Revenue from the Oil and Gas Sector: Issues and Country Experience

Key issues Why should countries adopt a fiscal regime specific to the petroleum sector? Why should countries adopt a fiscal regime specific to the petroleum sector? What are the advantages and disadvantages of alternative fiscal instruments? What are the advantages and disadvantages of alternative fiscal instruments? How do the fiscal regimes for the petroleum sector vary across countries and over time? How do the fiscal regimes for the petroleum sector vary across countries and over time?

Why sector specific fiscal regime? A valuable asset in the ground, that can be exploited only once. A valuable asset in the ground, that can be exploited only once. Leads to generation of economic rent. Leads to generation of economic rent. Fundamental conflict between government and investor over the division of risk and reward. Fundamental conflict between government and investor over the division of risk and reward. Aim for fair and rising government share of rent, without scaring off investors. Aim for fair and rising government share of rent, without scaring off investors.

Which fiscal instruments are typically used to tax oil and gas operations? The government share can be achieved by different instruments. The government share can be achieved by different instruments. Multiple objectives may require multiple instruments: Multiple objectives may require multiple instruments:  Product based instruments  Profit based instruments  Bonus and rental payments Fiscal stability clauses Fiscal stability clauses

Tax/royalty regime Royalty—secure minimum payment. Royalty—secure minimum payment. Regular income tax. Regular income tax. Resource rent tax—capture a larger share of the most profitable projects. Resource rent tax—capture a larger share of the most profitable projects.

Royalties Up-front revenue stream; regular minimum payment. Up-front revenue stream; regular minimum payment. Assessed on volume or value of minerals. Assessed on volume or value of minerals. Often considered disincentive to investment. Often considered disincentive to investment. Typically only deductible in home jurisdiction. Typically only deductible in home jurisdiction.

Corporate income tax Often taxed at a higher rate. Often taxed at a higher rate. Tax incentives: immediate recovery of exploration costs, accelerated depreciation, investment credits, and tax holidays. Tax incentives: immediate recovery of exploration costs, accelerated depreciation, investment credits, and tax holidays. Transfer pricing, “earning stripping”, and inflated expenditure deductions. Transfer pricing, “earning stripping”, and inflated expenditure deductions. Restrictions on interest deductions; transactions assessed on arms-length basis. Restrictions on interest deductions; transactions assessed on arms-length basis.

Resource rent tax Rate of return based—the tax is assessed when accumulated real cash flow turns positive. Rate of return based—the tax is assessed when accumulated real cash flow turns positive. RoR: investor’s opportunity cost of capital; country-specific mark-up on risk-free asset. RoR: investor’s opportunity cost of capital; country-specific mark-up on risk-free asset. If discount rate and RoR are close, investment distortions will be reduced. If discount rate and RoR are close, investment distortions will be reduced. Problems: setting RoR and tax rate; revenue back-loaded or zero. Problems: setting RoR and tax rate; revenue back-loaded or zero.

Choice Between Tax/Royalty Regime and Production Sharing Risk/Reward Trade-off Tax/Royalty Regime Production Sharing Low risk to government Royalty Explicit royalty; or limit on cost oil Medium risk Income tax Income tax, may be paid out of government’s share of production High risk Resource rent tax The determination of profit oil can mimic a resource rent tax

State equity Working interest, concessional, carried interest, “free” equity. Working interest, concessional, carried interest, “free” equity. Secure higher government share in up-side. Secure higher government share in up-side. “Ownership”, technology transfer, know- how, control over development. “Ownership”, technology transfer, know- how, control over development. Often large cash-calls for working interest. Often large cash-calls for working interest. Conflict of interest: role of regulator vs. shareholder. Conflict of interest: role of regulator vs. shareholder.

Indirect taxes Gas and oil projects often receive special treatment. Gas and oil projects often receive special treatment. Specialized equipment for exploration and development often exempt from customs duty and VAT. Specialized equipment for exploration and development often exempt from customs duty and VAT. Russian export duty. Russian export duty.

Cross-country experience Most countries have both production-based and profit-based levies. Most countries have both production-based and profit-based levies. Royalties—5 to 10 percent. Royalties—5 to 10 percent. Corporate income tax rate—higher for oil and gas sector or resource rent tax. Corporate income tax rate—higher for oil and gas sector or resource rent tax. Production sharing widespread—two-thirds of countries surveyed. Production sharing widespread—two-thirds of countries surveyed. State equity—countries frequently retain the right to take an equity interest. State equity—countries frequently retain the right to take an equity interest.

Evolution of selected fiscal regimes Norway, Kazakhstan, Indonesia and Angola Norway, Kazakhstan, Indonesia and Angola Fiscal terms influenced by oil price developments. Fiscal terms influenced by oil price developments. Fiscal terms influenced by home country tax policies. Fiscal terms influenced by home country tax policies. Revenue regimes become more progressive as the petroleum fiscal system matures. Revenue regimes become more progressive as the petroleum fiscal system matures.

Conclusions Broad range of fiscal instruments available to secure a reasonable share of economic rent. Broad range of fiscal instruments available to secure a reasonable share of economic rent. Most countries have both profit-based and production-based levies. Most countries have both profit-based and production-based levies. Tax/royalty regimes and production-sharing regimes can lead to similar sharing of risks and rewards. Tax/royalty regimes and production-sharing regimes can lead to similar sharing of risks and rewards. Market test for each country’s fiscal regime. Market test for each country’s fiscal regime.

Questions How do we reconcile the academic literature with actual practice? How do we reconcile the academic literature with actual practice? If the goal is contract stability, under what conditions should contracts be renegotiated? If the goal is contract stability, under what conditions should contracts be renegotiated? Afghanistan—a land-locked, war-torn country—what would induce companies to explore for oil and gas? Afghanistan—a land-locked, war-torn country—what would induce companies to explore for oil and gas? Would a production-sharing regime offer advantages over a tax/royalty regime? Would a production-sharing regime offer advantages over a tax/royalty regime?