Oil and gas fiscal regimes around the world

Background materials for UN workshop on oil and gas in Iraq
Dead Sea Marriott Resort, Jordan (April 4-6, 2006)

1. Module 2 Oil and gas fiscal regimes around the world Prepared by David Péloquin Background materials for UN workshop on oil and gas in Iraq Dead Sea Marriott Resort, Jordan April 4-6, 2006

2. Key challenge for (public) owners of oil & gas: Rents from oil & gas invite “rent-seeking behaviour”… … and the greater the rents, the more intense the behaviour Public ownership alone is NO guarantee of ability to maximize public benefits from oil & gas revenues Key challenge is how to minimize revenue leakages : to corruption / other private benefits from use of public funds to private / foreign oil & gas firms (e.g. above-normal profits) to private end users of oil & gas (e.g. excessive fuel subsidies) How to maximize public benefits 2

3. The problem of uncertainty Significant uncertainty surrounds the value of oil & gas wealth In most cases, (public) owners cannot readily assess the magnitude of potential revenues from oil & gas Governments have typically limited technical expertise: limited geological and other expertise relating to exploration limited access to advanced extraction technologies required to increase recovery and prolong life of maturing deposits Resulting “asymmetry of information” regarding likelihood of finding new deposits, their extent and production lives 3

4. The problem of uncertainty As a result, joint public-private involvement is usually desirable Private sector brings technical expertise (including cutting-edge technologies) and can also be: significant sources of capital (to fund oil & gas development) a source of expertise for local capacity-building (in private sector and even for governmental activities) a force for increased transparency in government management of the oil & gas sector (and in governance generally) 4

5. Risk-sharing under oil & gas fiscal regimes Need to strike right balance in public / private risk and rewards A wide variety of mechanisms is used in different countries to generate oil & gas revenues e.g. various types of taxes, royalties, production sharing, equity stakes, sales of rights to explore, develop and produce, etc. Used in different combinations, these mechanisms result in different patterns of public and private risk and reward… … and different incentives for investments in oil & gas 5

6. (Non-exhaustive) list of mechanisms for generating revenues from oil & gas General taxes (including “excess profits taxes”) Limited ability to effectively target rents (though high risk of unilateral revision may impede private involvement) ex post public Sale / auction of rights (at front-end) Especially if auctioned, maximizes capture of ex ante rents and may reduce other leakages through relatively high transparency ex ante private Royalties / production sharing (pre-“payout”) Low public share required to secure private involvement (and risk of further leakages to private sector if “pay-out” poorly defined) ex ante private Price-sensitive royalties / production shares Reduced risk (especially pre-payout) may prompt private involvement Public revenues maximized when prices are high ex post public Service contracts for exploration / development High risk limits private involvement (and resulting gross revenues) and relatively low transparency may facilitate leakages ex post private Oil & gas-specific (e.g. export / environmental) taxes Close substitutes for value-based royalties (pre- and post-payout), but higher risk of unilateral revision may impede private involvement ex ante private Royalties / production sharing (post-“payout”) Public revenues maximized by relatively high post-payout shares – but only if projects are profitable ex post public State / SOC equity stakes (e.g. joint ventures) Depends on size of public share (and corresponding leakages through private share), but relatively high transparency limits other leakages ex post shared Profits from state or state oil company (SOC) production Over-reliance on SOCs may limit access to capital and production / revenue-maximizing technology. Net revenues also depend on extent of leakages resulting from relatively low transparency ex post public Risk-sharing under oil & gas fiscal regimes Need to strike right balance in public / private risk and rewards 6 Main risk bearer Ex ante or ex post rents targeted? Implications for overall ability to generate net public revenues from oil & gas

7. Combinations of fiscal mechanisms work best But: Need the right “mix” to maximize public benefits Higher net revenues likely to result from: predictable fiscal/regulatory regimes (minimal case-by-case negotiation of terms, low risk of unilateral changes ex post facto ) substantial sharing of risk by governments (with resulting increase in private exploration and subsequent production) high degree of transparency (with fewer resulting opportunities for corruption / other leakages to public sector agents)… … with especially significant benefits from open auctions with multiple bidders when rules are known in advance 7

8. Combinations of fiscal mechanisms work best Illustration of “front-end” bids and “back-end” royalties / taxes Start of production End of production Rising production costs Production costs Auction of exploration / development / production rights (front-end loaded) Gross revenue generated Royalties / tax es / production sharing (back-end loaded) Exploration and development costs $ “Pay-out” Volatile prices “Normal” return to firms “Excess” profits 8

9. Legend dominant contribution major contribution minor contribution to revenues + + + = + + = + = General taxes (including “excess profits taxes”) Sale / auction of rights (at front-end) Royalties / production sharing (pre-“payout”) Price / production-sensitive royalties / production shares Service contracts for exploration / development Oil & gas-specific taxes Royalties / production sharing (post-“payout”) State / SOC equity stakes (e.g. joint ventures) Profits from state / SOC oil & gas production Combinations of fiscal mechanisms work best A wide variety of common practices around the world 9 + + + + + + + + + Canada + + + + Mexico + + + + Saudi Arabia + + + + + + + + + + Venezuela + + + + + + + + Norway + + + + + Indonesia + + + + + + Nigeria + + + + + + + + + + USA + + + + + + + + + + Malaysia + + + + Australia + + + + + + + + + + Brazil + + + UAE + + + + + + + +