The PIB: Nigeria’s Key Petroleum Fiscal Design Issues

By Opeoluwa Orekoya

Petroleum Industry Bill

The PIB was conceived as a solution to rectify some administrative issues in the Nigerian Petroleum sector and to increase the government take from the industry. This article will focus on the petroleum fiscal regime changes recommended by the bill. Seeing as this bill is seriously being considered, there is much debate as to its suitability. The following sections highlight the major provisions of the draft bill.

Nigerian Hydrocarbon Tax (NHT)

Under the new provisions the PPT (Petroleum Profits Tax) is replaced by an NHT which is fairly similar, and charges 85% of profits. However Tax offsets and Upstream Investment Tax allowances will be eliminated and items deductable from the NHT will be less than PPT. It also introduces a new volume or sliding scale based royalty that could be as high as 25% or more depending on oil price[1]. Contract areas in PSC (Production Sharing Contract) will be ring fenced for both cost and profit oil, with a cost recovery limit set at 80%. It will also introduce a non-recoverable cost/fair market value principle[2] based on current market prices to further reduce cost recovery.

Company Income Tax (CITA)

Additionally, oil companies including the JVC (Joint Venture Company) partners and PSC holders will be liable to pay corporation tax on profits generated from oil production aside from a higher local content mandate for professional and managerial staff for operation of petroleum mining leases. Coupled with this are marginal fields and relinquishment initiatives to allow the Petroleum Directorate to takeover licences after ten years of inactivity in order to allow for local participation.

NDDC (Niger Delta Development Commission) and other Social Levies

IOCs (International Oil Companies) will assist in the development of oil producing communities mandatorily through application of specific projects aimed at ameliorating negative impacts of petroleum production in these areas in addition to 3% of all costs NDDC levy[3]payable the Directorate for site rehabilitation, to correct environmental damage. However the measures required of the IOCs are not properly spelled out. There is also a penalty for flared gas which is set at $3.50 per scf[4] (Standard Cubic Foot). This will significantly impact associated oil and gas fields; coupled with the fact that the bill requires separate oil and gas contracts for their operations. Inclusive are education tax[5] as with the ETF (Education Trust Fund), ITF (Industrial Training Fund) and PTDF (Petroleum Trust Development Fund) at the same rate as in the PPT.

Fiscal Comparisons of the Bills

Having looked at the changes being made to the PPT in the PIB recommendations, I will proceed to analyze both bills in the light of the core concepts of resource taxation introduced in my earlier article, A Fiscal Background to Nigeria’s Petroleum Industry Bill.

Government Take

The PPT of 85% is relatively high compared to other rates around the world[6]. However, this could be considered as progressive being tax on profits. It is further made attractive by the availability of tax credits, and incremental scale royalties. Although the tax rate is high, the level of government take is lowered considering allowances such as PIA (Petroleum Investment Allowance), coupled with the absence of cost recovery limits in deep water PSCs’ ensuring quick recovery of costs by investors[7]. Deep water fields have a royalty system that reduces with water depth, and a 50% tax credit/tax allowance.

The PIB seeks to tighten government take by lowering tax allowances. Upstream investment will see significant increase in government take as all allowances will be eliminated. This is a significant reduction in international competitiveness of the regime. Although Government take remains high on larger fields, the PIB has reduced government take on marginal fields, as seen in the diagram below.

Source: NNPC (2009)[8]

As indicated above, the proposed system has significantly smaller government take especially on the most marginal fields as part of its aim in improving indigenous participation via its local content obligations[9]. Therefore the PIB will provide an overall cost increase to large producers with significant reduction on small fields. As the local content bill supports indigenous production, the PIB is very unattractive to foreign investors.

In terms of government take a regime must be competitive due to international competition amongst resource producers. The diagram below shows the international comparisons of the PIB with other fiscal regimes in terms of government take. It shows how Nigeria has the highest take on larger fields, and fairly lower take among the countries.

Source: NNPC (2009)

Such large take discourages investment among many opportunities. This can have significant impact on the industry in Nigeria.

Economic Rent, Efficiency and Neutrality

The concepts of neutrality and efficiency are related theoretically with government tax being on economic rent, best served by taxing positive NPV. However, the current system is front end loaded in its use of high royalty payments of up to 18.5%. These are insensitive to low profits and would be collected as soon as production begins, reducing the revenue of the investor and could be collected when there are no profits.

The PIB seeks to increase royalties, and this will discourage investment and lead to a further front load of government revenue and delay companies recouping revenue on projects, with implications for the time value of money and reducing NPV. Therefore this may result in loss of revenue to the government over the long term. Coupled with this is the introduction of company income tax which is a further liability in conjunction with the royalty payments. These both seek to reduce efficiency of taxes. However on the other hand, there are favourable provisions in terms of PSC where the cost recovery limit is 80% as well as significant reduction in marginal field taxes. 

Opportunity for Incremental Investment

Higher fiscal terms would discourage incremental investment particularly in the case of deep offshore fields where necessary large investments are being missed. The PPT provides a regime that is slightly tougher than the world average in terms of resource rent tax and royalties[10] and although the cost recovery limits are sufficiently high, government take is also high. With more competitive regimes available, such as Brazil with a government take of 60-65%[11], or Ivory Coast with as low as 49% government take on deep water regimes[12], opportunities for incremental investment are discouraged by the current tax regime. The further unfriendly terms of the PIB will further deter incremental investment. The diagram below shows the relative position of Nigeria among West African deepwater fields for incremental investment opportunities relative to the world average.

Source: Van Meurs, P. (1997)[13]

The incremental investment in Nigeria deepwater offshore fields is significantly lower than others in the West African region, and the world average. Unfriendly fiscal terms would further decrease incremental investment opportunities.

Stability

Nigeria has relative government instability especially in the Niger Delta where production has reduced since 2005 due to militant activity[14] costing more than $50 billion worth of production. This is a very high cost of doing business in Nigeria and will factor into calculations of expected discounted cash flow and potential NPV by IOCs.

However although this may be slightly significant, the issue of major importance is flexibility of the contracts to price changes. The fiscal regimes under the PPT have inbuilt adjustment mechanisms which enable contract review once the price rises above $20 per barrel and it may be reviewed after fifteen years[15]. These clauses provide an element of regularity, ensuring an understanding that so long as the government revenue objectives are met there will be no change to legislation.

The PIB does not significantly change these stabilisation measures, but the Niger Delta crisis which has curtailed a third of Nigeria’s oil production, and significant amounts of oil Industry revenue is a problem[16]. Therefore these potentially aggravate the issue of higher government take. The problem with the PIB is its increase on terms from the previous law and the 15% minimum tax liability; high royalties are burdens to companies especially during periods of low revenue or losses.

The PIB seeks to increase tax liabilities in larger fields in order to cream off rent from current and potential future high oil prices. However it does not provide for review in favour of the IOC in case of a potential fall in price below $20. In an attempt to increase government take, the government is using regressive measures which may only serve to reduce competitiveness of Nigerian Oil fields.

A key fault of the current tax regime in the country is the lack of provision for the areas that are significantly damaged by oil exploration and production activities which has lead to militant activity. Emphasis considering IOCs to provide for this has not been clearly spelt out in the NDDC levy[17] as there could be direct involvement by them in dealing with this issue[18]. Coupled with this, the government intends to shift responsibility of this development to investors, but at the same time increase it’s take through reduced allowances and increased royalties. The tax reform, to be effective should rather ensure greater IOC responsibility in the areas where they operate, and the bulk of tax increase should have gone there. It may even be advisable for the government to ensure that the IOCs pay towards this in the new legislation, without increasing other taxes and royalties, or by reducing them.

NUTSHELL:

Opeoluwa has compared the PPT and the PIB tax regimes. To him, the PPT is a relatively uncompetitive tax regime, but the PIB seeks to make the situation worse. His analysis has shown that in terms the measure of attractiveness of the fiscal regimes- based on government take, the PIB seeks to reduce a number of tax allowances and increase government take. Large fields will become less competitive internationally, with improvement in competitiveness only in Marginal fields. Should the bill be passed as it is, there will be significant discouragement of participation by IOCs due to profitability constraints.

According to Opeoluwa, the PIB seeks to increase revenue from royalties, and these will discourage investment. These criteria are necessary for encouraging investment to flow into the sector. He feels there is however a positive in the provisions that encourage marginal field development with progressive regimes. However overall increase in tax levels will affect incremental investment significantly. Coupled with these, Nigeria suffers from political instability in the major oil producing regions. Therefore the issue of political instability is already prevalent. However, in terms of flexibility, there is still maintenance of stability although this does not make provisions for significant oil price reductions.

An advantage of the bill is to make formal provisions for the reparations to the areas damaged by oil production. However, there should be more focus on these areas, and as an alternative to raising taxes, emphasis should be placed on oil companies being directly responsible for these areas.

Opeoluwa arrives at a conclusion that the current terms of the PPT discourage further investments in the country. It is assumed that these increases in government take will raise revenue although short term and government cannot afford to raise taxes if it should maintain desired levels of revenue. Emphasis should be on taxing positive NPV.  To view Opeoluwa's professional profile and for more information on this article please click here: -->