Introduction
In this ongoing series discussion of Guyana’s prospect during its coming time of oil and gas production and export (that is circa 2025), I had introduced in last week’s column the notion of the break-even price. As indicated there, this is the price at which the total cost of operating any business is just equal to the total revenue obtained from the sales of that business’ output. Cost, as used here, refers to opportunity or economic cost, as this was defined last week. Determining the break-even price is a strategic operational necessity for all businesses and is therefore essential for efficient decision-making in the emerging oil and gas industry in Guyana.
As was also described in last week’s column, the break-even price as used there, was approached from the perspective of private businesses, and in particular, those who are responsible for operating the business on behalf of its legal owners. In the case of Guyana’s oil and gas, this would be the consortium of foreign interests that are legally responsible not only for exploration and discovery, but also development and production of the oil and gas resources.
Today’s focus, however, is on what has been termed in the literature as the fiscal break-even price. In essence this price is derived from the perspective of the Government of Guyana, which on behalf of the people of Guyana, ‘owns’ the resources that are being exploited. This concept would therefore apply, whether or not Guyana’s oil and gas resources are being developed by the present business consortium, or through a specially created state corporation.
In this sense this is a social or national price, and not a price determined for private businesses. It is also a normative price, as explained below.
Fiscal break-even price
The fiscal break-even price can be described as the minimum price for a barrel of crude oil, which Guyana needs in order for its government to derive revenue from selling oil, which it decides is sufficient to meet its full spending requirements, (based on the policies, plans, programmes and projects it intends to implement) while maintaining a balanced budget. This is a normative price, because it is based on the price government feels it ought to receive rather than the price which is determined objectively in the market place.
Based on this definition, it follows logically that, if the price obtained for oil sales falls below the fiscal break-even price, then this would yield either 1) a national budget deficit, if spending is maintained at the contemplated level; 2) a reduction in government’s spending; or 3) some combination of both. If the opposite circumstance occurs, which is the price obtained from the sale of oil exceeds the fiscal break-even price, then logically also, the government can 1) increase spending; 2) earn a budgetary surplus; or 3) utilize some combination of both these outcomes.
Popularity
The practice of periodically estimating fiscal break-even prices for major oil producers has become an embedded feature of global economic, financial, political and governance (regulatory) reporting in today’s globalized energy environment. There are several benefits that are obtained from this practice, including the following: first, it provides a useful proxy which industry analysts use to assess political and economic risks facing those oil and gas producers which provide substantial fractions of global GDP.
Second, comparisons of fiscal break-even prices across key global energy suppliers also offer insights for assessing global energy output, demand, and the likely energy mix. From anticipated fiscal price behaviour, analysts are able to produce improved estimates. And associated with this improvement is better estimation of the energy-mix, and the geographical distribution of both overall energy output and specific components of it.
Third, all the main players in the oil and gas market: traders, investors, speculators, producers, consumers and inventory holders, rely on estimated fiscal break-even prices for oil to project the configuration of future energy market balances, over the short, medium and long term.
Finally, several governments use these estimates to aid the assessment of their fiscal capacity. Today, this is considered to be an essential tool for assessing both fiscal space and the fiscal policy reform agenda for oil producers.
As matters presently stand, these measures have become so influential worldwide that several institutions publish them on a regular basis, (this will be further discussed as treatment of this topic continues next week). For the time being it should be simply noted that presently, these estimates are considered fundamental for understanding the dynamics of entry barriers-sales-cost-output-price-demand-profits, and target-setting output in a globally competitive energy market environment.
Further, readers should also note those oil producers that possess significant market power, whether separately or in collusion with other significant suppliers (like OPEC), can potentially influence/ shape the configuration of the oil market. Indeed they have already done so (and will continue this practice) because of their power to steer the oil market in ways aimed at maximizing benefits for themselves. Here, market power is used as it is done in business and economics. It simply refers to the ability of enterprises to profitably raise prices above their marginal cost of production. This stands in contradistinction to businesses operating in competitive markets in which they cannot be price setters or makers, but only price takers.
Conclusion
In support of this analytic process, other key market concepts have come into play. Thus, for example, the concept of the shut-down price. This is the price at which oil sales do not cover the average variable cost of operations. However, as long as the price remains greater than average variable cost, producers should continue to produce, since although making a loss, this strategy minimizes the loss. This is so, because variable cost is covered with something left over to meet those indirect costs which the businesses cannot immediately avoid by shutting down.
Next week I shall continue this discussion and introduce data for readers’ benefit, analyzing current estimated fiscal break-even prices for several of the top 20 oil producing nations.
