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7/30/2019 Fiscal analysis.pptx
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Introduction to Upstream Oil and Gas Training
I4TH – 16TH May 2013, Intercontinental Hotel, Nairobi
Fiscal analysis
Risk and financial analysis in Exploration and production
Philip M. Tsar
(Petroleum Engineer – National Oil Corporation - Kenya) 1
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Scope
Fiscal analysis,
Structure of fiscal regimes,
Severity and efficiency of fiscal
regimes,
Incremental effects of fiscal regimes &
Revenue Sharing
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Background & Introduction
Kenya has been exploring for oil since 1937
Current framework (Petroleum Act and Model
Production Sharing Contract (“PSC”)) was developed
prior to discoveries; Model PSC is oil-centric
2012 discoveries in Turkana and gas-prone offshore
highlighted need to modernize existing framework
GoK and World Bank engaged Hunton & Williams andChallenge Energy (“Consultant”) to review and provideguidance for updating the existing framework
Background of Legal and RegulatoryFramework
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1. Fiscal Considerations – Progressive Fiscal Regimes
A progressive fiscal regime is one where the State‟s share of a project‟s
profits increases as the project‟s profits / rate of return increases.
S t a t e s
h a r e o
f t o t
a l b e n e f i t s
Project profitability
1
2
3
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Fiscal Considerations – Fiscal Instruments
A range of fiscal instruments exist:
• Corporate Income Tax
• Windfall / Special Petroleum Taxes
• Royalties (although often not viewed as a tax)
• Bonuses (not a tax but can be used in combination
with above)• Production Sharing (consistent with existing PSC)
• Daily Rate of Production
• Rate of Return
• R-Factor
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Fiscal Instruments
Benefits Drawbacks
CIT
• Familiar for both
parties
• Profit based
• Can be varied by theState so may
increase Investor risk
perception
• Requires additionalinstruments
WindfallSPT
• Progressive therefore
reduces impact on
Investor decisionmaking
• Flexible therefore
protects State
• Can be complex
increasing the
administrative burden
• Can be subsequently
modified by the State
so may increase
Investor risk
perception
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Fiscal Instruments
Benefits Drawbacks
Royalties• Immediate income for the State
• Simple administration
• Regressive
• Does not factor in
Contractor‟s costs
• Delays cost recoveryfor Investor
• Potentially complicates
double taxation relief
administration
• Limited flexibility
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Fiscal Instruments
Benefits Drawbacks
Bonuses• Guaranteed State
income
• Increases
Contractor‟s project
risk where exploration
uncertainty exists
Productio
n Sharing
• Progressive therefore
reduces impact onInvestor decision making
• Flexible therefore protects
State
• Immediate income for the
State
• Reduces the number of
fiscal instruments required
• Stable environment for
Investors
• Double taxation relief
administration
• In order to be stable,
must evaluate rates and
bands carefully before
PSC/PSA is signed
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Sharing Mechanisms
Some specific benefits and costs of each method of production
sharing are outlined below (in addition to those listed on the
previous slide):
Benefits Drawbacks
DROP based
on profithydrocarbon
s
• Relatively simple tocalculate and
administer
• Not based on project
profitability
• Low volumes but highprices can limit State
share
• Requires accurate
volumes
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Sharing Mechanisms
Benefits Drawbacks
Rate of Return
• Based on direct
measure of project
profitability
• Potentially no differenttreatment of oil and
gas Same rates can
be applied to onshore
and offshore projects
• Considers the timevalue of money
• Acceptable rates of return may vary
dramatically between
investors and concept
less simple than
volumes or R-Factor –
may complicatenegotiation
• Sensitive to timing of
costs
• Requires effective costaudits to be performed
regularly
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Sharing Mechanisms
Benefits Drawbacks
R-Factor
• Based on directmeasure of project
profitability
• No different treatment
of oil and gas required
• Same rates can be
applied to onshore and
offshore projects
• Conceptually simple:
once revenues >costs, taxation
increases
• Does not directly
consider the time
value of money
(although this can be
factored in through the
cost recovery cap)
• Requires effective cost
audits to be performed
regularly
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Wider Fiscal Issues Capital Gains Tax ensures where value is added by international
Investors, the Kenyan State will receive a share of the benefit.
• Transfer of interest via the sale of non-resident Companyshares does not appear to be directly addressed by the 9th
Schedule of the ITA.
• Clarity in relation to the „pay on behalf‟ scheme.
Withholding Tax protects against interest / dividend stripping by
non-resident companies.
• Interest stripping can result in income being paid to non-
resident companies via interest repayments (profits can be
removed by excessive repayments).
• Dividends paid to non-resident parent companies can help
owners realise an investments value whilst avoiding CGT.
VAT on sale to domestic end users reasonable (consistent with
HFO) but research required into VAT on LNG sales.
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Fiscal Instruments – Best Practice
Best practice:
• A progressive fiscal regime, as this is a highly desirablefeature for the Investor, balancing taxation of profits against
the project‟s profitability.
• Use of production sharing (most progressive / flexible)
either the R-Factor or ROR methods would be broadly
appropriate.• An R-Factor approach – why?
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Why R – Factor?
Under the R-Factor, profit hydrocarbons are allocated
using a measure of project profitability, therefore highlyprogressive and flexible (captures windfalls but also
reduces taxation for marginal investments).
The DROP method does not specifically include costs
when determining the profit hydrocarbon share so provides
limited relief for marginal projects. The DROP method requires additional instruments to
effectively capture windfall situations.
With the R-Factor it is possible to use only one method
of taxation reducing the administrative burden.
◦ Some form of windfall tax is required under the DROP
method.
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Why R – Factor?
Stable as the State does not need to alter the terms
agreed with the Investor if the project turns out to bemore or less profitable than expected.
Including a windfall tax to support the DROP method may
increase uncertainty for investors / reduce stability if
possible that rate may be modified in subsequent periods
by future Governments. Can be tailored to specific situations if required (such
as extremely long project timelines which may require the
cost recovery cap to be increased) – the same is true for
DROP.
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Why R – Factor?
Calculated using basic cash flows therefore simple to
calculate the R-Factor, but also relatively simple to audit costs incurred.
◦ DROP requires volumes to be measured accurately which can
be more complicated.
◦ DROP may under-tax profitable fields with low production
volumes Consistent terms for oil and gas, as well as onshore and
offshore developments may help to reduce the
administrative burden when implemented.
◦ DROP requires different terms or at least some form of
conversion of gas volumes into oil equivalents or vice versa.
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Oth B t P ti
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Other Best Practices
It is in good order that:
• The current VAT treatment is maintained for oil and gasdevelopments, however research is required into the
treatment of LNG exports.
• WHT should only be charged at generally applicable rates.
A specific study into the appropriate rate of WHT to be
levied on interest and dividend payments to non-residentsshould be performed.
• Revision of Schedule 9 of the Income Tax Act to remove any
uncertainty over how gains are taxed, and how these gains
interact with the PSC framework.
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Thank you!!
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