Economic double whammy: Declines in Energy and Non-energy sectors, Part III

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Read Part 1 of this story here: Economic double whammy: Declines in Energy and Non-energy sectors, Part I

Read Part 2 of this story here: Economic double whammy: Declines in Energy and Non-energy sectors, Part II

Threats to natural gas sector

In two previous comments, the TTWhistleblower explored the challenges faced by a declining non-energy sector, and dug deeper into the harsh conditions that face energy sector stakeholders. Today, we continue with the Poten report’s findings and recommendations in Part III of Economic double whammy: Declines in Energy and Non-energy sectors.

Poten position as at 2015

The Poten report on the natural gas sector was commissioned by former Energy Minister, Kevin Ramnarine, at a cost of US$1.4 million, and delivered in September of 2015. The report revealed a number of inconvenient truths that the present PNM and future Governments must face if we are to get fair value for declining energy resources, in a global sector that is severely challenged.

As at 2013, Trinidad and Tobago’s proven natural gas reserves stood at approximately 12 trillion cubic feet (TCF) and averaged maximum average demand of 4,423 MMcf/day or 1.616 TCF/year.

The report stated proven reserves peaked in 2002 at approximately 20.8 TCF. During 2003 and 2004 there was almost 100% reserves replacement because of the energy policies implemented in the years before, but by 2006 proven reserves had dropped to 17 TCF.

Public debate has remained vigorous on whether Trinidad and Tobago receives its fair share in the value for its natural gas resources from upstream investments and production; natural gas liquids; liquefied natural gas (LNG) and downstream through power generation and industry.

Poten suggested that one of the more substantial downsides of the operations of the natural gas sector was found to be transfer pricing: “Generally, the companies responsible for marketing the product have supply/offtake contracts with the producing company including exclusive long-term supply contracts. The terms of the offtake agreements are commercially confidential and transfer pricing is not transparent.”

In business operations, a transfer price is a theoretical value at which goods and services are traded between divisions in a decentralized organization. This business method can be used for performance monitoring to ensure departments meet strategic business targets.

Unfortunately, this business model can also be used to avoid profit taxes by claiming lower profit figures by creating theoretical costs between departments, despite there being not actually exchange of funds.

In most jurisdictions where energy firms operate, taxes are levied on profits based on a complex matrix of fiscal incentives. With transfer pricing providing an ‘out’ by generating notional internal costs to the business, it makes a justifiable argument for publicly posting lower profits than were actually achieved.

This could mean that the jurisdiction would be levying taxes based not on actual costs and income, but by factoring in these notional costs to conceal actual profit figures. This approach robs the energy rich jurisdiction of revenue to support its economy.

The report introduced its in-depth analysis of the gas sector saying: “T&T’s economy is highly dependent on the energy sector, which over the last decade has accounted over 40% of national GDP and around 54% of GORTT tax revenues. The sector is responsible for around 85% of the country’s exports, of which the majority is from natural gas. The tax revenues from the energy sector have grown with the development of gas utilisation over the last decade and in 2013 represented around TT$20 billion.”

Poten stated developments in both the local and global gas markets pose a threat to the local natural gas sub sector.

One local business magnate noted, this could mean that construction of the ALNG Train IV was a bad investment as it increased upstream activity matched with increased production with new gas contracts, but without an appropriate reserve replacement policy. This was, in part, natural gas demand rose beyond a sustainable level.

Trinidad and Tobago’s gas-based economy went into steady decline in gas reserves in the post-2002 period, eventually coming to a proven reserves to production (R/P) position of 8.3 years at the end of 2013. Poten suggested that new gas sales contract and fiscal terms will need to reflect higher exploration, development and operating costs encountered in the upstream sector which has significant implications for the downstream gas-consuming sector.

The challenge for Trinidad and Tobago

According to Poten, in 2014 T&T gas production was an average of 4.07 Bcf/d, with bpTT, BGTT, EOG accounting for nearly 90% of gas production in the country.

The report lists bpTT as the largest gas producer in T&T, with 10 gas fields in production, mostly in the East Coast Marine Area (ECMA) of the Columbus Basin.

In 2014 the energy giant produced an average of 2.17 Bcf/d, which accounted for 53% of the total production. BG produced an average of 0.93 Bcf/d (23% of the total) from seven fields in the ECMA, NCMA, and Central Block.

By the Poten report’s measure, the key challenge for T&T is now to incentivise enough exploration activity in deep-water blocks in an early enough timeframe to ensure that any gas present is developed in time to backfill the shallow-water production profile.

Following a deep-water bid-round in 2011 bpTT, Repsol and BHP Billiton won bids and production sharing contracts (PSCs) for this country’s first foray into deep sea energy exploration.

Repsol and BHP Billiton entered into the joint PSC for Block 23(b), off the east coast of Tobago. This particular block is prospective for both oil and gas and at that time of signing in 2013, then Energy Minister Ramnarine said seismic data suggested the block could hold anywhere between “304 to 907 million barrels (mmbls) of crude and 1.6 to three trillion cubic feet (TCF) of gas.”

The entry to deep-water exploration was in line with Poten’s proposal that urgent work was required to incentivise investments in the upstream (exploration) to ensure that the supply of gas to industry would be maintained and possibly increased in the near and medium-term.

The Poten report stated only one-third of deep-water blocks have been licensed and 8 exploration wells committed in the first term work programmes, and the midstream and downstream gas industry in T&T needs upstream deliverability of 4.3 Bcf/d in order to run at capacity.

How T&T uses its natural gas

Poten supported Trinidad and Tobago’s position as a major gas export jurisdiction both directly, in the form of liquefied natural gas (LNG), and indirectly through gas-based petrochemicals (ammonia/urea, methanol). This country ranked as the sixth largest producer of LNG in the world in 2014.

The sale of these products collectively account for approximately 80% of gas consumption: LNG accounts for 58% of consumption capacity; ammonia industries for 16%, and methanol for 15%.

The consultants have projected that the largest LNG markets will continue to be those of Asia, which is expected to account for around 70% of demand by 2025. The European market, which has been an increasingly important market for T&T LNG is expected to grow in this period, but at a much lower rate than Asia.

Poten has suggested that global methanol demand is expected to reach 117 MMt/y by 2025. This may not be the best news right now as Trinidad and Tobago’s Methanol production has declined in the recent past, due to under-supply of natural gas as feedstock.

Natural gas pricing

In Trinidad and Tobago, Poten found that the price of gas is set according to end-user. As a result, prices vary according to buyer: LNG, petrochemical production, power generation, heavy industry, or general commercial as shown in the following table:

End Use                                                                                   Pricing Mechanism
LNG                                                                                         Netback pricing
Petrochemical (ammonia and methanol)                               Product indexed pricing
Power Generation                                                                   Set by GORTT
Heavy industry                                                                        Cost plus
Light industry                                                                          Cost plus

Commercial                                                                            Set by GORTT

The use of netback pricing in LNG and petrochemical gas supply already allows T&T to share in the upside movement of commodity prices. The key issue, however, is not the pricing mechanism, but rather energy products attracting the highest value markets and whether the price mechanism captures the appropriate resource rent.

All sub-sectors considered, Poten found that the structure of pricing arrangements and use of netback price benchmarks have NOT delivered the kind of value to Trinidad and Tobago for its natural gas as it should have.

The Poten reports states: “Unfortunately for T&T, as detailed earlier in this section, the commercial and contractual structures of ALNG trains have been such that little of the benefit from high global LNG prices has flowed back to T&T.”

“This is illustrated by the low netback prices that have been realized over recent years (weighted average of $2.42/MMBtu in 2012, $3.07/MMBtu in 2013 and $3.22/MMBtu in 2014). As well as ammonia, methanol has also outperformed LNG over recent years, with weighted average netback prices of $3.90/MMBtu in 2012, $5.00/MMBtu in 2013 and $4.80/MMBtu in 2014.”

Also given the current natural gas supply setbacks and the demand by industry, Poten suggested there will be a need for active management of supply into consumption adding:

Given the knowledge that there is insufficient supply to meet the volume requirements of remaining contracted supply it would not appear prudent for NGC to extend any of its contracts that expire before 2019.”

Poten also noted there is at present no approved policy covering the gas sector for the master plan period. The Ministry of Energy draft Green Paper sets out the objectives for the energy sector and has a number of policy goals related specifically to the gas sector. However, it is not a Government-approved document.

Fiscal incentives

The Poten Report also focused on the energy sector’s competitiveness, stating: “Although T&T is a reasonable place to do business, improvements in fiscal terms and gas market accessibility are required to further attract investment.”

The PNM Government’s energy policy, however, is still unclear, with statements that have stopped short of a robust commitment to improve the sector.

In January, Finance Minister Colm Imbert, acting as Energy Minister told the annual Energy Conference that Government will restructure the fiscal regime for oil and gas production. He said the undertaking would be subject to a review by the International Monetary Fund (IMF).

This, however, differed from Imbert’s complaint in March 2016, that a bpTT tax write-off could hurt Trinidad and Tobago’s 2016-revenue position. At that time, bpTT had confirmed exploration investments of up to US$1.5 billion.

By October of 2016, bpTT Country President, Norman Christie was reported as saying: “If by the end of the year the Government and bpTT cannot reach agreement on “key issues” surrounding a new natural gas contract for Atlantic LNG, a new contract with the National Gas Company and the gas master plan then this country will again face gas shortages within the next four years.”

By December 2016, the Energy Chamber expressed mixed views and moderate optimism for improvement and acknowledged that it was “a tough year for energy”.

The Energy Chamber stated in its end of year round up: “The right policy environment could lead, in time, to increased production of both oil and natural gas… “However, if increases in production are to be sustained, policy decisions are required to ensure that Trinidad and Tobago is competitive and able to attract investment capital.”

Stating that significant discussions took place between Government and Energy Sector stakeholders in 2016, “clear detailed policy statements and actual changes to the taxation regime have not yet been forthcoming.”

Despite its optimism, however, the Energy Chamber expressed a level of dismay, saying: “The past year was tough for the energy sector and 2017 is unlikely to be much better.”

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