Policy considerations for the licencing arrangements of Guyana offshore blocks

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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.

To maximize the potential national benefits appropriate licensing, taxation, depletion and pricing policies are required. Given the high degree of geological uncertainty in the early years, some use of the discretionary licensing system to award acreage was appropriate, but greater use could have been made of auctions as the province matured. The taxation arrangements have certainty in collecting a high share of the economic rents to the state. The cost has been a very complex and frequently changed system. Depletion rates seem to have been set to very fast and largely market driven. Restrictive depletion policies may impose high costs. Hence, emphasis should be placed on policies to ensure that appropriate investment of oil revenues takes place rather than restrict output. Any given monopsonist position could distort the pattern of exploitation. While competition is developing within the current framework, the industrial market will become much freer.

The policy effects to be considered in the offshore blocks of Guyana should be those of:

  1. The time to reach the maximum rental payment, without changing the maximum amount payable.
  2. Increasing the incremental rate of the rental payments.
  3. Increasing the industry net cash flow.
  4. Improving the terms of accessibility to infrastructure; and,
  5. Reducing the waiting time to gain access to infrastructure.

The most effective policy tool will be the reduction in the time period to reach maximum rental payment without changing the maximum amount payable. This contradicts theoretical arguments against weaker government intervention, although it must be emphasised that the current views expressed here are not necessarily arguing for unbridled stronger government intervention. Clearly, the extent of appropriate government intervention would depend on the particular circumstances of each hydrocarbon province.

Understandably, all considerations should be given to both quantifiable causal factors, where historically available data are known, along with the incorporation of qualitative and other explanatory factors such as the kind of direct governmental intervention that has recently gained currency, and, therefore must have sufficient observations to justify their inclusion in any econometric model for the development of the offshore fields (Kemp and Kasim 2006).

It is now 20 years since the first major licence for petroleum exploration in the Guyana Offshore Blocks were issued. The offshore Guyana oil and gas exploitation is rapidly developing into a major industry since the first discovery of commercial hydrocarbons in May 2015. The exploration success rate has been high by international standards. However, caution must be applied for the pace at which reserves are expected to be depleted. Oil production will begin in 2020 and by the end of 2025 cumulative daily production is expected to 750,000 barrels of oil.

The current estimates show that the gross discovered recoverable resources on the Stabroek block have been increased to more than 6 billion barrels of oil equivalent (boe). This growing resource base further underpins the potential for at least five FPSOs by 2025.

The exploitation of oil and gas is having a major impact on the Guyanese economy. By 2022 the direct contribution of petroleum production to Guyana’s Gross National Product (GNP) will be substantial. Any major volatility in oil prices during this period will greatly affect this contribution, but it will remain substantial. The Guyanese government will benefit significantly from royalties and taxes on petroleum production, which is expected to reach a peak of 120,000 barrels of oil per day (bpd) in 2020.

The direct effect on the trade balance will be positive when self-sufficiency is attained. In some coming years, the surplus of oil export revenues over imports will be very large. Imports of equipment and services will reduce the trade surplus attributable to oil, but these are expected to decrease substantially in the periods after 2030. Interest, dividends and profits to be paid abroad will also reduce the oil current account surplus. After these have reached a peak, it will be leaving a major positive contribution in the years to follow.

The indirect effects of petroleum exploitation will also be highly significant. Capital investment in the Stabroek Block has been very substantial. However, this is still set to rise over the next few years, with the development of new fields. The Guyanese content of orders placed by the petroleum industry will continue to increase dramatically as each oil field develops and new discoveries are announced.

The importance of petroleum exploitation also includes its indirect effects on the non-oil sectors of the economy. The development of the offshore blocks has not only made a major direct contribution to the Guyanese balance of payments; it has also influenced it indirectly via its effects on the exchange rate. The expected high value of Stabroek production has affected the value of the local currency on the foreign exchange market to a level than it otherwise would have attained. In turn, this could have an adverse effect on the competitive position of the other tradeable sectors of the economy. The strength of this effect depends upon the volume and price of petroleum production.

From the above, it is clear that the petroleum production sector will become an important element of the Guyanese economy. To ensure that the industry produces maximum benefits to the national economy it is, in turn, clear that policies towards the sector must be optimal.

Licensing Arrangements

The operation of the discretionary licensing system can usefully be compared to that of the main alternative, which is some form of auction-based system to determine the allocation of licences. Such schemes are widely employed in the USA and Canada for government-owned properties, but not in other parts of the world. Generally, it has been argued that a bidding system can ensure:

  • That economically efficient exploration programmes are undertaken, and
  • That economic rents from petroleum production are collected by the state without distortions being caused.

A host government may have additional objectives in its licensing policies, but it can certainly be argued that economically efficient exploration and the collection of economic rents should be the most important ones. Whether a licence auction system is likely to lead to the accomplishment of these objectives depends upon a number of factors. If there is strong competition among companies applying for licences the consequence should be that the bids will reflect the expected size of economic rents. It is argued that investors are best able to identify prospects and measure the required exploration, appraisal and development costs. The winning bids will reflect the most economical costs, and the state benefits by collecting the highest foreseen economic rents. Exploration, development and depletion decisions are not distorted as a consequence of this procedure. It is also argued that a further desirable feature is that the exploration and other risks are placed on the investors rather than the government. A rational investor would assess a prospect by estimating its expected monetary value (EMV). The lower the exploration, development and operating costs, the greater will be the EMV and the higher the bid that can be made by an investor. Hence, it is apparent that the auction system has some obvious attractions. Payments are made on an entirely voluntary basis and no subsequent disincentives emerge. The host government receives the payments before exploitation commences, and the costs of operating the scheme are likely to be small in comparison with the alternative discretionary system (Kemp 1990).

Despite these attractions, there are problems associated with the application of an auction system. A high degree of competition among bidders is a necessary condition for the effective collection of economic rents. Lack of competition due, for example, to collusion among investors, means that bids may understate the economic rents. Although investor interest in acreage put on offer may be high in general terms, in most rounds the number of blocks offered has significantly exceeded the number of applications. To prevent acreage being awarded for very small sums, the government can, of course, have a regulation stating that it reserves the right not to accept any offer for a particular block if it felt that the bid was insufficiently high.

When a new province such as the Guyana Offshore Blocks is opened up for exploration the firm geological knowledge available is likely to be relatively small. When faced with high geological uncertainty under a bidding system investor are likely to react by putting a risk premium on the bids they submit. In general, the higher the uncertainty, the bigger the discount will be on the sums bided. In this sense, the host government actually shares in the exploration risks. While the sums bided reflect the exploration risk and thus the ex-ante or anticipated rents at that decision point, they will probably not reflect the rents expected at the time a discovery has been made: the greater the exploration risk the bigger the difference between the economic rents expected prior to the exploration and after a discovery has been made. A host government may well be dissatisfied with this situation.

While the behaviour of investors, when faced with high geological risk as discussed above, is entirely rational, a host government may feel that its appropriate reaction is to put in place a system of contingent, discretionary taxation which would ensure that a ‘reasonable’ share of the rents emanating from the exploitation of a commercial discovery accrues to the state. This forms part of the case for having a system of discretionary taxation to collect economic rents as they arise when fields are developed. When the exploration uncertainty is very great it is arguable that the case for such a form of taxation is stronger. Care must, of course, be taken to ensure that the fiscal system caters appropriately for the exploration risks.

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