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Tuesday, October 27, 2020

Dynamic influences on evaluating the fiscal terms of Guyana’s oil contracts

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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.

Oil is the world’s number one strategic commodity. It is of vital interest to developed and emerging markets that rely on imported oil and gas. It is also vitally important to exporting nations, many of them among the poorest countries in the world. For countries with petroleum resources, the contribution from the petroleum sector to the nation’s budget is often dramatically greater than the contribution to the country’s gross national product (GNP). For example, if the petroleum sector were to represent say 10% of GNP it would likely represent from 30 to 40% of the nation’s budget. Not only is petroleum very profitable relative to most other industries, but the effective tax rate for the petroleum industry is also especially high.

Numerous dynamics influence today’s industry. Oil demand continues to fluctuate, and at a faster rate than anticipated. Much of the new demand is still coming from the Asian giants India and China. Supply of oil and gas, however, is a function of exploration and production. There is now every indication that exploration and the resultant discoveries have peaked (although it remains uncertain when production will peak since production lags behind exploration, sometimes by as much as 30 years). Gas is becoming increasingly important, even if, because of the higher transportation and management costs, gas discoveries in many regions of the world are still often characterized as being ‘worse than a dry hole’. Gas is simply much more difficult to transport than oil and is still ‘flared’ (a process by which waste gases produced in the course of processing oil are disposed of through combustion) in many parts of the world.

As these features change there are also changes in relations between the main players in the industry. On one side stand the country governments and national oil companies (NOCs) that control the bulk of the available oil and gas reserves; and, on the other side, stand the international oil companies (IOCs) that meet the majority of the financial, technical, organizational, and marketing needs of exporting and importing countries. On the side of the producing countries, numerous economic and political complexities associated with managing oil and gas exist. These issues are important not only to domestic affairs in any given country but also to the relationship between national actors and private oil companies. Many of the problems associated with oil and gas exploration and production, particularly in low-income countries, can be associated with corruption. Although in some cases the problems stem from misunderstandings and poor communication in the course of negotiating and implementing an oil contract. In these cases, the government, the NOC, and the IOC can fall suspect to accusations of theft of a nation’s oil wealth. Moreover, the publics in these countries often no longer sit idly by. The results are usually not healthy to a country’s economic and political development.

While relations between major actors may be fraught with political difficulties, they are also important from a practical point of view. There is increasing competition among countries for the limited resources of the IOCs. The ability of countries to attract IOC investment depends on their prospectivity and stability, as well as on their marketing skills. When they succeed in attracting investment, they want the best terms they can get. Oil companies, meanwhile, want to explore in regions where there is a reasonable chance of finding oil and gas. They want to deal with stable governments and prefer contract terms that will provide a potential return-on-investment that is commensurate with the associated risks. They are also interested in (or rather obsessive about) “booking barrels” – adding reserves as assets to their balance sheets. Overall, the contract is the best indicator of how well the different goals of country governments and IOCs have been met. There is, however, no single clause or number contained in a contract that can tell you whether the country or the company (or neither or both) got a good deal. Rather, evaluating the contract requires examining a series of conditions. Therefore, critical to an economy like Guyana is the question of: How do the government, the local agencies, and IOCs work together in the process of negotiating an oil contract, and what types of contractual relations are likely to lead to better outcomes for the country?

This question is often examined by focusing more on the broad differences between the families of systems that exist (Johnston 2001). Indeed, there are myriad ways to structure business relationships in the petroleum sector. Yet, the first observation elaborated here is that, for all practical purposes, only two main families of petroleum fiscal regimes exist: ‘concessionary’ systems and ‘contractual based’ systems. Although differences exist between them, the differences are not great from either a mechanical or a financial point of view. Instead, working out the merits of a particular agreement requires a deeper understanding of how the different systems operate and, in particular, of the core fiscal elements (Johnston 2006)

Therefore, a framework for analysing the properties of different agreements must be established by identifying what is at stake with different provisions in an oil contract, regardless of which family an agreement comes from. Two measures must be examined, beginning with the most commonly cited – ‘Government Take’. Government Take is the government’s share of economic profits from almost all income sources, including bonuses, royalties, profit oil, taxes and government working interest. While an important statistic and widely used, it is nonetheless flawed because it does not take into account factors such as the timeframe for pay-outs to government and the level of government participation. In response to the issue of the timeframe, discussion on an oil contract must show how to calculate a companion statistic known as the ‘Effective Royalty Rate’ which measures the degree to which a contract ‘front-end-loads’ payments to governments. Moreover, there are five additional features of importance to governments and companies which must be considered:

  1. The degree of government participation, which comes at some benefit to governments but at a cost to companies;
  2. The “savings index,” which gives a sense of the incentives facing companies to keep costs down;
  3. Responsiveness of the deal to changing economic conditions;
  4. Provisions for minimizing risk; and provisions that allow companies to “book barrels”; and
  5. Some options which should be available to the government on deciding how to allocate future acreage.
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