Promoting Investment Incentives by International Financial Institutions: The Case of Fostering Natural Gas Investments in Developing Countries

Authors:
  • GSGaute Solheim
    Gaute Solheim
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Abstract
We examine two designs for the monetization of natural gas and generating revenues for the resource country. The cash flow taxation, adopted in Norway, is the closest to a rent tax and generates higher revenues for the country over the long term while attracting investors. The downside is that the Government is a silent partner in the project, providing “loss refund” when the cash flow is negative, a situation that low-income and lower-middle income resource-rich countries cannot afford. In the production sharing agreement (PSA), revenues flow to the Government from the first year, while the company faces high front-end loading of investment and substantial downside risk. The misalignment of incentives and risk perceptions may lead to stranding otherwise profitable projects. This can hamper the production of natural gas as lower carbon intensive fuel during energy transition. International Financial Institutions (IFIs) interested in fighting climate change can bridge the gap between the cash-flow regime expectations of investors and PSA regime expectations of Government. The latter will see an increase in revenues for development. The IFI intermediation can help alleviating other political and country risks that hinder credible intertemporal commitments between investors and countries. This is true to unlock supply beyond the gas sector, whether by directly incentivizing investments in green minerals, or indirectly through using gas as the least carbon intensive fossil fuel to generate the energy necessary for the extraction and processing of green minerals.