Challenge: Absorptive Capacity

Absorptive capacity has been defined as "a firm's ability to recognize the value of new
information, assimilate it, and apply it to commercial ends". It is studied on individual, group,
firm, and national levels. Antecedents are prior-based knowledge (knowledge stocks and
knowledge flows) and communication. Studies involve a firm's innovation performance,
aspiration level, and organizational learning. It has been said that in order to be innovative an
organization should develop its absorptive capacity,

Challenge: Enclave Economy

Turning to the economic challenge of an enclave economy, in Guyana this notion refers
to the situation in which, well-capitalised foreign-owned enclave firms extract petroleum for
export to the rest of the world, where it is either consumed and/or processed and re-exported. As
this develops, the enclave petroleum firms maintain minimal linkages and connections to the rest
of the domestic economy, which hosts it!
In a small economy like Guyana, the consequence of this is an economic system where
what is produced is not largely consumed domestically (directly or indirectly). The enclave
economy is therefore, distinguished by the peculiar feature of its not being integrated into the
remainder of the domestic economy; and alongside this, it remains closely integrated into the rest
of the world!
Challenge: Implementation Lags
In the Guyana Petroleum Road Map, the term “implementation lags” refers to all delays
encountered during the country’s preparations for its coming First Oil in 2020. It therefore
covers 1) a recognition lag, or the time it takes for the Authorities, industry operators, and other
key stakeholders to accept comprehensively the imminent development of Guyana’s petroleum
sector 2) a decision lag, or the time it takes to create a policy response to this, and 3) the
effectiveness lag, or the time it takes to get the complex state machinery operating in a manner
designed to deal with this coming formidable challenge.
In this formulation the State is treated as complicated, because this refers not only to its
executive function, but simultaneously to the legislative; judicial/legal; security; institutional;
financial management and fiscal/regulatory dimensions. At the core of this complexity is the
issue of timing. This core complexity makes implementation lags far from unique to the
petroleum sector. Indeed lags are a common phenomenon worldwide and lessons can be drawn
from these experiences.
Challenge: Intergenerational Equity
The notion of intergenerational equity has several components to it. These are not simply
economic in nature, but also apply across such crucial areas as environmental, sociological,
psychological, legal, and social matters. In these varied applications, the concept of
intergenerational equity conveys the principle of fairness across generations.
 Consequently, three petroleum industry-related concerns arise. First, Guyana’s petroleum
discoveries are, for practical purposes, finite and non-renewable. Consequently, after peak
production is attained, petroleum resource depletion kicks in. Thus, if these resources are to
benefit present and future generations, then fairness in their current use is an absolute obligation
to future generations.
Second, the petroleum industry is notorious for engendering environmental damage; due
to a mix of factors, including: willful neglect, cutting corners, lack of suitable preparation, and
the proverbial Acts of God. It is unfair therefore, for the present generation to use Guyana’s
petroleum patrimony, and leave behind related environmental damage, to be attended to by
future generations. This, however, raises a major practical issue: how to measure
intergenerational equity when every generation has an obligation to pass on petroleum assets in
reasonable condition to future generations?
Third, it follows that, Guyana’s long-term development strategy of promoting a “Green
State and Sustainable Development”, clearly, conflicts with a petroleum dependent path of
economic growth.
In conclusion, my earlier treatment of this topic I had highlighted the paradox that, “our
obligations to future generations compete with our obligations of justice to contemporaries”.
This paradox raises serious risks. One of these is, treating intergenerational equity as a zero-sum
game; where one generation’s benefit is another’s loss!
Challenge: Dutch Disease
Dutch disease is the apparent causal relationship between the increase in the economic
development of a specific sector (for example natural resources) and a decline in other sectors
(like the manufacturing sector or agriculture). The putative mechanism is that as revenues
increase in the growing sector (or inflows of foreign aid), the given nation's currency becomes
stronger (appreciates) compared to currencies of other nations (manifest in an exchange rate).
This results in the nation's other exports becoming more expensive for other countries to buy,
and imports becoming cheaper, making those sectors less competitive. While it most often refers
to natural resource discovery, it can also refer to "any development that results in a large inflow
of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and
foreign direct investment".
Challenge: Recourse Curse
The resource curse, also known as the paradox of plenty, refers to the paradox that
countries with an abundance of natural resources (such as fossil fuels and certain minerals), tend
to have less economic growth, less democracy, and worse development outcomes than countries
with fewer natural resources. There are many theories and much academic debate about the
reasons for, and exceptions to, these adverse outcomes. Most experts believe the resource curse
is not universal or inevitable, but affects certain types of countries or regions under certain
conditions
Challenge: Budget Rule (PIH)
Revenue Watch Institute (RWI), 2014 describes a fiscal budget rule as “a multiyear
constraint imposed on Government finances”. This is normally expressed in the form of
determinative revenue, expenditure, or debt targets. RWI has identified five options worldwide
as representing the major types or classes of fiscal rules utilised in petroleum-rich exporting
countries. These are the Balanced Budget Rule, as typified by Chile, Mongolia and is listed as
the first rule in the classic RWI publication: Fiscal Rules for Natural Resource Funds, (2014).
This is followed by the Debt Rule, as typified by Indonesia and Mongolia again. Next is the
Expenditure Rule, as typified by Botswana, Peru and Mongolia yet again. Finally, there is the
Revenue Rule as typified by Alaska, Ghana, Kazakhstan, Timor-Leste and Trinidad and Tobago.

Challenge: Expectation Management

The Economic Glossary puts it simply, expectations refer to “what people or businesses
anticipate will happen” especially in markets. This is so crucial a consideration that, in
“modelling market demand and supply schedules, expectations are held constant”. With the
emergence of Guyana’s petroleum industry there are expectations among most groups that there
will be “windfall revenues”. These revenues, they fear, may bring the risk of the “lottery-
syndrome”.
This syndrome describes the “stereo-typical non-rational behaviour” of some lottery
winners, who have so mismanaged their good fortune (winnings) that they actually end up
poorer! This may be rare, but it has happened. And, it is precisely because of this possibility that,
managing expectation constitutes one of the most potentially difficult of all the challenges.
Because of this risk of the lottery-syndrome, the Government of Guyana (GoG) may become so
risk averse that it hoards and not spends its petroleum revenues to promote development.
Hoarding is investing these “assets” in so-called safe overseas financial institutions. I label these
as “so-called safe” because of the mounting scandals associated with “managers of oil-rich
developing countries, natural resources funds”.
Wrapping-up the discussion of Gov’t Spending and the Tenth economic challenge-
September 29, 2019
IMF-International Monetary Fund
IMF Fiscal Transparency Code
The IMF has defined “fiscal transparency” as the “information available to the public about the
Government’s fiscal policy making process”. In turn this refers to the “clarity, reliability,
frequency, timeliness and relevance of the public fiscal reporting and the openness of
information” (IMF, 2014). For readers’ convenience, these six components are captured in
Schedule 1 below.
Taking the global and regional situation into account, I contend that, from the
macroeconomic management standpoint, the Transparency Code can help Guyana to mitigate,
through global and regional cooperation, adverse transmission effects; especially from price
volatility, which as readers are aware, is firmly embedded in petroleum markets.

Why a State-owned oil-refinery makes no economic sense- October 6,2019

What is an Oil Refinery?
It is useful to begin the discussion by asking the basic question: what is an oil refinery?
The standard description is: “an industrial plant that refines crude oil into a multiplicity of
petroleum products”. Such a plant adds value to the extraction of Guyana’s crude oil discoveries.
From this perspective, establishing an oil refinery in Guyana must be located in a global context,
since the petroleum products produced must be sold in markets far larger than Guyana’s, if the
refinery is to be commercially feasible. The next question that follows is: What is the state of
global oil refining?

Global Refining
Presently, approximately 100 million barrels of crude oil are processed each day. This
figure is up by about 14 million barrels per day (b/d), since the mid-2000s. There are
approximately 700 oil refineries, worldwide. This number and its distribution are revealed in
Tables 1 and 2. To add to this information, it is noted that, at the latest count, as many as 116
countries worldwide have established oil refineries! Their geographic distribution across regions
is wide, including also in the Caribbean area.
More on why a state-owned oil-refinery does not make economic sense- October 13,2019
Oil Refinery Capability
Oil refinery capability refers to the petroleum products which are produced from crude
oil. The basic requirement of all oil refineries is a distillation column. Typically, this separates
the crude oil into different petroleum products, based on their differing boiling points. The
distillation column is combined with secondary processing units. The information in Table 1
shows the varying boiling points for a sample of crude oil and its product derivatives.
Empirics: Nelson Complexity Index
The Nelson Complexity Index measures oil refining capability and complexity by the
level of secondary conversion capacity there is in the refinery, after taking into account the cost
of each major type of refinery equipment. For the Index, the distillation column is given a value
of 1 and the other units in the refinery are then assigned values on the basis of their conversion
capability and their cost relative to the distillation column, which is valued at 1. The larger,
therefore, the Nelson Index, the more complex is the refinery. And the more complex is the
refinery, the more capable it is of producing higher valued products. And, correspondingly, the
more costly they are to build and maintain.
Typical complexity factors are shown in Schedule 1. Two decades ago, back in the
2000s, the global value of this Index was 5.9

The Perspective of Private Sector Proposals to build oil-refineries- October 20,2019

Refinery Performance and Economics
Energy economists posit the strong view that, the performance of “mini oil refineries” (as
well as their “conventional” counterparts), must be treated as a function of seven crucial
variables. These variables are: 1) their location 2) their vintage (or level of complexity) 3) the
prevailing availability of investment funds 4) the availability of the “right” crude oil 5) the
specifications and requirements associated with the products the oil refinery produces 6) the
applicable environmental laws, regulations, and standards (local and international); and, 7)
“other applicable” local regulatory standards, such as various tax incentives, other tax
expenditures and credit facilitation.
Why a State-owned Oil Refinery makes no economic sense now- October 27,2019
Refinery Economics
The Haas’ Study identified the need for a “grassroots” refinery. That is, one built from
scratch (including refinery infrastructure). It is also expected to be constructed “at one go”. The
methodology utilised followed standard lines.
Thus, given expected prices, experts provided capital estimates, (construction costs and
their timelines); operating costs and revenues were proxied from existing refinery margins,
bearing in mind the estimated refinery configuration and what this predicts for capacity,
capability and complexity, and therefore, the refined products produced.
Refinery Model Assumptions
Several assumptions were employed for estimating refinery viability. These include:
1) size: 100,000 barrels of oil per day
2) the complexity level of fluid catalytic cracking
3) A 10-year average margin of a 50/50 mix of a Louisiana heavy and light low sulphur
oil in a typical US Gulf Coast refinery (US$5.84)
4) overall construction cost of US$5.2 billion
5) cost of debt equivalent to the Bank of Guyana’s 364-day Treasury, plus a 0.5%
premium; 6) a cost of 10%;
6) an exchange rate used of GY$206.5 to US$1
7) operating costs for the refinery are proxied by the IEA’s refinery margin estimates,
and given as US$3.30 per barrel of oil. And, finally, the timeline for construction of
the refinery is 60 months, with the project life that normally applied in such studies
─ 30 years. Given the refinery capacity, on completion, it exports the refined
products, which are not consumed locally.
IRR
The Internal Rate of Return (IRR) of the oil refinery project is negative.

NPV
The Net Present Value (Present Value of All Benefits less Present Value of All Costs) was minus
3.04 billion US$ for the base case scenario. The Study refers to two other scenarios for basing this
calculation; one of which obtains when the “location factor” for a Guyana grassroots refinery is calculated
at 20% and its offsite construction factor is costed at a factor of 80%. Here the result is minus 2.44 billion
US$. For the other scenario, the “location factor” is set at 40% and the grassroots effective construction
factor is set at 120%. In this case the negative NPV rises to minus 3.69 billion US$.

Decision Rules to Guide Investment in Downstream Oil-refining- November 3,2019

Private Refinery Proposals
I start with the observation that back in 2017, when I had first addressed this topic, there
were several private proposals to build refineries in wide circulation. Now, over two years later,
there is virtually no public comment on private refinery investments, despite the fact that First
Oil is as imminent as next month.
Nonetheless, I believe the economic features of modular mini-refineries remain attractive,
even though these are not attractive enough, in my own opinion, to warrant state participation!
To make this point, carefully, I start by briefly re-capping the commendable features of mini-
refineries, as I adduced them back in 2017.
Summary Features
There are 12 key economic considerations that make modular mini refineries attractive
for both private and state investors.
These are:
1) their pre-fabricated, skid-mounted construction, which makes them manageable in
Guyana-type environments
2) their “broad availability” in various sizes and configurations
3) their “manageability” in developing-country situations, given their small scale
4) their lower risk of “episodes of country-wide refinery failure”
5) the growing global experiences, with such refineries
6) their quick construction and short-term, stop-gap capability
7) their relatively low absolute dependence on state support
8) their locational versatility
9) their low investment/capital construction cost, which supports the principle: the less
state support the better
10) their flexibility
11) the growing evidence of increasing innovation and competition in these refineries;
and, finally
12) their suitability for flexible project financing.

Decision Rule 1: Private Oil Refinery

Because of these features, and, given Guyana’s capital market and private investors’ capability,
the overwhelmingly likely investments in a private refinery based on Guyana’s crude would
typically fall in the class of “small modular mini-refineries”. My decision rule, therefore, is: “if a
local oil refinery is established that is wholly owned, managed and operationalised, either
separately, or through a “partnership” (or some other joint arrangement), involving only 1)
foreign investors (whether these are private, state, or some combination thereof), or 2) domestic
private investors, this should be given the go-ahead, subject to one important “proviso or
caveat”.
Decision Rule 2: State Refinery
Based on the Haas study referred to last week, and given a worst case scenario, where that
feasibility study is only rated at 4 on a scale of 1-10 (with 10 being the best), it would be
economically unjustifiable for the State to opt for putting resource gains from its petroleum
wealth into a state owned, controlled, and operated oil refinery. My indicated decision rule holds,
given the context of 1) the economics of oil refining, 2) the most nationalist and sympathetic
interpretation of local content policy, and 3) absence of any proof that the author/sponsor of the
Haas study for the Ministry of Natural Resources fabricated the results, in order to deny Guyana
its “birthright” (an oil refinery), as some readers have indeed urged!

Natural Gas in place of value-added refining- November 10,2019

Guyana’s Natural Gas
The United States Geological Services (USGS) has provided two estimates of the
Guyana-Suriname Basin’s potential for natural gas; one in 2000 and the other in 2012. These are
shown in Schedule 2.
Two years ago, I had supported Government’s decision to engage Energy Narrative, to
undertake “a desk study to determine the options open to Guyana’s natural gas finds”.

Natural gas usage is relatively clean and affordable.

This study sought to determine for “official purposes”, the following: 1) the probable size of
Guyana’s “associated and non-associated” natural gas supply and demand; 2) the various market
and other economic options open for its usage; 3) likely costs; 4) the technical/commercial
feasibility of bringing national gas on-stream; 5) the technical/commercial feasibility of various
modes of transporting natural gas from offshore; 6) the economics of Guyana natural gas storage;
7) natural gas usage for generation and/or co-generation of electricity (technically and
commercially); and 8) other related matters (like accidents, environmental impacts, and health
impacts) as well as national security concerns.

The Department of Energy is reporting that initially, natural gas will be “on shore by 2023, but
the gas would not be available in significant quantities until 2035”.

I recommend Guyana’s pursuit of its natural gas option as an appropriate replacement for state
investment in oil refining.
This is all the more disconcerting as I have come across press reports that suggest Exxon Mobil
and its partners will be following the industry practice of pumping the natural gas back into the
oil reservoirs, in order to raise their pressure to facilitate extraction of crude oil.