THE NATURE OF CONCESSIONS AND ROYALTIES

By Mabel Imoh Gab-Umoden

The concessionary or Tax/Royalty system is quite a common fiscal regime for most countries. A concession is an agreement between a government and an oil company that gives the oil company the privilege to explore, develop, produce, transport and market the petroleum at its own risk and expense within a given area at a specified period of time (Nakhle, 2008). In exchange for these rights, the International Oil Company may have paid the government a signature bonus or license fee (Johnston, Johnston and Rogers, 2008). The concessionary system has the following features:

i)                    The oil company has privilege rights to explore and produce at its own expense

ii)                  The oil company owns the production and equipment

iii)                The oil company pays royalty to the government

iv)                The oil company pays taxes on profits

v)                  The oil company has the right to export the resource (Kjemperud, 2004).

                                   

HISTORIC FRAMEWORK OF ROYALTIES AS A FISCAL REGIME

In the early 1970s when the evolution of the UK North Sea tax regime began, royalty was one of the earliest forms of revenue the government imposed on the oil companies. The royalty rate in the 1975 fiscal regime was 12.5%. It was later on abolished in 2003. The aim of abolishing royalties was to achieve an improvement in the profit-related areas of the South Basin of the North Sea regime (Abdo, 2008).

HOW BENEFICIAL IS ROYALTY TAX TO GOVERNMENT?

Taxation generally is an important aspect of governance of the economy and the country at large and a proper tax regime should be in place to ensure that the objective of the host government is fulfilled. Since it has already been established that royalties are a form of taxation, one needs to understand the main underlying factor of a tax regime which is to help guarantee a stream of revenue from the petroleum activities carried out by IOCs (International Oil Companies) as well as also using it to promote both foreign and domestic investment in the sector to achieve maximum exploitation of the petroleum resources.

As with other aspects of a fiscal regime, royalties in the petroleum sector are mainly responsible for sourcing out the economic rent for the host government. Economic rent being the difference in the revenue accruable from the petroleum activities less the costs of production which may also include the opportunity costs. It is this economic rent that the government uses as a stream of income from such activities. Royalties are quite beneficial to a government as a form if taxation. Some of such benefits are discussed below:

i           Source of Finance: Royalties act as a source of funds for the government which can then use it to finance other capital projects in the country. The royalties received by the host government bring in huge income for the host government which amounts to hundreds of millions of US dollars and in some cases billions. Since royalties are paid in cash the funds accruable from it will not be subject to issues such as difficulties in selling the crude.

ii          Economic Rent: The crux of using royalties as a form of taxation is to exploit the petroleum activities of the stakeholders particularly the IOCs. This is done by taxing the revenue accruable from the petroleum activities less the costs of production. This gives the host government a tremendous edge of over the IOCs and goes to show that ownership of the resources and its control and sovereignty still belong to the host government.

iii         Control: Royalties act as a mechanism of control employed by the host government to aid in the regulation of petroleum activities. This can affect both the level of investment that the IOCs are willing to make in the sector as well as the scale of operations they are willing to implement in the sector.                   

iv         Investment Climate: The level of investment in the sector will be greatly influenced by not only the tax regime but also the royalties to be paid by the IOCs. Where the IOCs are of the opinion that the royalties to be paid are to high they may be reluctant to continue investing and this may have a ripple effect on other potential investors in the sector.

v.         Foreign Exchange: Since the international currency for oil and gas operations is the US dollar, most royalty fees are equally paid in this currency. This not only shores up the foreign exchange reserve of the host country, it also helps in stabilizing its currency against the US dollar as a result of such payments.

vi         Stability: A proper tax regime as well as scale of royalty fees paid will help bring about stability in the sector. This is as a result of the consideration the IOCs have to make in determining the level of investment required in each project. Where such has already been determined the IOCs confidence in the sector is greatly improved thereby promoting stability in the sector.

A CASE FOR PETROLEUM INCOME TAXES

Petroleum Income Tax applies to a company’s profit and is imposed at the corporate level (Nakhle, 2008). Below is a table showing a division of revenues:

Fig 5: Division of Revenues/ Production Accounting Hierarchy (Full-Cycle) (Johnston, Johnston and Rogers, 2008).

Petroleum income tax is a form of government taxation in which the income earned by the oil exploration companies is taxed. Oftentimes, this form of taxation is administered concurrently with another form of taxation, notably Royalty.

It is a form of tax that is targeted at the profit of the company after all costs have been deducted. It also suffices to say at this juncture that petroleum income tax enjoys the same status of other forms of tax targeted at the profits just as other ventures. In the UK, this form of taxation was known to apply to the net profit of the company and is usually charged after all other expenditures have been deducted from the revenues accruing to the company.  In a nutshell, the idea of Petroleum income tax has the same effect of all other forms of income tax, as obtained in all other industries.

  

This series of articles (Fiscal Regimes: Components and the Economic Rent, Fiscal Regimes in the UKCS and Nigeria & this final article) has considered various forms of petroleum taxation regimes and examined the countries in which they operate. While a caveat must be sounded that what has been done in the above analysis is not in any way exhaustive, it remains undoubtedly true that each respective fiscal system adopts the fiscal policy that suits it most. It is thus not appropriate to transpose the fiscal system prevalent in a particular system in another for the mere sake of its effectiveness.

The ST –Supplementary tax imposed by the UK within the period 2002-2005 remains one of the most visible examples of a fiscal system stretched beyond its practical limits and can make nonsense of government planning where it is not done appropriately and with regards to peculiar local or local circumstances. It is certainly not within the purview of this analysis to make this tax policy decision for any fiscal regime, however, it is for its academic and research purpose that a position is taken by this analysis.

It is also undoubtedly noted that Royalties remain one of the oldest forms of any resource rent systems anywhere in the world and as such still remains a common feature in virtually all systems with little modes of variation from one region to another. However, as seen in the above articles, most fiscal systems have made a gradual shift from Royalty-based systems to  more dynamic and resource-based rent extraction models so as to earn the best possible rent form the exploitation of their non-renewable and constantly depleting natural resources. What remains to be seen is how each individual system will evolve a perfectly-suited fiscal model, bearing in mind its peculiarities and locality.

 Whether this remains the ideal is left to the future of resource taxation, and what it offers in the long term planning of each fiscal system. The UK, on its part has evolved its own form of tax system, and very lately the socialist South American country of Venezuela has been able to do same. It may appear some other systems only duplicate already existing models of taxation for their own systems which have limited the originality of tax systems applicable across the various resource-based systems. At the end of all considerations made, every fiscal regime adopts its most effective tax option.

NUTSHELL:

According to Mabel, petroleum taxation is a means by which the governments of petroleum producing countries earn revenue from investors ( whether such investors are international Oil Companies or National Oil companies ) for a natural resource such as petroleum which is owned and controlled by the government. Fiscal regimes are essential to every natural resource producing country because they can either attract investors or send the wrong signal to investors. Mabel's analysis has identifed the different types of fiscal regimes in the UKCS and Nigeria. Furthermore she has discussed royalties and how beneficial they are to the government as a form of taxation. For more information on this article and to view Mabel's professional profile, click here.-->