1. The Heritage and Stabilization Fund (HSF) of Trinidad and Tobago, established in 2007, is an important national asset, which has broad-based political and social support. Its creation reflects the country’s high dependence on energy (see Chapter II). The fund, with assets of US$4.1 billion (18 percent of GDP) at end-September 2011, is currently under review by the authorities in line with legislative requirements. The HSF has performed well despite adverse global economic conditions and volatile financial markets since its creation, and compares favorably to other Sovereign Wealth Funds (SWFs) in transparency and governance.

Abstract

1. The Heritage and Stabilization Fund (HSF) of Trinidad and Tobago, established in 2007, is an important national asset, which has broad-based political and social support. Its creation reflects the country’s high dependence on energy (see Chapter II). The fund, with assets of US$4.1 billion (18 percent of GDP) at end-September 2011, is currently under review by the authorities in line with legislative requirements. The HSF has performed well despite adverse global economic conditions and volatile financial markets since its creation, and compares favorably to other Sovereign Wealth Funds (SWFs) in transparency and governance.

A. Introduction

1. The Heritage and Stabilization Fund (HSF) of Trinidad and Tobago, established in 2007, is an important national asset, which has broad-based political and social support. Its creation reflects the country’s high dependence on energy (see Chapter II). The fund, with assets of US$4.1 billion (18 percent of GDP) at end-September 2011, is currently under review by the authorities in line with legislative requirements. The HSF has performed well despite adverse global economic conditions and volatile financial markets since its creation, and compares favorably to other Sovereign Wealth Funds (SWFs) in transparency and governance.

2. Notwithstanding the HSF’s strong record, this note provides a number of recommendations in the context of the review. In particular:

  • The design of the HSF could be aligned with the government’s broader strategy for managing public finances and the sovereign balance sheet. In light of depleting energy reserves, a medium-term fiscal strategy outlining how much to save, consume, and invest will be essential to support the HSF savings and withdrawal rules.

  • Sustained transfers to the HSF could be based on a return to fiscal surpluses over the medium term to increase net wealth.

  • The HSF Act could be amended to establish a clearer focus on the heritage objective while preserving the stabilization objective of the HSF to provide some scope to manage the impact of high volatility of energy price on public finance.

  • Given a heritage focus and the HSF’s current size, the minimum HSF balance and maximum withdrawal rules are outdated and could be adjusted to provide a tighter constraint on withdrawals.

  • A clearer focus on savings together with more constraints on withdrawals would support an investment strategy with a longer-term focus.

  • The rules for calculating deposits into the HSF could be clarified and made public, by specifying which prices are used, lengthening the time horizon for calculating average prices, and adjusting the time frequency and lags for making deposits.

B. Background and Portfolio Performance

3. The HSF was established to save and invest energy revenue in excess of budgetary projections. In March 2007, the Parliament passed the HSF Act replacing the Interim Revenue Stabilization Fund (IRSF) with the HSF. The IRSF was introduced in 2000 to promote fiscal discipline, cushion the impact on the budget and the economy of unexpected drops in oil prices, and strengthen public sector savings. In the same year, the government transferred US$66 million (1 percent of 2000 GDP and about 5 percent of official reserves) into the IRSF.

4. The HSF, like the IRSF, has a stabilization objective, but the HSF also has a heritage objective with an emphasis on accumulating net savings over time for future generations. The creation of the HSF reflects in part past experience. In the 1970s, the country benefitted from substantial increases in energy revenue as a result of high oil prices, and at the same time embarked on expansionary fiscal policies. In the absence of significant savings of energy revenue, the country was forced to undertake painful fiscal adjustment when oil prices dropped in the early 1980s.

Figure 1.
Figure 1.

Energy Revenue and Fiscal Balances

(In percent of GDP)

Citation: IMF Staff Country Reports 2012, 128; 10.5089/9781475504019.002.A001

Source: Ministry of Finance of Trinidad and Tobago, and Fund staff estimates

5. The HSF Act introduced changes to strengthen the management of excess energy revenue through improved governance and rules for transfers into and out of the fund. The HSF governance structure compares well to international best practices for SWFs, set forth in the Santiago principles,2 especially on transparency and accountability. The Parliament’s role is to define the legal framework and to perform oversight. The HSF Act provides for a five-member Board of Governors. There are currently four serving members, consisting of two representatives from the private sector, including the Chairman, and one representative each from the Central Bank of Trinidad and Tobago (CBTT) and the Ministry of Finance. According to the HSF Act, members of the board should be persons of proven competence in finance, investment, economics, and business management or law and should satisfy the criteria for a fit and proper person under the Financial Institutions Act. The Board members are appointed by the President on the advice of the Minister of Finance for a three-year term and are eligible for reappointment. The Board determines the operational and investment guidelines and reviews portfolio performance. In line with the HSF Act, the Board delegates operational responsibility for management to the CBTT, which recruits external fund managers and custodians and produces quarterly and annual financial reports. The Minister of Finance approves deposits and withdrawals, and presents annual reports, including audited financial statements to Parliament. Following Parliamentary approval, the reports, which detail the HSF’s transfers, fund size, investment strategy and portfolio performance, are published in line with the Santiago Principles. The Auditor General audits the fund. The HSF scores well in terms of public information disclosure almost on par with the more established SWFs, such as the Norway Government Pension Fund and the Alaska Permanent Fund.3

6. The savings (withdrawal) rule is triggered when actual energy revenue exceeds (falls below) budgeted energy revenue by at least 10 percent.4 The estimated energy revenue is calculated on the basis of an 11-year centered moving average of crude oil and gas prices, i.e., with 5 years of history and 5 years of projections in addition to prices for the current year. The savings rule stipulates that a minimum of 60 percent of excess energy revenue would be transferred to the HSF in any fiscal year, while in the event of a shortfall in energy revenue, the withdrawal rule permits a withdrawal of up to 60 percent of the shortfall, or 25 percent of the value of the HSF, whichever is lower. Although these rules provide framework for stabilization, in practice conservative energy price assumptions have led to the accumulation of savings. There is also a minimum balance rule (capital floor), which requires that no withdrawal should reduce the HSF’s balance below US$1 billion.

Figure 2.
Figure 2.

The HSF Strategic Asset Allocation

(In percent)

Citation: IMF Staff Country Reports 2012, 128; 10.5089/9781475504019.002.A001

Source: Heritage and Stabilization Fund

7. The HSF portfolio was highly concentrated in short-term assets up to August 2009, reflecting a conservative investment strategy in the face of financial market turmoil. Assets are held abroad, providing a line of defense against volatile external flows, and preventing the 40 repatriation of proceeds from contributing to the deterioration of competitiveness of the nontradable sector. The HSF’s investments are guided by the Strategic Asset Allocation (SAA) determined by HSF Board. Its objectives aim to maintain sufficient liquidity for potential withdrawals, while also preserving and augmenting its long-term real value. Consistent with this, the SAA envisages a portfolio of 65 percent fixed-income securities and 35 percent equities. In September 2007, the HSF Board approved a 3-year transition plan for the SAA from a fully liquid portfolio composed of fixed-income securities. However, following the onset of the global financial crisis, the Board decided to postpone its implementation until markets stabilized. Implementation of the new SAA began in September 2009, and was completed in January 2011. In the interim, the HSF was managed conservatively in the mode of the country’s foreign reserves during the crisis.

Figure 3.
Figure 3.

Evolution of the HSF Portfolio

(In percent)

Citation: IMF Staff Country Reports 2012, 128; 10.5089/9781475504019.002.A001

Source: Heritage and Stabilization Fund

8. The HSF has performed well despite the adverse and volatile global financial environment. At inception in March 2007, the accumulated assets in the IRSF transferred to the HSF were US$1.4 billion (about 8 percent of GDP). At end-September 2011, HSF assets have increased to US$4.1 billion (about 18 percent of GDP), reflecting a total transfer of US$2.3 billion, and investment income and capital gains of US$374 million. Over the period March 2007 to July 2011—a period which largely overlapped the 2008/09 global financial crisis and its aftermath—the CBTT estimates an average annual nominal return on the HSF of about 5.27 percent, slightly above its benchmark of 5.24 percent. The equity portfolio, while more volatile, was the main driver of the return. This performance compares well to that of other SWFs, but largely reflects the modest share of investments in equities during this period. As a result, the HSF was among the few SWFs that did not suffer losses in any one year during the global financial crisis.1

Figure 4.
Figure 4.

HSF Portfolio Performance, March 2007 - July 2011

(In percent)

Citation: IMF Staff Country Reports 2012, 128; 10.5089/9781475504019.002.A001

Source: Central Bank of Trinidad and Tobago
Figure 5.
Figure 5.

Selected SWFs: Average Annual Rate of Return, 2007-2010

(In percent)

Citation: IMF Staff Country Reports 2012, 128; 10.5089/9781475504019.002.A001

Source: SWFs’ annual reports and reviews

C. Issues and Recommendations

9. The HSF needs to be considered in the context of the government’s medium-term fiscal strategy. The HSF, as an instrument for savings, is only one element of government finances and the sovereign balance sheet, and its role should be assessed in the broader context of the government’s overall fiscal strategy. Given declining energy reserves, this strategy will need to specify an appropriate balance between saving, consuming, and investing energy revenue, including in the HSF. The evolution of other items on the sovereign balance sheet, such as official reserves and public debt, will also need to be considered in developing a comprehensive approach to building savings for future generations. Recommendation: Root the HSF’s design within the government’s medium-term fiscal strategy, to align the savings objectives with the broader strategy for managing public finances and building the nation’s net wealth.

Figure 6.
Figure 6.

HSF/IRSF Balance and Public Debt

(In billions of TT dollars)

Citation: IMF Staff Country Reports 2012, 128; 10.5089/9781475504019.002.A001

Sources: Ministry of Finance of Trinidad and Tobago, and Fund staff estimates

10. In the context of a more comprehensive approach to building net wealth, the rules on transfers to the HSF could also take account of how the transfers are to be financed. When the public finances are consistently in deficit or in balance, deposits into the HSF would likely need to be financed by borrowing.2 While borrowing to save may be appropriate for a limited period to maintain a savings habit, this strategy is not sustainable over the medium term as it would not improve the net asset position of the sovereign, and would entail losses if the HSF’s investment returns were lower than borrowing costs. In the end, net savings of energy wealth will require returning public finances to surplus. Recommendation: Base sustained transfers to the HSF on a return to fiscal surpluses.

Figure 7.
Figure 7.

Energy Revenue, CG Fiscal Balance, the HSF Portfolio Size and Transfers

(In percent of GDP)

Citation: IMF Staff Country Reports 2012, 128; 10.5089/9781475504019.002.A001

Sources: Ministry of Finance of Trinidad and Tobago, and Fund Staff Estimates

11. Although the HSF has dual heritage and stabilization objectives, in practice it has served more as a heritage fund. The lack of withdrawals when energy revenues have fallen sharply together with conservative budget assumptions for energy prices suggest a strong preference to safeguard and to increase savings rather than to rely on the HSF for fiscal stabilization. In particular, the government chose to adjust the budget and draw down deposits in the CBTT in 2008/09 when oil and gas prices fell by nearly half percent, although a withdrawal equivalent to 2½ percent of GDP would have been permitted. In addition, the budget assumptions for energy prices have tended to be more conservative than the 11-year centered average fuel price would suggest (see also paragraph 16 below).3 Nevertheless, given the high volatility and dependence on energy revenue, the stabilization objective remains important. Recommendation: Amend the HSF Act to provide a greater weight to the savings objective in line with current practices while preserving its stabilization objective to provide some scope to manage the impact of high volatility of energy price on public finance.

Table 1.

Energy Revenue and Transfers to the HSF 1/

(In billions of TT dollars)

article image
Sources: Central Bank of Trinidad and Tobago, Ministry of Finance, and Fund staff calculations

Fiscal year ending September.

Calculated as 60 percent of the excess energy revenue.

12. The large accumulation of assets since 2007 would suggest a need to increase the minimum balance of the HSF. Given that the assets of the HSF are now over US$4 billion, the US$1 billion minimum balance could be raised, particularly if greater emphasis is given to the savings objective. If the ratio of the minimum to the actual balance were maintained at the level at inception in 2007, the new floor could be set at about US$2.9 billion. Furthermore, the floor could be adjusted upward automatically each year by maintaining a fixed share of the accumulated saving, which has been about 71 percent. Recommendation: Increase the minimum balance and consider establishing a floor that is a percentage instead of or in addition to an absolute dollar value.

13. By the same token, the 25 percent ceiling on the maximum withdrawal during a given year could be reduced. If greater emphasis were given to the savings objective, this limit could be revised downward to 10 percent of the HSF balance in any one year, with a cumulative withdrawal of at most 25 percent, which would be also consistent with the proposed capital floor. This would imply a narrowing of the space for withdrawals if there are several years of weak energy prices. At the same time, a persistent need for withdrawals could indicate a need to revise the assumed energy price projections. Recommendation: Limit the maximum withdrawal to 10 percent of the HSF balance in a given year and 25 percent on a cumulative basis.

14. Clarity over the HSF objectives together with updating of the withdrawal rules is essential in determining the investment strategy. The current portfolio allocation is broadly consistent with the HSF’s dual objectives. However, the current rules are stabilization oriented and could permit a withdrawal as high as US$1 billion (5 percent of GDP) and withdrawals nearly as large in subsequent years which could rapidly deplete the HSF. By contrast, if there were a greater focus on long-term savings together with an updating of the withdrawal rule, then the investment strategy could shift toward targeting a higher return over a longer horizon with greater risk tolerance.4 Recommendation: Clarification of the HSF’s objectives together with tighter constraints on withdrawals would provide a basis for pursuing a longer-term investment strategy.

15. The precise data and approach used to compute the energy price assumptions announced in annual budgets could be spelled out more clearly. In practice, the budget oil price assumptions have been more conservative than implied by the rules in the HSF Act (Table 2), and may have reflected judgments about market conditions and factors such as the quality of the country’s crude oil relative to international benchmarks (or a desire to achieve savings as noted above). The situation for natural gas prices is even more complex as it is no longer straightforward to identify which is the relevant price for the country’s LNG exports. Until recently, the U.S. market accounted for nearly all of gas exports, and the price at the U.S. port (Henry Hub) was clearly the relevant price.5 However, only 20 percent of gas exports in 2011 were to the United States with the remainder going to Latin America, Europe and Asia, each of which have their own reference prices which have diverged substantially from the Henry Hub price. In this context, it would be advisable to retain flexibility in determining the budget energy prices. However, greater clarity on price setting would enhance public understanding and accountability. Recommendation: Spell out more clearly the calculation of the budget energy prices used to estimate energy revenues to make it easier to determine ex post the prices used.

Table 2.

Budgeted and Actual Crude Oil Prices

(US$ per barrel)

article image
Sources: Central Bank of Trinidad and Tobago, Ministry of Finance, and Fund staff calculations

In 2008/09, the budget oil price was revised downward within the year to US$45/barrel and subsequently raised to US$55/barrel.

This includes 5 years of projections based upon the given year’s Fall World Economic Outlook projections for Dated Brent, West Texas Intermediate, and Dubai Fateh.

16. There is scope to enhance the rule for projecting energy prices. If a choice is made to follow a more rule-based strategy to determine the budget price, the 11-year centered average may not be optimal. It is short-term oriented as futures prices, which account for almost half of the sample to calculate the average, trend closely with current prices. This could increase volatility in estimating energy revenue, and could lead to less savings over time. Averaging energy prices over a longer period, with 10 or 15 years of historical and 5 years of projected data, while consulting with sector experts will provide a more stable, longer-term, and conservative basis for energy revenue projections (see table above). Indeed, the 15-year average (including 5 years of future prices) closely align with the budget prices since 2006/07. Recommendation: Consistent with giving greater emphasis to the HSF’s savings objective, lengthen the time horizon for setting the budget energy price.

17. There is also scope to adjust the procedures for calculating and making deposits into the HSF to increase transparency and to reduce the administrative burden. The HSF legislation requires that deposits be made on the basis of actual energy revenue received in each quarter, which may be volatile, and it is not sufficiently clear in the legislation whether the calculation should be made based on the year-to-date outturn or not. Further, it can be challenging to complete the required deposits by the end of the fiscal year before data on actual energy revenue is finalized. Recommendation: Make deposits into the HSF semi-annually rather than quarterly, on a year-to-date basis, and with a lag after the end of the period so that deposits can be made based on finalized data.

18. Although the HSF scores high in terms of its adherence to the Santiago Principles, it could strengthen the provisions for auditing. The HSF is currently audited by the Auditor General. However, especially with the move toward a more diverse portfolio, the HSF could benefit from the services of an external auditor with experience in asset management given the complexities of auditing foreign investments. Recommendation: Engage the services of a private sector auditor with experience in asset management.

D. Conclusions

19. The HSF has developed a strong record since its creation in 2007. It has performed well as measured by the accumulation of savings, the portfolio return, and adherence to the Santiago Principles for transparency and governance. This is particularly commendable given the global and domestic financial crises. The former provided a particularly challenging environment for managing HSF’s investments, while the latter could have resulted in withdrawals or substantially more modest accumulation. The fact that not only were there no withdrawals from the HSF during these difficult times, but that substantial additional savings were accumulated attest to the strong social consensus to save for future generations. This note has sought to identify some areas for improvement based on the experience to date that would contribute to achieving the HSF’s long-term objectives. The key recommendations are summarized in Box 1.

Key Recommendations

  • Root the HSF’s design within the government’s medium-term fiscal strategy to align the savings objectives with the broader strategy for managing public finances and building the nation’s net wealth.

  • Base sustained transfers to the HSF on a return to public finance surpluses (Achieve net savings of energy wealth by improving the fiscal position.)

  • Amend the HSF Act to clarify that the savings objective is primary while preserving the stabilization objective of the HSF to provide some scope to manage the impact of high volatility of energy price on public finance.

  • Increase the minimum balance and consider establishing a floor that is a percentage instead of or in addition to an absolute dollar value.

  • Limit the maximum withdrawal to 10 percent of the balance in a given year and 25 percent on a cumulative basis up to a floor.

  • With an increased focus on savings, and tighter withdrawal rules, consider pursuing a longer-term investment strategy.

  • Spell out more clearly the calculation of the budget energy prices used to estimate energy revenues to make it easier to determine ex post the prices used.

  • Lengthen the time horizon for setting the budget energy price.

  • Make deposits into the HSF semi-annually rather than quarterly, on a year-to-date basis, and with a lag after the end of the period so deposits can be made based on finalized data.

  • Engage the services of a private sector auditor with experience in asset management.

References

  • Board of Governors of the Heritage and Stabilization Fund, Annual Reports, various years.

  • Central Bank of Trinidad and Tobago, 2007, “The Heritage and Stabilization Fund”. Governor’s Address at the Heritage and Stabilization Fund Forum, Port-of-Spain, May. http://www.central-bank.org.tt/content/governors-address-heritage-and stabilization-fund-forum

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  • Central Bank of Trinidad and Tobago, 2011, “Review of the Heritage and Stabilization Fund,” presentation at the Heritage and Stabilization Fund Forum, Port-of-Spain, September. http://www.central-bank.org.tt/content/governors-powerpoint-presentation-review-heritage-and-stabilisation-fund-september-6-2011

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  • Kunzel, Peter, Yinqui Lu, Iva Petrova and Jukka Philman, 2010, “Investment Objectives of Sovereign Wealth Funds: A Shifting Paradigm,” in Economics of Sovereign Wealth Funds: Issues for Policymakers, eds. Udaibir Das, Adnan Mazarei, and Han Van der Hoorn, International Monetary Fund, Washington D.C.

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  • Parliament of the Republic of Trinidad and Tobago, 2007, Heritage and Stabilization Act. No. 6.

  • Truman, M. Edwin, 2010, Sovereign Wealth Funds: Threat or Salvation, Washington, DC: Peterson Institute for International Economics.

  • World Bank Treasury, 2011, “The Heritage and Stabilization Fund of Trinidad and Tobago, Key Considerations for the Review of the Strategic Asset Allocation,” Paper Presented at the Heritage and Stabilization Fund Forum, Port-of-Spain, September.

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1

Prepared by Joel Okwuokei, Hunter Monroe, and Judith Gold.

2

These principles were developed by the International Working Group on Sovereign Wealth Funds, which includes Trinidad and Tobago, and are also known as the Generally Accepted Principles and Practices (GAPP).

4

For the purpose of transfers to the HSF, energy revenue includes the Petroleum Profits Tax (PPT), Supplemental Petroleum Tax (SPT), and Royalties. Unemployment Levy, Oil Impost and Signature Bonuses are excluded.

1

SWFs’ performances are not easily comparable because of differences in objectives, and investment strategies. Data limitations also preclude performance analysis over a long period of time.

2

Over the past few years, the transfers into the HSF were financed by drawing down government deposits at the central bank, and therefore did not entail an increase in public borrowing notwithstanding the absence of fiscal surpluses.

3

However, the calculations in this paper may be based on different crude oil prices than those used by the authorities.

4

More time may be needed to evaluate the experience with the SAA, as it was only fully implemented in January 2011.

5

The natural gas price assumption announced in the budget is not Henry Hub but the netback price, which deducts the cost of liquefaction, transportation, storage, and regasification.

References

1

Prepared by Machiko Narita and Judith Gold.

2

Train 4 was the largest in the world until May 2011, when Qatar brought a larger train on line.

3

National Enterprises Ltd (NEL), a government holding company, owns 51 percent of Trinidad Nitrogen Company Ltd Plants I & II, which produce ammonia.

4

The largest producer of methanol is Methanol Holdings (Trinidad) Limited (MHTL), which is owned by CL Financial Limited in partnership with Consolidated Energy Limited.

5

The M5000 plant, owned by the MHTL, was closed for two weeks in July 2010 and for the month of October 2010 for maintenance activities.

6

The Ryder Scott Report, August 10, 2011, Presentation by the Ministry of Energy and Energy Affairs.

7

The government initiated an independent oil audit in 2008/09, but the results were not made public. Commercial production of oil started in 1908, reaching its zenith between 1974 and 1981. With the maturing of oil fields, development of new oil fields has become more expensive and technically challenging as they located deep in the ground or in deep water.

8

The construction of the first downstream Ammonia-Urea Ammonium Nitrate-Melamine (AUM) Complex by Methanol Holdings Trinidad Limited was completed in 2009.

9

About 20 percent of global gas consumption is priced on the basis of crude oil prices, particularly in Latin America and Asia, about 30 percent is priced on a spot basis, around 40 percent is subject to direct price regulation, and the remainder is sold at subsidized prices (International Energy Agency, 2009).

10

The EIA commissioned an external consultant, Advanced Resources International, Inc, to develop an initial set of shale gas resource assessments, which covered 48 shale gas basins in 32 countries.

11

Bloomberg reported that Qatar—the world’s largest producer of LNG—is seeking contracts for as long as 20 years, in the face of prospect of booming supplies from Australia, the US and Africa that raise the likelihood of a slide in prices. There are concerns that the world may face an LNG “glut” in the next eight years as production from hydraulic fracturing, or fracking, of shale deposits swells inventories, which has led U.S. gas traded at the lowest level in 10 years on January 23, while Brent crude jumped to a 3 ½-year high on March 1.

12

Since fracking requires a large amount of water and chemicals, fracking technology could cause ground water pollution. The environmental risks of the fracking method are still uncertain.

Trinidad and Tobago: Selected Issues
Author: International Monetary Fund