Last week’s column established that the mechanism of ring-fencing for determining recoverable cost is not, unambiguously, to Guyana’s benefit. While the chances of being of benefit are reasonable, there is no way now to establish this definitively. There is insufficient information available for anything better than informed guessing. The best advice that could be given to the authorities therefore, is to view ring-fencing as a policy trade-off. In the literature, this has been phrased: Resource Revenue Timing: Now or Later.
Introducing the notion of policy trade-offs allows me to introduce also, the four key policy trade-offs that are identified in the Natural Resources Charter. I believe this Charter constitutes the most thoughtful advice on natural resources policy formulation for application in Guyana-type economies: poor, small, open, and with dominant extractive export industries.
Before addressing policy trade-offs, there are two issues worth stressing, as these guide the State’s (Principal’s) perspective on ring-fencing. The first is specified in the literature as the intrusive v simplicity conundrum. This arises because management of recoverable cost has been widely observed as complex/ complicated features of PSAs. Close auditing/monitoring has to be applied intrusively in order to verify the Contractor’s activities, effectively. This is the only means of ensuring the Principal (State) receives full benefit. Guyana-type economies are rarely, if ever, able to raise the requisite skills to accomplish this. Secondly, several organisations/advisory firms have recommended, as a consequence, Guyana-type economies to rely on simple mechanisms upfront, until the State grows capacity. Typically, this is recommended, in the consolation that any excess benefits obtained by the Agent/Contractor, might encourage future investment flows.
The first policy trade-off identified in the Natural Resources Charter is termed “allocating risks”. Such risks have to be allocated between the Principal/State, on the one hand, and Agent/Contractor (which in Guyana is Exxon and its partners), on the other. Risks allocation arises as an issue because of the intrinsic volatility of revenue, prices, costs, and profits in the petroleum sector. Typically, the Principal/State desires a stable revenue stream (for all sorts of familiar fiscal reasons) and would hope, therefore, to shift as much of the resource revenue instability onto what it considers as the more financially robust Agent/Contractor. This, however, is not necessarily the perspective held by the Agent/Contractor. Clearly, a policy trade-off arises over risks allocation.
The second trade-off is typified in the instance of ring-fencing, where it has been termed as: Resource Revenue Timing: Now or Later. This occurs more broadly because energy analysts describe the typical time profile of revenue in the petroleum sector as being “humped-shaped”. That is, initially during the first years of the project-life revenue is quite low, as expenditures made on finding and developing the project area are high. After this period ends, and production is in full swing, revenue is steadily earned. And this continues to be the case, more or less, until the petroleum wealth is depleted. The desired design of the fiscal system should be to conform to this policy trade-off through the system of taxes used to generate public revenue. This requires determining the desired time-flow of state revenue; now and later.
The third policy trade-off the Charter identifies is given as “tax efficiency versus administrative simplicity”. This basically treats with what is termed as the “tax gap”. This tax gap is considered to be “the amount of revenue that the industry should pay to government and the amount that government actually receives”. The tax gap has been empirically established as a function of two elements namely: 1) “capability of the tax authority” (in Guyana, the Guyana Revenue Authority, (GRA)) and 2) “the simplicity of the fiscal system”. The Charter claims that “making the fiscal system simpler is a possible trade-off. In essence, to use fiscal instruments that are easiest to administer.”
The fourth trade-off is labelled as “political risk”. Because of price, value, cost, revenue, and profit volatility, and other uncertainties of the petroleum sector, both the Principal (State) and Agent (Exxon and partners) could hold different positions on the allocation of this risk, as was argued in the first trade-off discussed above. Thus, typically the State is incentivized to moderate instability in its revenue inflows, for all the reasons readers would readily assume. Because of its sovereign right to influence the fiscal package, the Agent may take what it considers the political risk on board, which is, the State may seek to change the terms of the contract.
It is usually assumed that “perceived or actual inequity” in the shares of resource revenue going to the State (Government take) and Agent (Contractor take) could lead to political challenges and public calls for changes in contract terms (renegotiations). The popular forces exert much of this pressure, to which the State has to respond. While both the State and Agent typically genuflect to the sanctity of contracts, worldwide experience shows that variations in contract terms are standard. In this sense, therefore, all contracts will have to adapt to conditions if and when they radically depart from those at the inception of the contract.
Turning to my running commentary on the local debate, it can be confidently asserted here that this debate has been particularly uncomfortable when addressing features of the Guyana 2016 PSA, which bear on governance of the petroleum sector. Over the years, however, across the world, there have been a number of case studies, commissioned reports, and other empirical studies/evaluations of PSAs in actual operation, particularly in developing areas. Indeed, I cited last week the Ghana case study and the useful lessons that its author has drawn out of this experience.
I make this observation in order to indicate that, studies/analyses of country experiences with petroleum contracts in periods before such contracts have been implemented must by any logic remain ultimately speculative. This conclusion does not claim that such studies/analyses are of no value. To the contrary. Personally, I believe my columns on this series have been a case in point. They seek to inform citizens about the critical issues. And, this is based on the presumption that, the more information which is put out there, the more informed are the likely outcomes. Misinformation, speculation and mis-specification when presented as ‘facts’ or ‘alternative facts’ do a great disservice to the country at large, even though I admit such actions, in an open society, cannot be stopped, given they are more about satisfying personal/ private agendas than the public good.