Privatesector P U B L I C P O L I C Y F O R T H E The World Bank May 1995 Note No. 46 Fiscal Systems for Oil The government “take” and competition for exploration investment Chakib Khelil Until the 1960s, petroleum exploration on an governments. The terms and conditions of such international scale was carried out by only a arrangements are established by law or negoti- few large petroleum corporations. But in the ated case by case. One important aspect of the past few decades, the number of oil companies arrangements is the fiscal terms and condi- has increased substantially. Now, more than 300 tions—these include bonuses, rentals, royalties, oil companies explore in two or more coun- production sharing arrangements, carried in- tries, and exploration by private companies takes terest provisions, corporate income taxes, and place in more than 150 countries. special taxes.1 Together, all the payments to government required under a petroleum ar- Exploration for petroleum occurs on the basis rangement can be called a “fiscal system.” In of concessions, leases, or contracts granted by some countries, a single fiscal system applies to the entire country; in others, a variety of fiscal systems exist. BOX 1 FISCAL SYSTEM RATINGS IN OIL-PRODUCING AREAS The large number of governments involved in setting terms and conditions for fiscal systems, Very favorable: Ireland, Spain, United Kingdom, Argentina, New the wide diversity of areas available, and the Zealand, Pakistan (zone 1), and Denmark (fourth round). large number of oil companies interested in ex- ploration have created an “international mar- ket” for exploration acreage. Governments offer Favorable: Northwest Territories (Canada), Illinois, Peru, Australia exploration acreage through formal bidding (offshore), and U.S. outer contintental shelf (Gulf of Mexico, deep). rounds or case by case. The “price” for the acre- age is the government take—the total effect of Average: The Philippines, U.S. outer continental shelf (Gulf of the fiscal system on the cash flow of an oil Mexico, shallow), Thailand (gulf, 1995 terms), China (offshore), field—and is expressed as a percentage. For Malaysia (deep water), Nigeria (offshore to 200 meters), Viet Nam, example, a government take of 55 percent and Trinidad and Tobago (onshore). means that the total government revenues re- sulting from the fiscal system represent 55 per- cent of the cash flow from the oil field. The Tough: Kazakhstan, Alaska (onshore), Ecuador (regular terms), world average government take is 64 percent. Texas (offshore), Alberta (third-tier oil), Netherlands (1995 terms), Ireland has a very low government take, at 25 Norway, and India. percent, and Yemen a very high one, at 95 percent. Most government takes are between Very tough: Louisiana, Russia (production sharing contract), 40 percent and 85 percent. Venezuela (new model contract), Indonesia (1994 terms), Malaysia How governments compete for exploration and (conventional), Angola, Nigeria (Niger Delta), Syria, and Yemen. development investments by private oil compa- nies is still poorly understood—by governments Note: This is not an exhaustive list of the results. and by companies. This Note analyzes the pro- cess of competition among governments. Industry and Energy Department ▪ Vice Presidency for Finance and Private Sector Development Fiscal Systems for Oil favorable conditions, such as the oil-exporting countries, demand tough or very tough terms FIGURE 1 EXPORTING AREAS AS A SHARE OF EACH FISCAL (figure 1). Provinces and states also follow that SYSTEM GROUP pattern: the exporting states of Louisiana and Percent Texas set tough or very tough terms, and the 100 importing province of Ontario offers favorable 90 terms. 80 35 70 25 The study found that the correlation between 60 fiscal terms and geological and economic con- 50 40 ditions is much stronger at the regional level 30 17 than at the global level. Thus, while companies 20 4 compete globally, governments seem to com- 10 pete regionally. 0 0 Very Favorable Average Tough Very tough Governments respond to market forces in set- favorable ting terms and conditions for their acreage. But they set these terms and conditions primarily in reference to the region. In other words, govern- ments in the Asia-Pacific region tend to compete Fiscal system ratings with other governments in that region rather than with governments in Europe or Latin America. In a study initiated and supported by the World There are two reasons for this behavior. First, Bank and private oil companies, 226 fiscal sys- some governments, particularly those of smaller tems in 144 countries were rated on the basis of countries, have limited information about fiscal a standard economic analysis of oil fields assum- terms and conditions around the world, but usu- ing the same prices and costs across the world. ally have better knowledge of the terms in neigh- The oil fields ranged in size from 3 million to boring countries. Second, it is often difficult for 300 million barrels. The rating is based on eight governments to defend terms and conditions sig- different economic yardsticks, including such fa- nificantly more favorable to foreign oil compa- miliar economic indicators as rate of return and nies than those set by their neighbors. A good net present value, the government take, and the political defense for the terms of a contract is geological risk in exploring for oil and gas fields. that they are similar to those of contracts in sur- rounding countries. This behavior by most gov- A point system based on the eight criteria was ernments leads to a regionalization of fiscal developed that simulates an investor’s decision- systems, creating important anomalies. making. Using this point system, the fiscal sys- tems were divided into five groups, ranging from Anomalies created by government “very favorable” (the best systems for investors) behavior to “very tough” systems (box 1). The first anomaly is that regions seem to “dis- In a competitive world, areas with the least fa- connect” from other regions. The government vorable geology, the highest costs, and the low- take for most fiscal systems in Europe ranges est wellhead prices would be expected to offer from about 35 percent to 65 percent—though a the best fiscal terms—and areas with the best few outlier values stretch the actual range for geology, the lowest costs, and the highest well- the region from 18 percent to just over 80 per- head prices the toughest terms. That pattern of cent (figure 2). In Sub-Saharan Africa, North competition does in fact exist. Countries with America, and the Asia-Pacific region, govern- unfavorable conditions typically offer very fa- ment takes typically range from roughly 40 per- vorable or favorable terms, and countries with cent to 80 percent. In the central region, which includes North Africa, the Middle East, and the million barrel field 64 percent. As a result, the countries of the former Soviet Union, govern- rate of return of a 10 million barrel field de- ment takes are 60 percent to 95 percent. Coun- clines significantly when the government take tries in each region seem to compete within that is taken into account. Most fiscal systems make region’s range of government takes. Latin small but potentially profitable fields uneco- America is the only region in which countries nomic. Oil-producing and oil-exporting coun- compete more or less globally, setting govern- tries set fiscal terms so as to capture the biggest ment takes that range over the entire spectrum— rent possible from large oil finds and may ne- from 25 percent to 90 percent. glect to promote private investment on small marginal fields. But oil-importing and self-suffi- North America does not seem globally competi- cient countries need more oil and thus have an tive. To compete with Europe and Latin America, incentive to ensure that private investment also several importing areas in North America should reaches small marginal fields. World oil produc- offer very favorable terms. Yet none of the im- tion could be significantly increased if govern- porting states and provinces of the United States ments of oil-importing and self-sufficient and Canada offers very favorable terms—remark- countries and provinces provided fiscal incen- able, because the United States is an important tives for production on small fields. oil importer. 2. The world average fiscal system The second anomaly has to do with importing is front-end-loaded. countries with modest geological prospects. These countries need to adopt very favorable or favor- On a standard 30 million barrel field, the gov- able terms to be globally competitive. Yet, driven ernment take is 68 percent during the first six by regional concepts of competition, many of these countries offer rather tough fiscal terms. Consequently, there are countries that are region- FIGURE 2 RANGE OF GOVERNMENT TAKE, BY REGION ally, but not globally, competitive, including the Republic of Korea, Nepal, Lao People’s Demo- cratic Republic, Bangladesh, India, Papua New Europe Guinea, Tanzania, Mozambique, Ghana, South Africa, Albania (offshore), Morocco, Romania, Jordan, and Mauritania. Latin America The average fiscal system is regressive and front-end-loaded North America To examine the global characteristics of fiscal systems, the study determined a “world aver- Asia-Pacific age fiscal system” by calculating the arithmetic average of all 226 fiscal systems. This calcula- tion produced some interesting results. Sub-Saharan Africa 1. The world average fiscal system is regressive for small fields. Central region Regressive means that the government take is a higher percentage of the cash flow for small and marginal fields than for large and profitable 20 40 60 80 100 fields. The average government take on a 10 Percent million barrel field is 68 percent and on a 300 Fiscal Systems for Oil countries have begun differentiating terms more TABLE 1 GOVERNMENT TAKE IN ONSHORE AND DEEP WATER to reflect differences among areas in such fac- CONDITIONS tors as costs, geology, logistical conditions, depth (percent) of water, and gravity of the oil. Governments compete by setting different government takes Country Onshore Deep water for different environments—for example, for onshore conditions and for offshore or deep Portugal 43.2 39.7 water conditions. Thus, Thai onshore terms com- Louisiana (federal) 69.3 47.2 pete with Indonesian and Malaysian onshore Thailand 67.0 57.5 terms, and Thai deep water terms compete with Nigeria 84.8 64.2 Indonesian and Malaysian deep water terms Malaysia 89.4 68.1 (table 1). This differentiation is intensifying the global competition for private investment in pe- Indonesia 89.8 81.1 troleum exploration. Conclusions years of production and 61 percent during the rest of production. Adopting back-end-loaded The study shows that there is an active interna- systems could significantly increase the attrac- tional market for exploration acreage. The tiveness of exploration and development. “price” of the acreage is the government take, generally between 40 percent and 85 percent of Trends point to lower government take the cash flow of an oil field. and greater differentiation in terms Governments compete to attract investments. But Over the past decade, fiscal terms and condi- the competition is primarily regional, and as a This series is published tions have changed significantly. Of the 226 fis- result, some countries or areas are not competi- to share ideas and invite cal systems analyzed, 130 have been changed. tive at a global level. On average, fiscal systems discussion. It covers make small but potentially profitable oil fields financial and private In almost all these systems, the changes reduced sector development as the government take. At the same time, the sup- uneconomic. Although this approach might be well as industry and ply of exploration acreage has increased. Many expected from oil-producing and oil-exporting energy. The views countries, it is not in the best interests of oil- expressed are those of countries have opened new areas, including the authors and are not China (onshore), Viet Nam, Cuba, Myanmar, importing and self-sufficient countries. Moreover, intended to represent Yemen, the countries of Eastern Europe and the world oil production could be increased signifi- an official statement of cantly if importing and self-sufficient countries Bank policy or strategy. former Soviet Union, and, recently, Venezuela. Many other countries have decided to accelerate offered better terms for such fields. Comments are welcome. the process of offering acreage, such as Argen- Please call the FPD Over the past decade, government takes have Note line to leave a tina and Peru. These changes have almost message (202-458-1111) doubled the acreage available for exploration by declined, and many countries have differenti- or contact Suzanne private oil companies during the past ten years. ated the terms they offer to reflect different eco- Smith, editor, Room nomic and geological conditions. G8105, The World Bank, 1818 H Street, NW, At the same time, the demand for acreage has Washington, D.C. 20433, fallen because of lower oil prices and smaller 1 In this Note, fiscal terms do not include downstream fuel taxes. For or Internet address cash flows for the oil industry. As a result, the a copy of the report on the study’s findings, “A Comparative Study ssmith7@worldbank.org. of World Fiscal Systems for Oil and Government to Government “price” for acreage—the government take—has Competition,” by Pedro van Meurs (Gordon Barrows, New York, 9 Printed on recycled been declining. This trend can be expected to 1994), call Ms. Shirly Rajan, 202-458-2317. paper. continue until a new balance is established be- tween supply and demand for acreage. Chakib Khelil, Petroleum Advisor, Industry and Another important development is the increased Energy Department differentiation of terms within countries. Many