THE REPUBLIC OF UGANDA

Oil and Gas Revenue Management Policy

Ministry of Finance, Planning and Economic Development Oct 2011

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Table of Contents Chapter Two........................................................................................................................................12 Assessment, Collection and Administration of Oil & Gas Revenues...............................................12 2.1 Legal Framework.....................................................................................................................12 3.1 Issues........................................................................................................................................14 3.2 Impact of Dutch Disease....................................................................................................16 3.3 Benchmark Oil Pricing............................................................................................................17 3.4 Fiscal Policy Management......................................................................................................18 The Government shall formulate a long-term development/fiscal strategy. The strategy shall assess the pros and cons of the alternative uses of oil revenues including increasing expenditures, cutting taxes, paying back outstanding debts and building oil savings. The strategy shall include (i) a prudent path of expenditures, with short-term adjustments due to cyclical variations; the possibility of front-loading expenditure path (ii) commitment that savings will be used to finance future nonoil deficit; and (iii) a comprehensive asset strategy.. .18 3.5 Fiscal Rule for Managing Petroleum Revenues......................................................................18 In theory, oil revenues should be handled in the budget execution process as the rest of government revenues. However, oil revenues can create great pressure to either increase spending above the budget appropriations or divert the use of oil revenues to non priority spending..........................................................................................................................................19 3.7 Oil Revenues and Inter Governmental Fiscal Transfers ........................................................20 3.8 Public Investment Planning....................................................................................................21 3.9 Local Content...........................................................................................................................22 Chapter Four.......................................................................................................................................23 Banking, Accounting and Auditing of Oil and Gas Revenues..........................................................23 4.1 Banking and Accounting Arrangements.................................................................................23 4.1.2 Legal Framework for the Petroleum Fund.......................................................................23 4.1.3 Deposit and Withdrawal from the Fund...........................................................................24 4.1.4 Asset Management Practices................................................................................................25 The criteria for investing the balance of the Fund are to be determined according to the volume; main expected use, and time horizon of oil savings. The responsibility of designing the investment strategy of government assets, including the Fund shall lie with Ministry of Finance. Within the ministry an investment committee shall be set up to advice the Minister on the liquidity requirements of the Fund in light of the MTFF and the budget. The committee shall not have direct investment responsibilities, which would remain with the Central Bank..................25 The management of the balance of the Fund shall be integrated into the government assetliability. The balance sheet of the Fund shall be consolidated with other government financial operations into a statement of assets and liabilities that is audited and presented twice a year to Parliament. The statement shall include information on public debt and asset liability position. .........................................................................................................................................................25 4.1.5 Accounting of Oil and Gas Revenues.................................................................................25 4.1.6 Auditing of Oil and Gas Revenues.......................................................................................25 4.1.7 Accountability and Transparency of Government Operations............................................26 5.1 Governance of the Petroleum Fund.........................................................................................27 5.1.1 Roles of MoFPED (Owner/Principal)..............................................................................27

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5.1.2 Responsibilities of the Central Bank (Manager /Agent).................................................28 5.2 Investment of the Petroleum Fund Proceeds...........................................................................29 5.3 Oversight and Controls...........................................................................................................29 5.5 Transparency............................................................................................................................30 5.6 Encumbrances..........................................................................................................................31 .......................................................................................................................................................31 Chapter Six..........................................................................................................................................32 Conclusion..........................................................................................................................................32 Appendix........................................................................................................................................33

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Acronyms BoU GDP IMF ITA MDA MoFPED MTBF MTEF MTFF NATOIL OAG PAYE PFAA PSA URA VAT Bank of Uganda Gross Domestic Product International Monetary Fund Income Tax Act Ministries, Departments and Agencies Ministry of Finance, Planning and Economic Development Medium Term Budget Framework Medium Term Expenditure Framework Medium Term Fiscal Framework National Oil Company Office of the Auditor General Pay As You Earn Public Finance and Accountability Act Production Sharing Agreement Uganda Revenue Authority Value Added Tax

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Executive Summary Following the discovery of oil in commercial quantities in Uganda in 2006, the probability of oil production is high, the volume, costs and timing of production will start in the medium term on completion of field appraisals and development of necessary infrastructure. sources. Oil production is to provide Government with substantial revenues in comparison to the existing non-oil If, as expected, these resources are well managed, they will represent a big economic opportunity for the country; not-withstanding their impact on macroeconomic management. However, the management of resource revenues tends to pose significant challenges in the form of the so called resource curse a complex phenomenon through which an abundance of resources revenues can translate into stagnation, waste, corruption and conflict. Some of these challenges derive from the macroeconomic and budgetary difficulties of managing large and volatile funds. Large-scale oil production in addition will have implications for Ugandas external position, monetary sector and the real non-oil sector of the economy. Therefore the future fiscal policy design has to take into the overall macroeconomic framework that incorporates oil production and revenues there from. In January 2008, a National Oil and Gas Policy was approved, which articulates a best practice framework for managing oil resources. The purpose of this paper is to detail a policy framework for the management of the anticipated oil revenues. Key Policy Highlights: The following are the key policy recommendations that have to be considered in the management of oil revenues to ensure that it contributes to the economic and social transformation.

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Collection of Government Take The current fiscal regime for the petroleum sector is governed by the Petroleum and Exploration and Production Act 1985(PEPA) and Production Sharing Agreements (PSA) the Income Tax Act, and other relevant tax laws. Expected revenues are signature bonus, royalty, profit oil, Income tax, dividends, premiums, in-kind-revenues, excise duty, VAT among others. Collection and Adminstration of the Government revenues from oil activities will be done by the URA, in collaboration with other relevant institutions, such as the Petroleum Regulatory Authority and the National Oil Company. These institutions will work together in the day-to-day monitoring of production, which will enable a proper valuation, assessment and collection of the Government revenues at the well-head level. Further, any revenues to be received after disposition of the in-kind oil after election by Government, will be deposited to the petroleum revenue account in Bank of Uganda. Oil Revenue and Inter Governmental Fiscal Transfers The Constitution vests with Government the responsibility of managing any natural resources on behalf of the people and to ensure its equitable distribution. Government, through the budget consultation process with stakeholders, shall put in place a mechanism of how oil revenues will be shared between the central and local governments so as to promote social cohesion and stable investment and production environment. Fiscal Policy Management The country will continue with its prudent fiscal policy that will include sustainable path for the non-oil budget deficit over the medium term. bust cycles and excessive borrowing. The fiscal policy will be aimed at avoiding the Dutch disease effects, boom and For both sound fiscal and petroleum revenue management, a special Fund will be set up in Bank of Uganda. The Oct 2011 6

Fund created shall be a separate Government account, which shall be managed in co-ordination with the national budget calendar. The Fund will have the twin objectives of being a source of financing for the budget and for savings for future generation. NonOil Tax Revenues The discovery of oil has the potential to undermine the current tax system. Government shall continue to ensure that tax policy and administration remains focused on improving the non oil tax revenue effort, in addition to ensuring that oil revenues do not undermine the current tax system given that oil is a depletable resource. There is a very limited scope for tax cuts. Cutting taxes alongside falling external support would impact on fiscal space for increasing public spending or investment. External Financing and Oil Revenues The National development plan has infrastructure investment mainly in transport, energy supply and ICT among others as the key growth drivers, this will require significant resources. Government will therefore continue in the medium term to borrow and solicit for grants to supplement the other sources of financing for the sector. However, debt acquisition will continue to be in line with the existing debt strategy. Fiscal Rule for Managing Oil Revenue A fiscal anchor to manage oil revenues will be put in place in order to mitigate the risks to the economy associated with natural resource wealth. The anchor sets out the level and process of integrating oil revenues within the overall fiscal framework in a manner that limits the impact on the non oil sectors. An expenditure path (which could be a nominal expenditure level to national output) consistent with the broader macroeconomic management objectives will be used as the fiscal anchor for managing oil revenues. After taking into account sectoral absorptive capacity, oil revenues drawn from the Petroleum Oct 2011 7

Fund will be transferred into the Consolidated Fund to finance the non oil budget deficit (i.e. the gap between non oil related resources and overall expenditures). Within the framework for managing oil revenues, a portion of these revenues will be set aside and invested for future generations use. These resources will be drawn on at such a time when the oil and gas resources are exhausted. Oversight and Controls The collection, management, and use of all oil - derived revenues shall be subject to detailed oversight as provided for under the Constitution, the PFAA 2003 and the National Audit Act 2008. These laws will be strengthened to ensure compliance.

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Chapter One Introduction

1. Background

Exploration work undertaken in the Albertine Graben confirmed the existence of reserves of oil in commercial quantities in Uganda during 2006. Estimates show that oil production could be sustained at around 150,000 barrels per day for 20-25 years based on the estimated reserves of 2.5 billion barrels. Production at these levels for 20 years would equate to total production of 1,095 million barrels. production. The emergence of the oil and gas resources presents opportunities as well as challenges. The key advantage is that oil revenues are generated by the discovery of a sub-soil asset -a gift from nature. The discovery of oil reserves will translate into an improvement in the Governments net worth and hence the expansion of the countrys GDP and the Governments net financial worth. However, experience shows that with oil revenues, there can be challenges, especially if these revenues are mismanaged. The key question is how to avoid the resource curse, a complex phenomenon in which, through several economic, institutional and political economy transmission mechanisms, oil revenues could translate into economic stagnation and waste. transmission mechanism is the Dutch Disease One of the that is the set of Following this discovery, the country has since embarked on the next phase which involves appraisal, development and

macroeconomic effects caused by a large increase in resource funded spending.. If mainly allocated to domestically produced goods, a large increase in spending can push up domestic prices, and eventually appreciate the nominal and real exchange rate. This results in a shift of capital and labor

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into the production of non-traded goods and an erosion of the competitiveness of the non-resource economy. A second transmission mechanism of the resource curse takes place through the extreme volatility of oil revenues, which can lead to waste, boom and bust cycles and excessive borrowing. Waste tends to arise out of the pressure to expand expenditure beyond the execution capacity of the economy and ensuing poor quality programs. Further, it could also arise from frequent upward and downward adjustments of expenditure and impacting on spending programs. Excessive borrowing arises from the notion of anticipating oil booms A third transmission mechanism arises from the fact that resources are generated by depleting a non-renewable non-financial asset, which means that oil revenues are temporary and exhaustible. The non-renewable nature of oil revenues implies that independently of their modality, resource revenues could be considered as derived from consumption or sale of an existing asset rather than additional income. This therefore calls for the establishment of a fiscal framework relating to the utilization, savings and investment of oil revenues that will ensure that the gains made over the last 20 years in the areas of economic and fiscal management are not reversed. The objective of this paper therefore is to provide details of a policy framework on the planning and budgeting practices to cope with the oil revenues which are volatile and exhaustible. The Government will be formulating and assessing long-term projections of oil revenues; outline the long term strategy for the allocation of resource among alternative uses and designing and implementing medium term fiscal plans conducive to achieving the countrys long-term strategy. The assessment shall take into account the size of the resource proven reserves, costs of production, realistic projections for world Oct 2011 10

prices, the extraction and depletion rates and the fiscal regime with all the uncertainties attached to these aspects. The paper is organized in six parts. Chapter two addresses assessment and collection of oil revenue and tax administration issues including the relevant legal framework. This is followed by a discussion in chapter three of banking, accountability and audit arrangements. The chapter also talks about the establishment of a Petroleum Fund. Chapter four discusses pertinent issues relating to integration of oil revenues into the fiscal and monetary frameworks as well as inter-temporal issues relating to savings of oil revenues. In chapter five, governance issues as well as general aspects of petroleum fund management are presented. Lastly, Chapter six presents concluding remarks and way forward.

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Chapter Two Assessment, Collection and Administration of Oil & Gas Revenues
2.1 Legal Framework

The legal framework shall include a broad definition and coverage of resource revenue to cover all types including royalties, taxes, bonus, dividends, premiums, and in-kind revenues. In addition, the legal framework shall mandate that all revenues be included in the budget documents on gross basis. 2.2 Collection and Administration

The oil and gas sector will generate a significant number of different cash streams that will in turn generate revenues for Government (see box 1). Streamlining collection of these revenues is essential to ensure transparency, ease of monitoring and accountability. In this regard, all revenues shall be collected and deposited in a special petroleum account to be established in Bank of Uganda, including collections from proceed of the sale of oil in kind. Profit Oil Received in Kind In some instances, the Government shall elect to receive its share of production of oil in kind. At this stage, the NATOIL1 will take charge of marketing the oil. However, once disposed of, the revenues received will be deposited directly on a Petroleum Fund account in Bank of Uganda (which will constitute part of the Petroleum Fund) within a time period to be stipulated. The operational costs of NATOIL will be financed through the Government

In line with the 2008 National Oil and Gas Policy, a National Oil Company (NATOIL) will be established whose main role, amongst others will be to take charge of marketing the oil received in kind.
1

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budget and the mode through which the company (NATOIL) will access funding for its activities will be stipulated in the law that will establish it.

Box 1: Evolve:

Summary of How Oil Revenues are expected to

Signature Bonuses and Surface Rentals Before actual oil production the only receipts are signature bonuses and surface rentals. (To date, these revenues have been collected by the line Ministry as Non Tax Revenues.) Royalties Under the terms of the PSAs and as contained in ITA oil companies pay a royalty on gross oil production, at a rate that varies with the rate of production (the rate ranges between 7% and 12.5%). Profit oil Given that oil companies have met all the costs of exploration, development and production they are allowed to recover their costs from oil produced (otherwise referred to as Cost oil). This is however subject to cost recovery limits. The remaining oil after cost recovery is referred to as Profit oil and is shared between the Government and oil companies in a ratio that varies with the rate of production. Taxation In addition to paying license and surface rental fees, oil companies are subjected to the usual business taxes on their share of profit oil. These include Corporation tax, PAYE on employee salaries, Withholding tax on interest and dividend payments, and income earned by sub contractors, and capital gains tax on the transfer of interests, all of which fall under the income tax head. In addition, as the sector develops, the operations further down the value chain may also be subject to tax under standard domestic tax laws. These include activities such as refinery operations and sale of petroleum products.

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Chapter Three Fiscal and Monetary Management Framework

3.1 Issues

The emergence of an oil and gas sector presents a unique opportunity for Ugandas next phase in the development process, given that the sector is expected to generate significant revenues to supplement existing resources. At the same time, if poorly managed without due regard to the economys absorptive capacity, the oil and gas wealth could easily reverse the gains made in the years especially in the areas of governance, export diversification, macroeconomic stability and structural transformation. International experience suggests that many countries rich in natural resources are poorer and less stable than countries that are less well endowed. To avoid this resource curse it is important to examine the policy challenges that arise with the integration of oil revenues into the Government budget and the overall macro economy. These challenges include; inflation control, exchange rate appreciation pressures and its implications on the tradable good sector, the need for equitable intergenerational distribution of oil resources, the need to consolidate revenue collections from traditional sources, the challenge of managing the Government budget in the face of volatility in oil prices and the risk of channeling oil resources to non-productive projects. The challenges are further elaborated in the sections below; a. Oil revenues show a bell-shaped pattern. The challenge is how:

(a) to transform a windfall to a permanent income (b) to avoid overheating the economy and instead sustain higher growth and(c) to avoid Dutch disease. As is the case in many natural resource rich countries, earnings from these resources constitute the bulk of government

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revenues. In countries where the authorities failed to strike the right balance between oil and non oil revenue generation, the result has been an over reliance on the former as the main source of budget financing. The non oil revenue sector is often neglected with the onset of oil related revenues inflows. b. Experience also shows that with a new found resource, a major

temptation in many new natural resource countries has been to use oil wealth to, among other things finance reductions in taxes in the non-oil economy. While in principle this could boost economic growth, by reducing taxes that distort the behavior of households and firms, empirical evidence has shown that that this is not always the case. Allowing non-oil sector revenue collections to fall would have the disadvantage of leaving little fiscal space for increasing public spending or investment. The only way the oil wealth will be beneficial to the country is if the budget is re-oriented towards export sector diversification and import-substitution production activities. c. It is important that Government remains committed to

enhancing the non-oil related revenues given that oil revenues are volatile and depletable. Our revenue effort has stagnated at about 12-13% of GDP over the last few years and theres scope for further improvement. d. Volatility of oil revenues. Due to the volatility of oil prices, oil

revenues can vary enormously from year to year. Past experiences of oil price developments confirm that prices tend to follow volatile patterns and have been known to change by as much as 50 percent or more from one year to the next. Short term prices shocks can result in even sharper movements in Given the volatility associated with oil revenues, this will revenue flows.

present a persistent governance challenge with regard to fiscal policy and investment. Protection of the budget from potentially large fluctuations in oil revenue is a big challenge and must be managed if we are to maintain macroeconomic stability. The challenge is further aggravated if oil revenues Oct 2011 15

are allowed to constitute a significant proportion of the countrys GDP, and especially overall fiscal revenues. Therefore, its imperative that oil revenue volatilities should not be allowed to spill into the fiscal operations, as they are likely to adversely affect economic management, as well as undermining the medium term fiscal framework including frustrating investment planning. e. Existing external support has been in form of direct support

through the budget (projects and budget support) and off budget through NGO and other multilateral arrangements with institutions like the UN and USAID. This support has been targeted towards both infrastructure and social development programmes. Government will continue to seek this support to supplement other sources of funding for the budget. On the basis of the estimated production profile production is projected to start at a modest daily output of about 20,000 bpd, which will gradually rise to 60,000 bpd, and further to 160,000 bpd by the end of the 15th year, and in line with demand projections From these projections, its clear that Ugandas oil output will not to be sufficient to meeting all the financing needs nor replace the external support in the medium term. It is therefore necessary that Government continues to engage development partners and solicit for effective external assistance which is consistent with our development and economic management objectives. New borrowings will be done in line with the Debt Strategy and the Partnership Policy

3.2 a.

Impact of Dutch Disease Among the other economic challenges, resource booms normally cause

the currency to appreciate as demand increases. The rise in demand for these resources, coupled with high prices leads to a crowding-out effect of the nonresource sectors, as the value of the domestic currency appreciates or as factors of production shift to the resource sector due to the relatively higher returns. This makes the non resource sectors less competitive. Such a

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phenomenon, normally referred to as a Dutch Disease, materializes due to a mismatch between demand and supply.

b.

Given the expected appreciation of the currency that would come with

sustained large foreign inflows from the oil, it will be important to focus on other factors that determine export competitiveness. The countrys landlocked situation, high transport costs, high fuel costs, and poor electricity supply, remain important considerations in this respect. It is therefore important that oil revenue is optimally applied to generate productivity gains and growth and also address the geographical disadvantage by linking the country to the rest of the world. 3.3 Benchmark Oil Pricing

The estimate of the average level of fiscal revenue which can be sustained over the long term would have to be based on realistic and relatively conservative projections for future oil prices, so that government does not incur expenditure commitments which subsequently prove unaffordable because oil revenues are much lower than were forecasted when the commitments were incurred. Consequently, a mechanism will be put in place to determine a benchmark petroleum price, which will be used for purposes of determining annual revenues from petroleum activities.

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3.4

Fiscal Policy Management.

The Government shall formulate a long-term development/fiscal strategy. The strategy shall assess the pros and cons of the alternative uses of oil revenues including increasing expenditures, cutting taxes, paying back outstanding debts and building oil savings. The strategy shall include (i) a prudent path of expenditures, with short-term adjustments due to cyclical variations; the possibility of front-loading expenditure path (ii) commitment that savings will be used to finance future nonoil deficit; and (iii) a comprehensive asset strategy.

The Government shall adopt medium term fiscal plans. The long-term strategy will be implemented through strengthening medium term (five year) fiscal/expenditure path framework (MTFF/MTEF). The MTFF shall be based on the formulation of alternative scenarios and the spending path that arises from considering the countrys administrative capacity and the most infrastructure needs. The MTFF would be updated each year before the budget for the following year is drafted so that allocations correspond to the first year of the rolling five year spending ceiling. The medium-term fiscal plan shall be the guide in the budget process, to ensure an appropriate management of volatile oil revenues. The medium-term fiscal policy statement establishing a medium term for expenditure aggregates; medium term macroeconomic forecasts and cash budget for MDAs. The government MTEF shall spell out the priorities and the public investment plan, which shall be updated annually. 3.5 Fiscal Rule for Managing Petroleum Revenues

In the near term, the fixed expenditure anchor and related non oil deficit will be used as the fiscal rule. This framework provides the flexibility desired to control overall Government spending to a level that is consistent with the economys needs and absorptive capacity. As part of the framework, a

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Petroleum Fund will be established whose proceeds will be invested for the benefit of future generation. Proceeds of the Fund will be separate from the Bank of Ugandas own foreign exchange reserves. A Petroleum Fund is no substitute for sound fiscal management but a well designed and managed Fund shall help fiscal policy and support a policy of wise-long term management of petroleum wealth. Therefore, the integration of the Fund with overall fiscal framework will be critical to maintaining macroeconomic stability. Uganda has established fiscal prudence over the past two decades, and this should be preserved. Fiscal prudence will help ensure that oil revenue is used productively. Given the countrys level of development, the demographic pressures of a fast growing population, and the publics anticipated gains from oil revenue, the pressures to increase public spending on infrastructure, education and health services, and raise public service wages must be properly guided. Government will be hard pressed to show rapid dividends from the countrys oil wealth. However in the long-term, adjustments will be made to ensure that overall government spending is restored to a level that is equivalent to the return on the Petroleum Funds assets. for future generations. 3.6 Oil Revenues and Budget Execution Therefore, there will be a deliberate effort, particularly in the initial periods, to ensure that significant savings are made

In theory, oil revenues should be handled in the budget execution process as the rest of government revenues. However, oil revenues can create great pressure to either increase spending above the budget appropriations or divert the use of oil revenues to non priority spending. The government shall enhance expenditure controls to prevent budget overruns. The main challenge is how to combat pressures to increase the

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annual withdrawals from the Fund above the level originally budgeted. The MTFF shall clearly establish the annual withdrawals from the Fund by (i) ensuring political commitment to the approved budget (ii) avoid surprises, and last minute requests, by formulating-regularly updating- prudent and sound commitment plans (iii) enhance accounting, reporting and internal control systems. The government shall establish a well designed mechanism for orderly amendment of the budget. The government shall conduct a mid-year review of budget execution. In case of an important shortfall in financing resources (in oil revenues, non-oil revenues, or budget support, among others) or an increase in expenditures beyond the governments control; the government shall (i) seek additional financing, without undermining the sustainability of the government s net financial position (ii) reducing, reallocating some budget allocations or and increasing nonoil revenues and (iii) request Parliament the authorization for a higher than budgeted withdrawal from the Fund. Finally government shall adopt a sound budget and accounting classification system and a well defined reporting system. 3.7 Oil Revenues and Inter Governmental Fiscal Transfers

The Constitution2 vests with Government, on behalf of all people, the responsibility over any natural resources in, on, or under any land or waters in Uganda. The Constitution also provides for Parliament to put in place laws relating to sharing of royalties between central Government and local governments. Oil revenue shared with local governments can be a source of destabilization to local government financing, budgets and investments. In order to avoid the potential to undermine local government operations, and the mode of sharing notwithstanding, oil revenues to be shared with the local governments will
2

In Article 244

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have to be pre-specified. Government will provide for a mechanism of how oil revenues will be shared with local governments and directly affected communities by oil production to ensure equitable distribution, social cohesion, stable investment and production environment. And regardless of the revenue sharing arrangements chosen, the responsibility for stabilization of oil revenues shall be managed by the Central Government, as local Governments capacity to manage such mechanisms is limited and could cause tension between the Central Government and Local Governments if not stabilized. 3.8 Public Investment Planning

Global experience shows that resource rich countries have often fallen into a resource trap in which gross domestic income rises fast, while non resource related domestic output stagnates. Oil resources are a depletable resource, and consequently it is important for sustainable development that the rents from resource extraction lead to income from other activities as a means to overcome the resource trap. Therefore, the manner in which rents from oil are spent is critically important. However, the policy in general and spending on public investment programs in particular should aim for the continuation of existing nontraditional exports and to facilitate the emergence of new export and import substitution sectors given that oil revenue is most likely not be sufficiently abundant to provide a permanent income stream. Government will continue to work towards strengthening the public

investment management system in MDAs.

Although there exists some

procedures to guide the preparation of investment projects, these are different across Ministries, and the capacity in Ministries to prepare, plan, and execute projects remains weak. To undertake public investments priorities, Government is in the process of developing an institutional and rules-based

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system, which requires proper prior analysis of expected economic and social benefits of each public investment project being proposed. 3.9 Local Content

Country experiences from all over the world have shown that local enterprises are the drivers of economic activity and development. The natural resource industry in general and the oil and gas sector in particular can however be elusive to local enterprises in the absence of well thought out policy measures to ensure their integration in the industry. In general, the promotion of local content in the oil and gas sector entails the development of local skills, technology transfer, and use of local manpower and local manufacturing. More specifically, it involves building a workforce with the required skills mix demanded by the sector and building a competitive local supplier base. In addition to the obligations to the oil companies provided for in the PSAs, there will be a deliberate effort to address vocational skills development in the sector in the short term. sector. Guidelines will also be developed to be used by sectors to assist them in aligning skills development with the needs of the oil And over the medium term, Government will focus on expanding and strengthening the delivery of oil and gas sector related education and training through local institutions, and supporting capacity development of local private sector players in the provision of ground handling and logistical services.

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Chapter Four Banking, Accounting and Auditing of Oil and Gas Revenues
4.1 Banking and Accounting Arrangements

4.1.1 Establishment of the Petroleum Fund Ordinarily, the oil and gas revenues should, like all other Government revenues be deposited in the revenue account of the Consolidated Fund, and allocated in accordance with normal budgetary process. However, (i) to help crystallize public support in building a resource buffer for the future; (ii) given the complexity of accountability for multiple petroleum revenue streams (iii) and to provide an easy and transparent way to present and manage the stocks and flows of oil revenues and the anticipated challenges that management of these revenues pose, requires that they are managed under a transparent and segregated arrangement distinct from the Consolidated Fund, into which all revenues directly attributed to petroleum revenues are deposited. The Fund shall be in Bank of Uganda and will be denominated in foreign currency. The inflows and outflows of oil and gas revenues shall be coherently integrated into the budget process. A Petroleum Fund will be established under the control of the Ministry of Finance Planning and Economic Development on behalf of Government. The Fund will be set up with the following objectives: i. ii. Budget Financing Provide for Savings for Future Generations

4.1.2 Legal Framework for the Petroleum Fund The Public Finance and Accountability Act (PFAA) is being rewritten to cater for the revenue the management of public finances, including oil revenues. Oct 2011 23

The PFAA will inter alia include; accounts management which involves components including rules on depositing and withdrawing from the Fund, how the principal and interest earnings may be employed by government and what procedures are to be followed to limit pro-cyclical influences on fiscal policy. 4.1.3 Deposit and Withdrawal from the Fund The Petroleum Fund will receive all revenues from oil taxes, non tax related revenues and any revenues realized from the disposal of the Governments share of profit oil received in kind. Annual withdrawals from the Fund will be determined in the annual budget and aimed at financing the non-resource budget deficit. Any authorization of larger than budgeted withdrawals from the Fund will be subject to transparent and stringent conditions to ensure accountability and misuse. Drawing from the Fund shall be regulated in accordance with established rules. The withdrawal shall be only for purposes of; budget financing aimed at financing the non-resource deficit and savings for future generations. In order to avoid parallel budgeting, the Petroleum Fund proceeds will not be used to finance any projects directly outside of the Government budgeting system. Any domestic spending of petroleum resources will be incorporated in the MTFF/MTEF and subjected to appropriation by Parliament. transferred from the Petroleum Fund to the Consolidated Fund. The amount of withdrawal each year, as determined through the budget process, will be

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4.1.4 Asset Management Practices The criteria for investing the balance of the Fund are to be determined according to the volume; main expected use, and time horizon of oil savings. The responsibility of designing the investment strategy of government assets, including the Fund shall lie with Ministry of Finance. Within the ministry an investment committee shall be set up to advice the Minister on the liquidity requirements of the Fund in light of the MTFF and the budget. The committee shall not have direct investment responsibilities, which would remain with the Central Bank. The management of the balance of the Fund shall be integrated into the government asset-liability. The balance sheet of the Fund shall be consolidated with other government financial operations into a statement of assets and liabilities that is audited and presented twice a year to Parliament. The statement shall include information on public debt and asset liability position. 4.1.5 Accounting of Oil and Gas Revenues

In order to align the activities in the petroleum sector with existing financial management requirements, a new chart of accounts will be introduced and will be used by all companies engaged in the petroleum sector. This will be the basis for determining contract expenses used in apportioning cost oil. It also sets out the cost recognition and accumulation policies for determination of cost/profit oil and also for tax purposes in determining allowable expenditures. 4.1.6 Auditing of Oil and Gas Revenues The Petroleum Fund shall be subject to periodic audits by the Office of the Auditor General who will in turn prepare and submit to Parliament audit reports twice in the fiscal year. The audits shall include audited and reconciled data on oil revenues, production, sales and prices.

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4.1.7 Accountability and Transparency of Government Operations All payments of oil revenues to the government, including by the NOC shall be transparent by expanding the content of the budget documents to include, aside annual budget estimates, the long term oil revenues projections, the MTFF/MTEF, a detailed explanation of the long term fiscal strategy and its assessment, an estimation of the governments non oil sources of financing, and the share of the budget appropriations allocated to priority spending.

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Chapter Five Governance Issues

5.1 Governance of the Petroleum Fund

The overall ownership and control of the Petroleum Fund will be vested in the Ministry of Finance, Planning and Economic Development (MoFPED). The Fund will be managed by the Central Bank on behalf of Government. function is to be provided by Parliament and the Auditor General. 5.1.1 Roles of MoFPED (Owner/Principal) MoFPED will be required to spearhead the amendments to the Public Finance, and Accountability Act 2003. The new Act will among other things provide for the establishment of a Petroleum Fund. The roles of the MoFPED will be: 1. Establish a Petroleum Fund Investment Advisory Committee and a Petroleum Fund Technical Committee. 2. Exercise ownership and control over the Petroleum Fund through the Petroleum Fund Investment Advisory Committee; 3. Issue strategic investment guidelines/benchmarks to the Central Bank 4. Draw up the management contract for the Fund 5. Monitor the overall performance of the Fund 6. Report to Parliament on the performance of the Fund on a periodic basis. Oversight

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Box 2: Proposed Governance Structure for Oil Revenues In respect of oil revenues, it is proposed that revenue management be institutionalized within the existing financial management structures with minimum adjustments to accommodate management of the Fund and revenue tracking and other petroleum revenue policy matters. MFPED will take ownership and control of the Fund. Other institutional structures will include; Petroleum Fund Investment Committee Composition: The Committee will constitute 5 persons, including the Secretary to Treasury, and 4 other persons to be appointed by the Minister responsible for Finance. These persons must be of high integrity and demonstrated competence in fields relevant to fund management and investment. Functions: Oversee the Fund, review and approve the Petroleum Fund Investment Policy, set reporting requirements for the Fund, report on governance of the Fund, ethical codes etc Fund Assets Management Department There will be a Department within the Ministry of Finance, whose main responsibility will be to coordinate activities related to the Petroleum Fund. Functions: a) The Department will formulate the investment strategy for the petroleum fund. The Department will also periodically review investment policy proposals before they are forwarded to the investment committee for approval. b) The Department will periodically review the operational management of the petroleum fund by Bank of Uganda. c) Ensuring that laws and regulations are followed, financial statements are prepared with a full account of the Petroleum Fund both in cash and petroleum stocks, prepare investment benchmarks for approval by the advisory committee. Bank of Uganda Fund Manager Bank of Uganda will be delegated the fund management role and will be responsible for the operational management on behalf of the Ministry of Finance.

5.1.2 Responsibilities of the Central Bank (Manager /Agent) Bank of Uganda will be designated as a Fund manager charged with the operational management of the Petroleum Fund on behalf of MoFPED. The key responsibilities will be; 1. Implementing an agreed Investment Strategy; 2. Establish appropriate structures to manage the Petroleum Fund. 3. Actively manage the Fund to achieve a reasonable return; 4. Risk control and reporting; 5. Provide professional advice on investment strategy; Oct 2011 28

6. Report on the performance of the Fund on a quarterly basis; 5.2 Investment of the Petroleum Fund Proceeds

Investments of the Petroleum Fund proceeds shall be made in low risk investment portfolios abroad. This will ensure that the risk to these savings is spread while at the same time guarantee availability should the need arise to draw on them. In addition, investing a significant portion of the petroleum In order to ensure sound management, all revenues abroad minimizes the risk on the economy of domestic spending of large foreign exchange inflows. investments of the Petroleum Fund shall be made in accordance with the investment policy approved by the Petroleum Fund Investment Committee. 5.3 Oversight and Controls

The collection, management, and use of all oil - derived revenues shall be subject to oversight as provided for under the Constitution, the PFAA and the Audit Act. The laws are being reviewed to ensure that they are adequate in management of oil revenues. 5.3.1 Petroleum Fund Investment Committee There will be a Petroleum Fund Investment Committee whose main role will be to provide technical oversight over the management of the Petroleum Fund Investments. The Committee will constitute 5 persons, including the Secretary to Treasury, and 4 other persons to be appointed by the Minister responsible for Finance. These persons must have a distinguished service career, be of unquestionable integrity and demonstrated competence in fields relevant to fund management and investment. 5.3.2 Petroleum Fund Audit The Petroleum Fund shall be subject to special audits by the Auditor General, which will be carried out twice a year. The OAG will prepare and submit to Parliament half-yearly statutory audits reports. The results of these audits will Oct 2011 29

be made available to the public within a stipulated timeframe following the conclusion of the audit exercise. 5.4 Financial Reporting and Accountability

Reporting on activities of the oil and gas sector shall include information on the resource reserves, costs of production, realistic projections for world prices, the extraction and depletion rates and the fiscal regime, contribution to the Governments wealth. Accounting of oil reserves and their depletion is essential whether oil production is being depleted in a sustainable way. The accounting of oil reserves helps to put in perspective the volume of the countrys resource wealth and deter over-expansive budgetary and borrowing policies. Accounting of proven reserves poses huge information and technical challenges. In preparation for production and development of the sector, the legal framework provisions will need to be under continuous review to ensure adequate treatment, scope and application in practice. In addition, the activities along the value chain will be assessed to ensure that the legal framework for taxation of all petroleum operations are captured appropriately, including the taxation of refinery operations, transportation and sale of final products. Periodic reports (probably quarterly or semi-annual) on the operations of the Petroleum Fund shall be prepared by the Investment Advisory Committee in a manner prescribed by the legal framework and submitted to Auditor General. The reports will in turn be submitted to Parliament and also made public in a stipulated time frame. 5.5 Transparency Only in cases where it is 30

The management of petroleum revenues shall be done with the highest standard of transparency by all parties involved. Oct 2011

demonstrated that certain information should be treated as confidential, the relevant laws will ensure that transparency mechanisms are put in place and there is free access to public information. 5.6 Encumbrances These assets should not be

The assets of the Petroleum Fund are the property of the people of Uganda and held on their behalf by the Government. encumbered in any way, whether by way of guarantee, security, mortgage or any other form of encumbrance. This will be emphasized during the revision to the public finance law.

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Chapter Six Conclusion

The main focus of the paper is to show how the anticipated oil revenues shall be integrated and managed within the existing public finance laws with a view of mitigating the overall impact oil revenues will have on the economy. The paper concludes with a key recommendation on use of the expenditure path as the fiscal anchor in the integration of oil revenues within the fiscal framework. More detailed work is on going on how the oil revenues will be integrated within the existing fiscal and monetary frameworks. Lastly, Government shall also undertake a public debt sensitivity analysis annually in order to ascertain our sustainability levels given the anticipated high oil revenues flows.

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Appendix Appendix 1: Revenue Management Policy Issues Summary

Policy Issue A. Tax & Revenues PSAs and ITAs set out terms of payment by oil companies and rates. Government profit oil is tax in economic substance. Signature bonuses, surface rental, royalties, taxes and receipts from sale of Government share of profit oil will accrue. Oil revenues should be handled like any tax or other receipt and as such, the collection and assessment is provided for in the Income Tax Act, in line with provisions in the PSA. Issues for Uganda & International experience Policy Principles & Proposals

Taxation & Revenue flows

Revenue collection

Experience from collection of non tax revenues through several MDAs suggest that transparency, accountability and efficiency of collection will be improved if all revenue are streamlined through one collection agency.

URA will assume this responsibility and oil flows shall be payable to a special account in Bank of Uganda in line with the relevant laws.

A Special Account Petroleum Fund in Bank of Uganda, into which petroleum revenues will be credited; Payment into account Payments shall be made by electronic transfer directly into the oil account by the entity bearing the payment obligation. Collection of oil flows and taxation will be in US$.

Currency units B. Expenditure Determining expenditure

Options include (a) Use The Fund shall be coherently integrated overall budget deficit (b) into the budget process as it is to primary non-oil deficit as % operate as a Government account

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Policy Issue

Issues for Uganda & International experience GDP. (a) has more uncertainty and makes planning difficult, (b) is more certain but not clear what desirable level of deficit should be. Due to higher uncertainty surrounding tax and nontax revenue at this time, fiscal policy needs an anchor i.e. fiscal control, public spending efficiency, standards of approval and execution and maintain stability objective. What should the cap be and how hard? Norway has no cap, which is flexible but might be open to uncertainty or political influence; Sao Tome & Principe has hard cap, Timor Leste has cap based on measures of sustainable income

Policy Principles & Proposals rather than a separate institution. The Fund will be managed by MoFPED; Expenditure path will determine spending, based on considerations of the economys capacity to supply non traded goods and the capacity of public administration to manage higher spending.

Integration with fiscal policy

Oil revenue management will be integrated with the Medium Term Fiscal Framework and Medium Term Budget Framework and expenditure path to be used as an anchor for fiscal policy

Spending limits

Principle should be to have the expenditure anchor aligned to the permanent income. As such, any windfall income in excess of a benchmarked price goes to the stabilization fund. This is to be used to support the budget in times of very low (below benchmark) prices

Sharing of revenues

In consultation with stakeholders, an appropriate mechanism will be put in RM law could specify spend place to ensure equitable distribution of only on priority sectors, or petroleum revenues. The mechanism regional or local allocations will recognize the areas that are (e.g. Sao Tome & Principe). directly impacted by oil and gas operations.

C. Establishing Fund Type of account The fund should be treated Petroleum Fund should be a financing as the savings to fund, reflecting government savings government from fiscal from petroleum wealth surpluses that arise from petroleum revenues, over & above those that can be used in MTFFs and MTBFs.

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Policy Issue

Issues for Uganda & International experience Could be trust fund, special account, sub account of reserves or segregated account held by Treasury. Offshore depository or domestic account?

Policy Principles & Proposals

Custodian

What should be the qualifications of the custodian? Central Bank or Treasury (as in Norway)? Should the fund be for monitoring oil flows, stabilization against price fluctuations, savings etc? What is desired size of permanent fund? Experience shows that price fluctuations can lead to expenditure fluctuations. The oil revenue fund should be used to meet the needs of both current and future generations. Given the unpredictability associated with oil prices, a significant reserve should be built in connection with the stabilization fund, while making use of conservative price estimates for resource projections.

Fund Purpose (savings, stabilization etc)

D. Management & Investment of Fund Reserves For purposes of transparency, payments by the tax entity will be made directly into the collection account by electronic transfer. Best practice requires clear rules and principles for proper management with regards to depositing and withdrawing funds. For withdrawals, a specified number of signatories will be required in line with PFAA and the Memorandum between MOF and BOU, supported by a technical committee. Unless otherwise, transfer of funds out of the Fund shall be limited to only three purposes: stabilization, savings for future generations and budget financing. The appropriate mechanisms will be detailed. Investment policy Theres need to have clear MFPED will be in-charge of the Fund but mandates in the law over will delegate Fund management to

Deposits & withdrawals

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Policy Issue

Issues for Uganda & International experience degree of discretion allowed to investment committee e.g. Sao Tome & Principe has little discretion with committee submitting plan to National Assembly for approval

Policy Principles & Proposals Bank of Uganda. There will be an Investment Advisory Committee comprising officials of MFPED, BOU, and competent persons to be appointed by the Minister who will have overall responsibility over investment policy for Petroleum Funds.

Investment managers

The PFAA and the Memorandum with the Central Bank is to be amended to Selection and oversight of provide a clear governance structure portfolio managers needs covering the main Petroleum Fund to be determined as well asset management functions; as their mandate and discretionary powers. The portfolio should be managed by experts appointed through a representative investment committee. Kuwait has Future Generations Fund subject to executive branch policy making and management by Kuwait Investment Authority. Norways Fund is managed by Minister of Finance through a Central Bank appointed management team. ST & P and Timor Leste limit Fund investments to secure, non-speculative instruments. Some advantages can be seen in borrow against oil revenues for human or capital investment, but the general experience is negative. As such, any such borrowing has been explicitly prohibited in law in the U.S(Alaska), Norway and ST & P.

There will be a limit to risky investments, no domestic investment from the Fund. Principle will be to limit investments to offshore assets (i.e. no domestic enterprise investment etc) in order to limit inflationary pressures and subsequently the Dutch disease effects.

Portfolio investment

Borrowing against oil resources or assets held in the fund to be explicitly prohibited; Revenue management law should prohibit the pledge or other such use of oil resources or Petroleum Fund assets as security for loans.

Borrowing

E. Governance Parliamentary & government oversight Theres need to have Domestic spending will be through the regularity in process of normal budgetary process which is revenue management and subject to appropriation by Parliament.

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Policy Issue

Issues for Uganda & International experience spending and to reduce the temptation to meet short term budgetary needs through oil revenues.

Policy Principles & Proposals

Review existing laws to ensure sufficient provision for oversight of collection, management and use of all oil-derived revenues.

Oversight board

Given the significance of revenues and limitations on existing institutions, Oversight functions will be provided by countries have set up the mandated institutions according to additional oversight the relevant laws. institutions to provide specific oversight functions and complement existing institutions. The Chart of Accounts is to be reviewed to align oil and gas transactions with International initiatives the existing financial management include Publish What you requirements. Pay and Extractive Industries Transparency Investment committee will report its Initiative & IMF Guide on activities periodically to government Resource Revenue and public and its activities should also be subject to periodic audits; Transparency 2005.

Audits & reporting

Transparency

In some countries, this is achieved through creation of supervisory bodies involving civil society; Requirements providing for creation of a public information office to enable public access to payment data and contracts.

The scope of public information to be availed should be agreed and mechanism put in place on how to access the information.

Public procurement

Revenue Management law should International experience stipulate that all significant contracts suggests this is most prone and agreements relating to oil revenues to corruption (favoritism). or to oil resources must be subject to open competitive tenders.

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