MORE than two years into oil production, misunderstandings and rumors continue to circulate around Guyana’s Stabroek Block Production Sharing Agreement (PSA).
One prominent opponent of global oil development, Tom Sanzillo, recently claimed that Guyana will have a “hidden liability” of more than G$6.27 trillion owed to oil companies, a claim that Vice President Bharrat Jagdeo and others quickly dismissed as nonsense.
This recurring discussion of Guyana’s oil contracts continues despite these claims consistently being disproven. Cost recovery is a standard fact of oil and gas contracts and a common feature of business deals around the world. Despite claims that Guyanese will “owe” as much as US$9 million per person, debt and cost recovery are entirely different elements of finance. However, conflating them is a tactic sometimes used by international anti-oil activists to scare developing countries.
There is a stark difference between debt and cost recovery; cost recovery is a mechanism in which a stakeholder of an oil and gas project can recover most of its capital and operating costs out of a specified percentage of production.
Therefore, the oil and gas companies have the ability to recoup some of the costs of their investments once the revenues start rolling in.
To put it in simple terms, say two partners agree to open a bakery. One agrees to put up all the money to get the business started, buying ovens and ingredients, paying bakers etc. In business terms, profits equal revenues minus costs. So, when the business starts bringing in revenues, the partner that put up the investment needs to make back their costs.
Vice President Jagdeo recently called out activists for misrepresenting this situation, saying that activists “claim all these debts have to be repaid before we get any payment and that is not true.”
According to international analysts, the contract Guyana has is quite average when compared to similar contracts of other new producing countries. Under the terms of the PSA, Guyana is entitled to a 2 per cent pre-cost royalty, 50 per cent of all profits, and a cost recovery ceiling of 75 per cent, which is normal when compared to frontier countries.
The average government take will generally be around 60 per cent of profits or 14.5 per cent of overall revenues, when both the pre-cost royalty and the post-cost profit-sharing are accounted for.
Part of the reason for this type of contract is that Guyana isn’t taking on any financial risk in a very high-risk industry. If oil companies had not found oil, they would have walked away empty handed despite billions of U.S. dollars in investment. Guyana has not had to put up any taxpayer money in exchange for half of all profits. That is a crucial aspect of the contract, considering that oil and gas development is extremely expensive, particularly up front.
Companies invested roughly US$9 billion to develop the Payara project alone and that is just one of at least 5 planned projects.
If Guyana had paid for the initial costs of the exploration and development, that would have required actual debt at an astronomical level—roughly 200 per cent of pre-oil gross domestic product.
That huge up-front investment is crucial to getting projects off the ground. Oil and gas have high up-front costs, but low production costs. So, while the cost to explore and develop reserves is usually high, once the costs are recovered it is a fairly minimal expense to operate these projects because the infrastructure has already been established.
That is why most contracts, including Guyana’s, have a clause that only allows a certain percentage of costs to be recovered each year. That makes sure there are profits flowing to the government from day one, contrary to activist claims.
A recent study by Rystad Energy outlined that Guyana’s oil production could reach 1.2 million barrels per day by the end of the decade, which translates to US$30 billion in annual oil revenues within ten years.
The government already expects to take in roughly US$1B this year, from just two projects operating so far. That kind of wealth makes it critically important that accurate information and relevant context is available when looking at the agreement that has facilitated all this growth.