The crafty contract and Guyana’s implicit and explicit earnings
By now many Guyanese would have heard about the 14.25% effective royalty, which combines the 2% actual royalty enshrined in the contract, the 50-50% profit share and the 75% cost-recovery cap. According to Article 11 of the Petroleum Agreement between the Guyana government and ExxonMobil subsidiaries, the cap on cost recovery is monthly. This means that if monthly unit cost exceeds 75% of market value, the rest is carried forward to the next period.
However, the contract does not specify a cut-off year for recovering the pre-production costs such as exploration, development and pre-contract expenses. Is the cutoff year 2024, 2025 or 2026? These costs will be added to the operating costs once production starts to come up with an overall average or unit cost of production. Students of cost accounting and microeconomics would think of this as an average fixed and variable cost of production. Since the time when these pre-production costs are fully recouped will determine the 50-50% profit share for government, it is surprising the government did not seek clearer language in the contract.
The price of oil is determined on the spot market and it changes each day. However, costs are much less flexible. Labour, transportation and other input costs are set by contract. They are sticky, while price per barrel is flexible. Therefore, it is possible for market price to fall below the overall unit cost, making profit oil negative. Therefore, the 75% cap of cost supposedly preserves a minimum point for Guyana.
This is important because during the unspecified cost recovery period the minimum that Guyana can receive is supposedly 14.25% of the market price for oil. The IMF report for the Minister of Finance presented one scenario. They assumed a market price of US$100. This means that after accounting for 2% explicit royalty and the 75% cap on cost, the cost oil is US$73.50. If you work this out Guyana gets 14.25% of the US$100 per barrel. This includes the 12.25% implicit royalty plus 2% explicit royalty.
What happens if the price is now is US$50 per barrel and the cost recovery limit is binding or enforced? Taking into account the 2% royalty and the 75% of market price cost cap, cost oil now becomes US$36.75. Again after profit share, this leaves Guyana with 14.25% of the US$50 per barrel. If we keep doing this using the prescribed formula, Guyana is possibly guaranteed 14.25% throughout the production period.
I find it interesting that all the average cost estimates, including the US$20.8 per barrel which the IMF uses in its calculations, are way below the average market price of oil since 2005. This implies that profit oil is most likely to be positive and therefore Guyana is expected to earn an amount in excess of 14.25% even from 2020. In my previous column, I used the unit cost of US$35 per barrel. The unit cost is almost non-binding since 2005. I said almost since only on one occasion West Texas Intermediate oil price breached the US$35 per barrel. This occurred in February 2016 when the price fell to US$32.32.
The chart presented shows that Guyana’s percentage take in any month exceeds the minimum of 14.25% once the market price rises to US$48 per barrel, at which point the country earns 14.54% of the market price. At US$60 per barrel, the earning is 21.83% of market price and at US$70 per barrel the earning is 26%. If the price jumps to US$100 per barrel, Guyana would earn 33.5% of that price. At a price of US$110, the take will be 35.09%.
However, all these percentages have to be discounted by the monthly transport cost and marketing fees since Guyana is being paid in profit oil and not US$. The Guyana government will most likely ask ExxonMobil to purchase and market the oil. Therefore, subtract about two percentage points for transport and marketing fees from each number in the chart to get an approximation of the monthly take for Guyana over various price possibilities.
If the overall average cost including pre-production and operating costs is almost non-binding, why not clearly specify a number of periods for recouping the costs? Why leave the contract open? Since no time period is