Petroleum Fiscal Regimes BASIC CONCEPTS

1

Petroleum Fiscal RegimesBasic Concepts

Dr. Alfred Kjemperud

Dr. Alfred Kjemperud 2CCOP, Pattaya, September 2003

Opening Statements

• The fiscal arrangement is the Government’s most important tool for managing petroleum resources

• It is mandatory for all managers and technical personnel in the Government and industry to understand the basics of fiscal arrangements

2


Government Options

• Value of National Resources -Determining Factors

The resource baseThe market – oil priceTerms and regulations


Costs

Income

Time

Pre-license Exploration Development Production AbandonmentProduction

Rehab.

Government

Activities and cash flow

Con

trac

t sig

ning

PDO

3


General Objective

The objective of petroleum resource management is:

To maximise the valueof the petroleum resource


Company objective

To attain maximum net present value of the petroleum resources

Build equity

4


Government Objectives

• Provide a fair return to the state and the industry

• Avoid undue speculation• Limit undue administration• Provide flexibility• Create healthy competition• Create a market efficiency


The role of the authorities

Definition of policySetting of termsPromotionLicensingMonitoring and supervisionAdjustment of terms as requiredManaging the impact

5


Petroleum Fiscal Regimes

• Covers :Legislative issuesTax issuesContractual issues

• There are more fiscal systems in the world than there are countries due to:

Negotiation of TermsNumerous vintages


Legal/Contractual Framework

The Constitution

The fundation which is the basis for all other regulationsThe Law

E.g. tax lawPetroleum Law and Legislation

Not all countries have a separate petroleum law. If that is the case the contract has to cover all aspects

Production sharing Contract

Concessionary agreement in countries using that system

Joint Operating Agreements

Between partners in a field (can also be the state company)

6


Economic Rent

• The Classic Definition by Economists

The produce of the earth derives from labour and capitalThe produce is divided between:

Labourers (Wages)Owners of Capital(Profit)Owners of Land (Rent)

Rent = Value - Cost


Resource RentAllocation of revenues from Production

After Johnston (1995)

•Bonuses•Royalties•Prod. Sharing•Taxes•Gov. Participation

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Regressive - Progressive

Regressive Progressive

Bonuses Royalties Profit TaxProduction Sharing

Gov

ernm

e nt R

isk

The non profit based government takes (bonus and royalties) are regressive i.e. the lowerprofitability the higher effective tax

Before cost recovery Cost recovery phases

Pre d

iscov

ery

Post

disco

very


Regressive system

85 %

0 %

20 %

40 %

60 %

80 %

100 %

Applica

tion f

ee

Signature

bonus

Discov

ery bo

nus

Produc

tion fe

e/Roy

alty

Produc

tion Sha

ring

Incom

e Tax

Specia

l Petro

leum Tax

Repatria

tion Tax

Individual taxesCummulative taxation


8


Progressive system

85 %

0 %

20 %

40 %

60 %

80 %

100 %

Applica

tion f

ee

Signature

bonus

Discov

ery bo

nus

Produc

tion fe

e/Roy

alty

Produc

tion Sha

ring

Incom

e Tax

Specia

l Petro

leum Tax

Repatria

tion Tax

Individual taxesCummulative taxation



Rent vs. Risk

• The Profit Margin for the Oil Companies must be large enough to accommodate failures

Nine out of Ten exploration possibilities are unsuccessful

9


Risk- & Non Risk-Takers

• Fiscal Terms must account for the large Risk in the Oil Business

Oil Companies are High Risk TakersCompanies can reduce risk by

diversification

Governments are Low Risk Takers Governments can reduce risk by introducing a Regressive tax system (Bonuses and Royalties)


Poor GoodGeological Promise

Gov

ernm

ent T

ake

Low

High

High interest from Oil CompaniesPotential for higher Government take

Low interest from Oil CompaniesLow potential for any Government take

Optimized Fiscal Terms

Global Exploration Market

10


Value of Discovery after TaxIllustrated as Field Size

A 25 million bbl field in Ireland gives the same profit after tax for the oil company as a 144 million bbl field in Indonesia

The Importance of Fiscal Regimes

117

46

75

45

144

25

99104 104

40

63

49

94

0

20

40

60

80

100

120

140

160

Angola

Camero

onChin

aGab

onInd

ia

Indon

esia

Irelan

d

Malays

ia

Nigeria

Norway

Philipp

ines

Vietna

m

Bangla

desh

MM

BB

LNecessary Field Size to match low esttax regime (Ireland)Reference Field Size (25 MMBBL)


UK Tax Reform

0

5

10

15

20

25

30

35

40

45

77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98

Years

MM

£

%

0

50

100

150

200

250

300

350

MM

tons

£/to

n

Tax revenue relative to Total revenue (%)Absolute tax revenue (MM£)Oil Price (£/ton)Production (MM tons o.e.)

PRT removed for new fields

Royalty removed for new fields

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Petroleum Fiscal Systems

• Two FamiliesConcessionary system

Allows private ownership to mineral resources

Contractual systemsThe State retains ownership to mineral resources


Fiscal Systems Classification

Petroleum Fiscal ArrangementsPetroleum Fiscal Arrangements

Concessionary SystemsConcessionary Systems

Contractual SystemsContractual Systems

NorwayNorway

United KingdomUnited Kingdom

PakistanPakistan

TunisiaTunisia

New ZealandNew Zealand

Service ContractsService Contracts

Production Sharing ContractsProduction Sharing Contracts

Pure Service ContractsPure Service Contracts

Risk Service ContractsRisk Service Contracts

Limited usageLimited usage

MexicoMexico

ArgentinaArgentina

BrazilBrazil

VenezuelaVenezuela

The PhilippinesThe Philippines

Indonesian (profit) Peruvian (gross)

Indonesia

Angola

Yemen

Albania

Nicaragua

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Systems around the World

Australia Pakistan (On) Bangladesh Mongolia PhilippinesBrunei PNG Cambodia MyanmarKorea, South Thailand China Pakistan (Off)New Zealand Timor Gap B India Timor Gap A

Indonesia VietnamLaos NepalMalaysia Sri LankaAzerbaijan RussiaGeorgia TurkmenistanKazakstan UzbekistanKyrghystan

Argentina Falkland Is. Belize Nicaragua Brazil HondurasBolivia Paraguay Cuba Panama Chile PanamaColombia T&T (On) Guatemala T&T (Off) Ecuador PeruCosta Rica Guyana Uruguay Haiti

Jamaica VenezuelaAbu Dhabi Neutral Zone Bahrain Oman IranAjman Sharjah Iraq Qatar Kuwait (OSA)Dubai Turkey Joran Syria Saudi ArabiaFujairah Libya YemenCanadaUnited States

Concessions (R/T System) PSC SC

North America

Far East

Former Soviet Union

Latin America

Middle East


Systems around the World

C. Afracan Rep. Namibia Algeria Liberia Chad Niger Angola LibyaCongo (K.) Senegal Benin MadagascarGhana Seychelles Cameroon MozambiqueMadagascar Somalia Congo (Br.) NigeriaMalawi South Africa Cote D'Ivoire SudanMali Tunisia (Old) Egypt TanzaniaMorocco Eq. Guinea Togo

Ethiopia Tunisia (New)Gabon UgandaGambia ZambiaKenya

Australia Italy AlbaniaBulgaria Netherlands MaltaCzech Republic Norway PolandDenmark Poland TurkeyFrance PortugalGreece RomaniaHungary SpainIreland UK

Africa

Europe

R/T System PSC SC

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Concessionary System

• Oil company have exclusive right to explore and produce at its own risk and expense

• Oil Company Owns production• Oil Company often pays Royalty and

Surface rental to Government• Oil Company Pays Taxes on profit• Oil Company owns equipment • Oil company has right to export

hydrocarbons


Production SharingContract

• The Contractor gets a share of production usually in kind

• The Contractor never holds title to oil

• The Contractor share the risk with the Government

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Risk Service Contracts

• The Contractor share the risk with the Government

• The Contractor gets a share of Profits usually as money

• The Contractor never holds title to oil


Technical Assistant (EOR) Contracts

• Joint Venture• PSC• Oil Company Financing• DMO (Domestic Market Obligation)

• Base Oil or Determined Oil

15


JV Burden on Contractor

Pure J

VAll c

ost/r

isk sh

ared

Typica

l JV

Govern

ment c

arried

throu

gh E

xplor

ation

Full C

arry

JV

Govern

ment c

arried

throu

gh

Explor

ation

and D

evelo

pmen

t

FSU ty

pe JV

Govern

ment c

arried

throu

gh

Rehab

. And

Dev

elopm

ent

until

cash

flow

from

Ope

ration

s

Light Heavy

Burden on Contractor


Direct State Participation

• Free RideHave access to all information

Can choose the goodies

Does not pay for pre-license explorationDoes not pay for R&D

• Carried interestThe State can be carried through:

ExplorationExploration +Development

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Elements in a PSC

• Work Commitment• Bonus Payment• Royalties• Cost Recovery (Cost Oil)• Profit Oil• Government participation• Domestic Market Obligation• Ring fencing


Indonesia- PSC (4th Gen.)Mother of all PSCs

•(85/15 Split)Royalty: 0%FTP split 20%Cost Oil : 100%Profit Oil: 28.8462%Tax Rate: 48%

•EffectsThe split does not change

with the level of costEffective Gov. take is 85%

Contractor GovernmentGross

Revenues100

5.8First Tranche

Petroleum 14.220 %14.2 %

Net Revenues80

28.0 Cost Oil35 %

Profit oil52

15.0Profit oil to

Contr. 37.028.8462 %

Taxable20.8

-10.0 Tax 10.048 %

38.8After tax

entitlement 61.2

10.8Net Cash

Flow 61.2

15 % Take 85 %

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Work Commitments• Acquisition of Seismic Data

Shooting, where and whenProcessingKilometres or Minimum Expenditure

• Drilling ObligationsNumber of Wells , where and whenStratigraphic intervalMinimum Expenditure


Bonuses• Signature Bonus

Paid upon contract signing

• Discovery BonusPaid upon first discovery

• Production BonusPaid when production reaches a specified level

• Bonuses makes a fiscal regime regressive and are unpopular with oil companies

18


Royalties

• Calculated from Gross Revenue• Can cause premature

abandonment• Ranges from zero to 20%• Sliding scale (Example.)

First Step Up to 5.000 bopd 5%Second Step 5.001-10.000 bopd 10%Third Step Above 10.000 bopd 15%


Special Royalty Schemes

• The Philippines have a negative Royalty up to 7,5%(Philippine Participation Incentive Allowance - FPIA)

• New Zealand have a hybrid system 5% Royalty or 20 % Accounting Profits Royalty

• Rate Royalty $/bbl (Columbia, Russia)

19


Negative Royalty SchemePhilippine RSC Flow Chart

Contractor GovernmentGross Revenues

100

FPIA 7.57.5 %

Net Revenues92.5

32.4 Cost Recovery35 %

Revenues for sharing60.13

24.1 Profit share 36.140 %

Taxable24.1

Tax paid by Gov.0.0 0 % 0.07.5 FPIA (% of Gross)

31.6 Service Fee

32.4 Cost Recovery

63.9 Entitlement 36.146.7 % Take 53.3 %


Cost Oil (Cost Recovery)• Cost Oil usually has an upper limit • Cost oil normally includes:

Unrecovered costs carried over from previous yearsOperating costsExpensed capital costsCurrent year DD&A ( Depreciation, Depletion & Amortisation)

Interest on FinancingInvestment Credit (Uplift)Abandonment cost recovery fund

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Cost Recovery

Cruel Unusual Low EndTypical

Upper EndTypical

Rare Concessions+ a few PSCs

0 20 40 60 80 100

Range of Cost Recovery Limits (%)


Profit Oil

• Profit oil = Net revenue - Cost recoveryNet revenue = Gross revenue - Royalties

• Profit oil is analogue to taxable income in a concessionary system and Service fee in a service agreement

• Profit oil is split between Government and Contractor

• Profit oil is usually, but not always taxed

21


Ratio-Factor (R-factor)

• ObjectiveSharing between the Governmentand the contrator is based onProfitability

• DesignBoth revenue and cost areincluded in the calculation

R =Contractors cumulative revenue

Contractors cumulative cost


Different R- Factors

• Cumulative revenues/Cumulative cost

• Cumulative Revenue-Cumulative Opex/cumulative Capex

• Cumulative Revenue – Cumulative Profit Share/Cumulative Investments + Cumulative Opex

• Cumulative net income/Cumulative Costs

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Peruvian onshore

R-Factor ************ROYALTY RATE ************* ≤ $15/bbl $25/bbl ≥ $35/bbl 0.0 < R < 1.0 19% 23% 27% 1.0 ≥ R < 1.5 24% 29% 32% 1.5 ≥ R < 2.0 30% 35% 37% 2.0 ≥ R 36% 39% 42%


Domestic Market Obligations (DMO)• A certain volume of oil to be sold to the Government• Discounted Price• Local Currency. Predetermined exchange rate

• Example - Indonesian DMO Production: 1 MMBBLOil price: 20 USD/BBLDiscount: 2 USD/BBLContractor’s profit oil: 28.8462% of total productionDMO: 25% of Contractors profit oil

• 1MMBBL*(20USD/BBL-2USD/BBL)*25%*28.8462%= 1,298 MMUSD• 1,298MMUSD/20USD/BBL=0.0649 MMBBL= 6.49% of total production ( Pure

volume calculation: 28.8462%*25%=7.21%)

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The Importance of Tax Holidays

0.0

5.0

10.0

15.0

20.0

25.0

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Years

MM

BB

LProduction curve (100 %)

Protected by 5y tax holiday (62 %)

A 5 years tax holiday represents 25% of project time, but 62 % of produced volume (Undiscounted)


Poor GoodGeological Promise

Gov

ernm

ent T

ake

Low

High

High interest from Oil CompaniesPotential for higher Government take

Low interest from Oil CompaniesLow potential for any Government take

Optimized Fiscal Terms

Global Exploration Market

Petroleum Fiscal Regimes BASIC CONCEPTS

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