What is cost recovery?

WITH this column, we try to make the global oil and energy industry more easily understandable.

So, with that in mind, imagine you open a restaurant. You build it on land owned by a friend, so you agree to give that friend half of the profits you make.
You’re lucky you’ve found a good spot and customers come; you are making cash. But before you take home profits, you must pay back the money you spent to build the restaurant and buy ovens, refrigerators, plates and glasses.

You’re already paying employees and buying food, so even though you’re generating cash, this money isn’t yet “profit”, because you haven’t made as much money as you put into it.
This is the concept of cost recovery. Before you take home cash for yourself and your partners as profits, you need to make back what you spent. Until you’ve made back those costs, every dollar you take in is just revenue, not profit.
In this scenario, you are ExxonMobil; your friend is Guyana.

ExxonMobil spent around US$460M searching for oil off the coast for 16 years before they found anything.
According to figures provided to the government by ExxonMobil subsidiary, Esso Exploration and Production Guyana Limited, US$230M was spent to drill the Liza Phase One well, which included follow-on wells and the costs of mobilising the drilling rig, helicopters, and supply vessels.

Such costs are relatively standard for drilling initial, or “pioneer”, wells in deep- water areas.
Offshore drilling in deep water like Guyana’s is the most expensive type of fossil fuel exploration; nearby countries, like Brazil, see costs of US$200-300M to drill comparable wells in new offshore territories.

During the exploration period, ExxonMobil also spent approximately $140M for comprehensive seismic surveys conducted over 20,000km of ocean floor. This was the largest single seismic campaign ever conducted by ExxonMobil, and the information generated allowed ExxonMobil to determine where drilling should occur. In addition, ExxonMobil spent $65M to pay geologists, geo-scientists and engineers to identify promising oil formations and to design the wells.

They spent a further $25M on overhead costs like block rental fees and training programmes. All of these costs were split by ExxonMobil’s two partners in the Stabroek field: Hess and CNOOC.
In the contract Guyana signed with ExxonMobil, which is the standard contract it signs with all oil companies, the terms are plain: If no oil was found, then the costs of exploration would have fallen to the companies alone, and they would have gone home empty handed and a few hundred million dollars poorer.

But since they found oil, they can now “recover” those costs. This cost recovery is not paid by the Government of Guyana, and it’s not tax avoidance. It just means that the companies that risked their money to explore for oil get to make the money they already spent before they start giving the government most of the oil revenues.
However, by the terms of the contract, those costs can’t be recovered all at once.

The contract stipulates that cost recovery can never take up more than 75 per cent of total revenues. That means that even in the first few years of production, ExxonMobil will still pay the government around US$300M annually.
By 2025, when those original costs have been mostly recovered, government revenues will increase to more than US$1B each year, since most of each barrel will be pure profit split between the government and ExxonMobil.

Ultimately, according to Norwegian firm Rystad Energy, Guyana will receive about 60 per cent of all profits from oil production.
This contract with ExxonMobil ensured that the Government of Guyana risked nothing on exploration. As failed drilling efforts in the Falkland Islands and Cuba have shown, exploration is uncertain, and there is a real chance of spending hundreds of millions of dollars and finding little or nothing.

Putting that risk on private companies, like ExxonMobil, is regarded by the IMF and others as the best solution. The chance of cost recovery in the event of success ensures that private companies will be willing to take on the risk themselves.
In turn, the government doesn’t need to gamble public funds for expensive and potentially unsuccessful exploration.