Oil Funds: Answer to the Paradox of Plenty?
A Policy Brief on Oil Revenue Monitoring Plans: Comparison Across Countries

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There is a growing body of evidence of the Paradox of Plenty- the poor economic, social and institutional development of natural resource-rich nations-, and a long list of failed, resource-rich states. Recognizing the development challenge facing poor, oil and mineral rich countries, the World Bank and the International Monetary Fund (IMF) are increasingly looking towards revenue management funds in an attempt to reap positive development outcomes from oil, gas and mining projects. Citing the experiences of the State of Alaska and Norway, Bank and IMF officials contend that proceeds from extractive industries can be used to fund social programs and/or stabilize government revenues during times of economic difficulty, thereby helping promote economic development.

An increasing number of large and controversial Bank-supported extractive industry projects feature revenue management funds as an important component of the project. For example, Chad's Revenue Management Plan (RMP) was an outcome of the protracted and acrimonious debate surrounding the approval of the Chad-Cameroon oil pipeline, and the Bank made the establishment of the RMP a condition of its financial support. Similarly, the IMF and World Bank are touting the Azeri state oil fund as a central benefit of the proposed Baku-Tbilisi-Ceyhan (BTC) oil pipeline.

Are oil funds the panacea to the Paradox of Plenty? Will they ensure that oil revenues are transparently recorded and spent on poverty alleviation and social development priorities? Will the revenues make it to actual programs that deliver real benefits to poor people? Or will structural weaknesses in the oil funds, insufficient political will, and failure to genuinely include civil society in national development dialogues prevent oil funds from making any meaningful contributions to development? This briefing paper takes a look at some of the recently established oil funds in developing countries, and asks whether these funds will be sufficient to ensure positive development outcomes, given flaws in their structure and difficulties implementing other revenue management funds in more open political environments.

A look at the characteristics of oil funds in Chad, Azerbaijan, and Kazakhstan shows significant structural weaknesses in these funds. The international community appears overly optimistic about the likelihood of these funds to transparently receive and disburse revenues from natural resource extraction in a way that is relatively immune to political influence and directs resources to community development priorities. For example, while a senior World Bank official described the Azeri oil fund as representative and participatory, all the members of the board overseeing the oil fund are appointed by the President and all but one member are government officials. This strong control by the executive branch has enabled uses of the fund that are contrary to its purposes. The Azeri government announced in July that the money in the oil fund, which is explicitly intended as a social fund and to develop the non-oil sector, would be used to finance the state oil company's share of the BTC pipeline.

Civil society should have a say in how and whether oil development occurs in their country, and how oil funds are part of that development. Civil society should have a primary voice in their country's development since ordinary citizens will face the economic, environmental, human rights, and social impacts of oil development. They are also best placed to monitor corporate and governmental accountability. Donors have recognized the importance of incorporating civil society oversight in official debt relief programs. Poverty action funds in countries receiving debt relief under the Heavily Indebted Poor Countries (HIPC) Initiative are an effort to ensure that a sudden influx of revenue is spent on priority social programs and development efforts- similar to the purpose of oil funds. In countries like Uganda, these poverty action funds have been designed to allow more civil society participation, including through formal channels such as board representation. Yet even in these circumstances, field research is indicating that the poverty action funds are failing to make a real difference in the lives of the poor and that additional monitoring and participation measures are needed.

If oil funds are to make any difference, a concerted effort by the international community will be needed to push for more representative bodies that are considerably less government-dominated and that include civil society. They should be immune from excess political influence and have the legal authority and resources to do their oversight functions properly. Transparent revenue and expense reporting is only half the picture, however. Revenue management funds must also be complemented by decentralized expenditure tracking and service delivery monitoring.

The Case of Chad

Key features:

· Nominal civil society participation

· Executive dominates oversight committee

· Law governs expenditure allocation but President can modify after 5 years

The Chad-Cameroon oil pipeline is a $3.5 billion project that will extract and transport 900 million barrels of oil from Chad to an export facility on the coast of Cameroon. The oil is projected to increase Chad's revenues by $80-100 million per year for the 25-year life of the project. This infusion of money will increase Chad's budget by more than 50%.

In January 1999, as a condition of the World Bank's involvement in the project, the government agreed to adopt a law governing the management of oil revenues and established the Revenue Management Plan (RMP). The RMP is supposed to ensure transparent and sound management of the influx of revenue from oil development, and channel increased expenditure to social programs and human development in Chad.

The RMP has a nine-member oversight committee that approves expenditures. The President appoints four members to the committee, each house of Parliament (both of which are controlled by the President's party) sends a member, and one comes from the Supreme Court, which is considered another arm of the executive branch. Two members of the committee must come from civil society.

The law that established the RMP designates priority sectors for investment: public health, social services, education, infrastructure, rural development, environment and water. Eighty percent of the oil revenues are to be dedicated to these priority sectors, but there are no fixed allocations for the various sectors. Of the remaining twenty percent, five percent goes to the oil-producing region, 10 percent is allocated to an escrow account for future generations, and 5 percent is left to the government's discretion. After five years, however, this law and the expenditure arrangements can be modified by presidential decree.

Further crippling the effectiveness of the committee is its weak capacity. The committee has no budget that would enable it to hire independent auditors or researchers to analyze data and assess expenditures for example. The committee is not empowered to subpoena records or to hold hearings with government officials compelled to testify. The committee does not issue its own reports.

The Case of Azerbaijan

Key features

· No formal civil society participation

· President appoints oversight body members

· President has main authority to decide expenditures

· Oil fund revenues and expenditures reported in the press

The State Oil Fund of the Republic of Azerbaijan (SOFAZ) was established by presidential decree in December 1999, and became operational in January 2001. The Azeri oil fund serves as a development/savings fund for social investments, and is meant to spur development in non-oil sectors of the economy.

The Fund receives all revenues associated with the new oil fields. These fields are the ones included in the 1994 Contract of the Century. It receives and records proceeds from the state's share of oil sales, royalties, pipeline fees, rental fees, bonus payments, and interest income. Most of the revenues presently come from the first and only operational consortium at the Azeri, Chiraq, and Guneshli (ACG) oil fields, the source for the proposed Baku-Tbilisi-Ceyhan oil pipeline.

The oil fund has an oversight board whose members are appointed by the president of Azerbaijan. The oversight board exercises general review over the fund's assets and recommends directions for use of the fund's assets. An independent auditor (Ernst and Young) performs an annual audit of the fund. The decree establishing the oil fund envisages that the oversight board will consist of representatives of relevant state bodies and public organizations, as well as other persons. However, currently nine of the ten board members are government officials from the President's party; the tenth is the president of the National Academy of Sciences.

The oil fund reports quarterly in the press on total amounts, inflows received, expenditures, and interest earned on the funds. The fund has a web site (www.oilfund.az), and its executive director issues periodic press statements and releases.

Nevertheless, transparency is not guaranteeing smooth operations of the fund. The oil fund's expenditures are supposed to come from a government approved Public Investment Program and Medium Term Expenditure Framework (MTEF), but the government has not produced these documents. More immediately troublesome and ominous is the government's recent decision to tap the oil fund to finance commercial pipeline development. Specifically, the government expressed its intention to use the oil fund to finance the state oil company's (SOCAR) share of the equity investment in Baku-Ceyhan, which amounted to approximately $170 million. After the IMF and World Bank expressed concern over the use of the oil fund for this purpose, the Azeri government agreed that $118 million would be taken from a separate fund of oil bonus money awarded prior to SOFAZ's creation that exists within the Azeri central bank. However, the remainder of SOCAR's equity investment will come from the state oil fund.

Publication in the press also does not guarantee an open climate to debate how the oil fund operates. According to the US State Department's human rights report for Azerbaijan, the government restricts freedom of speech and of the press, and the press faces harassment, causing them to practice self-censorship. The government controls most publishing houses, and has also been accused of intimidating advertisers in independent media. Radio and television are reported to be the main source of information for much of the population, both media which the government controls.

The independence of the oversight board is also a problem. The President selects the members of the oversight board, and has considerable authority over the oil fund's expenditures. The IMF originally wanted expenditures from the oil fund to be subject to parliamentary approval, but agreed to subject expenditures only to presidential approval. Parliamentary oversight over the budget is generally weak in Azerbaijan. Until very recently, when a new budget law with paragraph level reporting was passed, budget figures were only broken down into about 25 categories. For example, for education there are overall figures reported, rather than disaggregated breakdowns for primary and secondary education.

While budget reporting to Parliament has improved, its powers have not increased notably. In theory the Parliament can reject the entire budget, but it has no power to approve a budget that differs from the one proposed to it by the President. Though the government system is in principle based on a division of powers, with a parliament that approves the budget and can impeach the government, the State Department report notes that in practice there are few opposition members in Parliament and the Parliament exerts little independence from the executive.

The IMF reportedly plans to insist as part of its ongoing Poverty Reduction and Growth Facility (PRGF) loan arrangement with Azerbaijan that a new law on the oil fund be submitted to the Azeri Parliament. This law will in part call for parliamentary approval of the Medium Term Expenditure Framework and the Public Investment Program. These two documents will then set the parameters for what the oil fund can finance. The oil fund cannot finance a program that is not in either document.

The Public Investment Program is to be formulated based on the country's Poverty Reduction Strategy Paper (PRSP) consultations, which is supposed to be an open, consultative, national dialogue.

The Case of Kazakhstan

Key features

· No civil society participation

· President appoints oversight body members

· President has authority to decide expenditures

· Oil fund revenues and expenditures reported in the press

The Kazakh oil fund- the National Fund for the Republic of Kazakhstan (NFRK)- was established in August 2000 and further set out in a January 23, 2001 Presidential decree (no. 543). Its creation was sparked by both high oil prices at that time and increasing oil production in Kazakhstan as new oil fields come on line. With a significant increase in revenues, the government sought ways of walling off oil money to prevent excess pressure for government spending increases, and resulting inflationary pressure.

The NFRK has a more complex structure than many other oil funds. The NRFK has both stabilization and savings functions. The stabilization function works by setting reference prices for oil, gas, and four metals (copper, lead, zinc, and chrome). A government resolution lists 12 companies- the nine largest oil companies and three in the metals sector- that are subject to transfers based on the reference price. For oil, the rate is $19/barrel. Each company has a quarterly baseline tax payment target, based on the relevant reference price. Once the targets are exceeded, surplus tax payments are deposited in the NFRK. When market prices are below the reference prices, the Fund provides revenue to the government for its operations. The National Fund's savings portfolio is funded by a transfer of 10% of baseline revenues (based on the reference price). The NFRK also receives privatization receipts and large bonus payments from the petroleum sector on an ad hoc basis.

At least 20% of NFRK assets must be in the stabilization portfolio, which has specific investment criteria- foreign-issued, short-term highly liquid financial instruments that can be tapped easily in the case of a budget shortfall that arises suddenly. If budget revenues fall short of their quarterly targets, transfers equal to the funding gap can be made from the NFRK to the budget within 20 days of the quarter's end or before the end of the year.

The President may also request special transfers to the state and local budgets earmarked for purposes defined by the president. While Parliament approves the budget, it acts on a budget proposed by the President. To date, no special transfers have occurred.

The National Fund has an oversight board that is comprised of nine members of main economic ministries, state agencies, and the national bank, and is chaired by the President. The President appoints the Management Council, and has the power to dissolve it. The council's mandate is to advise the President on issues regarding the use of the NFRK's resources and to review the annual report.

An annual external audit of the fund is to be conducted, and the first one was released in April 2002 by Ernst&Young. The NFRK has a website, www.nationalfund.kz. However, there is currently no English-language content on the website. Only the total National Fund assets, broken down by portfolio, are reported in the press, making the fund less transparent than in the case of Azerbaijan.

Spending Debt Relief Proceeds: the Case of Uganda

· Real civil society participation

· Revenues and expenditures reported in the press

· Law directs areas for expenditures

Some countries receiving debt relief under the HIPC Initiative have established special funds to collect and spend the proceeds from debt relief. The rationale behind these funds is similar to the oil funds: ensuring that a sudden influx of new money is spent transparently and on priority investments for the country that will spur sustained development. Uganda's Poverty Action Fund (PAF) is probably the best known of these debt relief accounts. Uganda's PAF receives resources from HIPC debt relief, donor contributions, and the Government of Uganda. The PAF supports programs in primary education, primary health care, water and sanitation development, maintenance of rural feeder roads, agriculture extension, and microfinance. Some resources may also be provided for judicial sector reform efforts. Five percent of the resources are also allocated to institutions such as the state Auditor General, in charge of overall transparency and accountability of government resources. Since its inception in 1997, the PAF resources have been steadily increasing and now comprise about one-third of the national budget.

Uganda's Poverty Action Fund allows for much greater civil society participation that any of the oil funds discussed earlier. The Ministry of Finance organizes and hosts quarterly meetings that are attended by line ministries, donors and civil society. Line ministries present quarterly reports on resources received and how they have been spent, donors present on implementation issues that may arise, and civil society has a slot to present.

Transparency is facilitated by the quarterly meetings, but the government must also publish several times a year how much each district receives from the central government for poverty eradication, broken down by sector (health, education, water and sanitation, etc.). District monitoring committees were also established to have a presence in districts and monitor spending outcomes at a more decentralized level to help ensure that money pledged to the district level was actually disbursed and received.

Nevertheless, this transparency and monitoring have not necessarily led to improved social conditions for the poor. A recent study looking at the impact of Uganda's PAF in a rural district found that even though the PAF was funding services that should increase well-being and income, there was little impact on poverty reduction among rural farmers. Corruption and a lack of local government capacity impeded service delivery and resulted in poor quality services. Rural farmers also indicated that they were not involved in creating policies or designing services that affect them, and that the PAF's services did not help them meet their basic needs. This experience is particularly troublesome since Uganda is considered one of the best examples of how government and civil society can dialogue around poverty alleviation. Oil-rich developing nations by and large have much more closed political environments and lack of space for civil society debate and empowerment.

Recommendations

Oil funds should not be seen as the solution to the Paradox of Plenty. Oil funds improve budgetary transparency and accountability of governments, but in the absence of real political will to allow public scrutiny and involve civil society in decision-making, they will fail to address core issues of civic empowerment and democratic development. Revenue management plans do not address deeper issues surrounding oil development, including corruption and rent-seeking, local livelihoods impacts, environmental degradation, Dutch disease, human rights, and the tendency toward authoritarian regimes. Oil funds cannot be an excuse to dismiss the deeper issues.

The oil funds themselves could be significantly improved in all cases. More independent oversight could be exerted by including Parliament and civil society representatives on the oversight committees, and by involving parliaments in naming committee members. (Though in countries with dominant presidencies, parliament may be a virtual extension of the executive branch. However, as opposition parties gain clout, parliaments often offer the best avenue for political progress.) In addition, effective oversight committees would have the resources and authority to hold hearings and question government authorities, subpoena crucial documents, and issue public reports. The Ugandan PAF model of using a portion of the resources to fund accountability bodies such as the Auditor General may be worth replicating elsewhere to boost accountability over all government resources.

The executive branch of the governments in all three oil cases examined heavily control the operations of the oil fund, though in Azerbaijan the IMF seems to have a clearer plan for improving the situation. In general, however, the executives have considerable authority to make decisions regarding use of the funds' resources. As part of a general process of political reform, parliaments should have a greater role over budget allocations, both of general government resources and revenue management plans.

Monitoring the actual disbursement and use of the resources in oil funds, as well on-the-ground impacts, is also crucial. Decentralized networks with local government, community leaders, and civil society must be put in place to ensure that resources promised from the funds reach their destination and are directed to the services that will make the biggest difference in the lives of the poor.

Sources of information:

International Monetary Fund, Article IV consultations for Azerbaijan and Kazakhstan

International Monetary Fund, communications with IMF staff.

Andrew Lentz, Assessing the Impact of Uganda's Poverty Action Funds, World Learning 2002.

Peter Rosenblum, Managing Oil Revenues in Chad: Legal Deficiencies and Institutional Weaknesses, Harvard Law School Human Rights Clinical Program 1999.

Uganda Debt Network, www.udn.or.ug.

US Department of State country reports on human rights practices: Azerbaijan, Chad, Kazakhstan.

For questions or comments, contact:
Carol Welch
(202) 783-7400 x 237
cwelch@foe.org