Governments grapple with abandonment fiscal terms

Ashley Pittard
University of New South Wales
Kensington, Australia

Governments worldwide are grappling with ways in which to treat offshore-facility abandonment and oil and gas field abandonment in their fiscal and environmental legislation.

While some governments have introduced fiscal and environmental provisions for removing offshore installations, much of the legislation remains to be tested in practice.

Many other governments have yet to introduce specific terms and legislation regarding the process.

The method for financing offshore-facilities abandonment must be agreed upon between the operators and countries. Carryback provisions typically are the most economically efficient, otherwise all parties lose out.

Overall, because every country competes for a finite amount of funds, any hindrance to project profitability will ultimately hurt the government and therefore the continuation of economic development in the country.

Abandonment issue

Offshore-platform abandonment is a major issue for the international oil and gas industry. In the next 30 years, almost all of the existing worldwide offshore installations will be decommissioned.

The industry's adherence to the International Maritime Organization (IMO) guidelines and the U.N. law of the sea will mean that the cost of abandonment is likely to be high. The U.N. estimates that total cost of completely removing all existing platforms will be between $29 billion and $40 billion, 1997 U.S. dollars.

This article discusses abandonment costs and the fiscal and environmental provisions that governments have introduced to handle the activity.

Abandonment costs

Abandonment costs depend on such criteria as:

• Geographical location of the structures
• Number of platforms per field
• Water depth
• Topside weight
• Jacket weight
• Type of structure
• Proximity to shore
• Platform integrity
• Availability of equipment for facility removal
• Level of removal.

With such a range of factors affecting the costs, it is not surprising that costs vary significantly from one field to the next. Table 1 [32,527 bytes] illustrates this by listing actual abandonment experience to date and the associated costs in selected countries.

The abandonment costs of individual platforms range from $1.7 million to $10.8 million. The countries with the highest cost per facility have predominantly steel-piled structures.

These platforms are more expensive to remove than floating structures, semisubmersible, and jack up platforms because removal of the latter is limited primarily to plugging wells and decoupling.

In contrast, removal of fixed steel platforms involves detaching the platform from the seabed. To date, no heavy concrete platforms have been abandoned, but their costs are expected to be at least as much as those of steel-piled structures.

The relative abandonment costs (Table 1) show that the abandonment of three offshore fields in Russia have cost $10.8 million/structure. This reflects the complexity involved in abandoning fixed 24-pile steel platforms. Harsh weather conditions and high barge and crane costs are also factors.

Major cost components are the time spent offshore and the abandonment equipment. These potentially represent up to 75% of the total. The Baltic areas, as well as the North Sea, have the highest day rates.

At the other extreme, abandonment of a jack up facility in Benin costs only $1.7 million. This reflects the better weather and sea conditions as well as the fact that the platform is a jack up.

Table 1 also gives the estimated total costs of abandonment of all existing platforms in the selected countries. U.S. costs are the highest. This is primarily a function of the large number of structures that must be abandoned.

Individually, abandonments are relatively inexpensive because they usually have less weight and are in shallower water.

Fiscal provisions

Many governments have enacted legislation and introduced codes of practices and fiscal provisions covering the abandonment of offshore installations.

Table 2 [116,179 bytes] summarizes the liability regulations, security against abandonment default, and environmental abandonment provisions for selected countries.

In a majority of cases, the contractor is held responsible for abandonment. Even in countries without specific legislation, codes of practice, or fiscal provisions, companies are likely to have ultimate responsibility for abandonment. This could arise by virtue of other legislation or retroactive legislation.

The fiscal provisions for abandonment in a country tend to fall into one of four categories:

1. Carryback
2. Amortized over field life
3. Units of production
4. Expensed.

Carryback

In carryback (Table 3 [27,939 bytes]) cases, for tax purposes abandonment costs are carried back for a maximum period and offset against income in previous years for a stand-alone project.

For instance, in the U.K., abandonment costs can be carried back for a maximum of 3 years. The taxable income in those years sets a limit on the tax relief for abandonment that can be obtained.

A tax rebate would be obtained in the year of abandonment. Carryback provisions are incorporated in the fiscal terms of the U.K., Ireland, Greenland, New Zealand, and the Falkland Islands.

Amortized over field life

Indonesia is an example where abandonment costs are amortized over the life of a field (Table 4 [21,492 bytes]). In these cases after the government has approved an estimate of the abandonment costs, the costs are amortized over the remaining field life with the contractor depositing the amortized amounts into an abandonment fund.

The deposits are then recoverable from revenue generated from production under cost-recovery provisions.

The equivalent mechanism under a royalty/tax regime would involve the amortized amounts being deducted against tax.

From a company's perspective, a critical factor is whether actual funds are put aside for abandonment during field life or whether an accounting provision is made under cost recovery or tax arrangements and cost recovery increased or tax reduced during field life.

The latter would clearly be preferred from the oil company's perspective.

Units of production

In a similar way to that described for costs amortized over the field life, under units of production systems (Table 5 [23,150 bytes]), estimated abandonment costs are deposited into an abandonment fund and recovered on a units-of-production basis over the final years of the project.

Countries that have incorporated such provisions in their legislations include Venezuela, Angola, and The Netherlands.

Again, from the company's perspective, a critical factor is whether actual funds are put aside for abandonment during field life or whether an accounting provision is made under cost recovery or tax arrangements and cost recovery increased or tax reduced during field life.

The latter would clearly be preferred from the oil company's perspective.

Expensed

In some countries (for example Australia), the costs of field abandonment are expensed (Table 6 [18,604 bytes]) in the year they are incurred and written off against income from the field or from other sources.

The cost of abandonment effectively creates a tax credit or tax deduction in the final year of the project.

Fiscal provision effects

Economic analysis on the hypothetical stand-alone project cash flows in Tables 3, 4, 5, and 6 determined the relative economic attractiveness of each option.

The economic indicator used was the net present value (NPV) because NPV provides the present value of net cash flow and recognizes that time has a critical bearing on the value of money.

The relevant cash flows for the four fiscal provisions were discounted at 15%.

The economic analysis (Fig. 1 [46,303 bytes]) illustrated that the carryback against taxable income was the most efficient with a company NPV of $67.1 million. The expensed provision was the least attractive with a NPV of $64.78 million.

This was expected because the carryback provision only takes back money it needs. The money is also taken back later in the project's life; early revenue is therefore left alone.

The amortized provision uses a constant amount of revenue every year; it therefore impacts income throughout the project's life.

The unit of production fiscal provision front-end loads the cash flow. By front-end loading the cash flow, the unit of production provision decreases early cash flow when compared to the other provisions. Therefore, this gives a lower discounted value.

Company preferences

From an oil company's perspective, all other things being equal, abandonment provisions that involve making payments into an abandonment fund during field life would tend to be less preferable than those that allow a straight tax deduction or cost recovery in the last year.

The latter allow the company access to the funds during field life, and the funds can be used to earn interest or be put in alternative investments. Even when deposits are fully cost recoverable in the year they are provided, there is a time lag between the deposit and the recovery.

Whatever the abandonment provisions, ring fencing can have a critical effect. By its very nature, field abandonment occurs when little or no revenue is being generated by the field. The ability, therefore, to obtain cost recovery from, or tax deductions against, other sources of income outside the immediate area of the field or production license can be very valuable.

The wide ring-fencing provisions of countries like Australia can give companies considerable fiscal relief in this costly activity.

Acknowledgment

The author would like to thank Guy Allinson, Cairn Energy, for his input and support for this article. Thanks also go to Mark Elliston, Val Pinczewski, Bill Griffith, Petroconsultants S.A, Infield Data Systems, Twachtman Snyder & Byrd Inc., Reserve Engineering, Total Abandonment Services, Stolt Comex, Chevron Corp., Mobil Corp., Brunei Shell, and Esso for providing information for this article.

The Author