National Hydrocarbon Accounting: A New Methodology for Oil-Rich Countries

The Natural Resource Governance Institute has posted a discussion paper demonstrating how governments and citizens alike can tap open data to analyze countries’ hydrocarbon sectors.

The paper showcases a new “national hydrocarbon accounting” approach, an integrated methodology for accounting for both physical hydrocarbon resources and the revenues they generate at a national level. National hydrocarbon accounts bring together the information required to answer three key questions: How much oil and gas does the country have to extract? How much profit does it generate? And how much of that profit does the government collect on behalf of its citizens?

It utilizes an annual income statement, balance sheet and cash flow statement together with an annual reserves and resources report to analyze the state of the national hydrocarbon sector. It can be used to monitor the performance of the hydrocarbon sector, provide a foundation for revenue and production forecasting, and highlight data disclosure gaps or improve data sharing practices within government.

Since the launch of the global transparency movement, initiatives targeting the extractive sector have led to significant achievements in terms of disclosure of payments made to, and received by, governments. This push for open data in the extractive sector is motivated by twin objectives; to improve accountability by empowering citizen oversight, and to strengthen the government’s ability to manage resources effectively on behalf of its citizens.

Revenue flows to the government reflect physical production levels, the cost of production, and the government’s share of any profits generated. Making sense of payments made to and received by the government requires placement of the numbers into context. Annual data may reflect of contracts and investment decisions made years previously, whilst the sustainability of resource flows reflects the quantum of extractable resources and the rate of depletion.

The national hydrocarbon accounting (NHA) approach is aimed at bringing together in one place the key information needed to allow a concerned citizen to evaluate how well hydrocarbon resources are being managed on his or her behalf.

National hydrocarbon accounting tracks the discovery, development and production of physical oil and gas resources, together with sales revenues, costs, taxes and royalties in order to monitor rent generation and rent sharing between companies and the government. Using data published by the UK government, the application of NHA to the UK’s territory in the North Sea demonstrates how this approach can be used to monitor the historical performance of the country’s oil and gas sector over a 40-year period.

This paper highlights that government revenue data for any one year needs to be considered in the context of fiscal terms, contracts, and physical reserves and production volumes, capital and operating costs, and technical risks. Furthermore, this approach can be useful in the context of developing countries for highlighting gaps and weaknesses in data disclosure.

The government’s share of the profits generated from oil and gas production is often used when judging the “fairness” of state-investor contracts. The paper finds that the UK government captured just over half of the pre-tax profits generated between 1970 and 2012 in the North Sea. Government revenue peaked in 1984, nine years after production started, and has been very volatile.

However, a range of metrics are required in order to analyze how well a nation’s oil and gas endowment is being managed, how sustainable the resource base is, or for forecasting future revenues. These include the recycle ratio (RR), the proportion of profits reinvested domestically, and the return on capital employed (ROCE), which is a measure of investor returns. The study finds that both RR and ROCE have fluctuated over time in the UK, as they are both very sensitive to oil prices.

The UK experience also shows how difficult the decline phase of a geological basin can be to manage. From 2000 onwards production declined year on year but rising oil prices meant industry post-tax ROCE increased to above 40 percent whilst less than 50 percent of profits were being reinvested in the domestic industry. Mature fields with capital largely depreciated were still very profitable, but the industry was not investing sufficiently in bringing new fields into production.

Tailoring the regulatory and fiscal regime through the life cycle of a geological basin to secure the required investment, whilst maximizing returns to the state is a significant challenge. National hydrocarbon accounts bring together the key information necessary to judge just how well that challenge is being met.

Ability to answer key governance questions using various data sources

This set of measures can provide a context for discussion about sector performance and for making future projections. The measures allow a citizen to learn the answers to several key questions. How much of the resource do we have? How sustainable is it? How much does it cost to produce? How much is it worth? How much value, for the public good, is the government capturing from resource extraction? Is all the information accurate and in the public domain to allow me to make these calculations?

In light of the move to more transparency and greater public access to data, it is perhaps timely to start an informed debate about the evaluation of government performance in the management of the oil and gas sector. It is important to analyze not just what these governments receive in revenue for their oil and gas reserves, but to track the full cycle from discovery to production and eventual exhaustion of this precious resource.

Keith Myers is a NRGI advisory council member and a partner at Richmond Energy Partners.

NRGI invites discussion on national hydrocarbon accounting as a new approach and will be working to further develop it for application in oil-rich developing countries. If you are interested in getting involved or have feedback, please contact Jim Cust at jim.cust@naturalresourcecharter.org, or the author Keith Myers at kmyers@richmondep.com.