I. Past and Present Energy Booms in Trinidad and Tobago: Lessons for Fiscal Policy1
1 Trinidad and Tobago, the Caribbean’s largest producer of oil and gas, is expected to face a significant energy boom in the years ahead. Due to new large oil and gas discoveries and to a series of projects that are scheduled to come on stream in the next three years, energy production is projected to double by 2006–07. Consequently, government revenues will register a significant boost from energy receipts over the medium term. However, given the estimated reserves of natural resources in the ground, notwithstanding new discoveries, proven oil and gas reserves are expected to taper off by 2020.
2. The policy challenge that the authorities face is how to manage wisely their energy wealth so that they do not repeat the policy mistakes of the past. Trinidad and Tobago has already experienced the consequences of resource mismanagement during the oil booms of the 1970s and 1980s. An overly expansionary and short-term focused fiscal policy and a slow policy adjustment when oil prices dropped after 1982 led to a lengthy and painful recession. This chapter draws a parallel between the historical and the current energy booms, underlining the main similarities and differences between the two episodes and pointing out the main policy issues during boom times.
B. A Historical Perspective on Fiscal Policy During the Oil Booms of 1970–80
3. Trinidad and Tobago experienced substantial revenue and foreign exchange inflows during the oil booms of 1973–74 and 1979–80, but failed to manage this windfall appropriately. The authorities used the initial windfalls cautiously, by saving abroad a large fraction of the proceeds, and by investing the rest in infrastructure and other projects aimed at output diversification. However, political pressures led to a rapid growth of subsidies to consumers, labor, and failing firms. During the second oil boom, fiscal policy became expansionary and inefficiencies multiplied. A confluence of subsidies, price controls, and wage increases, together with an appreciation of the real exchange rate and an extension of public ownership, eventually undermined the non-oil sectors of the economy instead of boosting them. When oil prices dropped after 1982, policy was slow to adjust, and the economy entered into a lengthy recession.
4 Fiscal policy was relatively cautious during the first oil boom of 1973–74. The first oil windfall, which increased oil revenues from 5 to 37 percent of non-energy GDP, was used relatively cautiously, with around 70 percent of the windfall being saved abroad. This led to current account surpluses which averaged 7 percent of GDP over 1974–78. International reserves grew from US$47 million in 1973 to US$1.8 billion in 1978. To prevent wasteful expenditure of oil revenues, several funds (51 in total) were established, that could be drawn on only when project plans were properly designed and approved by the parliament. The rest of the windfall was divided between domestic investment (12 percent) and consumption (18 percent). Of the funds used for investment, approximately half went into economic infrastructure (transportation, power, and water), a fifth into social infrastructure (education and housing), and the rest were set aside to pursue gas-based industrialization.
5. As oil prices remained high during 1974–78, the fiscal stance weakened. During 1974–78, as a result of a mass nationalization campaign and of a strong push to reduce unemployment, the government acquired 40 companies, including the dominant sugar company (Caroni) and Royal Dutch Refinery (renamed Trintoc). Furthermore, subsidies for food, fuel, and utilities increased during this period. By 1978, subsidies accounted for around 6 percent of non-energy GDP, and recorded fiscal subsidies increased to over 18 percent of oil revenues. Labor was subsidized directly via a public works program that employed 2.5 percent of the total labor force at higher wages than in the agriculture sector.
6. By 1978, several danger signs pointed toward unsustainability of current levels of consumption and investment given finite oil revenues. Among the problems identified were: high recurrent expenditures; investment in declining industries, which diverted revenues into losses (i.e., the sugar industry); a loss of competitiveness in the non-energy sector (a decline in the share of non-energy tradables in non-energy output); poorly conceived programs to expand food supply were not generating planned revenues; import controls reduced competitiveness; and a steady increase of dependence on oil and oil-financed expenditures. The government had recognized these problems and planned to meet them, but new natural gas finds in 1978 and the second oil boom removed the incentive to be cautious.
7. During the second oil boom in 1979–80, fiscal policy became increasingly expansionary, as subsidized consumption and capital investments accelerated. Around 25 percent of the windfall was used for consumption, and 25 percent for domestic investment, while the remaining 50 percent was saved abroad. During 1979–82, the use of public investment funds was mainly geared toward loans and advances to meet startup requirements for large capital projects especially in the gas based and steel industries and to cover the cash-flow problems of state-owned enterprises. The losses of public enterprises during 1979–81 represented the equivalent of 55 percent of 1979 oil revenues, Furthermore, the new industries required greater than expected capital infusions. Subsidized consumption increased to 33 percent of oil revenues. High wages that outpaced productivity and large labor subsidies led to high domestic inflation, which together with a stronger US dollar implied an appreciation of the real effective exchange rate and a loss of competitiveness.
8. A lengthy recession began shortly after the second oil boom, uncovering the chronic problems with the policies adopted thus far. After 1982, unsustainable demands to finance investment, public consumption, subsidies and transfers threatened to eliminate the large international surpluses accumulated since 1973. In 1982-83, fiscal deficits equaled 77 percent of oil revenues and the non-oil balance reached 42 percent of non-oil GDP. Per capita GDP fell by about 33 percent, and international reserves contracted from a peak of USS 3,350 million in 1981 to US$175 million by end of 1992. The policy response was sluggish, as the authorities thought the shock was temporary. Unemployment rose from 10 percent to 19 percent.
9. With the benefit of hindsight, several problems with the fiscal policies adopted in the 1970s and 1980s are clear. First, the costly subsidies, credit facilities, and extensive protection to agriculture and manufacturing that were undertaken during the oil booms did not assist in restructuring these sectors, but were a continuing expense after the boom. Second, the protectionist trade policy adopted, which allowed for import restrictions, high tariffs on competing imported goods, and duty concessions on imported inputs, together with the real exchange rate appreciation resulting from the massive foreign inflows, eroded competitiveness and led to “Dutch disease” in the tradable sector. Third, the resource based industrialization strategy drained the oil revenues and added to indebtedness, and the highly capital intensive nature of these projects did not encourage employment. Furthermore, miscalculations of project costs, delays in project execution and implementation and the failure to consider future expenditure outlays for the operation and maintenance of investment projects led to the inefficient use of resources. Finally, excessive subsidization of utilities and state enterprises drained revenues, and the construction and the special public works programs drew resources away from agriculture and manufacturing.
C. Characteristics of the Current Energy Boom
10. At present, Trinidad and Tobago is facing a new energy boom which will increase fiscal revenues considerably, but by less than the previous oil booms. Unlike the two previous episodes of the 1970s and 1980s, the current boom is due primarily to large newly discovered reserves of oil and natural gas rather than to an increase in oil prices alone (although the latter has also been present in the second half of 2002, in the wake of the Iraq war). The expected increase in oil and gas production between now and 2006 is projected to be about 100 percent, somewhat larger than its historical counterpart of 1974–80, when energy production increased by 66 percent between 1973 and 1978.2However, due to the more diversified structure of the economy and to lower current and expected oil prices than those prevailing during the 1970–80 period, energy revenues are projected to register a more modest, although significant increase from about 24 percent of total revenues in 2002 to about 36 percent of revenues by 2006, as compared to an increase from 22 percent in 1973 to 67 percent of total revenues in 1974, and to about 64 percent in 1980.
11. Currently, the energy sector constitutes about 26 percent of total GDP, with its subcomponents distributed according to Figure 5. As of January 2002, total proven oil and gas reserves were estimated at 4,220 million of barrels of oil.3 At current rates of extraction,4 proven energy reserves are expected to be exhausted in about 18 years. Figure 6 shows the breakdown of overall energy reserves according to the ministry of energy classification into proven, probable, and possible reserves.5 Trinidad and Tobago has become one of the major natural gas development centers in the world, and is now the largest liquefied natural gas (LNG) exporter to the United States. Gas is expected to surpass oil as the main revenue earner for the country in the future. It is used for electricity and petrochemical production, as well as heavy and light industry. British Petroleum (BP) is the nation’s largest oil and gas producer, followed by Petrotrin, which is a state oil company. Trinidad now has eight ammonia complexes (with a ninth under construction), five methanol units, a urea plant, and an iron and steel complex. Trinidad is the world’s leading exporter of both ammonia and methanol.
Figure 1.Expenditure Categories
Source: Previous Staff Reports
Figure 2.The Real Exchange Rate and the Index of Competitiveness
Source: Previous Staff Reports
Figure 3.Current Account and International Reserves (US$ mil.)
Source: Previous Staff Reports
Figure 4.Overall and Non-Oil Balances and the Price of Oil
Source: Previous Stuff Reports
Figure 5.Composition of the Energy Sector in 2002
Source: Ministry of Energy
Figure 6.Risked Oil and Gas Reserves
Source: Ministry of Energy
12. According to energy ministry projections, production of oil and gas will increase by 70 and 130 percent respectively, raising the share of energy in GDP to 32 percent by 2006.6 These developments are attributed to three main factors. First, BHP Billiton announced three new hydrocarbon discoveries located off the northeastern coast of Trinidad and estimates that the region contains up to 1 billion barrels of oil and 2.5 trillion cubic feet of natural gas, making it the country’s largest ever offshore discovery. The company expects to start production from these new fields as early as 2004, and attain peak production by 2006. Consequently, overall oil production is expected to reverse its steadily declining trend over the past two decades and increase from about 125,000 barrels of oil per day (bopd) to about 203,000 bopd by 2006. Second, ALNG Company has recently begun operations of a third production train in April 2003, which has increased its production capacity by 50 percent. In addition, by 2006, ALNG train IV is projected to add another 56 percent to total gas production, and to raise LNG production by an additional 76 percent. Finally, one ammonia and two methanol plants are expected to become fully functional between 2004 and 2005, increasing petrochemical output by over 50 percent.
|Methanol||266||287||369||529||609|Figure 7.Crude Oil and Gas Production 10 Year Projections
Source: Ministry of Energy
13. Trinidad and Tobago applies a range of fiscal instruments to tax gas and oil production, refining and marketing. For oil extraction, production-based payments include: royalties at a rate of 10–12.5 percent, a production levy with a maximum of 3 percent, and a small petroleum impost to cover the expenses of the ministry of energy. Income-based taxes consist of: supplemental petroleum taxes (which are based on the oil price7), profit taxes (levied at a 50 percent rate), and an unemployment tax (at 5 percent). Gas producing companies must pay royalties (at a mutually negotiated rate), corporate income taxes (at a standard rate of 35 percent), and the impost. In addition, Trinidad and Tobago engages in production sharing in both the oil and gas sectors, and offers a number of tax incentives to energy producers, such as income tax holidays for up to 10 years on new investments, and exemptions on import duties and on VAT on imports.8
D. Fiscal Policy Issues
14. Despite the differences between the oil booms of the past and the present, the fiscal issues facing policymakers have remained largely the same. These include: large foreign inflows, which, under a heavily managed exchange rate regime, could put upward pressure on the real exchange rate and threaten competitiveness in the non-energy tradable sector; the risk that the energy revenues could be inefficiently used; and the danger that fiscal policy would become unsustainable in the face of macroeconomic shocks such as a global slowdown, a sharp drop in oil prices, and the eventual depletion of energy revenues. In addition, the deterioration in the fiscal stance is likely to be masked by growth in the energy sector, which lowers the overall and primary fiscal balances relative to GDP.
15. As past experience suggests, a responsible fiscal policy strategy during an energy boom would need to be aimed at: maintaining macroeconomic stability, spending energy resources efficiently, and strengthening the non-energy sector. High public expenditures could lead to an overheating of the economy, fueling inflation, and real appreciation of the exchange rate. This, in turn, may negatively affect the non-energy tradable sector, which is the engine of employment for the economy and the long-run generator of growth when energy resources are exhausted. Furthermore, if a negative shock occurs, such as a sharp drop in oil prices, cutting expenditures abruptly could generate macroeconomic instability and be disruptive for economic activity, as was the case after the oil boom of 1979–80. Consequently, smoothing the non-oil balance over the medium term would be more desirable than targeting the overall balance, which depends not only on the fiscal stance, but also on the composition and growth of GDP. Finally, energy resources would need to be spent efficiently, so as to target development in the non-energy sector and to avoid implementing projects with low rates of social return, leading to a waste of resources.
16. The current fiscal stance differs considerably from that of the 1970s and 1980s. while in the past, the bulk of the energy revenues was concentrated toward capital expenditures, presently, recurrent expenditures are rising due to increased social outlays. According to the budget for FY 2002–03, total expenditures are projected to increase by 15 percent over the previous year’s outturn, owing to an increase in current expenditure of 11 percent. Nearly all categories of current expenditures are projected to increase by double digit percentages: goods and services will increase by 30 percent, transfers to statutory bodies by 22 percent, current transfers, mainly to households, by 12 percent. In contrast, capital expenditures are projected to be reduced by 5 percent over the previous year. In the medium term, current expenditures are likely to increase even further, according to the authorities’ expressed desire to use a significant portion of the projected energy revenues to pursue poverty alleviation programs and to expand health benefits and education programs countrywide.9
17. To avoid the pitfalls of the past, the composition of expenditures would need to be carefully thought out, and better mechanisms would need be put in place to improve project appraisal, selection, and ex-post evaluation. Increasing current expenditures, such as subsidies and wages, may fuel demand and have negative macroeconomic consequences, as described earlier. Capital expenditures, on the other hand, targeting infrastructure, communication, and transport improvement could stimulate development of the non-energy sector, provided that appropriate mechanisms exist to ensure competitive bidding between projects such that only those with higher expected returns would be implemented. Health and education projects could also be beneficial for long-term development, if appropriately targeted toward primary and secondary education and primary healthcare.10 Furthermore, the long-term consequences of new projects (such as maintenance costs for infrastructure, new schools or hospitals) would need to be taken into account from the start and budgeted appropriately.
18. Trinidad and Tobago is currently facing an energy boom which constitutes a unique opportunity for policymakers to set in motion a virtuous cycle of growth and development. Given new large oil and gas discoveries, significant energy revenues are expected to flow during the next few years. A wise and prudent fiscal strategy could convert these temporary resources into permanent engines of development. In contrast, inefficient management of resources may lead to macroeconomic instability, to a deterioration of the non-energy sector, and to lower long run growth, as was the case after the oil booms of the 1970s and 1980s. To attain the authorities’ goal of developing a knowledge-based economy by year 2020, fiscal policy would need to be conducted prudently to avoid the policy mistakes made in the past and to ensure macroeconomic stability, efficient spending of energy resources, and strengthening of the non-energy sector.
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