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Sunday, February 28, 2021

Opportunities for State participation in Guyana’s oil development

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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.

The establishment of state oil companies is very common in oil-producing countries. Most petroleum producing countries have incorporated state participation in their licensing regulations and/or legislation. The establishment of a national oil company can be justified on several grounds.

  • First, it can be used as a device to procure national ownership of oil. This objective does not, of course, necessitate the involvement of a state company.
  • Second, it can establish state ownership of oil.
  • Third, it can be a mechanism for establishing state control over the industry (dirigiste rather than socialist philosophy).
  • Fourth, it is a means of increasing state revenues from the industry.
  • Fifth, it may be used as an adviser to the government on oil matters.
  • Sixth, a state company may be employed to procure security in oil supplies.
  • Seventh, the purchase contracts with the oil companies can be employed to attempt to iron out short-term price fluctuations.

There are three main riles of roles of a National Oil Company (NOC) involve addressing information asymmetry, improving the government’s take and enabling more government control of the petroleum sector as well as ensuring a steady supply of energy (Marcel 2006, Stevens 2012).

In Guyana’s case, it is likely that elements of all the above must be considered when a NOC is to be established. Compulsory licence participation in the orthodox sense must be present. Its effects on investment depend on precise terms regarding (1) carried interest of the state’s share and (2) the participation rate.

As usual, investors are faced with the possibilities of (1) exploration costs (E), (2) net present value (NPV) of discovery and (3) chance of discovery (P). At the exploration stage, the investor would make the decision as follows: if the Expected Monetary Value (EMV) is positive; then the exploration programme would go ahead. As an example, let the state oil company participate (GP) at the rate of 50%. Given that the EMV depends upon the carried interest terms. There are essentially three possibilities as follows:

  • The private oil company carries the state’s share of exploration costs which are not reimbursed. The effect on the investment decision is as follows: a negative EMV, this would mean that it is now doubtful if the investor would wish to explore. If the participation rate were to increase beyond the 50%, then the EMV becomes negative too and the investor would certainly be discouraged from exploring.
  • The state company pays its full share of exploration costs. The effect on the investment decision is as follows: a positive EMV, this would mean that the investor would normally be expected to proceed with his exploration effort. Participation will never turn an EMV negative if there is full risk-sharing by the state company. If the rate is very high the expected cash flows may be regarded as unexciting and the potential could be reduced very significantly.
  • The state company reimburses its share of exploration costs only where a commercial discovery is made. The position for the investor is as follows: a small positive EMV, this would mean that the investment remains acceptable. It should be noted, however, that this will not always be the case. At a high participation rate, the EMV could become negative and exploration would be discouraged.

The general conclusion from the above breakdown is that the participation terms should not cause any disincentives to exploration. The terms could in principle deter exploration where the expected profitability is quite low. The so-called voluntary participation that can be applied to licences already awarded may cause considerable controversy, moving forward. There can be undoubted pressure on the companies to conclude sales agreements (at market prices) with a NOC.

Under the discretionary licensing system, the oil companies will feel threatened because their future licence applications might be jeopardised by non-cooperation. The “no gain no loss” concept may also be felt by integrated companies to take no account of the advantages to them of being able to plan their supplies for their own refineries. Accordingly, they will be tempted to frequently negotiate buy-back deals as part of the participation arrangements.

A major reason for the introduction of participation agreements for existing licences will be the perceived need to provide for the security of oil supplies in the event of disruptions from other sources. There is no doubt that future oil supply disruptions are possible, and contingency planning by the government is a sensible precaution. However, it is not so clear that the purchase of crude oil by a NOC will constitute the most effective mechanism for dealing with the problem.

If the NOC does not own any large storage capacity or refineries, then once it sells the crude oil it has, there can be no further influence over its use. The NOC will not be able to prevent the refiner from selling the refined oil abroad, for example.

In general, some control over the disposal of refined products is necessary to deal with supply difficulties. Further, the government should develop some powers in the appropriate legislation which will allow for some authority to regulate the production, use and prices of oil and natural gas in the event of an actual or threatened fuel emergency, or if control were necessary to fulfil local or international obligations. In recent years more emphasis has been given to stocks of products to combat any short-term disruption to supplies. The government should note that participation can at best be seen only as underpinning the other measures already in place for securing supplies in times of crisis. The government of Guyana must secure assurance from oil refining and marketing companies designed to ensure the supply of oil products to the Guyanese market. These assurances are often commercially confidential.

It is clear that the emphasis should be on supplies of refined products, with powers to acquire control over crude oil being a back-up facility. Stocks of refined products, of course, require renewal and thus necessitate crude oil supplies. The experience over time indicates that the crude oil has to be forthcoming within a relatively short time. The NOC participation agreements can also be transferred to other appropriate regulatory organisations. However, these must be put into effect and activated as soon as possible, as the length of time leaves doubt about whether such dormant agreements could be sufficiently effective if supply disruptions occurred. Use of the powers of an effective legislation leaves considerable uncertainty about their impact because the extent of the powers must be precisely specified. Any uncertainties will generally not be conducive to a positive investment environment. Thus, straightforward participation is more likely to fulfil the back-up requirement without causing undesirable disincentive effects. In the present market circumstances, much of this discussion is of academic interest only. Market conditions will, of course, change unexpectedly.

Following the creation of a state agency to focus on the business aspect of oil and gas and the (unrelated) growth in the volatility of oil prices along with the growing spot market, some emphasis must be given to the role of a NOC as a short-term price stabiliser through its contract purchase price with producers.

It is clear that after 2020 oil production from the Guyana Basin will be large enough to influence prices, to some extent. A Guyanese NOC contract purchase prices may be able to influence prices in the short term, but it will be difficult to determine how such a NOC could be able to iron out price volatility by its future contract purchases and sales, given the other constraints on its behaviour.

If the local NOC does not have any major storage facilities and, apart from dealing in its own oil, does not actively operate in the forward market, then the volumes that the company will have to purchase could be very large and inflexible in the short run. Fundamentally, it is the volume of production coming on to the market which has the most important influence on price on the supply side, and a Guyanese NOC may not have any short-term impact on this. Hence, given the underlying volatility in the market, the government will eventually have to decide the respective functions of a NOC.

Of the other possible objectives of a national company discussed above, increased Guyanese ownership can be achieved and, of course, continued through the subsequent creation of other market-led companies. If the Guyanese company is as efficient as the best foreign alternatives, then Guyana benefits in terms of higher domestic income (profits are retained in Guyana).

The shift in the balance of control over petroleum resources from the International Oil Companies (IOCs) to National Oil Companies (NOCs) has ignited the debate among policymakers and researchers on the role of the latter institutions (Victor et al. 2012). As IOCs continue to experience declining control of the petroleum resources, the situation is different for NOCs: they now wield significant influence over oil and gas resources as custodians and developers of such resources (Al-Fattah 2014, Stevens 2008).

Therefore, increased revenues can accrue directly to the state if the national oil company profitably exploits oilfields. This raises all the issues concerning the relative efficiency of private and public enterprises. In general, the most appropriate mode of exploitation is that which minimises the resource costs to the nation acquiring the oil.

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