Democratic Republic of São Tomé and Príncipe: Selected Issues and Statistical Appendix

The paper reviews the background and the existing institutional framework for oil sector development in São Tomé and Príncipe and the challenges faced in implementing transparency rules in all oil-related transactions. It provides a quantitative analysis of the impact of oil sector development on government receipts, spending, and savings, and discusses the determinants of inflation from a statistical point of view. It also shows an analysis of the weak relationship between money growth and inflation.

Abstract

The paper reviews the background and the existing institutional framework for oil sector development in São Tomé and Príncipe and the challenges faced in implementing transparency rules in all oil-related transactions. It provides a quantitative analysis of the impact of oil sector development on government receipts, spending, and savings, and discusses the determinants of inflation from a statistical point of view. It also shows an analysis of the weak relationship between money growth and inflation.

São Tomé and Príncipe: Basic Data

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Sources: São Tomé and Príncipe authorities; and World Bank.

Figures for 2005 through October.

I. Institutional Framework for Oil Sector Development1

A. Overview and Conclusions

1. This chapter reviews the historical background and existing institutional framework for oil sector development in São Tomé and Príncipe. Section B summarizes the various attempts over the years to launch the exploration of the country’s potential oil resources. Section C discusses institutions put in place since 2000 to support the impending oil exploitation process. Section D discusses challenges associated with the development of the oil fields located in the Joint Development Zone (JDZ) operated with Nigeria. The chapter consolidates information collected from a number of official and public sources, as well as other unpublished data sources.

2. The analysis illustrates the protracted process of shaping transparent rules governing the relationship between oil companies and the government. Looking to the future, the paper suggests that the enactment of the Oil Revenue Management Law in December 2004 is possibly the best chance the country has to put in place strong governance and accountability provisions before oil production starts around 2012. Nevertheless, the difficulties found with the bidding process of Blocks 2–6 located in the JDZ point at important implementation problems of transparency guidelines, despite a better surrounding legal framework in place. Addressing these challenges will require resolute political will on the side of the Sãotomean and Nigerian authorities to enforce and implement transparency rules in all oil-related transactions that fall under their joint jurisdiction.

B. Geographical and Historical Background

3. São Tomé and Príncipe is an archipelago made up of two islands and many islets situated in the Gulf of Guinea, one of the most active regions for oil exploration in the last decade. It is located approximately 300 kilometers from the continent, has a total on-shore area of 1,001 square kilometers and a population of 160,000 people. São Tomé and Príncipe is one of the poorest countries in the world with poverty levels above the sub-Saharan average and a weak institutional framework. In terms of governance indicators, however, the country is reasonably well-placed, standing above the average levels recorded for the region.

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São Tomé and Príncipe: Governance Indicators, 2004 1/

Citation: IMF Staff Country Reports 2006, 329; 10.5089/9781451835090.002.A001

Source: World Bank Governance Indicators.1/Higher rank reflects better governance.

4. For hydrocarbon exploration purposes, the country’s territory can be divided into three distinct geographical zones: the off-shore Joint Development Zone (JDZ) operated with Nigeria (Box I.1), the off-shore Exclusive Economic Zone (EEZ), and the on-shore area constituted mainly by the island of São Tomé and that of Príncipe. The JDZ is the northern-most zone and borders Nigerian territories of very intense hydrocarbon activity. Specifically, Block 1 in the JDZ is located only a few kilometers south of Nigeria’s Akpo field which is believed to contain reserves as high as 1.0 to 1.5 billion of oil equivalent barrels. Extensive seismic data for the northern part of the JDZ suggests very promising oil prospects in terms of commercially viable discoveries. Oil production prospects in the EEZ are less promising to date, although preliminary seismic data and drilling in neighboring areas indicate some chance for commercial discoveries. The potential for hydrocarbon discoveries on-shore is considered low and, to date, the Sãotomean authorities have no plans for promoting exploration in this area.

Establishment of the Joint Development Zone (JDZ)

In 1998, São Tomé and Príncipe filed a territorial claim with the United Nations for the establishment of an Exclusive Economic Zone (EEZ), based on the Median Line Principle stipulated under the UN Convention on Law of the Sea (UNCLOS). This claim was contested by Nigeria on the argument that the northern part of the proposed EEZ was within Nigeria’s own EEZ. The area in dispute covered 34,548 square kilometers.

In February 2001, Nigeria and São Tomé and Príncipe signed a Treaty for the joint development of petroleum and other resources in the maritime areas contained in their respective overlapping EEZs, thereby constituting the JDZ. While the countries did not renounce their respective claims to the zone, the Treaty provided the framework for a joint exploitation of natural resources for a period of forty-five years, unless otherwise agreed following a review in year thirty. The Treaty can be extended by mutual agreement after the initial forty-five year term.

Under the Treaty, Nigeria is granted 60 percent and São Tomé and Príncipe 40 percent of the benefits and obligations arising from development activities carried out in the JDZ. The Joint Development Authority (JDA), based in Abuja, was created and made responsible for the management of activities relating to exploration and exploitation of resources in the JDZ. The JDA responds to the Joint Ministerial Council (JMC), composed of two to four ministers or equivalent rank officials from each country. The JMC is the ultimate decision-making body within the JDZ. The JDA and JMC decisions are taken by consensus. In the case of a deadlock at the JMC level, the disputes are referred to the Heads of State of the two countries for a final resolution.

5. Indications of the existence of hydrocarbons in São Tomé and Príncipe date back to colonial days. In 1974, attempts by the Portuguese Colonial Administration to sign a Concession Agreement with Ball & Collins—an Anglo-American company—were abandoned following the declaration of independence of the country in 1975. Since then, until the mid-nineties, several attempts at jumpstarting petroleum exploration failed, including a 5-year concession signed with Island Oil Corporation in 1989, which briefly conducted onshore drilling activities before ending its operations.

6. São Tomé and Príncipe has granted—and, in several cases, subsequently amended—preferential rights on oil exploration and development with various oil companies over the past decade. The revisions to initial contracts with foreign oil companies have generally come about in the context of widespread criticisms by major domestic and international stakeholders about the possible economic and financial losses to the country under the terms of the original contracts. While the amendments mostly succeeded in obtaining better terms for the country, there have been cases in which the imbalances in terms of profit distribution between the country and the oil companies were not fully redressed in São Tomé and Príncipe’s favor.

  • In May 1997, a Memorandum of Agreement signed with Environmental Remedial Holding Corporation (ERHC) and Procura Financial Consultants (PFC) granted these companies large preferential rights over oil exploration and development within the country’s territory (including surrounding waters). Notably, these preferential treatment included rights: (i) to perform a full and complete evaluation and feasibility study of the country’s oil, gas, and mineral reserves, (ii) to operate a number of oil fields and concessions, (iii) to establish a joint venture with the government on the creation of a state oil company, (iv) to negotiate the leasing of oil fields to other international oil companies on behalf of the government, and (v) to issue rules and regulations for the development and functioning of the hydrocarbons sector.

  • In 2003, an amendment to the Memorandum of Agreement curtailed some of ERHC’s rights within the JDZ, but it did not amend those pertaining to the EEZ. Even after the amendment, ERHC retained preferential rights in no less than six blocks within the JDZ and in four blocks in the EEZ. These rights often included generous exemptions over the payment of oil signature bonuses in oil exploration and development ventures.

  • In September 1998, São Tomé and Príncipe signed a Technical Assistance Agreement with Mobil Exploration and Producing Services Inc. (now Exxon Mobil) to conduct seismic studies in what now constitutes the JDZ. In virtue of this agreement, Exxon Mobil was granted preferential rights to acquire up to 40 percent of working interest in one block located in the JDZ (a preferential right that the company applied in the context of the exploration of Block 1) and the option to acquire up to 25 percent of working interest in two additional blocks in the JDZ.

  • In February 2001, São Tomé and Príncipe signed agreements with PGS-Exploration-UK (Petroleum Geo Services, from Norway), granting this company exclusive rights to conduct seismic surveys in the EEZ until concession awards were granted. PGS holds the right to sell the results of these surveys. Also, PGS, or its subsidiaries, hold preferential rights on shared participation in the exploration of two blocks located in the EEZ.

C. Oil Sector Institutional Framework: Recent Developments

7. Over the past five years, São Tomé and Príncipe has developed a number of institutions aimed at providing a sound regulatory framework for the development of the hydrocarbons sector. The policy objective behind these efforts has been to address the “curse” of oil identified in many resource-rich countries around the world. This “curse” has frequently been associated with resource waste and corruption, and has resulted in weak and ineffective governmental institutions, slow progress in addressing poverty issues, and, in some cases, armed conflict. Against this background, a number of legal instruments have been created to enable a balanced, transparent and accountable oil revenue management. Crafting these laws and regulations has been an open democratic process, in which representatives from all political factions and social segments participated in consultation with international experts in the area.

8. There are six main milestones among the recent efforts to set high transparency, accountability and governance standards in oil revenue management in São Tomé and Príncipe. These include:

  • The General Law on Petroleum Exploration and Exploitation of August 2000, which provides the overall legal framework for the development of the oil sector. The law states that all reserves and reservoirs of liquid and gaseous hydrocarbons belong to the State. It stipulates that petroleum operations are to be conducted either by the State, directly or through a state-owned petroleum company, or by commercial companies licensed by the State. The law specifies that the State can only enter into petroleum contracts of the type of production sharing agreements (PSAs), which are currently considered best international practice in the field.

  • The Treaty on the establishment of the Joint Development of Petroleum and other Resources with Nigeria of February 2001, which regulates the hydrocarbon operations in the Joint Development Zone and establishes the Joint Development Agency and the Joint Ministerial Committee to manage oil activities in the JDZ.

  • The decree Law No.3/2004 of June 2004, which creates the National Petroleum Council in charge of setting national energy policies. The Council is composed of fifteen members, including the President, the Prime Minister, several other ministers, representatives of the civil society, and other individuals designated by the President and the Prime Minister.

  • Law No.5/2004 of June, 2004, that creates the National Petroleum Agency (ANP). The ANP is in charge of managing and monitoring oil and gas exploration and development in line with the policies devised by the National Petroleum Council.

  • The Abuja Joint Declaration signed by the Presidents of Nigeria and São Tomé and Príncipe in June 2004. The Abuja Declaration sets transparency guidelines by which all JDZ operations must abide. The declaration also pledges adherence to the principles of the Extractive Industry Transparency Initiative (EITI).

  • The Oil Revenue Management Law (ORML) of December 2004, which regulates the payments, management, use and oversight of oil revenues resulting from oil operations in the entire national territory, including the EEZ and JDZ. The ORML establishes fiscal rules under which oil proceeds are to be used in the annual budgets.

9. The ORML is the key legislation providing for an open and transparent regime for the management of São Tomé and Príncipe’s oil revenue. The law was devised in close consultation with international experts on fiscal frameworks for resource-rich countries.2 The fiscal framework underpinning the ORML is based on Friedman’s (1957) permanent income hypothesis (PIH), which implies constant government consumption (in real terms) out of oil resources over time, equivalent to interest income on the net present value of the country’s oil wealth. The implementation of a PIH fiscal rule provides for the establishment of a Permanent Fund for Future Generations that would secure inter-generational equity and guarantee a permanent flow of resources into the budget to foster economic development even after oil resources have been exhausted (Box I.2).3

10. In addition to its sound fiscal properties governing the development of a Permanent Oil Fund, the ORML contains several provisions which, if adequately implemented, should ensure a transparent and accountable management of oil resources. The transparency principles contained in the ORML explicitly state the obligation to make public all oil-related transactions, while specifically prohibiting the introduction of confidentiality clauses in oil contracts (including Production Sharing Agreements). Also, to protect the integrity of the Permanent Fund for Future Generations and ensure full accountability, the ORML establishes an independent oversight board—the Petroleum Oversight Commission—to monitor compliance with the law. The activity of the Permanent Fund is also subject to two levels of auditing: one conducted by the Auditor General’s Office and another conducted by a reputable international auditing firm. Audits must be made public. In addition, the ORML provides adequate guidelines for the management and investment of the savings from oil proceeds.

Permanent Fund for Future Generations–Key Features

  • All financial resources owed to the State as oil revenue will be deposited at the National Oil Account (NOA), which is to be opened by the central bank, on behalf of the government, with a (foreign) custodian bank. The NOA will comprise an Unrestricted Portion, in which current oil proceeds will be deposited, and a sub-account named the Permanent Fund (PF), for long-term savings for future generations. The full balance from the unrestricted portion will be transferred to the PF once a year, after fees and annual transfers to the budget have been carried out.

  • All types of liens and encumbrances relating to the NOA or any other oil resources, whether existing or future, are prohibited, i.e. effectively barring oil-backed forward borrowing.

  • An annual funding amount is to be transferred from the NOA in a single transfer to the budget each year. During the pre-production years, the annual funding amounts will be subject to a set of formulas which take account of the various stages of oil exploration and possible production. Once oil production starts, annual transfers to the budget will be based on a PIH framework, which will preserve the country’s oil wealth and continue to support government spending indefinitely even after oil resources are exhausted.

  • Spending of the annual funding amounts should follow the priorities set forth in the country’s Poverty Reduction Strategy. Seven percent of the annual funding amount is reserved for the autonomous region of Príncipe and ten percent for local governments.

  • The portfolio management of the resources deposited in the NOA is the responsibility of a Management and Investment Committee, which is composed by five members, including the Minister of Finance and the President of the Central Bank. Investments domiciled in the country are prohibited. Private managers can be hired.

  • A Petroleum Oversight Commission is created to ensure the permanent monitoring and auditing of all transactions related to oil revenues and resources. It includes representatives of the civil society.

11. A remaining challenge for the Sãotomean authorities is to remove administrative bottlenecks that could prevent adequate implementation and development of the existing institutional framework. To address this concern, an ongoing World Bank capacity building and technical assistance credit includes a dossier on petroleum to provide extensive support to the government, particularly for capacity building in the National Petroleum Agency. Parallel efforts by the authorities and the World Bank have included the preparation of a handbook for the full implementation of the provisions contained in the ORML, as well as the design of a Petroleum Sector Strategy for the medium and long term, which is in the final stages of preparation. This strategy is expected to be widely discussed within the country before its adoption by the Government, presumably, in the course of 2006.

D. Licensing of Oil Fields in the JDZ

12. The first bidding round for licenses in oil fields located in the JDZ was successfully concluded in April 2004, resulting in the awarding of Block 1. The winning bid totaled US$123 million in oil signature bonuses, and the awardees were ChevronTexaco (with a 51 percent operating share), ExxonMobil (with a 40 percent share) and the joint Nigerian-Norwegian Dangote Energy Equity Resources Limited (with a 9 percent share). Chevron Texaco was the designated operator under the consortium, while ExxonMobil executed its preferential rights obtained under the 1998 agreement with the Sãotomean government. The Production Sharing Agreement (PSA) was signed in May 2005, and drilling exploration activities in the Block 1 area started in January 2006. Bids for six additional blocks were also received at that time, nevertheless, they were turned down due to technical and financial considerations assessed by the JDA.

13. A second bidding round, covering licenses for Blocks 2–6 in the JDZ, was completed in May 2005; subsequently the transparency of the auctioning process has been questioned. Indeed, shortly after the announcement of the winning bids, São Tomé and Príncipe’s National Petroleum Council (headed by the President) issued a communiqué recognizing some deficiencies in the awarding process. However, the Council indicated that the process would move forward, as the national interests had not been harmed. Following a subsequent inquiry by the Petroleum Affairs Commission, the National Assembly ordered a formal investigation of the licensing round by the Attorney General’s Office. The resulting report by the Attorney General, which was conducted with the assistance of an international expert, concluded that the procedures used in the selection process of oil companies had been seriously flawed, failed to meet minimum acceptable standards, and led to financial losses for São Tomé and Príncipe. The Attorney General’s report recommended a thorough restructuring of the procedures for future bidding rounds by the JDA with a view to conform to best international practices. Notably, the report also called for re-examination of ERHC’s preferential rights in oil exploration in São Tomé and Príncipe. ERHC executed these rights and has been granted interests in all five blocks awarded in this round. PSAs are currently being negotiated with awardees.

14. The Sãotomean authorities have acknowledged the seriousness of the alleged actions regarding the bidding process and the need for corrective actions. In line with the Treaty between São Tomé and Príncipe and Nigeria on the Joint Development Zone, the authorities intend to raise the issue at the forthcoming Joint Ministerial Committee meeting, scheduled for February 2006. The expectation would be to agree with Nigeria on a common action plan, supported at the countries’ highest political levels.

E. References

  • Friedman, M. (1957), “A Theory of the Consumption Function,” (Princeton: Princeton University Press)

  • São Tomé and Príncipe, (2000), General Law on Petroleum Operations, Law 4/2000” São Tomé, August. Available via Internet: www.anp-stp.gov.st

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  • ———, (2001), “TREATY between The Federal Republic of Nigeria and The Democratic Republic of São Tomé e Príncipe on the Joint Development of Petroleum and other Resources, in respect of Areas of the Exclusive Economic Zone of the two States” Abuja, February. Available via Internet: www.anp-stp.gov.st

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  • ———, (2004), National Petroleum Council, Decree-Law 3/2004” São Tomé, June. Available via Internet: www.anp-stp.gov.st

  • ———, (2004), National Petroleum Agency (ANP-STP), Decree-Law 5/2004” São Tomé, June. Available via Internet: www.anp-stp.gov.st

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  • ———, (2004), “The Abuja Joint Declaration Regarding Transparency and Governance in the Joint Development Zone” Abuja, June. Available via Internet: www.anp-stp.gov.st

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  • ———, (2004), Oil Revenue Management Law, Law 8/2004” São Tomé, December. Available via Internet: www.anp-stp.gov.st

  • Wakeman-Linn, J. et al. (2003), “Oil Funds in Transition Economies: Azerbaijan and Kazakhstan,” in Davis, J.M., Ossowski, R., and Fedelino, A., Fiscal Policy Formulation and Implementation in Oil-Producing Countries (Washington: International Monetary Fund)

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1

Pre pared by Alonso Segura.

2

The Earth Institute at Columbia University was the main external advisor in developing the ORML. The World Bank and the Fund staffs were also consulted at several stages prior to the final approval of the legislation.

3

See chapter II in this Selected Issues Paper for some preliminary quantitative estimates of the annual funding into the budget and the gradual build-up of the Permanent Fund for Future Generations.

Democratic Republic of São Tomé and Príncipe: Selected Issues and Statistical Appendix
Author: International Monetary Fund