Last Sunday’s column introduced a simple basic ‘Setting’ (as energy analysts label it) or more commonly, analytical framework drawn from energy economics, under which the Guyana 2016 Production Sharing Agreement (PSA) will be appraised in coming columns. The Setting reveals, what is proposed as an appropriate design for Guyana’s fiscal terms. It suggests also that these are principally, a function of the risks facing Guyana’s petroleum finds. Such risks can be broadly classed as 1) Economic/social/political, which occur at the local, regional, and global levels to varying degrees. Undeniably, these impact both local and global supply and demand for petroleum products. And, as a direct outcome, oil and gas prices; 2) Geopolitical, which mainly reflects the Venezuelan border controversy, and, to a lesser degree, the threat posed from environmental mishaps impacting on neighbouring states; 3) Geological, which, in effect, reflects the offshore location and depth of Guyana’s petroleum finds.
The last column had indicated too that, economic and financial modelling is being utilized in recent variants of the PSA. This has been introduced as a substitute for traditional PSA cost recovery mechanisms. However, while such modelling is used to determine State (Principal) and Contractor (Agent) take, it can be also utilized for contract negotiation and project evaluation.
Guyana’s 2016 PSA
Because of its comparative simplicity, it is common practice to explicate Guyana-type PSAs, with a brief recall of how the government’s ‘take’ is determined in traditional concessionary-type contracts, which are the alternates to PSAs. Here, royalties are the first item to be deducted from gross sales revenue, leaving net revenue. From net revenue, several deductions are allowed to arrive at taxable income. And, after taxes are paid, the remainder becomes the Contractor (Agent) take. The deductions referenced above would normally include operating costs, depreciation, amortization of debt, and indeed all other contract identified items. By comparison, energy analysts consider PSAs as more complex. And, using the format of this paragraph, PSAs are therefore summarily described as follows:
1) The Contractor/Agent (in Guyana’s case Exxon and its Partners) shall provide all installations, investments and facilities used to explore for and to produce oil and gas.
2) Typically, such facilities become the property of the State (Principal) sometime between their landing in the country and after their attendant costs have been recovered.
3) Under PSAs royalties are deducted first to arrive at net revenue.
4) Costs are then allowed to be recovered by the Contractor. The Guyana PSA specifies that the recoverable cost is “limited in any Month to an amount which equals seventy-five percent (75%) of the total production from the contract area”. (Article 11)
5) Following the above, the remainder is therefore the profits from oil and gas production
6) The State (Principal) share of this remainder is set in the contract. Guyana’s PSA specifies profit oil/gas shall be shared as: “Contractor fifty percent (50%) and Minister fifty percent (50 %)”.
7) Applicable taxes, under the contract, are applied to the Contractor (Agent) share.
8) And the taxable income, less actual taxes paid by the Contractor (Agent), becomes the take the Contractor retains.
There are therefore, certain basic features of PSAs to which I shall draw attention, at the start of next week’s column.
As promised, I shall endeavour to intersperse (in every column going forward) the analysis of the fiscal terms of Guyana’s 2016 PSA and commentary on the recent media debate/exchange on this topic. To meet this requirement today, I start with the first, of several specific observations on these debates.
First, the debate (exchange) has been reminiscent of the earlier independence debate on Guyana’s (and West Indies) development prospects. The similarity, I posit, is most striking around methodology. When considered carefully, the earlier independence development debate was entrapped in what economists today decry as the essentialist fallacy. And, amidst serious international debates on method, several theorists indicate today that, essentialism is the scientific idea most “fit and proper” to be retired to the intellectual dustbin of the history of scientific ideas (see Sergio Graziosi’s Blog, March 9, 2014).
Undoubtedly, this method did lead the independence development debate into a cul-de-sac. This came through its naïve search for the essential meaning of development. This was pursued, in the belief that, if this essence could be revealed, then successful development would surely follow. In other words, if the debate produced a “full understanding of Guyana’s development problematic”, then Guyana’s development would ipso facto unfold!
Questions were not raised as to whether the search for such an essence was a true or false conception. It was also not sufficiently recognized at the time that there are no sharp boundaries between development and non-development, only nuances. The very terms utilized provided evidence of there being no equivalent classes. Indeed, the contributions at the time did refer to a wide range of conditions that could be multiplied unendingly. Thus, the debate variants recognized countries at one end of the scale as poor, dependent, small, undeveloped, underdeveloped, unindustrialized, backward and even Southern. While at the other end of the spectrum, there was an ever-expanding range that included: developed, modernized, industrialized, first world, science and technology based, and even Northern. Anomalies, however, abounded, and the list of equivalent classes kept growing!
It is not my intent to revisit this debate here. My aim is simply, to remind readers there is no essentially perfect conception of an oil contract. Each oil contract is unique. And, therefore, such contracts should be evaluated against the purpose for which they were designed and the environments in which they are located. Further, every contract can be improved, but such improvement is relative. Contracts are not absolute or essentialist constructions. There are far too many unknowns, uncertainties, variations in country environments, along with, oil and gas firms, for anyone to offer anything but a relational better choice, rather than an idealist specification of a perfect contract. The danger though, of pursuing an idealist (illusory) ‘perfect contract’ view is that this aim becomes the enemy of ‘good contracts’, given overall circumstances.
Next week I shall continue the analysis and commentary of the fiscal terms of Guyana’s PSA.