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Fiscal regimes - some aspects

Benvenutta Henriksen NPD

The fiscal policy


Government objective
Maximise Government take
Get as high share of the profit as possible

A main concern: Maximise value of the petroleum resources

Companies objective
Maximise stockholders interest (private or public)

September 2002

Petrad 8 weeks course

The fiscal policy


The challenge of the fiscal system is
To ensure the government as high share of the value as possible While encouraging the exploration and exploitation of valuable resources

One has to find a correct balance between the state interest and the oil companies.

September 2002

Petrad 8 weeks course

The fiscal policy


It is important to create a win-win situations between the state and the oil companies The bargaining relationship depends mainly on the profitability and the risk
The government has to take the mother earth and the geological potensial into consideration when it design the fiscal packages

Crucial to relate the fiscal packages on the geological basis and where on the geological learning curve that province is.
September 2002 Petrad 8 weeks course 4

The geological learning curve


Recoverable resources Post Maturity Maturity Growth Pioneering

Years
September 2002 Petrad 8 weeks course 5

The fiscal policy


It is crucial to relate the fiscal packages to the geological basis in a petroleum province and where on the geological learning curve that province is. All along the geological learning curve one should pursue a forward-looking fiscal policy with suffcient options open for future use in either directions. The policy changes must, however, be predictable.

September 2002

Petrad 8 weeks course

The fiscal packages


The fiscal packages can be characterized both by the
The tax level The tax system

The fiscal policy can create disincentives to explore or to exploite the petroleum resources due to either the tax level or the tax system

September 2002

Petrad 8 weeks course

The fiscal package the tax level


The tax level Where the geological prospectivity is low the prospect economy most likely will appear marginal. Too high tax level can provide disincentives to incremental investments. Crucial to relate the tax level on the geological basis and where on the geological learning curve that province is.

September 2002

Petrad 8 weeks course

The fiscal package the tax system


The tax system set the marginal tax shares
The marginal tax share of incomes:
The taxes capture a part of marginal incomes through all tax elements (royalties, corporate tax, special tax elements, participation, etc.).

The marginal tax share of costs:


The taxes cover a part of marginal costs through tax deductions (depreciation of capital costs and operating costs, participation, etc.)

Crucial to design the tax system so that the it do not create distortions - investor after-tax decisions should not differ from the pre-tax decisions.
September 2002 Petrad 8 weeks course 9

The fiscal package the tax system


Due to the introduction of the tax shares the decision-makers only pay a part of the costs and only get a part of the incomes. If the effects of the taxation are such that the companys share of the incomes equals the companys share of the costs
The relative relation between income and outcome in the after-tax cash-flow do not differ from the pre-tax cashflow and the introduction of the tax share do not change the decisons

We define the fiscal package to be neutral if the after-tax decisions in relation to exploration, development, production and abondonment are identical to the pre-tax decisions.

September 2002

Petrad 8 weeks course

10

The fiscal package the tax system


If the effects of taxation are such that the companys share of the incomes is lower than the companys share of the costs
The relative relation between income and outcome in the after-tax cash-flow will be lower from the pre-tax cashflow And we might lose a prospect which has a positive EMV before tax, but which is considered negative for the investor

If the effect of the taxation are such that the companys share of the incomes is higher than the companys share of the costs
The relative relation between income and outcome in the after-tax cash-flow will be higher from the pre-tax cashflow And we might risk that the explorer overinvests and drill prospects with negativ EMV before tax
September 2002 Petrad 8 weeks course 11

An example non-neutral fiscal package


Assume a field development decision. Pre calculations give NPV = 25 mill US$ Introduction of new cash-flow:
Costs Income = 50 mill US$ (discounted) = 50 mill US$ (discounted)

Introduction of neutral taxes = = 20% After tax calculations Companys share of the additional NPV = 0 US$ The companys total NPV equal to 25mill US$

Company share of marginal incomes Company share of marginal costs Tax share of marginal income t(i) = 1- Tax share of marginal costs t(c) = 1-

Introduction of taxes t(i) = 80% and t(c) = 25% Companys share of the additional NPV = -27,5 US$ The companys total NPV become negative, equal to 2,7mill US$
September 2002 Petrad 8 weeks course 12

An example neutral tax and state participation


Assume a exploration decision. EMV = (- A) + (P * NPV) EMV = 50 mill US$ Introduce taxes t(i) = t(c) = 80% After tax calculations EMV= (- A) * + (P * NPV) * EMV= (-50)*0,2 + (0,2*500)*0,2 EMV = 10 mill US$

A=Exporation costs (disc)=50 mill US$ P= prob of discovery=20% NPV of field dev=500 mill US$ Company share of marginal incomes Company share of marginal costs Tax share of marginal income t(i) = 1- Tax share of marginal costs t(c) = 1-

Introduce Government (G) as participating in the license. The investor covers all the exploration costs the state participation is carried Assuming the Gov participation share = 60% EMV= (- A) * + (P * NPV) * (1 G) EMV= (-50)*0,2 + (0,2*500)*0,2 *0,4 EMV = -2 mill US$
September 2002 Petrad 8 weeks course 13

The fiscal package the tax system


We have mainly two fiscal systems Within concession frameworks
Fees Royalty Carbon tax Area fee State participation Income taxes Corporate tax Others
September 2002

Within production sharing contracts (PSC)


Cost oil Profit oil Contractor profit oil Fees Income taxes

Petrad 8 weeks course

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Main elements of concession systems


Royalties
Gross tax tax share of income and no tax share of costs
Might cause investment distortions Give early revenues to the Government Give relatively stable incomes to the Government

Production taxes
Gross tax tax share of income and no tax share of costs
Might cause investment distortions Give early revenues to the Government Give relatively stable incomes to the Government

September 2002

Petrad 8 weeks course

15

Main elements of concession systems


Corporate income taxes
Net income tax tax share of both income and outcome
Migh cause investment distortions due to the depreciation rules; the timing of the recovery of investments costs In a pure cash flow tax system the tax share is taken of all cachflow elements immediately when they occurs. In a net income tax system the investments has to be depreciated over a certain number of years. Due to the discounting and inflationary effect the tax share of the costs is lower than the tax share of incomes
September 2002 Petrad 8 weeks course 16

Main elements of PSC systems


Cost recovery
Rules for how fast the costs can be recovered
The costs can not be deducted immediately Migh cause investment distortions due to the depreciation rules; the timing of the recovery of investments costs Due to the discounting and inflationary effect the tax share of the costs is lower than the tax share of incomes

Profit oil
The remaining gross oil production after cost recovery every year are split between the Government and the contractor
Have the same effects as income taxes

September 2002

Petrad 8 weeks course

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