The pressure to source supplies from Guyana can lead to increased exploration, development and operating costs. Guyana’s offshore oil activity levels will be very sensitive to movements in oil prices and costs. At any one time in a province as large as the Guyana Basin, there will always be marginal projects. Thus, the pressure to purchase from higher-cost Guyana sources could in principle lead to marginally attractive projects being rendered non-viable. The pressure would lead to postponement of such projects and so a slower rate of oil depletion.
From a purely energy viewpoint, such distortions to decision making are undesirable. Even if a slow rate of depletion were desired, the artificial raising of costs is not the most efficient mechanism to employ to produce this effect. It also means that the tax revenues from oil production will be lower than they otherwise would have been attained. Some of the economic rents may be diverted away to less efficient supply companies.
It is difficult to gauge the extent to which costs have been increased as a result of purchases from Guyanese sources being made at prices higher than those payable on imports: the necessary information is generally not readily publicly available, and the knowledgeable parties are obviously reluctant to provide it. Only on rare occasions does the issue become debated in public by the key parties. However, these issues will become more noticeable as the local oil field supplies and services sector develop, after first oil. The respect government agencies will have to diligently in Guyana’s interest to exert every effort to ensure that the Guyanese economy derives the maximum benefit from every segment of the value chain of the industry, from the development.
The pace of licensing policy and the number of blocks awarded at each round must interact with Guyana’s onshore activity in other respects. The Guyanese supply industries will certainly likely to respond to the offshore market opportunities. What constitutes the optimal stimulus is not so clear, however. Is a very large and fairly sudden increase in demand for goods and services likely to produce a more effective response from the Guyanese industry than a much slower build-up in demand? On the one hand, a quick and large increase in demand may not give Guyana’s industry sufficient time to organize itself, invest in necessary plant and machinery, and hire the required skilled labour. The result would then be that the established foreign companies obtained a high share of the market. On this logic, a slower demand would allow Guyanese firms more time to prepare themselves for the new market opportunities. A contrary argument is that a very large, highly visible new market opportunity is more likely to procure a response from the local industry. A large increase in demand is more likely to provide opportunities for Guyana’s industry, as the chances of lack of capacity among established (foreign) suppliers become greater.
It is difficult to be sure which strategy is optimal. The next round of licensing will be significant and will come before large-scale capacity and skills are developed in Guyana. The demand for goods and services to be associated with this round will be very great. There is little doubt that this, in turn, may contribute to an enormous cost escalation in Guyana Basin projects which will take place post-2020. General inflation will be high, of course, but considerable real increases in Guyana Basin costs may be experienced due in part to the expected high demand for specific oil-related goods and services.
The large size of the next licensing round and the speed with which new field developments are being encouraged are due to the perceived need for early oil revenues. This may well be an instance of a conflict between the oil revenue and industrial strategies. For example, a very high share of the requirements for speciality steel pipes is being met from imports due to the inadequate indigenous capacity and the lack of time available to increase that capacity.
The fast rate of development and depletion of the Guyana Basin oil will have the effect of building up a large offshore supply sector. The result will be that the supply industries are going to be better placed to take advantage of opportunities in other markets than they would have been if Guyana Basin offshore oil activity does not reach the expected high levels to be attained, over the next ten (10) years.
One further argument could be employed in favour of the discretionary licensing system. It is sometimes argued that the auction system favours large oil companies as against small ones. The former has much larger financial resources than the latter, and it is argued that they will always win licences under an auction system. At least in some phases of the development of the Guyana Basin, the encouragement of small Guyanese oil companies must be seen as desirable. Perhaps this could be promoted in later rounds, as the industry and the calibre of local businesses grow.
The independent oil companies have always argued against a bonus-bidding system on the grounds that it puts them at a disadvantage. This may be so in general, but it is noteworthy that small companies have often been successful in bidding situations in other emerging markets, especially when they operate in groups or consortia. Independent companies will seek to participate in the limited auctions which will take place in Guyana. However, it has been noticed that these companies have also successfully farmed into existing licences, sometimes paying large sums for the privilege.
It may be, however, that the discretionary system does more readily permit the development of independent companies. In turn, this brings with it a more competitive situation with regard to applications for new licences. The key distinctive contribution which the independent companies make is that both the quantity and quality of exploration can be seen as being enhanced. In essence, the extra competition for licences will be beneficial. The independent companies will not constitute a drag on new developments.
Competition in this context means competition in relation to the established criteria for awards. This, in turn, means incentives to propose more imaginative and/or ambitious work programmes. This may lead to more effective exploration but could in principle also lead to some superfluous exploratory activity.
It is axiomatic that Guyana should devise policies to maximize the national benefits received from oil and gas exploitation. The above discussion has shown that there is a potential conflict, on the one hand between obtaining major industrial and ownership benefits, and, on the other, from the maximization of government revenues from bonus bids and taxation along with the attainment of the lowest exploitation costs. From purely energy and public finance perspectives, the latter objectives are the appropriate ones. Given that the other objectives mentioned above also exist, the skill in policy formulation and implementation is to ensure that their pursuit does not significantly reduce government revenues and increase exploitation costs.
It is difficult if not impossible to measure the extent to which the industrial and ownership objectives will increase costs. A suspicion must remain that some increase has occurred, but whether significant distortions to decision making have resulted is not clear. Some diversion of the economic rents from petroleum exploitation to the supply industries has doubtlessly occurred. The nation will obtain some return from this in the form of an enhanced and more efficient industrial capability to meet the future demands of the petroleum industry at home. The way in which the supply industries have responded to the pressures induced by lower oil prices indicates that economic rents can be received prior to a full assessment and development of Guyana’s future oil and gas projects and that its competitive edge has significantly sharpened. What is not so clear is the extent to which the current competitive industry will be due to the possible enforcement of a “full and fair opportunity” concept.
It is arguable that more use should be made of bonus-bidding in the areas of the Guyana Basin. The large amount of geological knowledge available for these areas for some years plus the continuing encouraging exploration success rate and the large sums paid for acreage and reserves in farm-ins and take-over bids all suggest that considerable sums could be raised in bonus bids. Selective use of the device could ensure that independent companies still obtained opportunities to acquire acreage from discretionary awards.
Another licensing policy issue that is of concern is the relinquishment conditions attached to licences. With the benefit of hindsight, it is arguable that the relinquishment conditions applicable to any amount of acreage, regarded as prospective by at least some oil companies, can be excessively lax, and will give insufficient incentives to engage in drilling or farm-outs. At the time the acreage was awarded its prospectivity was generally very uncertain, and it may have been thought by the government that lenient relinquishment conditions were necessary to attract investors.
The government will have to recognize that greater incentive either to engage in drilling licensed acreage or to surrender it has become appropriate. Thus, the regulations will have to stipulate that a certain percentage of the acreage must be surrendered after a given fixed period. The remaining acreage will be retained by the investor for a further fixed period. After this period, acreage can only be retained if there is a field under development or in production in the licensed area.
A very thorough reform of the licensing system can be suggested. This scheme could have several advantages including:
- a fairly constant workload for both the industry and responsible government agencies,
- the cessation of the “banking” of undrilled acreage,
- the facilitation of regional geological assessments,
- easier long-term exploration planning, and
- constant opportunities for the entrance of new investors.
Regular two-year licence rounds could become a feature of policies, after 2020. Increasing the frequency of rounds might bring the claimed benefits, but at least some sections of the industry and government would see this as sensible to prepare for rounds and digest the repercussions. The acreage which is put on offer is broadly that which is felt to be of interest to the industry. Putting all the acreage on offer would probably mean that bids would not be received for a large proportion of the acreage. It may be argued that this does not matter and that the system would cater to an investor who was taking an unorthodox view of the exploration prospects.
In general, it is certainly arguable that the licensing system should increase incentives on investors to engage in exploratory drilling and reduce the incentive to “bank” acreage. The nation does not gain from the latter. It is less clear whether the very thorough changes proposed are necessary to attain these goals.