Dear Editor,
While there are several weaknesses in the contract between Guyana and Esso Exploration and Production Guyana Limited (EEPGL), there is one outstanding feature that has not received the attention it deserves. That is, in a rising price environment, Guyana’s share of oil revenues will match or even exceed the share obtained by the state of Texas on state-owned oil and gas royalty interests and by the federal government of the United States in its deep water oilfields in the Gulf of Mexico.
The contract feature, which caps the amount that EEPGL can claim as expenses to 75 per cent of the revenue in any given month, has been widely misinterpreted to mean that Guyana, apart from its 2 per cent royalty, can get no more than half of 25 per cent or, 12.5 per cent of Stabroek block oil sales. That is incorrect. Guyana’s share can reach 24 per cent or even higher as the price of oil rises.
The cap on cost recovery protects Guyana’s share to not less than 12.5 per cent in low revenue months when the selling price of oil is low. But in high revenue months, when oil prices are higher, and the spread between selling price and cost price is greater, Guyana will get a much higher percentage, simply because the “profit” to be shared 50/50 between Guyana and EEPGL is so much bigger.
It is instructive to note that the number “12.5%” or the words “twelve and a half percent” do not appear anywhere in the Cost Recovery and Production Sharing section (Article 11) of the contract.
Right now, Hess Corporation has hedged most of its Brent oil production for the rest of this year at US$60 per barrel. Let’s run a simple pro-forma calculation based on some of Hess’ numbers.
1 – Assume that the selling price of oil is US$60 per barrel.
2 – Royalty payable to Guyana is 2 per cent or $1.20.
3 – Assume cost recovery of US$42 per barrel, a number I have extrapolated from Hess. This includes royalty paid, operating cost and capital expenditure, each prorated on a per barrel basis. I will explain the rationale for this number later. Note that the 75 per cent cap on expenses, in this case, US$45 does not apply because US$42 is already below US$45 so there is no need to invoke the cap.
4 – Profit is US$18 per barrel.
5 – Split that 50-50 between EEPGL and Guyana. Guyana’s share is US$9 per barrel.
6 – Add Guyana’s royalty of US$1.20 per barrel.
7 – Guyana’s total revenue per barrel of oil is US$10.20. That is 17 per cent of the selling price.
Let’s look at another scenario where the selling price is higher, say US$70 per barrel. Costs will be a little higher too. That’s just the way it works in the oil business. When the price is higher, costs increase. For instance, royalty payable to Guyana will increase by 20 cents per barrel. Labour costs increase and middle men demand more. So, let’s use US$45 as recoverable costs. Again, the 75 per cent cap, in this case, US$52.50 does not apply. Profit, therefore, is US$25 per barrel. Guyana’s half will be $12.50. Add royalty, and Guyana’s total take becomes US$13.90 or nearly 20 per cent.
Let’s now consider a lower selling price, say US$50 per barrel. The math is significantly different in this scenario because the amount that EEPGL can claim as expenses for that month is capped at 75 per cent of the selling price. The maximum that can be expensed is US$37.50 per barrel. (The amount that is not expensed is carried forward for a month when prices are higher) so now, “profit”, because of the cap, is US$12.50 and Guyana’s share is US$6.25 per barrel or 12.5 per cent of the selling price.
What this means, is that Guyana will always get a minimum of 12.5 per cent plus the two per cent royalty at the lowest of prices, but as the price rises, the percentage that Guyana gets rises exponentially.
Editor, let me explain why I used a selling price of US$60 per barrel in the primary scenario above. Firstly, this is the price that Hess Corporation has hedged its Brent oil. Secondly, it conforms with the future price deck established by the bank on whose board I serve. None of us claim to be experts at predicting the future price of oil but we use the best supply and demand, oil in storage, oil in transit, and takeaway capacity forecasts available to us. Thirdly, it seems to be around what the oil markets are projecting.
The assumption of US$42 in the cost estimates is derived from information from Hess Corporation. Firstly, Hess has a chart showing that the Liza 1 costs is smaller than 50 of the world’s leading oil basins, at around US$40 per barrel. Secondly, in another chart, Hess shows Liza 1’s operating costs at US$35 per barrel and capital costs of US$7 per barrel based on Expected Ultimate Recovery of 504 million barrels of oil from Liza 1. This matches the published capital expenditure of US$3.6 billion for the development of Liza 1.
Hess’ stake in the Stabroek block is greater than Guyana’s. Hess is a small corporation in which Guyana’s oil looms large in the company’s future. In my opinion, Hess will be Guyana’s best friend as far as the Stabroek Block is concerned. Their interest is much more closely aligned with Guyana’s than any others. Hess will want free cash flow or money in the hand as much as Guyana and as soon as possible.
There are matters pending that need urgent resolution if they haven’t yet been resolved by the Government of Guyana. Pre-development costs of around US$460 million should not be allocated to just Liza 1. It has to be allocated to the entire Stabroek Block. More importantly, that cost should not be front-loaded on the cost recovery regimen. It should be amortized either over the economic life of the Stabroek block or prorated on barrels of production. Hess’ pronouncements of US$35 operating expenses and US$7 capital expenses per barrel suggests to me that they have already found the light. Guyana would be wise to do the same.
Yours faithfully,
Dr Tulsi Dyal Singh
