Volatility of oil and gas prices in the extractive industry has generated a lot of interest as to which fiscal regime is suitable for effective revenue mobilisation for governments. Both governments (NOCs) and International Oil Companies (IOCs) are looking at a regime that will provide a win-win benefit. They are interested in maximising revenue and profits respectively. The amount Government take is understood by many to be the determiner of the attractiveness of a fiscal regime. Comparatively Ghana’s 38%-50% government take is lower considering Nigeria’s 64% -70%, Angola’s 64%, and 74% -78% for Cameroon as well as 65% -85% of IMF’s benchmark as we are told by its fiscal department in 2001.
However, this can be misleading for example a company is more likely to invest in a regime that provides 95 per cent government take while allowing rate of return of 25 per cent than a regime that provides 55 per cent government take while permitting 15 per cent rate of return. This shows that Government take does not influence the attractiveness of a regime, because it excludes any impact of the costs, complexity of extraction and realized prices resulting from both differences in location or market structure.
A fiscal regime’s attractiveness is ultimately decided upon the return on investment offered over the project’s lifespan. Although the UK’s regime displays a lower portion of government take around 50% except Ninian and Forties which has about 74%, the regime seems inaccurate when considered in absolute terms because it comes with some upfront taxes and charges that patch up the low percentage of government take.
Considering IMF industry benchmark of government shares between 65% -85%, a regime that falls short of this means there was rigid agreement. Obviously such a regime will be charitable to investor since it falls below the average (Ghana’s case) whiles it exploits the citizens of their national asset.
There exist a number of fiscal provisions for oil-producing Countries. A particular fiscal regime determines its fiscal mechanisms that can be applied to the country’s petroleum operations. Cases where the State takes all the risks of exploration and production, a fiscal regime is immaterial. The Concessionary or Royalty Tax systems are condition where the whole operation is given to an independent operator as in the case of Ghana (the jubilee partners) who bears all the risks and the state’s ‘take’ comes in a form of lease sales, income tax, special petroleum taxes and royalties.
Ghana’s fiscal package consists of royalties, carried interest, additional oil entitlement, petroleum income tax, and surface rental. The Modelled Petroleum Agreement and PNDC Law 84 provide rates between 5% and 12.5% to be charge on gross production of oil and gas as royalty, and this varies from block to block as well as water depth dependent.
The country’s Carried Interest ranges from 10% to 15% in each contract area but in most contracts so far it is fixed at 10%. This interest is “carried” during the exploration and development stages with IOC bearing all the risk through project finance
Ghana’s petroleum Income Tax Law (PITL) sets default rate at 50%, but has since been operated at 35% even before 1990. For example in Jubilee, the rate has been set at 35. Cost Containment is Unlimited carry-forward of losses under PITL. Five year straight-line depreciation of exploration and development costs and other capital thus decommission cost, expatriate nationals exempted from tax, expatriation of capital and dividends as well as exemption of import duties are enough attractions for IOCs.
Profit oil is shared between NOC and the IOC proportionally. Ghana sits on 10% withholding tax on amounts due to sub-contractors as specified in the Petroleum Agreement. Initial exploration period of US$ 30 per sq km, 1st Extension Period of US$ 50 per sq. km, 2nd Extension Period of US$ 75 per sq km exist in Ghana’s surface rental provisions.
There are other situations where States may finance their NOCs, in such instance both NOC and the IOC share in various degrees of exploration, development and production risk in varying proportions. For PSC, the possession of the resource belongs to the State and the IOC is hired to develop and extract the resource in return for a share of production. Ideally the IOC finances all explorations and if oil is establish in saleable quantities, part of the development and production costs is born by government. The government and the IOC each receive a portion of the profit oil after cost recovery according to an agreed formula.
However, Ghana’s upstream petroleum industry is characterised with a crossbreed of production sharing and concessionary regime because this option avoids the need for host countries to commit scarce funds up front for exploration. It is also a preferred option by the IOCs because it gives them the leeway to operate. The country is relaying on the framework of the GNPC Law, 1983, (PNDCL 64), the Petroleum Exploration and Production Law, 1984, (PNDCL 84), and the Petroleum Income Tax Law, 1986 (PNDCL 188) to conduct her business. Considering recent petroleum discoveries, it will be necessary to review and update these provisions in order to maximise revenue for national development. Obviously the over 26 year old regime cannot be used for a 4 year old commercial production. We understand that oil projects have long lead time, averagely 15 years and so are their regimes yet this does not deny the government the opportunity to organise stakeholders at the negotiation table for possible adjustments.
Even though they are risk averse, governments take do not in a larger extend influence the destination decisions of investor in the industry. An attractive fiscal regime is also one that provides some assurance that there will be sufficient cost recovery allowances to cater for its costs and risks during the exploration and production phases
Given the lead time of petroleum projects, the fiscal stability over the lifespan of the project is an important consideration for potential investors. With high uncertain political environment and volatility of oil prices, it is undesirable for a host government to continuously adjust fiscal regimes based on short-term price movements. Ghana’s young democracy has been stable since 1992 thereby promoting calm political and economic atmosphere.
Stability manages political risks, potentially prevent government of unilateral decisions and guarantee that contractual terms will remain constant throughout the life of a project, and that any change would require the consent of both parties. Again Ghana has no history of obsolescing bargain or unilateral decisions and therefore making retroactive changes to existing fiscal regime arrangements is not envisage.
A company will want to pay taxes in proportion to the profitability of its operations. Project profitability depends on costs and prices and the government is concern about increasing its take as prices improve or as initial costs is recovered making the project more profitable. A progressive regime tends to attract investments as it broadens the tax base and eventually resulting in higher government revenues.
The flexibility provision in Ghana’s fiscal regime exists in the AOE. The reviewing of this provision is aimed at limiting the adverse effect of fiscal stability clauses and to avert the unavoidable pressures to modify the original fiscal regime in the event of continued price increases. On the surface, Ghana’s fiscal regime, with minimum or no front-end charges and flexibility with the State’s take adjusting automatically with profitability, Ghana can be assessed as neutral.
The key issue for the country is determining the optimal thresholds, the ROR bands, and the applicable progressive take for each contract. In addition, the absence of cost recovery limit in Ghana’s fiscal regime, the absence of thin capitalization provisions and hence limits on interest deductibility, compromise the degree of progressivity that can be attained through the income tax and the AOE because of the scope of carrying expenses and limiting the tax base.
Many IOCs generally love to work with PSC, all other things being equal. A simple cost sensitivity exercise with a typical PSC will often demonstrate that raising operation expenditure significantly has very little effect on IOC’s economics. This is as a result of cost of petroleum which has much positive influence on the IOC. Higher costs translate to higher petroleum entitlement for IOCs which results in higher bookable reserves and consequently higher stock market capitalization.
A regime ultimately has a greater impact on a countries extractive industry economics with taxes and risk sharing being outstanding issues. While government is concern about maximising revenue it must do this with maximum neutrality. This can be done by designing a regime that will iron out any differences on economic rent and discount rates; IOCs use different internal rate of return (IRR) across countries depending on the level of risk they perceived. A low discount rate on the part of government makes it possible to reach a deal between NOC and IOC it will compel government to wait a while for its share of revenue.
Restricting tax on economic rent means government tax will come from profit and not revenue. Ghana’s fiscal regime is based largely on “bidding. The system has no cost recovery limits and therefore hampers progress, likelihood of government revenue delay are evident and there exist weak thin capitalization provisions.
The regime is limiting government take to economic rent, of cause taxing only profits will strengthen neutrality in the system. However, it poses its own challenges since the IOCs may not be fair in profit declaration. We call on stakeholders to expedite action on any reforms to enable the country maximise its take of the oil find, because the current regime is too attractive for IOCs and to the detriment of the state.
By: Mahama Hudu/citifmonline.com/Ghana