Guyana is estimated to have 4 billion barrels of oil in its Stabroek Block. This development would likely result in billions of dollars in government revenues.
Such large petroleum revenues, if wisely managed, can contribute to sustainable economic development. However, if poorly managed, they can retard economic development and create a ‘resource curse’. More specifically, they can lead to a loss of economic competitiveness, volatile and inefficient public spending and unsustainable consumption.
It is with this understanding in mind that organizations like Chatham House have been more than willing to help Guyana prepare adequately for the coming of oil. Chatham House is a London-based non-governmental organization which helps poor countries better manage their extractive industries.
In its many visits here, Chatham House has helped local authorities examine how petroleum funds might influence the country’s development trajectory as well as the various mechanisms for saving petroleum revenues and rules for spending them.
To discuss these new challenges facing Guyana, the organization held numerous discussions with officials from the Ministries of Natural Resources, Finance, Foreign Affairs, Agriculture, Communities and Education, the University of Guyana, the Parliament, the Guyana Commission of Geology and Mines, the Guyana Energy Agency, the Bank of Guyana, the Guyana Revenue Authority, the Department of the Environment, the Environmental Protection Agency, the NGO Conservation International and Go-Invest.
In determining its development path, Chatham House has noted that Guyana should consider the following issues:
- The pace of development – Guyana will need to consider how quickly it should develop its oil reserves and how much it can invest in the economy over time.
- It should also consider whether government or market forces would drive the chosen development path. There would be the tendency of government to establish new state vehicles (state-owned-enterprises, agencies) when they feel that the public sector is not responding or moving forward fast enough with their development agenda. However, these vehicles tend to create waste, confusion and opportunities for corruption. A culture change is needed so the private sector becomes willing to take risks.
- Should broad-based access to energy and inclusive growth guide Guyana’s development path? The discussion on this topic has often raised the concerns of indigenous communities in the hinterland, with some Guyanese officials suggesting that improving the livelihood of people and communities should guide the country’s thinking about the optimal path of development. It should be noted that domestic access to energy (especially in rural or remote areas) would not be supported by a centralized model (or grid). In any case, the development of the oil sector should serve the national vision. There is a risk that an emerging oil sector will undermine the national vision through economic distortions and by distracting policymakers from non-oil policy goals. Guyana will need a clear idea of what its priorities are.”
NATIONAL OIL COMPANY
Chatham House has noted that there is great anxiety by Government officials to create a National Oil Company (NOC).
But in setting up a NOC, Chatham House has advised that Guyana would need to think about what role it would serve in the value chain and that it is not a risky venture. It noted that NOCs can create value by developing technical capacity that enables them to take on operatorship of oil and gas projects. However, the time required to build the necessary capacity to handle such risk is long (one can expect 15 years of sustained efforts). Chatham House believes that another, more accessible ambition would be to offer a window to the operations. With a minority stake in licences (with costs carried by the partners until production), Chatham House says that the NOC can observe the decision-making of the oil company during development and production. It said that this helps to build capacity in the NOC and helps government understand operations.
Chatham House noted that the NOC can also be a centre for development of skills and capacity in the oil sector. It noted, however, that NOCs need constraints to avoid growing too ambitious, too slack in spending and too unfocused.
It said, “It is the government’s job to give the NOC a clear mandate and to oversee its performance. It needs to assess whether the NOC’s mandate and investments are too risky. The oil and gas sector is a capital-intensive one and the NOC would need to demonstrate its ability to manage risks. In light of the pressures a carbon-constrained world will impose on national or private oil companies, some thought should be given about how much to invest in developing its capacity and whether its mandate should include the support of renewables.”
“With regard to the creation of supply chains and opportunities for local content, the discussion emphasized the importance of identifying sectors with a competitive advantage. The small population and market size of Guyana is a disadvantage. Attracting the large Diaspora back to the country could be valuable. To reduce dependence on oil, Guyana should focus on supply chains that benefit growth in other sectors of economy (e.g., financial service, insurance, logistics)…”
FISCAL RULES
Chatham House has often emphasized to local authorities that oil is a commodity with volatile international prices. As such, it is important for all governments to understand the impact of spending those volatile revenues on a small economy. It has noted that these impacts demonstrate the necessity to de-link these revenues from public spending. There are numerous fiscal rules that can be used to this end.
According to Chatham House, these are:
• To spend based on structural income rather than on the volatile actual income. Structural income or permanent fiscal revenues can be determined by using the long-term average price for the commodity and save any revenues over that price. Governments can spend their savings when revenue flows fall below the long-term price. There are different ways to estimate the long-term price and none is perfect, but they do give a structure to the savings decision. Governments should also identify windfalls as transitory or permanent price surges and remain conservative in making this assessment.
• Under the so-called ‘Bird in Hand Rule’, the government saves all petroleum revenues in a fund and withdraws the long-term expected rate of return. This leads to a sustainable increase in public spending and, in consumption, disconnects public spending from volatile international oil prices and allows significant long-term savings.
The main disadvantage is that public spending only increases slowly, which may disappoint the public and be unsuitable for countries with pressing development needs.
• Under the ‘Permanent Income Hypothesis’, the aim is to achieve an equitable increase in consumption from petroleum wealth across generations. This is achieved by spending the long-term real rate of return from total petroleum wealth, when total petroleum wealth equals savings plus future petroleum revenues. The main disadvantage is the complexity involved in accurately forecasting future petroleum revenues.
RESOURCE CURSE
According to Chatham House, the ‘resource curse’ is not inevitable, but frequently occurs. Petroleum revenues can lead to it through volatile and inefficient public spending, Dutch Disease, an unsustainable increase in consumption and weakening institutions. The London-based body notes that fiscal rules form part of the solution to these problems, as do strong institutions. It said that emerging producers, such as Guyana, should consider carefully the capacity of their economy to absorb public spending. Many countries expect to use petroleum revenues to increase infrastructure spending and the productive potential of the economy.
Chatham House said that emerging producers – especially those in the pre-production phase – can draw important lessons on managing their economy post-discovery from their peers. It noted that research at the Natural Resource Governance Institute (NRGI) found that countries with giant discoveries tended to disappoint on economic growth forecasts.
It noted that many projects were delayed or faced cost overruns. No less than 73 percent were late and 64 percent had cost over-runs averaging 59 percent over budget. Others with early production faced a 60 percent drop in revenues as oil prices fell in 2014.
Common to the cases studied was the expectation of transformative economic impact from oil and gas as well as excessive borrowing, which led several countries in the study to be bailed out by the International Monetary Fund (IMF). Chatham House noted that the biggest discoveries and countries with poor institutional governance had the most significant economic disappointment. As such, it stressed that Guyana will need to manage expectations about spending levels, be cautious on accruing debt and work to build strong institutions.
