Cost Recovery and the fiscal terms of Guyana’s Production Sharing Agreement

Introduction

Following on several readers’ queries, perhaps I should indicate that I am by no means singular when treating cost recovery as a central component of the fiscal regime of petroleum producing countries. Presently, this is the standard formulation used by both “mainstream” and “critical” theorists. The reason why this has come about is simply that global practice has revealed clearly cost recovery provisions in petroleum contracts do not only impact the financial/economic bottom lines of petroleum contracting operators. They also affect governments that hold production sharing contracts (PSCs). The same outcome is, therefore, confidently expected to unfold within Guyana, after the much anticipated commercial operations start in 2020.

Having made this observation, it is necessary as well to acknowledge that, in practice, there are significant variations in cost recovery provisions among countries. Professionals who have studied these contracts advise that such variations could include, but are not limited to, variations in 1) those costs treated as legally recoverable; 2) the order of priority/scheduling indicated for recoverable cost claims, especially capital spending; 3) the ceiling set on cost recovery (in Guyana’s case 75 per cent); 4) the carry-forward provisions for cost recovery; and 5) allowances, which the contract permits.

Reimbursements or tax deductibles

Readers should also be aware that, energy economists engage in serious economic/financial debate on how recoverable costs ought to be perceived, both as legal and conceptual constructs. There are two challenging viewpoints. One of these treats recoverable costs as reimbursements to the contractor (in Guyana’s case Exxon and partners) for expenditures, which they have incurred in exploration, development, and ongoing petroleum operations. The other is to treat recoverable costs as tax deductibles, for which the contractor is entitled under taxation rules in force. Of note, this latter usage typically occurs in other businesses.

Practically, (and from the standpoint of an informed citizenry) I do not believe this distinction is of great moment, being at best, a matter for academic exploration. My columns rely on the first interpretation indicated above. However, the conclusion which perhaps is of most significance to the ordinary citizen is that this conundrum underscores the uniqueness or stand-alone characteristic of oil and gas contracts. As Wikipedia notes: “there are as many different fiscal regimes as there are countries … with petroleum resources”. (Wiki: Petroleum Fiscal Regimes).

Auditing, monitoring

One of the widest acknowledged weaknesses confronting Guyana, as it approaches 2020 is the dearth of skills (especially in areas such as oil and gas auditing/monitoring and doctoral/postdoctoral energy economists). These are desperately needed to ensure the effective operation of the PSA’s cost recovery mechanisms. This skills deficiency, however, is a structural one, and nobody should reasonably expect the country to overcome this over the short to medium term. It is true though (as some argue) that such skills can be bought on the world market, and/or sought from inter-governmental and non-governmental organizations and groups. And indeed, there are many such bodies jostling for such job offers/consultancies. By all accounts, this seems to be one of the fastest growing niches in the international market for business skills.

Recent press reports indicate there are, at least, three initiatives, which the authorities are undertaking to address this structural deficit. The first has been the provision of scholarships and training for Guyanese, mainly abroad, but also at home (University of Guyana). Second, there has been the announcement late last year of specialized training for the management and staff of the Guyana Revenue Authority (GRA). And finally, the authorities have established a specialized interministerial subcommittee, within the Ministry of Natural Resources, to address this specific area of concern.

The aim

Because the cost recovery provisions of Article 11 and Annex C of Guyana’s 2016 PSA are designed to allow Exxon and its partners (Agent) to recover costs, it purposely reflects the conviction of the Principal (State) of the necessity, to afford the Agent what is necessary in order to compensate for previous upfront expenditures on exploration and development; operations; as well as depreciation, depletion of the oil and gas finds, along with amortization (DD&A).

While such details are not of great concern to an informed citizenry, it is important to note that energy specialists insist the hierarchy under which these costs are recovered, could make a difference to the Contractor’s cash flow. This observation underscores the basic consideration, which drives Guyana’s cost recovery provisions. That is, the desire to permit Exxon and its partners to recoup their costs out of gross revenue/sales/output, with a ceiling of 75 per cent, while seeking simultaneously, to incentivize the Contractor to expand investment flows into the sector.

The debate

Judging from the public debate, so far, the most contentious public issue has been the level at which recovery cost is to be calculated and administered. This takes us directly to the topic of ring fencing costs in the Guyana 2016 PSA. This will be the first item addressed in next Sunday’s column. Not much will be discussed here in this week’s running commentary about the debate on Guyana’s 2016 PSA. Space would not permit. However, the topic that will be considered in next week’s column, ring fencing of cost recovery, symbolizes I believe, the simplifications and mis-specifications that have distorted much of the debate on Guyana’s 2016 PSA. This has occurred through the adverse selection of concepts that are intrinsically unknown, uncertain and multi-faceted.

What I would like, however, to emphasize for today’s column, is the continuing importance of my earlier observation concerning the uniqueness or stand-alone properties of each and every petroleum contract. Because of this uniqueness, evaluation of the performance of any given contract should be principally undertaken on data generated by the country whose contract is being examined. This would typically include information like: annual time series of Government Take; Contractor Take; Oil and Gas Output, Prices and Revenue (gross and net); GDP and its sectoral shares; Exports and Imports of oil and gas, and so on. These are not matters for speculation but instead rely on the concrete data available.