Africa Upstream Fiscal Systems: Evaluation and Rating, and Analysis of State Company Participation

Transcription

1 Africa Upstream Fiscal Systems: Evaluation and Rating, and Analysis of State Company Participation - CHAPTER 3: FISCAL SYSTEMS BACKGROUND & CONTEXT Prepared by: Rodgers Oil & Gas Consulting July, 2017

2 CHAPTER 3: FISCAL SYSTEMS BACKGROUND Fiscal Systems Classification: World fiscal systems are typically identified as one of three types: Concessions (under General Legislation / Regulation); Production Sharing Contracts (PSC s); and, Service Fee Contracts (SFC). There are two bases for classification: Legal; and, Economic. Classification on a legal basis distinguishes between: Concessions (often referred to as royalty and tax or R/T systems); and, Contracts (contracts can be applied in jurisdictions where the predominant mechanism is the concession, but usually they are associated with a production sharing contract or a service fee contract). Economic classification distinguishes on the basis of who pays; there are two alternatives: The contractor pays the government - (this category includes both concessions and PSC s); and, The government pays the contractor; (This situation is reflected in service or risk/service contracts). Figure 3.1 helps further illustrate the three fiscal system types. Concessionary systems generally apply in jurisdictions with well-developed and trusted private property rights; e.g., Australia, Canada, Great Britain, Norway, United States, etc. Concession systems allow private ownership of the jurisdiction s resources. Title to the jurisdiction s resources is granted to the developer, with the jurisdiction retaining, under law, the right to apply certain fiscal levies, including royalties. Production sharing systems had their first major application in Indonesia. Production is divided into two broad categories, referred to as cost petroleum and profit petroleum. Profit petroleum is 1

3 the portion of total production after cost petroleum. Profit petroleum is shared between the producer (often referred to as the contractor) and the government. The share of production permitted for cost recovery is most often limited in a given period. This limit is typically 45% to 65% of what is referred to as allocation petroleum. Allocation petroleum is total petroleum less allowable deductions. In some instances there are no deductions; however, where royalty is paid, the royalty is most often an allowed deduction in determining allocation petroleum. The Egyptian variation addressed the situation where actual cost in a period are less than the allowed cost limit for the period. While this difference is often shared on the same basis as the generally agreed government-contractor split of the profit share, the Egyptian variation allows for a different sharing of the excess, with 100% often going to the government. Whereas production sharing is a net profits concept, the Peruvian variation is based on gross revenue essentially a royalty but delayed until costs are recovered. Under production sharing arrangements resource ownership is legally retained by the state with the concept of sharing applied to the production. The difference between concessions and PSC s is largely one of legal nuance. From a financial or economic perspective, the two systems are very similar. The service fee system is different. This system arises from jurisdictions that explicitly prohibit foreign ownership of the nation s oil and gas resources. For example, Iraq, Mexico, and Saudi Arabia. In this case government retains the full resource value with investment facilitated by the jurisdiction agreeing to pay the developer a fee that is commensurate with the developer s investment in the jurisdiction. 1 Table 3.1 summarizes the distribution of fiscal systems by system type and by geographic region. 2 1 This fee would be determined in much the same way as would be the developer s share under concession and PSC systems. Where applicable, corporate income tax payable is determined on the basis of the revenue from the fee. Saudi Arabia and Mexico have recently taken steps to allow more foreign ownership. 2 Based on World Fiscal Systems for Oil & Gas 2012, co-produced by Van Meurs Corporation, Rodgers Oil & Gas Consulting, and PFC Energy. 2

4 PSC s are the predominant system applied in the Middle East and many African countries, and to a lesser extent, in Asia. Concession systems represent 100% of the North American systems. 3 By contrast, concessions in the Middle East jurisdictions account for only 21%, while PSC s account for 70%. Similarly, in Africa, concessions account for 25% of the systems while PSC s account for 75%. Overall, 67% of the world s fiscal systems are concessionary, 31% are PSC s and 1% are service fee contracts. Excluding North America and Europe, the world-wide share of PSC s is 53%. Many international oil companies (IOC s) prefer contractual systems over concessions as they feel that a contract provides greater financial certainty. 4 Table 3.2 identifies the fiscal system type by jurisdiction. On a country basis, petroleum fiscal systems are more-or-less equally divided between concessions (90) and contracts (88). State Company Participation: An important component of many resource management systems is state or national oil company (NOC) participation. While there are exceptions, NOC s tend to be the policy instrument through which many jurisdictions manage their oil and gas resources, particularly in jurisdictions applying contractual systems PSC s and SFC S. Table 3.3 identifies the various jurisdictions around the world that have state equity participation as part of their resource management/fiscal regime. Overall, 75 jurisdictions are identified as applying some form of NOC participation. 3 Although rare, concession systems can accommodate contracts; for example, the royalty/profit share component of the fiscal system applied to the Hibernia project in the Newfoundland and Labrador offshore on Canada s East coast. 4 An important drawback of many production sharing systems and the service fee approach is that the associated reserves may not be able to be fully booked as company assets. 3

5 Figure 3.1 Illustration of Fiscal System Types Table 3.1 Distribution of Fiscal System Type by Geographic Region 4

6 Table 3.2 Fiscal System Type by Jurisdiction Rodgers Oil & Gas Consulting, based on World Fiscal Systems for Oil & Gas

7 Table 3.3(a) Jurisdictions with State Petroleum 6

8 Table 3.3(b) Jurisdictions with State Petroleum (Continued) 7

9 World Fiscal Instruments: Both the concessionary and production sharing systems are typically made up of a number, or hybrid, of different fiscal instruments or levies; for example, property tax, import duties, value added tax, royalties, and corporate income tax. The various fiscal instruments are combined to address two broad government revenue objectives: (1) recover costs for services provided and (2) capture economic rent. 5 The combination of fiscal instruments designed to capture economic rent are generally referred to as royalties, the royalty system, or the fiscal system. Table 3.4 identifies the broad types of fiscal instruments and the base on which each levy is applied. There are important differences among these instruments, particularly in their performance in addressing fiscal system design criteria; and in their impact on investor returns and the level of risk that is shared between the resource owner and producers. 5 In this instance costs refers to the cost of being a member of society as reflected in the benefits received by the oil company from, for example, local research and education facilities, transportation infrastructure, and emergency services. Economic policy instruments may be for example directed to protecting domestic industry or helping ensure fair competition. The common characteristic of these instruments is that they are applied generally to all sectors of the economy and to all corporations operating in the jurisdiction. Those instruments used to capture economic rent are oil and gas sector specific and tend to be applied on a project basis. 8

10 Table 3.4 Fiscal System Taxonomy 9

11 Fiscal System Design Considerations: In addition to combining the various fiscal instruments in a manner that reflects the jurisdiction s resource development goals there are also fiscal system design considerations that are taken into account. There are three key goals for fiscal system design neutrality, equity, and efficiency. Neutrality: Economists identify two aspects of neutrality - inter-sectoral and inter-generational. Inter-sectoral neutrality means that the fiscal system should not discriminate between, for example, resource industries and other industries. Inter-generational neutrality means that the fiscal system should not alter the timing of normal investment decisions. Equity: Equity also reflects two conceptual variations - horizontal equity and vertical equity. Horizontal equity involves consideration of the fiscal system effects on one project, corporation, or individual, and another. To satisfy the criterion of horizontal equity the fiscal system would ensure that the relative ranking of equally attractive projects would not change after the fiscal system is imposed. Vertical equity considers how to treat projects with different - unequal - levels of attractiveness. This involves questions of fairness, implying that higher incomes should be taxed at a higher level than lower incomes. Efficiency: Efficiency can be considered under four headings; namely, administrative, investment, productive, and economic rent recovery. Administrative efficiency requires the minimization of administrative and compliance costs. Investment efficiency reflects neutrality and equity considerations, requiring that otherwise economically viable projects not be made unviable by the fiscal system, that the economic ranking of a project not change as a result of the system. Productive efficiency is concerned with maximizing the long run value of output - production. For example, a high ad valorem royalty might fail this test, as it would cause production to stop before it otherwise would. 6 6 While high ad valorem royalties are considered to be counterproductive in that they cause production to be curtailed prematurely, this system is a key feature of all oil and gas fiscal systems in the United States. USA jurisdictions favor this approach on the basis that it a high minimum share for the resource own tends to provide a strong incentive for developers to both innovate and minimize costs. This system is also more transparent and less costly to administer than a profit sharing system; these characteristics are particularly important for private resource owners. On the other hand, high ad valorem royalty systems fail to recognize up-front risks, which contributes to a lower government share. 10

12 Economic rent efficiency requires the system to be sensitive to profitability. This is sometimes referred to as system flexibility or robustness. Profit sharing systems do the best job in meeting these design policy considerations. There are however three important concerns: Profit sharing systems require higher administration costs than systems that do not require the tracking and auditing of project costs and other parameters; Profit sharing systems tend to be associated with increased complexity and reduced system transparency; and, Profit sharing systems risk the creation of gold plating effects. 7 Notwithstanding the concerns with profit sharing systems, good fiscal system design is extremely important. Good design can contribute to reduced risk and to win-win opportunities for both oil companies and governments. Fiscal Systems as Risk Sharing: Sharing of risk is a key consideration in fiscal system design and application. This, plus differing economic circumstances, resource characteristics, and economic policies, produce unique combinations of fiscal instruments for each jurisdiction. No single objective better accounts for the differences across fiscal systems than that of risk management. Table 3.5 illustrates the risk sharing options as a continuum ranging from the government accepting no risk to government sharing full risk comparable to that of the investor. 7 Gold plating refers to a situation where the fiscal system may encourage project developers to increase rather than decrease costs the royalty savings from higher costs may be greater than the costs. This situation was rather famously a characteristic of the Papua New Guinea system and currently is a characteristic of the new system being adopted in Mexico. Rate of return based systems tend to be susceptible to gold plating. 11

13 Table 3.5 Risk Sharing Options In the no-risk-sharing case the contractor pays the government a signature bonus for the lease and whatever rentals and fees may be required. If the prospect proves to be a dry well or otherwise uneconomic, the government still receives the bonus and rentals and fees, thereby accepting no risk. 8 With excise tax or units-based royalties the government accepts the risk associated with production but not price. Units based levies see the government receiving the same amount per unit produced, irrespective of the price for which the commodity can be sold. In the more traditional royalty where the government receives a share of revenue or resource value risk to government s share also comes from the price component. With fixed rate or ad-valorem royalties the government accepts the risk that production or price could be different than anticipated. Under profit-based systems the government is also accepting the risks that project timing and costs will be different than expected. Full risk sharing is represented in the situation where the government exercises the option to have a state company participate (share) in all project costs and revenues in exactly the same way as the investors. 8 Signature bonus refers to a fixed up-front payment, typically as the basis on which property rights are awarded or a requirement on the effective date of a contract. 12

14 A somewhat lower level of risk sharing occurs when the state company participates but does not share in all of the costs. This is referred to as a carried interest where the contractor carries the state company for its share of costs usually the exploration costs. Sometimes the cost of the carry is repaid either in part or in full and without or with interest. To help manage risks, most jurisdictions apply a combination of options 1, 2, and 3. As shown in Tables 3.3(a) and 3.3(b) above, 75 countries (48%) of the 155 countries surveyed also incorporate some form of option 4 - state company participation. Only 15 countries apply full working interest participation with a further 36 exercising a carried interest that is repaid, either fully or partially. Figure 3.1 illustrates that the fiscal system typically attempts to strike a win-win balance for both investors and resource owners; taking into account the various fiscal instruments available, the government s policy goals, and the respective tolerances for risk. Figure 3.1 Win-Win Fiscal Nexus 13