Introduction
Today’s column links my ongoing assessment of Guidepost 6 in Guyana’s Petroleum Road Map (that is, the average (unit) total costs for its crude oil export) to my previous presentations in this series on Guyana’s projected indicative price range per barrel of oil equivalent (boe) for its expected petroleum exports. Today I introduce the concept of a break-even price. This price exists from both a private commercial perspective and the fiscal standpoint of government.
As far back as two and a half years ago, I had elaborated in two successive columns, published during November 2016, on the notion of the break-even price for Guyana’s petroleum exports. Today’s and next week’s columns on this topic have, consequently, benefitted from those earlier efforts.
Break-even Price
I start with the query: what is a break-even price? After careful reflection, it is clear that the notion of a break-even price for Guyana’s crude oil exports is central to ensuring both the sustainability and commercial viability of its future petroleum operations. Readers should recall I had previously indicated that economists define the break-even price for any business, as the price at which the total cost of operating the business is just equal to the total revenue obtained by that business from its sales. The cost referenced here is also known as the “opportunity cost.” Economists further observe that opportunity cost is the same as “economic cost,” which in turn is defined as the “next best forgone alternative that was not chosen,” for whatever resources are invested in a business.
Readers are well aware that rational investors in any business would expect a return on their investment. Typically, this expected return is based on the risk-adjusted next best earnings they could obtain for their invested funds placed into that business. This rational return is also referred to by economists as normal profit, which in turn is simply accounting profit, when economic profit is zero.
The concept of the break-even price is applied quite frequently in business and economic analyses. Economists, however, emphasise that the break-even price is not a generic price. In other words, the break-even price varies across different types of businesses! Consequently, (for present purposes) it is noted here that, in business and economics the break-even price of crude oil has developed as a measure which is specific to the crude oil industry. Given this feature therefore, one can assert that today Guyana’s petroleum environment already displays certain unique features, even though the country is still at the pre-production stage!
On close consideration, several of these industry features are revealed. First, Guyana is certain to be a price-taker and not a price maker in global crude oil markets. Why is this the case? Bluntly put, we are aware today that even the world’s largest producers, operating as a cartel through OPEC, do not have sufficient market power to “fix prices” or indeed determine “broad price ranges” for crude oil. Second, there are also non-OPEC players with considerable “global geo-strategic weight” in the crude oil market, such as the United States, Russia, and China. These also cannot “fix market prices!” Third, we already know for sure that when Guyana’s petroleum production peaks, its projected daily rate of production (DROP) will still effectively remain a small fraction of global sales.
Readers may well ask today, as I did two years ago, why is knowledge of the break-even price important? The best answer I can give is that, knowledge of the break-even price is useful to Guyana’s oil and gas producers (exporters) for several analytical reasons. These include: 1) the need to determine a benchmark for rating Guyana’s competitiveness in the sector; 2) to guide Guyana’s market share strategy; 3) to determine the efficient expansion path for Guyana’s petroleum production; 4) to have an effective gauge of Guyana’s productivity; 5) to rate Guyana’s cost competitiveness and efficiency; and, finally, 6) to support Guyana’s market and pricing policies.
It can be inferred from this analysis, therefore, that the gap between the break-even price established for Guyana’s crude oil exports and the prevailing market price indicates the margin of safety, as it is termed, which exists for Guyana’s petroleum operations. Indeed, the wider is this gap, the greater is the margin of safety.
Readers should note that, as indicated above, the break-even price is, uniquely, 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. Since, as indicated, this cost refers to opportunity or economic cost, then based on this, the determination of the break-even price is a strategic operational necessity for Guyana’s crude oil exporters, as is indeed the break-even price for all businesses. In other words, it is absolutely essential for efficient decision-making in Guyana’s emerging oil and gas industry.
Comparative Break-Even Costs
As indicated above, break-even prices do vary across various regions. Schedule 1 reveals the variation. The range for these data is great. Thus, the highest break-even price estimate (Arctic Region @ US$75 per boe) is 2.8 times more than the lowest break-even price estimate (Middle East Onshore @ US$27 per boe)! Further, the mean break-even price is high, US$53.
Schedule 1: Estimated Average Break-even Price of
Crude Oil, by Region
Region US$ Boe
Onshore Middle East 27
Offshore Shelf Middle East 41
Heavy Oil Middle East 47
Onshore Russia 50
Onshore Rest of the World 51
Deepwater 52
Ultra Deepwater 56
North American Shale 65
Oil Sands 70
Arctic 75
Source: G. Kristopher 2016
Thus far, my analysis of the break-even price has approached it from a private business/ commercial perspective! In the case of Guyana, this perspective represents that of the foreign consortia legally responsible (as Contractor) for exploration, discovery development, production and distribution of Guyana’s petroleum resources.
Conclusion: Guyana’s Break-even price
There are two references that I know of concerning Guyana’s likely crude oil
break-even price per boe. One is the Wood Mackenzie claim that this price is less than US$40 per boe. No supporting analysis was presented. The second is the claim made by Hess Corporation, in its Barclays Conference paper, which has been discussed before. There, it claimed: “a WTI price of US$35, yields a 10 per cent margin on the cost of supply for Guyana’s offshore play.”
Next week I shall address the fiscal break-even price
