THE GOOSE IS ill !!!

Key trends in the hydrocarbon sector and implications for Government fiscal
position

Gregory McGuire
(Adopted from a presentation to the Conference of the Economy 2009(COTE’09), hosted
by the Department of Economics UWI St. Augustine October 1st 2009 )

It is now common knowledge that the performance of Trinidad and Tobago economy is
inextricably tied to the health of the energy sector. In the five year period 2004-08 ,
energy sector provided directly 40 % of GDP, 54 % of Government revenue and 88
%of merchandise trade. Its share of Government revenue and GDP is much larger if the
indirect contribution is considered. The robust average growth rate of 7.5 per cent per
year experienced during the period 2004-2008 was due mainly to energy sector expansion.
As we ponder on the future of the economy in general and Government fiscal position in
particular for the next few years, we need to understand what is happening in the
dominant energy sector. Sadly, the data show that the goose is ailing. The golden eggs of
the last ten years will not be easily hatched over the next decade. In fact, even before the
onset of last year’s crisis, the energy sector was showing signs of weakening. Energy
sector GDP decline in 2006 and 2007, but the impact on total GDP was masked by the
stronger performance of the non energy sector. The ability of the non energy sector to
sustain the momentum depends critically on Government’s fiscal position, as determined
by energy sector revenues.

Three key factors influence Government’s energy sector revenues output of oil and natural
gas and gas based export commodities, prices and the tax regime, particularly as it relates
to Exploration and Production. The latest available data indicate that crude oil production
for averged 114 thousand barrels per day in 2008, the lowest level in fifty years. As at
June 2009, the situation had deteriorated further with the half year production average
down a further 5 per cent to 109 thousand b/d. Unofficial data indicate that for the first
time since 1958, oil production dipped below 100 thousand b/d in July, a sharp fall from a
peak of 144 thousand b/d in 2005. The long awaited fiscal reform would have a bearing
on the rate of decline and indeed the future of the oil industry.
There is a growing tendency to brush aside data on oil production on the basis that
Trinidad and Tobago is now a gas economy. While this may be true, it must be borne in
mind that both in terms of energy content and market value natural gas but a fraction of oil
on a barrel equivalent basis. Will new gas output make up for falling oil production?
The situation in natural gas is very interesting. Over the last ten years natural gas
utilization expanded at an average rate of 16 per cent /yr driven primarily by the
commissioning of 4 new LNG plants, with additional contributions firm methanol and
ammonia and power generation sectors. Gas production increased in line to meet the
growing demand. It therefore begs the question whether this trend can continue?
The evidence over the last two years suggests that, at best, the energy sector downstream
expansion is stalled. Table 1 show that of the sixteen downstream energy sector projects
identified in the Vision 2020 Operational Plan 2007-10, only two- Methanol Holdings
AUM plant and NUCOR, has commenced operations. Two others are ongoing- Petrotrin
Gasoline Optimization and the Gas to Liquids plant. Both are long overdue and over
budget. Moreover, World GTL, Petrotrin’s joint venture- partner in the GTL project has
been placed in receivership!! Nine of the planned shortlisted investments are listed as
aborted, while the remaining three are classified as delayed. The later group includes the
Alutrint smelter and its promised downstream expansion expected to generate over 2000
jobs! This group also includes LNG Train X, which appear to have been delayed
indefinitely by the limited national reserves and the protracted negotiations with
Venezuela on the development cross border gas reserves. .
The optimism with which these gas based projects were announced in 2007 has now
dissipated due in part to the financial environment, the emergence of other low cost gas
locations in competition with Trinidad and Tobago, the gas reserves limitation and
Government’s fiscal constraints. The conclusion here is self evident. It is highly unlikely
that new gas production will make up for falling oil production. Therefore, GDP growth in
the energy sector over the next two to three years will at best be muted at around 1-2 per
cent. This prognosis renders the Vision 2020 target GDP growth of more than 9 per cent
per year highly unrealistic. With stagnant or falling output, Government’s revenue
prospects will be dependant on the level of prices.
.In the case of oil, the outlook for the next 18 to 24 months is for prices to remain in the
band of US$ 60-80/bbl. The major influencing factors are stronger demand, improvement
in global economic growth, the sustained discipline among OPEC members and relative
peace in the Middle East. This does not say however that the price used in the national
Budget should be shifted up and down speculatively. A flat price of US$ 50/bbl is
reasonable standard based on past fiscal performance and the market outlook for the next
24 months. Any excess revenue arising out of higher than budgeted oil prices or oil
production should be saved.

In the case of natural gas, the relevant gas price for making estimates of Government
revenue has been the subject of much debate and conjecture. Even Government ministers
appear to be unclear about the interpretation of the gas price used in the Budget. This
analysis assumes that the average well head price of natural gas in Trinidad and Tobago is
the gas price relevant to the Budget calculations. This is the price at which the
companies’ revenue and tax base is determined. However, the average well head gas
price therefore has several components the most important of which are:
i. The LNG netback price from the USA ( 30%)
ii. The LNG netback price from Europe( 25%)
iii. The average price from domestic market sales to petrochemical markets( 25%)
iv. – The average price from sales to other domestic markets.

Many commentators have complimented the Minister of Finance for what they perceive to
be a conservative gas price in the Budget. When all factors are taken into consideration
the budget price forecast seems overly optimistic. The expected average LNG netback
price combined with the wellhead price for gas sales to the domestic market yields an
estimated average well head price of US$ 1.85/mmbtu, nearly 50% below the price quoted
in the budget. To arrive at an average well head price of US$ 2.75/mmbtu, the average
LNG netback will have to be around US$ 3.60/MMbtu, which means that market prices
in the US and Europe would be in excess of US$ 7.00/MMbtu . There is broad consensus
that, at best, US gas prices will remain below US$ 4.00 /MMbtu, over the next 18 to 24
months. Prices in Europe and the Far East, which are linked more closely to the oil
market, will be slightly higher, but not high enough to result in the average implied by the
budget price. These estimates imply that the energy sector revenues of $9 billion
budgeted for 2009-10 may be overstated. It also means that over the medium term
Government should not anticipate the type of revenue flows from energy that
characterized the last four years. In 2008, for example, energy sector revenue amounted
to $ 25 .7 billion
The above context brings into sharp focus the issue of the new fiscal regime. Historical
evidence suggests that an appropriate fiscal regime could stimulate new exploration
activity, revive old and marginal wells and fields. One senses that the root cause of the
problem is finding the right balance between the Government’s revenue maximization
ambitions and the Companies’ profit motive.
A recent study by D. J. Johnston indicated that Trinidad and Tobago, with a government
take of about 80 %, ranked in the top ten among oil producers with the highest taxation
levels. Significantly the countries ranking above T& T are distinguished by the large stake
of the National Oil Company and the marginal role of the multinational majors.

There may be dire consequences of this delay including low interest in new exploration
and development, the extinction of marginal fields on land and offshore as a result of poor
economics, and an erosion of the Government’ bargaining position as the gas and oil
reserves continue to decline. The negotiators seem to have not given much consideration
to the fact that the real comparator for Trinidad and Tobago is not our past fiscal terms
but what obtains other deep water provinces such as Brazil, West Africa and the Gulf of
Mexico. There must be a recognition that T&T is in competition for the marginal
investment dollar, which the oil majors will place where they perceive there is the greatest
potential for success and returns.
The failure to settle the new fiscal terms casts a very long shadow over the industry and by
extension over the economy in the short to medium term.
Table 1

Project/Plant Investor Status

1. Gasoline Optimization Petrotrin Ongoing

2. Gas To Liquids World GTL/ Under construction

Petrotrin
3. Natural Gas Refinery Foreign Aborted
4. Ammonia Urea/ Melamine/ Methanol Ongoing ; Partial
(AUM) Holdings Start-up.
5. Ethylene Complex Westlake Aborted.
Chemicals.
6. UAN Complex AnsaMcAl Aborted
7. Ammonia-UAN La Brea Aborted
Nitrogen
8. Ammonia Urea Complex TEAL Aborted
9. Acetic Acid Urea Formaldehyde Not Identified Aborted

10. Methanol /Polypropylene(MTP) BASF/Shell Aborted

11. Malaeic Anhydride Processing ISEGEN (PTY) Aborted

12. Nucor Hot Briquetted Iron NUCOR Commenced

Operations
13. Steel Village Essar Awaiting financing
and Permitting.
14. Alutrint Smelter and GOTT Delayed
Dwnstream
15. ALCOA Smelter ALCOA Aborted
16. LNG Train X Gott and others Delayed