Full national considerations are also relevant to a depletion policy of a country’s petroleum resources. Security of oil supplies must be a consideration in Guyana. Possession of crude oil reserves can obviously make a contribution to the solution of this problem. It is sometimes argued that security of supply has some of the characteristics of public or merit goods: while the operation of the free market may result in some stocks being held for security purposes, under the provision in terms of the benefits accruing to all members of a society is likely to occur.
There are degrees of security in terms of oil supplies. A policy of self-sufficiency would represent an extreme case of attempting to deal with the security problem through the maintenance of indigenous reserves. Such a policy would almost certainly be very costly and impossible to sustain over the longer term. In the Guyanese context, on the demand side; measures to conserve oil consumption would also be relevant to this question.
Society may be willing to pay a premium to procure a level of security with regard to oil above that produced by the operation of the free market. The required premium obviously increases with the degree of security sought, but measurement of its size presents great difficulties. It is certainly not obvious that society is prepared to pay the extra costs required to procure self-sufficiency in oil. The level of security can, of course, be increased above free market-determined levels without going as far as complete self-sufficiency. The costs of obtaining increased security via this route are:
- All those associated with postponing production, and
- The costs of providing incentives to stimulate exploration and production.
While difficult to measure, these costs are undoubtedly very high. Further, the likely degree of success of these policy initiatives is difficult to forecast. The main emphasis should thus be placed upon stocks of petroleum. The costs and benefits of this policy are clearer and easier to measure. Guyana could put great emphasis on this technique through the development of its own Strategic Petroleum Reserve (SPR).
In this context, it is interesting to note that current fiscal incentives at the exploration level are very high for an investor who is already in a full taxpaying position. As a result of the immediate write-off of exploration and appraisal costs at the marginal rate of 75%, plus the crossfield allowance for the front-end drilling reliefs for corporation tax, an explorationist can find that the post-tax EMV (expected monetary value) can exceed the pre-tax figure. Society is sharing in the exploration risks to a high degree and is most certainly encouraging the discovery of future oil on supplies in the Guyana Offshore Basin.
It is arguable that oil depletion policies should also take into account the external effects of oil production on the economy. This subject has been debated at considerable lengths in the developed economies. In general. the discovery of large reserves of a highly tradeable commodity in Guyana where the exchange rate is relatively free will result in the markets for other tradeable goods being adversely affected. The exchange rate should rise as a consequence of the offshore revenues. This makes both exports of Guyanese manufactured goods and domestic production less competitive against foreign goods.
Many estimations will be made of the extent to which the exchange rate will be increased as a consequence of oil revenues. Opinions will vary about the extent to which manufacturing output has been adversely affected as a consequence of oil revenues. Clearly, it will be difficult to distinguish the effect of oil and the exchange rate from other factors. It will not only be difficult to disentangle the effect of oil on the exchange rate from other factors such as high-interest rates but what manufacturing output will be in the absence of oil also depends on how the government would handle any major balance of payments problems which the Guyanese economy would encounter without oil.
The depletion rate of Guyana Offshore Basin may be such that the periods of highest production will coincide with the times when oil prices are expected to be high. This means that the direct benefits from oil production may have been maximized by the depletion rate which has actually occurred. These benefits are the direct increases in real national income. This defines the benefits conventionally measured in national income accounts. It is arguable that the conventional procedure is misleading and that a more satisfactory treatment would define petroleum reserves as capital assets which are consumed in the process of depletion. Much of the benefit has taken the form of economic rents, a large share of which will be taken in the fiscal regime by the state. This is, in general, the most important benefit of offshore oil.
The same coincidence of the highest levels of oil production with the highest levels of oil prices also suggests that the indirect effects on the rest of the economy via the exchange rate may also be greater with the depletion rate actually produced (largely by market forces), than they would have been if the production profile is expected to be somewhat flatter. Any “hysteresis” effects of a requirement to foster the subsequent growth of the manufacturing sector would also be reduced.
This analysis obviously involves much speculation. Even if the basic argument has some foundation, a lower depletion rate could have the effect of reducing the direct benefits from oil. There will then be a trade-off between maximizing the direct benefits and reducing the adverse indirect effects of a high exchange rate.
These policy possibilities are in fact not exhaustive. Another would be to maximize the direct benefits produced by market forces, and, at the same time, introduce other macroeconomic policies which would ensure that the indirect effects were not unnecessarily damaging. In the specific case of Guyana, this would have entail introducing policies to prevent the exchange rate from rising to damaging heights against other currencies. This would have to involve the full range of interest rate, monetary and fiscal policies. This basic approach of maximizing the economic rents from Guyana Offshore Basin while adjusting other policies to ensure that the side effects are not unduly damaging is likely also to maximize the total benefits from the exploitation of the resource.
Therefore, in any time period, it is only appropriate to consume a certain share of the oil revenues. Estimates of the permanent consumption which can be sustained by Guyana Offshore Basin oil will be sensitive to the assumptions made regarding reserves, exploitation costs and the oil price. These are all subject to considerable uncertainties and change, and so, therefore, are the estimates of permanent consumption which can be sustained.
Nevertheless, it is clear that a substantial part of the revenues should be invested. How this should best be achieved will be the subject of much controversy. It is also argued that lower taxes should encourage investment as well as consumption. It has also been argued that cutting taxes and leaving individuals to determine the pattern of consumption and saving from the fruits of oil revenues might not produce the optimal result. The macroeconomic consequences of Guyana’s offshore oil will show that consumers are “unduly myopic or do not care sufficiently about future generations and are thus unlikely to save as much of the proceeds from oil as is socially desirable”. It follows from this that a mechanism is required to procure the extra desirable saving and investment.
There are several ways by which this could be achieved:
- To some, the emphasis should have been on improving the infrastructure which in turn would involve significant increases in public expenditure. The transport network, education and training are all elements of the public sector investment which could contribute to industrial development.
- Another approach would be for government or government agencies to invest directly in Guyanese industries through equity and/or loans.
- Another approach to the employment of oil revenues is to invest overseas. This could be in financial or physical assets. The idea here is that the return flow of dividends and interest should boost Guyana’s national income when the return from oil dwindles. If the foreign investment takes place when Guyana’s oil revenues are high the outflow should limit the appreciation of the local currency and hence, mitigate any adverse effects on the manufacturing sector.
There are arguments for and against the emphasis on any of the above methods of handling the oil revenue. The uses discussed are not, of course, mutually exclusive, and a package incorporating all the ideas could be designed. Another possibility would be to set up a separate oil fund into which would be put a proportion of the oil tax revenues. The fund would then employ the revenues for investment in industrial/commercial/infrastructure projects. A key feature would be that the fund would be independent of the government, which would not have access to its revenues. The central role of the fund would be to ensure that a given proportion of Guyana Offshore Basin revenues was actually invested rather than consumed. Further, being an independent organization, the fund would not be under political pressure to support declining industries which are in temporary or permanent difficulties. Governments are, of course, frequently subject to such pressures.
