The oil company does benefit by inflating costs

Nov 30, 2018 Letters

---

 

DEAR EDITOR,

I write in relation to a letter included in the Kaieteur News on 29-Nov-2018 with the title “A flawed conclusion from flawed information”, authored by a Mr Clement Smith.
The letter in question makes a number of inaccurate points and I attempt to address these below. In summary, the oil company does benefit by inflating costs.

1.
Claim:
Mr Smith claims the USD 4.4 Billion Exxon cost estimate and technical aspects for the Liza 1 project were adequately reviewed by the Government in late 2016/early 2017.

Response:
This is an incorrect claim by Mr. Smith.
The review by the Ministry of Natural Resources (MNR) of the Field Development Plan (FDP) submitted by Exxon for the Liza 1 Project was inadequate because:
1a.
The review of the cost estimate and of the geology/reservoir were NOT even part of the scope of work of the company hired to perform the review. Please see extract below from report submitted by Intecsea (the company hired by MNR to review the FDP):
“….. Aspects of the Liza Development plan that were not reviewed are:
– Assessment of future phases of development
– Assessment of reservoir depletion plan and reservoir management
– Evaluation of project cost, schedule and economics ….”
So how could the cost estimate have been reviewed if the company responsible for the review did not even look at the costs?
1b.
The company hired to review the FDP was a small engineering firm which was completely out of its depth as it did not have the experience to review a complete FDP for a country. It was not WorleyParsons as claimed by Mr Smith, but it was Intecsea. This small engineering company is part of the WorleyParsons group of companies. Even the parent company WorleyParsons would have no business reviewing a complete FDP for a country.
Not only was Intecsea out of its depth technically, but they did not review Exxon’s cost estimate (see 1a above).

2.
Claim:
The letter by Mr Clement Smith claims the Exxon cost estimate of USD 4.4 Billion need not be reviewed because it is only a “best guess” and not a final cost.

Response:
No Oil & Gas (O&G) company proposes a USD 4.4 Billion estimate for a project based on a “best guess”. This would be insane, and none of the major oil companies are insane. Far from it. As someone who has worked for a major oil company, and has been directly responsible for a project budget of about USD 500 Million, I know oil companies do not make these types of billion-dollar financial commitments based on “best guesses”.
And secondly, the review of cost estimates is standard practice around the world with Production Sharing Agreements like the agreement between Exxon and Guyana for the Stabroek Block. All countries that competently manage their O&G industries place importance on reviewing estimates and allocate resources towards these reviews.
It is not just the cost that has to be reviewed, it is also the scope of work. The interests of oil companies and the interests of countries diverge in a number of areas. For example, oil companies are driven to produce oil as fast as possible (which usually means leaving significant amounts of oil in the ground), because they value immediate returns on their investments. Conversely, countries tend to be driven by maximising the ultimate amount of oil extracted from the ground, even if it takes a much longer time, as countries with sound national development strategies think generations ahead, and not just towards the next election.

3.
Claim:
Mr. Smith makes an analogy to the construction of a home where he suggests home owners should ignore the builder’s estimate because it is only an estimate.

Response:
His analogy is too simplistic and even disproves his point.
A project to construct a simple home is very different from a USD 4.4 Billion O&G project. But if we indulge Mr. Smith’s analogy, even his own analogy disproves the point he is trying to make. No sensible home owner would hire a builder without first reviewing the builder’s estimate.
Please also see my response No. 2 above regarding “best guesses”.

4.
Claim:
Mr. Smith claims Exxon would never inflate costs as Exxon has no reason to inflate costs. He further states that Mr. Mangal makes foolish claims by calling for Governments to scrutinise the cost estimates made by oil companies.

Response:
A significant part of the cost estimate submitted by Exxon will include the cost for services provided by Exxon itself, and not just those of its contractors. It is likely Exxon also will be charging the people of Guyana for the interest on loans it has taken out from itself. These costs have to be closely scrutinised by Guyana as Exxon will be inclined to pad all of its own costs. One cannot just wait for the final bill, but one has to scrutinise the estimate and challenge the estimate where necessary. This increases the chance that the final bill will be reasonable and acceptable to Guyana.
I will give a couple examples from my own experience when I worked for Chevron in the Philippines. Every year the operator Shell (the equivalent of Exxon) would propose a budget to its partners, Chevron and the government (Philippine National Oil Company). The partners were sometimes able to get the estimate down by 20% or more. Once the operator said it needed a completely new office building for itself, and we rejected it. Another time the operator claimed it needed a new enterprise software system, and we rejected it. These were all multi-million USD line items. By reviewing the operator’s estimates we could verify if the contracts the operator wanted to sign with its contractors were reasonable (for drilling deepwater wells, fabricating offshore platforms, etc), and these estimates were in the hundreds of millions of USD.

5.
Claim:
Mr. Smith implies oil companies and their contractors operate in an environment driven purely by market forces where contracts are always awarded to the most able at the lowest price, and that Guyana should sit back, relax and not worry itself about checking the contracts Exxon is signing with its contractors such as SBM.

Response:
The environment of international O&G billion-dollar projects and investments is not an environment driven purely by market forces. The O&G world is probably only second to the international arms trade world when it comes to the presence of hidden drivers affecting high stakes multibillion-dollar decisions, and when it comes to the presence of illegal payments being made to influence decision makers.
Guyana cannot sit back and assume market forces are acting in its favour.
The world of oil companies and their contractors is one of long-term relationships and back scratching. One where they all move about the globe together and act in cohort. This is not a vibrant open market place.
I believe Exxon hired SBM for all of its boats in Angola (FPSOs, i.e. floating oil production facilities), and will probably do the same in Guyana and Brazil. There are other contractors who compete with SBM, but Exxon continues to always hire SBM. Guyana needs to verify that the contracts between Exxon and SBM are reasonable.
There also is a risk of oil companies using their contractors to influence government officials. The major oil companies which believe they have reputations to maintain will refrain from inappropriate behaviour, but they may have an interest in turning a blind eye to their contractors indulging in unethical and illegal behaviour.
Please note, SBM was recently fined about USD 200 Million by the Brazilian government.

6.
Claim:
Mr. Smith implies Mr. Mangal is misleading the people of Guyana, and is not acting in the best interests of the people of Guyana.

Response:
I believe Guyana has a bright future with O&G and also with Exxon and other companies, but we have to work very hard to increase the chance that the future will be bright for the majority of the people. If we sit back, then the only ones to benefit will be the businesses (both foreign and local), corrupt government officials, and the property owners in Guyana. The poor people of Guyana, i.e. the majority, will not benefit, and will likely become poorer due to inflation.
Every piece of advice I provided to the government was to increase the chance of a bright future for the poor people.
I recommended the contract with Exxon for the Stabroek Block be released. All the ministers I met were against this recommendation, but the President recognised the critical importance of transparency and the President took the decision to release the contract.
I recommended that no more blocks be awarded by one-on-one closed door negotiations (which have a high risk of corruption), and instead be awarded by transparent auctions.
I identified the unacceptable sloth and inaction on O&G matters in the Ministry of Natural Resources, and the President took the decision to setup a new entity for managing O&G (i.e. the new Department of Energy). My last deliverable to the Inter-American Development Bank and the President was the implementation plan for the new Department of Energy.
There were many other issues on which I believe I advised the President so as to protect the interests of the poor people of Guyana (e.g. inappropriateness of using taxpayers’ dollars to develop Crab Island, need for a comprehensive and independent study of the natural gas opportunity considering impacts of sea-level rise and long-term national development, etc, etc). My last focus was to get a fair deal for Guyana on the Stabroek Block, and I highlighted the need for a re-negotiation of the contract.
I also highlighted the need for an investigation of the highly anomalous awards of O&G blocks under the previous government (PPP) just prior to the last election. No country awards blocks like happened just prior to the last election, and these awards mean Guyana lost Billions of USD. The people of Guyana need to protect what is theirs and they have an interest in this matter being properly investigated.
Although I may come across as being negative about oil and negative about elements in the current government, let me stress the following. Firstly, I believe in the oil industry, but it will only work in our favour if we pursue it in a particular way. Secondly, I believe Guyana is very lucky to have President Granger in place at this critical phase. The country would be worse off with respect to O&G if the behaviours exhibited under the previous government were being exhibited now.
Although there are numerous rotten apples in the current government, the President is a stabilising force. But I worry he is the only one who has grasped the magnitude of the opportunity before Guyana, and grasped the challenges/risks. I worry about his recent illness because the O&G situation would quickly deteriorate if President Granger is no longer at the helm. Some of those around him are frankly dangerous to Guyana, as were elements in the previous government.

Faithfully,
Dr. Jan Mangal

---

---