Perspectives on policy and negotiations concerning FDI in non-renewable resources

BANGLADESH canvasses that it offers one of the best set of incentives for direct foreign investment. Yet, it has not been able to attract any significant investment which is large in magnitude and has a long gestation period. Foot-loose industries have attracted foreign investments of relatively small size. Foreign direct investments (FDIs) have had little impact on technological and managerial innovations and development of new sectors, new products and new markets.
The lackluster performance is explained by two factors. First, the government policy has been shifting: it starts with a bang and wobbles to an end with a whimper. Second, the foreign investors come to an inhospitable social environment, sometimes even hostile. This has happened to gas and currently to coal - two areas which need and could attract large investments. Export of gas-based product was a good option but was lost in the clamour against export. The investor's initial interest wilts.
Partisan politics makes fuzzy policies. Political leaders oppose and then enthusiastically advocate export as they shift from opposition to office. They lack credibility. Others counter by suggesting conservation for a long a period which needs strategies to reduce dependence on domestic gas - coal added now - and to define optimal use. Technological improvements and new discoveries change the parameters of profitability and policy.
While the political leaders have to be responsible and consistent in regard to policies, in this write-up we look at the issues for policy and negotiations including export versus domestic use only, pricing, taxation assurances, and energy security.
Thin distinction between tradable and non-tradable: Gas and coal are internationally traded products; their prices are to be aligned with border prices - i.e. the prices in the world market. The products which are traded between national economies are designated tradables; those which are not exchanged on the world market are non-tradables. As state authorities lower or abolish the barriers to trade with the rest of the world, the national economy becomes more open or part of a larger economic space.
Tradable products entail transportation over long distances which takes time and depend on technologies for transportation and conservation. As transportation and conservation technologies improve, the range of tradable goods and services expands. Factors of production also move among nations. Haircut and residence, for example were once considered non-tradables. But this has changed. Think of a Mexican barber who sets up a saloon in the USA and remits home the income (less consumption in the USA); or the Japanese who own or retain residences in Thailand and come there to play golf. The distinction between tradables and non-tradables breaks down with changes in technology, consumption habits of people, and laws opening up to immigration and ownership of property by foreigners.
The concept of borderless economy captures the essence of the ever broadening scope of the tradable economy. Hayek rejects the idea of a national economy and recognises the household as the only meaningful economic organisation. When the households engage in economic exchanges across the barriers of national economies, factors of production and products become tradable. The divide between the tradable and the non-tradable is superimposed on an economy from the state juridical boundary. Globalisation is all about tearing down those barriers, albeit the institutional arrangements are still weak and have exploitative traces.
Electricity is tradable which needs transmission system linking generation and consumption locations. The Nordic Power Exchange is an example of electricity as tradable. A common grid connects the generation plants in the various countries; electricity is bought and sold at the Nordic Power Exchange like any other commodity. An example near home is the Bhutan-India power cooperation. India made the investment and pays Bhutan royalty. Transmission of electricity is easier than transporting primary energy such as coal and gas.
The price of tradable items should be fixed in alignment with border prices. Even when the domestic prices are different, the economic implications should be judged in terms of border prices. Much confusion and flawed policy result from the failure to see the connection between domestic and border prices of tradable goods and services.
Use of border prices and depletion charges for fixing non-renewable resource prices: Pricing of non-renewable resources is complex for many reasons. The information is inadequate and a clear policy based on long experience is absent. The reserve is a probabilistic estimation; the transportation infrastructure is costly and takes time to build up; finally, the sunk cost is high which makes entry or exit difficult. The decision makers and negotiators have to deal with the complexities with a lucid understanding.
The cost of extraction from underground can be estimated like other engineering costs which have a market price. Depletion, which is a crucial element, however, is complex. Use of one unit of non-renewable resource is also the destruction of that unit and reduces the reserve correspondingly. When the same resource will not be available, a more costly alternative resource will be used. The cost is higher by definition - the cheaper resources are used first. Depletion measures the cost of the alternative resource when the currently used lower-cost resource will have been exhausted.
Currently, electricity produced from naphtha has the highest generation cost, followed by gas and hydroelectricity; a modest quantity is generated from diesel also. The scope for hydroelectricity is very small. Coal will be used in future (simultaneously with gas) for generation of electricity which will be cheaper than or equal to the cost of gas-based electricity. Depletion cost of both gas- and coal-based electricity may be measured in international prices.
Depletion charges accrue to the owner of the reserve and are available for outlay on the non-renewable resources, including investment in further exploration and development. Depletion charges shall not raise consumer level price of gas which now includes a high rate of value added tax (VAT) and Supplementary Duty (75-80% of consumer price) and a charge (about 20% of price) to recoup Petrobangla's loss from other commercial sales. The receipts on account of depletion charge shall not be available to the government for financing any budgetary expenditure as it wishes. The non-renewable resources sector will benefit from the more rational pricing.
The rate of exhaustion of gas and coal will depend on policies of the government and the investors' profitability calculus. The government may opt for moderate increase of electricity supply and domestic fertiliser production which entails a moderate rate of exhaustion. Contrarily, if the policy is to speed up supply of electricity - there is good reasons for that - the exhaustion also will accelerate. The per capita electricity consumption in Bangladesh is one of the lowest among the developing countries.
Domestic production of fertiliser poses different kinds of problems. Fertiliser is easy to import if there is enough foreign exchange to pay the price; also, the government has a long experience of importing fertiliser. For importing electricity, it is necessary to establish contract with the supply sources and construct the transmission lines which will take a long time (10-12 years roughly). The infrastructures for transportation and upstream use of gas and coal take money and time to build.
Open pit coal mining causes more damage than underground mining. Open pit mining makes the surface unfit for human settlement and cultivation. Refilling the surface at the end of mining is unfeasible. The soil had formed over a long period and cannot be reconstructed within a shorter time. Open pit mining could be justified if the coal deposit is close to the surface, the land were not inhabited, the population density were low and there were abundant unsettled land - say as in Australia.
For economic viability of non-renewable resource extraction, negative externalities are estimated in addition to depletion. Pollution of the environment is the major negative externality: gas pollutes less than coal and clean technology for coal-based electricity is evolving progressively. There is no market for pollution; the negative externality is measured by putting a putative (economic) price tag on the physical deterioration of the environment and often the cost for protecting or restoring the environment.
The techniques of benefit-cost analysis are designed on the assumption that a project generates benefits in small incremental doses which do not change the economy radically. Investments in gas and coal are not exactly that; these investments can transform the economy radically and have significant macroeconomic and social consequences which need to be evaluated carefully. The cost-benefit techniques are short of the needed epistemic.
Pricing models of KAFCO, IOC, IPP and draft coal policy: The pricing models of KAFCO, IOC, and IPP have certain common elements. The fuel value of gas is specified (sulfur content) and the price is linked with the Singapore spot market for petroleum, subject to a floor and a ceiling. Gas is treated as a substitute of petroleum. The user entities may buy directly from Petrobangla or may transact through an intermediary such as Bangladesh Chemical Industries Corporation (BCIC) in case of Karnaphuli Fertilise Company (KAFCO) and Bangladesh Power Development Board (BPDB) in case of certain independent power producers (IPPs). The intermediary is incidental, not an essential part of the pricing model.
In case of KAFCO, it was decided that BCIC would buy from Petrobangla at the administered domestic price and sell to KAFCO at the internationally indexed price, absorbing the loss or the profit. This arrangement was made to get around the reservations of the World Bank that Petrobangla's parlous finances be protracted from the international price expected to be low. In the event, BCIC made some profit initially when the international price was higher than the domestic price. However, BCIC spent away the money and could not pay when the international price fell. BCIC's default on the contract compounded Petrobangla's problem.
There were some reservations within the government about the above arrangements advanced by BCIC. Both BCIC and Petrobangla receive all their financing (debt and equity) from the government; sell their products at administered prices which do not reflect the cost or relative scarcity; and their losses are assumed by, or transferred to, the government. BCIC's solution was a fiction and caused the country a lot of problems. When the government did not pay the Japanese lenders, investment flows from Japan were suspended. Aid from Japan also came under stress. The government did not meet the obligations because of obscurantism, not shortage of foreign currency. Restructuring of KAFCO resolved the problems; BCIC's intermediation was removed.
The coal policy suggested by IIFC (Version 2) proposes export price for coal linked with an international price index. The domestic price is differentiated by uses. In the initial development period (ten years), two-thirds of the coal produced will be exported and one-third used domestically; thereafter, the split will be equal. The output also will increase. The domestic price is expected to be lower than export price and cross-subsidised by export.
The draft policy suggests two-part royalty for exported coal - a fixed component and a variable component. The formula for the variable component captures an increasing proportion of the rising export revenue. It works as follows: subtract the indexed price from the base price ($ 25.00 constant) and take the ratio of the difference to the base price; the product of the ratio and a constant (10) is the royalty. In the rare event of the indexed price being equal or lower than the base price, the variable royalty will be zero or negative, which can be avoided by taking the absolute value of the ratio. [Fixed royalty + {(transaction price - base price)/base price} x10}]
........................................................
The writer, a retired Secretary to Government, is currently the Managing Director of Credit Rating Agency of Bangladesh





More Headline


Perspectives on policy and negotiations concerning FDI in non-renewable resources

Was Indian one-time settlement of debts an eye wash?

Sesame street educates and entertains internationally