Crude oil production: royalty rates, profit-sharing, and accounting arrangements (Part I)

In our article of 15 May 2017, we referred to the announcement by ExxonMobil of “a world-class resource discovery of 1 billion oil-equivalent barrels” in Guyana’s waters. We noted that, while this is good news, there was no publicly available information as to the extent of oil revenues that will accrue to Guyana. The Government has since reported that it succeeded in negotiating a higher royalty rate from 1% to 2% on gross earnings. This is in addition to 50% of profits from the sale of all petroleum products by the oil company.

According to the Minister of Natural Resources, 75% of the revenue earned by ExxonMobil will be used to recover its investment, estimated at US$5 billion by the year 2020 when production is set to begin. The remaining 25% will be split equally, presumably after taking into account the cost of production, administrative, marketing and other related operational costs. In other words, Guyana will receive 12.5% of the net profit.

As can be noted, royalty rates vary from country to country and within countries, depending on several factors. However, it is not clear how many of these countries also benefit from profit-sharing arrangements, though reference was to Bolivia, Indonesia, Malaysia and countries in the Middle East and Central Asia.

In a profit-sharing arrangement, the oil company uses the revenue derived from production to recover its capital and operational expenditure. This is known as “cost oil”. The remainder, known as “profit oil” is split between the government and the company. To the extent that countries have this dual arrangement in place (i.e. royalty plus profit-sharing), it stands to reason that royalty rates will be lower than those that receive royalties only. The situation is further complicated by the level and other forms of taxation that countries impose on companies involved in crude oil extraction.