Fundamental Petroleum Fiscal Considerations
Fundamental Petroleum Fiscal Considerations / Daniel Johnston & David Johnston, Oxford Institute for Energy Studies, Feb. 2015, 14 p. (Oxford energy comment)
Presentation (© OIES) :
The most common business structures in the industry today are either production sharing contracts (PSCs) or royalty/tax systems (R/Ts). Roughly half of the governments of this world use PSCs and the rest use R/Ts. While these systems are fundamentally different from philosophical and legal perspectives, their structures are dramatically similar from financial, economic, and accounting points of view. Both of these approaches to the business relationship provide the IOC a means of recovering costs incurred and earning a share of profits if (1) a commercial discovery is made and (2) sufficient revenues are generated. There has always been discussion about the most efficient and effective contract design from a financial/economic point of view. There are many things involved especially considering these agreements are structured to last decades in spite of all the risks and uncertainties.
However, recently, hot debate is underway over one of the most fundamental aspects of the world’s agreements. The current debates in Mexico and India have been particularly intense. On one side of the debate are those who believe basic ‘profits-based’ structures found in the world’s PSCs and R/Ts are the best alternative. On the other hand there are those who propose a structure based simply on the division of production or revenues. The overriding concern behind this initiative is the lack of faith in the accounting for costs and the spectre of cost overruns, goldplating, or even cheating. In Mexico the debate has not entered the public domain but is being promoted by serious factions within Mexico. In India the positions have been formalized and explicitly articulated and publicly represented by two separate committees: The Rangarajan Committee and the Kelkar Committee. The Rangarajan Committee recommended the government move away from PSCs and embrace revenue sharing contracts (RSCs). The Kelkar committee contested the Rangarajan Committee recommendation to move to a RSC.
Profit-based systems represent over 90% of the governments worldwide with petroleum operations underway. The outliers are the big OPEC producers, most of Russia and until recently Mexico. A revenue sharing system can be somewhat easier from a government management and administrative point of view but will not necessarily eliminate oversight requirements. As contracts and systems worldwide have evolved and improved for the past five decades revenue-based systems have become, for all practical purposes, extinct. The alternatives are more efficient and effective.