Oil and Natural Gas depletion in Trinidad & Tobago:

Revenue Capture, Investment and Equity

Justin Ram

What I will cover

• Basic ideas around sustainability

• User costs / depletion and its measurement

• Depletion estimates for Trinidad & Tobago

• Modification to depletion estimates

What is Sustainable Development

• The notion of having growth without compromising or impoverishing future generations?

• The problem is really one of intergenerational equity.

Sustainability

• The level of consumption of future generations ≥ the consumption levels of current generations.

• This can be assured if the total stock of capital is sufficient to provide this; natural, man-made, human, social and financial.

What does this mean for an oil & gas economy?

• Hicks’ theory of wealth and income, assumes that income is a rate of return on comprehensive wealth/capital within society.

• If we are depleting one form of national capital (oil and gas), it needs to be replaced by other forms of capital if the welfare of future generations is to be maintained or improved.

Do we know what the level of depletion is or how it should be measured?

• Should it be a physical measure or monetary measure?

• What is it that oil and gas provides to current welfare, that if it was depleted it would not provide to future generations?

e.g.

Foreign exchange provision, consumption possibilities, poverty reduction, infrastructure spending and education.

Adjusted net savings (ANS) for T&T in 2008

-40

-30

-20

-10

0

10

20

30

40

Pe

rce

nt

of

GN

I

- Depreciation

of Fixed

Capital

+ Educational

expenditures

- Depletion

of natural

resources

- Pollution

Damages

Gross Savings Genuine SavingsDepletion Adjusted

Savings

Net Savings plus

Educational

Expenditures

Net Savings

ANS over time as a % of GNI

-25.00

-20.00

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

AN

S R

ate

s e

x P

M10

po

llu

tio

n

Adjusted Net Savings (ANS)

Average ANS 1970-2008

What’s driving this?

-

10

20

30

40

50

60

70

80

90

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Millio

n b

arrels

of o

il p

er a

nn

um

-

5

10

15

20

25

30

35

40

45

BC

M o

f G

as p

er a

nn

um

Oil Production

Gas Production

-

50

100

150

200

250

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Ye

ars

Oil Time to Exhaustion

Gas time to Exhaustion

Why is T&T in this predicament and what does this mean?

Price/Costs

P2

Pure Rent

Other Rent

Cb Quasi rent

Government's share of rent

Minimum possible variable costs

0

Mine Capacity

Insufficient rent capture as well.

User costs/depletion is also important.

• Accounting for user costs is an important economic factor in determining the sustainability of current resource extraction patterns.

• The fiscal regime associated with the resource and the use of the revenue emanating from the exploitation of the resource are also important.

Accounting for user costs

Many methodologies that give different estimates:

• Total rent approach

• Marginal rent approach

• El Serafy / simple present value approach

• Quasi Optimal approach

• Real asset value approach

Six primary methods:

Method Formula Assumptions

Total Rent UCt = pqt – c*qt

Constant unit extraction

cost c*, Hotelling rule:

Δp/(pt – c*t) = r

Marginal Rent UCt = pqt – c’(qt)qt

Constant price,

increasing marginal

extraction cost,

Hotelling Rule

Exhaustion

)1( rN

pqtUCt

Constant price,

increasing marginal

extraction cost,

Hotelling Rule

Simple Present

Value (El Serafy

method) )1( r

N

cpqUCt

Constant total rent

Quasi-Optimal

(Vincent method) )1)(1(1

)(

rN

cpqUC

Constant price,

isoelastic cost function

with increasing

marginal costs, ‘near-

optimal’ path for

extraction and marginal

rents

Real Asset Value

tT

N

rtT

RnRpSp e

tTr

)1(

1 )(

Accounting prices,

constant unit rent

Strengths and weaknesses

Method Strengths Weakness

Total Rent Simple to calculate Estimates tend to be very high and

are unrealistic

Marginal Rent Simple to calculate, theoretically

correct

Marginal costs are difficult to

estimate

Exhaustion Simple to calculate, theoretically

correct

Marginal costs are difficult to

estimate

Simple Present Value (El Serafy

method)

Simple to calculate and avoids the

need to forecast prices

Provides low estimates

Quasi-Optimal (Vincent method) Theoretically refined approach that

uses a good proxy for cost increases

Assumes optimality, which is

unlikely in the real world

Real Asset Value Has some relation to prevailing

welfare conditions of country

Determining the accounting or

shadow prices could lead to some

ambiguity.

Estimates for T&T

-

2,000

4,000

6,000

8,000

10,000

12,000

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

US

$ M

illio

n

Total Rent

El Serafy (Simple PV)

Quasi Optimal

Real Asset Value

0%

10%

20%

30%

40%

50%

60%

70%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Dep

letio

n as %

o

f G

NI

Total Rent Method

El Serafy (Simple PV) Method

Quasi Optimal Method

Real Asset Value Method

El Serafy comparisons with other countries

0%

20%

40%

60%

80%

100%

120%

140%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

% o

f G

CF

Trinidad and Tobago

Barbados

Venezuela

Indonesia

Real Asset Value comparisons with other countries

0%

50%

100%

150%

200%

250%

300%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

% G

CF

Trinidad and Tobago

Barbados

Venezuela

Indonesia

What are the implications?

• T&T should be saving or investing considerably more of its oil and gas revenue?

• Are sufficient rents being captured?

• Is depletion occurring too fast, who is benefitting from this opportunity cost?

However, what about current consumption

Critique:

• User costs do not account for prevailing social conditions and consumption needs.

• …this could be the reason why it has little resonance with policy makers.

Accounting for poverty

• Therefore, it seems appropriate that the method used to estimate depletion should have a connection with level of ‘wants or needs’ within the society ideally measured by the poverty rate as a measure of societal deprivation.

• Depending on the level of poverty within a country, it makes sense for that country to exploit its natural resources for immediate consumption and not be overly penalised by wealth accountants.

Suggestion

• The suggestion is for depletion estimate purposes, that user costs be adjusted based on the needs within society. These needs specifically refer to the needs of those individuals living below the poverty threshold.

Depletion and poverty • Depletion = UCt - PTCt

• UCt – user costs in period t

• PTC – Poverty Threshold Consumption rate in period t

With:

• PTC = Ppov * (WPov – Ypov)

• Ppov – Total population living on less than poverty threshold income.

• Wpov – Per capita 60% median income wage.

• Ypov – Average per capita income of individual living in poverty i.e. below 60 % of median income.

Poverty adjusted user costs for T&T

Poverty User Cost calculations 2007

Median income per month 7,427

60% of median per month 4,456

Consumption gap per annum 35652

Total households 384,879

Households below 60 % median income (27 %) 103,917

Consumption user cost component TT$ million 3,705

Consumption user cost component US$ million 588

Poverty adjusted user costs for T&T

• This represents about 9% of total user costs (US$6311 million) if the real asset value estimate of depletion for 2007 is used.

Conclusion

• User cost estimates are integral for measuring sustainability.

• T&T has an insufficient savings and investment rate – the reduction in the total capital stock will lead to welfare reductions in the future – (West Indies cricket team effect).

Conclusion

• There are many reasons why policy makers do not account sufficiently for user costs – political economy, ‘anticipation of better times’.

• Also due to consumption needs.

• User cost estimates should therefore account for prevailing social conditions.

Conclusion

• User costs must first of all be captured.

• Then invested.

• T&T should invest or save total user costs less amount to eradicate poverty.

Thank You – the end

Questions

Justin Ram

j.a.ram@lse.ac.uk

justinram@hotmail.com

011 44 77 99 601 046