Re: Intelligently spacing out oil & gas developments
I thank the Economic Advisor to the Leader of the Opposition for engaging me in the aforementioned topical debate. Readers would recall that in sections of the media, it was reported that the opposition is proposing the phasing out of oil and gas development or slowing down the pace of development. However, in his response to the undersigned’s article that appeared in certain sections of the media, he’s clarified that the opposition’s position is to “intelligently space out” future oil and gas developments. It remains unclear, however, as to what exactly this means for the opposition and how they propose to do so.
The Economic Advisor failed to illustrate by way of any analysis or economic modeling, at least at a high level, how intelligently spacing out future developments would work in practice―without disrupting the economy’s momentum. Notwithstanding, since the opposition’s clarification on this matter has proved unhelpful―the opportunity is presented to further develop the argument in support of the Government’s strategy to ramp up the pace of development in the sector over the medium term.
As explained in the undersigned’s recent column, the project lifecycle in the oil and gas industry includes three stages―namely, exploration, development, and production, spanning, on average, 30-40 years. In the case of Guyana, for example, exploration before the discovery of oil in commercial quantities lasted fifteen (15) years, followed by the development stage, which spanned another five (5) years before moving into production. And according to the terms of the production license, this is another twenty (20) years to produce the resource. In other words, it took twenty years before a single barrel of crude oil was produced to generate revenue from the sale/monetization of the resource in the Stabroek Block.
With this in mind, given the nature of the industry―that is, the petroleum geology of the fields, the engineering, and the economics, among other factors, developments in the industry are naturally and sufficiently spaced out. Bearing in mind that the geology and economics of each field are often times not the same. The aim, therefore, is to encourage and facilitate ongoing exploration in the sector. In so doing, should there be future commercial finds, by the time those new discoveries are developed, these should start to produce simultaneously―or to coincide with the decline curve of the currently producing fields.
In other words, if the Government opts to “intellectually space out” future developments, whatever this means if, for instance, it means that new exploration will be permitted every five years and new production licenses will be issued every three-four years, then the current producing fields will eventually start to decline. Hence, in the absence of new developments on stream, by the time production starts to decline, the country will have to endure declining production, which would translate into a loss of revenue to the national treasury and an overall decline in economic activities across the oil and gas value chain.
To the contrary, there are case studies of other petroleum-producing countries in the region, namely, Trinidad and Tobago and Venezuela, that, for various reasons, did not facilitate undisrupted ongoing exploration. The result in both cases is a declining economy, thus engendering a plethora of economic problems and challenges in these two countries. Additionally, there are several other global factors to consider that sufficiently justify the need to maintain the current pace of development. These are:
- In the Global oil outlook to 2040 report (2021) by McKinsey & Company, it is projected that new oil drilling is needed to meet demand by 2040. It states that by 2040, exploration and production companies need to add 38 MMb/d if new crude production from unsanctioned projects is to meet new demand. The newest production is expected to come from offshore and shale resources.
- Even in an accelerated energy transition scenario, McKinsey sees the need for new oil drilling by 2040. While most offshore regions will be under pressure in an accelerated energy transition scenario, the sector will still require new production of nearly 23 MMb/d to meet demand by 2040. Demand in a 1.5oC-pathway will force shut-ins.
The implications for Guyana based on scenarios (a) and (b) above are such that Guyana could lose out on the opportunity to be part of the global supply chain during this period―after which (beyond 2040, i.e.) the uncertainties in the global crude market will only deepen.
- By spacing out future developments to benefit from higher profit oil in the short-term (theoretically); having regard for the risks and volatility of the industry, capital raised for future developments may have to come from external sources versus internal sources of financing. This can be problematic in terms of the cost of capital for oil and gas development and scarcity of capital for oil and gas development in the future, which would only compound the cost of capital.
The current and future developments are financed from the operating cash flows from current operations, which is enabled by the lack of ring-fencing, viz-á-viz, the 75% cost recovery ceiling. Consequently, the cost of this form of financing is cheaper than raising capital externally through debt and equity financing.
That said, it should be noted that there are two types of ring-fencing: one relates to the geology and commercial viability of the wells―in terms of whether the exploration cost for a dry well is allowed to be recovered from another commercially viable well within the same field, or should it be disallowed and treated as a sunk cost. The other type of ring-fencing- the more contentious form―relates to the fiscal regime. For tax purposes, ring-fencing typically applies in determining the taxable income per field, thereby effectively disallowing future field developments to be financed from the operating cash flows generated from other existing/producing fields.
It is against this background that the proposal by the opposition to “intelligently space out” future developments in oil and gas has not been thoroughly informed. Accordingly, the case is made out herein, demonstrating that the opportunity cost to the country, in the long-term, is likely to far exceed the benefit.
Financial and Public Policy Analyst