GOVERNMENT PETROLEUM OPERATIONS: State Participation VS. Taxation & Regulation

By Blessing James Laburta

‘’The right of peoples and nations to permanent sovereignty over their natural wealth and resources must be exercised in the interest of their national development and of the well-being of the people of the State concerned ’’. Petroleum has been described as the most important natural resource in the world and the ‘’commanding heights’’ of any economy, accounting for a large percentage of Government revenue, foreign exchange earnings and Gross Domestic Product (GDP) of most Petroleum Producing Countries (PPCs) . Viewed as a commodity of strategic importance, most Countries vest ownership and control of petroleum in the State as a trustee for its citizenry .This implies that Governments of PPCs have an important role to play as policy makers in ensuring that a fair share of the proceeds from petroleum accrue to the State for the benefits of its citizens.

Challenges faced by most PPCs include the volatility of oil prices which affect revenue . For instance in Venezuela, oil revenue fell from 27% of GDP in 1996 to less than 13% of GDP in 1998 and subsequently rose to more than 22% of the GDP in 2000 .Secondly; questions of intergenerational equity arise from the fact that petroleum is an exhaustible resource . Furthermore, petroleum operations are characterized by capital intensive investments , high-risk, long lead periods and the necessity of special technical expertise which are often huge expenses for Governments of PPCs already overburdened with other social and infrastructural needs of the citizenry. Consequently, Investors comprising mostly of International Oil Companies (IOCs) and more recently Private Indigenous Oil Companies having the requisite expertise and financial prowess are involved in petroleum operations either on an exclusive basis or alongside the National Oil Company to ensure an optimal recovery of petroleum resources .

Investors in petroleum operations are interested in high yield ventures that offer immediate pay-back and huge profits .Governments on the other hand are interested in an orderly pattern of exploitation of the petroleum resource so as to conserve the resource base, maximising state revenue, technology transfer and capturing of spin- off benefits emanating from petroleum operations . Reconciling the interest of both parties is achieved through the imposition and administration of a neutral tax system that captures economic rent .Hence proponents of Taxation and Regulation (T&R) have highlighted the above position as the preferable option for Government in maximising revenue from petroleum operations.

Conversely, proponents of State Participation (SP) opine the need for Governments to maintain sovereignty and control over petroleum resources by active participation with the resultant effect of maximising Government revenue and facilitating transfer of technology, amongst others . The impasse therefore remains on the most appropriate option for Government in achieving its objectives in petroleum operations. Should State Participation or Taxation and Regulation be adopted? What are the benefits or drawbacks of these options?

2. OBJECTIVES OF GOVERNMENT IN PETROLEUM OPERATIONS

Governments do not constitute a homogenous group in respect of their objectives for petroleum operations . Different Governments have divergent objectives for petroleum operations depending on each Countries circumstances such as size of oil reserves, importance of petroleum to the economy, maturity of the oil industry, financial strength of the Government and stage of development of the non-petroleum economy .These objectives have however been classified into Economic or Fiscal Objectives and Non Economic or Non-Fiscal Objectives as enunciated hereunder:

2.1. ECONOMIC OBJECTIVES IN PETROLEUM OPERATIONS

Government’s Economic or Fiscal Objectives in petroleum operations can be achieved through a fiscal regime designed to capture economic rents. These objectives include:

i) REVENUE MAXIMIZATION

Government’s economic objective in petroleum operations is to maximize revenue earnings in order to finance public expenditure . To achieve this purpose it utilizes taxation to capture economic rents accruing from petroleum operations or direct equity participation to generate additional revenues in the form of profits or dividends. Taxation in petroleum operations is the primary source of Government revenue for most PPCs .

ii) CONTROL OF ECONOMIC DECISIONS IN PETROLEUM OPERATIONS

Economic decisions in petroleum operations are influenced by Taxation. As a result, most Governments use tax instruments to influence and control economic decisions in petroleum operations . An increase or decrease in ‘’Government Take’’ can encourage or discourage certain economic activities. For instance, tax incentives can be used by Governments to stimulate exploration activities. As a result, taxation affects company profits and influences major decisions by IOCs on the choice of projects and country to operate .

iii) DISTRIBUTION OF BENEFITS

Tax Policies are instruments employed by Governments in distributing the benefits from petroleum operations. Such distribution of benefits between Governments and Investors through taxation ensures that the State receives a fair share of its non-renewable resources .

2.2 NON- ECONOMIC OBJECTIVES IN PETROLEUM OPERATIONS

The non-economic or non-fiscal goals of Government are those objectives which cannot be achieved through a fiscal regime .Where the sole Government objective in petroleum operations is to maximize revenue; it may be prudent to adopt a fiscal approach . However, there are non-fiscal objectives that account for Government’s involvement in petroleum operations such as:

i) SOVEREIGNITY

Petroleum is a commodity of strategic importance to the development of most PPCs . Vesting petroleum operations solely in the hands of IOCs which are mostly foreign companies is viewed as a sign of imperialism. Government participation therefore implies sovereignty over natural resources and provides leverage for monitoring IOCs to ensure maximum utilization of non-renewable petroleum resources.

ii) EFFICIENT EXPLORATION OF PETROLEUM RESOURCES

Governments aim at maximizing the rate of exploration of acreages within their territories so as to harness the optimal potentials of their petroleum resources. They desire the rapid exploration of prospective areas over which exploration rights have been granted using a detailed work program and the most sophisticated available technology to enhance maximum recovery of petroleum resources .

iii) SECURITY OF SUPPLY TO DOMSETIC MARKETS

Petroleum Operations provide the needed avenue for Governments to ensure that the supply of a specified quantity of petroleum production is made to the local markets to meet energy demand. Such Domestic Market Obligations (DMOs) facilitate the reduction of foreign exchange debts generated by high cost of importation of petroleum products .The Nigerian Domestic Gas Supply and Pricing Regulation, 2008 is tailored in this respect .

iv) RISK SHARING

Petroleum Operations are cost intensive and risk-prone. Governments are unable to bear such risk on a sole basis due to competing social and infrastructural obligations to the citizenry. Conversely, IOCs are calculated risk takers that can limit risk through diversification , unlike Governments. Petroleum Operations therefore provide the opportunity for Governments to raise capital and share operational risk with IOCs which are usually endowed with financial capabilities and willing to assume risks that are commensurate to returns.

v) TRANSFER OF TECHNOLOGY AND EXPERTISE

IOC’s possess the technical skills and managerial prowess usually lacking in the host countries were petroleum operations are undertaken. Governments carry on petroleum operations with the ultimate view of taking over such operations from the IOCs. To achieve this, IOCs are mandated through local capacity development obligations contained in most petroleum agreements to transfer technology and skills to the host country . An example is the Nigerian Local Content Development Act, 2010.

vi) ENVIRONMENTAL AND SAFETY OBJECTIVES

As part of its responsibility to the citizenry, Government is concerned about the impact of petroleum operations on the environment. Strict environmental laws and good oil field practices are enforced to ensure that petroleum operations are conducted in a sustainable manner to conserve petroleum resources and the environment for future generations. Tax instruments such as Green Taxes are intended to reduce or prevent pollution from Carbon dioxide emissions (CO2) .

vii) NATIONAL DEVELOPMENT

Petroleum Operations are associated with spin-off benefits such as the development of related-industries like power, gas and manufacturing industries which enhance the overall development of a country . Furthermore, infrastructural facilities like electricity, roads and airports are benefits derived by indigenous communities where petroleum activities are undertaken .

Furthermore, the enclave nature of the petroleum industry due to its capital intensive feature as opposed to being labor intensive has made employment opportunities in the petroleum sector very scarce. However, petroleum operations provide an opportunity for the employment of local personnel by both IOCs and National Oil Companies (NOCs)

NUTSHELL:

This is the first of three parts of this article by the above named author addressing the debate on the best option for Government in achieving its objectives in petroleum operations. While recognizing the fact that petroleum operations are the mainstay of the economy in mist resource rich countries, the author has tried to analyze the various options available to the Government to find out how best Governments can harvest the profits of their resources without discouraging investors. Quare: In the light of the prevailing circumstances in various jurisdictions, would a synergy of both options facilitate in achieving Governments objectives in petroleum operations? What would be a better option? Look out in the coming weeks for the sequels to this article to find out the authors conclusion. Until then comments on this issue would be appreciated.