Eval­u­at­ing Open Oil’s Fi­nan­cial Model­ing of Guyana’s 2016 PSA – 5

Stabroek News Sunday - - REGIONAL NEWS -

In­tro­duc­tion To­day’s col­umn starts with a wrap-up of my re­sponse to the let­ter sent to Stabroek News by the au­thor of Open Oil’s fi­nan­cial model­ing ex­er­cise of Guyana’s 2016 PSA. Af­ter that, it com­mences to cri­tique that ex­er­cise. For the wrap-up, I of­fer two brief com­ments for read­ers’ ben­e­fit.

First, Open Oil’s Draft Re­port and Fi­nan­cial State­ments, 2015 states: “OpenOil is a limited com­pany in­cor­po­rated in Ger­many dur­ing Oc­to­ber 2011. It was founded as a so­cial en­ter­prise (my em­pha­sis) and un­der its ar­ti­cles of in­cor­po­ra­tion it is li­censed to en­gage in con­sul­tancy to im­prove gov­er­nance of the en­ergy sec­tor”. Ini­tially, I had sought to by-pass this de­scrip­tion, as I felt at the time of writ­ing, it could be con­fus­ing for the gen­eral read­er­ship of this col­umn.

Now, hav­ing re­flected on it, I am com­pelled to in­form read­ers that the In­ter­na­tional Com­par­a­tive So­cial En­ter­prise Mod­els (ICSEM) project, 2015 notes: “the term so­cial en­ter­prise ap­peared in Ger­many for the first time in the 1990s in the con­text of transna­tional re­search projects ini­ti­ated with the help of the Euro­pean Com­mis­sion … but only a small group of re­searchers par­tic­i­pated.” Fur­ther­more, “the terms so­cial econ­omy and so­cial en­ter­prise are not legally de­fined nor un­der­stood in de­tail in Ger­many to­day”. (Source: So­cial En­ter­prise in Ger­many: Un­der­stand­ing Con­cepts and Con­text, Work­ing Pa­per No.14, 2015). Read­ers can see why, in the in­ter­est of space, I sought to avoid en­gag­ing Open Oil’s for­mal so­cio-le­gal struc­ture.

Sec­ond, Open Oil en­joys col­lab­o­ra­tive re­la­tion­ships with two well known foun­da­tions that were es­tab­lished in the early 2000s. One is the Shut­tle­worth Foun­da­tion, of South Africa, es­tab­lished in 2001. That Foun­da­tion re­tains a 15 per­cent op­tion in the eq­uity of Open Oil. The Foun­da­tion de­scribes it­self as “a small in­vestor that pro­vides fund­ing to dy­namic lead­ers who are at the fore­front of so­cial change. We look for so­cial in­no­va­tors who are help­ing to change the world for the bet­ter and could ben­e­fit from a so­cial in­vest­ment model with a dif­fer­ence”.

The other is the Omid­yar Net­work. This is a “phil­an­thropic in­vest­ment firm com­posed of a foun­da­tion and an im­pact in­vest­ment firm”, es­tab­lished in 2004. It is “founded on the fun­da­men­tal be­lief that ev­ery per­son has the power to make a dif­fer­ence”.

Such associations sug­gest Open Oil is well po­si­tioned to de­rive sig­nif­i­cant val­ueadded from as­sess­ments, eval­u­a­tions, and cri­tiques of its ac­tiv­i­ties. In the next Sec­tion, I start my cri­tique of its fi­nan­cial model­ing of Guyana’s 2016 PSA.

Cri­tiques While the sev­eral cri­tiques to fol­low are given ran­domly, the first of th­ese is, in many ways, the most im­por­tant. The rea­son for this be­ing its fo­cus on both the log­i­cal weak­nesses in­her­ent to all fi­nan­cial/eco­nomic model­ing as well as those mod­el­ers who fail to de­clare up­front ap­pro­pri­ate cau­tions, when pub­li­ciz­ing their re­sults, par­tic­u­larly to non-mod­ellers/non-spe­cial­ists. Fi­nan­cial mod­els need to cap­ture the essence of the re­al­ity that is mod­eled. Given the vast­ness of de­tail re­quired for model­ing of petroleum projects plus their in­her­ent un­cer­tain­ties, this re­quires cau­tion­ing read­ers about the pre­dic­tive re­li­a­bil­ity, which should be at­tached to re­sults.

To see how im­por­tant this cau­tion is, read­ers should re­call my ear­lier pre­sen­ta­tion on the World Petroleum Coun­cil’s de­scrip­tion of petroleum projects. Sim­ply put, a petroleum project links petroleum finds/ac­cu­mu­la­tions to de­ci­sions and bud­get al­lo­ca­tions for the de­vel­op­ment of oil fields (of a wide va­ri­ety of types). Th­ese fields rep­re­sent spe­cific ma­tu­rity lev­els, in or­der to ar­rive at de­ci­sions as to whether to pro­ceed or not with spend­ing re­sources bring­ing the project to com­mer­cial pro­duc­tion. A project can be an in­di­vid­ual field or reser­voir, (like Liza 1 in the Stabroek block), an “in­cre­men­tal de­vel­op­ment” of a field, or the “in­te­grated de­vel­op­ment” of a group of sev­eral fields/reser­voirs that are held un­der com­mon own­er­ship.

As is widely rec­og­nized how­ever, “petroleum com­pa­nies gen­er­ally make the de­ci­sion for a cer­tain petroleum project on the base of eco­nomic mod­els” (K. Shere­ith, Doc­toral The­sis, Ber­lin, 2016). This the­sis ref­er­ences the three broad ap­proaches such mod­els use for risk as­sess­ment and the iden­ti­fi­ca­tion of prob­lems that could emerge dur­ing a project’s life so as to sup­port its ef­fi­cient ex­e­cu­tion/com­ple­tion.

That the­sis has eval­u­ated the Eco Petro _ Model, as a de­ter­min­is­tic model petroleum com­pa­nies use to eval­u­ate projects. The the­sis fo­cuses on two case stud­ies: the use of the Eco Petro _ Oil “model in an OPEC coun­try op­er­at­ing with a pro­duc­tion shar­ing con­tract” and a non-OPEC coun­try uti­liz­ing the “con­ces­sion­ary sys­tem”. Like the FAST Open Oil fi­nan­cial model eval­u­a­tion of Guyana’s 2016 PSA, it had to con­front the cen­tral prob­lems of all petroleum model­ing. Th­ese prob­lems are widely rec­og­nized as orig­i­nat­ing in the recog­ni­tion that “the eco­nomic struc­ture of the petroleum in­dus­try dif­fers strongly from other in­dus­tries”.

Those spe­cial fea­tures have been dis­cussed on sev­eral oc­ca­sions be­fore, and are sum­ma­rized in Sched­ule 1 be­low. The Sched­ule re­veals the in­dus­try faces enor­mous risks and re­lated un­cer­tain­ties. Th­ese are found in ev­ery di­men­sion of its op­er­a­tions: rang­ing from ge­o­log­i­cal and en­vi­ron­men­tal, through eco­nomic/fi­nan­cial (prices, cash flow, cap­i­tal in­ten­sity and so on) along with so­cio/po­lit­i­cal (geo-strate­gic, gov­er­nance/cor­rup­tion) over a long-term hori­zon. In­deed, most projects last over sev­eral decades. And, in the case of Open Oil’s fi­nan­cial model­ing ex­er­cise, Liza 1, in the Stabroek block, lasts for over four decades, 1999 to 2040.

From all that has been said so far on this cri­tique, two points are clear. First, op­er­a­tionally, most petroleum com­pa­nies are re­puted to “make the de­ci­sion to in­vest in a cer­tain petroleum project based on eco­nomics mod­els”. Th­ese are typ­i­cally con­structed as spread­sheets, which are “pre­pared by in­ter­nal econ­o­mists in the com­pany or by con­sul­tants based on the data pro­vided by their en­gi­neers, ge­ol­o­gists, and so on.” (Shere­ith, 2016)

Sec­ond, in­vest­ment de­ci­sion-mak­ing for petroleum projects is very com­plex, mainly due to the fea­tures noted in the Sched­ule. Eco­nomic/fi­nan­cial mod­el­ling aids in de­ci­sion-mak­ing. How­ever, by their very con­struc­tion, mod­els have lim­i­ta­tions. And, this there­fore, must al­ways be openly ad­mit­ted, by those rec­om­mend­ing their use. Next week I con­tinue this cri­tique.

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