Investments: frozen by the fiscal burden or encouraged by public policies?


by Daniel Apostol

In spring we started a number of analyzes prompted by the question “which tax regime is the best?”, analyzes that developed in fact the idea that there is no such a thing as “the best” tax system (the same goes for “the worst”) applied to the oil and gas industry. However, we have shown that “the most inappropriate” tax regime for any industry and especially for oil and gas is the regime which, instead of supporting economic development through investments, strangles it by increasing tax burden on investors. Therefore, I still claim, as at the beginning of this series of analyzes, that a “suitable” tax regime is the one that stimulates the formation of capital, development of new investment projects, allocation of important funds to research – development and new technologies, creation of new production areas and new jobs. Attending the event “Sustainable Romania – Taxation for Sustainable Energy”, which took place in October in Bucharest, expert Radu Dudau said that, taking as fundamental principle, the “most suitable” tax system for the oil and gas industry is the one that manages to maximize the state’s gain, but also to maintain investments in capital and technology. “Oil taxation is a leverage of economic policy by which producing states aim to acquire a larger share of the economic rent generated by oil and gas extraction. Governments sometimes promote social and economic objectives: jobs, transfer of technology, construction and infrastructure, keeping the macroeconomic stability by generating constant budgetary revenues etc. When production is made in concession regime, license holders aim to obtain profits proportional with the degree of risk taken by investments in the exploration and development of fields. For that, it’s necessary to have a transparent, predictable and internationally competitive regulatory environment”, Radu Dudau says. And according to Vasile Iuga (PwC), one can define several criteria for the comparability of tax systems: the type of resources and the exploitation method (e.g. oil/gas, onshore/offshore, conventional/unconventional methods); the degree of maturity and fragmentation of fields; the productivity of wells; the quality of hydrocarbons exploited; the geological and technical production conditions; costs with the discovery, development and operation of fields; prospectivity of the country in terms of new resources that can be discovered and commercially exploited; the degree of development of the hydrocarbon transmission infrastructure; the level of development and degree of liberalization of hydrocarbon markets. But let’s return to the transparent, predictable and competitive regime! What is the situation in Romania compared to the European Union? I wrote in spring about Deloitte study regarding the actual level of royalties and similar taxes as percentage of revenues obtained within the oil and gas exploration and production activities (“upstream”) in Europe.  Deloitte’s experts returned this autumn with more recent data which, seen from the perspective of state-investor relation, emphasize that the European states encourage by fiscal relaxation the investment projects in the industry subject to significant market restrictions caused by the collapse of oil prices. At the request of the Oil and Gas Employers’ Federation, Deloitte conducted a study in September 2015 in which it analyzed the actual level of royalties and similar taxes as percentage of revenues obtained within the oil and gas exploration and production activities (“upstream”) in Europe.  Here are the conclusions of the updated study.

ACTUAL ROYALTIES AND SIMILAR TAXES ARE DIFFERENT FROM NOMINAL RATES. Deloitte’s update must be considered within the limitation that every field is different let alone two countries. Royalties and sector specific taxes are driven by national priorities, market reality and in recent months also had been affected by or are in the process of revision due to the severe decline of oil prices. The current report is a brief update of the previous report, using 2014 data, unless otherwise specified. The updated overview is constructed based on publicly available information and doing an average computation purely on a mathematical basis for Europe, that hopefully can help one step in bringing some focus and basic input to the discussion that should be further built on more extensive analysis and commonly agreed approach. “In most of the countries with sizeable oil & gas production a declining trend is noted. Additionally there are a number fiscal changes to take effect from 2015. Keeping all the limitations in mind that can affect the results, a simple arithmetical average for the European producing countries would come to 11.7%, while the average of the closest comparable European producing countries based on well productivity would be 7.5%. At present, Romania has an average observable royalty and similar tax as a percentage of revenue of 15.7% computed as of June 30, 2015 (15% as of December 31, 2014), arising from the main companies SNGN Romgaz SA and OMV Petrom SA with 19.3% and 14.1% respectively (21.1% and 13.2% respectively as of December 31, 2014)”, Deloitte’s updated study reads. If we make a comparison between the average observable royalty and similar tax as of 2014 versus 2013 we notice the following major movers:

Romania: the average observable royalty and similar tax rate increased from 13.9% (9m/14) to 15.0% (12m/14) and to 15.7% (6m/15). This trend is primarily resulting from:

  • higher proportion of gas versus oil;
  • the overall production mix, gas being taxed with a supplementary tax of 60% on price increase resulting from the allowance under the liberalization calendar. Average non household gas price changed from 58.7 lei/MWH during 2013 to 85.1 lei/MWH during 2014 and average gas price for house hold increased from 47.4 lei/MWH to 52.3 lei/MWH;
  • although oil price declined in the second half of 2014, royalties charge formula uses reference price of preceding three months; in a declining market this resulted in a higher percentage of royalties.

Italy: the average observable royalty and similar tax rate decreased from 14.4% (2013) to 11.7% (2014). Italy had a profit surcharge on oil & gas and energy companies. The profit tax surcharge nominal rate was reduced from 10.5% (2013) to 6.5% (2014); this combined with lower profitability due to declining prices in 2014, resulted in an overall reduction in the percentage.

UK: the average observable royalty and similar tax rate as a percentage of revenues decreased from 11.3% (2013) to 6% (2014). A number of factors can be noted for 2014: •Decline in overall combined oil & gas average prices; •Increased maturity of fields requiring investments meant an increase of investments from GBP 14.4 billion to GBP 14.8 billion while the actual production was down by approximatively 2%; •Operating costs increased from GBP 8.9 billion to GBP 9.6 billion; •Production mix has high gas volume of lesser value than oil; •Structural issues given a large number of marginal fields requiring various allowances and incentives such as small fields, ultra heavy brownfield, etc.

Norway: the average observable royalty and similar tax rate decreased from 22.5% (2012) to 18.8% (2014) due to lower profitability in 2014 compared to 2012 (there was no information for 2013 at issuance of our previous report) due to: decrease in average realized oil price 90.6 USD/bbl (2014) vs 104.5 USD/bbl (2012) and average realized gas price 1.57 NOK/scm vs 1.84 NOK/scm correlated with an increase in investments in 2014 and 2013 vs 2012 and 2011 leads to a higher depreciation charge and also due to increase in exploration 2014 vs 2012 (exploration is fully deductible when incurred).

Hungary: the average observable royalty and similar tax rate decreased from 25.3% (2013) to 22.9% (2014) due to decrease of oil and gas royalty rates by 6% in Q4 2014 applicable to most fields, as Brent price was below 80 USD/bbl, while in 2013 royalty rates were at highest level as Brent price was above 90 USD/bbl. This decrease of royalty rates of 6% in Q4 2014 is mentioned in article 20 (4) of Mining Law. For gas fields commissioned prior 1998 formula includes a mechanism which leads to a gradual decrease of royalty rates, due to k factor mentioned at article 20 (3) par. ba) of Mining Law.

Austria: the average observable royalty and similar tax rate increased from 17.6% (2013) to 21.2% (2014) due to the fact that during 2014 the nominal royalty rates applicable in Austria increased compared to 2013 for both oil & gas.

Germany: the average observable royalty and similar tax rate decreased from 18.6% (2013) to 17.3% (2014) due mostly to decrease of gas royalties from Lower Saxony (74.5% in total royalties in 2014 vs 76.3% in 2013), which have a higher level of taxation compared to oil from both lands and gas from Schleswig-Holstein.

France: the average observable royalty and similar tax rate increased from 3.9% (2012) to 6.6% (2014) (no information available for 2013 at the issuance of our previous report) due to lower gas production 0,07 bn cm in 2014 vs. 1,08 bn cm in 2012; gas has 0% royalties due to low production fields vs oil royalties of 0-9%.

FISCAL REGIME CHANGES IN EUROPEAN COUNTRIES 2014-2015. Many European states took into account, in their public policies and in the construction of the tax regime, the decline in the global oil market and the need to support investments in the field. We give here the examples of UK and Italy, compared to the situation in Romania.

UK: Extensive consultations with industry on measures to incentivize investments and maintain jobs in oil and gas sector of North Sea.

  • Reduction of supplementary charge (“SC”) from 32% to 20% starting 01.01.2015;
  • Reduction of petroleum revenue tax (“PRT”)2) from 50% to 35% for periods ending after 31.12.2015;
  • Introduction of a 62.5% of investment allowance for expenditure incurred after 1 April 2015;
  • Deduction additional to investment costs and may lead to an effective SC rate significantly lower than 20%;
  • Transitional provisions will be implemented for fields that benefited from other allowances;
  • Introduction of a 62.5% of investment allowance for high pressure high temperature oil & gas projects from a cluster area which encourage exploration and appraisal for surrounding area;
  • Extension to 10 years of the ring fence expenditure supplement which provides an uplift of 10% on a company’s closing loss ring fence loss pool at the end of an accounting period. Previously, only 6 claims could be made;
  • In the summer Budget statement it was confirmed that additional categories of expenditure would be added in the scope of investment allowance.

Italy: In February 2015 CIT surcharge (6.5% in 2015) applicable to several industries, including upstream oil & gas, was declared unconstitutional. The CIT surcharge will not be applicable starting the date of publication of decision of the Constitutional Court.

Romania: Elimination of the tax on special constructions. According to New Fiscal Code, construction tax will be maintained in 2016 and it is intended to be eliminated starting 2017. Elimination of tax on crude oil from domestic production (18.95 RON/ton in 2015).

SHORT CONCLUSION: the updated Deloitte study shows two important aspects. On the one hand, the average level of royalties for oil and gas in Romania is far above the European average, despite all the populist speculations appearing in various public speeches. We don’t have the most difficult tax regime in Europe, but we are far from having the most encouraging tax regime for an industry in decline, in which the state takes an important part in the “budgetary piggy bank.” On the other hand, the tendency of governments in countries that have significant oil and gas industry is to assist producers who are today under threat of a very low price of oil prices (about one third compared to the “glorious” level of the last decade). One can therefore notice a fiscal relaxation dedicated to supporting investment projects and continuing the exploitation started. In Romania there is still a significant political stuttering that throws into mockery or worse, into populism, the proper debate on the fiscal regime imposed on oil companies.

Source: Economistul, October 5th

Image courtesy of suwatpo at