Eval­u­at­ing Open Oil’s Fi­nan­cial Modelling of Guyana’s 2016 PSA – 3

Stabroek News Sunday - - REGIONAL NEWS -

To­day’s col­umn ad­dresses Part 2 of the pro­posed three­part eval­u­a­tion of Open Oil’s fi­nan­cial modelling ex­er­cise of Guyana’s 2016 PSA. It presents a sum­mary of the main Find­ings of that ex­er­cise. I am con­scious that when do­ing so, this is a newspaper col­umn de­signed for gen­eral read­er­ship. This sug­gests that most read­ers would be dis­com­fited and/or in­tim­i­dated by pre­sen­ta­tions, which as­sume much beyond mid­dle level se­condary math­e­mat­ics or sta­tis­tics. This judge­ment, I be­lieve, is sup­ported by the head­line re­port­ing on this modelling ex­er­cise.

Per­haps the most im­por­tant find­ing of the fi­nan­cial modelling ex­er­cise is its es­ti­ma­tion of Gov­ern­ment take. This con­cept I have dis­cussed in sev­eral re­cent columns, and specif­i­cally in my col­umn of April 1, 2018. I had em­pha­sized in that col­umn, Gov­ern­ment take is a “fis­cal met­ric”, which is pri­mar­ily of con­cern to govern­ments. I had also posited that typ­i­cally, in­vestors fo­cus on mea­sures of project prof­itabil­ity and per­for­mance such as the in­ter­nal rate of re­turn (IRR), net present value (NPV) and the prof­itabil­ity ra­tio (PR). I had also sought to dis­tin­guish between Gov­ern­ment take and other im­proved mea­sures, such as the Ef­fec­tive Royalty Rate (ERR) in the April 1, 2018 col­umn.

The fi­nan­cial modelling ex­er­cise has in­di­cated that Gov­ern­ment would re­ceive US$7.79 bil­lion over the life of the Liza I Stabroek field project. This take is equal to 52 per­cent of the pos­i­tive cash flows of the project, at to­day’s prices. To re­call, based on my for­mu­la­tion in the April 1, 2018 col­umn, Con­trac­tor take (that is Exxon and part­ners) is equal to 1 – Gov­ern­ment take. In this case it is 1 – 0.52 = 0.48 or 48 per­cent. For this for­mu­la­tion, Gov­ern­ment take was de­fined stan­dardly (Tordo 2007, World Bank Work­ing Paper, 123). There it is given as “the per­cent­age of the pe­tro­leum pre-tax project’s net cash flow ad­justed to take into ac­count any form of Gov­ern­ment par­tic­i­pa­tion” (see Sun­day Stabroek, April 1, 2018). In Guyana, there is no Gov­ern­ment par­tic­i­pa­tion in pro­duc­tion and dis­tri­bu­tion.

The fi­nan­cial modelling ex­er­cise goes on to re­port: “Un­der any re­al­is­tic sce­nario rev­enues from Stabroek will trans­form the Guyanan (sic) econ­omy and pub­lic fi­nances. Size­able rev­enue will hit gov­ern­ment ac­counts within two or three years of pro­duc­tion start­ing in 2020”. In­deed, by 2025 these rev­enues could ex­ceed this year’s bud­get of G$267 bil­lion. That is rise to more than US$1.2 bil­lion.

Re­lated to this first find­ing is the sec­ond. That is, the main fis­cal mech­a­nisms (royalty and profit oil) are not pro­gres­sive fis­cal in­stru­ments. In­deed, they have been de­scribed as: “rel­a­tively flat”. This flat­ness, in turn makes for a third find­ing, which is such taxes are in­ca­pable of ad­e­quately cap­tur­ing su­per­nor­mal prof­its or sig­nif­i­cant eco­nomic rent ac­cru­ing to the Con­trac­tor (Exxon and part­ners). This would be to the dis­ad­van­tage of the Owner of the pe­tro­leum re­sources (Gov­ern­ment of Guyana).

These three find­ings are de­rived from the “base case project” that is mod­elled. To re­mind read­ers that project is the Liza I, Stabroek field of 450 mil­lion bar­rels size, pro­duc­ing 100,000 bar­rels a day at a US$55 con­stant price per bar­rel over the project life. And, for this base case, the Con­trac­tor (Exxon and part­ners) is es­ti­mated to earn an IRR of between 15 and 25 per­cent. This IRR is needed to en­sure, on the one hand that in­creased in­vest­ments con­tinue to flow into the sec­tor, and, on the other, un­taxed su­per­nor­mal prof­its are not flow­ing to the Con­trac­tor.

Model Vari­a­tions

It is a prac­tice of eco­nomic mod­el­ers to change cer­tain vari­ables in their mod­els, in or­der to ob­serve the im­pact of these changes on the Find­ings. Some­times this is con­ducted as a purely es­o­teric ex­er­cise to high­light unique out­comes. I do not want to con­fuse read­ers at this stage but the modelling ex­er­cise has changed some vari­ables in or­der to ob­serve their im­pact on out­comes. I be­lieve that two of the changed vari­ables are of use­ful­ness to lay read­ers. One re­lates to vari­a­tions in the size of the “base case” oil field. And, the other, is the as­sumed con­stant price for Guyana crude oil sales.

Vari­a­tion 1 The model as­serts that: if the price of oil per bar­rel is set at US$80 (and not US$55) and the size of the field is in­creased from 450 mil­lion to 750 mil­lion, rev­enues flow­ing to the State would rise to US$24.76 bil­lion and Gov­ern­ment take could be re­duced from 52 to 51 per­cent.

Vari­a­tion 2 Fur­ther, at US$65 per bar­rel, which was the price rul­ing at the time of the ex­er­cise (mid-March) and a field size of 450 mil­lion bar­rels, Exxon’s IRR is 19.6 per­cent af­ter tax. At a field size of 1 bil­lion bar­rels, Exxon’s IRR rises rapidly to 39.7 per­cent.

Vari­a­tion 3 Also, at the base case field size of 450 mil­lion bar­rels, Exxon and part­ners reach “max­i­mum IRR” at a price of US$75 per bar­rel.

Vari­a­tion 4 Fi­nally, if the field size rises from 450 mil­lion bar­rels to 750 mil­lion bar­rels, the “max­i­mum IRR” is reached at US$50 per bar­rel!

Liza I and Com­para­tors

As in­di­cated last week, the fi­nan­cial mod­el­ing ex­er­cise was con­ducted with the aim of draw­ing com­par­isons to other sim­i­lar types of pe­tro­leum fields. The Re­port on the modelling ex­er­cise claims: “The anal­y­sis shows that Guyana’s share of prof­its is low, not only com­pared to ma­jor pro­duc­ers but also to terms agreed in other fron­tier prov­inces at a time when they were early stage pro­duc­ers”. The data that I had cited in my col­umn of April 28, 2018 re­vealed that av­er­age Gov­ern­ment take for a group of 19 coun­tries over the pe­riod 2009 - 2014 had var­ied from a low of 23 per­cent (Poland) to a high of 88 per­cent (Al­ge­ria).

I’ll take up this point in the Part 3 cri­tique of Open Oil’s eval­u­a­tion. Ta­ble 1 shows the data for the com­pa­ra­ble projects, which the fi­nan­cial modelling ex­er­cise iden­ti­fied (as re­vealed in last week’s col­umn).

Con­clu­sion

Next week I shall re­spond to those al­leged in­ac­cu­ra­cies which Open Oil iden­ti­fied, and then com­mence my as­sess­ment of the modelling ex­er­cise.

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