EXXONMOBIL’S announcement that first oil will come earlier than expected has prompted increased focus on the long-term trajectory of Guyana’s oil production. This trajectory will be governed in part by the rate at which oil is developed and depleted in coming years.
This rate of depletion can be governed by a government’s “depletion policy,” which may consist of production controls or caps to manage the rate at which oil is taken from the ground. Guyana’s PSA gives the government the right to impose a national policy at any time to limit production rates down to the “minimum technically efficient rate.” That’s the lowest production rate at which the sophisticated machinery used for oil extraction can still operate efficiently.
While the PSA gives the government full right to establish and implement a depletion policy, it has not yet done so, and the question must be asked if it is even the right answer for Guyana.
Given that Guyana is only just about to enter the early production phase, it is not necessarily an immediate concern. Why would a government introduce a depletion policy? Generally, depletion policies are meant to address the fundamental fact that each barrel of oil extracted from the ground cannot be replaced. It is one way to preserve some of the production potential and therefore revenue for future generations.
However, Guyana has already taken steps to address this concern through the most common alternative, the creation of the Natural Resource Fund – our version of a Sovereign Wealth Fund. Funds such as the Natural Resource Fund can be a much more effective way to ensure that future benefit from today’s oil.
Depletion policies defer oil production and revenues into an unknown future to be realised – a future with the rapid growth of rival energy sources. Producing oil today and placing a large proportion of the revenues into a Natural Resource Fund is essentially choosing a way to earn interest for future generations. Such a policy is like putting money into a long-term savings bank account that begins earning low risk interest on large sums of money immediately.
The extraordinary pace of Guyana’s discoveries would make it very difficult to generate a specific depletion policy at this time, since the scope of reserves is a rapidly moving target. Guyana is also lucky enough that its reserves are so large that even if development and production proceeded as fast as possible, it would take decades to deplete just what’s been found so far.
Furthermore, advancements in production technologies are rapidly improving companies’ ability to extract oil and gas. Because projections about the proper rates of depletion are based on current technology, advancements often fundamentally alter the equation, allowing better, more efficient production.
The U.S. provides a good example of this phenomenon. From the late 1970s into the early 2000s, US oil reserves and oil production declined sharply from a high of 39 billion barrels to less than 20 billion by 2008. There was oil still in the ground trapped in shale formations and undiscovered fields, but low oil prices and a lack of technology meant that finding and extracting this oil wasn’t cost effective or feasible and so it wasn’t considered reserves.
But since the late 2000s, the technology of hydraulic fracturing has made this oil more easily obtainable and higher prices have incentivised more development. US oil reserves have jumped back up from below 20 billion barrels above the all time high of 39 billion.
Calculations for depletion policies generally have to assume that an amount of oil is static at the beginning and declines over time as more is extracted. But the kind of technological and price shifts that regularly rock the oil industry make that assumption tricky, especially in a country like Guyana when so much territory remains unexplored.
All of this means that Guyana will need to be thoughtful in considering whether a depletion policy is the right answer to generate value for the nation. An overly strict or inflexible policy might have far reaching implications for Guyana’s oil production and essentially clashes with the objectives of creating a well-endowed Natural Resource Fund that will grow the value of and carry the benefits of the oil for many generations to come.
With so much riding on the profits from that production — from social spending to new infrastructure and debt reduction — policies to restrict it should always be implemented carefully.