Review of the Forest Revenue System in Papua New Guinea

REVIEW OF THE FOREST REVENUE SYSTEM IN PAPUA NEW GUINEA 100 80 90 to 95 96 to 01 60 90 to 01 40 20 Do landowners receive enough ? 0 Does the -20 Government collect Share of the returns from logging (per cent). enough ? -40 Go v ern men t Do loggers receive Landowner Operator too much ? FINAL REPORT OF THE FOREST REVENUE REVIEW TEAM COMMISSIONED BY THE GOVERNMENT OF PAPUA NEW GUINEA 13 MARCH 2002 2001 FOREST REVENUE REVIEW Acknowledgements The Review Team received valuable help and assistance from numerous organizations and individuals in Papua New Guinea. Working facilities were provided at the PNG Forest Authority (Managing Director Mr Thomas Nen) at its Headquarters in Port Moresby and staff both at HQ and in the Regions and Provinces assisted with data capture and team travel. The Papua New Guinea Forest Industries Association (President Mr Stanis Bai) provided an invaluable gateway to consultations with the industry at large and assisted with team travel. SGS PNG Ltd. (General Manager Mr Bruce Telfer) patiently answered our many queries about the operation of the log export monitoring arrangements. We would like to thank all those who attended our workshop for presentation of the preliminary results and also the following individuals: Ms Felecia Dobunaba, OBE. and Mr Paul Barker (Department of the Prime Minister & National Executive Council), Ms Colette O’Driscoll (Internal Revenue Commission), Dr Benno Boeha (National Research Institute), Ms Peter McCrea (Department of National Planning & Monitoring), Mr Dick McCarthy & Mr Bob Tate (Papua New Guinea Forest Industries Association), Mr Philip Tiong (Vanimo Forest Products Ltd.), Mr Andrew Bond (World Bank), and Mr Ivan Lu (Rimbunan Hijau Ltd.). Numerous other persons assisted us, and we apologize for not being able to name them all. None of the above-named organizations or individuals are responsible for any errors or omissions that might remain in the Review. Such residual matters are subject to the disclaimer below. Disclaimer This Review was commissioned by the Government of Papua New Guinea and funded by the Government itself and by the Australian Agency for International Development. The Review Team has made every effort to ensure the accuracy of their data and to perform analyses and interpretation to the best of their ability but cannot guarantee a perfect result, nor be responsible for the results of applying its recommendations. The Team delivered the report to the Government for use as it sees fit, and its responsibility ended at that point. PAGE II 2001 FOREST REVENUE REVIEW TABLE OF CONTENTS ACRONYMS X EXECUTIVE SUMMARY 11 PART 1 INTRODUCTION 13 1.1 NATIONAL ECONOMY 13 1.1.1 Demography 13 1.1.2 Growth 13 1.1.3 Sectoral Performance 13 1.1.4 Employment 14 1.1.5 Trade 14 1.1.6 Inflation & Interest Rates 15 1.1.7 Exchange Rate 15 1.1.8 Government Finance and Taxation 15 1.2 THE FORESTRY SECTOR 16 1.2.1 Resource Characteristics 16 1.2.2 Commission of Inquiry 17 1.2.3 New Forest Act and Policy 17 1.2.4 Market Variations in the Last Decade 18 1.3 CURRENT STATUS OF THE FOREST REVENUE SYSTEM 18 1.3.1 Summary 18 1.3.2 Log Export Tax 19 1.3.3 Landowners’ Revenue 19 1.3.4 Other Government Revenue 20 1.3.5 Policy Support for Domestic Processing and Revenue Implications 20 1.4 METHODOLOGY ADOPTED BY THIS STUDY 21 PART 2 ANALYSIS OF MARKETS, TRADE AND INDUSTRY 23 2.1 PRODUCTION AND EXPORTS 23 2.2 PAPUA NEW GUINEA’S FOREST PRODUCTS EXPORTS 26 2.3 MARKET OUTLOOK FOR PNG LOGS AND PROCESSED FOREST PRODUCTS 30 2.3.1 The Certainties of Wood Demand 30 2.3.2 The Uncertainties of Wood Demand 31 2.3.3 The Certainties of Wood Supply 31 2.3.4 The Uncertainties of Wood Supply 34 2.4 CONCLUSIONS AND IMPLICATIONS FOR PAPUA NEW GUINEA 35 PAGE III 2001 FOREST REVENUE REVIEW PART 3 TRANSFER PRICING 36 3.1 ADMINISTRATION 36 3.2 TRANSFER PRICING INVESTIGATION 38 3.2.1 Types of Transfer Pricing and Information Sources 38 3.2.2 Volumetric Information 40 3.2.3 Species and Grades 43 3.2.4 Pricing Information 44 3.2.5 Freight & Insurance 47 3.2.6 Taun & Calophyllum Example 49 3.2.7 China, Hong Kong, & Korea 52 PART 4 FINANCIAL MODELLING 54 4.1 LOG PRODUCTION COSTS 54 4.2 OUTLINE OF PROCESSING OPTIONS 57 4.2.1 Financial Models for Processing 57 4.2.2 Sensitivity Analysis on Base Case Financial Models 69 4.2.3 Government Revenue Foregone Through Processing of Logs 70 4.3 International Competitiveness Issues Relating to Processing in PNG 71 PART 5 RESOURCE RENT 74 5.1 INTRODUCTION 74 5.2 THE FOREST REVENUE SYSTEM AND RESOURCE RENT 75 5.3 THE RESOURCE RENT ON LOG EXPORTS (IN THE ABSENCE OF TRANSFER PRICING) 76 5.4 ARE LOG EXPORT DUTIES TOO HIGH? 82 5.5 THE RESOURCE RENT ON PROCESSED LOGS 84 PART 6 AN ECONOMIC COST-BENEFIT ASSESSMENT OF PROCESSING 87 6.1 INTRODUCTION 87 6.2 THE BENEFITS OF PROCESSING 87 6.3 THE COSTS OF PROCESSING 91 6.4 WEIGHING UP THE BENEFITS AND COSTS OF PROCESSING EXPORT LOGS 93 PART 7 THE DISTRIBUTION OF RESOURCE RENT 99 7.1 AN APPROPRIATE DISTRIBUTION 99 7.2 THOUGHTS ON IMPROVED MECHANISMS FOR DISTRIBUTING THE RESOURCE RENT 102 7.3 OTHER ISSUES 105 PART 8 ESTIMATED ECONOMIC VALUE OF THE FOREST ESTATE 107 PAGE IV 2001 FOREST REVENUE REVIEW 8.1 THE RATIONALE FOR AN ECONOMIC VALUATION OF FORESTS 107 8.2 FOCUS: NATURAL FOREST LOGGING 108 8.3 A FIRST STEP TOWARD ECONOMIC VALUATION 109 8.4 THE ROLE OF FOREST TAXATION 109 8.4.1 Forest Asset Depletion 110 8.4.2 Landowner Costs 110 8.4.3 Sub-optimal Selection of Logging Over Alternatives 111 8.4.4 Flow-on or Multiplier Effects 111 8.5 ESTIMATING THE FULL RANGE OF FOREST VALUES 112 PART 9 AN INDUSTRY PERFORMANCE BOND 117 9.1 DESCRIPTION 117 9.2 RATIONALE 117 PART 10 KEY FINDINGS, CONCLUSIONS AND RECOMMENDATIONS 119 10.1 STRUCTURE 119 10.2 KEY FINDINGS ON THE ECONOMIC VALUE OF THE FOREST ESTATE 119 10.2.1 Model Findings 120 10.3 KEY FINDINGS ON FOREST INDUSTRY 122 10.3.1 Export Logs 122 10.3.2 Processing 122 10.3.3 Market Outlook 122 10.3.4 International Competitiveness 122 10.4 KEY FINDINGS ON TRANSFER PRICING 123 10.4.1 Japan 123 10.4.2 China and Hong Kong 123 10.4.3 Common Evidence 124 10.5 KEY FINDINGS ON RESOURCE RENT 124 10.6 CONCLUSIONS 126 10.6.1 Conclusions on the Economic Valuation of the Forest 126 10.6.2 Conclusions on the Forest Industry 126 10.6.3 Conclusions on Transfer Pricing 127 10.6.4 Conclusions on Resource Rent 127 10.7 RECOMMENDATIONS AND DISCUSSION 131 10.7.1 Recommendations for further study of the economic value of forests from the perspectives of landowners and the nation 131 PAGE V 2001 FOREST REVENUE REVIEW 10.7.2 Recommendations for the study and piloting of financial and operational mechanisms for enhancing the efficiency of forest allocation and preventing malfeasance 132 10.7.3 Recommendations for forest revenue policies that promote beneficial changes in the forest sector in response to changing market forces, emerging markets, the condition of PNG’s forests, and uncertainties 133 10.8 RECOMMENDATIONS FOR INDUSTRY 134 10.8.1 Recommendations on Transfer Pricing 134 10.8.2 Recommendations on the Industry Performance Bond 135 10.8.3 Recommendations for Short Term Action on Resource Rent Issues 135 10.8.4 A Model System for the Longer Term 136 10.8.5 Tax Rates and Thresholds 136 10.8.6 The Revenue Base 137 10.8.7 Administration 137 10.8.8 Implementation 137 ANNEX A DATA ON THE FOREST SECTOR 138 ANNEX B THE PERFORMANCE OF ALTERNATIVE LOG EXPORT REVENUE SYSTEMS 145 ANNEX C COST BENEFIT METHODOLOGY 163 C.1 OVERVIEW OF THE METHODOLOGY 163 C.2 INPUT-OUTPUT MULTIPLIERS 164 C.3 DATA 168 ANNEX D MISCELLANEOUS DATA 169 ANNEX E TERMS OF REFERENCE 171 ANNEX F REVIEW TEAM MEMBERS 176 REFERENCES 177 BOXES Box 6.1 Existing Tax Incentives for Downstream Processing 89 Box 6.2 An Economic Profile of Selected Timber Processing Operations 89 Box 7.1 The Extent of Competition in the Forest Industry 100 Box 7.2 Criteria Used to Assess Royalty Systems 104 PAGE VI 2001 FOREST REVENUE REVIEW FIGURES Figure 3.1 Log Exports from Papua New Guinea to Japan (SGS vs. JLIA Figures) 41 Figure 3.2 Log Exports from PNG to China and China Log Imports from PNG 41 Figure 3.3 FOB Prices for PNG Logs (1996-1999) 44 Figure 3.4 CIF Prices for Logs Imported into Japan from South Seas 45 Figure 3.5 Japan CIF and PNG FOB Prices for Taun and Calophyllum Logs 46 Figure 3.6 Differences Between cif Japan and fob PNG Prices for Taun/Calophyllum Logs 47 Figure 3.7 Evolution of Log Freight Costs to Japan (annual average) 48 Figure 3.8 Cif Prices for Tropical Logs Imported by Korea 53 Figure 5.1 Papua New Guinea Log Export Volumes and Average Prices 76 Figure 5.2 The Actual Level of Resource Rent From Log Exports (in the absence of transfer pricing)78 Figure 5.3 The Estimated Past Distribution of Resource Rent (in the absence of transfer pricing) 79 Figure 5.4 The Share of Log Exports Accounted for by Low Grade Logs 81 Figure 5.5 The Current Level of Costs and Revenue 82 Figure 5.6 The Actual and Potential Level of the Log Harvest 83 Figure 5.7 Purchase of New Heavy Equipment by the Logging Industry 84 Figure 6.1 Net Benefits of Processing for a Typical Year 95 Figure 6.2 Export Duty Foregone on ‘Exportable’ Logs Processed 95 Figure 6.3 Landowner Premium Foregone on Processed ‘Exportable’ Logs 98 Figure 10.1 Annual Net Returns to Natural Forest Logging in Papua New Guinea (2001) 121 Figure 10.2 The Past Distribution of Rent had the Preferred System Applied 128 Figure 10.3 The Actual and Proposed Level of Charges Under Different Prices 129 Figure 10.4 The Hypothetical Level of Resource Rent From Log Exports (assuming transfer pricing)130 Figure 10.5 The Hypothetical

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