At the beginning of this section we discussed the relative components of the various schemes including ownership, the manner in which entitlement to hydrocarbons is given or calculated, the manner in which payment is made, and operational freedom.
No one single parameter defines a contract style. There is a tendency to observe that tax/royalty contracts are the favored contract style in OECD countries, that take less than PSCs or service contracts and that they tend to offer greater operational freedom. However, there is in practice no limitation on what may be contained in any one contract style and, as noted previously, it is quite possible to take features from one contract and move them to another.
Production sharing has elements in it that are different to tax/royalty, but from a purely fiscal perspective it operates very similarly. A tax/royalty regime with a high production tax may leave the IOC no more in profit than a PSC; it just gets to that end point somewhat differently.
Looking at the overall level of government take is just as important as when the take occurs. Regimes may have very similar levels of government take overall, but timing can cause returns to be very different. Conversely, very different levels of government take can yield the very same return.
The illustrations below show four different fiscal structures where the government variously takes different amounts of bonus, royalty, production tax and income tax, or operates in a PSC or service contract mode. All yield the same rate of return to the IOC because the timing of the overall government take is quite different.
The first chart shows the profit split on the same field for four different levels of government take, all yielding a 20% rate of return to the IOC. The second chart explains why, showing the timing of that government take divided into three phases: that taken by the government prior to the investor recovering its investment (pre-payout), that recovered post-payout, but prior to the IOC receiving an appropriate return (pre-rent), and that received after it has received that return (post-rent).
For IOCs, the most attractive structure is in line with the first example; most of the government’s take occurs after they have recovered an appropriate return. On the other side, governments need to balance gaining the maximum return they can with the timing of that return; as early as possible but not too early or they drive down the IOCs return to the point of not being competitive.
There is no exact science in designing fiscal structure. It is a judgment made on a number of factors including non-fiscal ones such as geological potential, the cost structure of exploration and production in the area in question, and the overall business and contractual attractiveness. Establishing a competitive contract requires comparing the contract to those on offer elsewhere in countries likely to be competing for the same investment dollars; even then such competitiveness is unlikely to stay static over time, but move with oil or gas price, changing geological potential or cost structure and competition from elsewhere.
At the conclusion of this series of blog entries I would like to reiterate my appreciation for the contributions of Bob George from Gaffney, Cline & Associates. This material is immensely better for his substantial contributions.