Measuring policy effectiveness

As indicated, an essential ingredient of sector development is sufficient, substantial capital investment. Given the recent sustained commodity price downturn and the parlous state of the financial affairs of many resource sector investors/operators, the pool of available capital is at its lowest in some time. Given that increasing numbers of resource projects are chasing limited and diminishing investment, the effectiveness of policy and the perceptions of investors in this respect have become critical. One of the more prominent measures of policy-making and the perception of the investment community towards the resultant policy is that carried out by Canada’s Fraser Institute in its Survey of Mining Companies.2 This survey assesses the mining policy of 109 jurisdictions worldwide through its Policy Perception Index, a composite index that measures the effects of government policy on attitudes towards exploration investment. In looking at the top performers of that index one can distil a number of key recurring characteristics and principles that appear in the policies of jurisdictions globally that “get it right”. Set out below are a number of the key principles and characteristics that can be found in these sector policies of better-performing jurisdictions.

Importance of clear and precise policy-making

Sector policy is the key vehicle for setting out a government’s objectives, intentions and methodology for the development of the sector. To attract maximum attention from potential investors a government should try its best to send clear signals as to its intentions with respect to the development of the sector, applicable rules and the envisaged role of the various stakeholders.

Form of policy and basic content

While policy can have many manifestations, such as a specific policy document or interrelated documents, or can be inferred from legal instruments and/or administrative practices and/or government officers’ statements, ideally effective policy should be set out in a clear and easily identifiable form.3 Experience from successful jurisdictions indicates that policy should follow a clear set of principles which contain precise and concrete aims and objectives; specify rules and procedures for developing those objectives; identify the means and guiding principles by which the objectives will be achieved (for example, restricted or open market); and, identify and aim to reconcile dominant and conflicting interests of stakeholders. Policy should further identify the specific parties responsible for the implementation of particular objectives and provide a timetable within which the objectives should be achieved. Ideally, where the policy initiates significant reform or significant deviation from a prior approach, the policy should also be accompanied by an action plan specifying individual elements of policy and identifying specific steps and an appropriate timeline preparation and implementation of individual elements of policy.

Key policy objectives

The key objectives of an effective sector policy will be to attract investment; ensure development at a national, regional, local and community level; provide for development in a sustainable manner through the integration of environmental, social and economic impacts; and ensuring, insofar as possible, a positive social, economic and environmental legacy.

Key policy characteristics

Modern and effective policy should be forward looking and, given the length of sector cycles, take a longer-term view; clearly define specific expected outcomes from the application of the policy; and, where appropriate, draw on the successful experiences of other jurisdictions, while recognising the relative uniqueness of a country’s circumstances and the need to adapt the experience for it to be of true value. In setting out principles, objectives, actions and drawing on experience, the policy should provide clear, substantive and available evidence, commissioned by the policy-maker for the purposes of the policy or drawn from robust sources of international experience.

Given the extensive actual or potential linkages of the minerals sector to the broader economy and society, effective policy should seek to be broad and encompassing, ideally taking an integrated and holistic view, identifying how best the sector can be developed in a sustainable and environmentally friendly way, while providing maximum benefit to the widest range of citizens, both directly from the sector itself as well as from the backward and forward linkages that the policy should strive to promote and facilitate.

As policies can be time and place specific, there should be adequate provision and mechanisms for their review, the evaluation of impact and success, and the facility to revisit aspects where necessary.

Reflectivity of international standards

Effective policy will often reflect international standards and recognised best practice. Among the influences in this respect are:

• the Extractive Industries Transparency Initiative (EITI) is a high-level global initiative launched at the World Summit for Sustainable Development in 2002. The initiative was soon after endorsed by the G-7, the international financial institutions (including the EBRD), civil society organisations (CSOs) and major Western oil, gas and mineral companies. The EITI is a policy, legal and regulatory framework which aims to contribute to ensuring the proceeds of mining and energy industries are used for broader economic development. The EITI Standard4 provides an agreed framework for regular publication of all material oil, gas and mining payments by companies to governments and all material revenues received from oil, gas and mining companies to a wide audience in a publicly accessible, comprehensive and comprehensible manner. Once a host government chooses to endorse the initiative, then all revenue flows from oil, gas and mining companies to governments (such as royalties, bonus payments and general taxes) are disclosed to the public. Payments by companies and receipts by the government are reconciled by an independent third party and civil society is actively involved in the EITI process in each country, thereby enhancing wider accountability
• Publish What You Pay (PWYP) is a global coalition of CSOs united in their call for an open and accountable extractive sector, so that oil, gas and mining revenues improve the lives of citizens of resource-rich countries and extraction is carried out in a responsible manner that benefits countries and their citizens. PWYP advocacy and activities are guided and informed by their Principles and Standards5 in the belief that coordinating the collective actions, skills and interests of a diverse coalition of CSOs is the most effective way to influence key stakeholders and drive policy and practise change in the extractive industries and the governmental sector
• International Labour Organization Convention No. 169 Concerning Indigenous and Tribal Peoples in Independent Countries,6 which provides for recognition of the rights of ownership and possession over the lands that they traditionally occupy; prior consultation and participation in the benefits and fair compensation for any damages, with regard to the exploration and exploitation of mineral or subsurface resources; and, due respect to their customs or customary laws
• International Finance Corporation (IFC) Performance Standards on Environmental and Social Sustainability (also known as the “Equator Principles”),7 which have become globally recognised good practice in dealing with environmental and social risk management.

Key policy content

(a) Policy actions: Effective policy should set out the actions which the government intends to take in order to achieve the policy objectives. Among the key actions in this respect will be those aimed at creating an enabling and investor-friendly environment by:

• establishing clear and predictable “rules of the game” consisting of an appropriate legal framework, a framework which should comprise a series of laws or legal instruments (regulations, licences, procedures, guidelines, contracts) to cover matters such as the specifics of the sector (for example, a mining law), as well as provisions for the protection of investment (for example, investment and stabilisation laws), and laws to ensure environmental protection and sustainable development (for example, environmental and monitoring laws)
• elaborating on technical, financial, environmental, social and administrative requirements
• providing for a clear assignment of specific responsibilities of the provincial and national government
• establishing that enforceability of legal and regulatory provisions and contracts must be practical and affordable
• elaborating on an appropriate institutional framework, including:
  
  • cadastral-based institutions which will be responsible for broader regulation, including registration, licensing, mapping, and so on
  • an inspectorate which will be responsible for technical oversight, enforcement, health and safety
  • a geological survey, responsible for geoscience data and survey work
  • fiscal oversight authorities at a national and, where appropriate, provincial level responsible for tax, royalties and duties
  • environmental authorities, responsible for environmental enforcement, with sufficient capacity at both a national and sub-national level, given the localised nature of most environmental issues
  • labour and social protection authorities
• providing a framework for adequate and appropriate re-distribution of resource rents among central authorities, provincial levels and local communities
• providing a framework for adequate and sufficiently inclusive community participation in both implementation of the policy and its ongoing review and evaluation
• setting out the actions intended for national, regional and local development, for example, the government may pursue a policy on localised beneficiation whereby additional value accrues to the state by the processing of raw minerals before their export, or perhaps a policy to support local firms to provide goods and services needed in the mining production process
• elaborating on the steps that will be taken to manage the impact of mining operations, for example, provision for reclamation and reinstatement of land at the end of mine life and closure.

(b) A fiscal and commercial framework: Effective policy should elaborate on a fiscal and commercial framework that will comprise a combination of policies, laws and regulations and institutional arrangements. This framework should aim to give investors clear and definite guidance on the intended mining fiscal regime (that is, profits tax, royalties, dividend taxes, import duties, VAT, depreciation and amortisation schedules), as well as highlighting mitigants to various risks to investment, for example, a stabilisation agreement preventing or lessening the need for changes to tax and audit requirements.

(c) An environmental framework: Effective policy should set out clear provisions for environmental protection, elaborating on specific governance provisions through law, regulations, certifications, and so on. Good governance in this respect will be achieved through an appropriate balance between mining and environmental aspects. To provide sufficient force and effectiveness for the environmental provisions there should be an adequate financial regime to provide support funds in case of environmental damage. Given the extensive international experience in environmental protection in the context of the extractive sector, the policy should strive to apply international practice for environmental compliance standards and rules on involuntary relocation and compensation.

(d) Stakeholder consultation framework: Critically, to earn the respect, trust and confidence of stakeholders from investors to the local communities, policy should not be developed in isolation and must be inclusive, created following genuine and good-faith consultation with all relevant stakeholders. Effective practices in this respect should comprise a Stakeholder Participation Framework which will identify stakeholders; elaborate on formal and informal mechanisms to build stakeholder support; provide for open communication with identified stakeholders as a means of facilitating good governance; allow for public hearings, regular meetings, publication of relevant reports; and, crucially, compliance with the EITI.

The scope of policy

Policy should be clear in its scope and identify the range of minerals that it extends to. For example, some governments may choose to exclude specific minerals from general sector policy because of an actual or perceived additional strategic value (for example, uranium or other minerals used in nuclear energy processing). In addition, the government may seek to apply different rules (and therewith different policies) to the likes of artisanal mining. Some policies may seek to include provisions relating to both exploration and exploitation of minerals.

The role of the state

Effective policy should also be clear on the role of the dominant sector actor in many jurisdictions, that is, the state. In addition, the policy should clarify how that role will be defined and implemented (for example, in law). In providing clarity on this point, the policy should be clear on the state’s role as regulator and whether the state will intervene in the sector as an operator. Where there is such an intention, the policy should articulate the attitude to foreign investment and what the role of the investor will be.

Obligation of government

Policy should be structured so as to obligate the government in some way. While sector policy documents are not necessarily legally binding in most countries they can, once in the public domain, impose certain obligations on government to act in accordance with their declared intentions with respect to particular issues. Where properly constructed and published, sector policy documents can add political pressure to pursue the development of a particular sector.

Corruption and transparency

Keeping citizens ignorant of resource deals facilitates corruption, theft from public funds, misallocation of revenues and waste. Restricted access to key information is increasingly said to be at the heart of the gap between wealth creation and human development. One of the major aspects that policy is increasingly being called to address is the prevalence and impact of corruption on the sector, with the expectation that an effective policy will identify scope, potential incidence of corruption and highlight methods to be used to tackle it. Mining agreements can be particularly vulnerable to corruption because of discretionary powers that have traditionally tended to apply to their conclusion and operation. Bearing this in mind, transparency has emerged as a primary policy means of combating corrupt practice.

With its emergence as a key policy to counter corruption, there is also an expectation that effective transparency may go beyond the mere disclosure of information, to encompass the verification that the information made available is complete and accurate, to ensure that is presented in a format that can be understood by the wider public, and that will facilitate national dialogue on the issues at stake. Although many countries have made impressive progress; far more has to be done to unlock the transformative power of transparency.

The EITI can play a key role in the transparency process. Although launched as a technical, financial reporting process it has grown in its ambition to be a platform whereupon government, non-government organisations and companies are brought together and the national reports that are produced provide a focal point for national dialogue. The experience of Ghana (see Box 2) is illustrative in this respect.

Having put in place a clear, precise and certain policy the challenge then becomes to establish an equally clear, precise and certain supportive legal framework and a sufficiently robust institutional framework to support implementation of the policy.

Supportive legal framework

A supportive legal framework should reflect the following best practice principles:

Entrenchment of core principles and fundamental rights and obligations in primary legislation: Once sector policy has been decided on, the intentions contained in the policy document need to be translated into concrete actions and a legislative framework within which these intentions can be given life. This legislative framework should ideally be underpinned by a framework mining law which is itself necessary to entrench the core principles attaching to the sector, for example, transparency, non-discrimination, objectivity, promotion of sustainability and environmental protection, and so on. Generally speaking, framework legislation will be prepared by the responsible ministry (in consultation with the sector regulator and all affected stakeholders) and presented to parliament who will debate and pass this primary legislation as a law of parliament. Such primary legislation should be reflective of the following:

Statement of rights and obligations: Primary legislation should provide a clear and concise statement of the rights and obligations of all sector stakeholders.

Fundamental sector principles: Fundamental incontrovertible sector principles should be contained in primary legislation. Detailed procedures applicable to individual elements of the sector should then be contained in secondary legislation. Such practice allows entrenchment of fundamental principles that will be unlikely to change in primary legislation, while allowing the practical day-to-day operational and implementation issues that may be affected by changes in technology or operation of the marketplace to be included in regulations which can be more easily altered to reflect changing technology or marketplace.

Quality of entrenchment and permanence to critical elements: Once enacted as primary legislation by parliament, amendment is generally seen as a lengthy and cumbersome exercise in the majority of countries. Thus, although primary legislation does not cast principles in stone, the quasi-permanence allowed by the characteristics of primary legislation can protect it from political tinkering or short-term alteration. Even where the democratic credentials of parliaments in certain countries may not be as solid as they could be, the process attached to the amendment of parliamentary legislation nonetheless acts as a solidification of basic principles.

Actual content of primary legislation will vary: Actual content and level of detail of primary legislation will vary from country to country. In this respect, much will depend on the level of development of the marketplace, the strength of the surrounding administrative structure and the effectiveness of the underlying legal environment. Where these elements are sufficiently advanced, the amount of specificity required in primary legislation is reduced. Where sector reform has yet to begin or where the application of modern regulatory standards is in its infancy, more specific guidance of the law will be necessary. Similarly, where the legal environment, in particular the court administration, is not yet used to dealing with complex econo-legal matters, more detail will be necessary.

Creation of a solid institutional foundation

To implement the policy initiatives contained in primary legislation a strong institutional foundation should be established based on the clear separation of the following functions:

Separation of state ownership from regulation: A key element of a stable environment for resources is the establishment of a sector-specific regulatory authority. With the onset of modern regulatory practices where the state maintains a role in resource extraction operations, regulation by a government ministry making decisions about policy formulation, implementation and operation is clearly inappropriate, and could give rise to an actual or perceived conflict of interest. Given the competing objectives of those three roles it is highly unlikely that such conflicts could be resolved effectively within one authority. International experience has shown that a sector-specific regulatory authority, independent of both political and operational influence, has emerged as a central part of sector development. Such separation of ownership and regulatory functions increases perceived neutrality and insulation of the regulator from political pressure and investors will generally have greater confidence that such a regulatory authority will regulate in a transparent and objective manner. Accordingly, where the government retains any shareholding in an operator the regulatory function should be clearly separated from the control function of the operator as the shareholder. A common model for addressing this issue of operational control is to transfer the state shareholding from the ministry responsible for the resources sector to the ministry for finance or a state property/privatisation agency.

Separation of policy-making from regulation: The government functions as policy-maker to design the rules of play and format of operation of the resources sector. Implementation of these rules and policies more appropriately lies with an independent regulatory agency, separate from the ministry. Such separation generally allows efficient, objective and transparent implementation of sector regulation, free from most of the political pressures that dictate policy formulation.

As with the regulatory regime itself, clear rules and processes must also apply to the regulatory function and the regulatory authority, and, in addition, the basic procedures that will govern its interaction with the sector operators must be defined, preferably in primary legislation. Crucial also for any reform endeavour in this respect is the ability to develop a flexible regulatory capacity that can adapt to an evolving marketplace and that will take every opportunity to promote and facilitate both social and commercial objectives.

Conclusion

Critical to the sustainable development of the minerals sector in resource-rich, developing and transition economies is the attraction of substantial quality investment. The ability of an economy to attract such investment in an era of weakening availability of capital investment and increasing global competition for that investment will depend on what a country has to offer an investor. Clear and precise sector policy, legal certainty and robust institutions have prov

The EBRD is mindful that investors in the natural resources sector face significant challenges. Already the capital intensity, cyclicality and climate change pressures in the industry demand strong balance sheets and organisational capacity for long-term survival. Moreover, natural resources investors have a substantial share of their portfolio of extractive and supply chain assets in remote places and emerging markets. Emerging markets, of which many are located in the EBRD region, however also increase the risk exposure to, among many other factors, weak legal and institutional frameworks.

Discussion on how investors handle the risks of weak legal and institutional frameworks is the focus in this brief article. The question is at the core of the ongoing tension between investors’ needs for objective, neutral and fair rule-based institutions on the one hand, and vested interests of the host countries on the other. Even where the rule of law has triumphed after centuries of familial favoritism by clan leaders, some degree of threat often lingers that elected leaders may seize an opportunity to reverse the democratic transition. Furthermore, the economic and financial downturn with its pressure on budget revenues often triggers debates about re-nationalising key natural resources or increasing tax collection. The question for the natural resource investor in places with weak institutional and legal frameworks is therefore to which degree the host country (or region) is “ruled by law” where the legal system creates a level playing field for everyone except the host country’s leadership – and what can be done to ensure that the rules for an investment will be guided by the “rule of law” so the host leadership will have a strong incentive not to exempt themselves from the rules governing everyone else – including the natural resources investors.

In jurisdictions with weak legal and institutional frameworks the natural resources investor can face a variety of interference disrupting the rights and ability to control and operate assets in the supply chain. The key threat is actions of state institutions (for example, regional administrations, federal ministries, agencies and state-owned enterprises). Interference often concerns the access to public infrastructure and services. The severity can range from a local official’s inability to handle a required technical certification to unlawfully revoked permits and attempted extortion. The list of incidents “goes on and on” as risk insurers say.

In order to mitigate interference investors seek to protect themselves through extensive project documentation and increased capacity and efforts to solve problems. The responsible and law-abiding natural resources investor’s problem-solving capacity is mainly a function of available resources and leverage.

(i) The resources will include skilled manpower, management information systems, contingency budget, external supportive stakeholders and nurturing local relationships.

(ii) The negotiation leverage, which mainly stems from the value of the host government take (for example, economic benefit) from the asset and to what degree the investor is a fair, transparent and resilient counterparty, who ultimately has the strength to suspend local operations. An investor’s negotiation leverage can be very high, when the investment asset is critical for the host country’s reputation, budget income or energy security.

The investor’s problem-solving capacity is a critical success factor for operations in places with difficult investment climates. Complex project documentation requires continued monitoring and maintenance, which in itself demands a minimum level of problem-solving capacity from financial controllers, lawyers and compliance officers. However many more resources must be mobilised, when a legal and institutional framework deteriorates and becomes a deterrent to the investment process. As state interference increases, the investor’s required problem-solving capacity will need more resources until the costs undermine the return on investment and trigger the investor to reassess the strategy in the host country. The issue may be exacerbated if the investor relies on capital markets to provide a substantial part of the funding. The deterioration in the host country business climate or allegations of wrongdoing may weigh heavily on the investor’s share price and hence reduce the ability to attract funding. The outcome could be suspended operations or selling all or part of the investment to adjust the asset portfolio, as illustrated in Chart 2.

Problem-solving capacity is a critical success factor for a responsible investor, who bets on a long-term investment of strategic importance in investment climates rooted in an autocracy. The investor would typically face high political risk and ambiguity relative to the pace and direction of the leadership, legal and institutional transition. The investor would therefore need to design an investment structure, which would have very strong and lawful incentives for the local leadership to remain a supportive counterparty and continue to embrace an agreed government take as well as the standards and processes encompassed in the ESAP and EITI. As political risks are high, the investor would typically aim to share risks on the investment and insure risks to the extent feasible. This is where the EBRD may assist the investor’s project company by diversifying its funding sources, providing financing for the tenor that matches asset life and therefore supports building a stronger balance sheet with a leverage fit for purpose. Having a Resident Office and investment portfolio in the host country (or region), the EBRD is well positioned to assist the investor in dialogue with the local government and, if needed, provide technical assistance to help the country adopt the EITI and best-practice standards for environmental, health, safety, social and stakeholder engagement. Autocracy-rooted government institutions usually have limited capacity in implementing clear, objective and predictable regulation as the basis for attracting investors, who are committed to good corporate governance, EITI, best-practice ESAP and reliable enforcement.

In investment climates rooted in democracy the investors will often operate several parallel and complex joint venture structures with the aim to leverage partnership alliances to expand and diversify their global asset portfolios. The EBRD would often be one of the few financiers available to provide long-term limited-recourse project finance with equity, mezzanine finance and/or syndicated debt. At the same time the EBRD may complement the investor’s problem-solving capacity by its country presence, expertise and outreach to local companies. A local presence enables the EBRD to support the development of transport, energy, water infrastructure and waste management and other value-added facilities and services, which are key to the development of projects. Moreover, in those countries which are significant energy producers, the EBRD will also help diversify the local economies by attracting investors to other sectors.

For the sake of illustration only Table 1 shows various simplified highlights of investment situations and the possible EBRD support to responsible investors’ problem-solving capacities.

In conclusion, the EBRD has gained the trust of its partners and is recognised for its experience and pragmatic attitude in helping natural resources investors to coordinate and resolve a variety of issues associated with a project’s diverse and multiple stakeholders (that is, equity partners, banks, suppliers, competitors, unions, NGOs, courts, media, and so on) as well as devise the means to shape the behaviour of host countries’ leadership and government institutions. The EBRD is therefore well positioned to offer a problem-solving partnership for responsible investors operating in the EBRD region.

The governance question

In most cases a strengthening of governance, institutions, laws and regulatory policies will be critical if sustainable development policies are to be effective. Management and oversight are critical activities without which policies and plans will have no real meaning. Securing the consent of communities in this process requires the establishment of mechanisms for consultation and cooperation. This is where a “social licence to operate” is likely to be most acute.

Distinctions within extractive industries

Within the EI sector, distinctions need to be made to understand how sustainable development issues arise and how they can be addressed. The three main distinctions are: between hydrocarbons and mining activities; between social and environmental impacts; and, where appropriate, between the stages in the lifecycle of the particular activity. Oil, gas and mining can be vastly different in terms of their potential social and environmental impacts and in terms of their management processes. With respect to the former, pollution from oil spills can be important, while for mining the issues associated with artisanal and small-scale mining are equally important but are without parallel in the oil and gas sector. Environmental and social issues arising from EI development can also differ, sometimes very significantly. On some issues they involve a different set of actors, tools, regulations, guidelines and analyses. These and other differences also arise according to the lifecycle of the extractive project.

Why the development question has become important

There is increasing appreciation among established and prospective resource-rich countries, civil society and donors, that EI sector development can generate further benefits to the economy beyond the direct contribution of revenues, through its links to other sectors. Although the idea that governments should intervene to support broad-based economic growth is not new, the extent and type of intervention has evolved into policies designed to establish these linkages. The guiding idea is that, in the long run, a diversified economy can do better than one locked into resources exports.

There are three kinds of initiative for harnessing a growing EI sector to development goals that are important in current debates on law and policy:

Local content

These policies and the use of law to implement them are now seen as one way to create favourable linkages and build economic capital at the national and sub-national levels.10 Large EI companies with millions of dollars of annual procurement can provide a significant business opportunity to stimulate the local economy if they are prepared or encouraged to include local SMEs in their supply chain. In many respects, the EI sector is a very small contributor to employment creation but through indirect and induced employment in the supply chain and through the provision of support services, a specialised labour force may be built up. This is a window of opportunity which nonetheless requires attention in terms of its long-term sustainability (for example, when facilities close down).

How?

In principle it is possible for governments to use primary legislation to implement local content policies. In practice, this is done in the oil and gas industry but much less so in mining, where the contract instrument is preferred. An example in the oil and gas industry is the Nigerian Oil and Gas Industry Content Development Act 2010 which applies to all transactions or operations carried out in Nigeria’s oil and gas sector, and to all operators in it. There are four main objectives in Nigeria’s legislation:

• development of indigenous skills across the oil and gas value chain
• promotion of indigenous ownership of assets and use of indigenous assets in oil and gas operations
• enhancement of the multiplier effect to promote the establishment of support industries
• creation of customised training and sustainable employment opportunities.

Countries that have broad local content provisions for mining set out in their national legislation are Indonesia, South Africa and Zimbabwe. Under Indonesia’s Mining Law (2009) companies are required to give priority to local employees and to domestic goods and services, and to divestment of foreign shareholdings in local companies after five years of production. Regulations clarify the provisions in the Law. Further, there are provisions to encourage the development of processing and refining of mining products in Indonesia, with the promise that “the extent of the required local processing and refining are to be specified in the implementing regulations” (Articles 95-112 and 128-133).

Resources for infrastructure

In seeking multiplier effects in the local economy from EI development, infrastructure development plays a key role. It can open up opportunities in other industries, including agricultural exports and tourism. Yet gaps in infrastructure – from Mongolia to Mozambique – are one of the main bottlenecks to growth in developing countries and emerging markets. By leveraging investments as well as developing new initiatives, the EI large infrastructure projects can create or expand critical infrastructure and unlock regional development potential.11 This can include power, roads, rail, ports and information and communication grids. In practical terms, financing is a key issue. In Africa this has been a particularly acute problem with a shortage of infrastructure and a lack of financing. Some new investors have been willing to finance infrastructure (mostly hydropower projects, railways) in return for rights to natural resource exploitation and contracts in “resource for infrastructure” transactions, and for diplomatic ties with the host government concerned. Some of the major transactions have been government-to-government ones between the China Export-Import Bank and countries in Africa such as the Democratic Republic of the Congo (DRC) that are unable to provide adequate financial guarantees to back their loan commitments. The thrust of such transactions is that the country’s resources act as collateral to expand production, to rationalise transport and to make exports more efficient through finance.

Resource corridors

The catalytic effect of investment opportunities in infrastructure can be both long term and regional in character, creating multi-state zones and so-called “resource corridors”. The idea behind this spatial development initiative is to counter the enclave (small-scale, local, geographically limited) impact that is typical of hydrocarbons and mining projects by using large, commercial oil, gas and mineral investments (and their need for infrastructure and goods and services) to anchor opportunities for broader economic growth and diversification within the immediately impacted communities. The policy goal is a viable and diversified economic space, which would not occur through market forces alone.12 This involves two key elements: the establishment of a viable financial framework based on the expected increase of government revenues as a result of EI activity; and capacity-building among the government, private sector and civil society to develop and implement agreed development plans. This approach would be inclusive with respect to the impacted communities.

The core of the “resource corridor” concept is that port, rail and road investments can catalyse supporting and ancillary economic activity, creating “resource corridors”, alongside mining- or hydrocarbons-related infrastructure.13 Linked to this is a requirement that third-party access to such infrastructure be facilitated. Such shared infrastructure can benefit sustainable economic growth.14

It is important to note the differences in opportunity between various minerals. For example, a bulk commodity such as coal or iron ore will require the development of railways, while gold extraction will require only roads but correspondingly more access to water resources. Similar differences will arise with respect to energy demands. This will impact on demand patterns for third-party access to infrastructure.

Conclusion

For an ambitious government then, EI sector activities can be leveraged to generate economic development that may be wider and longer lasting than the EI sector activities themselves. This includes beneficial impacts that may well be regional as well as national in character. In combination, they provide an important justification for supporting the EI sector in spite of the challenges which this presents to many governments.

Grounds for optimism about the likely success of these linkages to development policy are provided by the changing attitudes of investors. There has been growing participation of private and other corporate investors in promoting integrated sustainable development at local, regional levels, placing their transformative investments within a development context. An early lead role was taken by Chinese companies in Africa. However, industry associations in the oil, gas and mining sectors remain very active in developing guidelines, toolkits and manuals for (and with) their members to raise the level of best practice in their operations, especially in terms of their social and environmental impacts.

A failure to engage is increasingly perceived by investors as creating a risk to their “social licence to operate”. The synergies between public and private investment lie in ensuring that EI projects in poor regions contribute to optimising the development potential of the affected local, national and regional communities. This requires industry as well as government to engage in avoidance, mitigation and amelioration of environmental and social damage, and community consultations at the very least.15 Oil, gas and mining companies can also demonstrate good corporate citizenship through policies of local sourcing and other pro-development initiatives.

One of the greatest risks associated with economic development in resource-rich countries is overdependence on resource revenues. Mining investment can trigger economic growth and poverty reduction in developing countries, but comes with a plethora of governance and economic management challenges. Further research by ICMM in partnership with the United Nations Conference on Trade and Development (UNCTAD) and the World Bank Group indicated that mining investment is most effective when accompanied by appropriate policy and institutional reforms, indicating that carefully designed governance reforms can enhance the impact of mining investment at both the national and local development levels.

A study17 completed by the McKinsey Global Institute in 2013 indicated that the number of countries where minerals are the main driver of economic activity has increased dramatically over the last 20 years and is now dominated by low- and middle-income countries. In response to this growing challenge, donor agencies have emphasised improving governance through building capacity and robust institutions, as well as encouraging transparency and accountability.

The taxation of natural resources is a particular challenge in developing economies. Governments of developing countries urgently require tax revenues in order to pay for basic goods, services and infrastructure for their citizenry. However, mining is a capital-intensive industry and it can take over a decade for a mining project to evolve from exploration to operation. Even once a mine is operational it can take a number of years for it to become profitable and for the company to start paying corporate income tax. It is difficult for a government to make long-term plans when short-term needs are so acute. This problem is exacerbated by the fundamental time horizon disconnect between a mining company, which sees its mine as a 30- to 100-year investment and a government, which may be up for re-election in three to five years, by which time it needs to be able to point to improved social and economic outcomes in order to be re-elected.

While mining companies typically contribute as much as 20 per cent of government revenue in low and middle income mineral-driven economies, that figure is just one element of mining’s contribution to social and economic development. Based on research undertaken by ICMM, in mineral-driven countries mining can typically account for 30 to 60 per cent of export earnings and 60 to 90 per cent of foreign direct investment. In addition, the returns to investors and to host governments (in the form of taxes and royalties) are broadly similar – at 15 to 20 per cent of total earnings. However, capital and operating expenditures typically account for 50 to 65 per cent of a mining company’s total earnings, in the form of wages, infrastructure and procurement. When the opportunities provided by these investments are properly harnessed and supported by an appropriate fiscal regime, the multiplier effects can have a transformative effect on social and economic development outcomes. However, too often mining’s economic contribution is reduced to a narrow focus on effective tax rates which are liable to change when commodity prices fall or when an election looms.

ICMM initiatives

ICMM’s Resource Endowment initiative was a multi-year research project, overseen by an independent international advisory group that started in 2004 in collaboration with UNCTAD and the World Bank. The initiative assessed the performance of 33 mineral-driven countries across a range of socio-economic indicators. It then developed an analytical framework that was applied to Peru, Chile, Ghana and Tanzania to identify the critical success factors that have enabled some countries to benefit from substantial resource endowments and avoid the “resource curse”. The initiative demonstrated that the resource curse is not an inevitable consequence of mineral investment: mining investments can and do drive economic growth and reduce poverty nationally and locally.

The three critical success factors were found to include:

• the presence of a favourable investment climate
• reasonable standards of governance nationally
• sound national macro-economic management.

However, the quality of governance at the sub-national (regional and local) level was also identified as an important factor. The research also found that companies alone cannot unlock the development benefits from mining – governance is key and multi-stakeholder partnerships to address issues such as revenue management or enhancing economic opportunity can help fill capacity gaps.

This project led to ICMM’s publication of the Mining: Partnerships for Development (MPD) Toolkit.18 The application of the toolkit in a given country enhances our understanding of mining’s overall contribution to sustainable development and poverty reduction through: foreign direct investment; exports; revenues and royalties; gross domestic product; direct, indirect and induced employment; local enterprise development; economic diversification; and enhanced revenue management.

ICMM’s MPD work focuses on enhancing mining’s economic and social contribution as a concrete and pragmatic way of avoiding the resource curse. It is based on the premise that mining’s contribution to broad-based social and economic development can be enhanced through collaboration among companies, government, local communities and development agencies – particularly at the local level.

Risks and challenges in developing economies

An array of challenging conditions associated with governance and company behaviour can be the obstacle in translating resource wealth into lasting prosperity and improved livelihoods for a resource-rich country’s citizens. A commitment by companies and government to transparency is a powerful means of preventing the misappropriation of revenues and the economic distortions caused by corruption.

As a consequence all ICMM members are required to support the Extractive Industries Transparency Initiative (EITI),19 a global standard to promote open and accountable management of natural resources. Through an innovative multi-stakeholder approach, the initiative seeks to strengthen government and company systems, inform public debate and enhance trust. At its core is a simple but effective process: companies disclose the payments that they have made to the government of the country in which they operate and the government discloses the payments that it has received. The two sets of figures are then independently reconciled and publicly disclosed. While EITI is not a “silver bullet” to reverse the resource curse, the information contained in an EITI report and the public debate that it spurs, can provide a timely boost for governance reforms and ultimately, development effectiveness.

Another key transparency pillar for resource-rich countries is the disclosure of an extractive company’s beneficial owner. This mitigates the risk of corruption, particularly in the licence allocation stage of the value chain. Without beneficial ownership information companies could unwittingly partner or enter into contract with a company or supplier owned by a corrupt individual. Non-disclosure of beneficial ownership is also thought to have enabled the use of shell companies by government officials or their associates to misappropriate public funds. Consequently, mining and metals company representatives on the EITI International Board have encouraged the disclosure of beneficial information to become part of the EITI Standard.

Misunderstandings around the content of contracts and mistrust among stakeholders can often lead to tensions. As a result, the disclosure of contracts, licences and agreements that govern the exploration and exploitation of natural resources should be encouraged wherever possible. This allows for commitments between governments and companies to be transparent, highlighting how resource-rich countries and companies agree to share the risk and rewards of a project over its lifetime.

Opportunities for progress

Enhanced governance and transparency can address the risks and challenges associated with resource-dependent developing countries. This reinforces the potential opportunity for capital-scarce countries to finance their development efforts, stimulate public investment and promote economic growth and social development.

As mentioned earlier, ICMM’s own research has demonstrated that the factors that help national-level benefits trickle down to the local level include: sound national macro-economic management and mineral fiscal regime; revenue transparency; engagement in and implementation of key international initiatives; and quality of governance at the sub-national levels, such as regional and local institutions.

Success also depends on the quality of collaboration among the government, companies, development partners and civil society organisations to enhance benefits. At the sub-national level, for example, the promise of greater economic opportunity and equitable social development depends on institutional capacity to drive change through effective planning and implementation of programmes and projects.

Some governance reforms result in policy changes that, if inappropriately applied, can have a detrimental effect on the performance of the industry and returns to all stakeholders, including host governments and communities. For example, dramatic fiscal regime changes, which may be motivated by a government’s desire to ensure mineral resources generate the maximum economic and social benefit for the population, can lead to companies reducing investment and, in some cases, placing their mine under care and maintenance if a mine’s profitability is threatened.

The methods by which the changes are introduced can also have unintended adverse consequences. For example, the application of policy changes could be viewed as inappropriate if changes are imposed by the host government without adequate consultation and/or are enforced over too short a timeframe for industry to adjust. Governance reforms should be designed in light of the constraints and opportunities facing individual countries, taking into consideration the factors that influence competitiveness.

Actions to enhance good governance and transparency

It is the responsibility of governments, mining and metals companies and civil society organisations to push for enhanced governance and transparency.

Responsible governments are obligated to commit to high standards of transparency related to the extractives sector, and this should be linked to a forum where debate can take place on the information disclosed. It is important that all stakeholders, including the general public, are involved in this process, ensuring government accountability for both the revenues and expenditures.

Governments also need to ensure that they avoid a narrow focus on fiscal terms, incorporating other elements that influence competitiveness, such as the political risk environment and the quality of infrastructure in support of mineral investments.

Leading mining and metals companies are responsible for engaging in governance reforms, balancing the legitimate desire of host governments to ensure that mineral resources generate the maximum benefit for the country, with the legitimate need of companies to profitably invest for the long term. Mining companies also need to engage constructively in appropriate forums to improve the transparency of mineral revenues – including their management, distribution and spending – or of contractual provisions on a level playing field basis, either individually or collectively.

Lastly, civil society organisations should continue to advocate for governance reforms and improved transparency to enhance the benefits of mining developments to host countries. For their efforts to be successful, they should work collaboratively with governments, development agencies and companies to support capacity building at the national and sub-national levels.

Role of the minerals sector and challenges to inclusive growth

Mongolia’s minerals sector has been the main driver of the country’s rapid economic growth: it currently accounts for 18.6 per cent of GDP and approximately 80 per cent of exports. In recent years, the sector has been responsible for over 70 per cent of new foreign direct investment (FDI) into Mongolia. It is also increasingly important to the state budget, accounting for approximately 30 per cent of government revenues.

Economically, Mongolia has become a mining nation, with significant ramifications for the country’s socio-cultural fabric. And while the country ranks among the top 10 countries in various mineral resources, policy-makers have yet to determine how best to leverage this wealth to advance national prosperity in a balanced and ultimately sustainable way. Although there are many solutions and diverse suggestions drawn from international experience and covering a range of outstanding issues, from institutional capacity to the management of resource rents, there is strength in the argument that Mongolia needs a more tailored approach which takes sufficient account of its unique location and developmental trajectory.

An approach that is tailored to Mongolia’s unique situation may be in order: since 2009, the Mongolian economy has tripled in size, largely due to tremendous investment in its copper and coal industries. Unfortunately, there is scant evidence to show that this staggering economic growth has been accompanied by the institutional reform that is essential to underpin the sustainability of that growth. Key indices, among them economic competitiveness rankings, governance indices and studies of corruption during a similar period have not improved to the extent that was hoped for.

In fact, the boom-and-bust nature of mining, coupled with Mongolia’s vibrant democracy, has created a number of new challenges for the country. Mongolia’s parliamentary elections of 2008 and 2012 were accompanied by protectionist undertones, as well as promises of cash handouts designed to win over voters who felt they had not sufficiently benefited from mining-led economic growth. This behaviour served to exacerbate state budget deficits and further damage the country’s balance of payments. This in turn fuelled inflation and put increased pressure on the national currency, the togrog. Ultimately, this worsened macroeconomic imbalances and served to hinder genuine efforts to diversify Mongolia’s economy and build inclusive growth.

For the Mongolian minerals sector to function efficiently and promote sustainable development, reforms should be founded on three pillars: (i) enhancing institutional capacity; (ii) building public support; and (iii) improving government support for investment. What follows is a discussion of each of these pillars individually.

Enhancing institutional capacity

After nearly seven decades of one-party socialist rule, Mongolia peacefully transitioned to a semi-presidential parliamentary democracy in 1990. At present, the parliament is the main policy-making body for the minerals sector and therefore exerts the greatest influence over its direction. It is not the only decision-making body, however: the government is able to enact regulations and also exercises control over the determination of areas which are open for exploration. The Ministry of Mining, meanwhile, is in charge of drafting policy and managing its two regulatory agencies: the Mineral Resource Authority of Mongolia (MRAM) and the Petroleum Agency of Mongolia (PAM). In addition to their respective regulatory duties, MRAM is responsible for the issuance of exploration and mining licences, and PAM is responsible for the issuance of oil and gas exploration licences and the execution of production-sharing agreements.

In 2014, the government initiated the amendment of several existing laws with the aim of liberalising the minerals sector and reducing bureaucracy related to permitting and contract negotiation. While both domestic and foreign investors have welcomed these improvements, low international price levels for Mongolia’s major commodities have meant that the country will have to wait for capital investment to return.

Among the goals of the latest Minerals Policy is an increase in the volume and quality of information in the state geological database, which the government plans to accomplish through the implementation of standard international surveying methods and mineral classifications. In late 2014, Mongolia joined the Committee for Mineral Reserves International Reporting Standards (CRIRSCO) and, as a result, adopted the Australasian Joint Ore Reserves Committee (JORC) Code. The JORC Code governs the classification of exploration results, mineral resources and ore reserves. (Mongolia had previously used an old classification system developed by Soviet-era geologists.) Experts hope that bringing the country’s geological database in line with international standards and updating it annually will encourage increased exploration by private companies.

While there has not yet been any comprehensive study of the institutional capacity in Mongolia’s minerals sector, sources such as the World Justice Project’s Rule of Law Index; the World Bank’s Worldwide Governance Indicators; the World Economic Forum (WEF) Global Competitiveness Report; and consulting firm Behre Dolbear’s rankings of top countries for mining investment all suggest that Mongolian government institutions perform poorly in supporting business and enabling sustainable investment. While the government has taken steps with the Minerals Policy to improve its ability to work with the private sector, currently available data indicates that it still has a long way to go.

Building public support

Further complicating matters is the fact that Mongolia’s mining industry is facing an identity crisis. The country is home to such world-class projects as the Oyu Tolgoi (OT) and Erdenet copper mines, as well as numerous medium- and small-scale mines, including some that are illegally operated by artisanal miners. These three mine classes are currently in contention in the public imagination for the defining image of the sector.

Improving government support for investment

At the core of the Minerals Policy’s numerous objectives is the need to foster the development of a responsible, transparent mineral extraction and processing industry that is sustainable, export-oriented and compliant with modern international standards.

Recommended next steps

Today, Mongolia’s economy is heavily dependent on the extraction of minerals and their export to China. Continued volatility in the demand for (and therefore in the prices of) these minerals means that in order to build sustainable long-term growth, Mongolia must diversify its economy and move on to higher value-added industries. This will require not only the development of such activities as minerals processing, but also support for other sectors of the economy such as agriculture and textiles (for example, cashmere), as well as a diversification of export destinations away from China.

There has been considerable progress towards this goal. In 2007, Mongolia announced that it would begin adhering to EITI protocols in order to encourage FDI, which has been the leading source of capital for the mining industry over the past decade. However, disputes in recent years over investment agreements have led some investors to increasingly view Mongolia with caution. Symptomatic of this, FDI has declined from its 2011 peak of US$ 4.6 billion to just US$ 542 million in 2014. (Although, this was also due in no small part to the decline in commodity prices.)

To jump-start growth in its minerals sector, Mongolia needs policies that:

• assess and enhance the climate for foreign investment in mining, with a special focus on human capital, corporate governance, business ethics and rule of law
• adequately direct policy-makers and those charged with implementation on mineral-sector reforms that facilitate both FDI and exports – including the development of clusters between multinational enterprises, local mining companies and small and medium-sized enterprises (SMEs) to encourage knowledge transfer
• enable the minerals sector to move up the mining value chain
• identify opportunities for technology transfer in the minerals sector.

In addition, strengthening the capacity of the government to engage in dialogue with the private sector and to manage contracts would help to increase the confidence of foreign investors and help pave the way for further reform. To judge its progress with respect to economic competitiveness, transparency and stability of policy, Mongolian policy-makers should pay closer attention to benchmark surveys conducted by international organisations such as the Organisation for Economic Co-operation and Development (OECD), the World Bank and the WEF. The OECD in particular has provided a number of recommendations to the government regarding how mining SOEs might improve their management and governance.

Mongolia has made notable progress with the creation of its National Council for Vocational Education, which has encouraged public-private dialogue geared towards helping the labour market supply the sort of skilled workers demanded by the private sector. The Council can be seen as a model for the private sector’s provision of guidance to the government (and the Ministry of Mining in particular) with the aim of increasing the sophistication of Mongolia’s minerals sector and should be further emulated. Public-private dialogue is also vital for enhancing the country’s system for dispute resolution.

As previously mentioned, reliable geological information is essential for the country’s attraction of investment into the minerals sector. However, enhancing Mongolia’s capacity in geology will require both investment and focus on the part of public decision-makers. Nevertheless, a national geological survey – created with the coordination of all relevant government agencies (that is, those dealing with water, industrial minerals, oil and gas and hard minerals) – should be developed under the guidance of the Ministry of Mining. The Ministry should in turn seek technical assistance from donor organisations for this project.

Conclusion

Mongolia has the potential to achieve national prosperity through the development of its vast natural resources. While it is too early to assess the effectiveness of this new Minerals Policy, the government should be credited for the steps it has taken in liberalising the minerals sector and encouraging the adoption of international best practices.

The impact of these reforms will only be felt in time, as the current economic slow-down in China has created unfavourable near-term conditions for Mongolia’s minerals sector. However, the country’s successful development of world-class megaprojects, such as the Oyu Tolgoi copper mine, suggests that Mongolia’s future is bright. However, political instability and poor institutional capacity remain as obstacles to Mongolia’s ability to attract foreign investment and improve its international competitiveness. It is well within the nation’s power to overcome these challenges, but doing so will require a firm resolve and a willingness among all stakeholders to work together towards a shared vision of prosperity.

Impact

Each of the three EITI stakeholder groups has different views of the EITI’s impact and benefits. Countries implement the EITI for a variety of reasons including to fight corruption, attract foreign direct investment, improve taxation collection and build trust with citizens. The EITI has been used in many ways, depending on the specific circumstances of the countries and their level of commitment to reform. In Nigeria for example, the EITI has been used to identify and recover missing payments worth US$ 4 billion owed to the government. As highlighted above, in a number of countries where the EBRD operates, the EITI has contributed to reforms in the extractive sector and making a traditionally opaque sector open and more accountable.

Extractive companies, of which 90 of the largest oil, gas and mining companies support the EITI, also do so for a variety of reasons. As long-term investors, they are interested in contributing towards an enabling investment climate, characterised by openness. Transparency reduces business risks. Companies have also found that EITI implementation contributes towards building trust with citizens. Banks and institutional investors support the EITI as it helps to promote open markets and economic development. EITI implementation can help uncover financial irregularities and inefficiencies, strengthen public financial management, and promote wider institutional reforms.

Civil society organisations, often brought together by the umbrella organisation Publish What You Pay, demand transparency as a means to hold governments to account. Transparency and participation in the EITI becomes a means to the ultimate goal of ensuring greater societal benefits from natural resources.

Each constituency sits on the EITI board and supports the strategic development and growth of the organisation. The EITI is also supported by major international financial institutions which are key suppliers of technical and financial support in many implementing countries. The EBRD, for example, has for several years provided political, financial and technical support to the EITI. The EBRD has assisted a number of countries with EITI implementation. For example, in Mongolia, the EBRD’s technical and financial support helped strengthen EITI Mongolia by incorporating the EITI into national legislation. The EBRD also supported the development of online reporting, enabling better public access to data and embedding a transparency mechanism in government systems. More broadly, the EBRD has supported Mongolia’s extractive industry through direct investments and loans. This is especially significant given the downturn in commodity prices. Mongolia’s commitment to the EITI and transparency has helped to attract investment from extractive companies.

Conclusion: EITI necessary but not sufficient

The EITI has come a long way in just over a decade and governance of the sector has improved. Bringing the diverse stakeholders together around the table was an accomplishment; producing the EITI Standard now implemented by 49 countries is an achievement. Transparency in the sector is increasingly a reality. All stakeholders must now work together to ensure that access to information is put to use, that transparency really leads to accountability. Information about laws, contracts and tax and royalty payments must form the basis for discussions about further reforms and improvements. The EITI must move from reports to results. Embedding the EITI into government legislation and systems is another challenge.

In recent years, within the EITI and elsewhere, there has been growing interest in the actual owners of operating companies. In too many countries this information is not available. A number of EITI-implementing countries, including Ukraine, have piloted ownership reporting. In a landmark decision in 2015, the EITI Board decided that disclosing the beneficial owners of companies would be mandatory. However, requiring the timely disclosure of beneficial ownership information also brings challenges. In many countries this will require legislative changes and cooperation between multiple government agencies. Some countries are focusing their efforts on the extractive industries, whereas others are considering broader changes to corporation law covering all industries.

With the recent fluctuations in commodity prices, and the uncertain outlook for investment, employment and government revenues, transparency in the extractive industries is more important than ever, so that governments and citizens can make informed choices about the development of these industries.

Technological and geographical factors

While economic considerations are typically the primary factor for a commercially driven oil producer to decide whether to flare APG or put it to commercial utilisation, a large part of the economic factors appears to derive from the technological specifics of APG production.

Despite their natural co-existence, crude oil and natural gas require separate technologies and equipment for production and processing, as well as connection to separate transmission and distribution networks. In addition, APG needs specialised processing into natural gas before it can be transmitted and distributed through gas networks. In fact, each type of APG utilisation calls for a separate type of technology or equipment, be it processing for sale along with “regular” natural gas, reinjection into oil fields to increase the oil production rate, or use as fuel on the production site. Associated costs – purchase, installation and maintenance of equipment, hiring or training staff, not to mention investigation of which method of APG utilisation is most appropriate – are often substantively disproportionate to the annual recovery rates for APG. This is becoming an increasingly acute problem for smaller and medium production sites. The latter, in fact, are becoming more and more popular.28 Obviously, employing two or more types of APG utilisation simultaneously increases costs accordingly. These factors can turn a potential investment in APG flaring reduction into a costly and low-return undertaking, which would rarely be attractive, particularly compared with the higher rates of return on crude oil production.

One recent initiative to counter what is seen as excessive cost in commercialising APG has been to cluster medium and smaller sites, using economies of scale to justify investment in expensive technology and build up network connections. Here geographical considerations, relevant to APG reduction mechanisms in general, have a significant impact, as the remoteness of APG processing sites from each other and from gas infrastructure reduces the attractiveness of the clustering mechanisms. Partnering investors specialising in APG investments could build synergies regarding selection of the right investment model and often the equipment issues, as well as help overcome competition of business streams.29 Related to this, location-wise landscape characteristics are particularly relevant – a flat terrain can be expected to make it easier to build the connections.

Structural and market factors

Gas market structure (for example, the degree of liberalisation) has a direct impact on APG flaring in that it determines the commercial viability of the end-product aimed for sale on the gas markets. Existence of a natural monopoly in the gas market, for instance, can hinder the marketability of the gas produced as a result of APG processing. Inefficient regulation of gas prices, for example, setting them below market values, makes selling gas less commercially attractive despite an increase in gas prices world-wide.

Furthermore, different owners of oil production sites, operation of networks, processing facilities and transportation infrastructure will create varying incentives for all the participants regarding employment of efficient technologies for APG reduction, which might hinder bringing APG to market. Lack of gas transmission and distribution networks across the country, or as the case may be, export routes, can also serve to disincentivise effective reduction in APG flaring. Moreover, the strategic role of the extractive industries for the economies of many countries often results in the main oil site operators being at least partially state-owned or operating with a state partner. This creates a duality of state interests as a partner in production, on the one hand, and the regulator, on the other. This duality is enhanced if the network operator also has state participation. The methods used to address these issues will differ from country to country, depending on the sector, market and regulatory structure.

Another ownership issue, related to legal and regulatory factors, deals with the ownership rights to APG. It is usually important that the oil site operator has full and unencumbered ownership rights to APG, thus allowing its commercial value to be passed on to the market. A review of the legal and regulatory regime and licensing and contractual arrangements will be useful in identifying and highlighting particular factors at work in a given country in this respect.

Economic factors

As indicated above, economic considerations are the main determinant for the oil producer in their decision to flare APG or find a way to use it. The fact that a large portion of APG is now being flared30 indicates that the current environment is not providing enough economic incentives for the operators to invest in APG reduction. Technological, geographical and structural factors identified above all translate into high costs for such investments.

Apart from these considerations, the lack of proper incentives and the absence of appropriate investment mechanisms requires parties to spend even more time and resources on navigating significant barriers before finding a viable investment opportunity. Accordingly, making information on successfully employed investment models more readily available to a wide circle of potential investors is one area that could help to enhance the sector’s investment potential. That said, interest in promoting investments and disseminating information must be balanced against the protection of the current investment, including by giving due consideration to confidentiality provisions of investment models and data. Disseminating best practices and lessons learned is a further step in this respect, and substantive work is already being undertaken in this respect by international initiatives such as GGFR,31 discussed below.

Legal and regulatory environment

One could argue that making APG exploitation commercially attractive should create the necessary incentives and resolve the issue of APG flaring reduction. However, investment opportunities do not turn into actual investments automatically – many hurdles and externalities occur on the way. This underscores the role of additional – such as legal and regulatory – incentives in creating an enabling environment for investment in APG flaring.32 A legal and regulatory framework plays an overarching supporting role to all other incentives in that in order for mechanisms to be transparent, effective and fully enforceable, they need to be endorsed in a legal or regulatory act.

An overview of international experience in the regulation of APG flaring recently published under the auspices of GGFR and based on the analysis of regulation in 44 oil-producing jurisdictions in both developed and developing countries distinguishes between policies, on the one hand, and legal and regulatory measures, on the other, among commonly used types of instruments aimed at reducing APG flaring.33 The report further separates between generic policies aimed at a more efficient use of resources and specific policies aimed at reducing APG flaring. Of policy measures, targets, such as those for reduction in APG flaring, are most common. It is acknowledged that while setting a target helps visualise the long-term goal, in order to be effective, any target needs to be supported by legal and regulatory measures identifying mechanisms, responsible parties and enforcement arrangements that will translate targets into measurable results.

Among legal and regulatory instruments, levels or caps on APG flaring are the most commonly used instruments.34 The GGFR’s overview of regulatory practices in APG flaring reduction separates technical regulation of the oil industry from economic regulation of network industries. While technical regulation is concerned with setting standards for performance of the industry in order to achieve relevant – environmental, health and safety – objectives, economic regulation of network industries is primarily conducted through setting tariffs for natural monopolies and requires an independent regulator (economic regulation of upstream oil production is not required due to substantive competition in the market).35 Both streams have an impact on the regulation of APG flaring. Being part of upstream oil production, APG flaring is often subjected to the same technical regulation as the oil industry. However, when it comes to giving companies incentives to reduce gas-flaring, then economic incentives might need to come into play.

There is no clear evidence of whether primary or secondary regulation is more appropriate for APG regulation. According to the GGFR’s overview, the majority of the few countries that have regulation prefer to have generic laws, mainly identifying which institutional capacity is to deal with APG flaring, and then some detailed gas flaring regulation in secondary legislation, and sometimes, also soft legislation in the form of guidance or recommendations.36

In terms of regulatory method, two types of regulation in the APG industry are common: prescriptive and performance-based. The prescriptive approach involves detailed and specific rules set by the regulator for the operators, both in terms of what is required and how it is to be achieved. While having the benefit of clarity and relative ease of tracking the performance, this approach requires a lot of upfront work without certainty as to the results, lacks flexibility in adjusting to any unforeseen challenges and requires strong enforcement capacity. With a performance-based approach, targets are developed in cooperation between the industry and the operator, with the industry then defining methods for achieving the targets while still having to submit a proof that its members comply with the agreed arrangements. Enforcement capacity is still needed, although it might be not as resourceful as in the prescriptive approach.

The available studies of the regulatory frameworks of APG flaring, including the GGFR Regulatory Overview and the Four Countries Study, reveal that a blueprint for an efficient legal and regulatory framework governing APG flaring reduction37 remains elusive. There are no internationally accepted standards and, given the relative youth of the sector, it may be too early to talk about established, best standards. However, an overview of the practices in various jurisdictions could be viewed as revealing an emerging set of best practices. Recommendations identified by the GGFR include, among others: (i) development of a policy framework identifying the role that APG flaring reductions should play to achieve a country’s environmental objectives; (ii) establishment of relevant primary and secondary legislation empowering regulators to deal effectively with APG flaring; (iii) independence, specialised mandate and proper staffing of regulators; (iv) the need for clear and efficient operational processes concerning APG flaring; (v) the need for clearly defined circumstances when operators can flare APG without prior regulatory approval, along with transparent application and approval procedures; and (vi) effective measurement and reporting procedures along with proper enforcement powers.38

As discussed above, having proper ownership rights to APG is crucial to the commercial viability of such APG. While APG flaring is commonly done under the agreements governing crude oil production – most often concession contracts and production-sharing agreements (PSAs) – ownership rights to APG in such contracts are not always clear, which creates issues for the title down the transmission chain. Without the proper rights to own and dispose of the APG the producer lacks an opportunity to pass on the title.

Recent initiatives to reduce APG flaring

While petroleum exploration dates back centuries, the reduction of APG flaring has been attracting the attention of governments and other stakeholders only relatively recently. The most prominent of the international initiatives is the GGFR, a public-private partnership platform combining the efforts of the governments of oil-producing countries, state-owned companies, major international oil producers, international organisations and donor countries to facilitate the overcoming of barriers to reduce APG flaring through exchanging practices and promoting better standards. The GGFR was launched in 2002 and, led by the World Bank, is now endorsed by 18 countries (including major oil producers of the EBRD countries of operations – Azerbaijan, Kazakhstan, Russia39 and Uzbekistan, as well as the world’s other major oil producers such as Iraq, Kuwait and Qatar); 13 major oil producers (for example: BP, Chevron, ExxonMobil, Kuwait Oil Company and Total); as well as three international organisations helping to steer efforts – the EBRD, the European Union and the World Bank.

One of the first initiatives in sharing experiences and shaping better standards is the Voluntary Standard for Global Gas Flaring and Venting Reduction prepared by the GGFR in 2004. This standard provides guidance on reduction of APG flaring and steps towards implementation, including preparation by operators of Associate Gas Recovery Plans and development by the relevant government of Country Implementation Plans, with the subsequent monitoring and reporting on progress.40

International efforts in reduction of APG flaring have been stepped up since 2005, with the launch, under the auspices of GGFR and championed by the World Bank, of the “Zero Routine Flaring by 2030” initiative. Supported by an even-greater number of governments, oil companies and development organisations than GGFR partners, the initiative presents to the oil-producing countries an ambitious goal of eliminating routine APG flaring by 2030.41 Importantly, the Organization of the Petroleum Exporting Countries (OPEC), bringing together major oil-producing countries, is an active supporter of the gas-flaring reduction initiatives.42

A number of individual countries have been trying to reduce APG flaring, including through reform of their legal and regulatory frameworks; however, the effectiveness of their efforts varies. Only very few countries have managed to achieve significant reductions, as a result of their own initiative, with Canadian province Alberta, the United Kingdom and Norway being top performers.43

Relevance of APG flaring reduction and EBRD countries of operations

Of the world’s top 20 countries with the largest volumes of APG flaring, three (Russia, Kazakhstan and Egypt) are EBRD countries of operations (see Chart 8). Thus, supporting the reduction of APG flaring is one of the priorities for the EBRD’s investment operations in the energy sector as well as a priority acknowledged under strategic policy documents such as the EBRD’s Energy Strategy.44 The EBRD is a key partner with GGFR and promotes APG flaring reduction both under the auspices of GGFR and as part of its independent activities. In 2012, the EBRD hosted the GGFR Forum, which reflected on the progress made in the GGFR’s efforts over the previous decade, since its establishment in 2002. The forum also emphasised the need for a coordinated approach among governments, the private sector and the international community for a substantive impact in reducing APG flaring, particularly in light of the global climate change agenda. As noted earlier, together with the GGFR, the EBRD commissioned a review of investment barriers in four of its countries of operations – Azerbaijan, Kazakhstan, Russia and Turkmenistan (the Four Countries Study). The latter provided an overview of the APG flaring situation as well as policy and regulatory frameworks in the four countries and identified areas where gas-flaring reduction efforts are needed, both through policy dialogue with the authorities as well as through investment opportunities. In particular, it was acknowledged that while many flare reduction projects are economic, due to competition in resources with the main business of oil production, they do not translate into actual investments. Partnering with specialised external parties to properly align the incentives with resources is a solution to be explored. Another key outcome of the Four Countries Study is that economies of scale is the key driver for investments in the covered countries, reflecting the global trend. Meanwhile small and medium sites cannot offer sustainable gas production streams, the clustering of such sites provides for viable APG recovery solutions.

Most recently, the EBRD has begun working to identify the scale of APG flaring and commercial opportunities to use APG in Egypt and intends to undertake a review of regulatory barriers to APG flaring in that country.45 The EBRD’s preliminary work has indicated that regulatory barriers to be explored include the structure of production-sharing agreements (PSAs) which preclude operators from having full ownership over APG produced and otherwise provide poor incentives to companies to reduce APG. Regulated gas prices are another issue – below-market gas prices are not incentivising the companies to invest in APG recovery. A review of barriers to APG investment is being undertaken in parallel with investment operations to stimulate the market and provide incentives for the oil operators to examine the reduction of APG flaring – as a recent example, in November 2015, the EBRD provided a US$ 40 million loan to Merlon Petroleum El Fayum, an independent oil and gas producer operating in Egypt, to support the development of the company’s oil and gas concession in the El Fayum area. In addition to a contribution to Merlon’s capital investment programme to develop producing fields, increase reserves and upgrade existing facilities, the proceeds of the loan will also be used to invest in the commercial recovery of APG.46

Conclusion

While gas flaring remains an issue on the global resources and climate change agenda, recent experience shows some progress in the reduction of APG flaring. Efforts need to be stepped up, however, to overcome barriers which include: high costs of investment in technology solutions, lack of developed infrastructure, regulated gas prices, as well as weak legal and regulatory frameworks and insufficient monitoring and enforcement mechanisms. Continuous support for efforts to reduce APG flaring on both policy, including economic and legal/regulatory, and operational levels by all the relevant participants –governments, oil producers and international partners, is key to a sustainable improvement in APG flaring. Information sharing and dissemination of best practices from both reform efforts as well as investment operations will be instrumental in achieving visible results.