Papua New Guinea's Deep Potential Starts to Emerge

By Moin Siddiqi, Economist

Papua New Guinea (PNG), the Pacific’s largest and most populous island state and home to a huge diversity of peoples, languages and cultures, and a unique biodiversity, is expected to record the world’s fastest growth of 21% in 2015 according to the Asian Development Bank (ADB) – thus consolidating on a decade of socio-economic advancements unparalleled in its history as a young nation that gained independence from the United Kingdom in 1975.

As one of the most isolated and remote countries on earth, PNG, often referred to as a tiger economy of the Pacific, is courting many prominent global investors. PNG and Britain enjoy a strong trade and investment relationship, underpinned by historical ties, similarities in legal frameworks (the local law is derived from the English common law) and by being members of the Commonwealth of Nations and the European Union (EU)/ African, Caribbean and Pacific (APC) Group of States.

For UK investors diverse opportunities lie in the services sector, management of large funds (including the recently formed Sovereign Wealth Fund), business/offshore financial services, ICT, manufacturing, education/ professional training and healthcare. This is not to discount other opportunities available in the extractive industries, renewable green technologies, tourism, agriculture, and basic infrastructure. Britain and PNG are bound by a double taxation treaty.

The Government of PNG is keen for local businesses to participate in future foreign direct investment (FDI) projects. HE Peter O’Neill, the Prime Minister of PNG, has urged foreign companies “to look at taking on board Papua New Guinean investors and partners from the outset. We have successful contractors, transport operators, engineers and other professionals, retailers, farmers, manufacturers and processors – all with funds or access to funds that can be used to participate directly in the next phase of the development of the resources sector.”

Steady Expansion

Annual real GDP growth of 7.5% in the five years to 2014, (comparable to India’s growth) was a full 4.5 percentage points higher than the average for Pacific Island States thanks to prudent macro-economic policies, fervent development of natural resources and increased FDI. Whilst higher commodity prices have supported incomes, much of PNG’s recent growth is attributed to the non-mineral economy, and in particular spurred by the liberalisation of telecommunications and aviation sub-sectors.

The real estate market in PNG has outperformed regional peers in terms of growth, bolstered by a decade of sustained FDI into both extractive and non-resource sectors. “Growth has been astounding in the past five years. I think the country still will grow,” said Garry Tunstall, chief executive of PNG’s largest superannuation fund, Nambawan Super.

PNG, traditionally reliant on foreign assistance from AusAid, the World Bank Group, and the ADB, is gradually reducing aid dependency, which fell from about 20% of total government revenue in 2003 to roughly 10% currently. The government has used mining receipts to retire some of its public debt, which, as a percentage of GDP, has steadily declined in the last decade.

The International Monetary Fund (IMF) noted: “Papua New Guinea’s economy is experiencing an important transition, which presents major challenges in the near-term to maintaining macro-financial stability, but also important opportunities if managed properly. In the face of a winding down of large liquefied natural gas (LNG) project construction, the government has embarked on a large fiscal expansion starting in 2013 to accelerate development and cushion the non-resource economy.”

Natural Advantages

PNG boasts significant natural resources which are currently in various stages of development. It has high prospects for hydrocarbons, deposits of which are found across the territory. Natural gas reserves are estimated at 26 trillion cubic feet (cf) – three times the size of Britain’s proved gas reserves. The US Geological Survey estimates a further 24 trillion cf is still yet to be discovered, which bodes well for foreign energy groups.

The country is immensely rich in minerals, producing both copper and gold. PNG is the 11th largest gold producer accounting for about 3% of global production. It also holds large silver, chromite, and cobalt, nickel and molybdenum deposits. The mining sector is expected to remain a major contributor to the economy. Australia-based ANZ Bank projects gold and copper exports of US$3.3bn and US$3bn, respectively, up until 2030. So far, mining exploration has only scratched the surface of PNG's resource base.

The mining boom has had positive spill-over effects in other sectors, particularly in the services, construction, and logistics sectors.

The country boasts nearly five times the renewable water supply of Australia at approximately 119.5mn liters per capita, according to the UN Food and Agriculture Organisation (FAO). About 40% of surface area is covered with exploitable trees. Agriculture is a mainstay for PNG's largely rural population. Cash crops ranked by value are coffee, palm oil, cocoa, copra, tea, rubber and sugar. PNG is the largest exporter of cash crops among Pacific Island states.

The Minerals, timber and fishing subsectors are dominated by foreign investors.

An Intriguing FDI Destination

This frontier market is attractive for inward investment due to low labour costs, the prevalence of natural wealth and continuous needs for large-scale infrastructure development. FDI inflows are increasing thanks to largely free-market/pro-business policies. PNG welcomes foreign investment in downstream processing, i.e. areas that process local resources and produce manufactured products for export and import substitution.
Statistics from the Investment Promotion Authority (IPA), which acts as a one-stop shop facility for prospective investors, revealed that some 24.6% of new FDI in 2013 was received by the construction sector, exceeding financial services, light manufacturing and mining, which accounted for 19.8%, 18.1% and 10.9%, respectively, during the reported year.
While Australia has historically been PNG’s largest trade partner and investor, with US$18bn, the US, Japan, Malaysia, New Zealand and China have also increased their investments in recent years. In fact, the US surpassed Australia as No.1 FDI source when Exxon Mobil entered the market in the late 2000s with its mega US$19bn LNG project. Chinese state-owned enterprises (SOEs) have been active in infrastructure (ports, roads), mining and construction (shipbuilding, convention centres). China EXIM Bank recently announced a US$2.67bn loan targeting infrastructure projects, which could expand to a comprehensive credit package worth US$4.44bn.

PNG has developed closer ties with a handful of major economies, ratifying bilateral investment treaties with Australia, New Zealand, the UK, China, Germany, Japan and Malaysia. There are different requirements for foreign investments in the natural resources, timber, and fisheries sectors, but in most cases 100% foreign-owned enterprises are permitted.

Some priority economic sectors requiring significant FDI inflows include agriculture (production and processing), fisheries, forestry, light industry, and tourism/travel and basic infrastructure. Asia Frontier Capital is bullish on PNG's growth prospects and sees lucrative opportunities for investors. PNG was, in fact, the largest recipient of transnational corporations (TNCs) announced investment in greenfield projects in Small Island Developing States (SIDS) between 2003 and 2013, according to Geneva-based United Nations Conference on Trade and Development (UNCTAD).

The country’s Vision 2050 and the Medium Term Development Plan
2011-2015 see tourism/travel as a growth industry. The government offers tax incentives such as double deductions for costs associated with export market development, and staff training costs. Accelerated depreciation is also another form of tax break whereby capital investment in eligible tourism facilities qualifies for 55% increased initial-year depreciation. Investors in large-scale resorts may be eligible for a concessional tax rate of 20%.

Major Multinationals in PNG

Exxon Mobil’s signature US$19bn LNG project is the largest undertaking in PNG’s history, with the potential to double GDP in the near-term and triple export revenue. Its construction (started in 2010) has raised PNG’s profile and boosted investor confidence in developing mega schemes in the future. Annual LNG production capacity over a 30-year period is expected at 6.9mn tonnes – with more than 9 trillion cf of gas being produced and sold to end-users under long-term supply and purchase agreements with Chinese Petroleum Corporation, Taiwan; the Osaka Gas Company, Japan; Tokyo Electric Power Company; and China Petroleum and Chemical Corporation.
A second flagship LNG project is moving towards a final investment decision in 2016. InterOil (US) discovered the prolific Elk-Antelope gasfield in 2008 – the largest undeveloped field in PNG to date and one of Asia’s biggest gas finds for over 20 years. Analysts believe Elk-Antelope LNG will be a competitive downstream project, making its construction probable once reserves are independently certified. If appraisal goes according to plan, then a 6.8mn tonnes per year two-train LNG facility could be sanctioned in 2017/18 with first production online by 2021/22.

PNG has a portfolio of mining projects spread across the country. New Ireland Province’s Lihir gold mine – the world’s third largest producing mine with a capacity of 1mn ounces of gold per annum – is operated by Newcrest Mining (Australia’s No.1 listed gold miner).The latter also has interests in Harmony (South Africa) Hidden Valley, open-pit gold and silver mine and extensive exploration tenements.

The Western Province’s Ok Tedi, PNG’s longest operating gold/copper mine is controlled by BHP Billiton (Angola-Australian multinational). Its lease has been extended to 2025. Prior to Exxon Mobil LNG venture, the US$2.1bn Ramu nickel/cobalt mine – owned jointly by Barrick Gold (Canada) and Metallurgical Corp; of China (MCC) was the single biggest investment in PNG in the past decade. The mine is expected to reach full capacity this year. Barrick also owns the Porgera gold mine.

Several international agro-firms have also established operations, including New Britain Palm Oil Limited – the largest palm oil plantation and milling operator in PNG. Thai Union, the world's largest fish processor, recently opened a tuna processing plant and Mitsubishi of Japan is planning to build a US$1bn petrochemical plant in Port Moresby.

Opportunities for PPP Projects

The business climate has improved markedly since the re-election of Prime Minister Peter O'Neill in 2012. The government has pledged to efficiently manage natural resource assets and promote Public Private Partnership (PPP), especially in the power generation and transportation sectors. A key  component within the Medium Term Development Plan 2011-15 is providing efficient infrastructure services – prerequisites for achieving robust private sector-led growth and a diverse economic base as well as improving the living standards for PNG’s citizens.

The utilities sector – after years of underinvestment – is improving reflected in the commissioning of new electricity projects and the expansion of water and sewage networks. In 2014, infrastructure spending rose by a third to PGK2.7bn (US$1bn), with some PGK1bn (US$406.5m) allocated for roads. PNG is also looking to renovate its main international airport as it prepares to host the Pacific Games in 2015 as well as the APEC summit in 2018. About PGK760m (US$308.9mn) is being spent to host the Pacific Games in Port Moresby later this year.

The country’s electricity infrastructure needs major overhaul – only a fifth of PNG’s population has access to reliable power, and most mining companies rely entirely on independent generators. As of end-2014, the combined installed capacity totaled approximately 500 megawatts (MW), around half of which is derived from hydropower. The low electrification ratio and frequent power outage are now being addressed through a number of measures to modernise the transmission and distribution networks.

Capital projects worth over US$50mn qualify for a PPP structure. There are a number of planned hydropower projects to address the country's energy deficit – notably the PGK2bn (US$813mn) Ramu-2 power plant and upgrades to Port Moresby’s power generation. Also in power, the ADB has identified potential PPPs for the US$100mn 80-MW Naoro-Brown hydropower project and the 1800-MW Purari hydropower system.

In transport, the largest projects/investments are PGK3.1bn (US$1.3bn) for rehabilitation of the Highlands Highway; PGK500mn ($203.2mn) for Port Moresby roads, and the US$500mn terminal and airside development of Port Moresby’s Jackson International Airport as well as two phases of concessions for the Lae container port and Port Moresby’s container port. Lae port, PNG’s most important port is undergoing major expansion – costing PGK730mn (US$296.75mn) – and development partners see its potential as a regional trans-shipment centre. The concessioning of shipping franchises for passenger and cargo transport are also envisaged.

The government hopes to attract PGK250mn (US$101.6mn) in private financing for building and rehabilitating schools and health clinics.
There will be longer term ‘multiplier effects’ upon the broader economy from infrastructure spending, however, upgrading implementation capacity of public agencies to deliver investment plans on time and budget remains a core challenge facing the authorities, say analysts.

The country’s industrial strategy aims to increase the value and volume of value-added products. It encourages greater ‘self-sufficiency’ by developing non-mining sectors, namely manufacturing, renewable resources such as agriculture and fisheries, and business services. These policies specifically focus on nurturing job-intensive industries, capable of sustainable growth even after natural resources are depleted. That said, PNG’s mining and hydrocarbons sectors are still under-invested, the government places a high priority on developing these important sectors in the coming years.

Future Challenges

The LNG project has transformed PNG's commercial landscape and propelled GDP growth, which is projected by the IMF at 7% on average over the medium-term. The Treasury forecasts revenues from PNG LNG to fluctuate between PGK1.6bn (US$650.4mn) and PGK2bn (US$813mn) annually for the first seven years from 2015. With Southeast Asian LNG production falling and the Australian LNG boom over, the focus is shifting to PNG, “which sits in the belly of Asia” – predicted to be the largest market for natural gas globally by 2025, according to London-based Petroleum Economist magazine.

As new extractive resource projects come on stream, there is no doubt that a transformative economic boom will follow, but the key to future prosperity lies in more sustainable and inclusive growth than before. Translating strong economic performance and fiscal revenues into tangible socio-economic development remains the key challenge for PNG.

To diversify the economy and increase employment, the World Bank recommends further improvements to the business climate, commercializing state-owned enterprises, reducing the regulatory/licencing burden on business start-ups, and providing equitable access to resources (including land) for national development.

The overarching challenge for all SIDS is to ensure that FDI activities do not increase their structural vulnerabilities and cause any permanent harm to the sustainable use of land, water and marine resources for future generations.

Excerpt taken from The Papua New Guinea Investment Report 2015 published by DMA, available here and was presented at the UK-Papua New Guinea Trade & Investment Forum, London, on 16th June 2015