Subject: AFR: Oil: Timor's Double-Edged Sword

The Australian Financial Review

September 29, 2007

Oil: Timor's Double-Edged Sword

Can this tiny nation avoid the 'oil curse' and succeed where so many before it have failed?

by Angus Grigg DILI, EAST TIMOR

Alfredo Pires is whispering. East Timor's newly appointed Energy Minister is being pushed for a number he's reluctant to give.

It is a number that will determine his country's future, determine if it remains the world's poorest nation and, ultimately, resolve whether this dusty half-island can become a viable, independent country.

It is the value of East Timor's oil and gas reserves - a billion dollar question that Pires is well qualified to answer.

The 43-year-old Australian-trained geologist with a business degree from Macau is an activist, and represents the new generation of East Timorese leaders in the six-week-old government of Prime Minister Xanana Gusmao.

"I have thought much about this number," Pires says. "If we find a few other goodies it could be worth over $100 billion."

Pires is referring to the government's petroleum fund, established in late 2005 to hold the revenue from the Bayu-Undan field in the Timor Sea.

Thanks to high oil prices, the fund is roaring ahead of expectations. Already it is worth $US1.6 billion ($1.8 billion), and is growing at an impressive $US100 million a month - 10 times ahead of what was projected just four years ago.

Thus East Timor is often said to be a rich country full of poor people. The United Nations estimates 40 per cent of children are malnourished and 60 per cent of the population illiterate.

It is the world's smallest economy and most of its 1 million people live on less than $US1 a day.

"Those figures would rival many places in sub-Saharan Africa. The development challenges here are enormous," says the UN's head of development in East Timor, Finn Reske Nielsen.

And time is running out. Alan Dupont, director of the International Security Centre at Sydney University, says East Timor has a small window of opportunity to avoid becoming a failed state.

"An independence dividend is needed. You can't live on vision alone, you need practical solutions," says Dupont, who is advising the government. Solutions are required to prevent a repeat of August's civil unrest that saw buildings torched and lives lost, in the worst violence since the "crisis" of last May.

Order has been restored for now, but with 40 per cent of the population unemployed and nearly 100,000 internally displaced people, the UN says trouble could flare up again.

That prospect and the lack of basic infrastructure will make foreign investors wary, which puts the onus back on the government to create jobs. Its ability to do this comes back to oil. It is quite literally East Timor's only chance.

Over the next two decades, as foreign aid declines, oil and gas are forecast to account for 95 per cent of the country's budget.

This year, petroleum will generate $US1.2 billion in export earnings, while coffee, its next largest item, will bring in just $US8 million.

The problem with oil is that it provides only a few jobs, therefore these petrodollars must be redeployed in other areas to create long-term local industries. This is where the petroleum fund comes in. It's a simple idea, modelled on the success of Norway's sovereign fund that totals more than $US400 billion.

For East Timor it's all about avoiding the "oil curse" and not following African and South American examples, where corrupt government officials and energy companies were often the only ones to benefit from the riches underground.

The hope for East Timor is that long after the last barrel of oil has been pumped, it will have a pool of capital from which to live.

To ensure this long-term prosperity the government can only take out 3 per cent of the fund's "estimated sustainable income" each year, or about $US300 million this year. But this figure only takes into account the Bayu-Undan field and not the many other "goodies" Pires likes talking about. "We have not even started looking onshore yet," he says.

"There are places in Timor where the drinking water is mixed with oil, yet we are still the world's poorest country."

Pires, who fled to Australia with his family after the Indonesian invasion in 1975, says the country must engage with the industry to get the most out of it.

"Without proper engagement we might only get $US40 billion out over the next 20 years," he says.

"If we do things properly, that number could increase threefold."

In truth nobody can really say what the magic number will be. There are too many variables - the price of oil, how many new fields are discovered, what percentage East Timor gets, and the rate of return on invested funds. But even the very conservative figure of $US20 billion, arrived at some years ago by the government, represents a huge cash injection.

"It equates to a tripling of the budget since the days of Indonesian occupation," says Dupont.

"For East Timor, it's a once in a generation opportunity to transform the country."

But this pool of money will have to go further each year.

As the statue of Jesus overlooking Dili reminds visitors, this is a very Catholic country with one of the fastest-growing populations in the world. If the current birth rate (7.8 per cent) continues, East Timor's population will double over the next two decades, halving per capita gross domestic product and placing a huge strain on government services. "That's why we need to engage," says Pires.

Part of this planned "engagement" is sending students offshore to study engineering and finance so international oil companies can be better scrutinised. "We need to keep a closer eye on these costs. The international oil game is a cut-throat business."

Engagement also means working the money harder. At present the entire fund is invested in highly secure, but low-yielding, US government bonds. Pires says the government is talking with Singapore about setting up a Temasek-style investment fund, which would diversify into equities, property and corporate bonds.

But these are all longer-term ambitions. In the short term, a liquefied natural gas plant is seen as the country's big hope. The plant, which would process gas from the giant Sunrise field, is seen as an economic saviour. But Charles Scheiner from the La'o Hamutuk Federation, a local non-government organisation, says the plant is unlikely to be built in Timor. Political risk aside, a deep water trench just off the coast makes constructing the required pipeline difficult and expensive.

So, though it is further to Australia's northern coast, Woodside (which will operate Sunrise) has indicated it favours building the plant in Darwin. And for Scheiner, it would not have been the boon many ministers suggested. "It would create about 200 permanent jobs. You could gradually train up locals for the higher paid and more specialised jobs, but in the early stages the East Timorese would be mopping the floors and serving the food." Former Victorian premier Steve Bracks, now an adviser to the East Timorese government, says oil can be used to broaden the economy.

"No one is going to invest here unless the country can develop reliable infrastructure," he says.

For the world's poorest country, even spending money is difficult.

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