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p. 12 of 30 BACK | NEXT Introduction Regional Energy Context Energy Policy Issues Structural Reform Background Multilateral Coordination Power Subsector Reforms Hydrocarbon Subsector Reforms Private Sector Role Energy Efficiency Energy Pricing Energy and Environment Rural Energy Development Regional Cooperation and Energy Development Conclusions and Recommendations

Bank Policy Initiatives for the Energy Sector : Energy Policy Issues : Structural Reform

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Hydrocarbon Subsector Reforms

24. Compared to the Bank's involvement in the power subsector, its involvement in the hydrocarbon subsector has been relatively modest (see para. 9). Most of the projects financed were related to transmission and distribution of natural gas and, to a lesser extent, to development of oil and gas fields. Oil to a large extent and coal to a lesser extent are internationally tradeable commodities and, therefore, their production is generally considered more attractive to commercial developers. Natural gas, on the other hand, is not a readily tradeable international commodity and, therefore, its development has greater difficulty in attracting investors. Moreover, natural gas transmission and distribution have the character of natural monopolies.

25. Hydrocarbons are critical to DMCs' economic development. Without a reliable supply of primary energy, it is not possible to build the key power, transportation, and manufacturing capabilities that are required for an outward-looking industry and service economy which is the key for rapid development. Expanding indigenous hydrocarbon resources, either through new finds or exploitation of undeveloped reserves, has a particular priority in meeting the primary energy requirements since many DMCs spend a substantial part of their scarce foreign exchange earnings on importing petroleum. Natural gas reserves in DMCs, in particular, are underexploited. Natural gas is the most efficient energy form for many applications and is environment friendly compared to alternative fuels. A more productive hydrocarbon sector will also create additional benefits through downstream integration as natural gas and associated liquids are the most appropriate feedstocks for the fertilizer and the petrochemical industries.

26. The Region's hydrocarbon subsector development needs are concentrated in the poorer DMCs. It is estimated that of the DMCs' total capital requirements of $55 billion a year in the 1990s, about 83 percent for oil and gas development and about 98 percent for coal development will be in DMCs with per capita GDP lower than $1,000 and with limited access to capital markets. As such large investment needs cannot be financed through government budgets, the majority of the investment has to come from the private sector, both domestic and foreign. To further augment resources, public sector hydrocarbon entities have to be corporatized and commercialized to achieve pricing and operational efficiencies that will support capital market access. Accounting and external audit practices also have to be improved to international standards to enable these entities to raise borrowings from the domestic and foreign markets based on their financial performance. In the medium term, it is clearly understood that governments should be able to divest to the private sector most of the commercial activities and retain for themselves only those which could be classified as providing merit or public good. Governments will therefore be encouraged to divest their oil and gas companies to the private sector. Such divestments will need to be done gradually, as the value of their equity may be several times higher than the present absorptive capacity of the domestic capital market.

27. There appears to be, however, some justification for the currently government-owned entities to construct and operate natural gas transmission pipelines as they involve long gestation and pay back periods not attractive to the private sector. Gas development will be critically dependent on transmission infrastructure in the DMCs. At present, the DMCs have just over two kilometers (km) of gas pipeline for every billion cubic meters of reserves (compared to 90 km per billion cubic meters in the United States). Many DMCs, despite having huge natural gas reserves, are unable to utilize them adequately because of the inadequate gas pipeline infrastructure. Plans are being made to construct a total of about 32,000 km of pipeline over the next decade so as to triple present transmission capacity, at a cost of $45 billion. Even after such expansion, the DMCs will lag far behind the more developed countries in respect of gas pipeline infrastructure.

28. Similarly, pipeline infrastructure for oil and oil products in many DMCs is grossly inadequate, resulting in supply shortages and inhibiting fresh private investment in exploration and development. Transportation by alternative means has resulted in unacceptable levels of congestion of roads, ports, and railways, environmental degradation, and safety risks. The Bank would encourage private sector investments in pipeline infrastructure, and to the extent it remains unattractive to the private sector, public sector investments in this regard would be considered acceptable provided they operate as a common carrier and encourage upstream investments in exploration and development.

29. There is an urgent need and significant scope for the improvement of efficiency and environmental standards. Operational efficiencies of many public sector entities in the hydrocarbon subsector are well below international standards. In some cases, institutional weaknesses include poor financial condition, low tariffs, high accounts receivables, and high system losses. Strategies and investments are poorly formulated resulting in the sub-optimal capturing of the true value of reserves and capital. Onstream availability and utilization of many refineries is below the acceptable norm of 90 percent despite a shortage of products. Safety and environmental aspects of coal mining are in urgent need for upgrading. Environmental regulations relating to nitrogen, sulphur, and lead need major improvement, as well as strict enforcement in all the DMCs. There is an urgent need to facilitate technology transfer for meeting more stringent environmental norms. The Bank can play a developmental role in these areas.

30. To enhance the indigenous self-sufficiency level of hydrocarbon supplies, the level of exploration and development will have to increase. For this, the governments will have to adopt well head pricing policies, procedures and mechanisms which make it attractive to the local and international oil and gas firms to invest in these activities. Steps that could be taken include identification of offshore and onshore blocks for exploration based on detailed resource surveys, carrying out credible rounds of biddings, adoption of a concessions approach or a production sharing agreement, accelerated development of already proven oil and gas fields on terms fair to both the bidder and the host country, and adherence in good faith to the signed contract. The existence of a transparent and fair regulatory system is an essential precondition for gaining the confidence of international investors.

31. In this context, the Bank's strategy for the 1990s in DMCs with significant hydrocarbon resources would be to stimulate their economic development and increase their market orientation by catalytic funding of reform-oriented public sector hydrocarbon entities, as well as resource constrained private ventures. The economic development will be stimulated by (i) accelerated indigenous hydrocarbon resource development; (ii) elimination of transportation and delivery bottlenecks; (iii) enhancing efficiency and effectiveness of energy production and utilization, with special focus on DSM in the industrial, transportation, and domestic sectors; and (iv) adoption and enforcement of stronger environmental regulations. Market orientation will be facilitated by financing projects and programs designed to (i) achieve progress in enterprise restructuring and regulatory reforms, skill building, and price reforms; (ii) promote private sector participation and investment; (iii) promote efficiency enhancing trade through regional projects in the subsector; and (iv) enhance the provision of "public goods" through appropriate regulation and adoption of industry standards.

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