Okop Usem Leadership Council:

Okop Usem Leadership Council: Resource Control/Resource Management By Dr Timothy E. Okon

Definition of Terms • There are broadly 3 ways in which the FGN derives revenue from petroleum (Oil and Gas) as Govt Take: • Royalty which is expressed as a percentage of Gross revenue and is paid to the owner of the resource. In addition to royalty, the FGN obtains rents for acreage and penalties known as the gas flaring penalty. • Petroleum Profits Tax (PPT) which is a tax on profits (Gross revenue less royalty less costs) expressed as a percentage of profits. • The third is through profits from its participation in the venture through NNPC. • The governing law which defines royalty is the Petroleum Act (1969) as amended. This law vests the ownership of petroleum resources in the Federal Government making the Federal Government the beneficiary of royalty payments. • Royalty is first take on gross revenue expressed as a % of gross revenue and the rates vary from 20% onshore (10% Inland Basins) to 18.5% offshore (less than 100m water depth); 16.67% from 100m to 200m water depth; 12% from 200m – 400m; 8% from 400m – 800m; 4% from 800m – 1000m and beyond 1000m water depth is 0%. • Derivation as currently applied is a % charge on Govt take: that portion of the distributable pool attributable to oil and gas revenues. This is currently 13%. • Oil producing states including the littoral states exclusively share in the 13% derivation account. They also participate in the remaining 87% of Govt Take and other revenue elements (such as CITA, custom and excise, VAT etc) according to the relevant revenue allocation formulae. Private & Confidential

Split of a $20/$40 JV Oil barrel Private & Confidential

Nigeria: Revenue Allocation (2001) Private & Confidential

Findings & Recommendations • Our analysis shows that the objective of S-S demands for 25% derivation based on Govt take (Roy+PPT+NNPC margin) is broadly equivalent to 100% Royalty payments (20% onshore – 18.5% offshore) to the oil producing states. • This is indicative in the $20/bbl case where the royalty of $3.7/bbl is equivalent to 25% derivation on Royalty & tax. Similarly, in the $40/bbl case 100% royalty of $7.4/bbl is almost equivalent to 25% derivation on Govt take. • The use of either methodologies would not preclude the oil producing states from obtaining additional revenues from the distributable pool according the relevant revenue allocation formulae. • However, we have a preference for the 100% royalty method because it would give de-facto recognition of ownership of the resource. This would require the following: • The amendment of the Petroleum Act to give ownership of resources to the states where they are found. In the case of the offshore, the recognition of state waters as being the continental shelf up to 200m isobaths. The amendment should state that all royalties are payable to the states from where the resources are derived. This would be applicable to all mineral resources in the Federation. • All taxes on profits (PPT) would be paid into the distributable account of the federation just like CITA and customs and excise taxes. • The payment of rents directly to the communities where these resources are found or the offshore communities whose land abort against the coastline. • The payment of the gas flaring penalties or any other environmental impact fees directly to the communities affected by the flaring activity. • One disadvantage however of this methodology is that it would require considerable amendment of laws whereas the derivation method would not. • With the 100% royalty method, the escalation clause from 25% to 50% based on derivation could be used as a bargaining chip since the oil producing states would still participate in the distributable account of the Federation. Private & Confidential

Nigerian Revenue Sharing: A history • After the amalgamation of the southern and northern protectorates in 1914, and between 1914-1946, the country was run as a unitary state. • Note that the amalgamation itself was done to allow for transfers of revenue from the south to administer the north. • 1946: The Richardson constitution devolved some powers to the regions and there was then a need to provide for financing of the regions. • Phillipson Commission (1946) was set up to recommend a revenue sharing formula. • It provided a tax base for each region composed of revenues easily identifiable as originating from the region (Direct taxes, licensing fees and mining rents etc) • Federally collected taxes (import and export duties, company taxes etc) were to be shared. • The basic premise of the commission was • The need to set the right incentives and • the view that derivation would provide the regions with some sense of financial responsibility. • There was no explicit recognition of the principle of need!!! • In 1951, the MacPherson Constitution provided an opportunity for revenue reassessment. So the Hicks-Phillipson Commission of 1951 was set up. The commission re-affirmed the following: Private & Confidential

Nigerian Revenue Sharing: A history (Cont’d) • In 1951, the MacPherson Constitution provided an opportunity for revenue reassessment. So the Hicks-Phillipson Commission of 1951 was set up. The commission re-affirmed previous principles but also added new ones: • The importance of regions having a tax base of their own was affirmed; • A new sharing system based on 3 new principles was advocated namely • Import and Excise duties were to be shared based on derivation • Regions would receive an allocation based on population • Special grants were to be provided for police, education in the regions. • Note that each region liked the principle that appeared most favourable to it. The north was population; the west derivation; and the east special grants. • 1954: The Lyttleton Constitution gave self-government to the regions and the Chick Commission (1953) was set up for this purpose. The commission adopted the following: • Mining rents and royalties and the personal income tax (PITA) were to be shared. • Derivation was to be applied to all resources and export duties. • Preparatory to independence, the Raisman-Trees Commission (1958) proposed the following: • PITA became again a regional tax • A pooling account was established for which all revenues were channeled. Mining rents and royalties were no longer assigned through derivation alone but through a distributable pool based on derivation and need. The weights attached to derivation and need became an enigma – a black box for political football. • However the Republican Constitution of 1963 gave 50% of the mining rents and royalties to the regions (including resources offshore aborting against the coastal regions) on the basis of derivation. • The 1963 constitution (under section 164) had a mechanism for the review of the revenue allocation formula. Thus the Binns Commission of 1964 was set up. Its recommendations centred on the • abolition of derivation and its substitution by nebulous concepts such as the region’s efforts to mobilize revenue • And the quality of services they were providing. • The Binns Commission’s work was overtaken by the civil war. Private & Confidential

Nigerian Revenue Sharing: A history (Cont’d) • The control of oil revenues was the direct incentive for both sides of the divide to prosecute the war. This is reflected in the actions taken by the military after the civil war namely: • Decree No 13 (1970) which allocated the bulk of all federally collected revenue to the Federal Government. Derivation was set aside and regional allocation was based on need defined by population and a lump sum transfer to cover fixed costs of running an administration (no incentive for the states to manage their bureaucracy in line with internally generated resources). • Decree No 9 (1971) introduced the offshore/onshore dichotomy. All offshore rents and royalties were now to be allocated to the Federal Government alone. • Decree No 6 (1975) channeled all revenues to be shared through the distributable pool account with the exception of the 20% of onshore mining rents and royalties due to the states of origin on the principle of derivation. • Note that this had gone down from the 50% in the 1963 Constitution. • Aboyade Technical Committee (1977) also proposed the abolishing altogether of the principle of derivation. Allocation was now to be based on nebulous concepts such as the need to provide for minimum standards and absorptive capacity. (The constituent Assembly in 1978 thankfully declined). • Okigbo Commission (1980) essentially echoed the needs defined by population and social service/fixed sum transfers for administration. This was rejected but a special fund for mineral producing areas was introduced based on derivation. But this special fund was so little (1-3%) that it simply was nonsensical. • 1999 constitution – 13% but this has been applied only to onshore oil production until the recent law in 2003 that abrogated the onshore / offshore distinction. • From Nigeria’s post independence history, the majority ethnic groups in Nigeria (Hausa, Igbo & Yoruba) have always considered the appropriation of oil resources of the Niger Delta as an important instrument of political hegemony. • Extended periods of military rule has led to the overwhelming strength of the centre and the abandonment of the fiscal federalism that characterized the foundations of the country. That over-centralization has bequeath only corruption and poverty on the Nigerian nation. Private & Confidential

Beyond Resource Control: Resource Management • The modern practice of resource control and revenue distribution has many facets. Nations have generally developed methodologies for this in sympathy with their political structure and or philosophy of governance. Nigeria is no exception. In discussing resource control there are primarily two issues at stake: • The ownership of and the right to extract petroleum resources (oil and gas) and • The formula for the allocation of the proceeds from the sale of the resources. • Other secondary issues such as ownership and operation of the downstream oil and gas sector and other derivative products of oil (refining & transportation), involvement of foreign companies, and mechanisms to ensure accountability and transparency do not often enlist the passion as resource control does, even though to a large extent these issues are often shaped by the resolution of the issue of ownership. • My focus therefore is to draw attention to this fact: the political economy of ownership and distribution of natural resource revenues very certainly defines the stewardship of the resources in terms of equity, accountability and beneficial effects. Private & Confidential

Resource Control Meeting: Washington DC Dec. 2005 • Agenda: • Welcome by Host: Prof. Mobolaji Aluko • Moderator: Clement Ikpatt • Meeting Rules • Protem Secretary • Presentation: • Resource Control/Management (Dr. Tim Okon) • Others • Discussion Panel (All) • Resolutions & Communiqué • Way Forward • Adjournment Private & Confidential

Why We are Here: • OULC exists to bring to Nigeria’s political and economic space alternative voices; to bring wisdom amidst the stridency of the resource control debate; to warn Nigeria of its weak foundations wracked by ever deepening conflicts and crises and to proffer solutions that strengthen its fabric through equity, truth and justice. • Resource Control is about the creation and management of an institutional framework and the environment in which they operate to affect economic growth. It is not merely revenue allocation. You cannot manage what you don’t control. We believe the stewardship of the Federal Government of Nigeria in the last 45 years has been frankly appalling. (See graph). It is time to have some oversight over that stewardship. • The Niger Delta is on the verge of a full scale rebellion.! Collier (1999) states that the motivation for instigating a rebellion is commonly • A blend of an altruistic desire to rectify grievances of a group (Dokubo group) • A selfish desire to loot the resources of the others- the classic conflict within the privileged class for the control of state power. (A coup to control the central bank – Abacha) • Both balanced against the costs of rebellion. The cost of rebellion now in Nigeria is quite low. (Egbesu boys, OPC, Area boys etc). • See the vicious cycle of conflict and underdevelopment. The four delusions of Nigeria. • What we propose (overleaf): Private & Confidential

What We Propose: • Repeal of all laws inimical to the development of the states (or sub-national governments): • Revision of the exclusive list of the 1999 constitution. Our FG is overstretched and incompetent. Expansion of the concurrent list to include sub-national governments participation (the Canadian model) • Revision of section 163 of the 1999 constitution that vest ownership of all mineral resources in the Federal Government. This exclusivity should be removed. • The amendment of the Petroleum Act (1969) – section 1 (vesting and ownership) to include sub-national governments. Amendment of section 38 of the same act to compel participation of state/local communities in the operations of mining in their jurisdictions. • All royalties, although federally collected should be paid to the state/local governments and not into the distributable pool. • The FG should collect PPT as it does CITA and this should rightly be paid into the distributable pool. • The abolishing of such bodies as NDDC. OMPADEC if their funding is not exclusively Federal. Since the FG controls these bodies the FG should pay for them. • From 1993-1998 the FG controlled 75% of the resources generated from oil mainly through such bodies and 1st charge on the Federation account. Private & Confidential

FGN Stewardship: GDP per Capita Private & Confidential

THE VICIOUS CYCLE OF UNDERDEVELOPMENT Private & Confidential

Beyond Resource Control: Resource Management • Resource ownership can be classified into 3 categories: • National ownership where the resources are vested in the central or in Nigeria’s case Federal Government. • Sub-National Ownership – where ownership rests in the regions or provinces where the resource is found (i.e. states within the Federation); or • Shared ownership – where ownership is shared between the national government and the regions/provinces. • Countries with national ownership are often characterized by highly centralized governments. These are commonly Middle-eastern countries, monarchies, and states with weak democracies (Indonesia, Russia, Venezuela, Nigeria) often marred by civil unrest (Aceh, and the Niger Delta crises are good examples). In short Nigeria has made its bed with this group of infamy. • The reason often given for national ownership is that this could reduce the potential for regional, sectarian or ethnic conflict over oil resources. However, it causes the exact opposite. Multi-ethnic societies such as Indonesia (Acehnese rebellion) and Nigeria (Biafra) are all poster-child of the consequences of centralized control of natural resources. The overwhelming evidence points to sovereign ownership creating conflicts between central and regional/provincial governments over revenue, geographic boundaries (onshore/offshore dichotomy) and regional disparities. Private & Confidential

Evolution of Revenue Allocation Schemes Private & Confidential

Beyond Resource Control: Resource Management Table 1 Table 1 Private & Confidential

Beyond Resource Control: Resource Management • Regional ownership on the other hand is well suited to a federal system of government because it fulfills the following: • Enables regional entities to retain a high level of fiscal autonomy from the centre. • Creates the right incentives for competition among the regions to encourage development. • Notionally, it should improve accountability because regional governments are closer to the grassroots and there is no monopoly of power and less political competition for the central government. However critics also point to the fact that where there is weak governance, an over-dependence on natural resource for funding of the state and poorly developed political culture and institutions of transparency and accountability, such an ownership structure suffers the same malaise as the centralized model. • The US/Alaska is perhaps the best example of this federal system where each state maintains ownership over its oil resources within its territorial boundaries. There is also the concept of state waters where resources in state waters accrue to the state. Alaska’s constitution (Art 8; Sec 11) grants ownership rights to the state but also grants the “right to capture” to private individuals, corporations and the US federal government. Payment of fees, rents and royalties are due to the owners. Taxes are paid to the state and Federal governments. • The United Arab emirates (UAE) is another example. Each of the 7 emirates owns its own resources and controls its extraction and development. Private & Confidential

Beyond Resource Control: Resource Management • Shared ownership provides a sort of compromise. It allows both federal and regional entities to exercise constitutional powers in energy development. Usually the regions maintain control within their jurisdiction while the federal government is involved in inter-regional and international aspects of energy exploitation. This requires the following: • Clear definition of the roles of the regional and federal authorities in order to handle the interfaces between both and the International oil Companies (IOCs). • Needs the right institutions of governance – a highly developed political culture of transparency and accountability so that regional authorities do not exploit the immense power of their ownership to subvert multi-ethnic and inter-regional balance. • Works best where there is no over-whelming dependence on oil as the major source of national income which may result in contentious political conflicts. • Canada is an example of a country with shared ownership. The provinces own and administer oil within their jurisdictions. The Federal government administers it in the frontier areas and offshore. However provinces such as Nova-Scotia and Newfoundland exercise control jointly with the Federal government in their offshore areas and collect royalties and provincial taxes through independent offshore petroleum boards. Both the Federal and provincial government agree legislation with regards to these offshore areas. Private & Confidential

Beyond Resource Control: Resource Management • Shared Ownership (Cont’d): • The Canadian example is important in addressing the issues of onshore/offshore dichotomy. • These two provinces have significant maritime resources. Communities that have for generations derived their means of existence from the sea cannot in all fairness be required to renounce all these rights in favour of the centre. If there is any claim to such resources theirs cannot be an inferior claim. • This is what has informed the “right to capture” clauses in constitutions such as Alaska’s. • Russia exercises national ownership over oil and other mineral resources. However given the multi-ethnic and the multiple sub-national jurisdictions (89 in number including 21 ethnic enclaves), Article 72 of the 1993 constitution allows for bilateral treaties between the central government and regional entities. E.g. the special treaties with the resource rich republics of Bashkorstan and Tatarstan. Under the 1994 Tartarstan agreement, Russia accepted Tartarstan’s ownership and control over its oil and other resources while Tartarstan accepted Russia’s taxing authority. • It suffices to say therefore that shared ownership offers some options for Nigeria to address its resource allocation logjam: • It presents the opportunity for equitable distribution – not as a federal handout, but offers the states a right to sit at the table (the Canadian example) through the entitlement to royalty payments; • The issue of disparities in fiscal capacity can be addressed through the significant FGN revenue from taxation (50-85% of Profits) by the FGN not paying equalizing grants meant to assure national minimum standards to relatively rich states. Private & Confidential

Resource Control: Fiscal Dependency Private & Confidential

Beyond Resource Control: Resource Management • A key consideration under shared ownership remains the institutions needed to improve accountability. The political institutions that at the federal level have bred profligacy would produce the same at the sub-national level. This presents two challenges: • Large influx of fiscal resources tends to encourage excessive and imprudent investments, therefore institutional capacity development must be addressed. Natural resource capital tends to crowd out human capital (Gylfason, 2000). • The distribution mechanisms if not well thought out results in what Karl (1999) refers to as a self reinforcing legacy of overly-centralized political power, strong networks of complicity between public and private sector actors, and highly uneven mineral based development subsidized by oil rents. • Eifert, Gelb & Tallroth (2002) in an essay on the political economy of fiscal policy and economic management of oil exporting countries propose a five-fold classification based on the • Stability of the political framework and of party systems; • The degree of social consensus; • The legitimization of authority and the means through which governments or aspiring governments obtain and maintain support and • The role of state institutions in underpinning markets and the distribution of rents. • The five categories are, Mature democracies, Factional democracies, paternalistic autocracies, reformist autocracies and predatory autocracies. Table 2 shows the classification and the type countries. Sadly Nigeria is classified under the “roving bandit” category - Predatory autocracies. • Institutional reforms are therefore a sine qua non to resource control/ management Private & Confidential

Beyond Resource Control: Resource Management Private & Confidential

Resource Management: Approaches • There is wide agreement that to improve resource management, oil dependent economies need to create oil funds. The objectives of such funds have been to: • Combat commodity price volatility, currency volatility and inflation (Stabilization funds) • Provide financial resources for future use (Intergenerational funds). See table below. • The approaches above are only focused on the financial side of the resource equation. There is a strategic reserves (actual barrels) or security of supply side of resource management which is equally important. • The two contrasting approaches are evident in the case of Britain and Holland. Britain is now a net importer of natural gas through the rapid depletion of its Southern North sea gas basin while the Dutch have managed their Groningen gas field which was discovered much earlier, more thoughtfully. In NPV terms given the current high price environment the Dutch approach would appear to be better. • Nigeria it would seem has unwisely adopted the rapid depletion approach accompanied by the lack of either stabilization or intergenerational fund accounts. Private & Confidential

Resource Management: A Proposed Framework • We propose that all the states in Nigeria have governing constitutions. In particular, Oil producing states need a body of laws establishing ownership and distribution of natural resources. This is imperative because of our fractured politics and the predatory disposition of our institutions. • Such constitutional framework must incorporate both stabilization and intergenerational components. • Key considerations for such funds must be that they are professionally managed by internationally recognized institutions with transparent rules, quarterly reports and audited by the auditor general. • Transfers to and from the fund into the government’s budget must be approved by parliament. • The intergenerational component of the fund must be invested abroad to assist the transparency of the budgeting process and to avoid the inflationary and wasteful consequences of excessive and imprudent spending. • Proceeds from oil rents, fees and royalties accruing to the states must be paid directly to the fund. That way the fund plays a supporting and not a primary role in budget making. Budgets must be based on taxation to reconnect the citizens with their rulers. • Aspects of the Norwegian Petroleum Fund, the Alaska Permanent Fund and more recently the Sudan Oil Stabilization Fund could form the basis for this constitutional framework. • Oil producing states must actively participate in a National Petroleum Agency whose functions would include resource management planning for Nigeria. Presently Nigeria appears to be in a resource depletion mode – selling blocks willy-nilly, subjugating its production policies to OPEC without the participation of its regional entities. Entrusting the rights to manage the oil resources of Nigeria to those who after nearly 50 years of oil production have left Nigeria prostrate is economic suicide. Private & Confidential

Evolution of Derivation in Nigerian Revenue Allocation Private & Confidential

Okop Usem Leadership Council: