Petroleum Bill: IMF warns of revenue shortfalls

Contrary to the general belief that the Federal Government’s new fiscal regime for oil and gas operations as proposed in the Petroleum Industry Bill (PIB) will significantly increase government’s revenue, International Monetary Fund (IMF), warns that it could actually lead to a reduction.

The Fund noted that the fall in revenues will occur because of government’s preference for the easy way out in dealing with oil and gas tax and revenues as opposed to dealing with the inherent structural issues.

In a confidential report titled, Fiscal, Financial and Governance Assessment of the Petroleum Industry Bill, the monetary fund agreed that in the near term, government’s revenues would increase however, “Near term investment could be expected to fall off sharply resulting in reduced medium to long term government revenues.”

Structural issues

The report, which was compiled in October 2009 at the request of the Ministry of Finance and exclusively obtained by NEXT, identified some structural issues contained in the new fiscal regime, which the Monetary Fund noted relies more on revenue-based as opposed to profit-based taxes.

Specifically, the Fund noted, “... the noticeable shift towards reliance on revenue based taxes, which while arguably simpler to implement than profit-based taxes, could negatively impact production and investment decisions given their regressive character.” Besides, it added, the fiscal regime being proposed appear tailored to expected project outcomes, which, “if different from expectations, could result in inappropriate levels of government take, either too high, or too low.” The report also contains comments and recommendations to key issues such as the fiscal provisions for oil and gas, controversies over costs, drawbacks to the fiscal administrations, and the commercialisation of the Nigerian National Petroleum Corporation (NNPC) and a host of others.

The Fund’s observations tally with some of the initial oppositions to the petroleum bill, particularly by the international oil companies, which criticised the fiscal regime and called for renegotiation of terms.

In making its recommendations, the report reiterated that, “The issues involved are complex, and their resolution can be expected to have significant implications for investment flows, industry activity and government revenues.”

Fiscal regimes

According to the report, the fiscal regimes under the Production Sharing Contracts (PSCs) for oil as proposed by the new legislation will be worse.

“The after-tax economics of operations under the production and sharing contracts (PSCs) would be significantly worse under the new regime than under current terms...as a consequence, near term government revenue would increase, but at the same time near time investment could be expected to fall off sharply resulting in reduced medium to long term government revenues.”

This position was stressed by Graham Kellas, VP Energy Consulting of Wood Mackenzie, at the last Lagos Business School roundtable series in September last year. “No field under the Production and Sharing Contracts is economic based on Petroleum Industry Bill terms,” he said.

To support this assertion, Mr Kellas said based on comparison of the bill’s terms with global fiscal terms for the sharing contracts using price margins of $45/bbl, $60/bbl, and $90/bbl, the fields are uneconomic.

Recommendations

Putting all the issues in context, the monetary fund recommends the enhancement of the terms applicable to deep water Product Sharing Contract (PSC) operations, particularly through royalty rate reductions towards the end of a field life.

The Fund noted that its comments and observations are based on the proposals contained in the Inter Agency Memorandum on the Petroleum Bill prepared by the Inter Agency Committee in July 2009 formed by the federal government to review the bill.

Furthermore, in dealing with some of the structural issues, the fund recommends “the introduction of a flexible National Hydrocarbon Tax rate responsive to actually achieved profitability measured by the investor’s rate of return.” For natural gas, it said that large non associated gas field economics “are jeopardised by the new terms.” The report recommended additional scrutiny of the existing and potential gas projects to “stress test” the proposed regime “against the wide range potential circumstances in which it is likely to be applied. It added called for “a review and possible revision of proposed regime parameters to make it less likely that large condensate/gas fields with positive pre tax returns are made non-viable.”

Contentious costs

Project costs in Nigeria up until 2006, followed the global trend where unit cost increased rapidly due to militant activity; large production volumes were lost and absolute cost are still rising, causing a steep rise in unit cost.

Project costs have always been a major talking point between National Petroleum Investment Management Services, which represents government, and the oil companies.

Costs have often generated arguments because of a lack of trust and mutual suspicion; hence as a safeguard, the bill proposes that all costs should be Bench-marked, Verified, and Approved with verification by the Federal Inland Revenue Services (FIRS) through audit processes.

Government argues that benchmarking will take into account the peculiarities of other industry specific issues like location of operation, size, and technology.

Industry operators, however list lack of reliable infrastructure, local content development, and funds as some of the key local cost drivers. Although a key goal of government, the local content development will be expensive during the capacity building phase and this will be stifled by poor infrastructure.

The report also warns that government’s strategy of waiting until costs fall substantially to a level where projects would be viable under the Inter Agency Memorandum is risky: “If costs don’t fall, capital expenditure, oil production, and ultimately revenue from Product Sharing Contracts will be at risk.

Given the importance of clarity on costs to the fiscal debate, the mission suggests convening a forum to flesh out these issues and that consideration be given to engaging an objective third party to undertake an independent assessment of cost.” Complex fiscal management The implication of these new regimes is that the fiscal administration aspect of the proposed inter-agency provisions becomes more complex as the Company Income Tax (CIT) will be applied to the oil industry for the first time.

There will be multiple collectors of revenue from the oil companies. (Signature bonus, rents and royalty will go to the Inspectorate; income tax, and other indirect taxes will go to the Federal Inland Revenue Service, production bonuses and PSC profit share to NNPC).

Given this will take time, “we suggest supplementing ongoing internal initiatives with professional external support on cost and tax audits.” The report suggested a model currently in use by Angola’s ministry of finance.

Petroleum Industry Bill

Taking cognisance of the significance of Nigeria’s petroleum wealth, the federal government launched a broad sector based reform culminating in the Petroleum Industry Bill, an omnibus legislation that will override the plethora of oil and gas laws in the country.

The Bill seeks to reshape Africa’s largest oil and gas industry by incorporating the existing joint ventures to address perennial cash call issues, set it on course to becoming a profit-driven and internationally competitive National Oil Company, streamline the regulatory processes in the industry, and ensure transparency of government’s revenues from the industry.

The bill also seeks to aggregate the impact of increased taxation and royalty, enforce a strict cost deduction regime, provide stringent license relinquishment, discretionary license renewal, and revocations, and proffer independent resolution system.