BILLIONS OF US DOLLARS COULD BE LOST BY FAILING TO DEFINE “MARKET RATE” IN THE OIL CONTRACTS

Sep 08, 2019 Letters

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On August 27th, 2019 the Kaieteur News published an article which reported that Guyana would be responsible for paying the interest on the oil companies’ loans. This fact is buried in the Production Sharing Agreements (PSA). (Stabroek Block PSA, Annex C Section 3.1 part (l). This flaw may cost Guyana billions of US dollars. It takes just over a billion US dollars to run the country every year.We cannot afford this mistake.
Why would Guyana agree to pay interest on loans that the oil companies negotiated with their bankers is puzzling? Guyana was not at the table when the loans were negotiated. Here is the more egregious flaw (if not a violation of business ethics): Guyana has to pay the interest on these loans at “market rate’. This opens up Guyana to various exploitation schemes, one of which is discussed below.
If one searches the Stabroek PSA that was released to the public (a searchable copy can be found here http://www.oggn.website/wp-content/uploads/2019/08/Oct2016-Petroleum-Agreement.docx), for terminology related to interest expense there are a few observations Government of Guyana (GoG) must take note of:
At the start of the PSA, page 3, there is a definition of “Agreed Interest Rate”. It gives a precise definition on how it should be calculated. This “Agree Interest Rate” definition is referred to several times in the PSA. However, where this definition is not used is in Annex C Section 3.1, a section titled “Costs Recoverable Without Further Approval of the Minister”. In Annex C, a section not released to the public, the use of ‘market rate’ seems deliberate to favor the oil companies given the term “Agree Interest Rate” is referenced several times before one would scroll down to Annex C.
Why would the oil companies want to avoid giving a precise meaning to “market rate”? One has to take note that the interest expense on oil company loans are part of cost recovery. (Up to 75% of oil revenue is set aside for Cost Recovery).
If you scan the Exxon Mobil Financial Reports, you would notice that Exxon has a credit rating of AA+. The credit rating gives you an indication of how safe it is to loan money to a company. Exxon has gold standard credit rating, on par with that of U.S. govt. That is if you loan Exxon money you are guaranteed to get your money back with all interest owed. Exxon’s credit rating is the best among large oil companies in the world. This credit rating would mean that Exxon would be able to take out loans at lower cost than its peers.
If we have a company like Exxon that is able to borrow money at low rates then the ‘market rate’ charged to Guyana should be low?

Here is the catch. PSA was not signed with the AA+ rated Exxon but with Esso Exploration and Production Guyana Limited (Esso). Esso is a company with negative equity, as depicted in a table by Chris Ram in 2018, see http://www.chrisram.net/wp-content/uploads/2018/05/2018.05.18_Table1.png. Negative equity means if you liquidate all your assets you still won’t be able to pay-off your current loans. Since no oil has yet been produced since Chris Ram created the table, then one can safely assume Esso’s negative equity has only increased further.
Thus ‘market rate’ (market interest rate for loans) that Guyana would be paying is not what would be charged for Exxon’s loans but Esso’s.
Exxon would be classified as low risk to lend money. But Esso would be classified as high risk. If one checks the market rates of bonds issued by Exxon you can find the yields of around 2%. But what rate would Esso — a company with negative net worth — be charged for its loan? Earlier this year, it was reported by CNN that because of the plunge in oil prices investors have lost their appetite for risky companies. CNN quoted Mark Howard, a senior analyst at a major bank, as saying, “The high-yield market went into a tailspin. It just wasn’t a good time for oil companies to issue debt, even if they wanted to.”
It may be highly unlikely Esso, a company registered in Bahamas and with negative equity, would be able to receive a loan in the market. This is where Exxon can leverage its low borrowing rate to its advantage. In a typical scenario with the big oil companies, Exxon can loan Esso the money. But what would be “market rate” charged to Esso?
Well, we should look at some of the small and risky oil companies to get an idea. One such company is California Resources, its debt currently pays a market rate of 30%. Another is Weatherford International, its debt currently pays a market rate of 18%. That is a big difference from 2% market rate on Exxon debt.
Liza Phase 1 has a projected gross capital cost of US$3.7 billion and Liza Phase 2 has a gross capital cost of US$6 billion – with total combined production estimated at 1.05 billion barrels of oil. One should observe that going from 450 million barrels in Phase 1 to 600 million barrels in Phase 2 increased the capital cost per barrel by 20%. However, one would expect, given the lessons learned from the first project, the cost per barrel for the second project should be less than the first. Instead, the difference in cost adds up to an additional US$1 billion!
Let’s scale up the capital cost up to the currently confirmed 6 billion barrels: That would mean the projected capital cost could be US$55 billion or more given the anomaly noted in the previous paragraph.

If we used ‘Agreed Interest Rate’ at present that would be about 3% higher than Exxon’s market. That would mean an extra US$1.7 billion going to Exxon instead of Guyana. But ‘Agreed Interest Rate’ was not use in Annex C. Would Exxon argue Guyana needs to pay the rate similar to that of small and risky oil companies?
What would a 15% difference in market rate mean on US$55 billion? That would be an extra US$8 billion going to the oil companies instead of to Guyana. What about a 30% difference? That would be US$16 billion going to the oil companies instead of to Guyana. Now, that sleight of hand not to use the ‘Agreed Interest Rate’ in a section titled “Costs Recoverable Without Further Approval of the Minister“ – doesn’t seem accidental but carefully planned by the oil companies.
Bottom Line: Guyana is stuck not just with paying loans negotiated by the Oil Companies – but at gouging market interest rates. Could this be an US$8 or $16 billion mistake buried in the contract that officials of GoG overlooked or never read.
Darshanand Khusial on behalf of OGGN

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