Please come and kick the tires of our open model of an oil contract!

In the next month or so, OpenOil and its partners will publish what we believe will be the first financial model of an oil contract under Creative Commons license. We would like to take this opportunity to invite the Open Economics community to come and kick the wheels on the model when it is ready, and help us improve it.

We need you because we expect a fair degree of heat from those with a financial or reputational stake in continued secrecy around these industries. We expect the brunt of attacks to be on the basis that we are wrong. And of course we will be wrong in some way. It’s inevitable. So we would like our defence to be not, “no we’re never wrong”, but “yes, sometimes we are wrong, but transparently so and for the right reasons – and look, here are a bunch of friends who have already pointed out these errors, which have been corrected. You got some specific critiques, come give them. But the price of criticism is improvement – the open source way!” We figure Open Economics is the perfect network to seek that constructive criticism.

Ultimately, we want to grow an open source community which will help grow a systematic understanding of the economics of the oil and gas industry independent of investor or government stakes, since the public policy impact of these industries and relevant flows are too vital to be left to industry specialists. There are perhaps 50 countries in the world where such models could transform public understanding of industries which dominate the political economy.

The model itself is still being fine-tuned but I’d like to take this chance to throw out a few heuristics that have occurred in the process of building it.

Public interest modelling. The model is being built by professionals with industry experience but its primary purpose is to inform public policy, not to aid investment decisions or serve as negotiation support for either governments or companies. This has determined a distinct approach to key issues such as management of complexity and what is an acceptable margin of error.

Management of complexity. Although there are several dozen variables one could model, and which typically appear in the models produced for companies, we deliberately exclude a long tail of fiscal terms, such as ground rent and signature bonuses, on the basis that the gain in reduction of margin of error is less than the loss from increasing complexity for the end user. We also exclude many of the fine tuning implementations of the taxation system. We list these terms in a sheet so those who wish can extend the model with them. It would be great, for example, to get tax geek help on refining some of these issues.

A hierarchy of margins of error. Extractives projects can typically last 25 years. The biggest single margin of error is not within human power to solve – future price. All other uncertainties or estimates pale in comparison with its impact on returns to all stakeholders. Second are the capex and opex going into a project. The international oil company may be the only real source of these data, and may or may not share them in disaggregated form with the government – everyone else is in the dark. For public interest purposes, the margin of error created by all other fiscal terms and input assumptions combined is less significant, and manageable.

Moving away from the zero-sum paradigm. Because modelling has traditionally been associated with the negotiation process, and perhaps because of the wider context surrounding extractive industries, a zero-sum paradigm often predominates in public thinking around the terms of these contracts. But the model shows graphically two distinct ways in which that paradigm does not apply. First, in agreements with sufficient progressivity, rising commodity prices could mean simultaneous rise of both government take and a company’s Internal Rate of Return. Second, a major issue for governments and societies depending on oil production is volatility – the difference between using minimal and maximal assumptions across all of the inputs will likely produce a difference in result which is radical. One of a country’s biggest challenges then is focusing enough attention on regulating itself, its politicians’ appetite for spending, its public’s appetite for patronage. We know this of course in the real world. Iraq received $37 billion in 2007, then $62 billion in 2008, then $43 billion or so in 2009. But it is the old journalistic difference between show and tell. A model can show this in your country, with your conditions.

The value of contract transparency. Last only because self-evident is the need for primary extractives conracts between states and companies to enter the public domain. About seven jurisdictions around the world publish all contracts so far but it is gaining traction as a norm in the governance community. The side-effects of the way extractive industries are managed now are almost all due to the ill-understood nature of rent. Even corruption, the hottest issue politically, may often simply be a secondary effect of the rent-based nature of the core activities. Publishing all contracts is the single biggest measure that would get us closer to being able to address the root causes of Resource Curse.

See http://openoil.net/ for more details.