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

What the paper says

We examine two approaches to the monetization of natural gas and the generation of revenues for resource-rich countries. The cash flow taxation model, adopted in Norway, is the closest to a rent tax and generates higher revenues for the host country over the long term while still attracting investors. Its drawback, however, is that the government acts as a silent partner in the project, providing “loss refunds” when cash flow is negative—a fiscal commitment that low-income and lower-middle-income resource-rich countries often cannot afford. By contrast, under a production sharing agreement (PSA), revenues flow to the government from the first year, while the company bears high front-end investment costs and substantial downside risk. This misalignment of incentives and risk perceptions can lead to the stranding of otherwise profitable projects, thereby hampering the production of natural gas as a lower-carbon fuel during the energy transition. International financial institutions (IFIs) engaged in climate change mitigation can help bridge the gap between the cash-flow regime expectations of investors and the PSA regime expectations of governments. For governments, this would translate into higher revenues for development. IFI intermediation can also help alleviate broader political and country risks that hinder credible intertemporal commitments between investors and host states. Such mechanisms are critical not only to unlock supply in the gas sector but also to support investment in green minerals—either directly or indirectly, by using natural gas as the least carbon-intensive fossil fuel to provide the energy required for the extraction and processing of these minerals.