Oil industry legal and Tax systems overview
Based on our current geological knowledge , the petroleum comes from organic substances decomposition accumulated in oceans during Silurian ( 450 years ago during the so-called geochronogical primary era, Jurassic and Cretaceous (respectively, 150 millions years and 100 millions ago during the secondary era). I will not go to details related to oil origins here, for more information, please refer to www.wikipedia.org
So, the petroleum and it`s derivate NGL (natural gasoline) is not a human product, but, something we look for in the Earth`s deepness's.
Since the Colonel Edwin Drake discovery in 1859, personal businesses and big enterprises like John Rockefeller holding (the so-called California Standard National Oil which became Chevron in 1984) developed high level and complex technologies to always be able to seek oil so far in seas...
Today, we have at least 6 big private companies generally called majors which are fully involved in the worldwide oil/gas exploration, development, production and abandonment (or decommissioning), trading, mid stream and downstream activities (Exxon Mobil, Royal Dutch Shell, British Petroleum or BP, Chevron, Total and ENI). You have also a couple of national oil companies which succeed their nationalization processes such as Aramco (Saudi Arabia), China National Petroleum Corporation (with more than 1 million employees), PETRONAS (Malaysia), Petrobras (Brazil), Sonatrac (Algeria), ... (that success is always relative because it depends on the corruption factor inside the country and oil/gas prices volatility)...
However, how many different legal and tax implications do we have around the world for that major or other private businesses? I mean, which kind of agreements are often signed off between different private operators and host governments to be authorized to operate in that different countries?
I believe, the best background about this question could be found in Daniel Johnston literature (available online). We`ll only focuse on Upstream here. To summarize, we have three different legal agreement in Upstream around the world; here are their implication in terms of taxes:
a) Concession: in a concession, the operator and it`s partners are the owners of the mineral working interest. They have just to pay the different taxes and specifically the Income Tax to the host authorities. We have this kind of Upstream agreements mainly in USA, Canada (such as Macondo or MC252, Eugene Island bloc 330, Tiber in Gulf of Mexico). We have also some concessions in Africa (Block 0 in Angola, Emeraude in Republic of Congo, etc.). So, the concessioner assumes all risks in this kind of agreement.
b) Production Sharing Agreement or PSA: in a Production Sharing Agreement (or Production Sharing Contract), the operator and it`s partners finance all costs related to exploration, development, Production and abandonment and they have to recover in kind those costs (the cost oil). Then, In practice, a certain quantity limited by a cost stop is recovered and indexed to a macroeconomic data. The difference between the net production (and the royalties which apply in a couple of countries) is the profit oil and is shared between the host government and the partners pool. Petroleum Income Tax or PIT rate as defined in each agreement is applied on the partners pool profit oil and paid in cash or in kind to the host taxes authorities (in some PSAs, that PIT (with royalties and other related taxes if apply) is automatically taken in kind to what we technically call the tax point (that is the case for the most of PSA`s in Republic of Congo except the Lianzi agreement for which PIT is paid in cash).
In the reality, there are many issues with PSA`s since the cost recovery is often linked to a couple of oversees macroeconomic indexes which are totally disconnected to the economy of Host countries. For example, some costs will not be certainly recovered in a couple of oilfields because they are indexed to the quarterly US GDP inflation rate, a low value compared to real costs involved in that sophisticated industry.
In a PSA, all risks are shared between host governments and contractors 'pools.
We have also some societal terms in a couple of PSA`s which are expressly included to support local SME`s (we can quote for example the PID or Diversified Investment Provision in Republic of Congo, you can find the related documentation online).
Let`s finish this paragraph with the ARO concept (Asset Retirement Obligation). Expenses related to ARO comply with FAS143 (this reference applies for the operators which use US GAAP for Reporting purposes around the world). In fact, any Rig operation violates the environment since, our nature was not created with oil/gas industry assets. So, each operator has to recognize a provision for future abandonment by creating a specific asset called ARO asset (that asset is created in accounting by debiting an asset account against an ARO liability account). Each year and till the end of life of the exploitation, an accretion (which doesn`t generate any cash flow) is recognized as an expense against the ARO liability. (In the reality, some partner`s transform that provision to a financial option and invest it on financial markets with high volatility risk. For example, it`s specified in the article 4.9 of Haute-Mer C PSA (available online) that the calculations related the financial products generated by the abandonment provision are indexed to the LIBOR rate published in the so-called TELERATE. You can by yourself imagine the financial disaster which could occur in the case of a Crash in this important segment of oil and gas industry).
c) Oil service contract: in this contract, all related costs are supported by host governments and the commitment of the contractor pool is only to execute the project. their remuneration is fixed in the contract and doesn`t depends on oil market prices volatility. Obviously, all risks in this kind of contract are fully assumed by host governments. All contactors pay the related Income tax as any company in compliance with the normal accounting systems (there are some variances in the different relating countries). For example, they pay only withholding taxes and a couple of other taxes in Kuwait except VAT because there is no VAT in that country. These contracts are common to Persian Gulf nations which already accumulated a huge amount of liquidities reserves to absorb the shock related to low oil market prices by diversifying their economy. (refer to the following publications for more details: African business Review, April-May edition, pp.88-90; Le Monde, Le Bilan du Monde, 2015 edition).
Finally, now you know the legal and taxes constraints behind the worldwide oil and gas market for private operators. Really, oil/gas market is very atypical since it underwent the effects of any environmental or geopolitical event. In August 2014 for instance, oil market prices start their decrease on US and European markets (respectively the so-called WTI and Brent) due to the abundant production of non-conventional oil/gas mainly from USA and Canada (with oil/gas sands and shale gas industry). Now, a lot of operators involved in that industry in Alberta around Mc Fort-Murray stopped production since a couple of days due to forest fires .... And, quasi automatically, oil market which were sensibly increasing that last days decreased..... In that confusion, it`s certainly interesting to ask yourself why that fires and other pipelines fires are common to certain regions around the world but are rare in others (the Persian gulf for example)....Is that climate change negative effects? Let`s analyse deeply this issue later.