Petroleum Contracts and Economics

Question: Discuss about the Petroleum Contracts and Economics. Answer: Ghana is a fastest moving growing economy in Sub-Sahara Africa due to its rising gas and oil industry. The earning from the gas and oil industry depends on the type of fiscal regime government operates. The revenue earned from hydrocarbon exploitation largely depends on the fiscal regime characteristics of a country (Mofep.gov.gh 2016). The fiscal regime of petroleum refers to the contractual framework and fiscal instruments that explains the countrys wealth share obtained from the production of petroleum through a number of instruments, like, profit oil, royalties, bonuses, taxes and government participating interest. According to Elmas and Songur (2016), several factors are considered while designing the fiscal regime, out of which, the key factor is the development of the countrys petroleum industry. The countries with developed oil producers gives higher share to government through the fiscal regime compared to the countries where there are few discoveries and where there are sti ll few investments. Further, fiscal regimes are influenced by geological condition of the area and the contractual policy framework that governs the activities of petroleum industry. As opined by Loloh (2012), the strategies that can be chosen to frame the petroleum production policy framework are first as Go-it-alone strategy where the state itself produce through a national oil company, like in Saudi Arabia. Second, the state gives private ownership and the oil companies have full control over their operations, like in OECD countries.Third, a partnership between the state and private players to undertake production which is generally adopted by non-OECD oil producing countries, for example, Ghana government policy follows this option. The different types of world fiscal arrangements are discussed here. In case of go-it-alone strategy, the state undertakes all the risk of production and exploration. The entire profit is accrued to the state without any requirement of fiscal regime as there are no private companies. According to Mittnik and Semmler (2012), in case of total private control, the risk of production and exploration are bear by them and the state take can be through different mixture of income tax, lease sales and special petroleum tax and royalties through concessionary royalty or tax system. In case of partnership between the state and private players the degree of risk of development, production and exploration are shared by them through a Production Sharing Contract (PSC) or Risk Service Contract (RSC). IN PSC, the ownership is with the State and the private companies are contracted to develop and extract resource in return for a share of production. Each takes the share after meeting the cost. As opined by Owusu and Waylen (2012), in RSC, the private companies are given a fee for the service which can be either in monetary terms or in kinds by the government to undertake the operations of petroleum. The fee can be fixed or linked to the profit. Ghana oil and gas industry follows a partnership between the state and the private players and so the most appropriate type of fiscal regime will be Production Sharing Contract or Risk Service Contract. More appropriate will be PSC that will develop the contractual agreement in the upstream petroleum industry. According to Burger and Marinkov (2012), the Petroleum Exploration and Production Law explain the terms and condition of fiscal regime. The points that should be considered in fiscal regime are given below: The percentage of royalty on the total crude oil production should vary in different blocks and should not be fixed. The interest received by the State on the contract area should be fixed and not to be exceeded beyond 10% as the risk of exploration and production is totally borne by the private companies. If the State desires to earn additional interest then they need to take the responsibility of cost during the production and development stage which varies for different contracts. As per the opinion of Kankam and Ackah (2014), the petroleum income tax should be decided based on the contracts and need to be lower than the corporate profit tax rate. However, by default the Petroleum Income Tax Law sets it at 50%, which need to be modified according to the contracts. The government can be entitled to get additional payment if the returns on projects are more than expected. Government can put other taxes and fees like surface rental fees and withholding taxes on subcontractors. The rules for cost containment, cost recovery and deduction should be clearly mentioned in the fiscal regime and can be changed according to the changes in the cost structure. The petroleum agreement needs to provide some protection to the companies in case of changes in the tax regime so that they are stabilised in their operation. As the contractors make all the arrangement for raising funds for exploration and production, the State should provide some assistance in terms of subsidised interest rates. According to Bellorin (2012), the key features of a fiscal regime that is important to the investors and government are stability, progressivity, flexibility and neutrality. The oil price being highly volatile, the contractors need the stability clause of the regime to be properly designed by giving importance to freezing clause and equilibrium clause. The freezing clause removes arbitrary changes in fiscal regime and equilibrium clause helps to reduce the shock of price changes. Two sections of stability provisions of Ghanas Model Petroleum Agreement states that: Article 12.2 with respect to income tax states: Where a new income tax rate comes into force Contractor shall have the option of either applying the new income tax rate or remaining under the Petroleum Income Tax Law.Article 12.11 also states: Should the fiscal authority involved determine that the Petroleum Income Tax Law does not impose a creditable tax, the parties agree to negotiate in good faith with a view to establishing a credible tax on the precondition that no adverse effect should occur to the economic rights of the State (Ankamah, 2012). According to Amponsah and Dartey (2012), flexibility and neutrality of fiscal regime helps the contractors to gain confidence and continuing investment in the gas field. Risk sharing is another part that needs to be handling properly. The risk is at every level, production; exploration and price .The production level risk need to be shared by the government and private players to reduce the cost risk and by providing cost recovery allowances. Further, Makkam (2014), cited that Steps should be taken to state clearly the rules for transfer pricing. It plays an important role in managing risk from volatility of prices. Further, the Additional Oil Entitlement (AOE) should tie to profitability if it is to help to make the tax system progressive and ideal The government of Ghana revenue from petroleum sector is shown in the statistics below for the period 2011 to 2013 budget Taxes 2011 2012 2013 Consumer taxes -- -- -- Petroleum tax 146 181 218.50 Producer taxes -- -- -- Oil royalties 63.4 90.6 92.1 Surface rentals -- 0.3 0.3 Income tax -- -- 35.8 Government of Ghana carried and participatory interest 165.8 234.5 238.5 Table 1: Government revenue from Petroleum sector, 2011-13 (Source: Mofep.gov.gh 2016) The table 1 shows the revenue generated by the petroleum sector for the government in 2011-13. It has increased over the period with prudent fiscal regime. However, the corporate profit level should be also taken care off in the development of future fiscal regime and some flexibility in the tax structure should be implemented. The paper thus discusses the formation of the future fiscal regime that maximises the revenue of the corporate and the government uniformly. References Amponsah-Tawiah, K. and Dartey-Baah, K. (2012). Towards an Accident Free Energy Regime in Ghana. IBR, 5(11). Ankamah, S. (2012). The Politics of Fiscal Decentralization in Ghana: An Overview of the Fundamentals. PAR, 1(1). Bellorin Nunez, C. (2012). Colombia's regulatory and fiscal hydrocarbons regime: explaining Colombia's success and the challenges ahead. The Journal of World Energy Law Business, 5(3), pp.248-260. Burger, P. and Marinkov, M. (2012). Fiscal rules and regime-dependent fiscal reaction functions. OECD Journal on Budgeting, 12(1), pp.1-29. Elmas, F. and Songur, M. (2016). Ricardian Fiscal Regime and Fiscal Theory of the Price Level: The European Monetary System. Ekonomik Yaklasim, 27(98), p.203. Kankam, D. and Ackah, I., 2014. The Optimal Petroleum Fiscal Regime for Ghana: An Analysis of Available Alternatives. International Journal of Energy Economics and Policy, 4(3), p.400. Loloh, F. (2012). Ghana: Fiscal Policy Responsiveness, Persistence and Discretion. SSRN Electronic Journal. Mittnik, S. and Semmler, W. (2012). Regime dependence of the fiscal multiplier. Journal of Economic Behavior Organization, 83(3), pp.502-522. Mofep.gov.gh. (2016). Ministry of Finance - Government of Ghana. [online] Available at: https://www.mofep.gov.gh/ [Accessed 12 Jul. 2016]. Owusu, K. and Waylen, P. (2012). Identification of historic shifts in daily rainfall regime, Wenchi, Ghana. Climatic Change.