GUYANA is set to be one of Latin America’s largest oil producers in the next decade, surpassing the production levels of regional energy giants like Venezuela. According to a recent Wood Mackenzie report, Guyana could one day be just the eleventh oil producing country in the world to surpass the one million barrels of oil production per day mark, with an estimated production capacity of up to 1.4 million barrels of oil per day.

But since oil development is still in the very early stages, it’s especially important now to understand how the revenues from that production are divided between recovery of past costs and profits. Under the terms of the Production Sharing Agreement (PSA), the three Stabroek Block co-venturers bear the cost and risk for investments, and there is a formula for sharing the revenues that are generated later on. Right now, 75 per cent of revenues from the oil being produced is used to recover the costs of exploration, drilling, development and production, all paid for by the Stabroek Block co-venturers.

The remaining 25 per cent of revenues are split evenly between the Government of Guyana and the Stabroek Block co-venturers. Once the costs of development are paid off, the share of profits versus costs will increase dramatically. New costs will be added to the Stabroek Block “cost bank” as new projects are approved and construction begins, but those projects will also “grow the pie” of revenue over the next decade, meaning that even 25 per cent of revenues will be a growing amount.

The combined effect of reducing costs to be recovered and growing total revenues is why the government is expected to generate billions of dollars in revenues annually within the next decade.

Production sharing contracts like Guyana’s allow governments to transfer 100 per cent of the exploration and development cost and risks—including billions of dollars in upfront costs—to private companies. If oil is not found, the exploration risk is entirely on the companies and with no production, there is no opportunity for cost recovery. But if oil is discovered, investors can retrieve the money spent during exploration and discovery through the sometimes misunderstood process of cost recovery.

Guyana’s PSA with the Stabroek Block co-venturers works similarly to contracts that are commonly utilised around the world to reduce risk, attract investment and align the long-term interests of governments and oil companies. Operators can use revenues from up to 75 per cent of oil production to recover eligible costs, after the 2 per cent royalty is paid to the government. The remaining production revenues are split equally, 50 per cent each to the operator and partners and the government. These revenues, along with royalties, are what the government has been saving in its Natural Resource Fund, which currently holds more than US$267 million that can be used for infrastructural development and social programme funding.

The costs of development cover a wide spectrum, but companies would have little incentive to invest huge sums of money if they were not eligible for recovery after production. Costs include billions of US dollars spent on exploration drilling, development wells, sophisticated subsea equipment and construction of the floating production storage and offloading (FPSO) vessel. Employee salaries and normal maintenance costs are also eligible for cost recovery and subject to audits. The Stabroek Block operator, ExxonMobil Guyana, has confirmed that other items, such as repairs to the Liza Destiny’s flash gas compressor or charitable contributions like the $20 billion GYD Greater Guyana Initiative are not eligible or won’t be claimed for recovery.

Another example of how this process will work is gas to power. ExxonMobil Guyana has said that the Stabroek Block co-venturers will construct the pipeline that will carry gas to an onshore gas treatment facility and subsequently, to a power plant. The cost of this pipeline, gas processing plant and other required civil works —around US$900 million—will also be recovered using oil and gas revenues. Without this arrangement, Guyana would have to borrow this money on international markets and likely pay a high interest rate. With cost recovery, however, Guyana can repay costs through oil revenues over time, interest-free. Thus, the economy will benefit from cheaper and more reliable electricity without taking on external debts for the pipeline.

A nuanced understanding of recoverable costs is also critical when thinking about issues like local content. Understandably, there is widespread enthusiasm for policies that would put Guyanese companies at the forefront of development. But it’s important to carefully balance potential costs with the benefits of growing local industry and individual companies.

Higher project costs increase the amount that will be recovered, reducing the overall profits that Guyana will share with the Stabroek Block co-venturers. This is why the government and ExxonMobil Guyana have a shared incentive to reduce costs.

Understanding cost recovery is critical to the country’s future. Even if the oil companies offshore Guyana bear the initial risk for exploration and production, growing profits by managing the cost of projects and growing total revenues over time are the key to funding the country’s development goals.