January 10, 2021

The Economy & Finance

Guyana Times

Article 03/2021

Response to Tom Sanzillo, Director of Financial Analysis at IEEFA (Parts 2 & 3)



Tom Sanzillo provided a response to this column’s edition that was featured last week, which was a direct response to Tom’s analysis on several issues on the Guyana’s oil and gas sector. This columnist is extremely pleased and elated that Tom Sanzillo responded to an open public debate on these issues.

In his response, Tom basically regurgitated his analysis that is already in the public domain and which this author briefly touched on last week. This is not only unfortunate but also disappointing on the part of Tom as he failed to offer any new and in-depth analysis – thus warranting his analysis inherently weak and unscholarly.

To summarize Tom’s response, he is basically contending that failing markets and weak revenues will result in anything but small benefits for Guyana and that revenue outlook is dim owing to declining markets for crude. However, he failed to provide and substantiate the underlying assumptions for this and the time frame in which one can expect an oil market crash – based on his analysis.

He is also contending that Guyana will saddle itself with burdensome debt by virtue of pursing ambitious development projects – that the country badly needs; which will position the country for bankruptcy. Not only did he not substantiate his absurd assumptions which are all speculatory – he did not fail to validate and prove the insanity contained in his baseless ramblings which leaves much to be desired.

While Tom is correct, however, on one point only – that the global oil market is diminishing though he did not forecast by what timeframe one can expect an oil price crash, this author in March 2018 would have argued that the global oil market has safely another 20 years before oil price becomes unsustainable. This is attributed to the notion that the world economy is moving towards adopting climate change policies and alternative sources of energy.

This obviously will not occur over night of course and it is for this reason in the said referenced article by this column wherein it was contended that Exxon will need to increase production capacity to as much as 1 million barrels per day by the end of the first decade. See link here for ease of reference: https://guyanatimesgy.com/the-changing-dynamics-of-global-oil-economics-part-3/.  Notably, Exxon appears to be well in line to achieve these targets based on its disclosed projections for increased levels of production capacity – reaching over 500,000 barrels per day by the end of the first five years.

More so, the Organization for the Petroleum Exporting Countries (OPEC) in its 2019 World Oil Outlook 2040 report, provided a forecast that is consistent with those of this author with respect to global demand for oil and gas in the global energy mix. To this end, the report noted that total primary energy demand is expected to increase by 25% between 2018 and 2040 with renewables leading the way in terms of growth, but oil and gas are still forecast to meet more than 50% of the world’s energy needs by the end of the forecast period (2040 / 20 years’ time). (see link to report here: https://www.energy-tomorrow.eu/wp-content/uploads/sites/15/2019/11/world-oil-outlook_executive-summary_2019.pdf).

The report cited as well that these trends can also be viewed in similar forecasts from other reputable organizations with long-term energy outlook. Hence, it is rather safe to conclude that oil price, though volatile will remain sustainable between US$40 – US$50 per barrel until the end of the next two decades while noting that oil will remain profitable above US$35 per barrel.

He further went on to say that Exxon is stumbling with the global market, but be that as it may it is not just the declining market that has been a contributory factor to Exxon’s poor financial performance. Other factors that led to Exxon’s poor financial performance include expenditure incurred owing oil spills globally – which amounts to over 300 oil spills from the period 2005 to 2018. Another important factor to consider includes the highly regulated industry in other markets which increases the cost imposed upon Exxon to operate in those countries.

In the case of Guyana on the other hand, Exxon has benefited from a favorable fiscal regime in addition to the fact that Guyana has a lighter and sweeter crude which is less costly to refine. These favorable conditions coupled with the need to rapidly increase production capacity are what makes the Guyana petroleum industry an attractive one against all the odds highlighted earlier with respect to the changing dynamics of the global energy market. So, here again Tom is wrong and does not fully understand the market dynamics globally and in the case of Guyana.

For these reasons, Guyana has to be wary of the pretentious lords in developed countries who want to stymie developing countries from prosperity so that they can lord over us. We, Guyanese, must not allow this to happen and must not allow so-called foreign experts to insult our intelligence.

The manner in which the IEEFA puts forward its contentions gives one the impression that for Guyana to become prosperous it is solely dependent on the oil and gas industry and that it seems Guyana is solely reliant on natural gas to solve its energy problems. This view by the IEEFA suggests that the IEEFA truly does not understand anything about the Guyana economy. Guyana is not dependent on oil, oil and gas is just a bonus. Guyana is rich in natural resources and has a relatively diverse economy to build upon which the Government is committed to so do.

In fact, in a previous response some months ago during the elections period, this author would have responded to the former Minister of Finance positing that we need not get excited about oil and gas as it is merely a premium. For Tom’s and the IEEFA’s benefit this article can be accessed here for my full analysis therein https://jbconsultancy.info/we-need-not-get-excited-about-oil-and-gas-as-it-is-merely-a-premium/.

The IEEFA concludes that Guyana will not earn much and that the earnings will not be sufficient to offset budget deficits. Now, let’s look at some analysis using Liza Phase 1 project alone. Liza phase 1 has a production capacity of 120,000 barrels per day and comprise of 450 MMbl.

Liza Phase 1 Projections
 Price (US$)Annual Revenue (USD$M)
Annual production: 43,800,00045    1,971,000,000
 Recovery Cost (75%)      1,478,250,000
 Investment Cost     4,400,000,000
 Profit share        246,375,000
 Royalty          39,420,000
 Total Annual Revenue         285,795,000
 Total Avg. Annual Revenue in first 3 years        857,385,000
   
 Avg. Annual Revenue Post Recovery:   
 Operating Expense (30%)        591,300,000
 Profit share (50% = 35%)        689,850,000
 Profit share for Liza 1 post recovery (7yrs)     4,828,950,000
 Royalty        275,940,000
 Total Revenue       5,104,890,000
 Projected Avg Revenue for Liza 1 (10 yrs life)     5,962,275,000
 Avg Revenue for 1st 5 years:      2,237,085,000
   
Exxon’s 2018 Operating Expense = 27% of total revenue
Liza phase 1 = 450 MMbl  
NPV investment recovery @10% discount rate = 4 years
Payback period = 3 years  

Tom Sanzillo and the IEEFA do not seem to comprehend that because of the 75% cost recovery threshold, the recovery period for these investments will be very short. Liza phase 1 in the above illustration for example, using an average price per barrel of US$45 at an annual production capacity of 43.8 million barrels of crude, the investment cost of US$4.3B will be within 3 years using payback method and using the Net Present Value investment appraisal method (NPV) with a discount rate of 10%, the investment can be recovered in 4 years. So, from Liza 1 alone Guyana can earn over US$2B in the first five years and up to US$6B in ten years – taking the post recovery period into the equation. In other words, Guyana’s projected earnings from the Liza 1 development alone over the first decade is equivalent to 120% of current GDP; 3.5 times current level of total public debt and 5 times Government’s revenue using 2019 figures.

The highest cost is usually the development cost and, therefore, when the development cost is recovered, the operating expense is minimal since the infrastructure to extract the crude is already in place. To substantiate this view with reasonable certainty, a perusal of Exxon’s 2018 annual report confirmed that total operating cost was just about 27% of total revenue. Hence, this means that in the post recovery period profit share will be greater assuming for example, that operating cost will be 30% of total revenue, then effectively there will be 70% of revenue for profit share of which 50% is Guyana’s share. Consequently, Guyana’s profit share can be as much as 35% post recovery + 2% royalty resulting in a total take of 37%; up from 14.5% in during the recovery period in the first three to four years for Liza Phase 1 development alone. Then there is Liza phase 2 and many other FPSOs and development fields that will be operationalized over the decade.

Now, let’s examine Guyana’s total public debt in the context of its future development trajectory and the potential impact on public debt.

Total Public Debt and other Indicators: 2009 – 2018 (GYD$)

 2009201020112012201320142015201620172018
Total Public Debt$282B$318B$356B$378B$359B$333B$321B$334B$349B$357B
Debt-to-GDP ratio78.43%77.3973.62%66.86%60.09%55.71%55.71%52.65%55.08%60.61%
Public debt-to- Gov’t revenue297.18%295.35%294.42%292.21%263.01%228.51%198.50%188.43%179.26%164.73%
central Gov’t surplus/deficit(15.3B)($13.5B)($16.7B)($27.6B)($27B)($35B)($9.3B)($31.7B)($33.4B)($27.3B)

Source: Bank of Guyana Annual reports

From examining the data above and looking at the trend over a ten years period with respect to Guyana’s public debt, Guyana has managed to maintain a debt-to-GDP ratio of less than 70% from 2013 onwards. With regards to the total public debt to total government revenue ratio, this was at a high of 297% in 2009 which reduced less than 250% in 2014 reaching as low as 165% by the end of 2018. The average ratio for the period is 240% which is also well below the international threshold of 250% according to the International Monetary Fund (IMF). By international standard as well, debt-to-GDP ratio of 60 – 70% is considered to be relatively sustainable.

Further, a perusal of the 2020 third quarter Bank of Guyana Report showed that the total public debt service ratio relative to government revenue is just about 30% and this level has been maintained, evidently over the last ten years or so.

Additionally, one would observe that from looking at the growth rate of public debt over the last ten years, the average annual growth rate of public debt is about 2.6% or less than 3%. The reason for this is simple. Government revenue is currently over $200 billion which means 30% of this which is about $60 billion, goes towards public debt service annually. Taking this into perspective together with the budget deficit, from the data in the table above one would observe that the average budget deficit is less than $30 Billion, which is typically financed by borrowing. Now what this means is that if the average annual debt service is $60 billion and the budget deficit is $30 billion, then the government is simply borrowing back just half the sum of the funds repaid in debt service which explains why the average annual growth rate in public debt is less than 3%. This is practically no different from how an individual credit card works.

With this in mind, the IMF has projected the Guyana economy to grow by 26.6 percent in 2020, owing to the emerging petroleum industry. As such, with substantial growth in GDP as a result of the activities of this new sector over the next decade coupled with the spinoff effects on the other productive sectors – perhaps by 100%. The impact on total public debt will be minimal and is likely to remain at sustainable levels – below international sustainable benchmark – that is, less than 70% debt-to-GDP ratio.

Let’s take the gas-to-shore project for example. As it is currently, the investment cost is unknown but is expected to be disclosed to the public when the negotiating process is completed. But for the sake of this argument, assuming the investment cost to bring gas-to-shore is US$500 million. We know that Exxon will be financing a percentage of the cost. Assuming Exxon finances 30% of the investment cost – that will be US$150 million and the Government will have to find US$350 million. This does not mean, however, that the Government would have to solely finance 70% of the cost. One has to consider the fact that because of Guyana’s development trajectory, and now political stability to some extent and its geopolitical importance, the financing model can take many forms aimed at reducing the financing risks. Due to these factors it is easier now to mobilize resources and raise financing from a variety of sources and instruments than it was 15 years ago when Guyana was not the center of global interests as it is now. As a result of these developments, investors’ confidence, both local and foreign is at it highest since the last two decades.

As such, the financing model for the project can very well be one in which there is a Private Public Partnership model where a consortium of investors can be put together and/or where a publicly traded company can be established to attract investors from anywhere in the region, locally, the diaspora and even global investors.  The point of these illustrations is to show that there are a variety of financing models that can explored to finance the project which can even result in the government having to finance just about 20% which would work out to just about US$100 million, hypothetically, if such models as described herein are explored, thereby effectively minimizing the financing risks. Thus, US$100 million is just over 30% of the average debt service figure of approximately US$300 million which would translate to almost zero impact on public debt at its current level.  This is only the financing aspect of the project to lend some sense of reason on the affordability. Clearly if it will cost US$500 million or even US$700 million, the country has reasonable affordability capacity. One also has to factor in the long-term economic benefits of such a project as well which will be dealt with in a separate series of articles.

It is against these backgrounds, that Tom Sanzillo and the IEEFA seem to have lacked the capacity to conduct any credibly sound and robust analysis on the Guyana case study and comprehension of the ‘country context’ from the many different dimensions – some of which were alluded to herein. Evidently, there are many variables omitted or ignored from the analysis with respect to Guyana’s macroeconomic framework, the development trajectory, the political economy, investors’ confidence and Guyana’s capability on these fronts. Hence, the analyses by the institute are undoubtedly weak and incogent.

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About the Author:

  1. Bhagwandin is an economic and financial analyst, lecturer and business & financial consultant. The views expressed are exclusively his own and do not necessarily represent those of this newspaper and the institutions he represents. For comments, send to jbbankingadvice@gmail.com.