Dear Editor,
Kindly permit me to respond to a letter in your July 5th, 2022 edition, under the title “Regardless of the number of wells explored Guyana’s profit share remains tied to 14.5%”. The writer is responding to my own response to an earlier letter of his. My assertion that at some point Guyana’s take of oil production will increase beyond 14.5% of total revenue is neither wishful speculation nor false hope, as claimed by the writer. On the contrary, it follows logically from the production sharing agreement (PSA) with respect to the Stabroek oil block.
Article 11.2 of the PSA effectively provides for all recoverable contract costs to be recovered from the value of oil produced and sold in the contract area, and limited in any month to 75% of the total production from the contract area for that month, less any oil used in operations, or lost. Article 11.4 of the agreement provides for the balance of the crude oil and/or natural gas available, after recoverable contract costs have been satisfied, as specified in Article 11.2, to be shared 50/50 between the government and the contractor. Article 15.6 provides for the government to receive, as royalty, 2% of the value of petroleum produced and sold, less any amounts used as fuel for petroleum operations and transportation. These then are the components of the PSA which forms the basis for concluding that the government will receive a minimum of 14.5% (or 14.25% as suggested by those who subtract the 2% royalty before computing cost and profit oil) of total revenue. The writer’s argument that “14.5 percent of revenue is written in the contract …” is, at best, flaky and detracts from his well-intentioned contribution to the subject. The 14.5% can be computed from the contract under certain conditions, but these do not remain static through the life of the contract.
The fact that the recoverable contract costs include exploration and development costs, and that the contractor is allowed to recover these costs with respect to any well explored, or developed, within the contract area from the proceeds of those that are already in production, makes the 75% cost recovery limit applicable to the aggregated recoverable costs and total revenues of all petroleum activities in the contract area. Had each project been “ring-fenced” in the contract, the cost recovery limit would have applied to each project separately and, once that project’s pre-production costs had been recovered, the only costs to be deducted from its total revenue before the 50/50 split would have been those relating to its current operations. During the life of such a contract, government would have earned the minimum 14.5% on some projects, while concurrently earning a higher share on other, more mature, projects. Clearly the lack of ring-fencing defers the higher government-take from the earlier projects until such time as the aggregated pre-production costs of all petroleum activities in the contract area have been fully recovered. I had stated in my previous response that “exactly when this will happen depends on the amount of wells explored before the contractor’s exploration license expires, and how many are developed for production”. I find it incomprehensible that the writer would construe this as a suggestion on my part that “more wells explored will increase the 14.5 percent share for Guyana”.
There are three dimensions at play here which have a combined impact on Guyana’s earnings from the Stabroek Block. These are: government’s 14.5% minimum take; the 75% cost recovery ceiling; and the lack of ring-fencing. The contentious issue concerns whether the 14.5% minimum take will ever increase. My view is that it will. The role of the cost recovery ceiling in determining this is as follows: all things being equal, the higher the cost recovery ceiling the greater the amount of recoverable contract costs recovered in any given period by the contractor and, by extension, the faster the recovery of pre-production costs. This, in effect means that the higher the ceiling the faster Guyana can get to the point where its take increases beyond the 14.5% minimum.
The impact of the lack of ring-fencing is not as straight forward, except for the fact that there is no separation of projects, and the increase in government’s take from the 14.5% minimum will begin at a single point in time with respect to the entire contract area. This will happen when the sum of the costs of production and the capital costs not yet recovered falls short of 75% of total revenues from all producing projects for any given period. The main problem associated with the lack of ring-fencing in the current scenario is that it defers any increase in the government’s minimum take by allowing the contractor to keep adding and reclaiming recoverable costs with each new exploration or development investment. However, this problem cannot continue in perpetuity since new exploration can only take place during the period in which the contractor’s petroleum exploration licence is valid. This period comes to an end in 2026, after which the contractor is required to relinquish all areas not under production, or slated for development. In terms of development investments, these may continue beyond the expiry date of the exploration licence with respect to those discoveries already made under the licence. However, related activities such as informing the subject minister that a discovery is of commercial interest, and applying for a petroleum production licence, are time bound under the Guyana Petroleum Exploration and Production Act. The contractor has up to two years after indicating that a discovery is of commercial interest to apply for a petroleum production license to exploit that discovery. This particular safeguard is subject to the minister’s discretion, and it is hoped that this will not be used unwisely.
The issue of whether Guyana’s take will ever exceed 14.5% hinges on whether recoverable costs will ever amount to less than 75% of the total value of all oil produced and sold from the Stabroek Block. It is perfectly in order to argue that the Liza Phase-1 and Phase-2 projects which, by 2027 would have yielded somewhere between 25% and 30% of their combined revenues for the government (based on an oil price of US$60 per barrel) under a ring-fenced arrangement, will continue to yield just the minimum 14.5% under the current contract. This is what many Guyanese resent. However, this argument cannot ignore the fact that the dollar value of the difference between these two scenarios represents costs recovered from newer projects. And if we accept this straightforward logic, then we must also accept the fact that this will ultimately lead to an earlier recovery of all pre-production costs than would have occurred under the staggered ring-fenced arrangement. There is sufficient information available on the first four projects already approved for production (Liza Phase-1, Liza Phase-2, Payara and Yellowtail) for a comparison to be made between the two cash flows. If the case can be made for four projects it can also be made for ten.
A simpler way to establish government’s take is to look at the big picture. At this point, there are potentially eleven billion barrels of oil in the Stabroek Block. Even if only six billion are produced and sold at an average price of US$60 per barrel, the total revenue generated would be US$360 billion. Estimating royalty, capital costs and operating costs (including decommissioning cost) at 2%, 25% and 35% of total revenue, respectively, leaves 38% of total revenue to be split 50/50 between the government and the contractor. This leaves government with 21% (2% royalty + half of 38%) of total revenues earned from production. This share is clearly greater than 14.5 % and, even with the low (6 billion barrels) total production, and the generous capital and operating costs (25% and 35% respectively) amounting to US$75.6 billion, some US$23.4 billion more than would obtain by just maintaining the 14.5% minimum take throughout the life of the contract. If total production were ramped up to ten billion barrels these figures would simply be scaled up accordingly. The point is that, barring some overt skullduggery, Guyana’s minimum take is just what the term implies – a minimum take – and will increase at some point.
Editor, I am aware that I have ignored a number of important issues relating to the benefits of ring-fencing. Interest rates, net present value and the incentive to explore and develop are all germane to extent to which Guyana loses or benefits as a result of not ring-fencing the individual projects. My view is that we ultimately lose by not ring-fencing. However, my main contention is that we cannot simply wish away our entitlements under the contract because it suits a particular line of argument. So once again, I maintain that we will, at some point, reach a stage where our take exceeds the 14.5% minimum. In closing, I agree with the writer that building and maintaining a transparent system that monitors exploration, investment, employment, daily production and marketing, while hiring the best and brightest, regardless of their political affiliations, is the best model for Guyana.
Sincerely,
Dominic Gaskin