Evaluating Open Oil’s Financial Modeling of Guyana’s 2016 PSA – 8

Introduction

Today’s column concludes the discussion of Open Oil’s modeling exercise of Guyana’s 2016 Production Sharing Agreement (PSA). I shall address the three topics last week’s column indicated, namely: information gaps; the treatment of Government Take; and national versus project-based modeling.

Information Gaps

Previous columns had expressed concern about financial/economic models, which are not forthcoming about the limitations of data inputted into them, particularly as regards their quality and coverage. However, I do not wish to single out Open Oil’s modeling exercise as a notable offender. To the contrary, under the header: “Information Gap Analysis and Next Steps”, the model’s Report declares “there are several gaps of information that, if filled, would improve the economic model.”

The model identifies five gaps. The first is Contractor estimates for expenditures on exploration, capital, and ongoing operations. This item is controversial, particularly because of Exxon’s recently announced claims on its exploration expenditures for cost recovery. The second gap listed is detailed estimates of petroleum reserves (based on the Society of Professional Engineers Classification system). As noted, the model’s base case utilises Liza 1, with a field size of 450 million barrels. It does reference Liza Phase 2, and indicates precise reserves data were not available. Consequently, the third information gap listed is a definitive fix on Contractor timing of its implementation, cost, and production profile.

The fourth gap refers to lack of precise data on the quality and grade of Stabroek crude. This absence caused the model to utilise “estimates for Brent benchmark oil” when pricing Guyana’s crude. The fifth gap is the absence of official project finance details, particularly debt and interest charges. The model Report notes: “there are currently no project finance costs estimated,” although these are recoverable under the PSA, and should make a difference to the project’s financing (for example, the amount of loan capital).

Although not identified specifically as an “information gap,” the project Report refers to ongoing debates in Guyana on the “fiscal regime” of the 2016 PSA. It hints at alternatives that would affect the model’s outcomes, particularly Government Take.

Government Take

Just prior to the publication of Open Oil’s modeling exercise, my columns were discussing Government Take and its limitations as a measure. I had directed readers to improved measures that are on offer by energy economists. In correspondence, some readers are perplexed by the implied equivalence in Open Oil’s statement: “Government Take, or what the IMF calls Average Effective Tax Rate stands at 52% of today’s (March 2018) Brent price and the development plan for 450 million barrels of oil.”

My treatment of Government Take had made several observations, including:

1) Government Take is typically treated as the division of profits between the Contractor and the Government

2) That take is the product of a negotiated outcome

3) It is, therefore, “not an economic statistic, but a fiscal metric”

4) It is also only a preliminary indicator and, therefore, “comparing the take of different projects and/or countries is a very difficult and often misleading exercise”

5) Energy analysts subscribe to the view that Government Take measures the percentage of the project’s [Liza 1] net cash flow adjusted for any Government participation in the enterprise, calculated at discounted or undiscounted value.

The cited articles had referred to several limitations, which have been identified when Government Take is used as a performance indicator of the fiscal regimes of PSAs. Therefore, I had indicated preferred measures, like Effective Royalty Rate (ERR), which measures Government take after recognising clearly defined accounting periods for the project.

I do not want to revisit the earlier discussion in full but the point I wish to stress here is Government Take and Contractor Take do not constitute a Zero Sum Game. I know ordinary Guyanese view one increasing only at the extent of the other. This can and does take place. However, Contractor incentives, if it boosts profits, can lead to both improved Government Take and Contractor Take! Open Oil’s casual equivalence of Government Take with other improved measures misleads non-modelers.

National versus project-based modeling

This is the last topic I shall address in the present commentary/critique on Open Oil’s financial modeling exercise. Open Oil had declared in 2016 “the portfolio of models it was releasing are all at the project level.” It recognised that modeling at the macro or national level complements this, particularly in the area of national tax policy and revenue yield. There is the firm conviction however, that “project modelling in the open space is essential to drive transparency forward.” Indeed, Open Oil deems the petroleum project as the “building block of the transparency movement.”

The Author of the Guyana 2016 PSA modelling exercise has advanced “Five reasons to model at the project level” (November 2016). These include, inter alia: the project is the core unit for building transparency; the place where the facts and specificities about the petroleum industry are located; and, as an extension where the known unknowns and the unknown unknown manifest themselves. Additionally, as abstractions, the project level and the petroleum sector level are best understood at the project level, where the sector as an aggregation of projects reveals itself. Moreover, project level analysis is portrayed “as the gateway to broad public literacy about the extractive industries”.

These are strong claims. I do not wish to engage them here, save and except to note that in very small economies like Guyana the pertinent levels of abstraction do not only exist at the micro (project level) and macro (national level). Big businesses, like Exxon and its partners, when operating in micro markets also function at what economists term the “meso” level. As the Open Oil model exercise indicates, Government Take from Liza 1 alone is likely to be larger than the current National Budget revenue! While, technically, one business, therefore, Exxon is simultaneously one sector that commands intermediate gravitas within the national economy.

Conclusion

This evaluation of Open Oil’s financial modelling of Guyana’s 2016 PSA, has taken more than double the amount of columns I had originally envisaged. I trust it was worth it for non-specialists and non-modelers. Next week, I resume the series on Guyana’s PSA, fiscal regime.  

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