Investors drawn to Papua New Guinea's primary sector

 

The landscape for trade and investment in Papua New Guinea has undergone substantial changes in recent years. This shift has been driven to a large extent by the country’s large liquefied natural gas (LNG) project, PNG LNG. The development comprises gas production and processing facilities, with its initial phase carrying an estimated cost of $19bn, an investment greater than the country’s GDP at constant prices in 2014, which stood at $15.8bn. Since the facility commenced production in April 2014, exports have reached record levels and the country has experienced its largest trade surplus ever. Even with fading hydrocarbons prices, key figures are holding up, putting PNG in an excellent trade position overall.

Regarding investment, the country’s geographic location, geopolitical importance and abundance of commodities, as well as the success of PNG LNG, have helped it become a favoured destination for Chinese and Japanese ventures, with expectations of further foreign direct investment (FDI) going forward, particularly in the primary sector.

However, PNG remains a challenging place for international participants, and while high-level, strategically important projects are likely to proceed smoothly, smaller, more entrepreneurial ventures may face difficulty. Despite PNG’s economy being nominally liberal, it is one where doing business can often be difficult and time-consuming. To ameliorate this reputation the country is trying to improve the transparency and efficiency of business transactions, though work is also under way on new initiatives that could see it adopt more protectionist policies, thereby going against the tenets of liberal economics it has traditionally embraced.

Key Trade Stats

Export figures for the majority of commodities, including agricultural goods, marine products, forest products and gold, have stagnated over the last five years. However, the introduction of LNG exports in the second quarter of 2014 has greatly improved the overall picture, with a 62% year-on-year (y-o-y) increase in total export value posted in 2014, from PGK13.3bn ($4.5bn) to PGK21.6bn ($7.4bn). Exports rose again in 2015, albeit far more modestly, by 6% y-o-y to PGK23.1bn ($7.9bn), despite the temporary shutdown of PNG’s largest mine, Ok Tedi.

In contrast, the outlook for imports is less positive. Consumer spending has declined sharply, and a lack US dollar availability has made it difficult for importers to buy products from overseas. Foreign purchases have also fallen since the construction phase of PNG LNG came to an end. Imports peaked at PGK3.2bn ($1.1bn) in the second quarter of 2013 and were down to PGK796m ($271.7m) by the fourth quarter of 2015. Several sectors and products saw a significant drop-off in 2015, such as the machinery and transport sector, whose import data was down by about 50% y-o-y, while a 54% y-o-y decrease was posted for mineral fuels, lubricants and related materials.

Trade Surplus

Due to these changes, PNG has recorded sizeable trade surpluses recently. The country has never actually posted an annual goods deficit, according to its central bank, and its surplus has grown substantially since PNG LNG began production. In 2015 PNG’s trade surplus for merchandise was PGK18.9bn ($6.5bn), up 60% on PGK11.8bn ($4bn) in 2014 and well above the PGK1.2bn ($409.6m) reached in 2013. The highest-ever quarterly surplus was PGK4.6bn ($1.6bn) in quarter three 2014. In services, a longstanding trade deficit remains, however, but this has narrowed considerably from a quarterly high of PGK2.1bn ($716.9m) in June 2013 to PGK398.5m ($136m) in the fourth quarter of 2015.

Despite this strong growth in exports, falling commodity prices across 2014 and 2015 have had a knock-on effect on earnings for most products being sold from PNG. Prices for goods central to PNG’s commodity mix, including agriculture, forest and marine products, along with minerals, have decreased in the last five years. The price of coffee, for instance, peaked at PGK14,408 ($4918) per tonne in 2011 but was trading at about PGK9000 ($3072) in late 2015. Rubber hit a high of PGK9887 ($3375) per tonne in 2011 but was being sold at more than half that at PGK4000 ($1366) in 2015. Overall, the export price index declined from a high of 1106.9 in 2011 to 718.4 in 2015.

Tariffs

Through the Tariff Reform Programme of 1996-2006, PNG – a World Trade Organisation member since 1996 – set duty rates to zero for most goods, except those produced or with the potential to be produced domestically. Duty-free line items went from representing 2% of the total in 1999 to 70% by 2010. Along with more open markets came changing trade patterns, with PNG shifting its focus from Australia to East Asia. While Australia is still a significant trading partner, accounting for 34% of all imports in 2014, this figure is a significant reduction on the 50% share it maintained of PNG’s total imports in the 1970s. Japan has since overtaken Australia as PNG’s top trading partner, and is purchasing a considerable share of PNG LNG’s output, with this leading to increased engagement with other PNG exports, such as shrimp, coffee and tuna, where Japanese technological solutions are able to contribute to the further development of these commodities.

For domestic companies the low tariffs have proven problematic, with rice, flour and livestock often imported below the price of production. Coupled with the high cost of doing business in the country, many companies in PNG have struggled to compete in recent years.

Foreign Interest

PNG remains an attractive country for foreign investment, particularly its primary sector, thanks to its abundant supply of commodities and a positive attitude towards investment from overseas. Its labour costs are lower than Australia’s, while its proximity to Asian markets and transparent tax and royalty regimes for LNG projects are advantageous to investors. PNG has its share of political challenges, but as a parliamentary democracy in a constructive partnership with neighbouring Australia, the nation is far less exposed to the risks that are common to other resource-rich countries.

FDI in PNG has historically been strong, and was given a boost during the construction phase of PNG LNG. In 2012, FDI rose to 12.2% of GDP, after which it declined to 5.1% by 2014, according to IMF data from November 2015, with estimates of it hitting 6.1% for that year. However, given the volatility of the primary sector and the time it takes to get large projects up and running, the future is uncertain. Long-term forecasts still see healthy levels of foreign participation in the economy, albeit at levels below historic averages, and the IMF predicts that FDI as a percentage of GDP will stay above 4% through to 2020 and at an average of 3.6% between 2020 and 2035.

These figures could conceivably be much higher over the long term, as a number of other large projects are in the pipeline following the success of PNG LNG. Such development could encourage significant foreign investment over the next decade and beyond. Two notable projects include a second phase of PNG LNG, which is being pursued at the P’nyang gas field, and an entirely new project, Papua LNG, which is also coming together quickly. The latter will involve an estimated $10bn investment and the hiring of around 10,000 workers. A formal launch is expected in 2018, while the first deliveries are scheduled for 2021. The hope is that by the project’s completion global demand will be greater due to contracts expiring, accompanied by a recovery in energy prices and higher LNG demand in China. France-based Total has a 40.1% stake in the project, while the two domestic players, InterOil and Oil Search, possess a 36.5% and 23% share, respectively.

Because the fundamentals are so good, the new project is seen as one of the few in the LNG space likely to obtain approval over the next few years. Reserves are estimated to be above 9trn cu feet, and as lifting costs were low at PNG LNG, the expectation is that Papua LNG will be highly efficient, too. Nevertheless, the development of the facility will be very different, as unlike PNG LNG it will not be a money-is-no-object venture built at a time of high hydrocarbons prices, but will instead focus on keeping costs low and being competitive.

The long hiatus between the completion of PNG LNG and the two upcoming projects is not ideal, but the fact that they are being pursued during a time of industry stress and capital investment cutbacks is certainly a positive sign and a reflection of the country’s strengths as an investment target.

Doing Business

In terms of investment, PNG is a study in contrasts. The economy is liberal and relatively open, yet it can be a difficult place to do business for a variety of reasons. The country is rated “partly free” in Freedom House’s “Freedom in the World 2015” report, with an overall score of 3.5 (down from 3.0 in 2014), where seven is least free and one is most free. PNG peaked at 2.5 between 1999 and 2003 but has managed to remain ahead of the majority of South-east Asian countries. In the Transparency International Corruption Perceptions Index 2015, PNG is 139th of 167 countries. A year prior it stood at 145th, having fallen one position on the index from 2013.

While PNG’s score on the World Bank’s 2016 “Doing Business” report rose to 50.74 from 50.67 in 2015, it fell four positions in the rankings, from 141st to 145th. PNG’s position dropped across the majority of categories, improving in just two: dealing with construction permits and resolving insolvency. In terms of starting a business, PNG is now ranked 138th, down 10 places on the previous year, with it taking 53 days to start a business. In terms of getting electricity, the country fell from 94th to 98th, and it also dropped two places to 119th for registering property. Access to credit, protecting minority investors and trading across borders were other categories where PNG was overtaken by other economies. In addition, the survey states that it takes 591 days on average to enforce a contract in PNG, and in this category PNG’s position remained unchanged (169th), as it did for paying taxes, where it remained 110th.

Meanwhile, problems with law and order have long been an impediment to investment. According to research published by the World Bank in 2014 on the socio-economic cost of crime and violence in PNG, the annual per capita homicide rate was 10.4 per 100,000, while the same figures in the National Capital District and the business centre of Lai were 33 and 66, respectively. As per the study, 81% of companies said that crime has an impact on expansion decisions, while more than two-thirds of businesses spend an average of 5% of their yearly outgoings on security.

While political stability has typically been a selling point for PNG, various conflicts and tensions have recently risen to the surface and threatened the calm that had been maintained previously. Prime minister Peter O’Neill, who in 2011 won the popular vote following an anti-corruption campaign, found himself the subject of a graft investigation in 2014. Discontent regarding the issue manifested itself in anti-government protests by a group of students at the University of PNG that were quelled violently by the police in June 2016.

Shortages Of Foreign Currency

Foreign exchange problems have also become a major issue for companies operating in PNG and create an obstacle for businesses considering entering the market. Speaking to local media in 2016, Paul Barker, executive director of the PNG Institute of National Affairs, highlighted that the lack of foreign exchange had initially only “affected smaller, medium-sized and particularly PNG-owned businesses”, while larger firms had fewer difficulties. However, he believes that today all businesses are finding the environment challenging, noting that “there is a multi-hundred-million-kina backlog in payments owing to overseas suppliers”, with these parties unable to offer sustained credit to PNG companies. The banks meanwhile have been forced to restrict currency exchange transactions to PGK25,000 ($8534) allotments.

China

Chinese investment in PNG tends to divide opinion due to the complex relationship between the two nations. Chinese funds have helped develop PNG’s physical infrastructure, and China is also known for approving disbursements quickly and without too many conditions. Its entrepreneurs bring services to places that would not otherwise attract capital very easily, and Port Moresby has been much improved over the past half a decade, a success story with significant levels of Chinese participation behind it.

At the same time, however, Chinese businesses are seen by some as encroaching on the markets of domestic ones with cheaply produced, low-quality goods, while its readily approved loans have become a burden on the PNG economy. The question often asked is whether the high level of Chinese engagement with PNG creates a win-win situation, or one from which China wins and then wins again. Some observers believe that the Chinese work in a closed system, taking out most of what they bring in, and fail to operate as full and constructive participants in the economy.

Some Chinese investments have garnered controversy, a prime example being the nickel mining and processing facility Ramu Nickel. Since its completion in 2012, the $2.1bn development has become a potent symbol of Chinese activity in PNG. The site was attacked by villagers angered by environmental and land ownership problems in 2009 – when the country was swept by a wave of anti-Chinese sentiment – and again in 2014. Issues regarding hiring practices and the lack of locals being offered positions have also caused tension. Furthermore, in early 2016 a slurry spill raised concern that the local water supply had been contaminated, and the ability of the management to monitor the environmental impact of the facility was brought into question. In the same year the mine was temporarily shut down following the death of a worker, an accident which is pending investigation. RamuNico, the Chinese-controlled company operating the site, has defended itself against critics, saying that the material transported in its 135-km slurry pipe is natural, comprising mostly mud and not toxic chemicals.

Diverse Involvement

However, Chinese investments in PNG have involved more than just the exploitation of resources and improvements to PNG’s physical infrastructure. China’s activities are becoming more broad-based and increasingly sophisticated, being seen by many as vital to the development of PNG. Other areas in which Chinese companies are looking to invest include aquaculture and water treatment. Tourism is another sector seen as ripe for expansion, particularly with 100m Chinese tourists travelling abroad each year.

In some instances, Chinese firms are working at the highest level. Huawei, for example, has been a major player in the upgrading of the country’s telecoms system, and in 2013 it signed a contract with PNG-based Telikom to develop a $200m broadband network. Furthermore, according to Ruiyou Li, the Chinese ambassador to PNG, the nation is China’s top priority as an investment target in the Pacific, and in early 2016 a Chinese trade delegation visited PNG seeking a wide range of new opportunities.

While Chinese goods have been a source of resentment for some, the relationship in terms of trade at least would appear to favour PNG exports. According to Ruiyou the total value of these exports to China is greater than the value of goods that PNG imports from it. Speaking to local media, Ruiyou highlighted that in 2015 China imported goods with the value of $1.3bn from PNG, up 47% on the previous year, while trade in the opposite direction reached $793m, a y-o-y increase of 71%.

Outlook

PNG has many of the pieces in place to become a magnet for foreign investment and to continue achieving record trade surpluses. It is awash with natural resources, has successfully completed a major LNG project and has yet to tap into its tourism potential. However, as highlighted by the US State Department’s “2015 Investment Climate Statement” for PNG, challenges to investment include “weak enforcement of contracts, inconsistent government policies, corruption, crime, inadequate infrastructure, lack of access to constant utilities, underdeveloped private markets and extremely high commodity and telecommunications cost. Equally challenging has been the ongoing political instability”

Measures are needed, and are currently being pursued (see analysis), for PNG to move beyond its reliance on large resource-related investments and to start improving the business environment for small and medium-sized enterprises. Attracting capital to a broader range of industries will help balance the economy, allowing the country to maintain growth between resource-related projects and distribute its wealth more effectively. In the short term, PNG needs to ameliorate its volatile political situation to avoid derailing its trade and investment prospects, while addressing public discontent with high crime rates, particularly corruption, is a key issue requiring immediate action.

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The Report: Papua New Guinea 2016

Trade & Investment chapter from The Report: Papua New Guinea 2016

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