A. Budget Documentation of Resource Revenues and Spending 3.1.1/3.1.4

89. Governments may receive resource revenues through a variety of tax or equivalent instruments. Budget documentation should clearly classify resource revenue-related receipts under the appropriate instrument. In some cases, some or all of those receipts may be directly placed in a resource fund. In other cases, such as the Norwegian Pension Fund-Global, all petroleum revenues and expenditures are recorded in the budget, and net proceeds are transferred to the fund. Thereafter, the necessary funds to finance the non-oil budget deficit are transferred back from the fund to the budget.⁸⁵ In other countries, such as the United Kingdom, the government receives all payments directly through the revenue authorities, and these are recorded against each type of revenue instrument. In the aggregate budget documents, such receipts are not separately identified, but detailed reports on such resource revenues by type of tax or other levy are regularly produced (in the case of the United Kingdom, by National Statistics⁸⁶). A basic principle in each case is that the tax payments are under the supervision of the relevant tax authorities, and all transactions are included in the budget (or related) analytical presentations. In advanced countries, well-established government tax administration and reporting and auditing procedures give credibility to reported data. Some developing countries also publish basic data on oil revenues in their budget documents. However, systematic monitoring and verification of data are often inadequate.⁸⁷

B. Reporting on Company Resource Revenue Payments 3.1.4

90. Many countries rely on established government accounting and reporting procedures to provide reliable information to the public on resource revenue receipts-as well as spending. In principle, governments in all countries should move toward compliance with the relevant reporting standards defined in the Code, the Manual, and this Guide, as well as the OECD Principles of Corporate Governance with reference to NRCs. However, many developing countries lack the capacity to move rapidly toward such standards. The EITI has initiated a model of standard reporting procedures to be agreed upon by a multistakeholder group in each reporting country that will help ensure that revenue receipts from natural resources are fully accounted for.⁸⁸ This initiative is aimed particularly at resource-rich developing countries where general revenue and budget administration controls do not currently reach good practice levels. For such countries, compliance with the principles for establishing reporting procedures set under the EITI for governments and extraction companies should represent a substantial step forward. Governments should also lift any confidentiality provisions that would impede reporting of resource revenue payments. It is important, in this context, to emphasize that there must also be adequate assurance of data quality, as discussed further in Chapter IV.

91. Under EITI provisions, the basic standards and procedures for companies and governments to follow in reporting resource production and revenue flows are as follows:

• Regular reporting by host governments in line with a government reporting template agreed to by a multistakeholder group;

• Regular reporting by companies, including NRCs, in line with a company reporting template agreed to by a multistakeholder group;

• Wide dissemination of comprehensive and comprehensible material on payments and revenues;

• Validation and publication of reports of aggregated data, and reconciliation and analysis, by an independent third party; and

• Active participation by civil society.

92. The EITI reporting requirements are applied only to upstream activities (that is, all activities up to the first point of marketable production-wellhead or mine gate) and are designed only for extractive industries, such as metal ores, gemstones, crude oil, and natural gas. Reporting covers a set of benefit streams defined by the multistockholder group, which may not include QFAs. To accommodate government accounting practices, and to promote reconciliation among the parties to EITI reporting, all benefit streams are reported on a consolidated cash basis.

93. Although the EITI criteria and reporting requirements cover only a narrow range of resource-related fiscal activity, they provide an important framework around which governments and companies can build a credible reporting base. Establishing a government commitment at this level and agreeing with companies on compliance with EITI reporting requirements is an important first step toward the broader goal of transparent resource revenue management.⁸⁹

94. Significant efforts are required, however, to apply the EITI mechanisms. By end-2006, some two dozen countries had either made formal commitments to participate in the EITI or indicated their intention to do so, but some had not moved beyond an expression of interest. In the future, a validation mechanism approved at the 2006 EITI Conference in Oslo will be used to determine which countries can be formally designated as EITI candidate countries (those who provide evidence of meeting four basic indicators of commitment), and which of these countries qualify as EITI compliant countries, having fully implemented EITI by meeting a series of indicators, including the publication and distribution of a validated EITI report reconciling aggregated resource-related payments reported by companies with resource-related receipts reported by the government.

95. Four phases of implementation are identified in the EITI process. The first or sign up phase determines whether a country is to be designated as an EITI candidate country and requires that four indicators be met: an undertaking to work with civil society, appointment of a senior official responsible for EITI, and publication of a costed work plan. The second or preparation phase of the EITI requires, among other things, that government remove obstacles to EITI implementation, agree on reporting templates, ensure all companies will report, and ensure that both company reports and government reports are based on audited accounts to international standards. The third or disclosure phase requirements include submission of an EITI report to the validator (the independent organization contracted to confirm that the process has been properly conducted) showing all material oil, gas, and mining payments by companies to government, and all material oil, gas, and mining revenues received by government. The fourth or dissemination phase requires that the EITI report be made available in a way that is “publicly accessible, comprehensive, and comprehensible.” Any discrepancies would be highlighted and appropriate follow-up action encouraged.⁹⁰

96. A number of countries have taken steps toward full implementation of the EITI in advance of establishing the validation process. Ghana and Guinea produced early reports on mining revenue collection and reconcilation. Nigeria and Azerbaijan were pilot countries for testing and evaluating the verification process and are now producing regular EITI reports. Cameroon, Gabon, the Kyrgyz Republic, and Mauritania have also produced EITI reports.⁹¹

C. Fiscal Balance 3.2.3

97. A central issue for countries rich in nonrenewable resources is how best to use revenue derived from the resource to promote a diversified economy and share the benefits with future generations. One approach is to treat resource riches as wealth, and only to consume the part of current revenue that is consistent with permanent income expectations (Barnett and Ossowski, 2003). To achieve such an objective, and therefore maintain a constant overall level of wealth (whether in untapped resources or financial assets) the nonresource primary fiscal deficit would need to be set equal to an estimate of permanent income from the government’s wealth (although this estimate may of course need to be adjusted periodically because of the difficulty of assessing the value of natural resource assets).⁹² In practice, the government might allow the actual level of the nonresource primary deficit to deviate for a period from the estimate of permanent income for macroeconomic reasons or because it decides to draw on some of its resource or financial wealth, perhaps to increase investment (human or physical). Although technically difficult, this analytical framework can play an important role in better informing the public and politicians on the policy choices that affect current and future generations and should be summarized in budget documentation.⁹³

98. In resource-rich countries with widespread poverty, a decision to target a higher nonresource fiscal deficit for a period may in part reflect a wish to permit additional investment in schools, health clinics, and other basic infrastructure.⁹⁴ The expectation would be that the resulting increase in human and physical capital would offset the decline in resource or financial wealth. However, the actual contribution of the new investment to improved growth prospects and the timing with which any benefits are realized are difficult to predict. They will depend on a range of issues including the quality and relevance of the investment, competitiveness, market structure, and economies of scale. Moreover, consideration must be given to the macroeconomic consequences in the short term. The accumulation of financial assets to ensure medium- and long-term sustainability therefore merits explicit consideration as an integral part of fiscal policy for resource-rich countries. If these assets are invested abroad, this approach can also help mitigate problems related to real exchange rate appreciation and Dutch disease.

99. Uncertainties notwithstanding, these considerations lead to the conclusion that the primary nonresource fiscal balance is an important indicator for measuring the direction and sustainability of fiscal policy in resource-rich countries.⁹⁵ Estimates should therefore be prepared from resource revenue projections of an appropriate level for this balance and used as a basis for determining fiscal policy and spending levels. As Barnett and Ossowski (2003, p. 51) point out with respect to oil-producing countries, however, few highlight the non-oil balance in their budgets—and it is likely that a similar observation would apply to mineral-rich countries. With respect to oil-producing countries, the IMF increasingly includes measures of the primary non-oil balance in country documents and advises country authorities to focus on such measures in budget and other fiscal policy documents.

100. Broader concepts of the fiscal balance may also be appropriate in countries where the NRC plays a large fiscal role. To the extent that NRCs have a dominant role in fiscal policy and carry out QFAs, there is a reasonable case for including them in a broad public sector balance or an indicator that consolidates with the general government all public corporations presenting fiscal risks for purposes of fiscal policy management. The general case for applying such a balance is recommended under practice 3.2.3 of the Code and described in the Manual. These considerations are particularly relevant for fiscal management in a number of resource-rich countries.

D. Reporting on Resource-Related Debt 3.1.5

101. Open and timely disclosure of all contracted debt and contingent obligations is another essential element of public information.⁹⁶ Such a disclosure provides an added assurance of transaction flow data—deficit/surplus data should fully reconcile with accumulated debt. Full disclosure of all liabilities and contingent liabilities is essential to assessing fiscal sustainability and setting medium- and long-term fiscal policy.

102. The extensive abuse in several resource-rich countries of borrowing by collateralizing future production is documented in Global Witness (2004). As noted in Chapter I, the legal framework should carefully define proper authority to contract such loans and require public disclosure of loan terms. But this framework needs to be supported by strong requirements for reporting by both borrowers and lenders. Clear standards for reporting debt are applied in many countries and this aspect is covered in the Manual. Governance and capacity issues must be addressed in those countries that do not at present comply with basic requirements in this regard. Measures are also needed to improve disclosure by the lenders that are involved in these transactions.

E. Reporting on Assets 3.1.5

103. The standard requirements outlined in the Manual apply to questions of disclosure of government financial assets. Two specific issues arise in connection with assets related to resource revenues in developing countries. First, such assets are often held in a separate fund with disclosure requirements that may differ from those of general government. Second, in many developing countries, and indeed a number of emerging markets and some advanced countries, requirements for disclosure of financial assets are not in compliance with the Code’s good practices.

104. Where assets are held in a separate fund, best practice (as in the case of Norway, see Box 4) is to set clear published guidelines for asset management and report on assets and asset management performance. Attainment of the basic elements of disclosure along these lines should be the goal of all countries—although the technical standards applied in advanced countries may not be achievable for developing countries in the near term. If assets are held simply as part of overall government assets, as is the case in the United Kingdom, reporting on financial assets becomes part of the government’s overall financial reporting to the extent that reporting on financial assets has been established.⁹⁷

105. Priority should be given by resource-rich countries to implementing appropriate practices for asset disclosure as soon as practicable. Tracking asset worth is a central element of a savings policy for long-term sustainability of fiscal policy. Some capacity building may be needed in this regard, but the benefits should greatly outweigh the costs.

F. Estimating Resource Asset Worth 3.1.5

106. If net worth of public assets is a central fiscal policy concern, an estimate of resource asset worth is a key input. As of yet, however, countries do not systematically include clear statements of estimated value of natural resources in their budget or accounting statements, reflecting measurement difficulties, uncertainty over physical volumes and prices, and the lack of current standards even for advanced countries.⁹⁸ The practice suggested above, therefore, sets a very high standard, which will be difficult to implement even for industrial countries. This Guide therefore recommends a pragmatic approach toward implementing a basic standard for low- and middle-income countries with significant new resource discoveries-essentially building on effective revenue forecasting methodology and focusing on the government’s share of asset value (Box 5). An explicit calculation of resource asset worth will be an important step toward transparency, and it will provide an important basis for long-term policy. Ideally, such calculations should be published in the budget documents. The high level of uncertainty associated with such estimates, however, suggests caution in publishing quantitative estimates, given possibilities of misinterpretation. Published documents should give assurance that fiscal policy is based on sound evaluation methodology and progressively move to more detailed quantification as production becomes established.

107. In the longer term, international standards for reserve estimates could establish relevant standards for country estimates of resource asset worth. As described in Box 6, however, development of comprehensive international standards for estimating reserves poses a host of complex technical and collective action problems. Individual country action should not, however, be delayed because of the absence of a fully agreed-upon standard. On the contrary, positive action by individual countries will help provide a basis for standards of wider applicability. Moreover, the basic elements of such practices should be applied irrespective of the level of economic development-a concern with asset worth is at least as important for developing as for advanced countries.

108. In developing such standards, an important distinction must be drawn between the use of asset worth statements for accounting or financial reports and that for budget and long-term policy purposes. Most work at the international level to date has been oriented toward the former purpose, a trend possibly driven primarily by company stock exchange listing requirements. For this purpose, although uncertainty is acknowledged, accounting reports⁹⁹ are obliged to set strict (and generally conservative) criteria for asset recognition (see Box 6).¹⁰⁰

109. Reserves estimates based on International Financial Reporting Standards (IFRS) or another national reporting standard, however, are of limited utility for purposes of setting national budget policy. Rather than determining an agreed-upon point value for resource assets to construct a balance sheet summary, long-term policymaking should be concerned primarily with potential responses to changing economic circumstances. Budget documents and other fiscal policy statements should thus clearly state the assumptions on which projections and estimates are based, and they should show the sensitivity of projections and estimates to changes in key parameters (with the resource price obviously being key, particularly in the case of oil).¹⁰¹ Similar technical and economic assumptions will underlie projections and estimates included in government or company financial statements and budget statements of reserves. It is essential, however, that the differing uses of these data be clearly recognized in the respective statements. More work seems required in both areas.

G. Reporting Contingent Liabilities and Quasi-Fiscal Activities 3.1.3

110. Any contingent liabilities arising from resource contracts should be disclosed in budget and accounts documents. A budget annex dealing with fiscal risk (see below) could be an appropriate form of disclosure for these and other forms of contingent liability. Government guarantees should be listed in government reports on debt (but separately identified as contingent debt).

111. As described in Chapter I, energy QFAs can be very large. These QFAs deserve more analytical attention than they have received in the past, because failure to report them masks the true extent of government activity in the resource sector and the economy as a whole. As far as public expenditure QFAs are concerned, governments of low-income countries should have a particular interest in presenting social service spending to the legislature and the public as a way to demonstrate that pro-poor spending is actually higher than reported in government budgets and accounts. Companies should also benefit from comprehensive and detailed disclosure of information on such spending as evidence of their corporate social responsibility. At any rate, the various mechanisms and types of QFAs outlined in Chapter I should be explained and disclosed in government budgets (e.g., as an annex to the budget) and other documents. In countries with very active NRCs and large QFAs, the fiscal reports of the government should be consolidated with that of the NRC and published.

112. Further assurance of reporting quality could be achieved if resource company reports also reported such activities clearly and in detail—particularly if these elements are subject to audit. Governments and energy companies should, as far as possible, analyze, quantitatively estimate, and regularly report the size of such activities. In the first instance, such data are likely to be most readily available through international and national company reports. Companies should be encouraged to disclose this information comprehensively and regularly through their annual reports, and they should make the basis of estimation clear and available to the government and the public. Government budget documents should derive information from these sources and regularly and systematically report on all such QFAs. These reports could be supported by analytical comments on the impact of such activities and future policies toward them.

H. Fiscal Risks 3.1.3

113. Resource-rich countries are prone to large, sudden, and unexpected changes in output prices, especially in the case of oil. Such price changes give rise to potentially large forecasting risks for revenue and other variables, both directly and indirectly. For example, a large change in the oil price would not only affect oil revenue directly but could also trigger changes in other key variables, such as the exchange rate and interest rates, which in turn could affect expenditure and financing projections, in both the short and medium term. Annual budget documents should transparently show the baseline price assumption and how it was determined. Moreover, sensitivity analyses should be carried out to address forecasting risks, especially for the oil price assumption, and their results should be disclosed to the general public and external experts for scrutiny.

114. The Manual advises against the practice of multiple supplementary budgets within a budget year because this reduces the transparency of the budget process and shows poor budget preparation, especially if it is a chronic practice. However, this may sometimes be justifiable in resource-rich countries in the case of consecutive large shocks, providing these are properly considered in the context of their medium- and long-term impact.

115. The Manual advocates publication of a statement as part of the budget (e.g., an annex) that systematically describes risks to the fiscal position associated with the budget estimates of revenue, expenditure, and the deficit. For resource-rich countries, risks that should be addressed in such a statement could include guarantees on loans or commitments (explicit or implicit) for environmental cleanup operations, other contingent liabilities, the holding of inventories, unforeseen shocks to costs and output variations (for example, in the case of oil mandated through OPEC), or unclear expenditure commitments or otherwise imprecisely defined fiscal policies.¹⁰² There may be implicit as well as explicit contingent liabilities. For instance, NRCs or other state-owned enterprises involved in resource exploitation or trading may have incurred liabilities (including labor-related expenditures and contingencies) that ultimately are likely to be served by the government. Risks from unclear expenditure commitments or imprecisely defined fiscal policies could include budgetary contingency clauses that allow higher than budgeted spending if the oil price exceeds a certain trigger level.¹⁰³

116. Measures to manage such risks should also be clearly explained. These measures could include provisions in government budgets or financial plans of NRCs. Governments should, at a minimum, appropriate the expected cash costs of payments on called guarantees in the next budget year. If an oil price contingency rule exists, the trigger price should be clearly established ex ante, and procedures should also be established ex ante that set possible limitations on the contingency spending and determine the budget formulation and decision processes to be used prior to authorizing any contingency spending.

117. Governments may use market-based hedging strategies to help manage their oil price risk.¹⁰⁴ Such strategies involve locking in the price of future production now or insuring against large price falls, or both.¹⁰⁵ In this way, rather than trying to cope with a volatile and unpredictable revenue stream, the revenue stream itself is made more stable and predictable. Hedging, however, may be constrained by political concerns, lack of implementation capacity and creditworthiness. Full transparency in implementing such strategies also presents difficulties for major exporters because of market sensitivity to such information.

118. The development of a hedging strategy and individual hedging decisions should be based on the general principle of conservatism and a clear set of rules and institutional responsibilities. For example, hedging by NRCs beyond that of short-term (1–2 months) commercial purposes and hedging by the government should be based on the same rules as far as accountability is concerned.¹⁰⁶ Governments that are using hedging strategies to mitigate price risk should inform the general public about the advantages (e.g., price and revenue stability, reduced risk of revenue shortfalls) as well as the costs (e.g., premiums, margin requirements) and risks (including the risks of not hedging). An explicit budget provision indicating broad estimates of these costs and benefits-but without revealing market-sensitive information-may be an appropriate method for governments to use transparently to insure against price risks over the budget year. Governments should also report ex post, publicly and regularly, any hedging activities of NRCs that go beyond short-term hedging and are not undertaken for the purpose of hedging the government budget price and revenue risk.

119. Hedging generally involves complex strategies and transactions, requiring a certain level of institutional capacity to ensure adequate management and administration, including recording, reporting, internal control, and evaluation and audit mechanisms to protect against speculative transactions or mistakes. Countries that do not have adequate capacity in these respects should seek support to strengthen the key institutions before engaging in hedging strategies.