Key Features of Legal and Fiscal Frameworks for Exploration, Development and Production of Hydrocarb

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• Key Features of Legal and Fiscal Frameworks for
  Exploration, Development and Production of
  Hydrocarbons
• Silvana Tordo, Sr. Energy Economist, COCPO
• Washington, D.C.
• May 16-17, 2007

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• Introduction
• Characteristics of the industry and its
  implication for policy makers
• The parties objectives
• Legal Framework
• Coherence and interaction with other laws
• Concessions and contracts
• Elements of successful legal frameworks
• Fiscal Systems
• What is there to share
• How it is shared
• Design issues
• Comparing fiscal systems

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Persistently high level of oil prices
Increased level of direct participation/control
Many HG seeking improvement in their contractual
terms
Better fiscal terms
Exposed inefficiency in existing fiscal systems
Triggered demand for services and equipment, thus
increasing their cost
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High risks and long project cycles are key
elements of the oil industry
Investing in a diverse portfolio of
projects Involving multiple partners.
Companies hedge against risks by
Designing flexible fiscal systems Transferring
part of the risk to those better suited to bear it
HG hedge against risks by
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Typical profile of a petroleum asset
implications on HC Revenue
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The global nature of petroleum investments poses
challenges to policy makers
Objectives
Relative position in the marketplace
Constraints
Design of appropriate policies, strategies and
tactics
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Oil Companies and HG common objective maximize
the revenue from the project
Oil Companies ensure that the return on
investment is consistent with the risk associated
with the project and with the strategic
objectives of the corporation (plus reserves).
Host Government maximize value over time in
terms of net receipts for treasury, plus a number
of development and socioeconomic objectives (such
as transfer of technology, local industrial
development, investment options, etc).
Decisions on the design of an appropriate legal
and fiscal framework can be supported by an
understanding of how its various components
influence decision making and outcomes.
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• Coherence and interaction
• Sector laws
• Hydrocarbon Code
• Regulations
• Contracts
• Coordination with other laws
• Constitution - Banking
• Taxation - Employment
• Foreign Exchange - Settlement of disputes
• Foreign Investment - Environment

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Two main systems have been developed to address
the rights and obligations of the state and of
the investors, and the ownership of natural
resources
CONCESSIONARY SYSTEMS
CONTRACTUAL SYSTEMS
Production Sharing Contracts
Service Contracts
Pure Service Contracts
Risk Service Contracts
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Main Differences between Concessions and PSCs
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• Elements of Successful Legal Frameworks
• Clear definition of the role of the state
• Security of title
• Freedom to operate on a commercial basis
• Comprehensive environmental protection
  requirements
• Competitive and stable fiscal terms
• Trends
• Modularity
• Transparency
• Protection of environment and local communities

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Sharing of benefits between HG and Investors

• Royalties
• Production Sharing
• Taxes
• Government Participation

After Johnston (1995)
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• Taxation instruments
• Taxes that apply to all other sectors of the
  economy
• Taxes that are specific to the oil industry
• Non-tax forms of rent collection
• Special provisions
• Various forms of additional costs

• Methods
• Revenue or volume-based
• Fixed fees
• Cost recovery provisions
• Rentskimming mechanisms
• Profit based
• State participation

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Relatively regressive systems Relatively
progressive systems (Ex high royalties,
bonuses, ( Ex. Income tax and
royalty low cost recovery limit, linked to
volume or value of ring fencing,..) production
, government take linked to production or
return on investment, )
Discourage investment Encourage investment
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• Ideally a HG would want to design a fiscal system
  that
• supports macroeconomic stability by providing
  predictable and stable tax revenue flows
• permits capturing a greater share of the revenue
  during periods of high profits
• avoids the introduction of distorting effects
  through the fiscal instruments
• maximizes the present value of revenue receipts
  by providing for appropriations during the early
  years of production
• is neutral and encourages economic efficiency as
  a yardstick

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• Ideally an investor would look for fiscal systems
  that
• provide a minimum number of front-end loaded non
  profit-sensitive taxes
• Provide the ability to repatriate profits to
  shareholders in their home countries
• Are transparent, predictable, stable and based on
  internationally recognized industry standards and
  the rule of law so that decisions can be made
  with reasonable confidence

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• Key Questions for the Design of Fiscal Systems
• What is the effect of the fiscal regime on short
  and long term investment decisions?
• Does it incentivize the development of marginal
  fields?
• Is it insensitive to price and cost variation?
• Does it influence the pace of development?
• Does it favor early abandonment?
• Does it encourage gold plating?
• In other words, how flexible, neutral and stable
  is the fiscal regime?
• How does it compare with other countries terms?
• Is it in line with sector and macro-fiscal policy
  objectives?

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• How to introduce flexibility in a fiscal system
• Sliding scales
• Daily or cumulative production level
• Level of oil/gas prices
• Water or well depth or other physical parameter
• R-factor or RoR
• Thresholds and triggers a real challenge

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• Design Issues
• A flexible structure is likely to be more
  efficient and stable
• Size and distribution of production in a given
  geological province is a key element variation
  in production (and price) have a large impact on
  projects economics (especially for projects with
  high operating leverage)
• Fiscal regimes that are less sensitive to
  variations in project economics increase the
  perception of risk, hence the cost of
  capital/exploration and development thresholds
• Cost recovery limits and carried interest have a
  big impact on project economics, especially for
  capex intensive projects
• The fiscal system should create incentives for
  cost saving

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• Design Issues (cont.d)
• HG participation on concessional terms impacts
  the investors IRR/NPV. Also cost to the HG
• Fiscal conditions, and the revenue available for
  collection, will change from time to time.
  Fiscal structure must be flexible to accommodate
  this
• Flexible/progressive systems may enhance HGs
  revenue volatility
• Flexible systems reduce the cost and need for
  renegotiation

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• Design Issues (cont.d)
• A simpler system may be more viable than a
  theoretically ideal but complex or contentious
  system
• Good fiscal design without complementary
  institutional structures may still not achieve
  the desired goals
• Design needs to be within the administrative and
  audit capacity of the relevant institutions

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• Comparing fiscal systems among countries can be a
  very difficult and often misleading exercise.
• The Government take handle with care
• At project level ability to forecast the
  expected cash flow availability of information
  that is normally proprietary
• At country level numerous vintages of contracts,
  more than one arrangement, contracts are often
  renegotiated
• Industry statistics theoretical price and cost
  assumptions. Normally undiscounted
• Combination of regressive and progressive
  elements different risk profile
• Does not capture the spill over effects of oil
  and gas projects on the economy at large
• G. Take How much the HG takes/not how it takes

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• Use take statistics for a given country as a
  first frame of reference to assess whether or not
  the fiscal terms applicable to a contract under
  negotiation are in line with those that already
  exist in that country, or as benchmark to
  determine the competitiveness of a countrys
  fiscal terms.

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Back up slides
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Example of fiscal instruments and their effects
on Host Government and Investors
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Elements of Successful Fiscal Regimes