January 2013

Hot Topic
Oil & Gas Tax Update

Nothing is certain: changes in tax and scal regimes are reshaping the way investors and companies evaluate oil and gas investments
Despite the uncertainty in the current global economic environment, the continued imposition of tax on income from oil and gas operations remains a certainty. The scope, impact and makeup of such taxes, however, are far from certain, especially in a global environment of constantly evolving tax and scal policy. Over the past ve years, oil and gas investors, international and national oil companies, and sovereign and other governmental funds have ventured and are expected to continue to venture into new markets, both established and emerging. The reasons behind this trend include, in part, geographic and resource diversication, the discovery of signicant reserves, and improvements in technology that have made and will continue to make previously unrecoverable reserves now economically recoverable. Further, relatively high oil prices and a decoupling of natural gas prices (and, in certain countries, a natural gas demand that is exceeding local country supply), have prompted numerous investors to look outside of their home countries for energy sources, either for pure supply reasons or as a hedge on future commodity prices, or both. With the globalization of investment has come an increased emphasis on global tax policy and regime changes and the impact such changes can have on investments. Globally, various countries have introduced or are contemplating to introduce changes in the way oil and gas operations from exploration and production to retail operations are taxed. This is being done to support the broader economic objectives of the country as well as, in certain circumstances, to taper or otherwise reduce certain tax incentives for oil and gas exploration and production operations in an effort to subsidize renewable or other green energy sources. Further, the global tightening of environmental standards and an increased awareness of the sustainability of oil and gas as a primary fuel and energy source have prompted a change in the way lawmakers think about tax policy. However, this is not new, as energy tax incentives, and the methods employed by various countries to shrink or expand such incentives, have undergone a substantial transformation over the past 20 to 30 years.

So what does this mean for todays investor or for a company looking to invest either domestically or globally or for an investor or a company that already owns oil and gas assets domestically or globally? Anticipating and managing tax risks and changes in the way oil and gas investments are taxed requires companies and investors to be proactive in tax planning and in the evaluation of investments, both current and prospective. It also requires them to be educated about the current and potential tax and scal regimes that could affect or have an impact on such investments, and be vigilant in choosing the right tax advisor with the experience, resources, and global reach to be properly apprised of potential tax changes and the impact of such changes on current or prospective investments. This article highlights the potential effects of changes in tax law, identies certain proactive measures that investors and companies investing in oil and gas assets should consider, and discusses trends in the general oil and gas sector and scal regimes.

Changes in tax law can affect all facets of an investment and ongoing operations
Tax changes and policy shifts can dramatically affect investments in oil and gas assets and ongoing oil and gas operations. For example, a change in tax rates, an additional tax, a modication of an existing tax or an elimination of a tax incentive could have an impact on the following: Any change in applicable tax law, even a slight change, could have a material impact on the rate of return of an investment or operation. Cash distributions to stakeholders could be negatively affected or a change in tax law could result in an increased tax liability, which would generally result in less cash available for distribution to stakeholders. A change in tax law that negatively affects the balance sheet could have a material impact on funds available for operating expenditures (payroll, maintenance, etc.), as well as funds necessary for future capital expenditures and development programs. Cash available to establish reserves or to service debt may be negatively affected by a change in tax law that can impact the balance sheet negatively, with the result that credit agreements and covenants may need to be examined closely. At a time of economic uncertainty, rapid globalization and increased competition, preparing for tax policy changes before they happen can give businesses and investors a competitive edge. Whether the proposed or potential change is a shift to a different tax rate, an expiring tax provision, an effort to expand the taxable base, a change to inbound or outbound tax provisions, a change to state and local tax, or tax law changes related to climate change and sustainability, staying ahead of the curve and proactively analyzing the potential effects of a change in tax law is a prudent course of action in todays uncertain tax landscape. Modeling the effect of proposed legislation or alternative decision scenarios; assessing federal, international, state and local, and book-tax implications of proposed tax changes; and planning for new tax laws and regulations are all critical and necessary tasks in ensuring that investment decisions are thoughtfully considered, especially with tax changes seemingly always on the horizon. Further, with respect to acquisitions and other transactions, planning up front with the end game in mind can often signicantly lower the tax on exit.

Despite global uncertainties, oil and gas investments continue to ourish

The past 12 to 18 months have been extremely volatile in the oil and gas industry. While political risk remains a key concern, unexpected disasters have also sent oil and gas companies back to the drawing board, with the focus being very much on alternative options to nuclear power, and with a particular focus on natural gas. Additionally, geopolitical upheaval has had an impact on oil prices, which have remained relatively high despite major economic woes. And, although environmental and safety concerns continue to intensify, the unconventional gas boom continues and has begun to internationalize. The search for recoverable reserves continues to globalize. As long as recovery remains economically viable, both established and frontier countries are expected to take measures to develop such reserves and/or take certain measures to attract capital or increase state revenue, or both. New frontier countries in which hydrocarbon reserves have just been discovered, such as the African nations, Cyprus and Israel, are working toward designing their national legal and tax legislation for the oil and gas industry. Both unconventional oil and gas are attracting the attention of more governments as they focus on forcing development of these reserves. Shale gas development is increasing in North America, and large-scale development may start in Europe too; for example, Poland is working on its tax regime for shale gas. Arctic countries are competing to attract investments in cost-intensive offshore and onshore projects and may revise their tax legislation; for example, Russia is in the process of designing a new, attractive tax regime for Arctic offshore projects. The discovery of natural gas in the Levantine Basin will drive Cyprus and Israel to develop this block. As the global search for recoverable reserves continues, taxpayers should pay attention to the possible tax law changes and incremental costs of such changes for tax planning purposes.

Conclusion
Anticipating and managing tax risks and changes in the way oil and gas investments are taxed require companies and investors to be proactive in tax planning and in the evaluation of investments (both current and prospective); educated about the current and potential tax and scal regimes that could affect or have an impact on such investments; and vigilant in choosing the right tax advisor with the experience, resources, and global reach to be properly apprised of potential tax changes and the impact of such changes on current or prospective investments. Continued monitoring is necessary to determine the impact of current or proposed changes on global tax and scal regimes.

For more information about this topic, please contact: Deborah Byers +1 713 750 8138 deborah.byers@ey.com Greg Matlock +1 713 750 8133 greg.matlock@ey.com

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