Production Sharing Agreements…Govt. uncertain if to walk away or strengthen flawed model

Nov 24, 2017 News

…Meets with Indonesian officials on transfer of skills, experience

By: Kiana Wilburg
At this point, it is difficult for the Government of Guyana to say if it would refrain from the continued use of Production Sharing Agreements (PSA) or strengthen this flawed model.

Natural Resources Minister, Raphael Trotman

This was confirmed yesterday with Minister of Natural Resources, Raphael Trotman.
His comment came on the heels of a Kaieteur News article that was published on Sunday. That news item focused on the lessons Indonesia learnt from using PSAs, a contractual model it is credited with creating.
This arrangement stipulates that the host country will receive its profits after the oil company deducts its operating expenses.
The Government of Indonesia thought that this was a wise move in the beginning. But with each passing year, it soon noticed that its cut of the spoils got smaller, the taxes from the oil sector began to shrink and the operators’ claims of deductable expenses were increasing by the millions.
The aforementioned convinced the Government that petroleum companies were inflating costs. The Government tried everything it could to keep oil companies from exploiting this loophole in the Production Sharing Agreement. But every accounting or auditing effort proved futile against the oil giants. Earlier this year, the country took the decision to move away from the very agreement it piloted.
With this in mind, Kaieteur News asked Trotman whether he believed that Guyana would be wise to move in the same direction.
The Natural Resources Minister said, however, that PSAs have advantages especially for countries which do not have capacities to monitor and be fully involved.
He said, “It took Indonesia decades to build capacity and to be able to de-link from it. We can’t compare Guyana with Indonesia.”
At this point, Kaieteur News emphasized to the Minister that it took a staff of over 700 individuals in Indonesia to monitor cost recovery claims by oil companies. The newspaper insisted that surely there is something to be learnt from Indonesia if that point is considered.
The Minister said, “Of course there is something to be learnt from Indonesia. We have in fact, met with officials of their national oil company. We are looking at areas of possible transfer of skills and experiences.”
But as it relates to walking away from the use of PSAs, the Minister said that it is difficult to pronounce on such a matter at this stage.
Trotman said, “We have had the current model reviewed and more reviews are being conducted by international agencies so it’s difficult to say at this moment whether we will walk away completely or strengthen the model we have.”
NEW MODEL
Since moving away from PSAs, Indonesia has employed the use of the “gross-split” method.
The gross split rules make contractors bear all the costs in turn for a higher share of the output. The base split for oil blocks is 57% to 43% for the government and contractors, respectively, and 52% to 48% for natural gas fields.
This is in contrast to the conventional cost recovery PSCs which caters for the sharing of profits after deduction of the exploration and production costs.
The economic benefit from the gross split PSC is that it awards the share of production, bonuses, income taxes and indirect taxes to the state, while contractors receive a share of the production according to the percentage agreed on in the contract.
INFLATED COSTS
Indonesia’s move from Production Sharing Agreements to the new model in January last was long in the pipeline.
In several media reports in that country, the Government said that under cost recovery, contractors inflated costs to increase their share of production, the result being that Government’s share is reduced.
In fact, the Supreme Audit Agency of Indonesia found that several oil and gas production sharing contractors inflated their operating costs claims to US$300M. The Agency also noted that many of the costs claimed by the company were not even in keeping with the rules and regulations of Indonesia.
By moving to a gross-split, the Government argued that contractors are forced to bear the costs of operating themselves. The Government believes that the new method will encourage the oil operators to spend more efficiently since there is no way to recover them.
The Government of Indonesia feels justified in doing away with a cost recovery mechanism for oil operators. The citizens there also believe that for too long, they have been abused by oil operators. In this regard, the Government revealed that in 2016 alone, cost recovery by oil operators climbed up to $13.9B.
This was more than the sector even contributed in revenues for that year.
Additionally, the Government bemoaned the administrative challenges that came with addressing cost recovery as claimed by companies. In fact, the Government said that the problem with cost recovery is there have been endless debates as to how much exactly the production costs should be.
The Government said it is not easy to calculate technology costs, especially in cases where only one company has a particular technology.
It was also noted in the Indonesian media that SKK Migas, a government owned entity that manages the oil sector, has a staff of 750 professionals. Approximately 80% of that staff is involved in the arduous task of ensuring that cost recovery claims by company are fair and accurate.
Anticorruption advocates in Indonesia are of the firm view that given its limited audit resources and benchmarks to evaluate cost claims, the Government’s response to move away from cost recovery as a basis for production sharing is perhaps, a sensible move.