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Oil & Gas – A framework for cost recovery
DEAR EDITOR,
Recently, there has been talk in the media about the Government’s share of the oil revenue from Exxon and its partners. It’s been alleged that the Government’s full share of the oil revenues will only be realised once Exxon has recovered its costs.
It is important to note here that there are always divergent interests between multinational natural resource companies and host countries with respect to resource extraction. The former wants to minimise its payments to the host country, and the latter wants to maximise those payments.
That said, let’s take a closer look at the concept of ‘Recovered Costs.’
While this concept can be a bit ambiguous and can vary depending on the terms and conditions of each contract, there are some general guidelines one can use in determining and establishing total costs incurred and the types of costs that are likely to be charged back to the host country.
There are three broad categories of costs. Pre-production, Production, and Sales costs. Below is a further breakdown of each cost category:
1. Pre-productions Costs
Property Acquisition Costs
The cost of acquiring unproved property for exploration.
Finding Costs
Cost of Geological and Geophysical (G&G) work; Cost of Licences, Signature bonuses, cost of drilling and exploration.
Development costs
Cost of acquiring, Constructing, Installing production facilities and drilling development wells.
2. Production Costs
Production Costs
Costs incurred to operate and maintain wells and related equipment facilities, including depreciation and applicable operating costs of support equipment and facilities, and cost of maintaining wells.
Production Taxes
Taxes or Royalties paid to the host State. Note, that this is potentially a wash for the oil company; in other words, the company pays the host country royalties and then charges those amounts back as part of the production costs.
Return on Capital
This is sometimes referred to as the cost of money. It is the Weighted Average Cost of Capital (WAAC). This is the average rate of return that companies are expected to pay to its debt and equity holders. This is influenced in part by the prime interest rate as well as other market forces and conditions. This information is readily available for all publicly held companies.
Risk Premium
Cost of uncertainty based on a country’s sovereign risk as well as uncertainties in the oil and gas industry. This is influenced in part by the host country’s credit or bond rating, where applicable as well as other market forces and conditions.
3. Sales costs (if applicable)
This cost is only relevant if the host country’s share of royalty is computed after the sale of the product rather than before sale.
Transporting Costs
Cost of getting the product to the Market
Selling and General Administrative Costs
Salaries wages & other indirect costs incurred by the Sales Department in the sale of the product. Typically companies have a stated General & Administrative (G&A) rate that they apply to other costs.
Floyd N. Haynes
Certified Public Accountant
Ramdihal & Haynes
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