 ($ billion) 85 1,296 2,066 1,637 883 159 304 402 377 39% 38% 24 17 22% 23% 2,236 100% 7% 14% 25% 15% 5% 33% 11% 43% 45% 11% 5% 6% 13% 8% 20% 18% 9% 8% 8% 6% 8% 9% 50% 7% 2% 14% 12% 10% 5% 5% Angola Australia 19% Brazil 5% 12% 11% 7% 3% 8% 8% 4% 1% 6% 1% 30% 8% 0% 13% 2% 12% 12% 6% 21% 36% 33% 10% 6% 24% 20% Canada 6% 7% 8% 3% 32% 16% 6% 4% 29% 19% 19% 8% 20% 51% 12% 5% 10% 13% 11% 20% Indonesia Kazakhstan Malaysia Norway South Africa Trinidad & Tobago Other Activities Transport, storage and communication Construction Wholesale, retail trade, restaurants and hotels Manufacturing Agriculture, hunting, forestry, fishing Source: Based on data from UN Statistics 2010. 139 12% 14% Uganda UK 1% Mining, Manufacturing, Utilities 120 35% 100 30% 25% 80 20% 60 15% 40 10% 20 Share of Value Add Value Add (Bn $) Figure 5.7 Malaysia: Contribution of Mining, Manufacturing, and Utilities to GDP, 19702010 5% 0 0% 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Contribution to GDP Percentage Share Source: Based on data from UN Statistics 2010. 5.2.2 Petroleum Geography Malaysia’s geography is unique—it is divided into two distinct parts: the first is Peninsular Malaysia to the west, bordering Thailand; the second is to the east, constituting of the two states of Sabah and Sarawak, bordering Indonesia. The continental shelf spreads alongside both regions and contains a total of six sedimentary basins forming the majority of the country’s petroleum geology (Bank Pembangunan 2011). The western Malay Basin and the Penyu Basin are located off the east coast of Peninsular Malaysia, while a number of subbasins are held within the major Sabah and Sarawak basins off the west coast of Borneo. Offshore of northeast Borneo lie the two small basins of Sandakan and Tarakan’s northern extension. The majority of offshore hydrocarbons are distributed across three main basins: the Malay basin in the west, and the Sarawak and Sabah basins in the east. The Malay basin holds oil and gas accumulations and is divided into the northern and southern fields. The southern Malay field holds oil and associated gas, while the northern Malay field mostly holds gas resources. Malay is a mature basin and has been in production for decades and covers approximately 83,000 square kilometers (km2) (Bishop 2002). The Sarawak basin contains eight geological regions, four of which are considered to be the major plays. Sabah currently holds 1.5 billion barrels of oil and 11 trillion cubic feet (tcf) of gas (IEC Midas 2012). Offshore reservoirs constitute most of the petroleum reserves in the country. The first offshore field began production in 1968 (Nordas, Vante, and Heum 2003). The depletion of mature oil reservoirs, however, has motivated the country to pursue deep-water exploration. The first deep-water discovery was the Kikeh oil field in 2002. Most of the country’s oil reserves are located in the Malay basin (PetroMin 2010). In 2010 the Tapis field 209 km off the east coast of Peninsular Malaysia in the Malay basin (Thu 1983) contributed half of all Malaysian oil production (PetroMin 2010). Going forward, it is estimated that deep-water fields will constitute between 20 to 30 percent of production in the next decade (Parshall 2011). Currently there is only one deepwater field in production capacity; others are still in their development phases. 5.2.3 Reserves, Production, and Consumption Oil reserves in Malaysia have been generally on a rise since 1980. Over the past two decades, oil reserves increased from 3.6 billion barrels in 1990 to 5.9 billion barrels in 2011 (BP 2012), but most of Malaysia’s oil fields are mature and in the decline phase. Estimates for 2016 predict a decrease in oil reserves down to 4.9 billion barrels (Business Monitor International 2012). On the other hand, natural gas reserves have been steady over the past two decades. Gas reserves in 2010 amounted to 86 tcf, constituting around 1.2 percent of world 140 reserves and ranking fourth largest amongst the Asia-Pacific countries (BP 2011). The current gas reserves are at almost the same levels as of 1996. Under current production rates, oil and gas reserves are expected to last for 28 and 39 years, respectively. Overall, maintaining the reserve base has been a key pillar in Malaysiaâ€™s oil and gas sectoral policy, which is centered on ensuring long-term supply security while providing affordable fuel to the growing population and consumption (EIA 2011). Table 5.5 provides a snapshot of the oil and gas industry in Malaysia. Table 5.5 Snapshot of the Oil and Gas Industry in Malaysia (2010) % Change 2011 Oil proved reserves, billion bbl Oil production, mmbpd Oil consumption, mmbpd Gas proved reserves, tcf Gas production, bcfd Gas consumption, bcfd Primary energy consumption, million toe 5.9 573.0 608.3 86.0 6.0 2.8 69.2 % of world 0.4% 0.7% 0.7% 1.2% 1.9% 0.9% 0.6% Global rank 23 46 29 15 45 27 31 1 yr 3 yrs 5 yrs 10 yrs 0.0% -10.9% 0.7% 0.0% -1.3% -10.5% -2.1% 0.0% -13.0% 2.6% 1.6% -3.6% -15.3% 0.3% 7.3% -16.1% 2.1% 2.2% -4.3% -14.7% 2.3% 29.1% -17.9% 17.0% -3.4% 27.9% 9.0% 32.6% Source: Based on data from BP 2012. Note: bbl = barrels; bcfd = billion cubic feet per day; boe = barrel of oil equivalent; mmbpd = million barrels per day; tcf = trillion cubic feet; toe = tons of oil equivalent. Oil production has been relatively stable since the mid-1990s, despite the dip following the peak production of 2004. Production in 2011 reached 573 million barrels per day (mmbpd), decreasing from 762 mmbpd in 2004. On the other hand, oil consumption has been on a rise, and the country moved to a net importer position in 2011 as can been seen in Figure 5.8 (BP 2012). Gas production has been on an upward trend increasing from 20.4 bcm in 1991 to 66.5 bcm in 2010 (Figure 5.8). The government had recognized the potential for gas production early on and developed plans for sustaining domestic demand, and for increasing exports of gas through extensive transport systems (Nordas, Vante, and Heum 2003). But it is expected that gas production would start its gradual decline phase starting at 60 bcm in 2012 to reach 15.5 bcm in 2025 (ETP 2010). Gas consumption showed a similar trend to production, increasing from 11.6 bcm in 1991 to 35.7 bcm in 2010 (BP 2011). Figure 5.8 Evolution of Oil and Gas Production and Consumption in Malaysia, 1991ď€2011 mbpd bcfd 800 7 700 6 600 5 500 4 400 3 300 2 200 1 100 0 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Oil Consumption (mbpd) 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Oil Production (mbpd) Gas Consumption (mbpd) Gas Production (mbpd) Source: BP 2012. Malaysia has one of the most widespread pipeline networks for transportation of natural gas in Asia. The Peninsular Gas Utilization project exceeds 1,400 km, and can transport 56 million cubic meters per day. Malaysia, Singapore, and Indonesia are now connected via the Trans-Thailand-Malaysia Gas Pipeline System, a step toward the realization of the Trans-ASEAN Gas Pipeline (TAGP) system, linking the producers and consumers in Southeast Asia (PetroMin 2010). Transport is carried out mostly by the Malaysia International Shipping Corporation (MISC) with Petronas as a major shareholder (62 percent). 141 Going forward, Petronas will be aggressively exploring around 5060 planned wells with a focus on increasing recoverability from mature basins through enhanced oil recovery (EOR) (Parshall 2011). Additionally, $4 billion was allocated in 2011 for exploration and development of deep-water projects (Yunus 2011). To this end, Petronas has recently signed PSAs for the use of EOR technologies with Shell Malaysia. The EOR contracts, with an investment of $12 billion over 30 years, will be applied in two oil field projects72 offshore East Malaysia (Abdullah 2012). 5.2.4 Sector Institutional Framework The governance model of the petroleum sector in Malaysia appears to be highly controlled by the state, through the office of the prime minister in the absence of a dedicated ministry for oil and gas (Lahn and others 2007). The prime minister has direct control over the energy sector as well over Petronas. The energy policy in Malaysia is set and overseen by the Economic Planning Unit (EPU) and the Implementation and Coordination Unit (ICU), which also report directly to the prime minister (EIA 2011). Policy design, targets, regulation, and operations functions are performed by individual departments within the NOC, Petronas. The Petroleum Management Unit (the regulator) is Petronas’ division responsible for planning, investment, and regulation of all upstream activities. All IOCs’ operations are carried out by means of PSAs with Petronas—by 2009, there were a total of 72 PSAs (INTSOK 2010). Petronas’ subsidiary Petronas Carigali also participates in the PSAs with IOCs (ETP 2010). In 1985 Petronas was granted the right for at least 15 percent equity in PSAs with all foreign and private companies (EIA 2011). The Petronas board is appointed by the prime minister, and rights to all exploration and production (E&P) projects in Malaysia are held solely by Petronas. Its business activities include (i) the exploration, development, and production of crude oil and natural gas in Malaysia and overseas; (ii) the liquefaction, sale, and transportation of liquefied natural gas (LNG); (iii) the processing and transmission of natural gas and the sale of natural gas products; (iv) the refining and marketing of petroleum products; (v) the manufacture and sale of petrochemical products; (vi) the trading of crude oil, petroleum products, and petrochemical products; and (vii) shipping and logistics relating to LNG, crude oil, and petroleum products (Petronas 2012a). Downstream activities are regulated by two ministries: the Ministry of International Trade and Industry (MITI), which issues processing, refining, and petrochemical production licenses; and the Ministry of Domestic Trade and Consumer Affairs (MDTCA), which issues licenses for marketing and distribution of petroleum products. 5.2.5 Market Structure and Local Capabilities Looking at the oil and gas sector in Malaysia since its inception over a century ago, one can identify three major milestones marking its development. The first milestone was the foreign-dominated days during the colonial era, when oil was discovered. The second was the Malaysian government enactment of the Petroleum Development Act, soon followed by the founding of the state company, Petronas (Bank Pembangunan 2011). The third milestone was the period of oil depletion marked by Malaysia’s ambitious moves on local and international fronts. Oil’s discovery in Malaysia dates back to 1910. The players enabling oil exploration and development in the early days were the IOCs. Shell was the first and the major operator to discover and develop oil in Malaysia. In fact, the first discovery of 1910 was announced by Shell, on Canada Hill in Miri city northwest Sorawak (Abdullah 2012). During the period leading to World War II, oil and gas exploration, drilling, and general activity experienced a slowdown; colonial policy concentrated on profitable exports such as tin and rubber (Curtin 2004). It wasn’t until after independence in 1957 that oil and gas began to surface as a major sector in Malaysia. During the 1960s, oil and gas discoveries were made and vast offshore resources were 72 The EOR PSAs will cover nine fields in the Baram Delta off Sarawak and four fields in the North Sabah development area. 142 found. Shell held on to its legacy, and led the upstream activities during the 1960s, to be followed by Esso and Conoco. The three main companies together dominated production, refining, and sales of petroleum products in Malaysia (Bank Pembangunan 2011). Following World War II and through the period of independence and toward the 1960s, a drive toward economic nationalism was witnessed in Malaysia (Martin 2006). This drive was seen to affect the oil and gas sector through the parliament’s enactment of the Petroleum Development Act in 1974. The new legislation marked the second milestone in the development of the petroleum sector in Malaysia. The law prioritized the state interest in all petroleum activities making the state the sole owner of all hydrocarbon resources. The law also created the state company, Petronas, and ensured its involvement in all upstream and downstream activities, with direct reporting to the prime minister’s office. Petronas’ partnering with IOCs for the exploration and development of oil and gas resources has undoubtedly transformed the local knowledge and capabilities capital, but the IOCs often remained the providers of technology especially in Malaysia’s oil and gas formation, which is dominated by technology demanding offshore and deep-water fields. This was evident in the country’s first LNG plant, where Shell took over the technical development and Mitsubishi carried out sales and marketing (Nordas, Vante, and Heum 2003). Alongside IOCs dominating upstream technology (mainly for offshore and, recently, deep-water activities), Petronas started gas operation activities in 1984, and oil operation activities in 1991. Petronas’s E&P subsidiary Caligari carried out gas exploration and development in Duyong and production began there in 1984, whereas the first oil field to be operated locally was offshore Dulang in 1991 (Nordas, Vante, and Heum 2003). Local capabilities were witnessed in the downstream sector particularly in the petrochemical industry. The Malaysian government was successful in forming three major petrochemical clusters containing international and local companies operating throughout the entire oil and gas value chain. The most diversified of the petrochemical clusters is in Kertih, Terengganu; the second is the Gebeng hub; and the third is the Pasir Gudang (MIDA 2011). The Petronas Petrochemical Integrated Complex (PPIC), for example, was formed in Kertih and contains gas-processing plants, petrochemical plants, utility facilities, training centers, tankage facilities, and two ports. Following the high production period of the 1980s, it was estimated that oil production would begin its decline. With reserves-to-production ratios decreasing, some estimates predicted oil depletion would be realized in 2012. This has stirred the authorities to new policies with regard to Malaysia’s petroleum resources. Petronas’ 2011 annual report clearly stated the new direction for petroleum resource management, as follows: “PETRONAS has identified Enhanced Oil Recovery (EOR) and CO2 Management as critical Exploration and Production (E&P) areas to build capability that will extend the life of our current assets, improve hydrocarbon recovery and enable the development of challenging assets”. In parallel, Petronas is widening its scope of operation abroad. Currently, Petronas operates internationally through partnerships with IOCs in 32 countries.73 Until 2005 Petronas had 101 wholly owned subsidiaries, of which 57 operate outside Malaysia. Subsidiaries partly owned by Petronas were 19 with 3 overseas. Additionally, Petronas was associated with 28 local and 29 overseas companies (Petronas 2005). The company employs over 33,944 people, and has total assets of $34 billion. 73 Algeria, Indonesia, Argentina, Iran, Australia, Japan, Benin, Mauritania, Cambodia, Morocco, Cameroon, Mozambique, Chad, Myanmar, China, Nigeria, Cuba, Pakistan, Egypt, Philippines, Equatorial Guinea, Russia, Ethiopia, South Africa, India, Sudan, Thailand, Timor Leste, Turkmenistan, United Kingdom, Uzbekistan, and Vietnam. 143 5.2.6 Management of Petroleum Wealth The Kumpulan Wang Amanah Negara, also referred to as the National Trust Fund (NTF), was created by the Law 339 of 1988 with the purpose of securing national wealth and making use of the country’s resources for future investment. The imminent depletion of Malaysia’s natural resources, particularly oil and gas motivated authorities to form the NTF for the benefit of future generations. The NTF is under the direct control of the Prime Minister’s Office. Earlier, contributions to the NTF came mainly from Petronas’ revenues, allocated through its annual budget (CPPS 2008), but in 2011 the contribution modality was amended (World Bank 2012a). Going forward, Petronas will be contributing annually based on strata that depend on the Weighted Average Realized Price (WARP) of oil per year. The strata enforced were as follows (Petronas Group 2012c): If the WARP is less than $70 per barrel, the contribution to the NTF is RM 100 million (approximately $31.4 million) If the WARP is between $70 and $100 per barrel, the contribution is RM 500 million (approximately $157 million) If the WARP is more than $100 per barrel, the contribution is RM 1 billion (approximately $314 million). Petronas contributed RM 1 billion to the NTF in 2011 as the WARP was above $100 per barrel. The fund’s cumulative assets reached RM 5.68 billion (approximately $1.8 billion) by year-end 2011 (Petronas Group 2012c), up from RM 3.8 billion (approximately $1.1 billion) in 2008 (CPPS 2008). The assets of the NTF are negligent compared to oil-rich countries such as Kazakhstan whose national oil fund accumulated approximately $25 billion in 2010 (Faizuldayeva 2010). There was a lot of criticism around the lack of transparency and public disclosure in the governance model of NTF. The Democratic Action Party (DAP), an opposition party in Malaysia, voiced its criticism in its 2010 Alternative National Budget proposition. It even suggested the remodeling of the NTF into a National Stimulus Fund to be activated by injecting funds in cases when economic indicators show GDP growth rates below 2 percent (DAP 2010). 5.3 Local Content Policies 5.3.1 Policy Objectives LCPs originate from the Petroleum Development Act of 1974 that bestowed the ownership of the national petroleum resources to Petronas. The objectives of the law were to: Provide affordable petroleum resources to the local market Build the foundation for forward links Secure local involvement and control of both upstream and downstream segments (Nordas, Vante, and Heum 2003). In relation to the third point, the mission statement of Petronas has always included a general commitment to the developing and expanding of the country’s industrial base, as well as developing local capabilities. More recently, and at the government level, backward link from the petroleum industry became a part of the national development plan of the country. Under the 2020 development plan, the Malaysian government aims at “strengthening value creating activities in the oil and gas value chain” and aspires to transform Malaysia into a hub for OFSE for Asia and the Middle East (Pemandu 2010). By achieving this, the government forecasted the creation of 40,000 jobs and the contribution of RM 14.3 billion to the country’s GNI by 2020 Figure 5.9. 144 Figure 5.9 Malaysia: Forecasted Contribution of the Energy Sector to the 2020 Gross National Income (RM billion) 23.1 131.4 Multiplier Total GNI Impact 109.6 241.0 2009 GNI 2020 GNI 53.8 7.4 20.3 47.1 14.3 8.5 E&P 4.0 Downstream OFSE Energy Total EPPs Business Baseline Opportunities Growth Source: Based on data from Pemandu 2010. 5.3.2 Policy Tools Local-content-related policy tools in Malaysia derive from the horizontal policies linked to the overall ETP and vertical policies specific to the oil and gas industry. Overall, the country uses a mix of regulations, incentivebased and capability-building programs to achieve the objectives discussed above. Petronas has been Malaysia’s main “vehicle” for the oil sector LCPs through its participation in PSAs and its policies focusing on developing the local workforce technical skills and the efficiency of the local supply industry (Tordo and others 2011). Given below are the different policy tools employed for the achievement of these objectives. Building Local Capabilities in the Petroleum Sector Under the PSA terms of 1996, production sharing (PS) contractors are required to: Minimize the employment of foreign workforce—to this end, the recruitment of foreign personnel requires the approval of Petronas Train internal Malay personnel—this includes the provision of capability development programs that enable Malay personnel to replace the expatriate workforce Commit a minimum monetary amount to be allocated to the training of Petronas personnel, the amount being contract specific Offer on-the-job training to personnel of the NOC, upon the request of Petronas. All training costs are cost recoverable. In addition to the provision of training programs, every PS contractor is subject to an annual research contribution equivalent to 0.5 percent of the sum of cost oil and contractor’s share of profit oil.74 The research contribution is tax-deductible. In parallel to the terms imposed on PS contractors, Petronas has heavily invested in building oil-and-gasrelated capabilities. On this front, the NOC has established four educational and training institutions and an elearning platform, as it has been sponsoring Malaysian students to pursue tertiary education in the country and overseas. Petronas established the Universiti Teknologi of Petrona1 (UTP) in 1996, which hosts over 5,000 students in engineering and technology-related academic programs. The school is locally recognized for its programs as it has established several industry and academic partnerships. In addition to this university, Petronas established 74 This is equivalent to 0.5 percent [cost oil + profit oil – Petronas share of profit oil]. 145 the Maritime Academy of Malaysia (ALAM) in 1983. The ALAM is a one-stop training center for maritime activities, and is owned and operated by Petronas and is a branch campus of the World Maritime University. In addition the ALAM has several partnerships with leading maritime educational bodies around the world. To develop the technical capabilities of its employees, Petronas founded in 1983 the Institut Teknologi Petroleum of Petronas (INSTEP). Originally, the INSTEP was designed to offer programs for oil and gas technicians. Over time, the institute evolved to offer technical programs to technicians, engineers, and technical executives. The institute has engaged most multinational companies operating in Malaysia as it has offered training services to other NOCs and partners with Petronas, such as Premier Oil of Myanmar, PetroVietnam, and Sudapet of Sudan. For managerial capability development Petronas established its Leadership Centre in 1992, which offers programs across all disciplines relevant to Petronas’ activities (Petronas 2012b). In addition to the above-mentioned institutions, Petronas developed an online e-learning platform. The available materials are accessible not only to Petronas’ employees, but also to government agencies as well as the private sector. Since 1975 Petronas has sponsored more than 11,000 students to pursue secondary education and over 19,000 students to pursue tertiary education at home and abroad (Petronas 2012b). The evolution of the number of students between 1975 and 2005 sponsored for tertiary education is presented in Figure 5.10. The share of students that pursued studies overseas was 38 percent of the considered period (Petronas 2005). Figure 5.10 Malaysia: Number of Scholars Sponsored by Petronas, 1975–2005 1,600 1,400 1,200 1,000 800 600 400 200 0 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Source: Adapted from Petronas 2005. On another front, and under the government’s plan to develop OFSE capabilities, a study has been under way to look at the gaps between the demand for OFSE talent and supply from academic institutions. The study serves as a basis for a series of programs that will ensure the adequate supply of qualified talent to future oil and gas projects in Malaysia. More specifically, the programs are expected to: Create sustainable links and initiatives Catalyze university-industry collaboration Support oil and gas international training programs to be done in Malaysia (MPRC 2012). As a starting point, two programs have been launched: The Pilot Internship Program for Engineering Consultancy Services The National Talent Enhancement Programme. The objective of the first program is to develop hands-on engineering consultancy capabilities for thirdyear engineering students through a 10-week internship. Well-defined company selection criteria and evaluation guidelines have been laid out. At this stage five memoranda of understanding (MOUs) have been signed, each extending for five years. The companies and universities engaged in this program are presented in Table 5.6. Going forward the plan is to expand the structure of the internship program to other OFSE 146 disciplines. Companies engaged in this program are offered a double tax deduction incentive for the expenses incurred on the interns75 (MPRC 2012). In line with the first program, the second program uses a similar structure while focusing on fresh graduate talents with less than two years of work experience. Table 5.6 Companies and Universities Engaged in the Malaysian Government’s Internship Program Companies Universities MMC Oil and Gas Engineering Kebangsaan Malaysia Aker Engineering Malaysia Sains Malaysia Perunding Ranhill Worley Putra Malaysia Technip Geoproduction Malaya RNZ Integrated Teknologi Malaysia Source: Based on data from MPRC 2012. In relation to labor laws affecting the employment of expatriates by OFSE suppliers, we note that Malaysian company law links the size of paid-up capital to the number and type of expatriate work visas that may be requested and obtained by a company (DoS 2012). Domestic Sourcing of Goods and Services Traditionally, Petronas has been the main driver for the domestic sourcing agenda in the Malaysian oil and gas sector. Petronas requires PS contractors to domestically source all goods and services incidental to upstream activities or source them directly from the manufacturer if not locally available. Procurement from foreign countries requires the approval of Petronas (Nordas, Vante, and Heum 2003). As per the NOC’s procurement process, suppliers of OFSE must receive a license from Petronas to be considered. Foreign suppliers can obtain the license in case they partner with local firms or act as contractors. If incorporated locally,76 foreign suppliers are restricted to a 30 percent equity stake (DoS 2011).77 On another front, and to encourage the engagement of local supplier in oil and gas activities, Petronas has been holding a touring “clinic” initiative. The clinic offers a platform for local suppliers to interact with Petronas staff—local suppliers learn about the online procurement system of the NOC as they get help in registering and accessing future opportunities. These include opportunities associated with the international activities of Petronas. Incentives for the Manufacturing Sector The Malaysian government, through the Malaysian Investment Development Authority (MIDA), extends a set of fiscal incentives for companies investing in the domestic manufacturing sector. These incentives derive from the Income Tax Act and Customs Act of 1967, Sales Tax Act of 1972, Excise Act of 1976, Promotion of Investments Act of 1986, and Free Zones Act of 1990 (MIDA 2012). The major incentives include the Pioneer Status and Investment Tax Allowance (ITA) that are extended based on the level of value-added, technology sophistication, industrial links, and other parameters. A Pioneer Status enables the company to enjoy partial exemptions from income tax over five years; tax is applied on 30 percent of statutory income.78 In addition, companies can carry forward any unabsorbed capital allowances and accumulated losses incurred during the pioneer period. Alternative to the Pioneer Status, companies can qualify for ITA. Under ITA, a company is extended an allowance of 60 percent on its qualifying For details visit http://sip.talentcorp.com.my/about.php. Such a restriction applies to other sectors such as legal services, engineering services, taxation and accounting services, professional services, telecommunications, advertising, financial and insurance services, and banking services (DoS 2011). 77 Shipping activities are restricted to Malaysian registered vessels. Foreigners are permitted to hold a 70 percent stake in shipping and logistics companies and 49 percent in forwarding agencies. The limitation also applies to vessels that support oil and gas operations. 78 After deducting revenue expenditure and capital allowances from the gross income (MIDA 2012). 75 76 147 capital expenditure.79 In addition, and on a yearly basis, the company with ITA status is allowed to offset its allowance against 70 percent of its statutory income. Unutilized allowances can be carried forward and the company is taxed on the remaining 30 percent of its statutory income (MIDA 2012). Companies engaged in high technology activities80 are extended Pioneer Status with 100 percent income tax exemption of their statutory income or ITA with allowance against 100 percent of their statutory income. To qualify for any of these exemptions, companies must spend at least 1 percent of their gross sales on domestic R&D and at least 15 percent of the company’s workforce should have a scientific and technical background with a minimum five years of experience. Similar, yet extending for a longer period, exemptions are offered to Strategic Projects81 and the Machinery and Equipment Industry. In addition, fiscal incentives are extended to a local company82 that acquires a foreign-owned manufacturing company located abroad and engaging in hightechnology activities for the purpose of utilizing the acquired technology in existing operations within Malaysia (MIDA 2012). In addition to the above, companies engaged in manufacturing activities are eligible for other exemptions such as reinvestment allowances, accelerated capital allowances, and tax exemption on the value of increased exports. Small- and medium-sized enterprises (SMEs) and small-scale manufacturing companies are also extended additional exemptions (MIDA 2012). Traditionally, all fiscal incentives are linked to performance requirements specific to every manufacturing license. Performance requirements are in the form of export targets, local content requirements, and technology transfer requirements. Failure to deliver on the agreed targets subjects the company to losing the extended benefits and its manufacturing license ultimately. Over the long run, the government intends to phase out all fiscal incentives (DoS 2011). Developing a Domestic OFSE Industry Under the ETP and to achieve the government’s objective of transforming Malaysia into a hub for OFSE, three initiatives have been launched. A description of the initiatives with their aspired contributions to the GDP and expected jobs to be created is presented in Table 5.7. Table 5.7 Malaysia: Industry Strategy, Expected Contribution to GNI, and Jobs to be Created Contribution to 2020 GNI EPP Jobs to be created Billion RM Share of Energy EPPs % # of Jobs Share of energy EPPs % Attract multinationals to bring their global oil field service and equipment operations to Malaysia. 6.1 9.6 20,000 42.4 Consolidating the domestic fabricators. 4.1 6.4 5,000 10.6 Develop engineering, procurement, and installation capabilities and capacity through strategic partnerships and JVs. 4.0 6.3 15,000 31.8 Total 14.2 22.3 40,000 84.8 Source: Based on data from Pemandu 2010. Note: GNI = gross national income; EPP =Entry point projects; JV = joint venture. Under the first initiative, the government’s ambition is to bring 40 percent of the regional business of 1020 multinational OFSE companies to Malaysia. This will be done through offering incentive packages, developing required infrastructure, and promoting Malaysia as a regional hub for OFSE. More specifically, to deliver these incentives and facilitate cross-border investment, the Malaysia Petroleum Resources Corporation (MPRC) was Factory, plant, machinery, or other equipment costs incurred within five years from the date the first qualifying capital expenditure is incurred. 80 List of activities are available on http://www.mida.gov.my/env3/uploads/images/invest/invest-pdf/APP2_02032012.pdf. 81 “Involve heavy capital investments with long gestation periods, have high levels of technology, are integrated, generate extensive links, and have significant impact on the economy” (MIDA 2012). 82 Locally established with at least 60 percent Malaysian equity ownership. 79 148 established in 2011. The MPRC administers programs to support Malaysian oil and gas companies in identifying business opportunities in other countries and to encourage global petroleum companies to enter the Asia Pacific Market using Malaysia as their platform. The latter is called the GIFT Program, and it is delivered jointly by the MPRC and LFSA (Labuan Financial Services Authority) through offering a set of incentives. The program’s incentives include: a flat 3 percent of chargeable income as corporate tax rate, an exemption on gross employment income for non-Malaysian professional traders and others in a managerial capacity of the Labuan International Trading Companies of 50 percent, and a 100 percent exemption on non-Malaysian director fees. By 2011 five companies had joined the GIFT program including: Vitol Trading, YTL Power International Bhd, BB Energy, and the Rotterdam Group. Going forward, the MPRC is planning on expanding the program’s outreach and attracting more companies to base their operations in Malaysia through a number of international road shows and through hosting international events (Ministry of Energy Green Technology and Water 2011). Under the second initiative, the government aims at achieving economies of scale and gains in efficiency through driving consolidation in the industry. Operationally, the consolidation effort will be led by Petronas and supported by government agencies. The NOC will limit the number of awarded licenses to fabricators open for the intervention of consolidation as it will expand the scope of awarded contracts, rather than doing that in tranches (Pemandu 2010). Today the Malaysian OFSE fabricators are less competitive than regional players. Overall, the industry is fragmented with five major local players. Most players experience low revenues and profit margins. According to Malaysian fabricators: Locals need to enhance capacity to enjoy economies of scale and drive cost down Productivity needs to be enhanced for local fabricators to become more competitive Cannot compete with China and Singapore when it comes to contracts in the Middle East Locals must be integrated in order to be more competitive High import content for materials impedes cost-competitiveness (Pemandu 2010). Going forward, additional mergers and acquisitions are being negotiated with the target of having two additional mergers/acquisitions finalized by the end of 2012. Looking at the value chain of OFSE, the Malaysian industry lacks local capabilities in engineering, procurement, and installation (as shown in Figure 5.11). To close this gap, the government will offer incentive packages for world-class multinational OFSE companies to establish joint ventures with local players. On this front, the government aspires that the established joint ventures will enable local companies to gain 15 and 50 percent of the Asia-Pacific OFSE market in shallow water and deep water respectively. Figure 5.11 Malaysia: Skills Gap in the OFSE Industry Procurement Construction Installation Commissioning MMC KNM MME Sime Darby SapuraCrest Petroleum SapuraCrest Petroleum AkerSolutions Cameron Rolls Royce Keppel Corporation Hyundai Heerema Cameron Rolls Royce Technip McDermott Halliburton Skill Gap World Class Multinationals Local Players Engineering Source: Based on data from Pemandu 2010. Note: Cells shaded in grey reflect EPPs related to the backward link of the petroleum industry. 149 5.3.3 Policy Channels In Malaysia, LCPs related to the oil and gas sector derive from: The Petroleum Mining Act of 1966 The Petroleum Development Act of 1974 Petroleum-sharing contracts The Companies Act 1965 The Economic Transformation Program 2010. 5.3.4 Institutional Responsibilities Local-content-related institutional responsibilities are mainly split between Petronas, the MPRC, and the MIDA. Petronas has two dedicated units responsible for the design and implementation of local-contentrelated initiatives: the supply chain management unit and the unit of education. Pemandu was established under the prime minister’s office in 2009 with an objective to drive progress and oversee the delivery of the Government Transformation Programme and the ETP (Pemandu 2012). Additionally, Pemandu’s role is to support other governmental entities in the planning process and delivery of objectives and to report performance and progress to the prime minister and other ministers. In relation to OFSE, Pemandu oversees and reports on the progress of the three ETP initiatives. The MPRC was created in April 2011 as a permanent government agency under the prime minister’s office. The agency started its operations in July of 2012 with an overall objective of transforming Malaysia into the leading regional hub for OFSE by 2017. The agency’s key responsibilities include: Recommending a restructuring road map for the domestic OFSE industry to increase its competitiveness and set it on a growth path Overseeing OFSE activities and coordinating cluster activities Creating an attractive environment for multinationals through streamlining administrative processes and developing attractive incentives Promoting the local OFSE industry. At this point, the agency has a board of four members representing the government, Petronas, and the MIDA. The MPRC is foreseen to comprise of 20 full-time employees with an expected annual operating budget of RM 5 million and a capital requirement of RM 6.8 billion to ensure the success of its mission. The agencies work engages the different industry stakeholders including government agencies, financial institutions, and domestic and foreign oil and gas companies. 5.3.5 Interlinks As discussed earlier, the LCPs in the oil and gas industry are part of the country’s economic development plan. Thus, there is a high interlink between the sector-specific policies and other sectoral and cross-sectoral policies. In fact as per the ETP, there are six cross-sectoral strategic reform initiatives, four of which are relevant to the backward link of the petroleum sector: Implementation of competition laws, adoption of international standards, and a liberalization of the services program shall all contribute to making local industries competitive in the international arena and attract FDI Reforming of public finance through the adoption of efficient broad-based taxes and reforming of fiscal policies and institutions Improvement of the performance of public services, and transformation of the role of the government into a lean, efficient, and facilitative one Development of the country’s human capital Streamlining of the government’s role in business. 150 Specific to the development of local capabilities, the overall plan is to: Modernize labor legislation Focus on up-skilling and upgrading the workforce Strengthen human resource management Leverage on women’s talent to increase productivity Undertake a labor market forecast and survey program Enhance labor safety net by introducing unemployment insurance (Pemandu 2012). In addition to the above cross-sectoral reform initiatives, international trade has been a key pillar of Malaysia’s economic development. As a member of the World Trade Organization (WTO) since 1995, the country’s trade policy has been focused on supporting global trade liberalization and ensuring a fair trade environment. In pursuit of these goals, Malaysia has also signed several bilateral and regional trade agreements (Ministry of International Trade and Industry 2008). As a member of the WTO, Malaysia has participated in WTO negotiation rounds and has made several commitments related to trade in goods and services. Negotiations on trade in services have covered liberalization and regulation of services sectors, in addition to regulations related to government procurement and subsidies. In such negotiations, developing countries have been seeking increased market access in several services subsectors such as telecommunications, financial, environmental, construction, distribution, maritime transport, and professional services, particularly architecture and engineering. Malaysia’s position on these negotiations has been in support of “offering market access for foreign services providers only in sectors where domestic suppliers are ready to compete and contribute to the development of the sector” (Ministry of International Trade and Industry 2008). To date, Malaysia has made commitments under the General Agreement on Trade in Services (GATS) in the following sectors: business and professional services, communications services, construction and related services, financial services, transportation services, healthrelated social services, tourism and travel-related services, and recreational and cultural services (Ministry of International Trade and Industry 2008). So far, no cases or complaints have been raised against Malaysia regarding its oil sector LCPs by any WTO member (WTO 2012b). But depending on the direction of these WTO negotiations, liberalization in sectors such as engineering services as well as in government procurement may have a direct impact on Malaysia’s oil sector LCPs. In addition to its WTO commitments, Malaysia has signed several bilateral and regional trade agreements. Today, Malaysia has bilateral trade agreements with Japan, Pakistan, New Zealand, India, Chile, and Australia, and it is a member of the Association of Southeast Asian Nations (ASEAN) free trade area. As a member of the ASEAN, Malaysia is also part of the ASEAN-Japan, ASEAN-China, ASEAN-Korea, ASEAN-India, and ASEANew Zealand/Australia trade agreements (Ministry of International Trade and Industry 2008). The country’s bilateral and regional trade agreements cover liberalization and reduction in tariffs on trade in goods and services as well as facilitation of cross-border investment and economic cooperation (Ministry of International Trade and Industry 2008). Most of these agreements, however, have attempted to exclude or maintain a certain level of protectionism in government procurement, mining and natural resources sectors, and oil-sector-related services, such as engineering services. For instance, the Malaysia-Australia Free Trade Agreement covers engineering services but allows commercial presence only through a representative office, regional office, or a locally incorporated corporation of Malaysian individuals or Malaysian controlled or both. Additionally, the agreement limits the aggregate foreign shareholding in the joint-venture corporation to 30 percent. Moreover, R&D services are permitted with no restriction, except for those involving Malaysia’s natural resources. Another example is the trade agreement with India, where the investment provisions exclude government procurement (Investment Provision of the Malaysia-India Trade Agreement). Going forward, Malaysia is negotiating several new trade agreements including a trade agreement with Turkey, a trade agreement with the European Union (EU), the Trans-Pacific Agreement, Trade Preferential System-Organization of Islamic Conference (TPS-OIC), and Developing Eight (D-8) Preferential Tariff Agreement (PTA) (Ministry of International Trade and Industry 2008). The result of these negotiations may 151 also impact the Malaysian oil sector’s LCPs. For instance, negotiations with the EU specifically cover government procurement, where a dedicated working group has been established to negotiate this area (Ministry of International Trade and Industry 2008). 5.3.6 Monitoring and Measuring Tools On the ETP front, each initiative is associated with well-defined targets and key performance indicators (KPIs). For the OFSE EPPs (entry point projects), the KPIs and 2011 targets are presented in Table 5.8. Table 5.8 Malaysia: OFSE EPPs, KPIs, and Targets for 2011 EPP KPI 2011 Target Attract multinationals to bring their global oil field service and equipment operations to Malaysia. Amount of investment made by OFSE multinationals. Consolidating the domestic fabricators. Number of successful merger of fabricators. 1 Develop engineering, procurement, and installation capabilities and capacity through strategic partnerships and JVs. Number of JVs between multinationals and local OFSE companies. 2 RM 320 million Source: Based on data from CIMB 2012. Note: EPP = entry point project; KPI = key performance indicator; JV = joint venture; OFSE = oil field services and equipment. Monitoring of the progress is continuously managed by Pemandu. Limited information is available around Petronas’ internal monitoring and measuring procedures in relation to the NOC’s local-content-related activities. 5.3.7 Policy Impact on Local Content Levels Information around the achieved local content levels in OFSE is limited. Nordas, Vante, and Heum (2003) report that local companies captured 74 percent of the value of OFSE contracts in 1995. Under the government ETP, the goal is to transform Malaysia into a regional hub for OFSE. Thus, the local content level in OFSE is not tracked. On the other hand, progress against set targets is monitored continuously. Progress for the year 2011 is presented in Table 5.9. Table 5.9 Malaysia: OFSE-related EPP Progress over 2011, and Target for 2012 KPI 2011 Target 2011 Actual 2012 Target RM 320 million RM 454 million — Number of successful merger of fabricators 1 1 2 Number of JVs between multinationals and local OFSE companies 2 2 2 Amount of investment made by OFSE multinationals Source: Based on data from CIMB 2012. Note: EPP = Entry point project; KPI = key performance indicator; JV = joint venture; OFSE = oil field services and equipment. Under the first EPP, Schlumberger launched a manufacturing plant for marine and land seismic equipment in July 2011. The plant is expected to combine local talent with international expertise. By the end of 2012, the plant is expected to employ 300 people. Under the same ETP, five trading companies have signed up to the Global Incentive for Trading Program, offering these companies with fiscal incentives to use Malaysia as a base for the Asia-Pacific markets. 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Khader, Fakhri R. 2012. “The Malaysian Experience in Developing National Identity, Multicultural Tolerance and Understanding through Teaching Curricula: Lessons Learned and Possible Applications in the Jordanian Context.” Department of Educational Sciences, Petra University, Amman. 153 KPMG, 2012. “Corporate and Indirect Tax Survey 2012” http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Documents/corporate-indirecttax-survey.pdf, 2012. Lahn, Glada, Dr. Valérie Marcel, John Mitchell, and Dr. Keith Myers. 2007. Report on Good Governance of the National Petroleum Sector. Chatham House, Royal Institute of International Affairs.London, United Kingdom. Mahalingam, Eugene. 2012. MMHE Sees Oil Prices Just Right for Investment in O&G Sector. Kuala Lampur: The Star. Martin, Sue. 2006. “Foreign Companies and Economic Nationalism in the Developing World after World War II.” University of Hertfordshire Business School. United Kingdom. MGI (Mckinsey Global Institute). 2012. Trading Myths: Addressing Misconseptions about Trade, Jobs, and Comptetitveness. Mckinsey Global Institute. http://www.mckinsey.com/insights/mgi/research/productivity_competitiveness_and_growth/six_myths_a bout_trade MIDA (Malaysian Investment Development Authority). 2011. MIDA.gov. http://www.mida.gov.my/env3/uploads/Publications_pdf/Profit_%20MalaysiaPetrochemical/Petrochemica l_Nov11.pdf. Ministry of Energy Green Technology and Water. 2011. “NKEA: Oil, Gas and Energy - ETP Annual Report “ Kuala Lampur, Malaysia. Ministry of International Trade and Industry. 2008. “Malaysia and the WTO”. http://www.miti.gov.my/cms/content.jsp?id=com.tms.cms.section.Section_f5694606-c0a81573-78d578d5759be8c9 MOHE (Ministry of Higher Education). 2012. http://educationmalaysia.gov.my/where-to-study/map. MPRC (Malaysia Petroleum Resources Corporation). 2012. http://mprc.gov.my. MSTTE (Ministry of Science, Technology and Tertiary Education). 2011. “Policy on Tertiary Education, Technical Vocational Education and Training and Lifelong Learning in Trinidad and Tobago that Was Laid in Parliament on January 12th, 2011.” http://www.stte.gov.tt/. Mun, Har Wai. 2007. “Malaysian Economic Development: http://harwaimun.com/Malaysian_Economics_Development.pdf Issues and Debates. Nordas, Hildegunn Kyvik, Eirik Vante, and Per Heum. 2003. The Upstream Petroleum Industry and Local Industrial Development—A Comparative Study. Bergen: Institute for Research in Economics and Business Administration. Parshall, Joel. 2011. Interest Grows in Asia Pacific Offshore Projects. Journal Of Petroleum Technology. Volume: 63, Issue: 11, Pages: 40-48 .Pemandu. 2010. Powering the Malaysian Economy with Oil, Gas and Energy. KL: Pemandu. ———. 2012. “Performance Management and Delivery Unit.” http://www.pemandu.gov.my. PetroMin. 2010. “Malaysia’s New Fields Offer Optimism.” Country Report (PetroMin). ———. 2011.“Deepwater Sector Leads Malaysian Upstream Growth.” Country Report (PetroMin). Petronas. 2005. “Investing in Oil Sector Capacity Building: Petronas Case Study on Education.” Presentation to Good Governance of the National Petroleum Workshop 2, London, September 21-23, 2005. ———. 2012a. “Corporate Profile.” http://www.petronas.com.my/about-us/Pages/corporate-profile.aspx. ———. 2012b. “Education.” http://www.petronas.com.my/community-education/education/Pages/default.aspx 154 ———. 2012c. Petronas Group Financial Results Announcement: Financial Period Ended 31 December 2011. KL: Petronas Group. PKF. 2012. “Malaysia Tax Guide 2012.” http://www.pkf.com/media/387143/malaysia_2012.pdf. Schwab, Klaus. 2011. The Global Competitiveness Report. Geneva: World Economic Forum. Thu, Goh Sing. 1983. “Exploration, Development and Reservoir Engineering Studies for the Tapis Field Offshore Peninsular Malaysia.” Journal of Petroleum Technology. Volume 35, Number 6, Pages1051-1060. Tordo, S.; Tracy, B; and Arfaa, N. 2011. National Oil Companies and Value Creation. World Bank Working Paper, Washington D.C. Transparency International. 2012. http://cpi.transparency.org/cpi2011/results/. “Corruption Perceptions Index UHY (Urbach Hacker Young International Limited). 2011. “Doing Malaysia.”http://www.uhy.com/wp-content/uploads/Doing-Business-in-Malaysia.pdf. UN (United Nations), Department of Economic http://esa.un.org/unpd/wpp/unpp/panel_indicators.htm. and Social 2011.” Business Affairs. In 2010. UNDP (United Nations Development Programme). 2010. “Human Development Index.” http://hdr.undp.org/en/statistics/———. 2011. “International Human Development Indicators.” http://hdrstats.undp.org/en/countries/profiles/MYS.html. United Nations Statistics. National Accounts Main Aggregates Database. New York: United Nations, 2010. USGS (U.S. Geological Survey). 2010. World Petroleum Resource Project 2010 . Washington, DC: USGS. World Bank. 2011a. “Ranking of Economies.” http://doingbusiness.org/rankings. ———. 2011b. “World Bank Development http://data.worldbank.org/indicator/IC.TAX.TOTL.CP.ZS/countries/1W-TT-ZJ?display=graph Indicators.” ———. 2012a. Malaysia Economic Monitor. World Bank office Bangkok: World Bank. ———. 2012b. “The World Bank.” http://www.worldbank.org/en/country/malaysia/overview. ———. 2012c. “World Development Indicators http://databank.worldbank.org/data/home.aspx and Global Development WTO (World Trade Organization). 2012a. “Statistics http://stat.wto.org/StatisticalProgram/WSDBStatProgramSeries.aspx?Language=E. ———. 2012b. “Trade http://stat.wto.org/CountryProfile/WSDBCountryPFView.aspx?Language=E&Country=MY. Finance.” Database.” Profiles.” WEF (World Economic Forum). 2011. The Global Competitiveness Report 2011-2012. Geneva: WEF. Woo, K.Y. 2006. “Malaysian Private Higher Education: A Need to Study the Different Interpretations of Quality.” University Examination Board, UCSI, Kuala Lumpur, Malaysia. Yunus, Kamarul. “The Oil and Gas Finds are Timely When Malaysia's Oil and Gas Reserves and Production Capacity are Seen Dwindling.” (Read more: Petronas Discoveries Come At Right Time.) http://www.btimes.com.my/Current_News/BTIMES/articles/monv211/Article/index_html. 155 6. Trinidad and Tobago The petroleum sector sits at the heart of this Caribbean island, population 1.3 million. In 2008 the sector contributed to 40 percent of the country’s GDP, 58 percent of government revenues, and 88 percent of exports (World Bank 2008). Trinidad and Tobago (T&T) has a long history in the petroleum sector that dates back to 1908, when oil was first produced. Under the British colony, until 1962, the country supplied a major share of the British Empire oil consumption, which reached 40 percent in 1930 (Muclshansingh 1971). While oil production peaked in 1978, natural gas production has been on an increase and major discoveries have been made in the 1990s. In 1998 T&T started exporting liquefied natural gas (LNG) to become the fifth-largest LNG exporter and major supplier of LNG to the United States. Historically, T&T’s government has played an active role in developing select sectors in the economy through industrial and import substitution policies. Such policies achieved mixed results. More recently, the government adopted a modern approach to productive development policies centered on addressing market failures83 (Moya, Mohammed, and Sookram 2010). In relation to local content in the petroleum sector, the topic first appeared in T&T in the year 2000 when the government agreed to the establishment of Policy Guidelines for the Utilisation of Local Goods and Services for Government and Government Related Projects. Early efforts were driven by the private sector, mainly the National Energy Business Alliance84 and the Energy Chamber of T&T. Four years later the Ministry of Energy and Energy Affairs (MMEA) developed a Local Content and Local Participation Policy Framework specific to the energy industry and appointed a Permanent Local Content Committee. The policy framework was officially launched in 2006 (MENAS 2008). This latter effort was driven by a national strategic plan. In 2005 a national committee finalized Vision 2020 Strategic Plan that was approved a year later by the parliament. The plan calls for the adoption of sustainable development and the transformation of T&T into a developed country by 2020 through: Developing innovative people Nurturing a caring society Governing effectively Enabling competitive business Investing in sound infrastructure and environment (National Committee 2005). Overall, the country aims at increasing its gross national product (GNP) versus GDP and the production of higher-value-added goods and services directed toward export markets. Driven by its central role to the economy, future developments, and low levels of local capture, which were around 10 percent, the energy sector was at the center of this strategic plan (MEEA 2006) The first goal for the energy sector within the strategic plan was “to encourage local players within the energy sector” (National Committee 2005). As argued by the MEEA: “Local Content is intended to aid the Government’s sustainable development goals by providing economic opportunities for T&T businesses to capture greater value-added and by allowing locals to have more meaningful participation in the energy sector and its decision making process” (MEEA 2011). Despite all these developments, there is an absence of a well-articulated local content strategy that 83 84 A review of productive development policies adopted in T&T is presented by Moya, Mohammed, and Sookram (2010). Represents a group of organizations involved in the energy sector. 156 includes measuring and monitoring tools. Today, T&T is at the early stages of implementing local content policies (LCPs) as it is faced by the challenge to replenish its depleting reserves. 6.1 Structural Context In the 2011 Global Competitiveness Report, the World Economic Forum (WEF) improved its rating of T&T for the second consecutive year, placing the country 81st out of 142 countries. This is a five-position improvement from the 2009 placement. T&T ranks well above neighboring Haiti and Venezuela (141st, 124th), though it is behind more-developed Latin American economies such as Brazil and Colombia (53rd, 68th). Financial market development is T&T’s most noteworthy strength relative to other similarly competitive economies. Quality of education in the Caribbean nation is also highly ranked (37th of 142) (WEF 2011); however, there is still room for improvement especially in tertiary and vocational education (MSTTE 2011). Additionally, improvements can be pursued in the government bureaucracy, which now makes doing business in T&T more challenging than similarly developed economies. 6.1.1 Economy As of the early 1960s, T&T’s economy has been highly dependent on revenues from hydrocarbon resources. Windfall revenues experienced from the rise in oil prices during the oil embargoes of 1973 and 1982 instigated rises in income, expansion of public sector employment, and improvement in physical infrastructure and living conditions. But a large share of expenditure was not channeled into sustainable development. Such expenditures included production subsidies and high public sector salaries. The latter led to the inflation of overall labor cost throughout all sectors of the economy, hindering the competitiveness of the nonhydrocarbon sectors of the economy. To this end, a limited number of jobs were created in competitive sectors. Following the depression in oil prices experienced in the 1980s, T&T’s economy has undergone a severe contraction. Compared to 1982, per capita GDP in 1993 dropped by 44 percentage points and the unemployment rate almost doubled to reach 20 percent. Coupled with limited development in competitive areas, the economic contraction has led T&T’s government to cut on the high levels of spending, thus cutting on expenditure in social programs and reducing employment in the public sector. Coupled with other structural factors, this has led to a higher unemployment rate and ultimately to an increase in poverty levels. In response to this situation, T&T embarked on pursuing an economic reform plan centered on achieving macroeconomic stability to reduce the country’s economic exposure to volatility in oil prices, economic diversification away from the hydrocarbons sector, upgrade and expansion of the country’s infrastructure, development of the private sector, and reform of the public sector’s institutional capacities. Today, T&T is considered a high-income developing country. The country experienced strong growth in its GDP over the last decade, reaching $22.5 billion in 2011. This growth has been fueled by the hydrocarbon sector and related inward investments. The 2008 global recession had a high impact on the growth of the economy given its high dependency on natural gas exports. GDP per capita is among the highest of Latin American economies. Following the economic reforms experienced in the 1990s, the country has been enjoying macroeconomic stability. More recently, T&T has been experiencing a surplus in the fiscal balance with moderate inflation rates. Table 6.1 presents key economic indicators for T&T. As noted in Vision 2020, T&T is challenged with increasing sustainable economic development beyond the petroleum sector. The sector accounts for half of the government revenues and over 90 percent of foreign direct investments (FDI). As shown in Figure 6.1, petroleum products have always dominated the value of T&T’s exports. In 2010 petroleum products constituted 73 percent of the value of exports. Chemicals were the second-largest exports by value (WTO 2012b). 157 Table 6.1 Key Economic Indicators for T&T, 1980–2010 1980 1985 1990 1995 2000 2005 2006 2007 2008 2009 2010 GDP (constant 2000 $, billion) 7.5 6.7 6.0 6.4 8.2 12.0 13.6 14.2 14.6 14.1 14.1 GDP per capita (constant 2000 $) 6,947 5,702 4,912 5,071 6,311 9,102 10,265 10,715 10,960 10,556 10,516 Inflation, CPI (%) 3.6 5.5 4.1 3.8 3.7 6.9 8.3 7.9 12.0 7.0 10.5 Real interest rate (%) 3.2 12.4 18.7 1.2 2.8 -6.9 9.0 -0.8 -7.8 48.8 4.6 Exchange rate (LCU per $) 6.3 6.2 6.2 6.3 6.3 6.3 6.3 6.3 6.3 6.3 6.4 Trade (% of GDP) 104.6 99.9 95.0 90.0 96.7 104.8 107.0 100.6 103.0 Source: World Bank 2012. Note: CPI = consumer price index; GDP = gross domestic product; LCU = local currency unit. Figure 6.1 T&T’s Exports by Commodity, 1980–2010 ($ billion) 4.1 3% 1% 2% 2.1 18% 2% 2.0 6% 7% 6% 15% 2.5 8% 10% 9% 1% 4.3 6% 6% 6% 9.9 7% 17% 11.0 3% 3% 100% 11% 18% 3% 9% 68% 73% 3% 25% 94% 80% 66% 65% Other Iron and steel Clothing 48% Agricultural products Chemicals Fuels 1980 1985 1990 1995 2000 2005 2010 Source: Based on data from WTO 2012a. 6.1.2 Taxation T&T revenues from taxes constituted 26 percent of the country’s GDP in 2009. This rate is in line with the United Kingdom and at the higher end of neighboring Latin American countries (Figure 6.2). The Finance Act of 2006 streamlined the tax regime in T&T. The country applies a flat income tax rate of 25 percent and a valueadded tax rate of 15 percent. 85 The corporate tax rate in T&T is low relative to the regional rates (World Bank 2011a), and companies are taxed as either “resident” or “nonresident” based upon the location of their management. Resident companies, controlled from T&T, are taxed based on their global profits. Nonresident companies, managed outside of T&T are to pay taxes on profit accrued from doing business in T&T (Inland Revenue Division 2012). 85 Value-added tax (VAT) is zero percent for certain items. 158 Figure 6.2 T&T’s Tax Revenues and Corporate Tax Rate Compared to Other Countries, 2009 and 2010 Tax Revenues as % of GDP, 2009 Corporate Tax Rate, 2010 Angola 43% Norway Angola 35% 27% Brazil Trinidad and Tobago 26% Australia 30% United Kingdom 26% India 30% South Africa 26% Uganda Netherlands 23% Australia 22% Malaysia 16% Chile 16% Brazil 13% Canada 12% Uganda Indonesia India Kazakhstan 12% 30% Canada 28% Norway 28% South Africa 16% Russia 34% 28% Indonesia 25% Malaysia 25% Netherlands 25% Trinidad and Tobago 25% UK 11% 10% 8% 24% Chile 20% Kazakhstan 20% Russia 20% OECD 14% Source: Based on data from CIA 2012; Deloitte 2012; World Bank 2011a. Note: For Angola and Tanzania tax revenues reflect 2011 levels and include social contributions—such as payments for social security and hospital insurance—grants, and net revenues from public enterprises. 6.1.3 Population and Labor Force Since the late 1980s T&T’s population has been growing at a rate of less than 1 percent annually. Totaling 1.36 million in 2010, the population is expected to continue growing at a slow pace until it peaks around 2025, and eventually declines to the level of year 2010 by 2050. The labor force in T&T has reached its peak in size in 2010. The elderly population is growing and is Figure 6.3 presents the evolution of T&T’s population by age group. Million People Figure 6.3 Evolution of the T&T Population and Labor Force over Time) 1.6 80% 1.4 70% 60+ 1.2 60% 50-59 1.0 50% 40-49 0.8 40% 30-39 0.6 30% 20-29 0.4 20% 10-19 0.2 10% 0-9 0.0 0% % 15 - 64 Source: Based on data from UN 2010a. Backed by the economic growth, the unemployment rate in T&T reached its historical low level of 4.6 percent in 2008 (WTO 2012b). Affected by the global recession, the unemployment rate increased to 5.4 percent in 2010. The knowledge base of T&T’s labor force is limited relative to other mature economies and oil producers. The percentage of the labor force with tertiary education in Australia, Canada, Norway, and the United Kingdom is more than twice that of T&T. In addition, the mean of years of education of T&T’s labor 159 force is in line with the United Kingdom but lower than that of Australia, Canada, and Norway. Table 6.2 presents a summary of indicators on T&T’s labor force in comparison to select countries. Table 6.2 T&T Labor Force Indicators Compared to Select Countries, 2010 Labor force (million) Angola Australia Brazil Canada Indonesia Kazakhstan Malaysia Norway South Africa Tanzania T&T Uganda UK 7.1 11.8 101.6 19.0 11.8 8.8 12.0 2.6 18.2 22.1 0.7 13.4 31.8 Educational attainment (% of total) Primary n.a. 27.3 n.a. 13.5 n.a. n.a. 18.3 19.9 15.8 n.a. 25.3 n.a. 19.2 Secondary n.a. 38.9 n.a. 40 n.a. n.a. 56 43.5 74.2 n.a. 63 n.a. 44.4 Tertiary n.a. 33.8 n.a. 46.5 n.a. n.a. 21.1 35.8 5.2 n.a. 11.1 n.a. 35.4 Mean years Minimum wage of education ($ per month) Unemployment, total (% of total labor force) 4.4 12 7.2 12.1 5.8 10.4 9.5 12.6 8.5 5.1 9.2 4.7 9.3 25.0 5.2 8.3 8.0 7.1 6.6 3.7 3.6 23.8 10.7 5.4 4.2 7.8 127 1597 300 1903 133 n.a. n.a. 3609 543 59 n.a. 3 1655 Source: Based on data from World Bank 2011a; UNDP 2010. Note: Educational attainment data for Australia, Canada, Malaysia, South Africa, and T&T represent year 2008 levels. Unemployment data for Brazil, Kazakhstan, Malaysia, South Africa, and Uganda represent year 2009 levels. n.a. Not applicable. 6.1.4 Education T&T is committed to developing a “more diversified knowledge intensive economy.” In a demonstration of this commitment, the Ministry of Science Technology and Tertiary Education spent $2 billion between 2000 and 2010 toward enhancing postsecondary education. The expenditure was a success, boosting tertiary enrollment from 7 percent in 2001 to 40 percent in 2008 with plans to achieving 60 percent enrollment by 2015 (MSTTE 2011). Achieving this target will put tertiary enrollment in T&T above that of the United Kingdom in 2009. Additionally, the Ministry of Education (MEO) increased expenditure per primary student by 54 percent from 2007 to 2009. Enrollment in primary education in T&T is below that of Australia, Norway, the United Kingdom, and the overall OECD average. Youth and adult literacy rates are strong in T&T at 99.6 percent and 99.8 percent, respectively. See Table 6.3 for a comparison of education in T&T to other countries. Table 6.3 T&T Educational Indicators, 2010 Literacy rate (%) Adult (15+) Angola Australia Brazil Indonesia Kazakhstan Malaysia Norway South Africa Tanzania T&T Uganda UK 70.1 n.a. 90.3(a) 92.2(b) 99.7 93.1 n.a. 88.7(c) 73.2 98.8 73.2 n.a. School enrollment (%) Youth (1524) 73.1 n.a. 98.1(a) 99.5(b) 99.8 98.4 n.a. n.a. 77.3 99.6 87.4 n.a. Primary Secondary Tertiary 85.7 97.1 94.1(b) 95.9 89.5 n.a. 99.1 85.1(a) 98.0(2) 93.9 90.9 99.6(a) 11.5(a) 3.7 79.9 36.1(a) 23.1 38.5 40.2(a) 74.4 n.a. 2.1 40(b) 4.2(a) 58.5(a) 85.5 82.0(b) 67.3 88.2 67.9(a) 93.9 n.a. n.a. n.a. n.a. 96(a) Source: Based on data from Gomes and Weimer 2011; UNDP 2010; World Bank 2012; MSTTE 2011. Note: (a) year 2009, (b) year 2008, (c) year 2007, (d) year 2006 data. n.a. Not applicable. 160 Public expenditure on education (% of GDP) 3.6 5.1(a) 5.4(b) 2.8(b) 3.1(a) 5.8(a) 6.5(b) 6.0 6.2 3.8(d) 3.2(a) 5.4(b) 6.1.5 Business Environment Government bureaucracy, corruption, and a poor work ethic are three of the main issues raised by the WEF report of 2012 (WEF 2011). A close look at the governance indicators in T&T shows that compared to year 2000 the country has fallen back on all governance indicators in 2010. As shown in Figure 6.4, the country still has a long way to go to achieve the Organisation for Economic Co-operation and Development (OECD) levels. Overall, the country was ranked 68 out of 183 in the Doing Business indicators of 2012. The time spent to start a business in T&T is 42 days, 31 more than in the OECD countries. Another notable impediment attributed to bureaucracy is registration of property, which takes 162 daysâ€”over five times as long as in the OECD countries on average. Construction permitting is another weakness, averaging 297 daysâ€”145 days longer than the OECD average. T&T is relatively efficient at providing access to electricity and credit (World Bank 2011b), but bureaucratic delays can be frustrating to investors (DoS 2011). A comparison of indicators of the ease of doing business in T&T and the OECD countries in presented in Table 6.4. Figure 6.4 Governance Indicators in T&T Compared to the OECD Average Control of Corruption Voice and Accountability 100 80 60 40 20 0 Political Stability/Absence of Violence T&T 2010 T&T 2000 OECD 2010 Rule of Law Government Effectiveness Regulatory Quality Source: Adapted from Kaufmann, Kraay, and Mastruzzi 2011. 161 Table 6.4 Indicators for Doing Business in T&T in Comparison to OECD Average, 2012 T&T OECD 1. Starting a business 6. Protecting Investors Procedures (#) Time (days) Cost (% of income per capita) Paid-in min capital (% income per cap) Rank (Change in rank from 2011) 9 43 0.9 0 74 (-5) 5 12 4.7 14.1 17 297 6 93 (-5) 14 152 45.7 5 61 7.9 24 (0) 5 103 92.8 8 162 7 175 (-4) 5 31 4.4 8 4 0 46 40 (-3) 7 5 9.5 63.9 Extent of disclosure index (0-10) Extent of director liability index (0Ease of shareholder suits index (0Investor protection strength (0-10) Rank (Change in rank from 2011) 2. Dealing with Construction Permits Procedures (number) Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) Payments (number per year) Time (hours per year) Profit tax (%) Labor tax and contributions (%) Other taxes (%) Total tax rate (% profit) Rank (Change in rank from 2011) Documents to export (#) Time to export (days) Cost to export (US$ per container) Documents to import (#) Time to import (days) Cost to import (US$ per container) Rank (Change in rank from 2011) 5. Getting Credit Strength of legal rights index (0-10) Depth of credit information index (0-6) Public registry coverage (% of adults) Private bureau coverage (% of adults) Rank (Change in rank from 2011) 4 9 7 6.7 24 (-3) 6 5 7 6 39 210 21.6 5.8 1.8 29.1 65 (+32) 13 186 15.4 24 3.2 42.7 6 18 1257 7 20 1546 52 (0) 4 10 1032 5 11 1085 1340 33.5 42 169 (0) 518 19.7 31 4 25 17.9 133 (+6) 1.7 9 68.2 8. Trading across borders 4. Registering Property Procedures (number) Time (days) Cost (% of property value) Rank (Change in rank from 2011) OECD 7. Paying Taxes 3. Getting electricity Procedures (number) Time (days) Cost (% of income per capita) Rank (Change in rank from 2011) T&T 9. Enforcing Contracts Time (days) Cost (% of claim) Procedures (number) Rank (Change in rank from 2011) 10. Resolving Insolvency Time (years) Cost (% of estate) Recovery rate (cents on the dollar0 Rank (Change in rank from 2011) Source: The World Bank Group 2012. 6.2 The Petroleum Sector 6.2.1 The Petroleum Sector in the Economy T&Tâ€™s economy relies heavily on the petroleum sector. As shown in Figure 6.5, the sector has historically contributed 30 to 40 percent of the countryâ€™s GDP. Compared to other countries, the intensity of the petroleum sector in the economy is similar to that of Kazakhstan, Norway, and Malaysia (Figure 6.6). On the employment front, the sector has historically employed around 3 percent of the labor force (Central Bank 2012). 162 300 35% 250 30% 25% 200 20% 150 15% 100 10% 50 Share of GDP GDP (Bn $) Figure 6.5 T&T: Contribution of Mining, Manufacturing, and Utilities to Value-added, 1970–2010 5% 0 0% 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Contribution to GDP Percentage Share Source: Based on data from UN Statistics 2010. Figure 6.6 T&T and Select Countries: Breakdown of Value-added by Economic Activity in 2010 ($ billion) 85 1,296 2,066 1,637 883 159 304 402 377 24 17 22% 23% 2,236 100% 7% 14% 25% 15% 5% 33% 11% 43% 45% 11% 13% 8% 20% 18% 9% 6% 8% 9% 50% 7% 2% 14% 12% 10% 5% 5% Angola Australia 12% 7% 3% 8% 8% 4% 4% 1% 32% Canada 6% 7% 8% 8% 0% 13% 3% 30% 16% 6% 11% 2% 12% 12% 6% 21% 36% 33% 10% 6% 24% 20% 19% Brazil 5% 8% 6% 1% 29% 19% 19% 20% 8% 51% 12% 5% 10% 13% 8% 38% 39% 5% 6% 11% 20% Indonesia Kazakhstan Malaysia Norway South Africa Trinidad & Tobago Other Activities Transport, storage and communication Construction Wholesale, retail trade, restaurants and hotels Manufacturing Agriculture, hunting, forestry, fishing 12% 14% Uganda UK 1% Mining, Manufacturing, Utilities Source: Based on data from UN Statistics 2010. 6.2.2 Petroleum Geography Oil production started in earlier days of the 20th century in the southern areas of Trinidad. The country had its first offshore development in 1955, and since then production has shifted further to the east and more recently to the north coast areas. Overall, the country is a mature hydrocarbon province with future developments expected to come from deep-water areas of the east and north, and the shallow water marginal fields. It must be noted that T&T is endowed with untapped offshore heavy-oil reserves estimated to range between 2,600 and 5,000 million barrels (McGuire and others 2009). 6.2.3 Reserves, Production, and Consumption T&T’s oil production peaked in 1978 at 230 million barrels per day (mmbpd) and has been on a decline since then. The 2011 country’s reserves stand at 800 million barrels with production output of 135.9 mmbpd. On the gas front, T&T’s proved reserves stand at 14.2 trillion cubic feet (tcf). Production of natural gas has been on an increase (11 percent compound annual growth rate [CAGR] between 2000 and 163 2010) putting further pressure on the country’s depleting reserves. To reverse this, the government has recently improved its upstream fiscal terms to attract exploration activities in deep waters. Table 6.5 provides a snapshot of the oil and gas resources in T& T and Figure 6.7 presents the evolution of oil and gas production. Table 6.5 Snapshot of the Oil and Gas Industry in T&T 2011 Oil proved reserves, billion boe Oil production, mmbpd Oil consumption, mmbpd Gas proved reserves, tcf Gas production, bcfd Gas consumption, bcfd Primary energy consumption, million toe 2011 0.8 135.9 34.4 14.2 3.9 2.1 21.5 % of World 0.1 0.1 — 0.2 1.2 0.7 0.2 Global rank 42 32 67 33 9 33 58 1 yr 0.0 -6.5 -3.5 5.3 -4.2 -2.7 -2.8 % Change 3 yrs 5 yrs 0.0 -4.7 -9.9 -11.8 -2.5 1.8 -1.7 -16.6 0.2 4.3 5.4 8.6 4.8 8.0 10 yrs -26.2 -12.3 35.2 -31.9 125.7 73.1 69.3 Source: Based on data from BP 2012. Note: bcfd = billion cubic feet per day; boe = barrel of oil equivalent; mmbpd = million barrels per day; tcf = trillion cubic feet; toe = tons of oil equivalent. — Not available. Figure 6.7 T&T: Evolution of Oil and Gas Production, 1970–2010 (in million tons of oil equivalent) 50 45 Gas Oil 40 35 30 25 20 15 10 5 0 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: Based on data from BP 2012. To meet its local oil consumption, T&T complements its domestic production with imports from Venezuela, Brazil, West Africa, and Colombia. Domestic and imported oil is refined locally and mainly consumed in the transportation sector. As for natural gas, around half of the production is exported via four liquefied natural gas (LNG) terminals with a total capacity of 15.1 million tons per year. Over half of the remaining production is directed to the domestic petrochemicals industry and the rest split mainly between power generation, the industry, and the energy industry’s own use (IEA 2011). 6.2.4 Sector Institutional Framework The petroleum sector in T&T is mainly governed by the Petroleum Act of 1969 and its amendments. Petroleum resources are owned by the citizens of T&T and the state acts as the custodian of these resources (McGuire and others 2009). The MEEA assumes policy development and regulatory responsibilities. As stated by the ministry, these responsibilities include: Formulation and implementation of sectoral policies and legal instruments Management of the state’s interests Leasing and/or licensing of exploration and production (E&P) areas Regulation and management of development and production activities 164 ď‚ˇ Administration of domestic marketing of petroleum products, natural gas transmission/sales, petrochemical manufacture, and other natural-gas-based industries. Government policies require approval from the cabinet. The ministry is supported by a Standing Committee on Energy chaired by the prime minister and including the ministers and permanent secretaries of energy and finance and heads of various state companies. On the operations front, companies are engaged in upstream activities through production sharing agreements (PSAs). There are three model agreements customized for oil and gas activities in onshore, shallow-water, and deep-water activities. Traditionally, PSAs require the approval of the parliament. 6.2.5 Market Structure and Local Capabilities Upstream, there are 35 local and international companies engaged in oil and gas operations, including Chevron, British Petroleum (BP), and British Gas (BG). Among these companies is the Petroleum Company of T&T Limited (Petrotrin). Petrotrin, wholly owned by the government, was incorporated in 1993 and mandated to engage in the petroleum value chain from exploration to distribution. The company owns and operates the only refinery in the country. The company is the result of several mergers and acquisitions outlined in Figure 6.8. Figure 6.8 T&T: Evolution of Petrotrin UBOT (1912-1956) SHELL (1956-1974) TLL (1911-1956) TEXACO (1956-1985) TPD (1918-1961) APEX (1919-1960) KTO (1920-1961) BP (1956-1969) BP, TEXACO, SHELL (1952) TEXACO, TESORO, SHELLL (1969-1974) TRINTOC (1974-1985) TRINTOC (1985-1993) PETROTRIN (1993) TESORO (1969-1985) PETROTRIN (2000) TRINTOPEC (1985-1993) TRINMAR LTD. (1993-2000) TRINMAR, TEXACO, PETROTRIN TEXACO, TESORO, TRINTOCO (1974-1985) Source: Based on data from Petrotrin 2012. Another state-owned company is the National Gas Company of T&T Limited (NGC), established in 1975. The company is responsible for the purchase, transportation, and distribution of natural gas to industrial users. In addition, the NGC is part of the Atlantic LNG company responsible for the liquefaction and export of LNG (Table 6.6). Table 6.6 T&T: Capacities and Shareholders of LNG Plants (1999, 2002, 2003, 2006) Shareholders Startup date Capacity (mtpa) BG BP GDF Suez NGC Repsol YPF ALNG Train 1 ALNG Train 2 ALNG Train 3 ALNG Train 4 1999 3.3 26% 34% 10% 10% 20% 2002 3.3 33% 43% 2003 3.3 33% 43% 2006 5.2 29% 38% 25% 25% 11% 22% Source: Based on data from Deutsche Bank 2010. In addition, T&T has a well-developed industrial base. The country produced ammonia, urea, methanol, iron, and steel. Most of the production facilities engage foreign companies, as shown in Table 6.7. Downstream, another state-owned company, the National Petroleum Marketing Company, is one of two companies licensed to carry out petroleum products marketing activities (WTO 2012b). 165 Table 6.7 T&T: Energy-Intensive Industrial Base by Company Company PCS Nitrogen Point Lisas Nitrogen Limited Product Country of origin of main shareholders Ammonia and urea Canada Ammonia United States Nitrogen 2000 Caribbean Nitrogen Company Tringen Ammonia T&T/Germany Ammonia T&T/Germany Ammonia T&T/Norway Yara Methanol Holdings Trinidad Limited Methanex Ammonia Norway Methanol T&T/Germany Methanol Canadian Mittal Iron and steel United Kingdom Nu Iron Iron and steel United States Source: Adapted from Energy Chamber 2009. The downturn experienced in the 1980s has strongly affected the domestic base of suppliers in the oil and gas industry. Many companies closed and others ramped down their operations. The T&T Central Statistical Office reports that there are around 400 small- and medium-sized enterprises (SMEs) providing services to the energy industry on T&T, 250 of these being engaged with upstream petroleum operators. The activities these companies engage in include the provision of goods, equipment rental, maintenance, and consulting services. Of these companies, three are believed to be among the top ten providers of goods and services to the T&T petroleum sector. 6.2.6 Management of Petroleum Wealth Driven by the volatility in oil prices and the increase in the domestic production of natural gas, the government of T&T created an Interim Revenue Stabilization Fund (IRSF) in 2000. In 2007 the fund was enacted by the parliament, which changed its name to the Heritage and Stabilization Fund (HSF). The objective of the fund is to invest the surplus from petroleum revenues to support public expenditure in case of a downturn caused by oil and gas prices or depletion of resources. In addition, the fund is supposed to “provide a heritage for future generations” (Finance 2010). The fund is governed by a board of governors composed of five members who are appointed by the president. Management of the fund is delegated to the central bank of T&T. As a starting point, the accumulated funds in the IRSF were transferred to HSF. These totaled in $1.3 billion. Subsequently, the fund has been financed from its own investments as well as from petroleum revenues86 in excess of 10 percent of expected revenues87 on quarterly basis. At least 60 percent of the excess revenues shall be transferred to HSF. Based on the defined objectives, HSF’s funds can be withdrawn in case petroleum revenues for any year are lower than expected revenues by at least 10 percent (Mcguire 2009). By September of 2010, HSF had accumulated $3,621 million. The evolution of HSF’s funds is presented in Figure 6.9. As defined by the Petroleum Taxes Act. Signature bonuses and revenues from gas liquefaction and other midstream activities are not included (Mcguire 2009). 87 In case revenues exceed expected revenues by less than 10 percent, the minister of finance can still transfer the money to HSF. 86 166 Figure 6.9 T&T: Evolution of Funds, September 2001–September 2010 ($ billion) IRSF HSF 3.62 2.89 2.96 2008 2009 1.68 1.35 0.64 0.45 0.16 0.16 0.25 2001 2002 2003 2004 2005 2006 2007 2010 Source: Adapted from Mcguire 2009; HSF 2010. 6.3 Local Content Policies 6.3.1 Policy Objectives The overarching driver for LCPs in T&T is the Vision 2020 strategic plan of 2005. The plan has put the increase of local industries involvement in the energy sector value chain as the first objective. Objectives, actions, and stakeholders engaged to achieve this goal are presented in Table 6.8. Table 6.8 T&T: Vision 2020, Goal 1 for the Energy Sector Objective 1: To boost local involvement in the energy sector facilitated by government activities Actions Develop policies to maximize the level of local participation and equity ownership in the sector value chain. Assess opportunities/feasibility for state/private sector investment within the value chain in and outside of T&T. Establish policy to cause operators to partner with local institutions to develop training programs and pursue research and development projects. Adopt and implement policy on local content and participation to facilitate local participation and partnering in new ventures, sustainable development, and so on. Review regulatory framework regarding investment in energy projects toward inclusion of local participants (for example, financiers, investors, service providers, and so on). Establish a certification process of international benchmarking for local energy-based companies, goods, and services. Evaluate options and methods for the divestment of state holdings in energy companies. Objective 2: To Define Metrics, Targets, Measures, and Requirements for Local Content Actions Define metrics and establish targets to track upstream performance, percentage of in-country expenditure/activity. Identify and empower agencies responsible for policy implementation and monitoring. Establish processes and framework to enable transparent measurement, management, and reporting on percentage expenditure/local content. Define, develop, and implement an independent framework to measure local content and targets for local participation in subsector activity. Develop an “audit system” for local content. Energy companies to develop a “Local Content/Sustainable Development Charter,” which defines targets and strategies for increasing local content in projects and operations. Establish a special fund to support domestic investment in services that do not currently exist locally. Owner PLCC PLCC MEEA, MoTI PLCC, MEEA MEEA, MoF MEEA MoF Owner MEEA, PLCC PLCC PLCC PLCC PLCC Operators, PLCC MoF Source: National Committee 2005. Note: MoF = Ministry of Finance, MoTI = Ministry of Trade and Industry; PLCC = Permanent Local Content Committee; MEEA = Ministry of Energy and Energy Affairs. Compared to other countries, local content in T&T has broader objectives, scope, and definition. Two interlinked objectives are separately mentioned in the policy framework of 2006: 167 Maximize the level of participation of T&T’s national people, enterprises, technology and capital Maximize the value to the country from its assets (MEEA 2006). These objectives are achieved “through the development and increasing use of locally owned businesses, local financing and human capabilities.”88 The scope of these efforts covers “all activities connected with the energy sector, along its entire value chain, within and outside of T&T.” Extending the scope to external geographies is underpinned by a view that local capabilities will be essential to capture opportunities beyond the borders of the island, and a plan to grow the country’s GNP. In T&T local content is considered as the “usage of local goods and services, people, businesses and financing.” More specifically, local content and participation imply local value-added that is defined in terms of ownership, control, and financing by citizens of T&T (MEEA 2006). In its latest National Energy Policy Consultations, the MEEA outlines the following potential benefits of LCPs: Greater retention of foreign exchange earnings and export of services Development of human capability in key areas of the sector National development including new business and employment opportunities and increase in the country’s GDP Long-term sustainable development and growth Export of local services and skills (MEEA 2010). 6.3.2 Policy Tools In the policy framework of 2006, the government laid out the menu of high-level fiscal and nonfiscal instruments that can be used to capture local content in T&T’s petroleum industry. The fiscal instruments include: Taxation and royalty policies Government expenditure to capture value from the sector and to extend it by building local capabilities that support the sector’s growth. Nonfiscal instruments include: Local participation—maximizing the depth and breadth of local ownership, control, and financing in order to increase local value-capture from all parts of the value chain created from the resource, including those activities in which nationals, local business and capital are not currently engaged, at home and abroad Local content—maximizing the level of usage of local goods and services, people, businesses, and financing Local capability development—maximizing the impact of the ongoing sector activities, through the transfer of technology and know-how to: o Enhance, deepen and broaden the capability and international competitiveness of our people and businesses within the sector o Create and enhance capabilities that are transferable to other sectors within T&T; and o Create and support cluster developments with other industries that have a natural synergy with the energy sector and which may have the capacity to diversify and/or sustain the economy after the resource is depleted (MEEA 2006). The policy framework also outlined an inclusive approach to maximize local content and participation, outlined in Figure 6.10. In the introductory notes of its local content and local participation policy framework, T&T admitted the limited availability of local human and capital resources and that the country will still rely on foreign expertise and resources. 88 168 Figure 6.10 T&T: Approach to Maximizing Local Content and Participation Source: Based on data from MEEA 2006. Upon approval of the policy framework, PSAs were amended to include provisions on local content. Contracts mandate operators to comply with LCPs issued by the cabinet. In addition, contracts outline local content provisions on procurement and capability development aspects. On procurement: Operators must maximize their utilization of local goods, services, and facilities Within the work programs and budgets submitted to the MEEA, operators must indicate the level of local content they intend on achieving Contracts shall be unbundled, as much as economically and practically feasible, to match the timing, and financial and human capabilities of local enterprises Contracts shall be advertised locally ensuring access of local enterprises to all tenders Tender evaluation processes should put a high weight on the local value-added. On capability development, provisions include: Priority to employing nationals Recruitment and training of nationals to be consistent with the operator performance standards Provision of training and development programs to enable nationals to replace expatriate personnel Transfer of technology and business expertise in, but not limited to, the following areas: o Fabrication o Information technology support, including seismic data acquisition, processing and interpretation support o Operations and maintenance support o Maritime services o Business support services, including accounting, human resource services, consulting, marketing and contract negotiations o Financing o Trading (MEEA 2012). The employment side of local content is also managed through a work permit procedure. A Work Permit Advisory Committee, chaired by the Ministry of National Security and represented by the MEEA, supports local content objectives through (i) advising the minister on work permit decisions upon ensuring that locals are not denied from jobs because of foreigners being employed and (ii) appointing a local successor to the expatriate where expatriate employment is necessary. 169 6.3.3 Legislative Channels The sources for LCPs are: The Petroleum Act Chapter 62:01 and implementing regulations The Fiscal Incentives Act, Chapter 85:04 as amended, which grants fiscal incentives to qualified companies in areas that are considered important to economic development The Foreign Investment Act, Chapter 70:07 The Unemployment Levy Act Chapter 75:03, which provides for training and relief employment for the unemployed The Petroleum Production Levy and Subsidy Act Chapter 62:02, which is used to fund subsidies on petroleum products The Local Content Policy Framework Production-sharing contracts. 6.3.4 Institutional Responsibilities Appointed in 2004, the PLCC (Permanent Local Content Committee) was mandated to support the implementation of the local content and participation framework (MEEA 2009). More specifically, the PLCC: Develops policies and strategies that ensure the transfer of knowledge and technology that improve local capabilities, in addition to business and the capital market Updates local content and participation policies, as required Ensures compliance with set policies. The PLCC is chaired by the Energy Research and Planning Division (ERPD) of the MEEA, which also takes on secretariat responsibilities. In addition to the ERPD, the PLCC engages representatives from the Ministry of Works and Transport, Ministry of Local Government, Oilfield Workers Trade Union, the banking sector, and other private sector representatives.89 On another front, the ERPD advises on policies related to work permits in the energy sector. It also: Supports the formulation of LCPs Acts as a focal point for the PLCC Identifies critical skills in the energy sector and manages a related database Advises on policies related to work permits in the energy sector and represents the MEEA on the Work Permit Committee. Another major contributor to the local content agenda is the Energy Chamber of T&T. The chamber, an independent body, helps to: 89 Ensure that LCPs are implemented in all sectors of the energy industry Monitor future projects and share information about potential opportunities for local companies Develop a methodology for measuring what is a local company Strengthen and update existing database of local companies and their scores Identify export opportunities for local companies in regional/extra-regional markets Encourage co-operation between local companies and facilitate investment into new equipment, training, and so on Lobby the government for changes to the customs and excise legislation and practices that hamper the movement of equipment in and out of T&T Educate member companies and the general public about the energy services sector, including the local capacity and the potential for development (Marajh 2012). The detailed structure of the PLCC is available in the Local Content and Local Participation Policy Framework document of 2004. 170 6.3.5 Interlinks At the strategic level, local content activities led by the government are part of the country’s 2020 Vision. The vision complements LCPs with educational and industrial policies, aimed at building local capabilities and developing an industrial base for export. But some of these policies appear to be at odds with existing international treaties. For instance, the 1994 Treaty between T&T and the Government of the United States of America concerning the Encouragement and Reciprocal Protection of Investment should be renegotiated to address the significant barrier presented by certain clauses of this Treaty. The treaty mandates T&T to accord treatment to U.S. companies that is not less favorable than what is accorded to local companies (Governments of T&T and United States 1994). Another issue is raised by the Caribbean Community90 (CARICOM) treaty, which would require the inclusion of CARICOM nationals in LCPs. It must be noted that T&T has been a member of the World Trade Organization (WTO) since 1995 and grants most favored nation (MFN) treatment to all its trading partners. The country has to incorporate the WTO Agreements into its law to make it legally binding (WTO 2012b). 6.3.6 Monitoring and Measuring Tools While the government has laid out a policy framework in 2006, implementation remains piecemeal. As stated by the MEEA, the main challenges at this stage are: The absence of regulatory measures to ensure mandatory compliance with objectives local participation in the energy sector The development of institutional capacity for the implementation, monitoring and auditing of local content targets State support for programs to encourage research and development, technology transfer, skills development and business incubation in the energy sector Mobilization of local financing to support the services sector The existence of bilateral treaties with other states, which seek to discourage the implementation of local content program (MEEA 2006). Overall, LCPs are not integrated in the government’s regulatory activities of the sector. More specifically, there is absence of a well-defined monitoring and measurement system. For instance, more recent PSAs include a provision mandating: Operators to maintain records to facilitate the determination of the local content of expenditure incurred for petroleum operations; these records shall include supporting documentation certifying the cost of local goods, labor, and services used and shall be subject to audit by minister Operators to report on their local content activities to the MEEA on a quarterly basis Training and development programs to be approved by the MEEA and progress to be reported quarterly Monitoring of the transfer of knowledge and expertise to the appointed local successor, when an expatriate is appointed. But no guidance on certification of local content or reporting is outlined. 6.3.7 Policy Impact on Local Content Levels Within the regulatory context discussed above, most local content activities have been driven by the private sector. In fact, a survey was recently carried out to evaluate the satisfaction of T&T’s oil and gas service companies with LCPs. Results show that 51 percent of local companies are somewhat satisfied with the government LCPs, and 44 percent are not satisfied. Local companies showed higher satisfaction rates with multinationals efforts (Figure 6.11). The results were driven by the absence of a well-articulated policy and a 90 Includes 15 Caribbean nations. 171 perception that the government has not been active in promoting and pushing the local content agenda (Energy Chamber 2009). Figure 6.11 T&T: Survey of Domestic Services Companies Satisfaction with Government Local Content Policies Satisfaction with Multinationals Efforts on Local Content Very Satisfied 2% Very Satisfied 0% Satisfied 2% Satisfied Somewhat Satisfied Not Satisfied 13% Somewhat Satisfied 51% 44% 49% Not Satisfied 38% Source: Adapted from Energy Chamber 2009. A major success story promoted in the country is the establishment of the first specialized fabrication yard in the country in 2004. Driven by the need to increase local spend in upstream activities and its foreseen investments, BP T&T supported the creation of a fabrication yard through establishing two joint ventures (JVs): An engineering and construction management JV between the U.S.-based Fluor Company and local engineering firm Summit A fabrication JV, TOFCO, between the U.S.-based Chet Morrison Contractors and Weldfab Limited of T&T. Both JVs were to be initially mobilized for the development of the Cannonball project platform. As a starting point, the first JV trained 40 nationals in the area of engineering and procurement and assigned to them mentors from Fluor. Similarly, TOFCO trained its 230 employees, of which 184 where locals (Arthur Lok Jack Graduate School of Business 2005). Initially, BP was concerned with the cost of domestic fabrication. The company estimated that the domestic fabrication of the Cannonbal platform would cost $10 million more than the $44 million cost of importing it. Another concern was timely delivery. By the end of the project, the cost premium was $9 million as it achieved a 40 percent local content in spending, 65 percent in project management hours, and 85 percent in fabrication hours. These were significant achievements following previous near-zero levels. Subsequently, the learning curve enabled BP to realize $11 million in cost saving over the Mango and Cashima platforms. In addition, the TOFCO JV became competitive and won several bids. Today, the yard’s facilities are used for manufacturing of topsides for large offshore platforms, jackets, and structures up to 3,000 tons (IPIECA 2011). Table 6.9 presents the local content in expenditure of platform fabrication in T&T. 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