WITH more than two years of oil production under its belt, Guyana is well poised to continue to reap the benefits of steady and sustained investment in the sector. There are still, however, misconceptions around the terms of the Stabroek Block Production Sharing Agreement (PSA). The contract terms, especially those dealing with profit share, royalties, and cost recovery are often misunderstood or even misrepresented to advance the narrative that Guyana is getting a bad deal.

In seeking to develop resources, countries must strike the right balance between ensuring maximum return and incentivising development. Contracts that are too heavily weighted to the resource owner could delay investments, or drive investors away entirely. That ultimately means development does not take place and a “better deal” remains purely hypothetical. Getting that balance right requires fine tuning the fiscal and non-fiscal factors that go into a contract.

One way countries incentivise investment is through “cost recovery” provisions. Owing to the terms of the Stabroek Block Petroleum Agreement, Guyana took on no financial risk to develop its oil and gas. Instead, the Stabroek Block co-venturers invested money to explore the block with the requirement to share all profits with Guyana after recovering that money, or “costs.” If no commercially viable oil was discovered and no production took place, then the co-venturers would simply lose all that money. To date, this is the case for other blocks in Guyana though future production is still possible in some cases.

Under the terms of the PSA, Guyana is entitled to two per cent of all pre-cost revenues as a royalty and 50 per cent of all profits. There is a ceiling on how much revenues could go toward cost recovery. That ceiling, which is 75 per cent, is why Guyana has earned more than US$1 billion even though there are still costs to recover. While there are still costs to recover, the average government take will generally be around 52 per cent of profits or 14.5 per cent of overall revenues. Once all or most of the costs are recovered, Guyana’s share of the revenues will increase from 14.5 per cent toward 52 per cent as almost all the revenues will be profits except for operating costs.

Contract structures could be very different around the world. Most deals are either “profit-and-royalty” deals like Guyana’s or “tax-and-royalty” deals like those used by the US and UK. Deals that have high royalties and where companies pay income taxes as part of deals do not normally split profits, while countries that tax operations heavily normally receive lower royalties and no share of profits. Both types normally include cost recovery, which is a standard factor of oil and gas contracts and a common feature of business deals around the world.

This mechanism allows stakeholders to an oil and gas project to recover most of the startup and development capital and operating costs out of a specified percentage of production. Through this mechanism, oil and gas companies could recoup some of the costs of their investments once the revenues start rolling in. This is not money that Guyana owes to companies. In fact, it’s more accurate to say that this is money that the oil companies owe to their own lenders.

Even large companies have lenders and creditors they turn to in order to finance major investments. Each stage of the Stabroek Block development has cost billions of US dollars that companies took from profits elsewhere or borrowed from creditors to pay out to vendors for goods and services like production equipment, seismic surveys and drill ships.

Companies are now using cost recovery to recoup those investments and pay off creditors and vendors since their expensive bet on exploration in Guyana paid off. If Guyana had paid for these initial costs of the exploration and development by itself, it would have required debt at an astronomical level—roughly 200 per cent of pre-oil Gross Domestic Product (GDP).

The upfront costs of exploration and development are the largest capital outlays for oil production while day to day production, once wells are in place, is relatively inexpensive. As more projects come online and production increases, the rate that these initial investments are paid off rapidly increases. That means that a higher and higher share of oil will be profit which the government is entitled to.

These costs are also closely audited to ensure that there is no padding of expenses or frivolous spending. In May, the Ministry of Natural Resources signed a contract with a consortium of local companies to conduct a cost recovery audit of ExxonMobil Guyana’s 2018 to 2020 expenses. This audit is expected to be completed sometime this month.

Once the audits are completed, they’ll be made public and submitted to the Auditor General’s Office for public inspection. A transparent and diligent auditing process is yet another important element in dispelling any myths or lingering doubts about Guyana’s fortunes and the contract terms.