Lower oil price forces tax regime changes
The effective oil price ceiling created by the US shale boom is causing governments elsewhere to revise their tax codes
The shock of the dramatic fall in the oil price since 2014 has been reverberating ever since. But now there is a grudging acceptance that US shale oil could limit the price of WTI to a $55-65/bl band for a prolonged period, leading governments to permanently reform tax codes.
Governments have a particularly tricky task if oil and gas revenue is the primary source of income. A balance must be struck between the conflicting demands of competing for international investment capital and collecting tax revenues.
"Some countries have reduced the tax burden to try to maintain investment," says Derek Leith, global oil & gas tax leader at financial services firm EY, and contributor to its Oil and Tax Guide 2019. "If they are seeing larger investors depart, depending on how material oil and gas tax revenues are, they may be inclined to lower the tax rate and look at the wider economic benefit of having oil and gas production in the country.
"Equally, some have done the opposite. When they have seen the oil price under pressure, they have introduced new taxes or put the tax rate up."
He says this has so far been most apparent in the Middle East and the treatment there of national oil companies. The social contract—often involving expensive consumer subsidies—worked effectively when pumping large volumes at high prices, but balancing the budget has since become problematic.
"There is a demonstrable wave of reform in these countries away from a model that worked in the past," says Leith. "They need to raise revenues in a fundamentally different way."
One way the six Gulf Cooperation Council (GGC) states reacted, in 2016, was by making a commitment to introduce VAT. Saudi Arabia and the UAE have already implemented a 5pc tax and the IMF recently recommended increasing it. In February, the former also introduced transfer pricing regulations for the first time.
However, there are dangers. The introduction of VAT can have an overly detrimental effect on attracting investment where there are doubts about the country’s fiscal position, warns Leith.
"VAT and other indirect taxes can have a very, very significant impact on project costs, particularly if it is not recoverable on the construction phase of the project. In some other countries, the law may state you can recover it but, if the country has cashflow difficulties, it may be very hard to do so."
Companies recognise that, to be sustainable at prevailing prices, they need to be in fields with high production volumes, low unit costs and stable tax regimes, according to Leith.
"We are seeing some of the larger international US companies retrenching into the US because of the attraction of unconventionals. Others are clearly withdrawing from basins that they feel are more marginal and into ones where they feel there is greater opportunity."
The US shale boom shows no sign of abating; a new record of 8.46mn bl/d is expected to be set May 2019, according to the US Energy Information Administration.
The abundance of opportunities means that investors can afford to be selective. There is still significant interest from international companies in developing nations with genuinely large oil and gas positions that have not been exploited; for example, Mozambique LNG is attracting a lot of international attention and capital.
However, Leith can imagine a time when countries need to offer fiscal incentives to attract investment. "It is something I expect might change over the next three or four years as people realise that this is not a blip. They are going to have to make some significant changes to how they run their countries to balance their books and keep people happy."