Last week’s column welcomed the coming release of Guyana’s petroleum contracts. It also identified that, based on the standard industry classification, there are four principal types of such contracts. Brief pro forma descriptions of three of these were provided, namely, concessionary, service, and joint ventures. Today’s column begins with a brief pro forma description of the fourth, which as indicated is the production sharing agreement (PSA). This happens to be the contract type with which ExxonMobil and its partners are operating in Guyana. That petroleum agreement was signed as far back as 1999. And it has been amended since. Regrettably, neither the amendments, nor the original 1999 contract, has been released, I therefore do not have enough official information at the time of writing today’s column.
However, on Friday, December 1, a report headlined in the local press stated: ‘At long last; Exxon contract to be made public within days’ (Kaieteur News). After this release takes place, I shall, in subsequent columns, accommodate my presentation on this topic, for any additional official information that is forthcoming. For present purposes, I confine today’s column to a brief summary pro forma description of the fourth type of petroleum contract (PSA).
The pro forma PSA
Solely for present purposes, I indicate a brief description of a typical PSA. Under this contract: 1) The state keeps ownership of the oil and natural gas along with the installations for extracting and processing the petroleum at source. This differs from the concession contract described last week, in which the contractor owns the land (and sub-surface rights). 2) For the PSA the contractor is legally contracted to get the oil and gas out of the ground, on behalf of the state, and 3) for these purposes there are pre-agreements on (i) how the contractors costs are recovered (both for ongoing and upfront already expended exploration costs); (ii) how the profit is to be shared among the parties to the contract; and (iii) the several taxes required to be paid by the contractor, on ongoing activities and from net profit.
Several differences between contracts are immediately apparent. Thus, there is a difference in ownership of the oil and gas. Under concessionary contracts the contractor ‘owns’ the petroleum taken out of the ground. Under other contractual systems (service contracts and PSAs), the state retains ownership of the resources in the ground, up to a contract specified point. Again, under service contracts, the state pays the contractor a fee, in cash, but under PSAs the payment may be made in kind (crude oil). Further, each contract type favours particular types of fiscal rules/regulations.
From now, until the official release of Guyana’s contracts, I am unable to describe definitively, the key economic/ financial features of the Exxon and Government of Guyana Petroleum Agreement. Instead, therefore, I will use this interval to consider two related, but important topics. The first of these is the recent variation to PSAs (as introduced by Indonesia early this year). This variation has been described as part of the Indonesian Government’s “desperate and unpopular attempts” to reverse the steep and dramatic decline of its petroleum sector. This sector has shifted structurally, from Indonesia being a leading OPEC oil-exporting country to its becoming today a net-importer of oil. The second topic I shall treat with, is my reflections on the nature of the recent petroleum contract debates which have taken place in Guyana, including their revealed follies and grave misdirections.
Going directly to the point, I believe that, for countries like Guyana, all contract types contain, at the minimum, at least one vital, if not immutable, flaw. Why do I claim that? Countries like Guyana have weak capital raising capacity; low technological dexterity and managerial capability; overall weak institutional and governance structures; and therefore, cannot overcome certain challenges. Thus, concessionary contracts would have no truly domestic takers for such concessions. They would therefore contain the flaw of risking the ceding of ownership of the country’s petroleum resources to foreigners. Similarly, service contracts, as a rule, do not incentivize contractors to maximize profits. Instead, contractors seek to obtain, upfront, the agreed management fee plus the desired margin on this fee, the contractor targets. In like vein PSAs, which provide for cost recovery, incentivize contractors to gold plate their costs. Most, if indeed not all industry analysts would readily admit this routinely happens. Further, given the lack of country capability, joint ventures are hardly likely to represent partnerships of equals, or even it may be said, near-equals.
The worldwide evolution of petroleum contracts reflects the power of the forces mentioned above. In the mid-19th century concessionary contracts dominated. This was aided by US law and the colonial expansion of the period. This later also facilitated the rise of service contracts. However, with growing worldwide anti-colonialism and national independence movements, foreign ownership and control of a country’s petroleum resources were increasingly resisted. This led eventually, to the hallmark creation of the Organisation of Petroleum Exporting Countries (OPEC). And, following this, by the end of the 1990s, roughly two-thirds of all petroleum contracts were in the form of PSAs, (see Oxford Institute for Energy Studies, Working Paper, 25, 1999). In this study, 268 PSA’s were subjected to rigorous economic analyses by K Bindermann. Notably, this paper has attributed the introduction of the first PSA to Indonesia in 1966, but the Russian scholar Irina Pallashvill in The Concept of Production Share, 1998 has attributed the first PSA to Bolivia back in the early 1950s.
Gold plating of costs and other similar complaints against PSAs have led to PSA’s themselves being subjected to intense re-assessment. The difficulty remains, however. That is, of finding a mechanism which would retain the beneficial elements of standard PSAs while reducing the gold plating of costs by contractors. This gold plating resulted in Indonesia’s controversial introduction of what is termed the Gross-Split PSA mechanism in January of this year. As we shall indicate, this itself has been recently revised/amended.
Next week I shall expand on the PSA mechanisms, with special reference to the fiscal and financial ones, as I proceed to evaluate the variant known as the Gross-split PSA-type contract.