Considerations for delivering a successful extractives-Led growth agenda for Guyana

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Bobby Gossai, Jr.
Bobby Gossai, Jr. is currently pursuing the Degree of Doctor of Philosophy in Economics at the University of Aberdeen with a research focus on Fiscal Policies and Regulations for an Emerging Petroleum Producing Country. He completed his MSc (Econ) in Petroleum, Energy Economics and Finance from the same institution, and also holds an MSC in Economics from the University of the West Indies. Mr. Gossai, Jr.’s professional experiences include being the head of the Guyana Oil and Gas Association and senior policy analyst and advisor at the Ministry of Natural Resources and Environment.

In terms of practical policy and economic advice, the extractives-led growth agenda has tended to reinforce domestic, government and investor pressures to ‘develop fast’. At the same time, it will reinforce the emergence of several initiatives to enhance transparency, local capacity building, environmental best practice and human rights in and around the sector.

This ‘fast-track’ approach by donors and international advisers is often inevitable, given the obvious benefits of foreign-investment inflows and export revenues for countries suffering from poverty, lack of infrastructure and high levels of indebtedness.

There are six main questions that Guyana should address:

  1. Are the necessary resources available for long-term growth? If not, how long can they be expected to last and what are the depletion timeframe options and what contribution is the sector likely to make to development during its lifetime?
  2. How will the country deal with a downturn in prices? Will society and the country’s leadership be prepared for a slump? If there are significant threats to stability, is it worth raising expectations about development?
  3. What is the plan for strengthening the rest of the economy, reducing reliance on extractive export revenues and cutting back on the subsidised use of oil and gas as inputs to industry? This is a long-term strategic question that should be addressed in earnest as soon as resources have been discovered. The plan must be adapted to take into account the expected depletion timeframe as well as human and other country potentials. This leads to the key question of how to build linkages from the extractive to the non-extractive sectors of the economy.
  4. Following on from the above, what are the potential scenarios for long-term demand, bearing in mind the global shift to lower-carbon economic systems? The various scenarios differ depending on the resource. How they play out leads to the question of how much sustainable employment can be generated from extractive projects and how to tackle retraining, particularly in the case of the mining industry, which employs a larger (often more politically significant) number of nationals.
  5. Are there enough robust institutions to manage the new sector well and, if not, are there options of delaying or slowing down development? These are valid options for Guyana, given the enormity of the governance and political stability challenges it may face. In certain cases, it may be better not to produce the resource at all until conditions improve. Bad governance will probably be made much worse by the availability of resource revenues.
  6. Are extractives-led growth agendas compatible with low-carbon or climate-smart development? This is an important consideration from a political perspective given the stated interest of many donor countries in promoting low-carbon development, and the growing enthusiasm for cleaner technologies by civil society in those countries that already face environmental degradation and will be hardest hit by climate change. There is little understanding to date of whether and/or how the various extractive-sector activities can make a significant contribution to the low carbon economy through their investments and operations.

Moreover, the extractives-led growth agenda has been promoted largely in a generalized way; as a result, the varied and complex circumstances of individual countries and their resource base has been overlooked. There are several serious issues for Guyana to contemplate when considering an extractives-led growth agenda, these include:

  • Loss of the underlying context for extractives-led growth: We no longer live in a world of high and rising commodity prices, and a slump in many extractive prices will lead some companies to withdraw investment from ‘higher-risk’ projects, while any oil price decline will likely to discourage major investment in countries with little infrastructure, as is the case with Guyana. Moreover, financial markets have changed significantly following the financial crisis of 2008: financial investors have lost their appetite for large, long-term, high-risk projects.
  • Ignoring the heterogeneity of existing and prospective producers…: Getting governance right to manage the sector effectively will be much harder and more expensive.
  • … and the size of the resource base: This factor is fundamental to deciding whether and to what extent a country can depend on resources serving as a driver of growth. Guyana currently has a sufficiently oil large reserve. This does not necessarily mean that the resources should be large relative to the rest of the economy. It could be argued, for example, that any competitive diversification of the economy has more chance of succeeding if the resource base is modest, since Dutch disease and the ‘crowding out’ phenomenon can be more easily avoided.
  • Overlooking other (potential) choices: Such choices include leaving resources in the ground or developing them more slowly than investors would like.
  • Insufficient attention to the risk of putting ‘all one’s eggs into one basket’ …: This risk is particularly acute as the rest of the world may move away from some extractives. The problem of stranded assets – or, at least, declining terms of trade in a carbon-constrained world – remains a threat to wealth creation from hydrocarbons owing to the length of time from discovery to production.
  • … and to the danger of locking in high-carbon infrastructure, practices and interests: Low carbon or climate-smart transition would be more difficult and more expensive if this danger is not averted.

The Pace of the Sector’s Development

All countries face the challenge of finding economic pathways towards the sustainable and equitable use of resources, especially given environmental pressures, increasing human demand and climate change. A national dialogue to help guide and inform industrial strategy could be useful (Hobbes 2014).

The development of an existing or potential resource sector should be part of that dialogue. Once a country has discovered a potentially significant subsoil resource on its territory it would be sensible to initiate a national dialogue among stakeholders and members of society to discuss how quickly or slowly the resource should be exploited. Indeed, it could be an option not to develop the resource at all and simply leave it in the ground. The classic example of such a debate is that of Norway when North Sea oil was first discovered (Stevens 2011). Among other benefits, a national dialogue can help manage the expectations inevitably triggered by the announcement of a large extractives find, and if a consensus view on how to develop the resources can be reached, decisions related to depletion are, in effect, removed from the political process. At the very least, such stability could encourage more inward investment in the sector.

The reality is, of course, that not all governments would welcome such a dialogue. At the same time, it is unclear who should lead the debate. An institutional structure like that of stakeholders associated with the Extractive Industries Transparency Initiative (EITI) is a possibility, especially if such a structure could be created before resource development. Nevertheless, there is no guarantee that a national dialogue would lead to a stable development policy. If the dialogue is lengthy, investment could be inhibited as some companies wait to see what the outcome will be and find that by the time an outcome is reached, the initial conditions to encourage investment are no longer available.

Just how ‘fast’ or ‘slow’ production should be depended on the state of the economy, the strength of the private sector and the degree of ‘technological strangeness’. Obviously, the greater the disparity between the project and the capabilities of the local economy, the slower the advisable pace of project development; and the same applies if the private sector is weak. In most cases, the government is able to determine directly the pace of development through the regulatory process.

As the owner of the subsoil resources, it can decide how many exploration licences are granted; and, in most cases, it approves development plans on an individual basis. Moreover, there often exists legislation whereby the government can directly influence the rate of production.

The case for slow development

For most countries, the rate of developing extractive projects needs to be slowed down if only to allow time for the private sector to develop the capacity and capabilities to take advantage of the forward and backward linkages with the rest of the economy. There will inevitably be pressures to produce the oil and gas as rapidly as possible. For this reason, it is necessary to examine how to reduce the rate of depletion.

Slowing down the development of a specific project may be problematic if investors are incentivized to maximize its net present value. However, according to option theory, a business case for the slow development of a specific project can be made on the grounds that it can add value (Stevens and Considine 2013). That assertion stems from the proposition that ‘uncertainty creates value’ when a project operator has the real option to develop investment opportunities in stages. By biding its time in between stages and waiting until more information is available, a firm will be able to make investment decisions that are more informed and better suited to the economic and political situation that is most likely to prevail throughout the project’s lifetime.

Indeed, the energy literature has long emphasized the value of using the theory of irreversible investment under uncertainty to quantify the ‘option-like’ characteristics of large-scale energy projects (Dixit and Pindyck 1994). Some companies do try to take option value into account in their assessment of project economics. However, if there is value in ‘optionality’, is it realistic to assume that the government will allow a company to choose when to employ that option and gain value rather than trying to capture that value for itself?

The case for fast development: treating the sector as a ‘development opportunity’

To use its extractive sector to jump-start growth while allowing enough time for sustainable diversification, a country needs a sufficiently large resource base. The rate of transition slows as a country’s resource production increases and then plateaus. To gain investor attention in order to unlock the type of large-scale project that requires, for example, transportation and power infrastructure, a country will need to demonstrate resource potential. As a new and prospective producer, Guyana cannot currently lay claim to such potential. Hence, Guyana will need to consider whether it can use the sector as a ‘one-off opportunity’ for development.

If the sector were to be used effectively in this way, the revenue stream would need to be channelled into various investments that are deemed sustainable in the long term without creating the kinds of economic distortions that follows from the effects of the resource-curse. However, it is doubtful whether this is a realistic option for new small-scale producers that have limited capacity. A fund to manage revenues would almost certainly be necessary. Usually, the prospects of such a fund being effective in such countries are highly uncertain. Thus, recommending the ‘one-off opportunity’ approach to a new producer would not be a viable alternative to slower development of the extractive sector.

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