Petroleum Fiscal Systems and Contracts

The petroleum fiscal system for a country is essentially the taxation structure, including royalty payments, that has been established by legislation. More broadly, the fiscal system includes all aspects of the contractual and taxation framework that governs the relationship between the host government and an international oil company. Worldwide, there are many different fiscal systems with different taxation and contractual terms. These vary from country to country and some countries use more than one system. Countries, for example, may offer concessionary system arrangements or service and production sharing agreements. Whichever system prevails, the issue for an oil company is how can it recover costs expended and how will the profit be divided. This depends upon tax regulations and the principles of the economics of the life of a field.

The focus of this book is on the mechanics of the various kinds of fiscal systems and the factors that drive exploration and development economics. The emphasis is on practical aspects of petroleum taxation and industry/government relationships. There is also fertile ground for considering the philosophy of petroleum taxation which has changed the industry. Legal and operational aspects of contract/fiscal terms are also examined to provide a foundation in the dynamics of international negotiations.

Both industry and government viewpoints are addressed in this book since a complete grasp of the subject requires an understanding of the aims and concerns of both sides. There are few things more discouraging for a government’s national oil company than an unsuccessful licensing round. Yet prolonged, inconclusive negotiations can be equally frustrating for oil companies.

This book has been written for those interested in petroleum taxation and international negotiations, and the way to carry out successful exploration and development projects. Much of the subject has evolved years ago whilst some aspects of taxation are timeless. Examples are included to give the reader a wide perspective about the implementation of fiscal systems.

The terminology has changed over the years and will continue to develop. There is little standardisation of terms in the industry and the abundance of jargon can be rather daunting. The subjects covered in this book are often simple concepts wrapped up with industry and legal jargon. A glossary is provided to help with this.

Much of the material provided here was inspired by questions most frequently asked on the subject. The best answers are supported with specific examples and many of these are used throughout the book. The summaries and analyses of various fiscal terms and contract conditions are believed to be accurate, and every practicable effort has been made to gather up-to-date information about the current conditions in the countries cited. Examples of fiscal terms used here are drawn from numerous public sources. Confidential information has been carefully excluded.

Perhaps more effort could be directed toward the cultural aspects of negotiations and doing business in the international arena. Unfortunately it is beyond the scope of this book to cover that ground.

Chapter 7, Taxes; Capital Expenditure Reliefs:

Ring fence oil and gas attract various capital allowances treatment. These include:

Research and Development Allowance (R&DA), Mineral Extraction Allowance (MEA), and Plant and Machinery Allowance (P&M).

Under the R&DA scheme, capital costs of exploration and appraisal activities are allowable in full in the year in which the expenditure is incurred. Exploration and appraisal capital expenditure up to the time a decision is made to develop a field is also allowable. On disposal of assets treated as R&DA expenditure, there is a balancing charge to claw back the value by treating this as a trading receipt.

The capital costs of drilling development wells are allowable under the MEA system. Exploration and appraisal costs may also qualify here, as an alternative to the R&DA code. There is a 100% first year allowance (FYA) for MEA expenditure incurred as part of a ring fence trade. For expenditure on mineral assets such as license costs, relief is available at 10% on a reducing balance basis. MEA also applies to mineral exploration and access costs where there has been transfer of a license interest and part of the value is attributable to drilling expenditure incurred by the seller. On disposal of assets representing MEA expenditure there is a claw back of allowances, as for R&DA.

The P&M code allows for relief on all the major capital costs of acquiring or building infrastructure such as platforms, treatment facilities, pipelines, and other capital equipment used in oil and gas production. There is a 100% FYA for P&M expenditure incurred as part of a ring fence trade, except that which is incurred on long-term assets with an expected useful life of more than 25 years where the FYA is 24%. P&M allowances may be clawed back as a balancing charge on disposal of the assets. P&M allowances may be transferred when assets are sold as part of the transfer of a field interest but the allowance available to the purchaser is limited to the cost of the assets to the vendor.

The costs of decommissioning offshore infrastructure in accordance with an approved UK abandonment programme are allowable in full under the P&M code. Where a North sea company has ceased to trade and incurs decommissioning costs within three days of the cessation, the company can claim a 100% allowance in respect of the expenditure in its final trading period. Losses arising from decommissioning can be carried back for set off against profits in the preceding three years, instead of the normal one year. The costs of obtaining a bank guarantee or letter of credit against future abandonment costs are also allowable in full but not any sums set aside for future abandonment costs.

All 100% allowances for major capital expenditure, except for post-trade cessation decommissioning, are only available in the year the expenditure is incurred.