Mutual benefits
Government take in E&P: framing a more balanced dialogue. By Iván Martén, Philip Whittaker, and Álvaro Martínez de Bourio
The decline of crude oil prices since mid- 2014 has hit oil producers hard, wiping out 36 per cent of revenues across the industry. Not surprisingly, companies have responded to this decline by aggressively cutting costs – but one cost has been impossible for companies to cut: the ‘government take’ or the share of oil and gas upstream revenues that governments capture.
The percentage of government take of upstream revenues is particularly critical because it defines a country’s competitiveness for internationally mobile exploration and development capital and it shapes global oil prices. If a country’s take is too onerous, companies will choose to explore elsewhere, leaving potentially lucrative reserves untapped. The percentage of government take becomes even more relevant as oil prices fall and companies cut capital spending, because countries find themselves competing to attract a shrinking pool of capital.
The government take is by far the largest cost for E&P companies and has been on the rise since 2000. Governments increased their take for several reasons, including rising oil prices. Some countries realised that the existing financial terms they had established for producers when oil was $20 a barrel were poorly suited for a world in which the price was closer to $100 per barrel.
Declining prices, of course, decrease the government take automatically – average lifting costs have fallen by about $9 a barrel in the past year – but more government action to reduce take is needed in a number of countries. So far, governments have responded more slowly than they did to rising prices in the past.
Despite these pressures, some governments still see capturing a significant share of oil and gas revenues as a route to shoring up government finances. For example, Russia’s finance and economic ministries are debating tax changes that could increase the government’s take by more than $20 billion over the next three years.
Both governments and oil companies would benefit from a level of government take that is more appropriate for today’s market. Fiscal regimes that are out of step with industry revenues constrain oil companies, preventing them from pursuing viable project opportunities. In the longer term, some governments’ revenues will fall as a result of these lost opportunities.
Governments and operators must work together to frame a balanced dialogue so that fair responses on taxation and other forms of government take can be executed. On the basis of our experience, both sides should work together and take these three steps in order to have a more balanced dialogue.
1. Conduct a strategic review of the country’s competitiveness related to resource development. The government and operators should honestly assess the competitiveness of the country’s resources and its current level of take. Our experience is that both aspects must be assessed on four dimensions:
The Attractiveness of the Country’s Resources. The government and operators should evaluate the attractiveness of the country’s resources – particularly the remaining recoverable reserves – and the success of recent exploration investments.
The Current Fiscal Package. A government must reflect on the types of contracts and the terms it puts in place.
The Current Nationalisation Requirements. Both sides must candidly explore the costs, practicality and effectiveness of local content requirements.
The Country’s Perceived Institutional Stability. Lower political, economic, and reputational risks can make a country’s resources more attractive and justify marginally higher government take.
2. Consider adapting the country’s fiscal regime if necessary. Being open to changing tax and non-tax measures can lead to a more balanced dialogue and, ultimately, to improving a country’s competiveness. We have found three areas in which tax packages typically can be adapted:
Tax Mechanisms. A country can adjust its tax or royalty terms by field type or size to compete for investment.
Tax Regulations. A government can change tax rules governing depreciation, losses, and ring fencing and adopt a cost-recovery scheme.
Tax Refunds and Deferrals. These measures can be incorporated in the terms and conditions of a contract to incentivise exploration and accelerate payback periods.
3. Be open to adopting an alternative fiscal regime. Governments can facilitate a more balanced dialog by assessing whether the current fiscal regime creates a competitive investment environment and, if not, by making changes, such as offering various types of contracts.
Concession agreements that offer ownership of oil reserves have been the most effective way to attract exploration investment, as they hold the potential for large gains. Production-sharing agreements (PSAs) can offer a fair return for both parties. Investors find the stability of PSAs appealing, given that they are governed by the principles of international commercial contracts.
Service contracts are generally less attractive because they limit potential benefits and relegate oil companies to a contractor role. These contracts are often employed in situations in which competition for access is fierce.
In the current environment of lower oil prices, governments must work with producers to develop fiscal structures that accommodate the current price environment and address the rising impact of government on the industry. By working co-operatively and with greater urgency than we currently see, governments and operators can shape a more appropriate level of government take that will be mutually beneficial and ensure that oil and gas production will continue to power local economies regardless of crude oil prices.
The Boston Consulting Group
Iván Martén (Marten.Ivan@bcg.com) is a Senior Partner, Managing Director and Energy Practice Global Leader; Philip Whittaker (Whittaker.Philip@bcg.com) is a Director, and Álvaro Martínez de Bourio (Bourio.Alvaro@bcg.com) is a Principal – all at The Boston Consulting Group. The Boston Consulting Group (BCG) is a global management consulting firm and the world’s leading advisor on business strategy. It partners with clients from the private, public, and not-for-profit sectors in all regions to identify their highest-value opportunities, address their most critical challenges, and transform their enterprises.
For further information please visit: bcgperspectives.com/energy_and_environment