Ministry of Higher Education and

Scientific Research
University of Technology
Petroleum Technology Department

Scientific Report

Fiscal Regimes

Homam Mohammad Radhy Alwan

‫همام محمد راضي علوان‬
3rd Stage (2019/2020)
Economics
 Fiscal Regimes

Prepared by

Homam Mohammad Radhy Alwan

17/July/2020

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Abstract
Fiscal Regimes is one of the most important factors to be considered for investment
decisions in oil and gas industry. Royalty Rate, Cost Recovery, Contractor Share,
Domestic Market Obligation, Investment Credit, Signature Bonus, Production Bonus,
First Trance Petroleum and Corporate Tax Rate have a significant effect on the
investment decisions.

The paper examines and compares the fiscal regimes in Australia, China, India,
Indonesia and Malaysia. In order to analyze the advantages and disadvantages of each
fiscal regime, the economic analysis of the same hypothetical fields with the
applications of those different fiscal regimes are presented and discussed. Generic
fiscal terms are used in the analysis since contractors usually can negotiate the special
terms with governments.

The information of this paper is useful for oil and gas companies around the world
when they want to decide where in Asia Pacific Region they want to invest their
money. They can compare which fiscal regime gives them the most favorable return
of their investment. In addition, the information is useful for the governments when
they want to assess their fiscal regime competitiveness compared to other fiscal
regime in that region. In depth analysis on fiscal regimes of those countries is very
important for oil and gas industry and it will add to the knowledge base of this
industry.

Conclusions are made of the effects of these different fiscal regimes on oil and gas
company cash flow and profitability and how they affect company investment
decisions in oil and gas industry and government policy.

Introduction
Asia Pacific is still one of the most attractive places for investment in oil and gas
sector. Among countries in Asia Pacific, China, Indonesia, Australia, Malaysia and
India are the largest oil and gas producers respectively (see Table 1). Being the largest
producers countries, every country tries to attract companies from various aspect of
investment. Fiscal term is one of the aspects for investment decision. Obtaining good
terms in the global context is one thing, but nobody wants to negotiate the worst terms
in a country even if these are relatively good terms. For many oil companies, an
important part of the negotiations is to secure terms acceptable to the new potential
partner. Knowing the market and what terms are realistic depends on a region's
potential and factors.

Most countries developing petroleum fiscal systems are opting for the Production
Sharing Contract (PSC). Now, nearly half of the countries with the petroleum
potential have a system based on the PSC. However, financial result could be the
same as in royalty/tax arrangement. Economics depend primarily on division of
profits or what is known as government/contractor take. Fiscal comparisons center on
government/ contractor take. Contractor take is the percentage of profits going to the
contractor or oil company. Government take is the remaining share. Division of
profits is one of the most important benchmarks for comparing fiscal systems. It
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correlates directly with reserve values, field size thresholds, and other measures of
relative economics.

Detailed economic modeling using cash flow analysis is the best way to compare the
fiscal terms for each country. Once cash flow is projected, the respective profit shares
can be evaluated. Besides the profit share, the contractor receives revenue or
production for cost recovery. Profit share combined with cost recovery is the total
contractor entitlement.

CLASSIFICATION OF PETROLEUM FISCAL

SYSTEMS
Petroleum fiscal systems whereby the owner of mineral resources
receives levies from the extraction company can be classified into
two main categories These are concessionary systems and

contractual systems as shown in Figure 1-1.

[1]

In most countries, except the United States of America, the owner

of the mineral resources is the government. In the USA, the
owners are private individuals or companies that pay taxes on
production to the state.
Worldwide, every country has developed its own petroleum fiscal
systems to be applied. Under concessionary systems, the
government will transfer title of the oil and gas to a company if
they are produced. The producing company then pays royalties
and taxes.
Contractual systems are in most cases either production sharing

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agreements or service contracts. The private companies under contractual systems
have the right to receive a share of production or revenues from the sale of oil and gas
in accordance with a production sharing agreement (PSA) or a service agreement
(SA). The state companies either self produce or share the production and selling of
the oil or gas. Revenues then flow into the finance ministries’ treasuries. In most
contractual systems, the facilities installed by the contractor within the host
government’s territory become the property of the state either as soon as they are
landed or upon start up or commissioning. Sometimes, the asset or a facility does not
pass to the government until the expended costs have been recovered. This transfer of
title for asset facilities does not apply to leased equipment or to equipment brought in
by service companies. The difference between service contracts and production
sharing contracts depends on whether the contractor receives compensation in cash or
in crude. Under a production sharing agreement, the contractor receives a share of
production and hence takes title to this crude. In a concessionary system, the transfer
of title occurs at the point of export instead of at the wellhead. In a service contract,
there is no issue of title since the contractor gets a share of profits rather than
production. Under some service agreements, however, the contractor has the right to
purchase crude from the government at a discount. Despite the differences between
the systems the same economic results are achieved. When the contractor is paid a fee
for conducting exploration and production operations, then this system is a risk
service contract. The difference between risk and pure services contracts depends on
whether there is a fee on the profits or not. The pure service contract is without risk in
exploration and development. Consequently, this is usually used by conservative
nationalized companies or by states that have capital but are lacking in technology
and management capability.
The different fiscal systems are further illustrated in Figure 1-2, showing the differing
points of transfer of title and methods of remuneration.

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 [1]

In addition to the concessionary and contractual systems, which

are the two most used systems, there are some further variations
that could be considered as types of fiscal system.
The joint venture is a variant fiscal/contractual system. It is used
where the national company and contractor company establish a
working interest arrangement. This is found in both concessionary
and contractual systems.
Technical assistance contracts (TACs) are sometimes used for
enhanced oil recovery (EOR) projects or restoration and
redevelopment managed under a production sharing agreement
or a concessionary system.

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Basic Elements
There are two basic elements in the production sharing fiscal
structure. The first is the operational element and the second is
the revenue or production sharing element. Each of them have
national legalisation and contractual aspects. The national
legalisation aspects such as government participation, mediation,
insurance and ownership transfers are unchangeable in the
operational period, as are revenue factors (royalties, taxation,
depreciation rates, investment credit and domestic obligations).
The contract conditions, however, are negotiable. For example,
the oil ministry can negotiate the split of oil but cannot negotiate
the tax rate which is fixed. The oil companies are able to negotiate
the structure of production sharing contracts. Negotiable aspects
include the area of lease, work commitment, commerciality,
renouncement, bonus payments, cost recovery limits, and
production sharing percentages.
Work commitments are generally defined in terms of kilometres of
seismic data to be acquired and the number of wells to be drilled.
There are some cases, however, where only seismic
commitments are defined and drilling is optional.

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Bonuses
There are different flavours: signature bonus, discovery bonus, first oil sales,
production bonus.[3]
Signature bonus is a onetime fee for the assignment and securing of a license, paid
irrespective of economic success for the contractor or licensee. Not all states use
bonuses, but the government may charge a minor fee for handling license
applications.
Corporate tax
Corporate tax is the standard company income tax used in many countries, and will
similarly apply to oil companies.
Royalties
Royalties are shares of the extracted hydrocarbons entitled to the host state. The state
can agree with the licensees to take it in kind or in cash. This arrangement applies to
both crude oil and to natural gas, both in concessionary and contractual license
systems.
Production shares
The body of a production sharing contract layouts the production share between the
contractor(s) and the state or its state-owned oil company. Typically, most of the early
production will be set aside for recovering the costs incurred during development by
the contractor (cost oil), while the state receive an increasing share of production after
costs are recovered (profit oil).
This is a specific contractual license system arrangement.
Surface fee
Surface fee is a yearly fee, paid per square kilometre or square mile occupied by the
license or leased area. This type of fee is used in Brazil[4] for the exploration
phase,[5] and for large production volumes, named "Occupation or Retention
Fees".[6] In the Norwegian fiscal regime, it is known as area rental fee and is only
paid for "passive licenses", and for exploration areas before a Plan for Development
and Operations is submitted to the government.[7] If an oil company has found all or
parts of an exploration area of little interest, the area can be relinquished to the state,
to save expenses for fees. Other countries enjoying surface fee
include Algeria, Angola, Benin, Cameroon, Mauritania.[6]
More country specific elements
Special petroleum tax
This is a concessionary license system taxation, to tax a high proportion of the
resource rent. In the United Kingdom, it is known as Petroleum revenue tax (PRT),
where a 50% tax is accounted for income from each oil field.[8] In Norway, special tax
can be up to 50% on top of 28% corporate tax, however, the income and taxes are
calculated for the entire portfolio of fields in which the company participates, and
losses can be carried forward from previous years. In this way, profit from one oil
field can be balanced against loss on another field, which lowers the maximum tax
burden.[6]

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Ring Fence Corporation Tax (RFCT)
This is country specific for UK, it is a tax of 30%. A 'ring fence' prevents taxable
profits from being reduced by losses that the oil company experiences from other
activities.[7]
Environment fees
According to Norwegian fiscal regime, a CO2 tax is paid per volume liquids and gas
burnt or emitted directly to air on the continental shelf. It is classified as a deductible
operating cost, hence reducing the other taxes paid to the state.[6]
State's Direct Financial Interest
An example of a unique implementation of government take is State's Direct
Financial Interest (SDFI), the Norwegian state directly owned shares of exploration
and production licenses on the Norwegian continental shelf.[9] Although SDFI gives a
take effect similar to royalties, it is not classified as royalties by the government,
reasoned by that this arrangement also commits the state to contribute in investments
with the same proportion of capital as they take out their share of the revenues.[7]

Conclusion:
The petroleum fiscal regime of a country is a set of laws, regulations and agreements
which governs the economical benefits derived from petroleum
exploration and production. The regime regulates transactions between the political
entity and the legal entities involved.[1] A commercial or legal entity in this context is
commonly an oil company, and two or more companies may establish partnerships to
share economic risks and investment capital.
Although petroleum, oil and gas, and hydrocarbons are not
technically mineral resources, the term mineral rights is used to denote rights to
exploit oil and gas resources from the underground. Onshore, in United States, the
landowner possesses exclusive rights for mineral rights, elsewhere generally the state
does.[1] For this reason, the fiscal regime of US is divergent from that of other
countries. The petroleum licensing system of a country may be considered interwoven
with the fiscal regime, however, a licensing system has its distinct function: to grant
rights for petroleum exploration and production to commercial entities.
Because each country has distinctive legislation, there are theoretically just as many
different fiscal regimes as there are countries in the world with petroleum resources,
but the regimes can still be categorized based on their common characteristics.

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Discussion:
A fiscal regime is the set of instruments or tools (taxes, royalties, dividends, etc.) that
determine how the revenues from oil and mining projects are shared between the
state and companies. This reader discusses the factors governments consider when
selecting fiscal tools, what types of fiscal tools governments often use, and the common
loopholes or pitfalls with different fiscal tools.
The details of what fiscal tools are used and how they are applied to a particular
mining or oil project are part of a country’s legal framework, which includes the
laws, regulations and contracts. There are many considerations a country makes in
determining which fiscal tools to use and how to use them. While the government may
have preferences, it must also respond to the needs of the companies if the state wants to
attract investment. Some of the broad considerations include:
• What is the timing of the revenues? Some fiscal tools provide governments with
more money early in the life cycle of an extractive project, while others do not deliver
significant revenues until the project has already turned a profit, which can take years.
For example, signature bonuses represent revenues early in the extraction project,
called front-end loaded, while profit-based taxes tend to be back-loaded.

How does the government revenue change when profitability changes?

As commodity prices, production techniques and production rates change over
time, so does the profit margin for the project. The impact that a fiscal tool has on
government share of the profits when the project’s profit margin increases can be
placed into one of three categories. Neutral fiscal tools give the state the same share
of revenue whether profitability increases or decreases. Progressive fiscal tools give
the government a larger share of the profit when profits increase. Regressive fiscal
tools give the government a lesser share as profits increase.
Each option can be beneficial depending on the desired outcome. The steady flows
of revenues that come from neutral or regressive fiscal tools can help governments
with weak auditing capacity increase collection and ensure that they receive
revenues earlier in the project life cycle. However, regressive or neutral tools can
discourage investment, particularly for projects with small profit margins, because
they require companies to pay the state even when the costs of extraction are greater
than revenues. Progressive fiscal tools, by contrast, are seen to protect the interests
of companies during periods of low profitability while giving the government
an ability to capture a significant share of windfalls when profits are high. These
progressive tools, however, are frequently more difficult to enforce effectively,
because they require an ability to audit costs and calculate profits.

Who carries the risk? Not all extraction projects are successful. Fiscal terms
are usually agreed to very early in the project, before extraction is underway. A
company’s investment in the expensive infrastructure and supplies necessary to
extract natural resources represents a risk, as the investment may not equal future
profits. With some fiscal packages, a government shares more of the risk with the
company than others and is subject to losses when a project is not profitable.
Governments can consider these broad issues and then choose a combination of fiscal
tools that meet their objectives. The industry often uses a shorthand by referring to
the government take and the company take. Though it is tempting to simply compare
different countries’ government take, it is very complicated to determine whether a
government take is fair or good for a particular contract. The type of mineral being
extracted, the quality of the crude or ore, and the costs of developing a project vary
greatly and have a large influence on government take. Establishing a transparent fiscal
system enables better oversight by government agencies, civil society organizations
and parliament.

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References:
1. Iraq Petroleum
2. Johnson, D. The Production Sharing Concept. PetroMin Magazine-Singapore, August 1992:
26-34.

3. Mazeel, M. (2010) p.208

4. "Brazil official has opened its oil sector to foreign players" Alexander's Gas & Oil
Connections. 28 September 1998. Retrieved 31 May 2013.

5. "Final Tender Protocol (Edital de Licitações) For the Contracting of Oil and Gas
Exploration, Development and Production Activities Brasil Round 6" Agência
Nacional Do Petróleo (Anp). 2005-06-25. Retrieved 2013-06-01.

6. "Global oil and gas tax guide 2012" Ernst & Young. 2012. Retrieved 2013-06-01.

7. Taxation of petroleum activities". 006031-990016. Ministry of Finance, Norway.

2007-10-15. Archived from the original on 2013-08-17. Retrieved 2013-06-01.

8. "HM Revenue & Customs: A Guide to UK and UK Continental Shelf". HM Revenue

& Customs in United Kingdom. 2008-09-16. Retrieved 2013-06-01.

9. "SDFI and Petoro annual report 2012 - Front page". Petoro. 2013. Retrieved 2013-
06-01.

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