When it comes to the discovery of oil, nations across the world have experienced a number of challenges; one of them being the bill presented by operators for unsuccessful operations.
Fortunately, many nations like Uganda and Indonesia have learnt from the mistakes of their counterparts. In this regard, these nations have ensured that there are strict clauses which specifically state that oil companies are not allowed to recover such costs prior to the date of production. It therefore means that the operator must bear the cost of exploration.
One can see a glaring example of this in the Production Sharing Agreement (PSA) that was signed between the Government of Uganda and British operator, Tullow Oil. That entity is also exploring in Guyana’s deep waters.
In that PSA, the Government categorically states, that the oil operator cannot recover costs incurred before the effective date of the contract.
But Guyana’s case is quite different. There is no provision in Guyana’s contract with USA oil giant which safeguards against this. Hence, ExxonMobil was able to ensnare Guyana in the oil agreement with a US$460M bill.
This can be found in Annex C of the contract which speaks to Cost Recovery. The bill is referred to in the PSA as “pre-contract cost.” The pre-contract cost includes contract costs, exploration costs, operating costs, service costs, and general and administrative costs and annual overhead charges.
Newcomers to the oil and gas industry are often obsessed with one thing—billions of dollars in revenue.
Issues like adequate ring-fencing provisions quickly fade into the background of nothingness.
More than 80 countries worldwide have not only paid dearly for such a mistake, but the future of their governments and generations to come will be haunted by it.
The lessons of these nations were adequately summed up by the World Bank in one of its many reports on the sticky issues of exploration. In one of its documents, Fiscal Systems for Hydrocarbons, the World Bank explains that ring-fencing is an industry-specific feature. This refers to the demarcation of taxable entities.
The World Bank said that while corporate income tax normally applies at company level, in the petroleum sector the taxable entity is often the contract area or the individual project. When ring fencing applies at contract area or project level, income derived from one area/one project cannot be offset against losses from another area/project.
Another type of ring fencing separates upstream from downstream operations. Usually, all costs associated with a given block or licence must be recovered from revenue generated within that block: the block is ring fenced.
The World Bank emphasised that the objective of ring fencing is to protect the level of current tax revenue and, to some extent, level the playing field by treating newcomers and existing investors equally.
It noted that the disadvantage of ring fencing is that it does not incentivise exploration and investment activities. The Bank stated however, “by allowing costs to cross the fence, the host government may end up subsidising unsuccessful exploration.” (More in this regard can be read by following this link: https://openknowledge.worldbank.org/bitstream/handle/10986/6746/409020PAPER0Fi1C0disclosed0Sept0181.pdf?sequence=1).
ExxonMobil has already announced that the Liza one was the discovery well in 2015. Since then, it has successfully drilled Liza 2, 3 and 4 which helped the company to understand the size of the accumulation of oil and gas. It has noted that Phase one of its production will include at least 17 wells. It said that this will help develop part, not all of the Liza field.
In August 2016, ExxonMobil drilled their “Skipjack” exploration well but no commercial quantities of hydrocarbons were found.
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