Ramkarran’s estimate of government revenue from oil is too high

Dear Editor,

Ralph Ramkarran, in his article in SN of August 7, 2016 ‘Guyana’s future as an oil producer’, estimates that Guyana can expect revenues of US$5.5 billion a year from the recent Liza oil discovery by ExxonMobil and partners. Ramkarran uses three variables to arrive at his figure: an oil price at US$ 80 a barrel, a daily production of 500,000 barrels, and a government share of 40%.

Based on my own general understanding, this estimate is extremely optimistic because the numbers he uses are either highly speculative or, in one case, likely inaccurate.   That said, as any other Guyanese, I hope Ramkaran’s estimate turns out to be correct. Maybe he knows something we don’t. But regrettably, revenues are likely to be more modest if we use more plausible numbers and formulas.

First, there is no guarantee that the oil price will rebound to $80 a barrel by 2020 when production is scheduled to start in the Liza field. But that is not the main issue with Ramkarran’s calculation. Next, a yearly production of 500,000 barrels a day is five times more than that projected by the company itself based on known reserves. True, if more oil is discovered in other offshore fields, such as where the third well (Skipjack) is currently being drilled, projected daily production could increase. But it is safer at the moment to work with the company figure of 100,000 to 120,000 barrels a day from the Liza field. Yet, this is not my main bone of contention with the Ramkarran estimate.

It is the third variable in his calculation (a government share of 40%) that may be most off the mark if, as is likely the case, revenue is shared between the Guyana government and the oil consortium based on the model agreement posted on the GGMC website. The terms to determine how production/revenues are split or shared are contained in an agreement known as a Production Sharing Agreement (PSA). The model PSA on the GGMC website covers the three main elements in the calculation. First, there is a cost recovery element. The model agreement stipulates that the oil company can keep up to 75% of oil production (referred to as cost-oil) to recoup the cost of its investment on exploration, development and production. After the company has taken off this production, the second element in a PSA, called production sharing, comes into play. Production sharing in our model PSA divides the remaining 25% of production (referred to as profit-oil) between government and company 50/50. Therefore, the government take is more likely to be around the 12.5% mark rather than Ramkarran’s 40%. From Liza’s projected daily production of 100,000 barrels, the government daily take will therefore be 12,500 barrels. Multiply that by whatever is the prevailing world oil price and you arrive (as a first approximation) at how much revenue the government can expect.

A lower cost-oil (say 40% or 50%) greatly increases government revenue. But the decision on where to split production between cost-oil and profit-oil is not straightforward and depends on several considerations, such as having an attractive investment climate and the costs of extracting oil from the ground. True, as a company recovers more and more of its initial investment, the cost-oil factor should decrease—which would put more money in the government’s coffers. Should production decline simultaneously, however, due to resource depletion (without new discoveries), there would be a smaller pie to share.

Other potential sources of government revenue from an oil deal do exist and include royalty, taxation and duty. Our 1986 petroleum act mandates royalty payments, but royalty is hardly mentioned, if at all, in the GGMC and other official literature. The reason for this shyness is simple. Royalty as an upfront off-the-top payment by the company makes Guyana less attractive by increasing the cost of doing business here. I suspect that a small royalty rate may possibly be included in an actual PSA, but only for token compliance with our petroleum law.

As regards taxes and duties, our model agreement indicates that these could be reduced or waived.  The Order passed in the National Assembly on August 8th indicates that this is what the government intends.

As currently advertised, Guyana’s model PSA is considered highly attractive not only because of the nice elements it contains (75% cost recovery, 50/50 production sharing, low royalty and taxation) but because of the elements it does not include compared to typical PSAs worldwide. Excluded are such elements as sliding scales (to determine, for example royalty rates and production sharing), production bonuses (recurring payments to government by the company when cumulative production reaches set levels) and signature bonuses (a one-off payment to government on signing of a contract). Indeed, Minister Trotman did indicate in an interview with an online oil industry journal that he favoured the expansion of our PSA to include some of these terms. It should be noted that the government can sign different PSAs with different companies and even for different oil fields with the same company. The practice worldwide is for a government to demand a bigger cut in succeeding PSAs as it gains experience and clout.

In June this year, a new PSA was reportedly signed between the government and the consortium led by ExxonMobil. The actual terms of the PSA remain to be seen. But chances are they will follow closely that of the agreement displayed on the GGMC website. The country will still earn a game-changing several hundreds of millions of dollars from the oil discovered so far. But I doubt whether the Liza field alone will be a yearly multi-billion dollar earner for the government. In this largely underexplored basin, revenues will approach Ramkarran’s estimate as more oil is discovered as it surely will.

Yours faithfully,
Sherwood Lowe

 

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