Combining government take and other benefits

2016 PSA Fiscal Regime

Introduction

Today’s column expands on last week’s discussion of the government take, as it relates to Guyana’s 2016, Production Sharing Agreement (PSA). The kernel of standard definitions of this fiscal metric shows it simply means that, if the take is estimated at 50 per cent, then the total of all revenues received by the Government of Guyana (GoG) from the PSA is equal to one-half of the net cash flow generated through the operations of ExxonMobil and its partners. These revenues can be measured in discounted or undiscounted values.

As indicated last week, most of the energy economics literature is replete with advice to readers that this fiscal metric is a “misleading indicator”. I have already introduced last week, one of the reasons behind this warning. Here I merely wish to add the further observation that this fiscal metric is not prominent among the measures private investors in the petroleum sector would utilize in order to guide their decision-making. Their decision-making would utilize standard private sector valuation metrics such as: Net Present Value (NPV); the Internal Rate of Return (IRR) and the Profitability Ratio (PR), all of which were described in last week’s column.

Readers can see the wisdom of this observation, if they were to reflect on the following commonly cited illustration. Generally, petroleum investors are more likely to invest in a country which has a fiscal regime, that provides a government take as high as 90 per cent, while simultaneously allowing an IRR of 20 per cent for a given project, than one which provides a much lower government take (say 50 per cent), while allowing a much lower IRR of 10 per cent, other factors remaining the same. From the profit motivated preference function of the petroleum investor the focus is on comparative profit opportunities available for a given amount of investment outlay. The government, however, would have a different preference function. One, which seeks to capture its own political/social/economic/geo-security imperatives, as realistically as it can.

Other government benefits

On this particular point, it should be emphasized it has not been sufficiently acknowledged in the ongoing debate on Guyana’s 2016 PSA, that government benefits (other than fiscal receipts) play a very significant role in the terms and conditions of the fiscal regime. Consider a few of the major ones: 1) Regulated local content requirements (LCRs) bring significant benefits under the 2016 PSA; 2) Research and Development (R&D) is also quite integral to the governmental benefits the PSA provides; 3) Technology transfer is also fostered in the PSA, along with skills training (on the job) and also through supporting opportunities for further education.

Added to such measureable benefits are others, which are intrinsic to the major transformation/ diversification, offered by Guyana’s petroleum production and export. Without going into details these ‘other benefits’ provide opportunities for the development of inter-industry and intersectoral linkages in the country’s economy. Additionally, there are the income multiplier effects of public and private spending, producing and consuming of goods and services.

Sufficient to note, it can reasonably be concluded, the government take as it is traditionally defined, while offering significant benefits from the fiscal regime of the 2016 PSA, remains under-stated, as it does not also include the other benefits referred to in this Section.

Contract review

In last week’s column, I had adverted to the Nobel Prize winning economic theory (2016) of “incomplete markets”. The main purpose for introducing that notion was to emphasize that, given the independent preference functions of the GoG (Owner) and Exxon and partners (Contractor), there remains a “rational choice” for both parties to seek the “re-negotiation” of the 2016 PSA, if the underlying conditions of the contract change drastically from that which obtained in 2016. Within a day of my making that prediction the GoG, through the Minister of Natural Resources was cited in the media as claiming: “All terms of the ExxonMobil Petroleum Agreement will be up for review in four years” (Guyana Chronicle).

It would also be recalled that, at the end of last year (December 29, 2017), at an Exxon press conference, the public had been firmly advised by the Contractor that: “the petroleum agreement that was signed with Guyana is globally competitive for countries at a similar stage of exploration”. And that in February 2018, Oil Now had quoted Minister of State, Joseph Harmon declaring:

“The President has said it, that we have dealt with the ExxonMobil contract, and we are not going back on it, we are not going back on it as it was dealt with at Cabinet and the President has pronounced on the matter and that is the final pronouncement as far as we are concerned.”

I would argue here that the underlying conditions of the 2016 PSA are rapidly changing. These changes are occurring mainly in the area of risk reduction. This reduction is happening in all of its major dimensions (political, geo-strategic, geo-political, environmental and economic) of Guyana’s political economy of oil and gas. Second, Guyana is on a steep learning curve in the preparation for its domestic petroleum production. Third, shared experiences with Exxon and its partners have been growing day by day. And, further the parties to the PSA are getting to know each other better in an operational environment. On their own I think, these considerations are sufficient to urge movement in the direction of a review of the 2016 PSA.

Pipeline for contracts

It is of great significance also that evidence shows a growing pipeline of petroleum companies wanting to secure exploration and production contracts.

There are perhaps over a dozen such companies from countries as diverse as Chevron (United States), Petrobas (Brazil), Total (France) as well as an India state-owned company seeking either “direct engagements” with the GoG, or queuing up to take part in a select bidding process for the auction of blocs by the GoG if this emerges. Some of the other companies whose names have surfaced include CGX, Tullow Oil, Andarko, Ratio Oil, ON Energy and Nabi Oil & Gas Inc.

As stated last week, in order to be accurate, the government take should be measured over the full life-cycle of the oilfield project.

However, this life-cycle can take decades. For what it is worth, during the period 2009-2014, government take worldwide has been estimated at 52 per cent (I. Marten, et al, Government Take in Upstream Oil and Gas, December 2015).

Around the Web

Comments