Introduction
Because of its centrality to the query — as to whether projected oil revenues are likely to be large enough and sufficiently stable to finance successfully income transfers of the magnitude and stability required to alleviate substantially income poverty in Guyana — I need to explore more fully the workings of Government Take under the ruling PSA.
The above has been complicated by the relentless mis-specifications of the term Government Take in the local social and print media. In earlier contributions, I sought to make it clear that Government Take is a fiscal metric and therefore needs to be defined to avoid ambiguity. It is used as a metric for: 1) assessing government/company oil contracts, and 2) comparing these projects within and between countries. This is a supremely complex exercise.
Fake News and the Royalty Rate
While this column is not designed to once more revisit Guyana’s PSA with ExxonMobil and partners. I can illustrate the difficulty through the specious manner in which the social and print media regularly treat the royalty rate. Because 50 per cent is 25 times 2 per cent it deceptively seeks to convey the fake news that a royalty rate of 50 per cent is considerably better than a 2 per cent rate. A little reflection reveals the deception. In economics, 50 per cent does not always mean better than 2 per cent.
First, the proximate effect of moving from 2 to 50 per cent is invariably better if, and only if, the item being measured is what economists label as a “virtuous good”. Second, non-proximate effects can potentially reverse this. Third, if the good is non-virtuous, like crime, the proximate effect is invariably worse
Definition
As a rule, energy analysts define Government Take as “the percentage of the petroleum pre-tax project’s net cash flow, adjusted for government participation, if any [and] calculated in discounted or undiscounted values”, S. Tordo, World Bank Working Paper, 2007. In Guyana, the royalty rate varies by agreement and under the ruling PSA with Exxon and partners it is 2 per cent on an ad valorem basis. As the IDB notes “this is well below what is observed internationally”. From a balanced perspective, this is undeniably a benefit and loss for Guyana.
Readers should never forget that Contractors under the PSA use economic indicators not fiscal metrics to evaluate projects. Thus, they measure project performance by: 1) the Net Present Value (NPV) of the project’s cash flow, 2) the Internal Rate of Return (IRR), which indicates the relative attractiveness of projects, or 3) the Profitability Ratio (PR), which is the NPV divided by total capital invested. .
Alternative Conceptualization
Earlier, I had offered an alternative perspective on Government Take. That is, to conceptualize fiscal systems linked to oil contracts as functioning in a global petroleum market, where scores of governments are selling oil contracts and, similarly, scores of companies are buying these contracts. Supporting these transactions are a large number of available oil fields/reserves. Here, Government Take reflects the balancing of demand and supply for these oil fields/reserves. The “price” obtained for any given field/reserve is basically the balancing of demand and supply. Hence, Government Take or the price yielded by the “total effect of the fiscal system on the cash flow of an oil field or country’s reserves” (World Bank, Note 46, “Fiscal System for Oil”), 1995.
At that time [1995] the World Bank had estimated world average Government Take was 64 per cent, ranging from a low of 25 per cent (Ireland) to 95 per cent (Yemen). The modal Take ranged between 40 and 85 per cent.
Limitations
As a performance indicator of the fiscal regime, government take has several limitations. First, (like the Guyana 2016 PSA), it is not “neutral” in regard to the impact of oil price changes on it. Government take will vary with both crude oil prices and Contractor profits. Given this, profits, prices, and therefore production and costs should be measured over the life cycle of the oil field, if they are to be relied on. Second, a similar “non-neutral” situation exists for the production of crude oil.
Thirdly, because it is the full life cycle of any oil field (project) that has to be considered, readers should bear in mind that this could last for several decades! This makes estimation hazardous. It also makes the time sequence of the profit-flow relevant to the outcome. This consideration relates to the concept of the time value of money. Because of this factor, economists and accountants have evolved a preferred measure to Government Take ̶ the Effective Royalty Rate (ERR). The ERR measures Government take after considering clearly defined accounting periods.
Conclusion: Zero-Sum Game?
Industry analysts often take great care to ensure that divisions between Governments take and Contractor’s profit are not represented solely as a Zero-Sum Game. That is, one in which one party gains only at the expense of the other. As we saw, the Contractor focuses on the NPV, IRR or PR and, therefore, it is in practice possible for the value going to both groups to rise, if market conditions favour this outcome
However, this does not mean there is zero likelihood of a zero-sum game. No! This potential resides in the timing of returns. Both Government and the Contractor may strive for early returns. Typically, Government spending needs for public goods and services are urgent. Investors also want to get their returns early. This competition can lead to a zero-sum game, but this may not always be the case!
Next week I advance the thesis that the Buxton Proposal is congruent with the United Nations, Sustainable Development Goals paradigm.
