Eval­u­at­ing Open Oil’s Fi­nan­cial Model­ing of Guyana’s 2016 PSA – 7

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To­day’s col­umn con­tin­ues with my cri­tiques of Open Oil’s fi­nan­cial model­ing of Guyana’s 2016 Pro­duc­tion Shar­ing Agree­ment, PSA. To sum up the dis­cus­sion at this stage, the first cri­tique un­der dis­cus­sion urges that a ba­sic obli­ga­tion of fi­nan­cial model­ing stud­ies is to am­plify their re­port­ing on the lim­ited pre­dic­tive power of such model­ing sim­u­la­tions and their re­sults. I do not want to in­volve non-mod­el­ers and/or my more gen­eral read­er­ship into the es­o­teric realms of fi­nan­cial model­ing. The fact is how­ever that the model used in the Open Oil ex­er­cise is one based on spread­sheet model­ing, utiliz­ing Mi­crosoft Ex­cel.

This ap­proach has en­coun­tered widely rec­og­nized prob­lems among an­a­lysts. This cir­cum­stance in­di­cates it­self in the ti­tle of Fairhirst’s (2009) study: “Six rea­sons your spread­sheet is NOT a fi­nan­cial model”. Such crit­i­cisms point out the “un­re­al­is­tic im­plicit as­sump­tions and in­ter­nal in­con­sis­ten­cies” of sev­eral spread­sheet based mod­els. Such ob­ser­va­tions also sup­port the view ex­pressed in my pre­vi­ous col­umn that, all too of­ten, mod­el­ers fail to state ex­plic­itly the full as­sump­tions and lim­i­ta­tions of the data, which they are in­putting into their mod­els.

De­spite such ob­ser­va­tions though, I firmly be­lieve that “hon­est model­ing” adds much to the de­bates on the role of petroleum, and per­haps more broadly - the ex­trac­tive sec­tor, in Guyana-type economies. It cer­tainly, how­ever, does not close the de­bate or in­deed yield fi­nal­ity and set­tle­ment of dis­putes on the role of the petroleum sec­tor in de­vel­op­ment. ac­knowl­edged. I shall il­lus­trate this ob­ser­va­tion, with two ex­am­ples, one ex­oge­nous and the other en­doge­nous to the model.

Close ob­servers of Guyana’s cur­rent sit­u­a­tion and re­cent po­lit­i­cal econ­omy would con­cede, I be­lieve, Venezuela’s geo-strate­gic bor­der threat con­sti­tutes, by any mea­sure, the great­est ex­is­ten­tial­ist threat to its com­ing time of oil and gas pro­duc­tion and ex­port. As such, that threat drives the dy­nam­ics of Owner (Gov­ern­ment of Guyana) and Con­trac­tor (Exxon and par­ties) ne­go­ti­ated re­la­tions go­ing for­ward. In­deed, the Gov­ern­ment of Guyana has ad­mit­ted to this cir­cum­stance. Na­tional se­cu­rity con­sid­er­a­tions have guided Guyana’s choice of the Con­trac­tor and its re­lent­less de­ter­mi­na­tion to sweeten the pot in or­der to en­sure this group con­tin­ues to lead the de­vel­op­ment of its petroleum sec­tor.

On the en­doge­nous side, the model does not ad­dress the con­sid­er­a­tion that both the Owner and Con­trac­tor will be “learn­ing by do­ing”. That is, as the project ad­vances, the Owner (Gov­ern­ment) will be “learn­ing” the busi­ness of “do­ing” (op­er­at­ing) un­der the PSA. This will im­prove Gov­ern­ment’s ca­pac­ity to mon­i­tor costs, im­prove tax col­lec­tion, and in­cen­tivize new in­vest­ments, whether in the form of local con­text, com­ple­men­tary link­ages, scale ef­fects, or skills en­hance­ment.

“Learn­ing by do­ing” is not only likely to lead to pos­i­tive out­comes for the sec­tor. Based on the his­tor­i­cal record of petroleum sec­tors in poor coun­tries, much of this “learn­ing” will be lo­cated in the prac­tice of cor­rup­tion and de­cep­tion! Con­trac­tors will grow in their ex­pe­ri­ences of deal­ing with reg­u­la­tors. His­tor­i­cally, all too of­ten a fer­tile en­vi­ron­ment for cor­rupt prac­tices has flour­ished to the dis­ad­van­tage of both part­ners to the contract. One re­cent pos­i­tive oc­cur­rence has oc­curred in Guyana to con­front these chal­lenges. That is, the Gov­ern­ment has in­di­cated it will es­tab­lish a na­tional oil com­pany (NOC), which could have a sig­nif­i­cant im­pact on the dy­nam­ics of its PSA.

All the is­sues raised in this and pre­vi­ous col­umns about Open Oil’s fi­nan­cial model­ing are in­te­gral to Guyana’s de­vel­op­ment, based on its re­cent petroleum dis­cov­er­ies. It is dif­fi­cult there­fore, to en­vis­age a use­ful model of this sec­tor that does not ex­plic­itly in­cor­po­rate these el­e­men­tal fac­tors.

The above dis­cus­sion is symp­to­matic of the model’s weak treat­ment of risk and un­cer­tainty. Al­though ad­dressed in the model, par­tic­u­larly in terms of mar­ket price and field size, their treat­ment re­mains too lim­ited. In ear­lier col­umns of this se­ries, I have of­ten re­peated that, the petroleum in­dus­try dis­tin­guishes it­self from other busi­nesses by the level of risks it car­ries. This fea­ture must there­fore af­fect model­ing of the in­dus­try.

To re­cap these risks are quite wide rang­ing. They in­clude ge­o­log­i­cal, geostrate­gic, po­lit­i­cal (ex­pec­ta­tions) tech­ni­cal and tech­no­log­i­cal (highly lo­ca­tion de­pen­dent, for ex­am­ples, in Guyana “deep off­shore”); eco­nomic/fi­nan­cial (prices, cost, rev­enue flows, sup­ply and de­mand) fis­cal rev­enue pat­terns, high cap­i­tal-in­ten­sity, phys­i­cal prop­er­ties of the, oil “find”, as well as en­vi­ron­men­tal. Read­ers should note this list­ing in­cludes all of A. Beat­tie’s “5 big­gest risks faced by oil and gas com­pa­nies”, 2018.

My third cri­tique re­lates to the dis­tinc­tion, which is cen­tral to project model­ing. That is, stud­ies are ei­ther pro­jec­tion-based (“be­fore the event, prospec­tive-based”). These take place be­fore the project is com­pleted and its ef­fects felt. This type of study is termed ex ante. It sim­u­lates the pro­jected be­hav­iour of the project through time. Stud­ies are also ex post. These take place as eval­u­a­tions of the project or im­pact as­sess­ments. The truth is how­ever, that such ex­er­cises con­ducted on a va­ri­ety of projects, which I have come across sup­port the con­clu­sion: “Most ex ante mod­els had a ten­dency to over­es­ti­mate the ben­e­fits and un­der­es­ti­mate the costs”. This has there­fore, led to the view that ex ante stud­ies have “weak cred­i­bil­ity” and the ad­vice is “Pol­icy mak­ers should thus treat [their] re­sults with … ap­pro­pri­ate skep­ti­cism”.

While I agree with this and sup­port cau­tion, ex post stud­ies also face se­vere lim­i­ta­tions. The most striking of these, is the po­si­tion where (due to pri­vacy and con­fi­den­tial­ity con­sid­er­a­tion) ac­cess to the req­ui­site sta­tis­tics and in­for­ma­tion are not forth­com­ing.

Next week I shall round off my eval­u­a­tion of Open Oil’s model­ing of Guyana’s 2016 PSA. This task has taken much longer than I had orig­i­nally in­tended. I shall in con­clu­sion there­fore fo­cus on three top­ics, namely 1) the in­for­ma­tion gaps iden­ti­fied by the Au­thor in model prepa­ra­tion 2) the “treat­ment” of Gov­ern­ment take, given my ear­lier dis­cus­sion of this topic, and 3) na­tional ver­sus project-based fi­nan­cial/eco­nomic model­ing in Guyanatype economies.

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