Wednesday, December 7, 2022

Tom Mitro failed to prove Guyana losing big on cost oil deductions

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OilNOW
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By Joel Bhagwandin – OilNOW

I am tired of responding to first world “so called experts” who have their own agenda and based on their absurd pronouncements on Guyana’s affairs, probably believe that we are an uneducated population and lack critical thinking abilities.” I will never stop, however, to challenge, expose and discredit their arguments and pronouncements because that notion is not true, and I will never allow these foreigners to treat us as such. It is totally disrespectful and derogatory on their part, and what’s even worse, local media houses give them a platform to propagate their nonsense. We, as Guyanese, must never allow this level of disrespect, as there is no foreigner on this planet that is superior in intellect than Guyanese.

According to the publication, Mitro argued that “the country is losing primarily through the deductions being made by the operator and not necessarily in the profit-sharing aspect of the deal. Mitro contended that “one such provision allows Exxon to recover all interest on loans borrowed to fund the development of related oil projects. In practice, Mitro said, this means that the operator and its partners can charge Guyana for the cost of borrowing from their affiliates with no limits. “Contracts typically have cost recovery mechanisms, but usually with limits,” Mitro said, explaining that without written limits, companies can abuse the amount of borrowing they do within the conglomerate.”

Now, let’s deconstruct Tom Mitro’s wild and careless assertions as was reported by the Kaieteur News edition of June 24, 2022. The current Production Sharing Agreement (PSA) does in fact stipulate limits in two forms. The first being the 75% cost recovery ceiling, this is a limit; the second is not administered by limits for each line item per se, but the PSA prescribes what expenditure is cost recoverable and those that cannot be. It also speaks to approval having to be sought for certain costs to be in the cost recoverable bank. Mitro is therefore incorrect when he suggested that there is no limit within the PSA on costs.

With respect to imposing limits on items such as financing cost, that would be imprudent and in contravention of basic, fundamental accounting principles.

Let’s take it to the basics. In elementary economics or even at the [Caribbean Secondary Education] CSEC/CXC level business subjects, students are taught about the “factors of production”, divided into four categories:

i) Land

ii) Labour

iii) Capital

iv) Entrepreneurship

This means, that to start any type of business and to ensure it remains a going concern, the investor(s) need to have land (the building or property where the business will operate out of); labour which is the people resource, and everyone brings their own unique skill sets and competencies, financial capital and entrepreneurship acumen. These are four crucial elements to ensure the success of any business.

Further, each of these attract a cost for the acquisition of same – that is, there is a cost for land, building, furniture, equipment, labour, and there is also a cost for capital.

Financial capital is usually in two forms, equity, and debt. Equity is shareholders or the owners’ money that they accumulate in savings or sale of an asset, and debt is borrowed capital. Both forms of capital like the other factors of production have a cost to obtain same. Typically, equity is more expensive than debt and that is because shareholders demand higher returns for their investments.

In the case of ExxonMobil, the cost of debt capital is around 4.25% and the cost of equity is around 8.65% giving rise to weighted average cost of capital (WACC) of about 8%.

The cost of capital (financing cost) is treated as an expense and therefore deducted from the profit and loss account as an expense. In other words, the interest expense, for example, charged on a loan which is a form of debt, is a financing cost which must be deducted as an expense from the profit and loss account. This is a standard universal accounting practice and fundamental. Thus, there is absolutely nothing unusual about it.

Further, Tom Mitro did not conduct any analysis to support his view that “Guyana is losing big” as a result of deducting financing cost as an expense. Hereunder, let’s look at the actual financing cost based on the 2021 financials of Exxon, Hess and CNOOC and the amount of debt financing the company actually employed in its capital structure relative to equity.

Toward this end, an examination of the statement of comprehensive income for the oil companies ending fiscal year (FY) 2021, total revenue amounted to GY$545 billion, financing cost amounted to GY$822 million representing 0.15% of revenue, lease interest (another form of debt financing) amounted to GY$6.6 billion representing 1.21% of revenue, altogether the (lease interest plus financing cost) represents a mere 1.36% of revenue – thus having a very minimal impact on profit.

Most important to note is that oil companies typically employ a low level of debt in their capital structure. This is largely because of the complex nature and high-risk factor of the industry where the life cycle between exploration stage, development and production stages can be as long as 10–20 years. In the case of Guyana, for example, exploration commenced shortly after the 1999 agreement was signed with ExxonMobil, oil was discovered in commercial quantities in 2015, approximately 16 years later, and production commenced another 5 years later following the development stage. Altogether, the exploration to production cycle in Guyana spanned almost two decades. Then, another two years later, into production, the oil companies made a profit for the first time.

That said, the long term-debt-to-equity ratio for the oil companies operating in Guyana is 0.2 or 20%. This means 80% of the companies’ capital structure comprise of equity financing (typically, this ratio for other industries is as high as 50% – 70%).

More so, owing to this low level of long-term debt, the financing cost as shown in the statement of comprehensive income represents less than 2% of revenue.

Consequently, the companies’ financing expense has an extremely low impact on profit oil for Guyana and the oil companies’ share of profit.

In view of the foregoing, the argument put forward by Tom Mitro is unmeritorious.

About the Author

Joel Bhagwandin is a financial and economic analyst, an academic researcher and writer, a junior business executive, lecturer, and thought leader. Joel is actively engaged in providing insights and analyses on a range of public policy, economic and macrofinance issues in Guyana for the past 5+ years. In this regard, he has authored more than 300 articles covering a variety of thematic areas. Joel possesses more than fourteen years’ experience in the financial sector and private sector development combined. During this time, he has accumulated more than five years of professional experience in providing financial and business advice to both large corporations and Small and Medium sized Enterprises (SMEs) and eight years’ managerial experience. Academically, Mr. Bhagwandin is the holder of a master’s degree in business management with specialisation in banking and finance from Edinburgh Napier University. His specialties and skills include: Corporate Finance, Banking, Capital Markets & Securities, Business Intelligence & Data Analysis.

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