Introduction
Last week’s column identified several of the ‘known unknowns’, as these are termed in strategic management. They help determine the likely revenue yield from Guyana’s 2016 Production Sharing Agreement, PSA. The known unknowns include the actual outcome of 1) Risk-sharing between Guyana and the private Contractor (Exxon and partners); 2) Returns to the two Parties (Government revenue and Contractor profit); and 3) Sustainability of investment flows to the petroleum sector through time. Alongside such known unknowns, there is the more difficult category of unknown unknowns. By definition, we cannot be cognizant of these now, except for the fact that we know they exist.
Elaborations
Today’s column offers five elaborations on last week’s key observations. First, the division between Cost Oil (that is the percentage of the value of total output, which is allocated under the PSA to Exxon and its Partners), and Profit Oil (as defined in the PSA) which is deliberately designed to compensate or secure for Exxon and its partners (Contractor) for the risks attached to their previous exploration and development as well as operational expenditures. When recognized this way, it means that through this mechanism the PSA in effect guarantees a minimum return to Exxon and partners. This further indicates, therefore, the limitation identified here, is insensitive to price rallies in the petroleum market, which I think one can reasonably predict would occur, at least during the medium-term after 2020, when Guyana’s oil and gas production and export is expected to come onstream.
Second, it would be a safe observation to conclude that history is not on the side of Guyana-type economies being able to find what is labelled as the right balance in the policy trade-off between revenue extraction now, and encouraging adequate long-term external investment flows.
Third, it is presently estimated that worldwide, there are over 500 different fiscal regimes operating in the petroleum sector. And, since this number is far larger than the number of countries, it is self-evident that some countries have multiple fiscal regimes co-existing within their domestic oil and gas sectors. Indeed, this might well also eventuate in Guyana, if the present inherited 1999 PSA as modified in 2016 is kept for Exxon and partners but different contractual arrangements are later negotiated for any subsequent production blocks. It should be further noted here, the World Bank has reported there are more than 30 countries which have engaged in revision/ renegotiations of their existing petroleum contracts during the first decade of the 2000s.
Fourth, readers should also recall the effective fiscal yield of Guyana’s 2016 petroleum fiscal-regime is technically dependent on the quality of its petroleum, which we have already reported, is a high quality light sweet crude. This indicates Guyana falls in the lower range of the Energy Return on Investment Index (EROI). This elaboration is justified in order to reinforce the industry truism: ‘All first oil contracts are more difficult to negotiate than subsequent ones’. This happens to be the case because fiscal regimes impact on both the technical and commercial choices of the Contractor (Exxon and partners).
The final elaboration warranted here is that, worldwide, oil and gas resources yield very high levels of economic/resource rent. This rent is also formally described as the ‘surplus value’ obtained from sales of petroleum products after all extraction/production costs plus normal returns to the investors are deducted. This notion has been alternately labelled: ‘excess or supernormal profit’.
In Guyana’s case, this excess profit is further enhanced by three characteristics, namely, 1) the existence of differential value (as specified in the quality of its crude); 2) relative scarcity (where the same applies); and 3) entrepreneurial skills (global reputation of Exxon and its partners as leading oil majors).
To conclude on this topic, readers should bear in mind Guyana’s fiscal regime covers both 1) the basic constitutional, economic, financial, and accounting legislation of the Guyana State, and 2) the specific terms and conditions of the 2016 PSA.
Valuation issues
Most laypersons to whom I have spoken, assume that if Guyana’s petroleum resources were left underground and underwater, they would have no value. From an economic perspective, this is not accurate. Such resources have value, and the country needs to appreciate this feature. Two ways of observing this are explored in this section.
One perspective is to consider all Guyana’s natural resources as constituting a basic factor of production; that is, similar to our acceptance of labour and capital along with land being the basic factors of production. The economic price of any such factor of production is, therefore, its opportunity cost. In other words, the next best alternative benefit the factor could yield. In the market place, this notion is accommodated by the wage rate for labour, interest for capital, and rent paid for land.
What then is the benefit to the State (Owner) of petroleum resources not extracted? On examination, this can be seen as the benefit of not using it now, but later when extraction is perhaps less costly and its market price may be improved. It also gives the Owner (State) time to avoid the mistakes and/or learn from past experiences of resource mismanagement.
This explanation leads to a critical observation; namely, the aim of the Guyana government should not be limited to capturing as much as the excess profit in the sector, as it can, but to go further and affect the behavioural incentives, which taxation offers to investors. As Precept 4 (Fiscal Regimes and Contract Terms) of the Natural Resource Charter puts it: “A fiscal regime that merely captures economic rent … does not affect the behavior of the extraction company ̶ it is said to be tax neutral [but] we want the tax system to change the behavior of the company so as to use the resource reserves efficiently”.
Conclusion
The local debates do not acknowledge the above nuances. At best, they focus on highlighting the huge ‘excess profits’ Exxon and its partners might make, with great certainty! At the core, however, the real issues are avoided; both deliberately (to score points) and otherwise.
