Lecture 6: Petroleum Fiscal Regimes
Dr. Jonathan Atuquaye Quaye
Department of Petroleum Engineering
College of Engineering
KNUST, Kumasi.
Email: jaquaye@[Link]
Fiscal Regimes
❑ 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.
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Classification of Petroleum Fiscal Systems
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1. Concessionary System
❑ Under a concessionary system, the state government grants a Concession or
License to an international oil company (IOC) or a consortium which gives
rights for a fixed period to explore for and produce hydrocarbons within a
certain area (License Area or Block).
❑ The IOC may be required to pay a signature bonus or a license fee to the
government to secure the Concession or License.
❑ Thereafter, the government will obtain compensation usually through
royalty and tax payments when hydrocarbons are produced.
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Calculation of Government and Contractor Take
❑ The contractor or operator take can be calculated as percentages in steps:
The gross revenues are always 100%.
❑ 1. Subtract the royalty percentage to give the percentage net revenue.
❑ 2. Deduct capital and operation expenditures for the entity as a percentage
from net revenue.
❑ 3. Subtract the government’s profit share, taxes, levies, etc. This gives the
contractor's share of profits.
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❑ 4. Subtract the percentage of costs from gross revenues to equal total profits.
❑ 5. Divide the contractor percentage of profits after income tax by total
profits. This is the contractor take percentage.
Try Questions
❑ 1. What will be the contractor and government take for a contract with 20%
royalty and 50% income tax, where project costs are 30% of a gross revenue
of USD 2 billion?
❑ 2. A government has signed a PSC with an investor which has the following
terms. What is the contractor and government take expressed as a
percentage?
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❑ Royalty - 12.5%
❑ Life – of – field cost recovery – 33%
❑ Profit oil split 50% to government, 50% to investor
❑ Profit related income tax – 30%
❑ Oil price ($/bbl) - 60
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The contractor take percentages, cost recovery limits and participation of selected systems.
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2. Production Sharing Agreements(PSA)
❑ Production sharing contracts or agreements (PSCs or PSAs) give an
international oil company (IOC) or consortium exploration and production
rights for a fixed period in a defined Contract Area or Block.
❑ The IOC bears all exploration risks and costs in exchange for a share of the
oil or gas produced.
❑ Production is split between the parties according to formulae in the PSC that
may be fixed by statute, negotiated, or secured through competitive
bidding.
❑ If the IOC does not find a commercial discovery, there is no reimbursement
of costs by the government.
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❑ The advantage to the host government of this system is that the
government will generally receive a large share of the oil or gas.
❑ This can be sold and the revenue used according to the government’s
development programmes and economic needs.
❑ Contractors are required to submit a programme and a budget to be
approved by the national company.
❑ The type of contact depends on the level of reserves and political economic
aims of the host government.
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❑ It is important to note in such contracts both the level of percentage of
recovery of costs and also the way in which the exploration or development
costs may be recovered.
❑ If there is costs recovery before sharing of production, the contractor is
allowed to recover the costs out of net revenues.
❑ The costs recovery limit is the only true distinction between concessionary
systems and PSCs.
❑ The amount of revenues remaining after royalty and cost recovery, is
termed profit oil or profit gas.
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❑ This is the equivalent of taxable income in a concessionary system. Within
the service agreement, it would be termed the service fee rather than
profit oil or gas.
❑ The contractor share of profit oil or gas is taxed at the rate of sharing.
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.
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❑ 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.
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❑ Negotiable aspects include the area of lease, work commitment,
commerciality, renouncement, bonus payments, cost recovery limits, and
production sharing percentages.
a. Royalties
❑ The basic concept of royalties which is similar under all fiscal systems is
that royalties are taken straight off the top of gross revenues.
❑ Many production sharing contracts (PSCs) do not have a normal royalty
because of the ownership issue.
❑ Payment of royalty implies ownership on the part of the royalty payer but
in a PSC the contractor has no ownership at this stage.
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❑ Where PSCs do include a royalty, this can typically range as high as 15%.
❑ A PSC royalty is treated just as it would be under a concessionary system; it
is the first calculation made.
❑ The royalty level is clearly very important and rates above 15% may be
considered by the contractor as excessive.
❑ Governments may now scale royalties accordingly to the field size since it
can be inefficient and counterproductive if royalties are set too high.
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b. Sliding Scales
❑ A characteristic encountered in many petroleum fiscal systems is the sliding
scale (or progression of steps) used for royalties, taxes, and various other
❑ items. The aim is to create a flexible system with sliding scale terms so that
as production rates increase, government take increases.
❑ Terms can be set appropriately for the development of varying sizes of
field. Some contracts will provide flexibility through a progressive tax rate.
❑ Others will tie more than one variable to a sliding scale such as cost
recovery, profit oil split, and royalty.
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c. Rate of Return Contracts
❑ Under an ROR contract, the government does not receive payments until
the contractor has recovered its initial financial investment plus a
❑ predetermined threshold rate of return. The government share is
calculated by accumulating the negative net cash flows and compounding
❑ them at the threshold rate until the cumulative value becomes positive.
When that happens, additional resource rent taxes (RRT) are levied
❑ but the contractor still receives some of the profits in excess of the
threshold rate of return.
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3. Service Contracts
❑ Many service agreement are identical to PSCs in all but the method of
payment, either by production sharing or profit sharing.
❑ Many service agreements, however, have unique contract elements that
are used in calculating the service fee.
3a. Pure Service Contracts
❑ A pure service contract is one where the contractor carries out exploration
and/or development work on behalf of the host government for a fee and
❑ the contractor bears no exploration risk.
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❑ This kind of contract is not used widely but may be used sometimes,
typically in the Middle East, where the state has substantial capital but
seeks only expertise. Examples are contracts placed for drilling services,
development services and some exploration services.
3b. Risk Service Contracts
❑ A risk service contract is radically different from a pure service contract and
bears little similarity to an oil service industry service contract.
❑ Under a risk service contract awarded by a host government, the contractor
provides all capital associated with exploration and development of
petroleum resources, bearing all the exploration risk.
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❑ If exploration is successful, the contractor is allowed to recover costs
through sale of the oil or gas and also receives a fee based on a percentage
of the remaining revenues.
❑ As well as bearing exploration risk, the contractor does not get a share of
production.
❑ However, although there is no production sharing or profit oil, the contract
terms allow the contractor a share of revenues similar to that derived from
a share of production in a PSC.
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❑ The host government maintains ownership of the hydrocarbons produced
and the contractor does not acquire any rights to oil and or gas unless the
❑ contractor is paid its fee in kind as oil or gas. The contractor may also be
given preferential rights to purchase production from the government.
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4. Joint Ventures
❑ International oil companies often form joint venture (JV) partnerships with
industry partners to share risk and reward for large scale or high risk
ventures.
❑ Joint ventures may also be formed with direct government participation. In
a pure joint venture, the host government and the contractor would share
equally in costs and risks but in practice the extent of government
participation varies.
❑ In most JVs with government participation, the contractor oil company
bears the costs and risks of exploration so that the government is carried
through exploration.
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❑ Government participation has the effect of reducing the potential rewards
of exploration.
❑ Where the government actually pays its share of JV costs, the government
share of profits cannot be considered as a tax on income.
❑ However, if government is carried through exploration, government
participation acts like a capital gains tax.
❑ In extreme cases such as Russia where the contractor pays all
rehabilitation, development and operating costs, the government share of
JV profits constitutes an added layer of taxation.
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❑ The contractor will recover exploration and development costs by means of
either cost recovery, deductions, or direct reimbursement but there is an
important difference of timing between direct reimbursement and cost
recovery.
❑ The Extent of Government Participation in a Joint Venture
❑ The range of government participation can be characterised from Light to
Heavy:
❑ a. Light - Pure Joint Venture
❑ All Costs/risks shared
❑ Very rare.
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❑ b. Mauritania Type Participation
❑ Government carried through exploration
❑ Contractor recovers exploration costs plus 50% uplift on government share.
❑ c. Typical Joint Venture
❑ Government carried through exploration
❑ Contractor can recover exploration costs.
❑ d. Colombian Type Joint Venture
❑ Government carried through exploration and delineation.
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❑ e. Full Carry
❑ Government carried through exploration and development
❑ Not common.
❑ f. Heavy - Russian Type of Joint Venture
❑ Government carried through rehabilitation and development, until it has
cash flow from operation.
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5. Technical Assistance Contracts (TACs)
❑ Technical assistance contracts (TACs) are commonly applied for work on
existing fields in production or abandoned fields with the purpose of field
rehabilitation, redevelopment, or enhanced oil recovery (EOR) projects.
❑ The contractor will undertake to provide capital and specialist expertise
and will take over control of operations including equipment and personnel
if applicable.
❑ If there is existing production, a production profile with a specified decline
rate is negotiated.
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❑ Future production as defined by the negotiated decline rate is exempt
from the sharing arrangement and goes directly to the government.
❑ Increased production above the negotiated rate is deemed to be due to
the contractor’s technical assistance.
❑ This incremental production is normally subject to a production sharing
arrangement although TACs can be found under a variety of systems.