“More contract disclosure will not necessarily result in greater understanding of the economic implications of fiscal terms. The terms only become meaningful when their interactions are understood alongside relevant national tax laws and regulations. So to make real sense of the economic implications, the fiscal terms must be considered under varying scenarios of production, price and costs. In other words, they must be modeled. Economic modeling is currently considered an advanced and esoteric pursuit, but we believe that this can be turned on its head: methodologically sound models starting from a pedagogical viewpoint can actually be the entry point to understanding the economic implications of extractives contracts. And, to put the converse case, the transparency community will not succeed in spreading public understanding of what these contracts mean unless this modeling does take place because in the case of complex extractives projects “you don’t know what you’ve got until its modeled”.
Excerpted from Don Hubert of OpenOil:
“The norm of contract transparency is gaining ground and more contracts governing extractive sector projects are becoming public – through several channels. Some governments have disclosed contracts as a matter of policy. International lenders, including the International Finance Corporation, are encouraging contract disclosure. Smaller, publicly listed companies have long been required to disclose contracts in the United States and Canada if those contracts could affect their share price. And, of course, sometimes contracts end up in circulation after having been informally disclosed, as is the case with the recent Statoil contract amendment in Tanzania. Many of these contracts can be found on sites including resourcecontracts.org and the Publish What You Pay site Who has published contracts?
Increased information in the public domain can only be a good thing. But more information does not necessarily mean more understanding. In fact, there is a risk it can result in more confusion, as Michael Jarvis of the World Bank pointed out in a blog post last year.
In the petroleum sector, public “model” contracts are commonly available. But what is often missing is not the general structure of the contract but the economic terms. Against this background, and coming from a low base of what we might call “contract literacy”, the first response to publication of contracts has been to focus on royalty rates, income tax rates, and possibly the level of government equity participation.
But what do such headline terms really tell us by themselves? Not much.”
* Modeling as an Essential Component of Sector Good Governance
Economic models are in widespread use in behind-the-scenes decision-making by companies and governments. All too often, governments rely on the company’s model during a contract negotiation. Curiously, economic models are not yet part of the extractive sector transparency agenda. In part, this is because the models themselves are almost never publicly accessible. But we suspect that it is also because economic modeling based on elaborate spreadsheets is seen as technical and esoteric – beyond the reach of many of those interested in better management of the extractive sector.
We want to change this. In our next post, we will review the common uses for project economic modeling in the extractive sector as well as some of the private and public organizations that build models. In the current environment, the characterization of models as highly technical and esoteric certainly rings true. These models are forbidding rather than user friendly.
It is easy to build models that are intelligible only to a very few technical experts. But we contend that this complexity is not inherent to modeling. Rather it is because, not surprisingly, existing models have been built by economists for economists.
There’s no doubt that it is easy to get lost when you combine 100+ page contracts with a model spread across multiple sheets in an Excel file. But if we make pedagogy a leading requirement in model design, it should be possible for models to be the best way to see the forest of extractive economics rather than just lots of trees.
Modeling needs to be mainstreamed. Currently, fiscal regime analysis is the precursor to building project models. We want to test the opposite hypothesis: that models can empower, and provide the best entry point to understand the economic implications of contract terms that are increasingly in the public domain but not often well understood.
In fact, we suggest there really is no alternative. Because when it comes to understanding the economic implications of extractive sector contracts, “you don’t know what you’ve got until its modeled.”