IMANI Alert: Watch These Oil Numbers!
2/22/2010 6:57:00 PM -
February 21st 2010
Finally! We have something to applaud the Ministry of Energy for! Those who have been following our releases should by now be familiar with our incessant ranting about 'transparency'.
This week the Ministry of Energy announced that it shall be subjecting the draft petroleum revenue management bill to a full and open public discussion extending to all corners of Ghana prior to its submission to the relevant select committees in parliament. All hail transparency!
But we at IMANI are not cheering yet. We have some serious questions about, you guess right, the 'level of transparency' that government has allowed in its own preparatory work for this national discussion about petroleum revenue.
Government of Ghana (GoG) has provided some information about the prospective fiscal regime in order to guide the debate about how oil income accruing to the nation ought to be utilized. In due course IMANI, like many other interest groups and individuals, shall be commenting on the issue of revenue management (bearing in mind that our colleague, Kofi Bentil, has time without number offered detailed suggestions about that matter). But we are of the opinion that such a discussion should in the first place be grounded on a clear and thorough appreciation of the facts and figures involved.
As far as we can tell, only two pieces of information have to date been provided to aid the public in its debate on the draft petroleum revenue management bill (PRMB). Firstly, that government expects an output of 120,000 barrels of oil during the first phase of the development of the Jubilee field. Secondly, that $60 is the assumed average price of oil during the first phase of development (expected to run from 2010 to 2015).
Now, it is elementary to assume that a great deal of analysis has gone into arriving at these and related assumptions, particularly the latter. It would be much helpful for GoG to release all this analysis into the public domain in the form of a press release. Financial projections are never a product of neutral, objective, intellectual exercises. They embody prejudices of strategic planning, financial and commercial machination, as well as policy preferences.
Most interested Ghanaian observers would be best served if GoG lists in full all the relevant assumptions as well as the philosophical/strategic principles that have guided those assumptions. They would also like to be much better informed about the two pieces of information that have thus far been provided - anticipated volume of production (AVP) and anticipated unit price (AUP).
There are two cardinal principles in industry and policy practice associated with the projection of AVP and AUP. The first, concerning AVP, is to adopt the low output scenario. That is to say if the installed capacity of the Jubilee field at the end of phase 1 corresponds to a production volume of 120,000 barrels per day (bpd), then it makes sense to use an average production rate significantly below this number for your financial projections. This allows you to better accommodate unforeseen developments that may lead to temporary closures of the field in the event of, for instance, adverse weather activities, strikes, industrial accidents etc, not to mention periodic or unscheduled maintenance. Policy prudency would require that a lower output figure, say 90000 bpd, be used.
Concerning AUP - the projected average price of oil for the designated period - one is similarly concerned that for prudency reasons the approach should be to adopt a figure below the historical price of oil. There are of course technical accounting reasons why this, together with a net present value, approach is elementary. With US inflation inching close to 4% it is obvious that $60 in 2010 would not have the same value as $60 in 2015. But the real importance of prudential discounting lies in the extreme volatility of the oil price. It is not too long ago that oil was selling for $10.
One does acknowledge that the long-term trend for oil prices appears to be upward, in line with fundamentals. Furthermore, multi-year averages of oil futures on the authoritative New York Mercantile Exchange (NYMEX) for the medium term period of jubilee production under discussion do seem to correspond well with the government's adopted $60. The truth though is that in this discussion we are most concerned about the spot price in the most highly traded markets, such as Rotterdam port and North West Europe.
Which brings back to the fore our earlier point about low transparency on GoG side. Is the quoted $60 the wellhead value, or is it net of transport costs (which can be as high as $6 per barrel)? Has the premium discount already been applied? By the preceding we are asking whether the NYMEX quote for West Texas Intermediate, Brent Crude, or a basket of benchmark grades of oil, was what was first used to arrive at a figure which was then discounted to give us the $60 quote. Because, as everyone knows, the actual price for a barrel of oil from Jubilee shall be non-trivially lower than the quoted prices for premium grades of oil on the NYMEX. The price shall be dictated by the commercial marketing contracts entered into by the owners of Jubilee oil with their respective trading partners (buyers).
As we have no information on all these vital issues, let's just assume that all the relevant alternative scenarios have been considered by GoG and the products of that process are $60 and 120,000 bpd. We shall even go further to assume that these figures are 'low return' scenarios in accordance with the principles of financial prudency.
We are still, notwithstanding the light of all the above presumptions, lost.
Government says we should expect to be earning *$1 billion per annum* from Jubilee oil.
We note that it is possible for other prospects in the offshore region to come into play - Tweneboa, Odum, etc - though of course the Kosmos impasse might delay developments in the West Cape Three Points area. However, it is highly unlikely that additional resources will come onto the market besides Jubilee's during the period under discussion.
We argue that, even after accommodating all the ambiguities surrounding the AVP and AUP, $1 billion per annum is an unrealistic projection.
National income from oil in Ghana's case overwhelmingly derives from about eight streams: income tax levied on profits (about 35%), royalties (about 5% in the unitisation agreement for Jubilee), surface rents, port charges and other fees (undeclared, but not more than 1%), dividends from carried interest (10%), dividends from additional interest (3.75%), Additional Oil Entitlement (a windfall tax arrangement, which is unlikely to apply in the period under discussion), and dividends from participating interest (which shall only apply if Government succeeds in increasing its stake in Jubilee). Indirect gains such as payroll taxes and taxes on auxiliary activities are extremely hard to predict in advance, and in our peculiar circumstances and for the period under analysis are all but negligible.
We note that royalty payments can be adjusted in a particular fiscal window to track profitability and that the income tax level quoted above is the upper bound. We also note that even should government succeed in increasing its stake in the Jubilee field, as for instance through the Kosmos divestment, compound interest payments and other costs of the capital used for that acquisition are likely to offset any gains made with respect to dividends from participating interest, at least during the phase of production under consideration.
Thus, the best case scenario assigns to Ghana 55% of all the oil revenues. The Ministry of Energy itself employs 52% as Ghana's share of earnings. As we have said already, financial prudency frowns on 'best case scenarios', but for argument sake let us allow this figure to prevail.
An AVP of 120,000 bpd implies an annual volume of a little less than 44 million barrels of oil. At the assumed price of $60 this implies a financial return of ¬$2.6 billion. 55% of this sum amounts to a little more than $1.4 billion. It would seem at first sight that GoG has taken care of all the various financial risk issues we raised by commuting this figure to $1 billion. Alas, there are two key factors to further consider.
A critical look at the profile of oil income outlined above indicates that 65% of all earnings accruing to Ghana shall derive from income taxation, *which is levied on profits*. Hence, the cost of production is a key issue to consider since profits are levied on net operating results and not on gross earnings. The deepwater nature of our Jubilee resource and trends in the oil production equipment market suggest a production cost of $33 per barrel. Two years ago, the United States Energy Information Administration mentioned $29 per barrel for Gulf of Guinea production, but the situation seems to have deteriorated slightly.
In these circumstances, after Government of Ghana has received about $130 million in royalties, the remaining $2.47 billion can only be taxed and assessed for dividends after costs of production (and the costs of outlier risks) have been accommodated. Total costs could, as discussed above, easily amount to $1.5 billion. This leaves a net outturn of $970 million to be assessed for tax and dividends. Having already accounted for royalties, 50% of this net sum ought to be assigned to tax and dividends. But wait.
We actually need to account for one other major factor of production, insofar as it hasn't already been captured in the cost of production per barrel. This factor is capital depreciation or amortisation. While the depreciation of the actual oil infrastructure over time is best considered under cost of production, the recoupment of initial capital investments made towards the development of Jubilee is an accounting item likely to be treated separately.
The Jubilee partners have estimated the costs of development over the first phase to run into $5 billion. It is possible that they may exceed this budget. We can all recall how the West African Gas Pipeline, initially budgeted at $400 million overshot its budget by nearly 150%. But let's keep it simple - let's stick to $5 billion. In standard international investment practice, the partners shall seek to recoup this amount over a period of about five years, corresponding to the first phase of development. In crude terms, what we are saying is that a good accountant working on behalf of the partners could justify a tax-deductible item of $1 billion per annum.
We could assume for the sake of this analysis that the Large Taxpayers Unit is likely to take a very dim view of this state of affairs and might be able to claw back some cash. We doubt that more than $270 million (limiting amortisation to $700 million) shall be extractable in these circumstances, and not the $485 million initially supposed.
This leaves us with a grand $400 million per annum as the most realistic level of national income obtainable in the first phase of Jubilee's production. Hence rather than the 17 pesewas per capita per day that the Ministry of Energy has quoted, the share of said revenue due each Ghanaian per day is more likely to be around 5 cents - 7 pesewas - than 17 pesewas. The annual per capita figure is consequently 26.5 Ghana Cedis thereabouts.
Given that these calculations are elementary arithmetic, what is the reason behind the seeming overoptimism on government's side? We are sure you have guessed already. Government of Ghana is engaged in a high-profile, high-tension, effort to secure funding to participate more actively in the oil business. In these circumstances, it helps to be as optimistic about projected oil revenues as one can get away with, after all the higher the likely return on investment the better the credit and collateral terms. Especially also when the multiple assumptions at play can so effortlessly be made to aid the wiles of creative accounting and manipulation.
Furthermore, anti-corruption crusaders are likely to be least worried about Government's over-declaration of likely income. The usual frustration is that governments and the contractors are wont to under-declare income in order to create room for corrupt and other fraudulent activities. In the view of some observers, therefore, over-declaration of income on Government side can only limit the latter's flexibility to siphon off resources.
So why are we worried? Well, we have always believed that in this country we tend to overemphasise corruption to the neglect of other important performance indicators. Prudent public finance management through budgetary discipline is one such major indicator of government performance, and it relies on rigorous and accurate facts and figures.
Anyway, doesn't it seem odd that even while government keeps saying that it is interested in managing the expectations of the population it should at the same time be exaggerating the likely income from oil for strategic, commercial or whatever reasons? As the Americans would put it: 'make up your minds, dudes'.
Courtesy of IMANI Center for Policy & Education & Africanliberty.org