Privatisation’s role in maximising Guyana’s total benefits from the petroleum sector

Must Read

OilNOW is an online-based Information and Resource Centre

Too often countries do not get the full value of their resources. A government would genuinely be interested in using its good luck of an abundant resource endowment for the benefit of its people. However, first, it must somehow extract the resources from below the ground and sell them. To do that, it will have to rely on public employees and/or private contractors. It can hire the private contractors to undertake specific tasks, or it can sell them the natural resource in return for a fixed amount and/or a royalty on whatever is sold. Many of these parties upon whom it must rely have, however, another objective: maximizing their income or wellbeing, which in turn means minimizing the amount paid to the government. This is a natural and inevitable conflict of interest. Both in the public and private sector, there are many who would also like to use the country’s wealth for their private purposes. Thus, a key challenge any government faces is to work out how to engage with these other actors, whose objectives inevitably differ radically from its own.

How should governments work with the private sector to maximize the total (expected present discounted value of) revenue it receives from its natural endowment? The prospects of cheating are very real and very great and can arise at every stage of the transaction. The government may get less for the lease than it should – there may even be attempts to restrict competition in bidding. Whatever the contract that has been signed; corporations are tempted to cheat – to pay less than they are supposed to – because the amount of money that can sometimes be made by doing so is so large. The occasions to cheat arise not simply in countries like Guyana.

There is no easy way out of this problem. Privatisation – the process of turning over natural resource assets to the control of the private sector – is not the answer, or at least it is not necessarily the answer. Although, while there is no simple solution, some governments have done better than others in obtaining for their citizens a large fraction of the value of their resources. Hence, some of the things that the government of Guyana can do to increase that fraction include strengthening institutional structures before engaging in privatisation, holding corporations to higher standards, and carefully evaluating contract terms.

Privatisation and Problems of Agency

The central problem facing resource-rich countries may be easily stated: various individuals wish to divert as much of that endowment as possible for their private benefit. Modern economic theory has analysed the generic problem of inducing agents (here government officials) to act in the interests of those they are supposed to serve (“the principals,” here citizens more generally). Agency problems arise whenever there are problems of information imperfections. This is why there is a need to emphasize transparency or improving the openness and availability of information in an attempt to control corruption.

Information is not the only way by which agency problems might be mitigated. Constraints can be imposed on actions that can be undertaken. Constraints on decision-making processes might affect the magnitude of the distortions that arise – for instance requiring multiple approvals might increase the number of people who have to be bribed to get resources at below-market prices. The more people involved, the greater the probability that at least one is incorruptible (at least at going prices), thereby decreasing significantly the risks of corruption. With the cost-benefit calculus for corruption changed, there might be less corruption (Stiglitz 2006).

Every interaction opens up scope for an agency problem (and corruption is only one form which agency problems take.) There are agency problems within firms, within the government, and in the transfer of assets from government control to the private sector. The entire set of rules governing the extraction of natural resources affects the magnitude of the agency problem – and the benefits that accrue to society from that country’s natural resources.

The General Problem of Diversion

A look at experiences around the world shows a rich catalogue of ways by which resources get diverted and in which, in accomplishing the diversion, economic efficiency is impaired. In many emerging countries, government-run oil companies have been marked by high levels of corruption; even when there is no overt corruption, those running the oil companies often pay themselves and their worker’s above-market wages – resulting in less money left over for the rest of the country. In countries with high levels of unemployment, the government-run oil companies become bloated with employees, a sort of ‘welfare program’ directed disproportionately at the well-connected.

Much of the public discourse has focused on government corruption – the attempt by government officials to divert as much as possible for their use. This has led many (including the international financial institutions) to encourage privatisation – turning over, in one way or the other, the development of natural resources to the private sector. A few decades ago, at the beginning of the wave of privatisation, it was hoped that privatisation would solve these problems. The private enterprises would have an incentive to be efficient. Especially if the resources were put up for auction, the winner would be the firm best able to extract resources; economic efficiency would be assured, at the same time that government revenue was maximized. Although what has happened in the last few decades has made it abundantly clear that privatisation does not eliminate scope for corruption, or more generally, eliminate agency problems. There are agency problems within private firms, just as there are in government enterprises. This is especially the case in those countries without good corporate governance (which means almost all emerging countries). Those controlling the corporation (the company’s officers) typically have the opportunity to divert the company’s resources to their benefit – and they not infrequently take advantage of that opportunity. Indeed, because public scrutiny of corporations, even public corporations, is typically less than public scrutiny of government enterprises, the scope for diversion is all the greater (Humphreys et al. 2007).

However, the concern here is with the impact of these agency problems on the revenue obtained by the government. Privatisations typically entail not only a one-time payment from the private sector to the government but also an on-going stream of payments, in the form of taxes. Leasing tracts of land entails further streams of payments, in the form of royalties. In many cases, the government is a (minority) shareholder in the corporation given the right to extract the oil or natural resources. Each of these arrangements entails different potentials for “diversion” and different agency problems, and there is potential for diversion at each stage of the transaction, for example, both at the time the contract is signed and at the time it is implemented. When, for instance, private corporations in which the government is a minority shareholder are entrusted to develop an oil field, there is a standard set of corporate governance problems: the abuse of minority shareholders by the controlling shareholder, or of shareholders by the “manager.” Often, for instance, the company hires a foreign firm to “manage” the oil well. The question then is: What is the appropriate compensation? Even if the manager is directly compensated appropriately, he/she may pay a related third party more than fair market value for services – diverting value away from the government. Even when the only ongoing relationship involves taxes or royalties, there are problems, as the company may attempt to cheat, hoping that if the amounts per barrel are small enough, they will go undetected. Nonetheless, pennies a barrel times hundreds of millions of barrels adds up.


Partnered Events

Latest News

Hess facing three lawsuits over disclosures in Chevron deal

(Reuters) - Oil producer Hess (HES.N) on Tuesday said it is currently facing three lawsuits alleging inadequate disclosures over...

More Articles Like This