Macroeconomic and Fiscal Implications of Natural Gas Project1
With exploration concluded at the Rovuma offshore gas fields in Northern Mozambique, international oil companies developing offshore gas projects are close to taking the first round of Final Investment Decisions (FID) for major investments in the construction of gas processing facilities. This annex aims at assessing the impact of the gas projects on Mozambique’s economy, including on fiscal revenues. Results, which are based on the Fund FARI model, suggest that, by the mid-2020s, half of the country’s output will be generated by natural gas. However, the fiscal revenues from the projects will remain moderate until the mid-2020s because of large depreciation costs for gas liquefaction facilities. Although the economic potential emerging from the projects is tremendous, macroeconomic and fiscal implications are quite sensitive to international commodity price developments and other risk factors, highlighting that the government’s authorities would be well-advised in taking a cautious approach.
A. Background and context
1. Development of the Rovuma offshore gas fields will be the largest project in Sub-Saharan Africa in terms of its investment size. The Rovuma offshore gas fields, in Northern Mozambique near the border with Tanzania, are divided into two concession areas, Area 1 (lead concessionaire: Anadarko) and Area 4 (lead concessionaire: ENI). Total amount of the gas reserves is estimated at about 180 trillion cubic feet, which is equivalent to the entire gas reserves of Nigeria. The total investment for the projects is projected to exceed $100 billion. Once gas production reaches its peak, Mozambique could become the third largest liquefied natural gas (LNG) exporter in the world after Qatar and Australia.
2. Final Investment Decisions (FID) for constructing the first round of gas liquefaction and processing facilities (“trains”) are expected to be taken by mid-2016. Both Area 1 and Area 4 operators have submitted their development plans to the authorities, and the government and the operators are currently negotiating the project structure as well as other development plan related issues. Area 1 operator proposed a structure integrating gas extraction (upstream) and gas liquefaction (midstream) activities, while Area 4 operator proposed a structure segmenting the upstream and midstream activities. The proposed project structure includes creating Special Purpose Vehicles in other countries for marketing and financing of the projects. Other issues, such as the revision of existing exploration contracts and the resettlement of domestic residents should be addressed before the FID. If all these issues are resolved soon, FIDs for the initial liquefaction plants (‘trains”) can be taken by mid-2016, and operators can start constructing liquefaction trains and finalizing their sales and purchase agreements with prospective LNG buyers.
3. Operators remain confident in the projects’ profitability over the medium term; but further price decreases could pose risks. The gas reserves are located under the deep ocean floor, which could increase the costs of drilling wells and building pipelines and other facilities compared with onshore gas fields. Nevertheless, the developers can take advantage of economies of scale with large amounts of gas located in a few numbers of field, thereby requiring fewer wells than other gas projects. In addition, construction costs of liquefaction facilities could decrease, as new gas projects in some other countries stopped because of the low commodity prices. Finally, operators assume that hydrocarbon prices will increase somewhat over the medium term. However, already ongoing LNG projects are still numerous, including in Australia and the US (on account of shale gas production). Completion of these projects would substantially increase gas supply, which may further decrease gas prices in the medium term if demand does not rise enough. In 2015, gas prices in the East Asian market, where operators envisage to sell most of the Mozambican gas and where gas typically fetches the highest prices, have already dropped substantially compressing the price difference vis-à-vis the North American market.
4. Staff assumes that production and exports of LNG will start in 2021, and production volume will be gradually scaled up during the 2020s. The Area 1 consortium initially plans to construct two onshore liquefaction trains, each of which will produce about 5.5 million tons of LNG per annum. The Area 4 consortium will primarily build a floating liquefaction facility (FLNG), which will produce about 3 million tons of LNG per annum. Both operators could start production of LNG in 2021, and they will utilize cash flows generated from sales thereof to finance construction of additional liquefaction trains. In total, we expect that 13 onshore trains and 4 floating trains will be built for the gas project. The total production volume of the LNG could reach 89 million ton per annum by 2028.
B. Macroeconomic and fiscal implications
5. Staff updated the assessment of the impact of the gas projects on growth, fiscal revenues and balance of payments applying the Fiscal Analysis of Resource Industries (FARI) model. The FARI model, developed by the IMF’s Fiscal Affairs Department, constitutes a tool to support the design of fiscal regimes by providing annual fiscal revenue projections for individual petroleum and mining projects based on various assumptions in terms of fiscal regimes parameters, production volumes and profiles, and prices2. The results reflect staff’s best estimate based on latest information from the authorities and the gas companies, but are likely to evolve as the projects are implemented and new information becomes available.
- Growth: During the 2020s, the gradual increase in production of LNG will significantly raise GDP growth rates. The average real GDP growth rate between 2021 and 2025 could reach 24 percent. As a result, share of the LNG projects in total nominal output of Mozambique could reach more than 50 percent by the mid-2020s. After LNG production reaches its peak level in 2028, with the final liquefaction train starting operation, the real GDP growth will moderate to 3-4 percent. This reflects underlying growth of 6-6½ percent of the non-LNG economy and no further growth of the LNG sector. Therefore, the LNG share in total output would gradually decline starting in the late 2020s.
- Fiscal revenues: The total fiscal revenues from the LNG project throughout the entire project period until 2045 could reach about $500 billion. Main sources of the fiscal revenues are (i) the government’s share of profit gas, (ii) the corporate income tax on the concessionaires, and (iii) the dividends paid by the state-owned hydrocarbon company (ENH), which owns a 15 percent share of Area 1 and a 10 percent share of Area 4. Even though the gas production would rapidly scale up during the early 2020s, fiscal revenues during the first few years are limited, because of the large cost recovery for continuous investments in building liquefaction plants. It is important for the fiscal authorities to be aware of this time lag between gas production and fiscal revenue flows when planning their medium-term fiscal strategy. By the late 2020s, the fiscal revenues from the gas projects could account for more than half of total fiscal revenues.
- Balance of payments: Mozambique will experience unprecedented large current account deficits during the late-2010s, peaking at more than 90 percent of GDP in 2020, due to the massive investments in the LNG trains. Once the gas production begins, the current account balance could gradually improve and reach surplus in 2025. Following a similar pattern to the fiscal revenues, the current account during the first few years of the 2020s will remain in deficit because of investments in subsequent trains. By the mid-2020s, LNG will account for about ¾ of the total exports. After that period, staff assume that increased public investments, e.g. in infrastructure, and reforms will improve external competitiveness of the non-mining industries and crowd in private investment leading to a subsequent increase exports of other products. Assuming that risks of a Dutch-disease induced by exchange rate appreciation can be contained, this gain in competitiveness could materialize from late-2030s, and the overall current account balance would remain in surplus until the end of the LNG production.
6. Various risk factors could significantly change the long-term projections.
- First, sales prices of the gas could drift below the baseline assumptions. An enduring slowdown of the global economy could trigger further declines in global gas prices. Also, if the first FIDs were significantly delayed for some reasons and in the meantime other global LNG projects meet most of gas consumers’ demand, sales prices could be lower. Fiscal revenues could be particularly sensitive to lower gas prices, because most of the revenues are related to the profits of the projects.
- Second, changes in taxes and other fiscal regimes could pose large impact on fiscal gains. The Decree Law legalized in 2014 ensures long-term fiscal stability, in which planned development of royalty tax rates (initially 2 percent and gradually raised to 6 percent) will not be changed without agreements between the government and the company. However, changes in the project structure as a result of the current negotiation could still negatively affect government revenues, if profits were shifted abroad or to other entities to which lower tax rates apply.
- Finally, long-term economic growth could naturally be dampened if the windfalls from the gas projects were not appropriately managed. If the government spent money mostly on non-productivity enhancing current spending or less efficient capital investments, the growth of the non-LNG economy may not be as high as estimated in the baseline scenario. Also, it is important to forestall any loss of external competitiveness of the non-mining sectors due to “Dutch Disease” by effective management of fiscal revenues. In this regard, Ross (2014) highlights several avenues that Mozambique could follow, including setting up a Sovereign Wealth Fund, managing savings, and fiscal rules, as well as increasing competitiveness in non-resource based sectors. Such topics will become more prominent in future policy discussions.3
Figure 1.Mozambique: Macroeconomic and fiscal implications of the LNG projects
Sources: IMF staff estimates and projections.
Prepared by Keiichiro Inui, Leandro Medina (both AFR), and Christian Henn (SPR).
The assumption of gas prices is based on oil price projections in the latest World Economic Outlook, and a constant coefficient of 0.14 is applied to calculate gas prices from the oil prices.
Ross, D., (Editor). 2014, “Mozambique rising: building a new tomorrow,” Washington: International Monetary Fund, 2014.