Royalties and taxation policies for Guyana’s oil sector

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Successive Guyanese governments will essentially be relying on royalty and taxation measures to capture a “reasonable” share of the economic rents from Guyana Basin oil exploitation. This practise has also been followed by other host governments in geographic areas with similar resources. While there is general agreement among economists that economic rents from natural resource exploitation are a suitable target for collection by the state, the measurement of these rents and the efficacy of the various fiscal devices which may be imposed are highly complex matters. If the taxation measures are directed at the economic rents, investment decisions should not be distorted. In brief, the economic rents may be measured in practice:

  1. At the field development stage by the expected net present value (NPV), and
  2. At the exploration stage by the expected monetary value, both calculated at the investor’s discount rate.

The effects of the various types of fiscal measures depend on a combination of nominal tax rates, the extent of and pace at which exploration, development and operating costs are deductible. The structure of the system is as important as the rate of tax. While all devices which are not accurately targeted on economic rents are liable to cause disincentives and/or distortions to decision making, as a generalization it can be said that impositions based on gross revenues rather than profits are more likely to cause disincentives (Kemp 1990).

The impact of fiscal arrangements in the petroleum sector must incorporate all the fiscal terms at the time of the development decision and where the present value of tax take is expressed as a percentage of the pre-tax net present value, which is a measure of the share of the economic rents collected by the state.

In Guyana’s situation, the 2016 fiscal package is expected generally to take a modest share of the expected rents. The take may also be seen frequently to be regressive in its relationship to economic rents. This follows principally because the royalty, being partly related to gross revenues, is regressive in its relation to profits. There is no corporation tax is that is directly related to economic rents as it does not allow a normal return on investment as a cost. There is no Petroleum Revenue Tax (PRT), which can be more closely, though not directly, related to economic rents. In some cases, in the inclusion of such a package collects more than 100% of the expected rents and can thus cause investment disincentives.

A consideration for the inclusion of a PRT can allow for the effective take to be significantly increased. The bite of PRT will increase substantially. The scheme is rather less regressive across fields because the incidence of the extra PRT burden falls disproportionately on the more profitable fields. Other distortions can be produced. The uplift provision can encourage more capital-intensive exploitation methods than a neutral scheme. The interaction of this allowance with the safeguard provision means that gold-plating incentives can be produced: an incremental unit of investment can increase the safeguard base for PRT such that tax savings exceed 100% of the cost. This possibility can become stronger under the new changes when a progressively higher effective rate of PRT increases the chances that a field would come under the safeguard provision.

Moreover, oil price swings will lead to further adjustments in the fiscal terms. The biggest change can occur if there is consideration of the introduction of Supplementary Petroleum Duty (SPD).  The take in terms of share of economic rents to be collected can become extremely high. The system is regressive across the set of fields. The continuation of the royalty plus the gross-revenue related SPD could play a major role in producing this effect. However, field development disincentives can be produced by the system. Some field developments can be postponed by investors as a consequence of the very high level of tax.

Further, any significant reductions in the oil prices can lead to adjustments to the tax system applied to new fields. The main change which can occur is the lowering or removal of royalty and the doubling of the volume allowance for PRT in the Guyana Basin. There is now a wide range of field development costs for new projects, depending on whether or not the project can utilize the existing infrastructure. The take is frequently broadly proportional to changes in costs and oil prices. The level of take will be lower on the smaller fields due principally to the volume and if there are cross-field allowances for PRT. The system should not cause disincentives to new field developments for existing taxpayers.

The position for investors who are not already in a taxpaying position is seen to be rather different. Under low costs, the level of take is similar to that facing an investor with full tax shelter. At high-cost levels the take facing new investment becomes much higher: the system is regressive with respect both to oil price and development cost changes. The lack of the benefit from a potential PRT cross-field allowance and the front-end reliefs for drilling costs against corporation tax will produce this effect. Under combinations of very low oil prices and high development costs, relief for abandonment costs for corporation tax purposes for a single-field investor can also be incomplete. The result is that the effective tax take is increased.

In extreme cases (general combinations of low prices and high development costs) the take can exceed 100% of the economic rents and thus cause field development disincentives. This is caused by the incidence of corporation tax, not PRT. The government view should be that corporation tax is applied throughout the economy and the special concessions for the upstream petroleum sector would introduce investment distortions between that sector and the rest of the economy. At present there is an incentive for investors to acquire Guyana Basin taxable income to obtain shelter for both a potential PRT and current corporation tax to facilitate new exploration and development.

The above analysis has briefly summarized the main impacts of the various Guyana Basin oil fiscal arrangements since the initial package was established in 1999. The current changes and the suggested changes will mean that, in making decisions, investors have had to form expectations of possible future changes in fiscal and other licensing terms. This is an example of political risk which has been defined to exist:

  1. When discontinuities exist in the business environment,
  2. When these discontinuities are difficult to anticipate, and
  3. When they result from political change.

The net effect may be to raise the discount rate employed by investors. In turn, this could adversely affect the development of marginal fields.

The large number of suggested fiscal changes could reflect the lack of accurate targeting of the instruments employed. Should the taxes been directly related to economic rent, the suggested changes would not be necessary, and the investment uncertainties would not be increased. The enormous complexity of PRT and the adverse effects of the uncertainties regarding the possibilities of future changes constitute the hidden costs of the system. It is also clear that a wholly profit-related system applied to new fields can constitute a major structural improvement which will improve the investment environment in the emerging Guyanese oil and gas sector of the offshore basin. The technical fiscal problems generally reflect the effect of a system which is still not accurately related to economic rents.

With regard to licensing arrangements, the employment of the discretionary system should ensure that opportunities are provided both for Guyanese oil companies and the offshore supplies industries. It should be backed up with more employment of the bonus bidding system in the award of licences in mature areas. There is a suspicion that the system will allow for a situation that could sometimes lead to some of the economic rents from oil exploitation being transferred to the supply industries. The relinquishment conditions must encourage the optimal use of acreage awarded. The new cycle of licensing will have to produce a satisfactory outcome in terms of activity levels.

A fiscal package to collect economic ex-post rents is generally agreed to be necessary. The 2016 package is not very accurately targeted on economic rents. The many discretionary changes which have been made reflect this as well as a desire of governments to accelerate their take from the Guyana Basin. The future legislative changes to the fiscal area will have to indicate that the Guyanese government should have in practice, employing a moderate discount rate in Guyana Basin matters. The introduction of SPD and Advanced Petroleum Revenue Tax (APRT) in particular could be used to reflect this, wherever applicable. The greater the government’s reliance on Guyana Basin revenues the higher its effective discount rate will be. The fiscal structure applied to the Guyana Basin oil and gas will become economically much more efficient over the next few years. Profit-related systems are much less likely to introduce major distortions to decision making. This is because they are not directly targeted on economic rents. Hence, the possible, though reduced, need for further discretionary changes remains.