COST recovery is a straightforward concept, and it’s one that this column has touched on in the past. Given ongoing interest in the issue, we take a deeper dive this week.

Fundamentally, oil-and-gas exploration and production contracts usually allow companies to recoup their costs: the money they spent doing the exploration and development, after oil production begins.

Production Sharing Agreements (PSAs), like Guyana’s, normally include a cost-recovery mechanism to make up for the inherent risk of drilling in new areas, and government preferences to avoid that risk themselves. Companies use revenue from the initial oil production, called “cost-oil”, to recover their expenses and operational expenditures over the first few years of a project.

This process essentially recognises the fact that a government probably has not made any contribution of its own to the huge up-front investments required to tap an oil discovery. They avoid the up-front risk to billions of taxpayers’ dollars, by asking private companies to raise that financing and take on that risk themselves.

The company can recover these sole-risk expenses before the “profit-oil” is split between the government and the companies.

In most countries, companies are allowed to recover all of their costs. Though cost recovery is often confused with some sort of government payment or tax break, it’s important to note that funds for cost recovery come from the sale of oil, and not from government coffers.

Companies can only recover costs that are equal to the expenditures made to produce oil without any profit margin. It’s dollar for dollar spent. All of these expenditures are declared to the government regulator, and available for audit.

In Guyana’s case, oil companies are entitled to recover 75% of their recoverable costs in a given month, as per the 2016 deal. That last 25% ensures that, even in year one, the Guyana government will collect hundreds of millions in revenue, even before Exxon has recouped its expenses.

But what counts as a recoverable cost?
That’s a more complicated question, and the absence of a clear answer has led many in Guyana to question what will be recovered and what won’t, and even to question whether charitable donations, such as the ExxonMobil Foundation’s gift to Conservation International, could be recoverable.

The answer to the questions about the Exxon Foundation’s US$10M donation to Conservation International is a plain “no”; the contract covers only Esso Exploration and Production Guyana Limited (EEPGL), and the ExxonMobil Foundation is a separate non-profit organisation that is not legally connected to EEPGL, and thus has no legal standing under the production contract.

In terms of the broader question about which costs will be recoverable, Annex C of the 2016 Petroleum Agreement provides a thorough guide that specifies each type of recoverable expense, from training costs and salaries to transportation and equipment.
Recoverable costs include the major expenses that come with more than a decade of exploration and development; things such as drilling, geological and seismic studies, building warehouses, crewing ships, and operating rigs. Allowing companies to recover these costs without profit is standard in the oil industry, since it incentivises investment and development.

Overall, the provisions that determine recoverable costs in the 2016 contract are very similar to those in other contracts signed by countries such as Indonesia and Angola, and identical to the contracts that Guyana has signed with other oil companies to date.
Expenses that are defined specifically as not recoverable include: any marketing or transportation costs outside of Guyana; any costs for legal arbitration of contract disputes; any fines or penalties imposed by Guyana’s courts; and any costs incurred as a result of misconduct or negligence, as well as several other smaller categories.

The misconduct and negligence clauses should put the minds of many Guyanese at ease in case of an accident, since any fines from the Environmental Protection Agency would not be recoverable, and EEPGL would be obligated to pay in full.

It is important to remember that even with these cost-recovery provisions, Guyana will receive hundreds of millions of dollars in the initial years of oil production, and then one billion dollars or more per year after the costs are fully recovered.

When handled correctly under the framework of a clear and enforceable production-sharing agreement, cost recovery provisions such as this balance risk and reward: incentivising investment, while making sure the government gets its fair share.

Getting the balance right is key to Guyana’s energy future.