A. Pedro van Meurs
Van Meurs & Associates Ltd.
Calgary
During the last decade there has been significant change in fiscal terms and conditions applicable to petroleum exploration and production.
An analysis of 226 fiscal systems in 144 countries indicates that there has been a substantial downward trend in government take. Of the 226 fiscal systems analyzed, 130 were changed during the last decade. The changes resulted in a lower government take in almost all cases.
During the last decade the supply of exploration acreage has increased due to the fact that a large number of countries decided to open new areas. These countries include the Former Soviet Union, Eastern Europe, onshore China, Viet Nam, Cuba, Myanmar, Yemen, and recently Venezuela.
A number of other countries decided to accelerate the process of offering acreage, such as Argentina and Peru. In total, the acreage available for exploration by private oil companies almost doubled during the last 10 years.
At the same time the demand for acreage has been reduced due to lower oil prices and reduced oil industry cash flows.
As a result, the "price" for acreage-in terms of government take-has declined. This trend is continuing today and can be expected to continue until a new balance has been established between supply and demand for acreage.
This development has created a new situation in which governments are now strongly competing for exploration and development investments. The question is, how do governments compete and what is the current status of the competition? The process of competition among governments is still poorly understood by governments and companies.
RATING OF FISCAL SYSTEMS
Van Meurs & Associates carried out an in-depth analysis and rating of world fiscal systems for oil. The study received support from the World Bank and is available from Barrows Inc., New York.
In some countries in the world there is a single fiscal system applicable to the whole country, while in other countries there is a considerable variety of fiscal systems within the country. It is not possible, therefore, to rate "countries," so this study rates "fiscal systems."
The fiscal systems have been rated on the basis of an economic analysis of standard oil fields based on the same prices and costs across the world. The standard oil fields range in size from 3 million bbl to 300 million bbl.
The study is based on relatively low cost fields. Several fiscal systems include sliding scales based on R-factors or rate of return based formulas. In order for many of these scales to "click in," one needs to study fields that are relatively profitable prior to any government take. Otherwise, it is impossible to differentiate between fiscal systems and study their "upside."
The rating is based on eight different economic yardsticks. Six yardsticks involve a "stand alone" analysis of the fiscal systems, and two yardsticks were the result of an "incremental analysis."
The following criteria were used on the basis of "stand-alone" cash flows:
- net present value per barrel, discounted at 15% ("NPV @ 15%"),
- the rate of return,
- the maximum sustainable risk, discounted at 15% ("MSR @ 15%"),
- the undiscounted government take ("GT @ 0%"),
- "bonanza" economics based on a 300 million bbl field, and
- the degree of "front-end loading."
The maximum sustainable risk is a ratio that indicates the number of exploration programs that can be paid from the cash flow of a single discovery. This yardstick indicates the attractiveness of exploration. It measures the maximum geological risk that can be sustained against a particular prospect. Signature bonuses, rentals, and other payments during the exploration phase, impact negatively on the maximum sustainable risk.
The first four criteria are based on a weighted average of six onshore fields and six offshore fields in order to evaluate how fiscal systems impact on a wide distribution of fields.
It is still the dream of most oil companies to discover an "economic bonanza." Favorable economics for a really large discovery are an important attraction to investors. Therefore, this fifth criterion was included.
In view of the current relative shortage of capital in the petroleum industry, the degree of "front-end" loading of a fiscal system is also an important characteristic. This aspect has been measured by calculating the government take during the first 6 years of production.
Most oil companies have already established their operations in several or a large number of countries. Therefore, most investments are incremental investments. Some fiscal systems encourage re-investment in the same country or contract area, through special uplifts, R-factors, or ROR based formulas. Other fiscal systems do not.
The economics of incremental investments is measured by determining the net costs of:
- an incremental investment in exploration, and
- an incremental investment in further development wells.
Based on the eight criteria a point system was developed, simulating the decisionmaking process of an investor. Using this point system, the fiscal systems have been divided into five groups, from "Five Star" systems (the best systems for investors) to "One Star" systems.
The following are the classifications of some of the systems at this writing:
- "Five Star:" Ireland, Spain, United Kingdom, Argentina, New Zealand, Pakistan (Zone 1), and Denmark (fourth round).
- "Four Star:" Northwest Territories (Canada), Illinois, Peru, Australia (offshore), and U.S.-Outer Continental Shelf (Gulf of Mexico-deep).
- "Three Star:" Philippines, U.S.-OCS (Gulf of Mexico-shallow), Thailand (Gulf, 1995 terms), China (offshore), Malaysia (deep water), Nigeria (offshore to 200 m), Viet Nam and Trinidad & Tobago (onshore).
- "Two Star:" Kazakhstan, Alaska (onshore), Ecuador (regular terms), Texas (offshore), Alberta (third tier oil), Netherlands (1995 terms), Norway, and India.
- "One Star:" Louisiana, Russia (PSC), Venezuela (new model contract), Indonesia (1994 terms), Malaysia (conventional), Angola, Nigeria (Niger delta), Syria, and Yemen-1.
Twenty-four of the above fiscal systems are tabulated here along with three of the eight criteria used for the rating (Table 1)(27399 bytes). The table shows how certain fiscal systems rate well for certain criteria but poorly for others. North American systems typically have a relatively low government take. This is attractive to investors. However, at the same time the rate of return and the MSR @ 15% are typically also low as a result of front end loading and bonus bidding requirements. This is unattractive to investors.
An overview of the distribution of the company take and government take for the 24 fiscal systems is also shown (Fig. 1)(111135 bytes).
One would expect that in a competitive world areas with the least favorable geology, highest costs, and lowest wellhead prices would offer the best fiscal terms, while areas with the best geology, lowest costs, and highest wellhead prices would offer the toughest fiscal terms.
This overall competitive framework does indeed exist. Typically countries with unfavorable conditions offer Five and Four Star terms and countries with favorable conditions demand Two and One Star terms.
For instance, Fig. 2 (49288 bytes) shows the percentage of major exporting regions in each of the five classifications. A "major" exporting area is defined as an area that produces an amount of oil equal to 125% of the consumption or more. The graph shows that there is a strong correlation between being a major exporter and the fiscal terms and conditions. Most major exporters demand One or Two Star terms. Interestingly, this concept applies not only to countries but also to provinces or states. The exporting states of Louisiana and Texas demand One and Two Star terms, while the importing state Illinois offers Four Star terms. The exporting province of Alberta demands Two Star terms, while the importing province of Ontario offers Four Star terms.
A very important result of the study is that the correlation between fiscal terms and geological and economic conditions is much stronger at the regional level than at the global level.
Governments respond to market forces in setting terms and conditions for their acreage. However, governments set terms and conditions primarily with reference to a regional framework. The reason for this behavior is two-fold.
First, governments, particularly of smaller countries, often have limited information about fiscal terms and conditions on a global basis, while their knowledge of the terms in neighboring countries is usually better.
Second, it is often difficult for governments of countries with poor geological prospectivity to defend terms and conditions that would be significantly below those of their neighbors. The safest political defense for the terms of a particular contract, is that the terms are similar to contracts in surrounding countries.
This behavior of most governments results in a regionalization of fiscal systems.
Governments compete regionally, while oil companies compete globally. This creates important anomalies.
The first anomaly is that "regions" as a whole seem to "disconnect" from other regions. Fig. 3 (55361 bytes) is a graph showing the weighted NPV @ 15% per barrel for all 226 fiscal systems grouped in six regions. Note that the terms in the European Region typically result in 50/bbl more than in the Asia/Pacific Region. Africa south of the Sahara and North America are equal to the Asia/Pacific Region.
The "Central Region," which includes North Africa, the Middle East, and the states of the Former Soviet Union, has terms that typically result in 500/bbl below the Asia/Pacific Region. Latin America is the only region that competes more or less globally.
An important observation is that North America as a whole does not seem competitive on a global basis. Terms and conditions of several important areas in North America should compete with Europe and Latin America on the basis of Five Star terms. However, there are no Five Star systems in North America, except Greenland and St. Pierre et Miquelon (off southern Newfoundland), which have "European" fiscal systems.
This is remarkable because the U.S. is an important importer of oil. Many oil producing regions are now in a phase of decline with high costs per barrel. The various governments should consider making their fiscal terms considerably more attractive. One could, for instance, recommend a 0% royalty for waters deeper than 400 m in the Gulf of Mexico.
The second anomaly relates to many importing countries with relatively modest geological prospects. These countries need to adopt Five Star and Four Star terms in order to be globally competitive. Yet, driven by regional concepts of competition, many of these countries have rather tough terms.
Consequently, there are a number of countries that seem competitive regionally but are not competitive globally. These countries include South Korea, Nepal, Laos, Bangladesh, India, Papua New Guinea, Tanzania, Mozambique, Ghana, South Africa, Albania (offshore), Morocco, Romania, Jordan, Mauritania, and Yugoslavia.
FISCAL SYSTEM
In order to study the global characteristics of fiscal system, a "world average fiscal system" was determined.
This system was calculated by taking the arithmetic average of all 226 fiscal systems. This calculation shows some interesting features.
The world average fiscal system is regressive for small fields.
"Regressive" means that the government take, in percentage terms, is higher on small and marginal fields than on large and profitable fields. The average government take on a 10 million bbl field is 68% and on a 300 million bbl field is 64%. As a result, the rate of return of a standard 10 million bbl field declines from 33% before government take to 14% after government take. Most fiscal systems in the world make small but profitable fields uneconomic.
The same applies to small exploration prospects. A profitable standard 30 million bbl prospect that can sustain a minimum 5% probability of success prior to any government take needs a minimum probability of success of 22% after the application of world average fiscal terms.
World oil production and exploration could be significantly increased if governments of oil importing and self-sufficient areas would provide fiscal incentives for small field development. This could include 0% royalty provisions for an initial volume of cumulative production or similar allocations under production sharing contracts. The volume subject to a royalty holiday could be different from area to area depending on the circumstances, but a level of 30 million bbl could be recommended for areas under favorable economic conditions.
The world average fiscal system is "front end loaded."
The government take during the first 6 years of production of a standard 30 million bbl field is 68% while on the remainder of the production it is 61%. The attractiveness of exploration and development could be significantly enhanced if more governments adopted "back end loaded" systems.
GOVERNMENT TAKE TRENDS
At the beginning of this article, it was mentioned that there is a downward trend in government take.
Another important trend is the introduction of a greater differentiation in terms. Many countries are now adopting a greater differentiation based on differences in geology, costs, logistical conditions, water depth, gravity of the oil, etc. This is leading to a much more intense competitive global framework.
From government takes for a number of countries for onshore, offshore, and deepwater conditions (Figs. 4,(49451 bytes)5)(51335 bytes), it can be seen how governments compete in these two environments on the basis of different levels of government take.
Thai onshore terms compete with Indonesian and Malaysian onshore terms. Thai deepwater terms compete with Indonesian and Malaysian deepwater terms.
RECENT DEVELOPMENTS
From the overall analysis of fiscal systems in a global context a number of conclusions can be drawn for individual fiscal systems that existed as of this writing in late 1994.
Bolivia is considering attractive terms under a possible new hydrocarbon law. Various alternatives are still being considered, but all options are Four or Five Star systems. Attractive terms are necessary in view of the low wellhead values because of high transport costs.
The new terms for Denmark for 1995 are attractive Five Star terms. This should help in increasing interest in further North Sea exploration.
All new terms in Indonesia are still One and Two Star terms. Indonesia would benefit from a wider differentiation of terms, including Three Star terms for some areas. Consolidation of corporate income tax would also stimulate exploration.
The terms of Myanmar seem too tough in view of the modest results so far. The terms in Myanmar make specifically small fields uneconomic. This does not seem appropriate in a country that only produces 13,000 b/d of oil from a number of fields.
The Netherlands is considering for 1995 a 0% royalty policy for small fields as well as a lowering of the state participation from to 40% from 50%. Yet these anticipated new terms are still relatively unattractive because of the high overall government take.
New Zealand recently changed the royalty formula. This makes the new system a highly attractive Five Star system.
The terms for the Barents Sea in Norway appear too tough. The terms are essentially the same as those for the North Sea. Norway could develop a greater diversity of oil activities by adopting a policy of wider differentiation of terms.
The new terms for Zone 1 in Pakistan are attractive.
Papua New Guinea should consider adopting a greater differentiation of terms, such as introducing a lower government take for high risk areas.
Russia's terms for possible new PSCs are still too tough. Russia could stimulate exploration and development by foreign and domestic oil companies with a wider differentiation of terms, including Three and Four Star terms for some areas.
South Africa's new terms are highly innovative and very attractive on the basis of incremental economics. However, the terms could still be improved in order to attract new "stand alone" investors to the country in a more determined manner.
Venezuela's new model contract terms seem in a realistic range for an important oil exporting country but provide very little "upside" to investors.
