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Academia
Fiscal regimes describe all legislative,
taxation policy, contractual, and fscal
elements under which petroleum
operations are conducted in petroleum
provinces or nations.
There are far more petroleum fscal
systems worldwide than petroleum-
producing provinces. Kaiser and
Pulsipher (2006) give some explanations
for this phenomenon, including the fact
that contracts originating under several
different fscal regimes may be in effect
at any given point in time.
Other reasons cited include adoption
of more than one fscal arrangement
during a licensing round, changes in
political and economic conditions as
well as in prospectivity assumptions
of frms seeking the right to explore
and develop petroleum resources, and
the host governments motivation to
maximize economic rent collections from
its countrys endowed resources.
Host Governments vs. Investors
Usually, the primary objective of the
host government in a petroleum-
producing nation is to ensure maximum
economic benefts for the country
without necessarily seeking total control
of all exploration and production (E&P)
terms and conditions, investments,
and/or production. Other objectives
may, however, be pursued, including
effcient resource development, access
to technology, skilled national manpower,
investment funding for local E&P activity,
and sustainable economic growth
(Iledare,2008).
On the other hand, investors
tend to view host countries fscal
regimes critically on the basis of their
fnancialobjectives.
E&P frmsor investors bidding
for the right to explore and develop
petroleum in a host country desire to
receive a fair and satisfactory return
on investment in a quick and orderly
manner. Thus, some fscal instruments
and terms are negotiated while others
are determinedthrough the host
countrys legislative process, keeping
in perspective the hostgovernment and
E&P frms objectives.
One important and critical concern
to investors in deciding where to search
for and develop oil and gas resources
is stability in a host governments fscal
arrangements (Johnston, 2003).
To attract investors to a petroleum
region, an area must not only be highly
prospective in the geologic sense, the
area must also have a dynamic, effcient,
and stable fscal arrangement.
Dynamic and stable fscal systems
literally may require surrendering a
great proportion of economic rents
to investors to ensure the prospect of
high rewards in countries with high
exploration risk and low prospectivity.
Of course, if exploration risks are
low and geologic prospects are high,
then the host government can be
expected to capture signifcantly high
economicrents.
Investors have no obligation to
develop petroleum resources in a
given country when factors affecting
the balance between the inherent
risks and rewards are incoherent, no
matter how promising the economic
opportunitieslook..
Concessionary vs. Contractual
Fiscal Systems
Certainly, the host government exhibits
great infuence and considerable leeway
to avoid terms and conditions that could
easily dampen investors interest in
maintaining an operational presence in its
country. Thus, over the years, operators
and petroleum-producing countries
host governments have negotiated their
interests using two basic fscal systems
concessionary or contractual.
The fundamental difference
between the two fscal arrangements
has to do with ownership of petroleum
resources and how taxes are imposed.
In a concessionary system, the host
Upstream Petroleum Economic Analysis:
Balancing Geologic Prospectivity with Progressive,
Stable Fiscal Terms and Instruments
Omowumi O. Iledare, Louisiana State University, Center for Energy Studies
Wumi Iledare is a professor of petroleum economics and
policy research at Louisiana State Universitys Center for
Energy Studies and a distinguished fellow of the Nigerian
Association for Energy Economics. Iledare, a recipient of an
SPE Regional Award in management and information, is also
a senior fellow and past president of the US Association for
Energy Economics; 2013 president-elect and executive
council member of the International Association for Energy
Economics; and an associate editor of SPEs Journal of Economics and Management.
He serves as an adjunct or visiting professor of petroleum economics at fve
universities in the US and Nigeria, and has contributed to professional education
and human capacity development by teaching petroleum economics at various
professional organizations and businesses worldwide. Iledare earned a BSc degree
in petroleum engineering with honors from the University of Ibadan, Nigeria; and
also an MS in energy resources from the University of Pittsburghs School of
Engineering and a PhD in mineral economics from West Virginia Universityboth
with an emphasis on oil and gas economics.
http://www.spe.org/twa/print/archives/2014/2014v10n1/14_Academia_v10n1.pdf
29 Vol. 10 // No. 1 // 2014
government transfers ownership of
resources to private entities, and in return
gains a royalty or tax. Under a contractual
system, the host government retains
ownership of the petroleum resources.
A unique feature in all contractual
arrangements is the cost-recovery limit
(CRL) specifcation, which is based
on allowable capital and operational
expenditures with a ring fencing clause
incorporated in mostcases.
Classification of Fiscal
Terms and Instruments
For the purposes of this discussion,
the fscal instruments and terms in a
typical petroleum fscal arrangement are
classifed as pre-discovery provisions,
post-discovery contract terms, and proft-
based elements.
Pre-Discovery Signature Bonuses
and Rentals
Signature Bonus and RentalsThe
application of pre-discovery payments
in petroleum fscal arrangements is
common worldwide. Nearly half of all
countries with petroleum fscal systems
include at least one form of pre-discovery
payment to the host government.
The types of pre-discovery
payment evident in fscal regimes
are signature, rentals, and discovery
or prospectivity bonusesthey are
not necessarily legislated but are
negotiable. Such bonuses are classifed
as front-end loaded payments that are
highlyregressive.
Post-Discovery Royalties and
Production Bonuses
RoyaltyRoyalties can be paid in
kindor in cash and represent a cost of
doing business. They are tax-deductible
in oil and gas economic calculations.
The tendency in most fscal
arrangements is to defne royalties
usinga sliding scale according to water
depth, location, hydrocarbon type, and/
or value.
If royalty rates are specifed by value,
they are designed to allow the host
government to share in windfall profts
subsequent to any unexpected increase
in crude oil and natural-gasprices.
Production BonusProduction
bonuses provide future revenue to
the host government when various
levels of production and discovery are
reached. Production bonuses permit the
application of a sliding-scale payment
schedule to rectify the repressiveness
of production bonuses on the economic
performance of E&P projects.
It is also apparent that there is a
conscious recognition that production
bonuses are payments that can create
a barrier to entry, and reduce project
cash fow as well as a ventures
attractiveness. Thus, the determination
of productionbonuses is allowed to be
contract-specifc.
Crypto FeesCrypto fees are indirect
means through which a government
can receive additional revenue through
levies, imposition of duties, and other
fnancial obligations imposed on oil and
gas producing companies. For example,
the more prominent crypto fees or taxes
in Nigeria include 3% of a projects annual
capital budget as a contribution to the
Niger Delta Development Commission
(NDDC) and an education tax of 2% of a
projects chargeable proft.
It is important to note that the
instruments and terms highlighted above
are not favorably disposed to assets
proftability. Theyare front-end loaded
and tend to lower proftability of assets in
economicterms.
Post-Discovery Proft-Based Take
Corporate Income Tax (CIT)Before
the introduction of reform bills in Nigeria,
for example, upstream companies were
exempted from paying corporate income
tax. Instead, a special petroleum proft
tax (PPT), based on assessable profts,
was operational for every production-
sharing contract (PSC) in Nigeria and
the amount varied depending on location
and hydrocarbon type.
It is interesting to note that a new
taxation layer, called the Nigerian
Hydrocarbon Tax(NHT), is being
proposed. NHT, in my opinion, is
analogous to severancetaxes (taxes
on production) paid to US petroleum-
producing states by onshorepetroleum-
producing companies. This apparent
double taxation is, however, not
uncommonworldwide.
Education TaxSeveral fscal regimes
in developing economies have an
education or training tax in addition to
a value-added tax (VAT). The former is
based on quantifable proft, which does
not include capital allowances and the
latter is based on sales.
AllowancesInterestingly, there can
be a clear specifcation for an investment
tax credit (ITC) and a petroleum
investment allowance (ITA) as incentive
mechanisms to drive E&P investment. It
must be stated, however, that ITCs and
ITAs are effort-based, so allowances on
the basis of output (reserves addition
or production) and/or prices are
underconsideration.
Proft OilCost-recovery limit (CRL)
specifcations determine the proft oil
(PO) to be shared between the host
government and the contractor. Proft
oil is defned as hydrocarbon revenues
remaining after royalty and cost oil.
Commonly, there are provisions for
a sliding-scale CRL based on volume,
value, or some other variable to make
the CRL dynamically progressive and
lessregressive.
The general consensus is to set the
CRL at 70% to 80% of gross revenue less
royalty. This is to ensure some minimum
proft oil for distribution until all eligible
costs are recovered.
The proft-sharing ratio is
determined on a sliding scale in
all Nigerias existing PSCs and the
proposed reform bill. This is tied to
either cumulative production or the
R-factor (i.e., the ratio of cumulative cash
receipts to cumulative expenditures in
the conduct of petroleum operations as
defned in the related contracts).
The Way Forward
Demand for environmentally friendly
alternative energy sources is increasing,
but fossil fuels are still the main energy
source in the global economy. It does
not appear that the status of fossil fuels
30
Academia
will change any time in the near future.
Increasing amounts of petroleum
need to be found and developed to
meet the growing energy needs of the
developingworld.
As alternative technologies are being
developed, the search for new fossil-fuel
sources will continue to stretch into more
remote areas worldwide.
Certainly, technological
advancements of the last several decades
have improved effciencies in exploration,
drilling and completion, and production
operations. These enhancements have
given the industry the potential to
search for and produce petroleum in
a cost-effective and environmentally
responsible manner.
As a result of improvements in
seismic imaging, for example, areas once
considered untouchable have become
prime targets for petroleum exploration
and development.
All of the above notwithstanding,
the search for and development of
petroleum resources having become
more globalized, besides geological
prospectivity, the attractiveness of fscal
regimes has become a lot more relevant
to investment fow than in years past. This
has increased the level of competition
in the bidding process for oil and gas
blocks and/or leases worldwide.
Thus, in order to attract investors,
petroleum-producing regions must not
only be highly prospective in a geologic
sense, they must also have dynamic,
effcient, and stable fscal arrangements
to facilitate optimal hydrocarbon
resource development and reward.
A dynamic and stable fscal
system must include terms whereby
host governments willingly give a
signifcant proportion of economic rents
to investors in order to promote the
prospect of sustainable investment fow.
High exploration risk and low-prospect
regions must balance government
take with attractive fnancial returns
toinvestors. TWA
Selected References
Iledare, O.O. 2008. Petroleum and
the future of Nigeria: Challenges,
constraints and strategies for growth
and development. IPS Monograph
Series No.5. Institute of Petroleum
Studies, University of Port Harcourt,
Nigeria. 30 pp.
Johnston, D. 2003. International
exploration economics, risk, and
contract analysis. Pennwell Books,
Dallas, TX. 401 pp.
Kaiser, M.J. and A.G. Pulsipher. 2006.
Capital investment decision-making
and trends: Implications on petroleum
resource development in the U.S. Gulf
of Mexico. U.S. Dept. of the Interior,
Minerals Management Service, Gulf of
Mexico OCS Region, New Orleans, LA.
OCS Study MMS 2006-064. 130pp.
batteries for electric vehicles after they
graduated with their BS degrees rather
than go to graduate school. After a year,
during which they found incubator
lab space and a small amount of
funding for experiments, they decided
commercializing the technology was
going to take too long and require
too much money. The four went off
to different graduate programs but,
based on how much they learned about
being entrepreneurs, I am confdent
they will be involved in successful new
businesses in the future.
Question: In your opinion, are
there any specifc factors a young
entrepreneur in the oil and gas/energy
sector needs toconsider?
RL: As opposed to our colleagues
in the software industry, ours is an
industry of long lead times, large capital
investment, and strong dependence on
intellectualproperty.
We need to recognize that our
ventures will be long term and will
require persistence, patience, and
great focus both on the details of our
ideas and on the quality of our results.
It becomes a life-long adventure, one I
have embraced with great joy because
it has allowed me to be engaged with
exciting teams for long periods of time
and, perhaps most importantly, to attempt
to make a difference in some of the most
important needs of the world: energy and
healthcare.
I therefore encourage young
entrepreneurs to choose carefully what
venture they will dedicate their lives to,
make sure they are totally dedicated, and
stay very fexible as they face the many
ups and downs that are inevitable in a
multiyear endeavor. My advice: Never
give up, and never run out ofcash!
HR: There is tremendous unmet
need in the energy sector both in
the more traditional areas like oil
and gas and newer areas like solar,
wind, fuel cells, and batteries, to
name a few. A few specifc challenges
that exist are that creating new
businesses in the energyindustry
often take many yearsand signifcant
investment. There are also signifcant
factors, such as oil prices, that
are outside theentrepreneurs
control. In addition,there can
be some inertia caused by the
large capital investmentalready
made in plants andequipment; on
paper a new technology may look
very cost competitive but when
the infrastructurefor the current
technologyis already in place and
paidfor, it can in fact be cheaper to
use the current technology on an
ongoingbasis.
Overall, there is an opportunity
to have a huge impact on society by
starting new businesses in the energy
feld, so if you are up to the challenge, go
for it! TWA
Technical Leaders
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