Papua New Guinea - Petroleum Exploration and Development Technical Assistance Project

Document of The World Bank FOR OFCIAL USE ONLY Report No. P-5730-PNG MMORANDUM AND REONMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN THE AMOUNT EQUIVALENT TO US$11.0 MILLION TO THE INDEPENDENT STATE OF PAPUA NEW GUINEA FOR A PETROLEUM EXPLORATION AND DEVELOPMENT TECHNICAL ASSISTANCE PROJECT OCTOBER 27, 1993 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (as of July 1993) Currency Unit - Kina 1 Kina US$1.026 US$1.00 Kina 0.97 WEIGHTS AND MEASURES 1 barrel - 0.159 cubic meters 1 kilometer (km) - 0.621 miles (mi) 1 kilowatt (kw) - 1,000 watts (v) 1 megawatt (MW) 1,000 kilowatt (kw) 1 cubic foot (CF) = 0.0283 cubic meter (cu m) ABBREVIATIONS AND ACRONYMS BCF - billion cubic feet DMP - Department of Mining and Petroleum GOPNG - Government of Papua New Guinea MHBBL - million barrels MCP - 1000 cubic feet PAB - Petroleum Advisory Board PDL - Petroleum Development License PPL - Petroleum Prospecting License TCF - trillion cubic feet BBLPD - barrels per day FISCAL YEAR January 1 - December 31 FOR OFFICIAL USE ONLY PAPUA NEW GUINEA PETROLEUM EXPLORATION AND DEVELOPMENT TECHNICAL ASSISTANCE PROJECT Loan and Proect Summary Borrower: Independent State of Papua New Guinea Amount: US$11.00 million equivalent Termst 20 years, including 5 years of grace, at the Bank's standard variable interest rate Financing Plan: Local Foreign Total ------- US$ million ------ Government 1.15 - 1.15 IBRD - 11.00 11.00 TOTAL 1.15 11.00 12.15 Economic Rate of Return N.A. Staff Appraisal Report: N.A. Poverty Category: N.A. Nalp: IBRD No. 23508 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE INDEPENDENT STATE OF PAPUA NEW GUINEA FOR THE PETROLEUM EXPLORATION AND DEVELOPMENT TECHNICAL ASSISTANCE PROJECT 1. The following report and recommendation on a proposed loan to the Independent State of Papua New Guinea for US$11 million equivalent is submitted for anproval. The loan would have a term of 20 years including five years grace, at the Bank's standard variable interest rate, and would assist in financing the Petroleum Exploration and Development Technical Assistance Project. Part I: Country Policies and Bank Group's Assistance A. Introduction 2. PNG faces a unique and very difficult set of development challenges.l/ A numerically small modern sector has emerged since the country became independent in 1975. It is based on natural resource extraction (minerals, oil, timber, plantation agriculture) which is financed by foreign investment, on ancillary domestic private activities, and on a public service supported by substantial aid flows. This modern sector is built around several small urban centers and extraction enclaves where it coexists with a traditional rural sector. The modern and traditional sectors intermingle and people move between them, but the cultural and socio-economic distance remains vast between various tribes and clans and Western oriented elites. Despite an average 3.8 percent per annum GDP growth during the past decade, development patterns have been unbalanced between these two sectors and among regions, creating unmet expectations, and increasing social stress and lawlessness. High costs and low productivity make PNG uncompetitive in many export markets except for extractive activities. Only about one fifth of the labor force is engaged in the formal wage earning economy. The remainder is engaged in subsistence agriculture or is unemployed. Successive governments have been able to maintain macro economic stability, but have not been able to accelerate employment and growth in the non-mining sector. In the formulation and execution of a development strategy for PNG, it is essential to acknowledge the country's unique cultural and political dynamics, geographic challenges, and the dependence on natural resource exploitation. j/ Analyses of PNG's development challenges, current economic status and prospects, public sector management, and governance issues are provided in the latest economic report, Papua New Guinea: Jobs, Economic Growth and International Competitivenessa Report No. 11653-PNG of May 3, 1993 and Papua New Guinea: Competitiveness. Growth and Structural Adjustment, Report No. 10319-PNG of March 31, 1992. The report of the most recent Consultative Group meeting, Chairman's Report of Proceedings, adds further information on a number of issues, particularly implementation. - 2 - B. Historical Perspective and Recent Economic Performance (a) Historical, Cultural, and Political Perspectives 3. Until the latter part of the nineteenth century, PNG had very limited commercial or cultural ties internally and virtually none externally, except for some coastal and island areas. The country was nearly impenetrable, and most of the population lived in isolated tribes. The existence of over 700 distinct languages indicates the extent of fragmentation of the population. Tribal warfare was (and to an extent still is) common. When the country became independent 19 years ago, the tasks of nation-building and putting the economy on a viable, self-reliant, and sustainable footing had to begin from a frail base in terms of human resources development, administrative capacities, and socio-political structures. In addition to the central government, provincial parliamentary governments were established and given responsibility for a number of public services, including education, health, and local infrastructure. These governments are supported by financial and staff resources from the center, but many have not functioned well, and some are currently suspended. 4. PNG has maintained a well functioning Westminster style parliamen- tary system at both national and provincial levels. Elections are well run and administrations change peacefully, but perhaps too frequently. Each national government has been a coalition in need of maintaining careful balance among factional interests and the personal ambitions of major players. PNG cabinets have been under persistent threat of being voted out of office, resulting in a short time perspective in which to see their initiatives effected, a very political focus in decision making, and a high degree of discontinuity in development strategies.Z/ Nonetheless, thanks to a small cadre of well qualified public servants assisted by expatriate advisors, basic government functions have been maintained. However, the public service itself faces problems: remuneration is high by international normsI policy and program implementation structures are extremely challenging; and coordination among departments and agencies, at the central, provincial, and local levels are difficult from a logistic and institutional point of view. 5. The country has rich but difficult to access reserves of gold, copper, oil and gas, as well as large forest and fishery resources. It has also been the recipient of large amounts of concessional aid. Over 20 percent of government revenues is from grants, mainly budget support from Australia. The large endowment of depleting resources and budget support have been both a boon and a bane. Reliance on aid flows and mining revenues (averaging 8 percent of government revenues) has enabled successive governments to maintain financial stability and high levels of consumption. The associated foreign exchange availability, including some borrowing, assured external balance. But these factors have also supported a high wage modern sector and a set of relative prices that make most other activities uncompetitive. At the time of independence, urban minimum wages were statutorily doubled, contributing to the high cost of labor. Although the country's per capita 2/ Under a new rule, and any newly elected government has a grace period of eighteen (18) months before a vote of no confidence is allowed and then six (6) before a subsequent one. - 3 - income is now estimated at US$950, incomes outside the modern sector probably average about US$300 per capita. 6. A factor in PNG's stability has been the resilience of its subsistence sector and the mutual support within clans. These provide for basic needs and food security for the bulk of the population. Despite high population growth (2.3 percent per annum), virtually all villages have access to land for growing a range of subsistence and some cash crops. Customary land holding practices, however, introduce great inflexibility in land use. Internal rural migration is limited, resulting in severe land pressures in some areas, local deforestation, and impediments to land use for development. For most, producing a subsistence living does not require full time effort. This has resulted in a high "reservation wage", another factor in the high cost of labor. However, the traditional socio-economic patterns have increasingly come under stress, and the ensuing pressures are evidenced by urban migration, unemployed youth, rising crime, and some incidence of tribal warfare. 7. Poverty. Available information does not indicate the oxistence of absolute poverty. Food and shelter needs are largely met because of the dominance of subsistence farming and the support provided by traditional clan and social structures. Living standards, however, for the vast majority of people are akin to those in low income developing countries. 8. Impressive improvements have been made since independence, in reducing infant mortality and improving literacy rates. Secondary school enrollment, however, stagnated and population growth continues at 2.3 percent per annum. The Government has recently put in place major new programs to deal with population growth and education which are supported by World Bank Loans (Lu. 3537-PNG Education Development and Ln. 3591-PNG Population). These programs are closely coordinated with several donors and rely increasingly on Women's Groups, NGO's, and the Churches in addition to government delivery systems. Women face particular difficulties in this traditional male dominated society: their subsistence labor burdens are greater, access to education and health services more limited, and opportunities in the modern sector narrow. 9. While considerable progress has been achieved since independence, PNG's social indicators lag far behind those of other East Asian or Middle Income Countries. Table 1: SOCIAL INDICATORS Lover Middle ---PNG ------------ Eas Income 1975 1980 1985 1990 Asia Countries Population Growth 2.4 -- -- 2.3 1.5 1.7 Infant Mortality Rate 93.0 78.4 68.0 57.5 33.6 49.5 Life Expectancy at Birth 49.2 51.3 52.4 54.7 68.6 65.3 Primary School Enrollment Ratio 56.0 62.0 64.4 73.0 130.4 100.5 Secondary School Enrollment Ratio 12.0 11.0 14.5 13.0 46.9 58.3 Literacy Rate 32.1 -- -- 48.0 75.9 77.1 Source: World Bank, Social Indicators of Development, 1991-92; World Bank, World Tables, 1989; and World Bank, World Development Report, 1987. 10. Environment. Due to extremely rugged terrain, PNG still possess large tracts of unexplored and unexploited lund. Its primary tropical forests are second only to Indonesia in the region. Its biodiversity is rich and not fully charted. There are many endemic species of flora and fauna, including many unique species of orchids and butterflies, and of course birds of paradise, the national symbol. Efforts to map and catalogue species have started. In Forestry, the rate of logging has increased sharply in recent years due to restrictions on exports of logs from nearby countries. Current cutting rates are above sustainable levels, and there are strong pressures on Government from logging interests and customary landowners to continue. The Government, with support from many donors and a Bank executed technical assistance program, is moving to rationalize and reduce the rate of cutting through the National Forest Authority. Mining activity has created localized environmental problems. Environmental legislation in this area is considered adequate, and the mining companies have made extensive efforts to comply. Nevertheless, the Government needs to increase its capacity in environmental monitoring and to depend lose on experts from the mining or logging interests. The Government is aware of the importance of environmental factors and has adopted its environmental program to the Earth Summit at Rio de Janeiro in 1992 as Action Plan. The Government has also begun working actively with NGO's in this area. (b) Economic Performance 11. Recent economic performance reflects first and foremost investments, price, and output fluctuations in the oil and mining sector. With considerable variation, growth has averaged about 4.8 percent per annum over the past five years, well above the 2.3 percent per annum population growth, and average 10 percent per annum during 1991-93. Non-mineral sector growth, however, has been only 2.2 percent over the past five years. It reached 3.6 percent per annum during 1991-93, primarily due to tree crop production stimulated by price support, timber extraction, as well as construction and transport activities in support of the mining and oil investments. Table 2: ECONOMIC TRENDS 1983-87 1988 1989 1990 1991 1992 1993 1988-93 Est. (ave) Nominal GDP (K million) 2,457 3,170 3,046 3,076 3,606 4,080 4,574 3,592 CDP Growth (2) 2.9 2.9 -1.4 -3.0 9.5 9.0 12.1 4.8 Mining 12.1 2.6 -37.9 22.8 41.9 42.0 45.0 19.4 Non-mining 1.2 3.0 4.9 -5.6 5.2 3.0 2.7 2.2 Import Growth (Z) -1.0 15.3 -5.1 -25.8 30.3 4.8 -6.5 2.2 Exort Growth (t) 8.9 -2.8 4.5 -3.4 26.4 37.9 18.2 13.5 Tema of Trade (1992 - 100) ** 140.3 116.2 100.8 103.9 100.0 98.0 -- Fixed Investment (% of GDP) 22.5 23.3 26.0 25.1 28.0 21.4 15.6 23.2 Public 6.1 5.0 4.7 5.1 4.7 4.0 3.7 4.6 Private Mining 7.3 8.8 11.6 11.4 15.9 10.9 5.8 10.7 Private Non-mining 9.1 9.4 9.6 8.6 7.4 6.5 6.0 7.9 Government Revenues (K million) 742 905 1,014 989 1,123 1,119 1,311 1,077 Ut Which: Urants 209 190 190 222 312 196 198 218 2 of revenues 28.6 21.0 18.7 22.5 27.7 17.6 15.1 20.4 Of Which: Mining Revenues /a 38 92 120 6 13 83 321 106 % of revenues 5.0 10.1 11.8 0.6 1.2 7.4 24.5 9.3 Government Expenditure (K million) 793 935 1,049 1,089 1,188 1,357 1,560 1,196 Suelue () or yeficit -) (K million) -51 -30 -35 -100 -65 -238 .249 -120 4 VDr -2.1 -1.0 -1.2 -3.3 -1.8 -5.8 -5.4 -3.1 /a Excludes import duties. - 5 - 12. Private fixed investment in the non-mining sector as percentage of GDP declined since 1990 to 6 percent of GDP in 1992 and public fixed investment fell to 4 percent of GDP, an extremely low level considering the important development needs of PNG for human resources and infrastructure. This level of non-mining investment reflects difficulties in project implementation; scarcity of viable opportunities due to lack of physical and administrative infrastructure and law and order problems; and competitiveness constraints imposed by high wage levels, low labor productivity, and an exchange rate level maintained by mineral/oil exports. 13. Performance on Structural Reforms and Recent Economic Developments. The economy faced a severe crisis in 1989-1990, precipitated by the closure of the Bougainville copper mine. At the same time, PNG faced sharp declines in export crop prices and lose of agricultural production on Bougainville island. These events caused shortfalls in export and fiscal revenues of 30 and 17 percent respectively. The fiscal deficit more than doubled te 3.3 percent of GDP. With support from the Bank, the Fund, and other donors, a stabilization and structural adjustment program was implemented. The main elements of the program were: (a) reduction in domestic demand to achieve fiscal stability, with the primary objective of reducing public consumption expenditures while protecting essential social services and priority investments; (b) structural reforms in public resource management and the regime for private investment; and (c) improving competitiveness of the non- mineral economy to promote private investment and economic diversification. In pursuance of these objectives, the Government introduced spending cuts amounting to 2.5 percent of GDP in 1990 as well as new revenue measures to yield the equivalent of 1 percent of GDP. Monetary policy was kept tight, and public wage constraint was exercised. Moreover, the Government devalued the Kina by 10 percent in 1990. As a result of these measures, PNG successfully reduced the budget deficit to 1.8 percent of GDP in 1991, curtailed inflation, and maintained external stability. GDP, however, fell 3 percent in 1990. 14. In the area of private sector development, macro measures to improve competitiveness (e.g., wage restraint, exchange rate policy, and trade policy reform) were supplemented with sector specific measures, including the establishment of the Investment Promotion Authority and the initiation of a privatization program. Measures were also introduced to broaden the tax base, reorient indirect taxation towards consumption, rationalize the import and tariff regimes, and prepare for a phased removal of quantitative import restrictions. With respect to public resource management, the Government initiated a civil service reform program, including staff retrenchment to reduce administrative costs and to improve the efficiency of public administration. While a major retrenchment was carried out, it was partly offset by expanded expenditures on security forces. The objectives of increased competitiveness and efficiency have as yet not been attained. Expenditure reduction efforts have turned out to be often at the expense of public investments and the maintenance and operation of existing assets, rather than through reduced current expenditures. 15. Growth resumed when the Porgers gold mine and, after mid 1992, the Kutubu oil field entered production and has averaged 10 percent per annum during the 1991-93 period. Government revenue from oil now exceeds mining income by a factor of 3-4 and will soon be equal to grants as a major source of supplemental revenue to the Government. Oil exports have pushed the trade account into surplus, in 1992, although the current account remains in - 6 - deficit. Inflation has been stabilized at around 4-5 percent. Recent substantial increases (64 percent) in log exports have also contributed positively to Government revenues and GDP growth. 16 With elections in 1992, the Government was not able to continue expenditure constraints, leading to a reopening of the budget deficit to 5.8 percent of GDP. After a hiatus due to the elections, the pace of reform measures picked up again. The new Government designed its own stimulus program, which included substantial measures to deregulate wages, liberalize the foreign exchange regime, expand subsidies to tree crops, reduce income taxes, reduce or eliminate school fees, restructure provincial governments, and develop a village services program to address rural development priorities more systematically. The wage reform was particularly important since it will help undo the high wage rate structure adopted at independence. New employees are being hired at the new, lower wage rate, which will help lower real wages over time. Success of che critical wage reform will depend on the ability of the Government to restrain wages in the public sector. 17. Civil service reform resumed, and in December 1992, a special task force was established by the cabinet to review the public service to rationalize the structure and procedures, inter alia, through redefinition of departmental functions and elimination of duplication of responsibilities. A new authority was established to accelerate privatization. To foster improved interdepartmental coordination and better cohesion in cabinet decisions, the new Government revived the National Planning Committee at ministerial level and established the Policy Coordination and Monitoring Committee (PCHC) comprised of departmental secretaries. 18. The Government's expansionary fiscal stance - essentially using rising oil revenues to boost economic activities through tax cuts and subsidies to tree crop growers has been initially successful as output of cocoa, coffee, copra an palm oil rose by 10 to 13 percent, starting 1992. However, the tree crop subsidies have turned out to be more costly than envisaged due to the strong supply response. There have been expenditure overruns elsewhere, particularly concerning law and order activities and operations related to Bougainville. Moreover, there have been some further revenue shortfalls from the mining companies. Also the tax cuts threaten to erode the tax base after the reforms of the stabilization program. The Government reconfirmed its commitment to exercise expenditure control, but the 1993 fiscal deficit is now expected to be well beyond the planned 3.4 percent of GDP. 19. Economic Prospects. PNG recovered from the shocks of 1989-90 through a combination of policy action to stabilize the economy by reducing the financial deficit and the rate of inflation and of sharply increased resource flows from mining, oil, and logs. The policy agenda for the future relates to implementing policies and projects, generating sustainable supply response in non-resource based sectors, establishing realistic relative prices, and increasing international competitiveness. Further, macro economic stability will have to be monitored carefully. 20. Current base case projections assume that the prudent policy stance of the recent past will continue. This would include reducing the fiscal deficit to about 3 percent of GDP, continued wage restraint, reduction in the tree crop subsidies, and sound management of oil mineral receipts and natural - 7 - resources. If this degree of reform can be achieved, somewhat better growth rates than the past decade could be realized. Real growth in labor absorbing (non-mining) sectors would be fairly strong in the short run, peaking at 6.8 percent per atnum in 1994, before stabilizing at about 2.2 percent per annum after the middle of the decade, versus less than 2 percent in the eighties. This projection assumes that mineral and oil development will level off in 1996, based on conservative projections of output. Additional mineral --primarily oil or gas--exploitations would increase the overall GDP growth rate, and provide additional resources to expand basic services. Nevertheless, the projected growth will fall short of the rate required to create enough jobs to absorb the large number of new entrants in the labor market. C. External Economic Environment 21. As a primary product exporter, PNG is vulnerable to shocks emanating from world commodity prices. The markets for each of its major exports groups (tree crops, timber, minerals, and oil) pose different risks to the Government. PNG is also still highly dependent on concessional aid for budget support. 22. Tree crops account for about 10 percent of PNG's total export. In 1989, PNG experienced a 17 percent drop in the country's merchandise terms of trade on account of the decline in tree crop commodity prices, which remain depressed. Stabilization arrangements exist for each of the major tree crops. However, the persistent decline in world prices without a shift downward in the reference price Las exhausted reserves and STABEX financing is phasing out. At current prices and exchange rates, the tree crops sector is not viable, and the Government price support may well reach $100 million in 1993. Timber exports have been booming, reaching export values at par with tree crop exports. The present rate of extraction is not sustainable from an environmental viewpoint. PNG has made good progress in implementing Forest Guidelines to reduce the rate of logging and introduce more sustainable practices. Reduced revenues will be offset by capturing a larger portion of the rent through increased taxes. 23. Minerals. Gold is PNG's major mineral export accounting for one third of total export earnings at present. The mines, in addition, re;.esent sources of local wealth, and friction with local landowners has been common, which has had repercussions on investors' confidence. During the past year, relations with foreign mining interests have been strained as a result of the Government's actions to acquire a higher equity stake in the Porgera gold mine. Although the issue was settled by mutual agreement, the value of PNG mining stocks fell drastically and may influence investors' perceptions of PNG's investment climate. The rate of new exploration in both mining and oil is declining, in part also due to the opening of attractive opportunities elsewhere. 24. Oil. With the start of oil production in 1992, the diversity of exports improved. Revenues from oil will account for 13 percent of total Government revenues in 1993, and one third of export earnings. There is considerable uncertainty concerning the magnitude and duration of PNG's oil reserves. There are indications however that new oil discoveries are likely - 8 - and sufficiently large to maintain currept production levels beyond 1996, when production from present reserves is projected to decline. 25. To illustrate PNG's vulnerability, . 10 percent decline in oil prices would result each in a nearly 3 percent decline in Government revenues in the near term, and a 4 percent drop in export earnings. A sustained drop of 10 percent in all commodity prices in 1996, when all mineral and oil projects under implementation are expected to be on stream, would result in a reduction in export earnings equivalent to 4 percent of GDP. The prices of both tree crop and mineral/oil exports are highly variable in the short-term and are estimated to have only modestly positive trends in the longer run. 26. The external debt is about equally divided between public and private debt. Most of the private debt is related to mineral development and repaid out of mineral earnings. Since 1987, the Government has reduced its level of borrowing and debt outstanding from private sources, increasing its reliance on concessionary financing. In 1992 public debt service was estimated at 12.4 percent of exports of goods and services, versus 18 percent in 1988. The debt service to export ratio, including the private, mineral related debt, currently is 23.5 percent. The current level of debt and expected borrowing from traditional sources do not pose a risk. The rapid expansion of oil revenues presents opportunities to borrow against future revenues from commercial sources. Should the Government embark on a continued borrowing program from commercial sources, the risk of overborrowing could become important and upset macro economic stability. D. PNG's Development Obiectives and Stratea" 27. The present Government came to power in %id 1992 on a platform of restoring growth and accelerating socio-economic development. It has articulated the following objectives and strategies, as central to its approach: Effective management of the economy throuth agaressive but responsible macro economic policies which are designed to restoring medium term fiscal balance, further opening the economy to competition, and providing wage, taxation, monetary and foreign exchange policies that are competitive by regional standards. Development of a vibrant private sector at all levels, through continuation of trade liberalization/investment reforms, and reduction of corporate taxes and taxes on inputs. The PNG Holding Corporation has been created to accelerate the implementation of the government's privatization policy. Improved delivery of rural services and increased opportunities for rural production. The Village Services Program and increased investments in Infrastructure, Health, Education and Extension Services are designed to implement these objectives. In addition, introduction of "guarantee" prices for treecrop production for the coming five years are intended to stimulate rural income and employment. -9- Employment creation in the formal and informal private sectors; important changes in the vage fixing system -- strongly supported by the new government -- with one single minimum wage for urban and rural employees and deregulation for all labor classification will provide a basis for more competitive wage setting. These measures are planned to be supported by more investments in skills developmentleducation and improved provision of public service. Streamlining of Public administration to become more responsive to the nation's objectives and priorities. This includes: (i) restructuring of Provincial Government to reduce fiscal outlay and ensure better service delivery and response to local demand; and (ii) improvement in Public Investment management to increase drawdown of concessionary financing. The Government's approach is a positive response to difficulties in past development programs and has been supported by the donor community. 28. The provincial government structure, frequent changes in government or the threat thereof, and customary land tenure have all inhibited more development oriented programs. Project implementation is impeded by issues of complicated bureaucratic processes, lack of skilled manpower, and difficulties on the ground in carrying out projects in tribal areas (e.g., disputes over land rights). Furthermore, the inability of many provincial governments to execute programs is a major factor in declining performance in health and education. Shortfalls in these areas are of particular concern because of the need for sustained progress on human resource development. The Government's initiatives to reform the provincial government and institute a village services program are appropriate to these concerns. 29. Beyond the mineral and forestry sectors and supporting activities, there are few obvious sources of growth under current conditions. Further analysis is needed to identify ways to increase productivity in tree crops and develop potentially profitable alternatives in agriculture. Providing rural income opportunities is clear- important to stem migration to urban areas. The tree crop subsidies are viewed as a transitory measure to increase rural incomes, and must be supported by measures to increase productive efficiency and competitiveness. In industry and services, a combination of high wages and low skills limits the opportunities for manufactured exports on a competitive basis. While shifts in key relative prices will help open new opportunities, it will take time to lay the foundation for sustained growth in these areas. 30. The 1993 investment budget is in line with appropriate development priorities. It aims to strengthen infrastructure and education by more than doubling investment allocations. The low allocation to agriculture, however, is worrisome. Development expenditures in the sector, apart from subsidies, are falling. While higher allocations would be desirable in many areas, implementation problems limit the scope for substantial increases in the near term. - 10 - E. Bank Group Country Assistance Strategy 31. A major effort was begun in 1987 to improve the quality and effectiveness of Bank group support, including more comprehensive economic and sector work and the initiation of the Consultative Group for PNG in 1988. The Government and donors have welcomed this initiative and a Qonstructive dialogue on all major policy and implementation issues has developed. 32. The Bank accounts for only 4-6 percent of annual aid flows to PNG, as all other donors provide concessional financing or grants at more favorable terms; PNG, thus, wishes to limit borrowing from the Bank as long as cheaper term financing is available. 33. Past Bank Group Involvement. The Bank Group has been involved in PNG since 1963, and its first operation was approved in 1968, well before independence. To date, the Bank Group has made 26 loans and 13 credits, amounting to US$531 million and US$114 million respectively for a total of 35 projects. Since 1983, there have been no further IDA credits in view of PNG's relatively high per capita income, mineral earnings, and its access to concessionary funding from sources other than IDA. Eight projects with a total loan amount of US$202 million are currently under implementation. 34. In August 1993, IFC's Board approved a US$13 million investment in a tuna canning operation in PNG; the first IFC investment in the country. IFC continues to look for other private sector initiatives. PNG is a signatory to the MIGA convention. Tus far, no MIGA guarantee arrangements have been concluded. FIAS has provided advice to the Government to help reorient the investment regime from excessive control orientation to a promotional approach. Table 3: LENDING OPERATIONS 1968-1993 No. of Total Sector Operations (US$ mil) Infrastructua 10 182.3 Agriculture 10 146.8 Human Resources 5 113.2 Power 3 62.5 Multisector 3 47.7 Public 3ector Management 2 40.4 Mining, Petroleum 1 3.0 Structural Adjustment 1 50.0 35. Of the 23 projects reviewed by OED, 19 were rated satisfactory, i.e., 83 percent of the portfolio meets economically acceptable standards with an average 17 percent ERR after completion. During the eighties, implementation performance and project sustainability of agricultural projects declined due to increasing institutional constraints generally and declining quality of project management. Infrastructure projects have experienced long - 11 - implementation delays due to cumbersome contracting procedures, law and order problems, difficulties in securing land, and inadequate interdepartmental coordination. Disbursement averaged more than 35 percent in FY91 and FY92 during the disbursement of the SAL operation, but fell to a low of 8 percent last year due to problems with auditing, special accounts, delays in project start-up after effectiveness, and design issues in on-going projects. 36. Bank Strategy. The primary focus of the Bank's strategy is to help improve institutions and implementation capacity at project, program, and policy levels, identify sustainable real sector growth possibilities and address urgent environment, infrastructure, and human resource development issues. In order to address these priorities and establish a basis for sustainable growth, it is vital that macro economic stability be preserved while reorienting key macro economic variables to support growth in the non- extractive sectors. The Bank, in concert with the IMF, the ADB, and other Consultative Group participants, has stressed and will continue to stress the Importance of macroeconomic stability while addressing the implementation and supply response issues. 37. The Bank's strategy of assistance to help achieve the Government's objectives would focus on four areas: * Macro economic and competitiveness policy analysis; * Analysis and technical assistance in areas of institutional and sector reform to help improve public service delivery on the national, regional and local level; * Assistance to improve project implementation performance; and Selective project interventions in coordination with other donors in areas of institutional development, sustainable development, environment, and Basic Services/Human Resource Development. The matrix on the following page sets out the objectives and actions/steps discussed with the Government in relation to our joint agenda and the Bank's work and lending program. 38. Macro economic analysis to be coordinated closely with the IMF will be supplemented with analyses of structural factors that would enhance a sustainable supply response rather than demand side stimulation. The analysis in the upcoming CEM will elaborate on the key challenges to improving economic competitiveness, creating more widespread income generating activities, and reducing the degree of dualism in the economy. The recent surge in oil revenues increases the resources available to the Government, which can either be invested in economically productive activities on consumed at levels that are not sustainable. The analyses and policy discussion will also focus on appropriate actions to prevent unsustainable budget deficits and limit commercial borrowing, and make better use of concessionary financing. 39. Economic and Sector Work includes an annual economic report as the focal instrument to maintain and deepen the macro economic dialogue. The CEM also forms the basis for discussions with other donors through the Consultative Group meeting. The sector work will be directed toward questions of increasing productive potential in the indigenous, non-extractive, sector - 12 - PAPUA EW GUNEA MLICT OBJECTIVES AmD COUNTRY ASSISTACE STRATROT Oblectives 1a£ction/ Nat stop9 Bank Baend Intruaete å& BH1fl NtANAOsiTa å1.Naoro Soo Stability follo CIr ou on vag* deregulation and policy dialogu., CN analyst, CC Improved meroeconoi exohange res ; containe t of inflation§ meeting competitivenese. phacc Out tre. erop Wubidies in tande vith å@*Cur69 to nera competittIvene and officiencylproductivltr taprovemente. £2. tner d i weatmeant consistent with policy dialogu, Cm analyse, Co Prudent anagement of devl eof apacitioe for Mötlng windfall revenues. *ffientleffeotive iaplementations sterilisation of funde csceeding aiplementation capacitise expand tag ha**# _________________________ and improved expenditure controle. __________________ ål. further liberalisation of trad& policies. poley dialogue, Cm analyse., CO Trade and tax policie licening practices (national an regional) Meetög. conducive to sustainable IDF Grant support for industrial invetmente and an open policy development ongoing. trade reaim. A4. complotion and folov tbrm4gh cocootor dockor wok; vartiotpation thr~ug Articulation of ewlicit revies tntenmify donor coordination of C oca in jot acrtor önd feasible aetoral analytical ctor work and ecctoral review. with OPM and donore. strategie. inveatment prograws. >L PUIC scInR 13~ KU~s Bl. ompltion of ongin of public a~ CM, analyttcal support isetitutol administration anid provin=tal soverna~n and for lustitutional. development ratinalisation to Iffrove follomup t~rough barly lementation of through anna economic reports public secotor gemt reaceendatione ben ed to help rectore donor coordination throug CO and policy and Inviatment contnuity in public adM atrations mechaniams; ID Grant support on implementation. *trengthening of PC. auditing ongoILng. 52. accelerated implementation of training support through Public Seotor Accelerated mobilisation program.l rationalise personnel anagement Training Project (La 3290). of oritical skulle. procedures and practice. tnuding tachnical coordination with MDP S lasietanc management. 33. ivatitn o f io follou through on privatisation program, 0 Institut support not within the purviev of Tel.acnca tis ro ot (195) governmuent. 4av1.P eträtegtea to m oe 'atR l soura* Strategy (96); CI. acc*** to ~duation, beaxth and rgåltion ~ovrty Å#***~en («793>8 Kusen Resoures service. and to improve cost recovery. Public Setor Training Project (Ln Developments Poverty 3290); Education Projeot (Ln 3537)t and Population Project (Ln 3591). C2. accelerated development of sector atratUeG nalytical cupport through Cef and Enancod agricultural retonal development planat institutia setor wrk on traditional productivity and rural etrealA~, to support dissemination of agriculture and rural servicels services improved tochnology and cost effective Forc*try project (FY95>. port servicel; adeuate resource Village gervice Project (196). ocationa to the seotort mobilise 100'. active at local levela. C3. articulate seoctor strategy, priorities and analytteal support through CM and Improved transport and program. with foena on rural requiremente. ector work on local con" ationa infraetructure rat I infrastructure. lnfrastructuro lend ration (1197; tele Mat project (M95) C4. etrongthen Inotitutol capalcae for ;cDPIDM funded TA projectt suatalned Development uta ble foreat mange t 95 Porestry project Implemont Forcetry Gulillmoj; GIF sitdivergity Tåg nviroumnta Attlon plan. Donor cordition on DC inatitutional support# Ln 3485 <Oro Project) contal butterfly habitat conservation component. 05. z~ndr lPå fully Operati~#l entahliak and analyt10al ~tpot tUroggh CEKt Facilitation of foreign maintai Consistent Inveetmant re~. for IfatItutional support t~ D Inveetasnt Promotions miningfoil and non-aining ectore. Grant 193); Ft r s o nt .stablisbing la (ggr, petroleum Technical köbitance Project (FT94). C6. accelerated Implementation of land technical analytieal and financial Rationalisation and mobilisation program. upport through the Land acceleration of land lobilisation projeet (Loan 3051). mobilisation procedures. - 13 - and enhancing human resource development. Proposed work includes: Local infrastructure strategy in support of efficient gr-wth at rural and village level; Traditional Agriculture and Rural Services in support of sustainable development objectives for the indigenous economy and in conjunction with the work on local infrastructuret and a Health Sector Study. The Bank's sector work is being coordinated closely with other donors. AIDAB is completing initial analyses in several sectors (Education, Health, Law and Order, Agriculture and Infrastructure) to support the shift in its assistance program to project aid. These studies address many issues of common interest and will serve as the basis for further actions. UNDP is continuing efforts to improve administrative capacity, in coordination with the Bank. 40. Of particular note in the Forestry sector, the Bank is the executing agent for UNDP and AIDAB grants to help reform the new National Forest Service, to support forest development and conservation reforms, and to equip the agency to manage forest resources under new Forestry Guidelines. These reforms are expected to increase forest sector revenues while reducing the rate of deforestation, which is probably the most critical environmental issue facing the country. A GEF project has been initiated by UNDP to address biodiversity issues. Problems faced by women in the traditional PNG society are well known and will be the subject of further review in the context of the planned work on Poverty Assessment, Traditional Agriculture and Rural Services as well as Health Sector reports. 41. Strengthening of institutions, absorptive capacity, and skills development has been the center of many initiatives by the Government and donors during the past 5-7 years. A UNDP funded/World Bank executed technical assistance project, "Support for National and Provincial Economic Management", has provided advisory services in various fields of public sector management and all projects include important and generally helpful capacity building components. UNDP initiated last year a NATCAP review to coordinate better provision of technical assistance. 42. Project Imolementation problems cited above were addressed in the first Country Portfolio Performance Review (CPPR) held in PNG in April 1993. Implementation was also the special topic for the 1993 meeting of the Consultative Group held on June 1-2, 1993. In addition to continuing annual CPPR's, the Bank will intensify its own project supervision work. New projects will be designed to better reflect the realities of PNG's implementation capacity and they will include TA directed at improving implementation capacity and sustainability. 43. A number of measures were discussed with the Government to facilitate implementation, including making counterpart funds available in a more timely way; more careful project preparation and implementation planning; and closer coordination among the Ministry of Finance and Planning, the line ministries, the Ministry of Works, and the donors. In consequence, the Government announced at the Consultative Group meeting its plans to establish an implementation monitoring unit in the Department of Finance and Planning and to convene regular implementation review meetings with donors. In preparing its 1994 budget, the Government is currently putting particular focus on programming and budgeting for active projects in its Public Investment Program. Progress under these proposals will be reviewed and further recommendations made in the next CPPR, scheduled for early 1994. Considering the increased levels of resources available to the country as a - 14 - result of the oil revenues and the shift of Australian grant aid from budget to program assistance, determined efforts will be required to overcome existing constraints t2 project implementation. 44. Operational Interventions. As "lender of last resort" with limited number of direct loans, PNO makes active use of the Bank's non-lending forms of operational interventions. Two IDF activities for trade policy assistance and strengthening of the Auditor General's Office are being implemented. Further, the Bank acts as executing agent for UNDP and AIDAB in forestry and capacity building projects and handles a number of PHRD grant arrangements. Similar activities will develop in the future in line with the priorities outlined in the above matrix. 45. The Bank will undertake new lending operations where it can concentrate on institutional development, employment generation, sustainable development in rural areas, the environment, or human resource development, and where it will provide exceptional value added, either through coordination of other donors or where there are vital issues to be addressed, such as major reforms in forestry activities. The two projects processed in FY93 (Education and Population) reflect this strategy. Similarly, this proposed Petroleum Technical Assistance project is designed to strengthen the Government's capabilities in managing the critical petroleum sector. Petroleum exports are an increasingly important source of foreign exchange and fiscal revenues. This project supports a comprehensive assessment of Government fiscal, regula- tory and ownership policies in the petroleum sector and of the means to improve the policy environment for foreign investors. The project would also help upgrade and consolidate Government technical expertise to rearrange the sector, analyze key policy options of downstream development, and establish standards for safe operations and environmental protection. 46. The Bank's operation program for FY95-97 consists of five projects totalling US$115 million. It includes a Forestry Project (FY95:US$15 million) to provide institutional support for forest managementl Telecommunications IV (FY95:US$30 million) to support Institutional strengthening, the Government's privatization program, and enhanced nation building through communications; and a Village Services Project (FY96tUS$20 million) to assist in achieving sustainable development of rural areas. The tentative lending program for FY97 includes operations in conservation (US$10.0 million) and local infrastructure (US$40.0 million). HRD components also figure in the projects in preparation. Depending on the progress under the ongoing Education and Population projects and the results of our Health Sector Study and the AIDAB studies, an additional human resource development project may be added to the program in FY97. 47. This program represents an upper range if the Government is able to sustain macro economic stability and policy reforms, improve implementation, and wishes to borrow from the Bank despite available cheaper concessionary funding. Slippage on the policy front would result in reducing the program to a core focussed on environmental, rural and HRD development activities in the order of $65-85 million for FY95-97. 48. Cooperation with IMF, ADB. and other Donors. IMF and Bank staff are cooperating closely, particularly during the stabilization period of 1990- 1992. Article IV consultations are being conducted annually. The most recent IMF mission was in August 1993 and board discussion is scheduled for December. - 15 - Presently no standby arrangement is under discussion. The Bank also works closely with ADB, AIDAB and other donors and joint efforts have been made to improve implementation, sector analysis and policy dialogue. 49. The Consultative Group, chaired by the Bank, provides a donor forum to discus. recent economic, social, and political developments and assists the Government in rising concessional assistance available to PNG. Australia, with its annual aid program of about A$250 million, is the largest donor, followed by ADB with an average of US$100 in annual commitments, and Japan ($30-65 million). Both the EC and UNDP are important donors, providing also grants and technical assistance. Whereas in recent years, the Consultative Group meetings have concentrated on stabilization and adjustment measures support, attention to implementation and sector issues has been increased to better assist PNG achieve its development objectives. It is clear that more assistance would be forthcoming if PNG were able to absorb project financing more effectively. In addition to Consultative Group meetings, the Implementation reviews convened by the Government and the ongoing sector studies should provide the opportunity for continued coordination between the Government and donors. 50. Creditworthiness and Risks. The Bank's portfolio on PNG is small (0.3 percent of the total Bank portfolio) and represents 17 percent of the Government's foreign debt (public and public guaranteed). The total long-term debt service ratio is 31.4 percent (including private mineral related debt), the public debt service ratio is 12.4 percent, and the ratio of Bank debt service to exports is 2.0 percent. Bank share of public debt service is 20 percent, and the preferred creditor's share is 31 percent, below guidelines. The Government's record of repayment is excellent. The Government has reduced its private source debt from US$624 million to US$360 million since 1987, and much of the bilateral assistance is in grant form. This explains the recent increase in the Bank's and preferred creditor shares in total debt service, as Bank's net disbursements have been relatively low. The Government is preparing to borrow US$160 million commercially this year to finance the budget deficit. This amount of borrowing should not impair the country's creditworthiness in the short run. However, continued commercial borrowing could pose risks which require careful monitoring. 51. On another level, the risks of failing to achieve sustainable development in the near term are high. PNG's economy is narrowly based on extractive industries and subject to considerable price and revenue variability in its major exports. Sustaining macroeconomic stability is critical to its medium-term prospects. The Government has a good track record in this re,ard, but the possibility of sustained high budget deficits and the temptation to engage in excessive borrowing against oil revenues present real risks. More fundamentally, the internal cultural and institutional impediments to development remain daunting. Nevertheless, the country remains creditworthy for Bank lending, and continued Bank Group support will help preserve and extend the important accomplishments to date and move PNG closer to achieving sustainable development. - 16 - F. Aenda for Board Consideration 52. PNG faces profound development challenges to evolve rapidly from a highly fragmented, very traditional, subsistence based polity and economy to a functioning modern state. It has made remarkable progress in establishing a democratic state with regular and free elections. Its Government is committed to pursuing development. From its own natural resource wealth and generous concessional aid, it has the resources to do so. Success in maintaining macro economic stability has not been sufficient to promote growth and employment in non-mineral sectors. Many contributing factors such as declining export prices, cultural practices, and a high reservation wage are beyond the Government's control in the short to medium term. Other factors such as low skill levels, poor public services, lack of consistent development programs, implementation problems, low investment levels, and relative price distortions that reduce incentives and competitiveness are to a greater or lesser extent under Government control. The reasons for current difficulties are understood, and the Government is ready to embark on significant further policy improvements. The Bank and other donors stand ready to provide necessary support. 53. The Bank's strategy is to continue to support the Government with economic analysis and advice on both a macro level to maintain stability, and on a sector level to help promote a supply response. It will be necessary to work simultaneously to improve economic management and institutional capacity, in particular through increasing investments. The Government has not requested substantial levels of financial support, so the lending program is modest. It could increase if implementation capacity improves, and shrink if there are major policy slippage.s but in PNG, the size of the lending program is less central to Bank's strategy than the extent and content of the policy analysis and advice the Bank can offer. 54. This approach carries minimal risk to the Bank's portfolio and offers the best chance to build a solid basis for development in PNG. The Executive Directors may wish to discuss the proposed balance between ESW and lending and its effectiveness in addressing the special challenges of PIG'S dualistic economy. They may also wish to address the challenges to effective implementation of development plans and assistance programs. Part II: The Petroleum Exploration and Development Technical Assistance Proiect 55. Backyround. The first efforts at exploring for oil and gas in PNG were made as early as 1913. About 130 wells had been drilled by the mid- eighties when for lack of significant hydrocarbon discoveries, prospecting companies started to pull out. A subsequent Government initiative, supported by an IDA credit, to map systematically PNG's petroleum reservoirs, identify new exploration leads and promote interest by the international oil companies was successful in revitalizing exploration activity. About 70 wells have been drilled between 1988 and 1991, mostly of them in the Papuan Basin. They have led to 23 oil and gas discoveries with possible reserves of about 600 million barrels of oil and condensate, and about 20 TCF of gas, respectively. The commercial development of these reserves has commenced only recently in 1991 with the completion of the Rides condensate and gas field development project - 17 - in the Southern Highlands province. Production from the adjacent but much larger Kutubu development started in late June 1992. 56. Economic Importance. PNG's oil production in 1993 has been averaging close to 140,000 barrels per day (b/d), virtually all of which is exported. Gross foreign exchange earnings from the export of oil were above US$300 million in 1992. Forecasts for 1993 are in the order of US$800 million, equivalent to more than one third of total estimated PNG exports. The fiscal take from royalties, dividends and taxes of petroleum production is estimated at US$130 in 1993 which would account for 14% of total Government revenues. However, this performance cannot be sustained in view of the initial high production pressure and related steep yield decline curve of the Kutubu field. Oil output is forecast to decline to 110.00 b/d in 1994 and further to 55.000 b/d in late 1996 when production of about 50.000 b/d from the Gobe and Mananda fields is expected to come on stream. While development of the Gobe and Mananda reservoirs will raise total oil production up again to 1994 levels, new fields will have to be brought into production subsequently in fairly short intervals to sustain output performance. 57. Sector Prospects. Petroleum investments, after peaking at US$235 million in 1990, have been falling to US$83 million in 1993, with a consequent decline in the number of exploration wells drilled. The reason for this sharp drop is related to the decline worldwide in exploration budgets of international oil companies on account of falling petroleum prices, competition from emerging investment opportunities in other countries and the perception of higher risks in PNG associated with a deterioration in incentives and problems related to law and order. However, indications are that petroleum investments may have reached bottom and be again on the upswing. For one, the smooth completion and successful start of the Chevron led Kutubu development in very difficult terrain has rekindled the interest of other petroleum companies. Furthermore, GOPNG has rescinded the moratorium it had imposed on signing petroleum agreements before the start of exploratory drilling and it has flexibilised the interest rate provisions applicable to accumulated negative cash flows. 58. The renewed interest of the petroleum industry is evident in plans to drill between 8 to 11 exploration wells in 1994, which would require investments of about US$120 million. Maintaining this level, coubined with outlays of about US$100 million p.a. for field development should allow sustained oil output at about 100.000 b/d in the foreseeable future. PNG's prospects for natural gas development are more promising then those for oil, considering the ratio of 9:1 in exploration finds to date. Simulation forecasts would indicate that Government revenues from the export of liquified gas could reach and possibly surpass present revenues from oil productiun. The lead time for developing the scattered gas fields and installing the gathering, transportation and liquefaction system would be about 10 years with massive investment requirements of between US$ 5 to 8 billion. 59. Institutional Arrangements. The broad responsibility for the assessment and development of PNG's petroleum resources is vested with the Department of Mining and Petroleum (DMP). Until June 1993, it was organized in four divisions: Minerals and Energy Policy; Geological Survey; Mines; and Finance and Administrative services (Attachment A-2). The management of petroleum exploration and developmentowas split between two divisions of DMP. The functions of plannirg and coordination were placed in the Minerals and - 18 - Energy Policy Division, while the functions of petroleum exploration and development license administration, resource assessment, archive management, drilling monitoring and reservoir engineering were grouped into the Petroleum Branch of the Geological Survey Division. This organisational split impaired efficient planning and monitoring of petroleum exploration and development activities and led to delays in the issuance of petroleum prospecting and development licenses. Before negotiations, at the Bank's advice, the government recently consolidated all petroleum functions into a single Petroleum Division reporting to Secretary, DHP (Attachment A-1). 60. Contractual Arrangements. All petroleum exploration and development activities are performed by oil companies holding petroleum prospecting licenses (PPLs) and petroleum development licenses (PDLs) that are governed by the Fatroleum Act of 1977. The licenses are granted by the Minister after clearance with the Petroleum Advisory Board (PAB), which is a statutory body established under the Petroleum Act of 1977. Any area in PNG can be the subject of an application for a PPL. In the event of a commercial discovery, the licensee has the right to obtain a PDL. The State has the option to obtain a "carried interest" of up to 22.5 percent through both exploration and development with "carry" repayable from the State's share of future production. The licensee pays 1.25 percent royalty, a 50 percent petroleum income tar and an additional profit tax payable after the investor has recovered his investment and a predetermined return on capital, which is broadly in line with practices in competing oil exporting countries. 61. Petroleum Sector Issues. Dominant issues in the petroleum subsector of PNG are: (a) the impact of government fiscal, regulatory and ownership policies in the petroleum sector on investor confidence and government revenues; (b) the need for more efficient management of petroleum exploration and development; (c) the case for setting up a petroleum refinery to help meet the domestic demand for petroleum products; (d) the possibility of developing and liquifying natural gas reserves for export; and, (e) the need for appropriate legislation to ensure safety and environmental protection in the storage and transport of petroleum products. These are briefly discussed in the following paragraphs. 62. The Incentive Regime. A World Bank supported petroleum exploration technical assistance project (Cr. 1279-PNG) made available to investors improved geologic information on the country's petroleum resources. In this context, the government undertook a vigorous promotion campaign and set transparent and stable fiscal arrangements. PNG's incentive package for petroleum sector development are considered middle of the road by the industry in comparison with other petroleum exporting countries. While this package has been successful in attracting investors, increasing competition from other countries have prompted the Government to reassess the fiscal, regulatory and ownership policies in the petroleum sector so as to better meet investors' requirements and its revenue needs. 63. Consequently, to improve competitiveness internationally, the government is currently undertaking a comprehensive review of these policies, taking into account a recent study of the IMP (prepared at the request of the Government), with the objective of enhancing the policy environment bolstering investor confidence and increasing government revenues from the sector. An understanding was reached with the government that it would discuss with the Bank the preliminary results as they emerge during the course of this review - 19 - as well as the final report and its recommendations, which are expected by June 1994. The government has agreed to use the services of a fiscal expert and a lawyer financed under the project for advice and technical assistance in implementing the recommendations. 64. Management of Petroleum Kloration and Development. The Petroleum Branch of the Department of Mining and Petroleum (DMP) has petformed a key role in the promotion of exploration through compilation of geological data and administration of the licensing process. Apart from negotiating and monitoring this large program, the Petroleum Branch has been rendering technical advice to the government on the granting of exploration and development licenses. Besides the constraints caused by the organizational split referred to in para. 65, this unit has also been facing a severe shortage of manpower and therefore is in danger of losing its effectiveness. The attrition of staff has been largely due to poor working conditions and remuneration, less than one-third of that offered by the industry. Key functions were left unattended, leading to insufficient evaluation of license applications and inadequate monitoring of the license holders' exploration and development activities, and hence significant reduction in economic benefits to PNG. (A lack of monitoring capability in 1983 resulted in the Pasca blowout and the subsequent loss of about 12 HBBL of condensate, with a sales value of about US$250 million.) To cope with the increasingly complex challenges in the sector and to maximize the benefits to the national economy, DMP has begun to strengthen its capabilities in the management of petroleum exploration and development by consolidating all the petroleum activities under one division and also by upgrading the positions in the Division, and thus improving staff remuneration, to facilitate hiring and retention of qualified professionals. The project would provide technical assistance to further strengthen the government's capabilities in the management of the petroleum sector. 65. Refinery Development. In 1988, DMP's preliminary evaluations indicated that, while a small refinery sized to suit the demand of the Highlands region (about 2,500 BBLPD) would be a profitable add-on to a petroleum export project, a stand-alone (25,000 BBLPD) refinery would not be profitable and would cost the Government about US$50 million in annual subsidies. However, recently the government has received a number of proposals for the establishment of a stand-alone oil refinery. These proposals, including the estimates of their economic viability are being evaluated by the government. The government confirmed that it would not support any refinery project that was not economically viable. The refinery planning study component of the project would facilitate the government's evaluation of the refinery proposals. 66. LNG export. Indications are that there is a market for LNG export from PNG to Japan and other East Asian destinations. These buyers' need to diversify their sources of supply and PNG's independence from any strategic shipping lane could be a favorable factor for market development. For PNG, the choice would be between the promotion of a small LNG export project based on the reserves in the Gulf of Papua (about 4-5 TCF), or a larger project based on the combined resources (about 9-10 TCF) of the Gulf of Papua and the Papuan fold belt (Hides, lagifu/edinia gas caps, SE Hedinia, etc.). An audit of gas resources is already in progress and upon its completion DMP will conduct under the project an LNG export feasibility study that would include the preparation of a policy and regulatory framework for gas development, - 20 - followed by the presentation of the results to interested parties in an international LNG export promotion seminar. 67. Standards for Safe Operations and Enviromental Protection. Existing provisions of the Petroleum Act and regulations adopted in 1987 provide controls on the operators of exploration and development activities with respect to the safety of operations and protection of the environment as well as restoration in case of damage. Such requirements complement the provisions of the environmental legislation administered by the Department of Environment and Conservation. The 1987 regulations are currently under review with the intent to strengthen them, if needed, and submit appropriate modifications to the Cabinet for approval and promulgation. 68. The Government has sought and obtained assistance from the government of Australia, which includes expert advice and the installation of navigational aids, to ensure environmentally safe off-loading of crude oil to ocean going tankers from the Kutubu marine terminal and to permit safe passage through the Gulf of Papua. Insufficient attention has, however, been devoted to managing safety and environmental aspects of inland oil storage and transportation. Generally, Australian standards are followed by the oil marketing companies in the absence of comprehensive Government regulations. Downstream, the application and monitoring of safety precautions are left to the sub-dealers, retailers and transporters who may not be fully conversant with or apply the Australian standards. During the project, DMP would engage consultants to compile appropriate safety standards for handling, storage, and transportation of petroleum products (on the basis of prominent world standards) that would be promulgated by the national government of Papua New Guinea. The responsibility for widespread dissemination and monitoring the application of these standards would be vested with the provincial governments with DMP performing the coordinating role. Past Exnerience and Rationale for Bank's Involvement with the Proposed ProSect 69. The Bank Group has supported the development of PNG's petroleum sector through a Petroleum Exploration Technical Assistance Project (Cr. 1279- PNG) which was completed in December 1988. This project was a success; it had a catalytic effect in revitalizing exploration in PNG at a time when the international oil industry's interest in investing in PNG was flagging. Bank support for this second project would help the government consolidate the gains and maximize the benefits to the national economy by enhancing the attractiveness of the petroleum sector to international investors and strengthening the capability of the government in policy formulation, safety regulation, evaluation of development proposals and monitoring of ongoing sector development programs. During the extended project preparation period, a close and constructive relationship has been established between the Bank staff and DMP which allowed to put in place already the organizational changes required to ensure effective support for policy formulation and implementation and for project execution. 70. Project Objectives. The proposed project has been formulated to address the aforementioned issues and has the following objectives: (a) to assist in the development of an improved framework of regulatory and ownership policies that would increase investment in the petroleum sector and government revenue; (b) to strengthen the capacity of the government for comprehensive mangement of petroleum exploration and development; (c) to upgrade the - 21 - capacity of the government to gather, process, analyze and market to international investors exploration and development data on the sector; (d) to formulate better standards for safe and efficient storage, handling and transportation of petroleum products; and, (e) to evaluate the potential for commercial development of natural gas reserves for LNG export, develop an appropriate framework for gas development, and present the results in international seminars to attract investment. 71. Project Description. In support of the above objectives the proposed project will provide funds for the following components: (a) For institutional Strengthening of DMP, experts in petroleum geology, archive management, geophysics, reservoir engineering, production engineering, drilling, pipeline and facilities engineering, petroleum economics and legal and fiscal policies will be employed for about 3 to 5 years (the experts will provide responsible advice and technical assistance, and concomitant with this, they will also provide on-the-job training to national officers); (b) Studies and Promotion. These would involve the provislon of experts and services to: (i) conduct studies on location, size, product mix and feasibility of a petroleum refinery, and the feasibility of LNG export; (ii) organize and conduct international seminars to promote LOG export; and, (iii) compile appropriate standards for safe handling, storage and transportation of petroleum products; (c) Iquipment and Support Facilities. To enhance the capability of DMP in monitoring and analyzing petroleum exploration and development activities: (i) a computer system with appropriate hardware and software; and (ii) laboratory equipment will be funded; (d) Training: (i) activities would involve post-graduate studies of nine nationals in foreign universities in various petroleum disciplines and internships with operating companies; and (i) training of six nationals as laboratory technicians. 72. Project Cost and Financing. The total project cost is estimated at US$12.15 million with a foreign exchange component of US$11.00 million. The foreign exchange requirements would be financed under the proposed Bank loan and the local cost by the government. Retroactive financing up to US$400,000 (for expenditures in connection with the establishment of a Petroleum Division) is proposed for expenditures on equipment and training incurred from January 1, 1993. A breakdown of project costs and the financing plan is given in Schedule A. Amounts and methods of procurement and of disbursements and the disbursement schedule are given in Schedule B. A timetable of key project processing events and the status of Bank Group operations in PUG are given in Schedules C and D respectively. A map of PNG's petroleum resources (IBRD No. 23508) is also attached. 73. Implementation. The project would be implemented over six years by DMP. The head of the Petroleum Division will be the Project Manager. Experts will be engaged to help DMP carry out the project (Attachment 1 provides more details on implementation arrangements and Attachment A-3 shows the implementation schedule). 74. Actions Agreed and UnderstandiaM. During negotiations, agreements were reached with the government that: (i) it will provide DMP with sufficient funds, necessary permissions and clearances for timely implementation of the project; and (ii) all studies under the project will commence not later than December 31, 1994 by which time all experts to help strengthen the government's capacity in the management of petroleum sector would also have - 22 - been recruited. The recommendations of the studies and the compilation of safety standards will be provided to the Bank for comments. The Government will, thereafter, implement and monitor such safety standards. Furthermore, an understanding was reached with the Government that it would discuss with the Bank the preliminary results of the review currently being undertaken by the Government of its fiscal and ownership policies in the petroleum sector before deploying the fiscal and legal experts. 75. Environment. The proposed project will assist in the protection of the environment by: (a) ongoing consultation with the Government during implementation confirming that standards for petrolem exploration and development are environmentally sound; (b) enhancing the government's capabilities in monitoring compliance with these standards; and (c) formulating better standards for safe storage and transportation of petroleum products and ensuring corresponding business practices. 76. Sustainability. The project is expected to make a significant contribution to sustain effective development of PNG's petroleum resources and with it to ensure continued sizeable foreign exchange earnings and fiscal revenues. 77. Benefits and Risks. An improved framework regulatory and ownership policies is expected to lead to greater private investment and government revenue from the petroleum sector. Since exploration and development activities involve large expenditures, inadequate analysis and monitaring can lead to significant reduction in benefits to PUG. The project would enable the government to maximize the benefits from petroleum exploration through improved analysis of development options and monitoring of work programs. The project would also provide for technology transfer, and it would contribute significantly to the protection of the environment. In order to contain possible risk of delays in contracting consultants and recruiting national staff, terms of reference for the required consultants were reviewed during negotiations. Furthermore, DMP has decided, in agreement with the Bank, to retain the 6ervices of experienced and reputed organizations in Western Europe, North America and Australia to ensure that the required specialized consultants are obtained as quickly as possible and provided under one umbrella. The DMP has prepared plans for staff recruitment and enhanced remuneration packages which should allow DNP to recruit capable staff in appropriate numbers for satisfactory project implementation. Recommendation 78. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and I recommend that the Executive Directors approve the proposed loan. Lewis T. Preston President Attachments Washington, D.C. November , 1993 October 1993 -23- Annex A Page 1 of I BANK FACT SHEET BANK LENDING PROGRAM, FY91-97 BY SECTOR AND LENDING INSTRUMENT (% oF TOTAL COMMITMENTs/DISBURSEMENTS) Actual Estimate Past Curret Planned al FY91 FY92 FY93 FY94 FY95 FY96 FY97 IBRD Commitments (US$m) 50.8 27.0 41.9 11.5 45.0 20.0 50.0 Sector (%) Agriculture 100.0 33.0 100.0 40.0 Industry and Finance 67.0 Energy 100.0 Puwer Public Sector Management Infrastructure & Urban Dev. 59.1 60.0 Human Resources 40.9 100.0 Environment Mining & Other Extractive Multisector TOTAL 1000 1000 1000 100.0 100.0 100.0 100-0 Lending Instrument (%) Adjustment Loans L - - - - Specific Inv. Loans & Others 100.0 100.0 100.0 100.0 100.0 100.0 100.0 TO_AL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Disbursements (US$m) 59.9 49.0 12.2 35.5 NA NA NA IFC Approvals (US$m) e 13.0 Sector (%) k/ Agri-business 100.0 Cap. Markets Chem-Fertilizer Infrastructure Manufacturing Oil-mining Total 100.0 Investment instrument (%) Loans 92.0 Equity 8.0 Quasi-equity 4/ Total 100.0 E/ Program and Structural Adjustment Loans, Sector Adjustment Loans, and Debt Adjustment Loans. h/ For future lending, round to nearest 0 or 5%. g/ Program and Structural Adjustment Loans, Sector Adjustment Loans, and Debt Adjustment Loans. d/ Includes both quasi-equity loan and quasi-equity equity types. j/ The first IPC investment in PNG, US$13 million in a tuna canning operation, was approved in August 1993. -24- Sept 1993 Annex B Page 1 of 5 PNG - PRIORITY POVERTY INDICATORS 1970 1980 1989 1990 1991 1992 Poverty Unes Upper Poverty Une Headcount .. .. Lower Poverty Une Headcount at .. .. .. Memorandum Itern GNP Per Capita (USS) b .. 770 900 870 930 950 Income Indicators Urban Mininmum Wage (K per week) of .. .. 53.96 55.71 59.10 61.79 Rural Mininmum Wage (K per week) c/ .. .. 20.13 20.78 22.00 23.03 CPI (Food) (1977=100) 189.4 207.5 223.6 230.9 Rural Terms of Trade (1988=100) d .. .. 74 54 54 53 Social Indicators Share of Public Expenditures for Basic Social Services In GDP (%) e/ .. .. 13.0 13.0 15.0 16.0 Primary School Enrollment Ratio .. 59.0 73.0 73.0 NA NA Under-Five Mortality (thou. live births) .. .. 80 77 74 71 Immunization (% age group) Measles .. .. 52 .. .. 63 DPT .. .. 53 .. .. 64 Child Malnutrition Femaleo-Male Ufe Expectancy .. .. 1.0 1.0 1.0 1.1 Total Fertility Rate (births per woman) 6.1 5.7 6.1 5.0 4.9 Maternal Mortality (per 100,000 live births) .. .. 700 *I The upper poverty ne Is the out-off for the poor, the lower poverty line Is the out-off for the very poor. W World Bank Atlas methodology. of For 1992, the figures shown relate to the first half of the year. For the second half of the year, the unified average minimum wage for the whole country Is K23.19 per week. -25- Sept. 1993 Annex 8 Page 2 of 5 PNG - KEY SOCIAL INDICATORS OF DEVELOPMENT, 1993 25-30 15.20 Most Same region/Income Group Years Yeare Recent Lower Ago Ago Estimate East midde. (mre) Asia Income Human resources Size, Growth, Structure of Populadosf Total Population (mre (1991) In thousands) 2,148 2,729 3,964 1,666,723 773,803 14 an under (% of population) .. .. 40.3 29.5 36.8 15.64 (% of population) .. .. 572 65.1 58.7 Percentage In Urban Areas (% of population) 10.0 16.0 52.0 54.0 Population Growth Rate (% per annum) 2.4 2.4 2.3 1.5 1.7 Determinants of Popuatkn Growth Fertlity Crude Birth Rate (per thousand population) NA 42 34 24 28 Mortality Crude Death Rate (per thousand population) NA 18 11 7 12 Infant Mortality Rate (per thousand lIve births) 140 82 55 42 40 Lfe Expectancy at Birth (years) 44 49 6 68 67 Natural Resources Area (thousand asqks 463 463 463 16,369 23,990 Density (population per sq.km) 5.0 6.0 8.0 99 31.0 Access to Safe Water (% of population) .. 20.0 34.0 71.8 Urban (% of population) .. 30.0 93.0 82.5 Rural (% of population) .. 19.0 23.0 80.7 Acoe to Sanitation Servoes (% of populatfon) Urban (% of population) .. .. 95.0 Rural (% of population) .. .. 15.0 Nutrition Daily Calorie Supply (calories per person) .. .. ..96 Daily Protein Supply (gm per person) .. .. Investment In Human Capital Populadon per Physician (number of persons) 1Z635 11,733 12,874 1,028 Hospital Bed (number of persons) 202 299 553 509 Educaon Gross Enrollment Ratios Primary (% of school-age pop) .. 52 73 Secondary (% of school-ag. pop.) 4 8 13 50 56 Female 2 4 10 43 Tertiary .. 2 NA Literacy Rate Overall (% of population; age 15+) 29 .. 48 76 at Daily per capita calorie supply as percent of requirements. Sources: World Development Report, 1993; UNDP* Human Development Report, 1991; and UNICEF - The State of the World's Children, 1991. -26- Sept. 1993 Annex B Page 3 of 5 PNG- KEY ECONOMIC INDICATORS 1988 1989 1990 1991 1992 Est NATIONAL QaC U faU GDP at Current MarketPrIces) Gross Domestic Product m.p. 100.0 100.0 100.0 100.0 100.0 Agriculture 30.7 30.1 30.9 27.5 26.1 Industry (Including Mining) 35.9 31.7 32.4 36.5 40.1 Services 33.4 38.2 36.8 36.0 33.8 Consumption 61.5 88.9 83.9 82.5 81.1 Gross Investment 27.2 23.2 24.4 27.4 21.4 Public 5.0 4.7 5.1 4.7 4.0 Private a/ 22.2 18.5 19.3 22.7 17.4 Exports of GNFS 43.3 40.6 40.6 42.3 47.5 Imports of GNFS 51.9 52.7 48.9 52.2 50.0 Gross National Saving 18.3 180 21.6 20.4 10.4 Gross Domestic Saving 25.6 20.5 28.7 25.4 20.5 Memorandum Iteml GDP (US$ million at current prices) 3656 3559 3221 3787 4230 GNP Per Capita (US$) b/ 860 900 870 930 950 PJBLIC FINANCE (as % of GDP at Our. Mkt P.) Current revenues 28.6 33.3 32.1 31.1 27.4 Currentexpenditures 25.6 30.0 304 282 31.0 Surplus (+) or deficit (*) 3.0 3.3 1.7 3.0 4.6 Capital expenditure 3.9 4.5 5.0 4.8 2.3 Foreign financing .. .. REAL ANNUAL GROWTH RATES (%) Gross Domestic Product 2.9 -1.4 3.0 9.5 9.0 Gross Domestic Income 5.7 -7.9 -5.0 9.5 9.0 REAL ANNUAL PER CAPITA GROWrH RAT ( Gross Domestic Product 0.6 4.7 -5.3 7.2 6.7 Total Consumption *2.5 -1.6 -12.8 5.5 5.7 Private Consumption -1.9 4.5 -15.7 9.2 4.8 MONETARY INDICATORS M3/GDP (%) 31.1 34.1 352 35.3 35.1 Growth of M3 () 4.4 5.3 4.3 17.6 12.5 Private sector credit growth/total credit growth 0.8 0.8 0.2 0.6 0.3 at includes change In stocks. W World Bank Atlas methodology. -27- Sept. 1993 Annex 8 Page 4 of 5 PNG - KEY ECONOMIC INDICATORS 1988 1989 1990 1991 1992 Est A O * *1 fuas t:(US$ millions at Current Prices) Exports of Goods & NFS 1593.7 14862 1401.9 1672.3 1980.7 Merchandise (FOB) 1472.2 1322.7 1196.4 1369.7 1755.5 Non-Factor Services 121.5 163.5 205.6 302.6 225.2 Imports of Goods & NFS 1803.9 1757.8 1509.3 1946.4 21192 Merchandise (FOB) 1383.4 1346.1 1106.4 1403.3 1515.1 Non-Factor Services 420.5 411.7 403.0 543.1 604.1 Resource Balance .210.2 -271.6 -107.4 -274.0 *138.5 Net Factor Income *206.3 *179.4 -102.9 -248.9 -532.7 of which: Interest payments 162.0 158.0 156.0 133.0 Net Current Transfers *124.6 *130.9 -106.8 44.1 -54.1 Current Account Balance -541.1 *581.8 417.0 587.1 -725.3 Official Grants 216.9 217.3 225.0 323.5 259.3 Publio & Publicly Guaranteed Loans (net) -28.8 -22.2 87.9 -5.7 99.1 Private Capital (ne) a/ 290.8 324.8 49.2 234.2 298.4 Change in Gross Reserves (Increase *) 62.3 61.9 -45.1 85.0 70.6 Memorandum IteM Gross Reserves 588 398 403 318 238 Gross Reserves (months of nonmineral imports) 6.5 4.7 5.0 3.6 2.8 Exports as % of GOP 43.6 41.8 43.5 44.2 46.8 Imports as % of GDP 49.3 49.4 48.9 51.4 50.1 Resource Balance as % of GDP -6.7 -7.6 -3.3 -7.2 3.3 REA ANUAL GROWIT RATES f198 PRICES) (122mrle Merchandise exports -2.8 4.5 4.4 26.4 37.9 Primary -13.0 33.4 -17.5 -7.1 25.4 Manufactures Merchandise Imports 15.3 -5.1 -25.8 30.3 4.8 PRICE INDICES (1992=100 Export price index 128.4 108.8 101.9 101.5 100.0 Import price Index 91.5 93.6 101.2 97.6 100.0 Terms of trade index 140.3 116.2 100.8 103.9 100.0 Real exchange rate 105.2 108.7 98.1 100.6 100.0 Consumer price Index (% growth rate) 5.4 4.5 7.0 7.0 4.7 GDP deflator (% growth rate) 7.9 -2.5 4.1 7.0 3.8 af includes errors and omissions. -28- Sept. 1993 Annex B Page 5 of 5 PNG - KEY EXPOSURE INDICATORS 1988 1989 1990 1991 1992 Est (million US$ at current prices) Total Debt Outstanding (TO) a/ 2249 2305 2572 2734 3736 Of which: Public & Publicly Guaranteed 1252 1314 1501 1591 1539 Net Disbursements al 108 234 190 123 891 Total Debt Service (TDS) at 498 515 557 508 660 (percent) Debt and Debt Service Indicators TD0/XGS b/ 131.4 146.6 170.5 156.8 183.1 TDOGDP 61.5 64.8 79.8 722 88.3 TDS/XGS 29.1 32.7 38.9 29.1 32.4 ConcessionalTDO 19.7 19.9 24.0 25.7 18.6 (percent) IBRD Exposure Indicators IBRD Debt Service/Public Debt Service (DS) 7.7 16.9 10.2 13.5 20.4 Pref. Cred. DS/Public DS 10.3 20.8 15.7 20.3 30.6 IBRD DS/XGS 1.4 2.5 1.9 1.8 2.0 IBRD Portfolio Share 0.2 0.2 0.2 02 0.3 MIGA (million US$ at current prices) MIGA Guarantees IFC cl el Includes public and publicly guaranteed debt, private non-guaranteed debt, use of IMF credits, and short-term debt. bf Exports of goods and services. o/ The first IFC investment of US$13 millon was approved In August 1993. -29- October 1993 Annex C Page 1 of 1 SELECTED INDICATORS OF PORTFOLIO PERFORMANCE AND MANAGEMENT FY91 FY92 FY93 FY94 Current Portfolio Performance No. of Projects under Implementation 11 11 13 8 Average Implementation Period (years) g 4.0 4.2 4.5 3.1 % Projects Rated "3" or 4" Development Objectives h/ 9 9 0 0 Overall Status i 18 27 8 12.5 Average Ratings Development Objectives 1.45 1.60 1.54 1.55 Overall Status 1.82 2.10 1.77 1.80 Disbursement Ratio (%) 4/ 37.4 32.5 8.0 23.0 1I Memorandum Item: % Completed Projects Rated Unsatisfactory f/ 19 19 17 20 Portfolio Management gI Supervision Resources (total sws) 107.8 121.0 105.7 83.7 S/ Average Supervision sws/project 9.8 11.0 8.1 9.3 e/ Supervision Resources by Location (in %) % Headquarters 100.0 100.0 100.0 100.0 % Resident Mission 0.0 0.0 0.0 0.0 Supervision Resources by Rating Category (sws/project) 7.9 7.9 8.0 10.2 1/ Projects rated "1" or "2" 13.9 13.9 9.5 12.3 e/ Projects rated "3" or "4" A/ This is the average age of a project in the Bank's portfolio. h/ Extent to which the project will meet its development objectives. A rating of "1" means that all development objectives are expected to be achieved; "2", some of the minor objectives may not be achieved but major objectives are expected to be met; "3", major project objectives are likely to be achieved only in part and the continued justification of the project is uncertain; and "4", major objectives will probably not be achieved, and the project appears to be no longer justified (Annex D2 of OD 13.05). g/ Assessment of overall performance of the project based on the ratings given to individual aspects of project implementation (e.g., management, availability of funds, compliance with legal covenants, etc, and to development objectives. A rating of "1" means no significant problems; "2", moderate problems; "3", major problems but appropriate actions re being taken to address these problems; and "4", major problems, but the problems are not being adequately addressed or are caused by exogenous factors with no readily available solution. The overall status rating is not given a better rating than that given to project development objectives (Annex D2 of OD 13.05). d/ Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year. q/ Projected for FY94. f/ Projects rated unsatisfactory as % of OED evaluations completed. g/ Excluding PCR, ARIS, and CIR. -30- Schedule A PAPUA NEW GUINEA PETROLEUM EXPLORATION AND DEVELOPMENT TECHNICAL ASSISTANCE PROJECT Estimated Cost and Financing Plan (US$ Million) Local Foreign Total Estimated Cost (a) Institutional Strengthening - 4.30 4.30 (b) Studies and Promotion - 1.40 1.40 (c) Equipment and Support Facilities 1.00 3.90 4.90 Base Cost 1.00 9.60 10.60 Contingencies /a 0.15 1.40 1.55 1.15 11.00 12.15 Financing Plan Government of Papua New Guinea 1.15 - 1.15 IBRD - 11.00 11.00 1.15 1.-0 0 12_.15 I-a Based on a projected foreign inflation of 3.2% p.a. and a local inflation of 5.0% p.a. during the project period. -31- Schedule B Page 1 of 2 PAPUA NEW GUINEA PETROLEUM EXPLORATION AND DEVELOPMENT TECHNICAL ASSISTANCE PROJECT Procurement Method and Disbursements (US$ Million) Procurement Method /a A. Category ICB LCB Other Lb N.B.F. Total Equipment and Support Facilities 4.65 0.47 5.12 (4.0) (0.47) (4.47) Consultant Services and Training 6.53 6.53 (6.53) (6.53) Civil Works 0.5 0.5 12.15 (11.0) /a Figures in parenthesis are the amounts financed by the Bank and include contingencies. /b Local and international shopping and consultant's selection following Bank guidelines. N.B.F.- Non-Bank financed. -32- Schedule B Page 2 of 2 B. Disbursements Category Amount Expenditure to be financed Equipment and Support Facilities 3.90 1002 of foreign expenditures, 100% of local expenditures (ax-factory) 65% of items procured locally Consultant Services 5.20 100% Training 0.50 1002 Unallocated 1.40 Total 11.00 Estimated IBRD Disbursement Bank Group Fiscal Year 1994 1995 1996 1997 198 99 Annual 0.55 1.75 3.75 2.75 1.65 05 Cumulative 0.55 2.30 6.05 8.80 10.45 11.0 The loan closing date will be December 31, 1999. -33- Schedule C PAPUA NEW GUINEA PETROLEUM EXPLORATION AND DEVELOPMENT TECHNICAL ASSISTANCE PROJECT Timetable for Key Processing Events (a) Time taken to prepare S 4 months (b) Prepared by S DMP with assistance from the Bank (c) First Bank Mission a November 1991 (d) Appraisal Mission a November 1991 (e) Negotiations a October 1993 (f) Planned Date of Effectiveness a March 1994 (g) List of Relevant PCRs and PPARs a Loan No. Proiect ICR Date and No. Cr. 1279-PNG Petroleum 09/1911989 8069 Exploration Promotion Technical Assistance The project was appraised in November 1991 by a Bank mission composed of Mr. S. Rhwaja, Senior Gas Specialist, and Mr. L. Zubair, Consultant. Mr. A. Liebenthal was the peer reviewer. Mr. P.R. Scherer, Chief, EA31E, and Ms. M. Haug, Director, EA3DR, have endorsed the project -34- Schedule D STATUS OF BANK GROUP OPERATIONS IN PAPWA NEW GUINEA A. STATEMENT OF BANK LOANS AND IDA CREDITS (as of September 30 1993) /a Amount (USS million) Loan Bank IDA Credit Fiscal Original Principal Undis- number Year Borrower Purpose (less cancellation) bursed Eighteen loans and thirteen credits fully disbursed 319.58 113.77 Of which SECALS, SALS and Program Loans: 3218- PNG 1990 PNG Structural Adjustment 50.00 - 2742- PNG 1987 PNG Transport Improvement 42.82 11.51 3051- PNG 1989 PNG Land Mobilization 19.60 14.37 3154- PNG 1990 PNG Third Telecommunications 17.20 12.42 3289- PNG 1991 PNG Special Interventions 30.00 20.59 3290- PNG 1991 PNG Public Sector Training 20.80 19.52 3485- PNG 1992 PNG Oro Smaliholder Oil Palm Dev. 27.00 27.00 3537- PNG 1993 PNG Education Development lb 35.00 35.00 3591- PNG 1993 PNG Population lb 6.90 6.90 Total A18. 113.Z7 .1 of which has been repaid 130.17 8.14 Total now held by Bank 3g8,73 10.63 Amount sold 15.39 of which repaid 15.39 Total undisbursed 147.31 B. STATEMENT OF IFQ INVESTMENTS (as of September 30, 1993) None /a The status of the projects listed in Part A is described In a separate report on all Bank/IDA-financed projects in execution, which is updated twice yearly and circulated to the Executive Directors on April 30 and October 31. b Not effective as of September 30, 1993. ..'A5. Schedule E PAPUA NEW GUINEA PETROEUN EXPLORATION AND DEVELOPMENT TECHNICAL ASSISTANCE PROJECT Proiect Supervision Plan The mix of specialties, frequency and duration of missions likely to be needed to ensure adequate project supervision as follows: Mission Time Specialty/Duration (Weeks) Total No. Mo/Yr ES PS ES FE Staff Weeks 1 5/94 1 1 1 - 3 3 2 11/94 1 - 0 1 2 2 3 5/94 1 1 1 - 3 3 4 11/94 1 - - 1 2 2 5 5/96 1 - 1 1 2 2 6 11/96 1 - - - 1 1 7 5/97 1 1 - 1 1 1 8 5/98 1 1 1 2 1 1 9 5/99 1 1 - 1 1 1 RS - Hydrocarbon Specialist PS - Procurement Specialist FE - Fiscal Expert Attachment A Page 1 of 5 PAPUA NEW GUINEA PETROLEUM EXPLORATION AND DEVELOPMENT TECHNICAL ASSISTANCE PROJECT Technical Annex PNG's Petroleum GeoloAy 1. Papua New Guinea's land mass is about one and a half times that of the Philippines. It comprises 461,691 km2 on the eastern half of the world's largest island and over 600 islands of varying sizes lying at the east end of the Indonesian archipelago, conjuncturing with Australian continental and Pacific ocean plates. It has endured a stratigraphic and structural history conducive to the generation and entrapment of hydrocarbons. Its five main sedimentary basins aret Papuan Basin (212,000 km), North New Guinea Basin (93,000 um2), Cape Vogel Basin (26,000 km2), Bougainville Basin (4,400 ka) and New Ireland Basin (56,400 kma). (a) The Papuan Basin, the most explored of all, is the largest sedimentary basin in the country (about the same size as Syria in the Middle East). It is effectively the continuation of the Capentaria Basin in North Queensland, Australia. It is composed of Mesozoic and Tertiary deposits formed over the crystalline basement of Australian plate. All the elements necessary for the generation and entrapment of hydrocarbons are present in most areas of this basin. These include a wide range of structural and stratigraphic traps, good source rocks at sufficient burial depths, good to excellent reservoir rocks, and suitable cap rocks. About 250 wells have been drilled since 1913. The main target is a Mesozoic, late Jurassic to early Cretaceous shallow marine sand called Toro sandstone. All of PNGs hydrocarbon discoveries have been located in this basin. (b) The North New Guinea Basin is mainly composed of Pliocene and Pleistocene rocks which uncomformably overlie thrusted Miocene sediments. A limited amount of exploration has taken place, with only eleven wells drilled to date, and sparse seismic survey coverage. There is up to 5 km of sedimentary section in some parts of the basin. The oil generating potential of this region is suggested by the presence of numerous oil seeps. (c) The CaRe Vogel Basin is largely offshore and has been only partially explored. Shallow bores drilled on Cape Vogel peninsula (in 1928) did have some shows of hydrocarbons but only two deep exploration wells have been drilled (in 1973) and there are few seismic data available. Large structures are known to exist in the subsurface offshore but these hove not been tested by drilling. There is a thick section of tertiary sediment the basin but much of the sequence cannot be identified from the existing data, which include only limited onshore exposure. It is likely, however, that reservoir sandstones and shaley source rocks occur at depth. The basin is adjacent to the tectonically active New Britain trench, which may also be a source for hydrocarbons. (d) The Bougainville Basin is located offshore on the western side of Bougainville Island. Very little exploration work has been done in this region. Only one well has been drilled. It is very much a "frontier area." There is up to 5 km of sedimentary section in parts of the basin and several large drillable structures have been recognized from existing seismic data. It is believed likely that suitable fine grained source and carbonate reservoir rocks will be intersected at depth. (e) The New Ireland Basin is the least explored of all. In fact, it was not recognized as a basin with resource potential until a research vessel cruised the waters to the northeast of New Ireland in the early 1980s. The only available data that give clues to the potential of this basin are the results of the research cruise Attachment A Page 2 of 5 seismic survey and mapping of onshore sequences of New Ireland. From this limited information, it is possible to say that there is some potential for hydrocarbon accumulations off the coast of New Ireland. Much of the basin is in deep water so it will likely be necessary to look for structures near the shore. Suitable source, reservoir and cap rocks have been recorded in the onshore sedimentary sequence and are believed to extend offshore where there is probably more than 4 km of sediment. In addition to these basins, there are large areas of Bismarck and Solomon Seas under which the thickness of sedimentary section is virtually unknown, although they have been partially covered by separate seismic surveys. Petroleum Exploration and Development 2. Oil exploration in PNG was first attempted between 1913 and 1920 with the drilling of six bore holes in Gulf Province (Papuan Basin). It yielded small amounts of crude which was considered commercially unattractive. By 1981, about 130 vells had been drilled with no significant hydrocarbon discovery and the prospecting companies were pulling out. In 1983, GOPNG obtained IDA credit (No. 1279-PNG) for a technical assistance project to generate an integrated picture of PNG's petroleum potential, identify new exploration leads and strengthen GOPNG's capacity to promote and offer exploration acreage to international oil companies. The project revitalized exploration activity. Since then, 98 wells have been drilled, mostly in the Papuan Basin, with 22 oil and gas discoveries along with the possible reserves estimates which are shown in the Table 1. 3. Among these, the prominent discoveries are Iagifu/Hedinia/Usano (225 MBBL oil and 1.03 TCF gas); Hides (40 MMBBL condensate and 2.7 TCF gas); Pandora (1.5 TCF gas); Angore (61 MMBBL condensates and 2.8 TCF gas; SE Gobe (73 MMBBL oil); and SE Mananda (48 MMBBL oil). The lagifu-Hedinia structure inclusive of nearby Agogo and Usano fields would account for possible reserves of 277 MMBBL oil and 1.52 TCF gas; and Pandora together with adjacent reefal accumulations could provide reserves of up to 5 TCF. 4. The interest of international oil industry in Papua New Guinea's petroleum exploration although waning in recent years remains strong, particularly in the Papuan Basin. In August 1993, there were 31 Petroleum Prospective Licenses (PPLs), covering about 165,000 sq km, and 5 applications pending. Out of the 31 PPLs, six are in the North New Guinea Basin and 25 are in the Papuan Basin. However, 4 of the North New Guinea Basin PPLs totaling over 46,000 sq km are in the process of being surrendered. Three 3 PPLs in the Papuan Basin consist of only 1 block each. The highlights of petroleum exploration since 1985 and the current year program are summarized in Table 2. 5. The dispersed and remote locations of oil and gas finds combined with the small size of the domestic market j/ constrain their development for local consumption. Also, due to the remoteness of oil and gas finds, extensive assessment of infrastructure needs is required to promote export based development project. Commercial development of hydrocarbon resources commenced in the last quarter of 1990 with the grant of petroleum development licenses (PDL1 and PDL2) for the development of Hides condensate/gas field and I/ Total consumption of petroleum in 1990 amounted to about 4.0 million barrels. Attachment A Paae 3 of 5 lagifuledinia oil fields in the Southern Highlands province. The Hides Development Project, completed in 1991, is owned by a joint venture consisting of British Petroleum (95 percent) and Oil Search (5 percent). It involves drilling of two production wells and construction of a gas processing plant, gathering lines and a condensate storage facility, at an estimated cost of US$40 million,g/ for supply of 15 MKCFD natural gas to a 42 MW power station owned by the Porgera mines. The lagifulHedinia development, called the Kutubu Development, is owned by a joint venture comprising GOPNG and six international oil companies 3/ with Chevron as its operator. It is based on the production and export of oil from lagifu, Redinia and other prospective fields in the vicinity. It involves the drilling of production wells, construction of gathering lines, a central production facility, a 260 km long pipeline for oil transportation and a marine loading terminal. The project was estimated to cost about US$1.0 billion 4/ and the production of first oil commenced in late June, 1992. Proiect Imolementation 6. DNP will have overall responsibility for implementation of the project. The head of the Petroleum Division will be the Project Manager. The Finance and Administrative Services Division of DMP will assist the Project Manager in project accounting, procurement and recruitment. DMP intends to employ experts through a long-term (3-5 years) technical collaboration arrangement with an appropriate organization in a developed country, instead of direct recruitment by the Department, as it would provide a greater assurance of the quality of staffing, accountability and commitment of those involved, and ease of replacement, if necessary. For this purpose DMP has contacted appropriate organizations in Western Europe, North America and Australia. Experts in petroleum geology, archive management, geophysics reservoir engineering, production engineering, drilling, pipeline and facilities engineering, petroleum economics and legal and fiscal policies will be engaged. These experts will be responsible for monitoring, control, planning, evaluation and promotion of petroleum exploration and development in Papua New Guinea; preparation of TORs and supervision of studies; preparation of a training program for national officers; on-the-job training for national officers; preparation of procurement documents and evaluation of bids for procurement of equipment and installation services. The experts will also supervise installation and commissioning of equipment. Construction of laboratory building will be carried out by local contractors. The project implementation schedule is attached as Annex G. 21/ Exploration expenditure is estimated to have been US$52 million. I/ The State - 22.5 percent (carried interest); Chevron Niugini - 19.38 percent (operator); Ampol Exploration - 16.46 percent, BHP Petroleum - 9.68 percent; Oil Search Ltd. - 7.76 percent; and Mitsubishi - 4.8 percent. Through royalty, taxes and equity, the State could receive about US$1.1 billion by the year 2000. 4/ Excluding exploration expenditure which is estimated to have been $440 million. -39- Attachment A Page 4 of 5 Procurement and Disbursement 7. All major items of equipment financed from the proceeds of the loan will be procured through international competitive bidding (ICB) in accordance with the Bank guidelines except for items of small value to be used in the installation of computers and laboratory equipment (not exceeding US$50,000 each and US$470,000 in total) which are available off-the-shelf, such as electrical switchgear, flex, pipes, valves, etc. Such small value items will be procured through local and international shopping after receiving price quotations from at least three eligible suppliers in accordance with the procedures acceptable to the Bank. Bidding packages of US$300,000 or over will be subject to the Bank's prior review. Standard bidding documents will be used for ICB procurement. Consultants' services under the project will be procured in accordance with Bank guidelines. Prior Bank review or approval of budgets, short-lists, selection procedures, LOI, proposals, evaluation reports and contracts will be required for consultancy contracts costing more than US$100,000 equivalent each. However, this threshold will not apply to the TOR of such contracts or to the employment of individuals, to single source selection of firms or to assignments of critical nature, all of which will be subject to prior review. 8. The Bank loan will be disbursed against: (a) 100% of the foreign exchange cost of imported equipment, materials and related services; (b) 100% of local expenditures (ex-factory cost); (c) 65% of the local expenditure for other items procured locally (off- the-shelf); (d) 100% of expenditures for training; and (e) 100% of expenditures for consultants' services. 9. The Implementation period for the project is estimated at six years and the disbursement schedule is largely in line with the Bank's standard disbursement profile. Projected disbursements are based on loan effectiveness and the signing of major contracts in FY94. 10. To facilitate disbursements, a Special Account will be opened in the Bank of Papua New Guinea by DMP. The Account would be maintained in Kina and an initial deposit of US$700,000 equivalent (approximately equivalent to four months estimated average eligible expenditures) would be made to this Account. Disbursements under the project for contracts below the value of $100,000 equivalent would be made on the basis of Statements of Expenditures (SOEs). All documentation in respect of SOE disbursements will be maintained in the DMP and will be subject to periodic sample review by the Bank. All payments for contracts above this threshold would be supported by full documentation. To the extent possible, all payments would be channelled through the Special Account. However, disbursement against expenditures in respect of contracts involving foreign currency payments could, at GOPNG's request, also be made under IBRD direct payment procedures, subject to a minimum of US$200,000 per application. 4u Attachment A Pafe 5 of 5 Project Reporting, Accounts and Audits 11. The DMP will prepare and submit quarterly progress reports on an agreed format to the Bank on the status of the project. This report will be the main instrument for monitoring project accomplishments. 12. The DMP will maintain separate projects accounts in a form satisfactory for annual audit. These accounts, including the Special Account, will be audited annually by independent auditors acceptable to the Bank and will include opinions on all expenditures including those made against SOEs. The DMP will submit the audited accounts to the Bank not later than six months after the close of each fiscal year commencing with 1994. Agreement was reached at negotiations on the above reporting, accounting and auditing arrangements. Supervision Plan 13. Biannual supervision for the first three years and annual supervision for the next three years is envisaged. The supervision would cover the studies, formulation of standards, impact of fiscal policies, LNG promotion activities as well as the progress in procurement, disbursement, technology transfer and institution building. The mix of specialties and frequency and duration of missions likely to be needed to ensure adequate project supervision are given in Annex H. PAPUA NEW GUINEA PETROLEUM EXPLORATION AND DEVELOPMENT T/A PROJECT DEPARTMENT OF MINING AND PETROLEUM Secretary for Mining & Petroleum III I I Minerals & Mines Geological Finance & Energy Policy Survey Administrative Services II II I I ll i I Petroleum Branch Petroleum Resources Archive Drilling Reservoir Petroleum License Assessment Engineering Geophysics Administration Minister Secretary Executive Deputy OMcer Secretary Mining Policy Petroleum Corporate Service Geological Survey Division DivisionDivision DivIsion DIsion Resource Development Mining Policy License Administration Finance & Accounts Geotechnical & Hydrogeologic Surveys Inspection & Engineering Petroleum Policy Exploration General Administration Geological Mapping Titles Administration Petroleum Engineering Computing & Database -Geophysical Surveys Coordination Small Scale Mining Drafting & Printing Volcanological Observatory L Library Project Implementation Schedule 1994 1995 1996 1997 1998 1999 1_2_3_4_1_2_1234123412341234 12341234 Consultants Advertisement and Preparation of T.O.R.s --- Duration of Assignment Extention of Contracts of Consultants (if necessary) Training Recruitment and Selection of Candidates --- Admission Fellowship Fellowship Courses Building Tenders ---- Construction - Computer Center Ordering Equipment ------- InstallatIonflraining Laboratory Ordering Equipment --- ---- Installation/Commissioning Studies Refinery LNG Study LNG Promotion Safety Study ----- Preparation of TOR or inviting and analysis bids TABLE 1 : HYDROCARBON DISCOVERIES IN PAPUA NEW GUINEA CURRENT DISCOVERY YEAR TYPE POSSIBLE RESERVES NO. OF PROVINCE OPERATOR RECOVERABLE WELLS IN FIELD Barracuda Kuru 1956 Gas 3 Gulf Barracuda Bariweka 1958 Gas 0.09 TCF 2 Gulf Command Purl 1958 Oil - 1 Gulf Barracuda lehi 1960 Gas 0.07 TCF 1 Gulf Barracuda Bwata 1960 Gas 0.08 BCF 1 Gulf Trend Uramu 1968 Gas 0.12 TCF 1 Gulf Pasca (1) 1968 Gas, condensate 0.14 TCF, 10 MMBC 3 Gulf Chevron Juha 1984 Gas, condensate 1.34 TCF, 57 MMBC 3 Western Chevron lagifu 1986 Oil 0.25 TCF, 90 MMBO II S. Highlands Chevron SE Hedinla 1987 Gas, oil 0.15 TCF, 3 MMBO 3 S. Highlands BP ides 1987 Gas, condensate 2.71 TCF, 40 MMBC 3 S. Highlands ' Chevron Hedinia (2) .1988 Gas, oil 0.25 TCF, 78 MMBO 12 S. Highlands IPL Pandora A (3) 1988 Gas 1.49 TCF 1 Gulf IPL Pandora B 1992 Gas 0.08 TCF 1 Gulf Chevron Agogo 1989 Gas, oil 0.18 TCF, 14 MMO0 7 S. Highlands Chevron Usano 1989 Gas, oil 13 MMBO 2 S. Highlands BP Angore 1990 Gas, condensate 2.8 TCF, 61 MMBC 1 S. Highlands BP/Santos Elevafa 1990 Gas, condensate 0.53 TCF, 15 MMOC 1 Western Conoco/DuPont Tarim 1990 Gas Not defined 1 Western Chevron P'nyang 1990 Gas, condensate 1.86 TCF, 16 MMBC 3 Western BP/Santos Ketu 1991 Gas, ?condensate 0.59 TCF, 16 MMBC 1 Western Chevron SE Mananda 1991 Gas, off 87 MMI0 1 S. Highlands Barracuda/Chevron SE Gobe 1991 Oil 110 MMBO (possible) 6 Gulf/S. Highlands Source: Department of Mining and Petroleum. TABLE 2: PETROLEUM EXPLORATION HIGHLIGHTS 1985 1986 1987 1988 1989 1990 1991 1992 1993 EST. NEWLY PPLS GRANTED (a) 1 12 16 6 5 4 5 5 8 PPLS EXPIRED, SURRENDERED OR 0 3 4 1 5 2 12 8 12 CANCELLED TOTAL NUMBER OF PPLS (b) 12 21 33 38 38 40 33 30 26 APPROXIMATE EXPENDITURE K32.3M K45M K74M K116M K149M K225M K170M K80M K55M EXPLORATION WELLS DRILLED (c) 4 3 7 10 27 21 11 7 3 DISCOVERY WELLS (c) 1 2 3 6 14 8 6 4 2 Ln NEW FIELD DISCOVERIES (d) 0 1 2 2 1 4 3 2 0 NOTES: (a) PPL is a Petroleum Prospecting Licence (d) 1986 = IAGIFU PDL is a Petroleum Development Licence 1987 = SE HEDINIA, HIDES PLL is a Pipeline Licence 1988 = IEDINIA, PANDORA 1989 = AGOGO (b) Figures at year end 1990 = ANGORE, ELEVALA, PNYANG, USANO 1991 = KETU, SE MANANDA, SE GOBE (c) Excludes development wells but includes 1991 = GOBE, PANDORA B extension discoveries and sidetracks. -PAPUA NEW GUINEA 0~ NEW PETROLEUM EXPLORATION AND DEVELOPMENT TECHNICAL ASSISTANCE PROJECT PETROLEUM RESOURCES DISCOVERIES; MANUS GAS V o OIL -F S T GAS AND 01L l EAST SEPIK | GAS CONDENSATE ¯ - NEW IRELAND SEDIMENTARY BASINS s M AJOR PETROLEUM STORAGE DISCOVERIES UNDER DEVELOPMENT PETROLEUM UCENSE 8OUNDARIES -20.m MADANG Ltu z j,-n PETROLEUM IMPORT PORTS 9n - PROVINCE BOUNDARES 7 o -ESTE KL.b--- INTERNATIONAL BOUNDARIES x 9rkoES EAST 0 H s u -"STERN - N EW BRITAIN BOitVU OROBE WBIOUGA\ iE ,\7L owa ERN - - - - - - -- - - - - SOLOMON 69G|lF ISLANDS " ~ 12 <i Ppodfti CP VOGEL ' SBASIN 12 <pPORT --UTA A Y -- AUA- -lA MILNE BAY CENTRAL 0o 0 0 0 150 200 250 310 samri IOLOMETES PAPUJA ' 0041 ýEW GUINEA DOONESIA / SOMON ISLAND$ VANUATU 00. g0aIYrWlS.t004f AIJSTRAIS A CALEDONIA 144 146° gSo 152- 154- 1 . .1. .2JANUA19L0