Why the Rush for a SWF for oil in Lebanon

The Budget and Finance parliamentary committee has announced the finalization of a draft law on the establishment of a Sovereign Wealth Fund (SWF) for oil and gas following a 7-month discussion in Parliament .

Fiscal and macroeconomic conditions are key considerations when assessing the utility of a SWF. Additionally, establishing an SWF should be accompanied by prudent investment and governance practices to ensure the fund's effectiveness and long-term sustainability. The second objective is subject to the first; there is no point in discussing the governance structure of an institution if its very purpose is not determined yet.

One common economic challenge that countries face when benefiting from a large resource windfall is the possible occurrence of the “Dutch disease”. The Dutch disease refers to the risk that sustained large external inflows, such as those occurring in the case of hydrocarbon-led windfalls, could rapidly stimulate aggregate domestic demand and the economy beyond its potential thereby creating inflationary pressures and leading to an appreciation of the real exchange rate relative to the country’s trading partners. This exchange rate appreciation would, in turn, diminish the export competitiveness of the non-resource part of the economy and possibly lead to persistent trade account deficits.[1]

The law organizing the oil and gas offshore sector (2010) states that proceeds from oil and gas shall be allocated to a SWF. The purpose of that provision? was essentially to avoid any political and clientelist capture of this future wealth. It explicitly stipulates the establishment of a Sovereign Wealth Fund leaving the “statute regulating the Fund, the rules for its specific management the principles of investment and use of proceeds to be regulated by a specific law.”

Principles reveal that SWFs vary tremendously with regard to a number of issues.[2]

One is transparency. Many SWFs, in particular those from emerging economies, have failed to develop appropriate standards that would allow their domestic constituents to understand where the nation’s wealth comes from, what is done with it, and where it goes. Little information is given about the funding arrangements of the fund, the investment management practices, and the withdrawal policy.

Second, is the relationship between the owner, in other words the political leadership of a country that ultimately supervises the fund, and the operational fund management.

The operational management of the SWF, in turn, should implement the SWF’s strategies in an independent manner and in accordance with clearly defined responsibilities. Most SWFs covered by the Santiago Principles are linked to the Finance Ministry as the political authority supervising the fund. The ministry is ultimately accountable to the representative body of the people, the Parliament. Only in very few cases, such as in Azerbaijan or Singapore, does the president play a more than symbolic role in supervision of the fund.

Operational management is mainly carried out by the Central Bank or a specifically dedicated investment company, wholly owned by the government. In turn, the operational management might decide to outsource fund management functions. ADIA for example outsources up to 80 percent of its assets to outside managers.

Third is the objective of the SWFs. Most commodity based funds have adopted the principle to stretch the benefits of their country’s wealth in natural resources across multiple generations by transforming natural resource assets into financial assets. Their withdrawal policies indicate more precisely who the beneficiaries of the funds revenues are.

Based on best practices, SWFs are not established prior to any commercial discovery. According to the timeline mentioned in the agreement between Total and Israel, production is not expected before the third to seven year after a commercial discovery. In the best base scenario, future oil and gas proceeds are not expected to materialize before 2027, on the condition that a commercial discovery happens this year and there are no delays in field development.? In the absence of macro-stability and of any vision on future needs it is, by design, impossible to decide on the allocation of oil and gas proceeds, which is precisely the purpose of a SWF.

It is important to note that there is absolutely no urgency in creating a sovereign fund. In fact, quite the opposite, as evidenced by international experience in this regard.

The discussion on SWF is today a diversion from other urgent priorities. Discussing a SWF is part of the authorities’ kick-the-can-down-the road strategy. Debating the SWF is reinforcing the myth that oil and gas resources can be a lifeline. MPs, government and the public at large should be discussing and mobilized around the only appropriate discussion and top priority on how to get the country out of its unprecedented crisis.

?

[1] File22.pdf (institutdesfinances.gov.lb)

[2] A Lebanon Fund: What We Should Know - Carnegie Middle East Center - Carnegie Endowment for International Peace (carnegie-mec.org)