UG economist sounds warning about the oil scenario

Feb 21, 2017 Letters

Dear Editor,
In November 2016 I wrote an essay titled “First Oil in Guyana: Headlong into the Paradox of Plenty?” that was circulated privately and also sent to your newspaper. Many of the points made in that essay are either more relevant now or are being confirmed by recent market developments.
For example, I had pointed out that the Hotelling rule for optimal extraction of a non-renewable resource would suggest that oil companies, had they owned or controlled a resource such as the Liza and Payara Wells, would in fact choose not to produce if they expected the net price (i.e., its price less extraction costs) of oil to rise in the future, and in particular to rise faster than the interest rate. It was further pointed out that ExxonMobil was expecting oil prices to remain stable at its current low level until about 2040, when an expected increase in global demand would finally put an end to the glut on the market.
I now wish to bring to your attention to the article “Energy Companies Face Crude Reality: Better to Leave it in the Ground,” which appeared in the Wall Street Journal of February 17, 2017. On the same date WSJ carried a related article titled “Worst Gasoline Glut in 27 Years Could be Oil Rally’s Nemesis,” while Bloomberg carried an article titled “Oil Closes Near $53 as Record U.S. Supply Counters OPEC Cuts.” [Readers who do not have a WSJ subscription might access the first article at: http://www.foxbusiness.com/f eatures/2017/02/17/energy-comp anies-face-crude-reality-bette r-to-leave-it-in-ground.html].
The decision, reported in the first-mentioned article, not to extract the planned 3.6 billion barrels of oil from Canada’s oil sands comes after Exxon would have made a $20B investment there. In other words, the size of an investment today is no indication of the particular production decision that would eventually be made.
A general point ought to be made, and it is that if the authorities believe that oil production in Guyana would surely start in 2020 because ExxonMobil is saying so ‘in word and in deed,’ then they would be guilty of ignoring both logic and the news about recent developments. As would any other company, ExxonMobil would make its production decision on the basis of the net price in 2020 and beyond, and not on the basis of net price today.
There is every reason for ExxonMobil to develop the oil resources in Guyana to replenish its reserves, to reassure investors, and to satisfy regulatory requirements. Whether Guyana can infer a production decision from this is however, is another matter altogether. But it would appear that such an inference has already been made, as the Government of Guyana has decided to build a US$500M onshore oil and gas facility at Crab Island!
The theory of ‘mechanism design’ in economics recognises that private agents often have important information that they withhold for strategic, “self-interested,” reasons and makes the design of ‘truth revelation’ mechanisms central to the task of making optimal plans and decisions. In this regard, it is instructive to note that ExxonMobil did not say that it will have to consider the feasibility of investing in the Crab Island facility. Rather, it was quite a simple matter: ExxonMobil will not be investing in the facility.
Editor, before the Skeldon Sugar Factory investment was undertaken, I was one of the few people, if not the only one, to have pointed out the risks and the uncertainties that made it an imprudent one. I even calculated the expected return to the investment under different risk scenarios at a public seminar hosted by UG’s Dept. of Economics. It was only with great self-restraint that I refrained from suggesting that some of the proponents of the project might have invested their pensions in the project to show their willingness to underwrite the very risks that the Guyanese taxpayer was being made to underwrite. Is Guyana hurtling headlong into a resource curse phenomenon? Only time will tell.
Thomas B. Singh
Senior Lecturer
Dept. of Economics
University of Guyana

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UG economist sounds warning about the oil scenario

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