For starters, the Petroleum Industry Bill is anchored on five major goals which include the creation of new regulatory institutions, transformation of contractual agreements, introducing new Fiscal Regime, Deregulation of the Downstream Sector, government participation in the Industry and finally, introducing transparency in contractual agreements.
The Bill’s greatest critic has come from the upstream operators which has criticised two major aspect of the Bill – transformation of contractual agreement and the introduction of new fiscal regime. The critic of the bill by the operator is the insinuation that the bill will affect project economics in the industry and ultimately affect its investment prospect, hence, hindering the growth of gas investment in the country.
Today I write not as critic of the Bill or a proponent of the operators view, but would like to see this issue in light of the global trend in the oil and Gas industry. A basic question one would ask is what makes up the ingredients for increasing investment prospectivity for petroleum industry in any country? Two ingredients are key, first is the investment friendliness of the host country which also include the security of investment and the Fiscal regime used in the industry.
Nigeria has proven to be among investment friendly nations for Oil Multinationals, not only for her Geology but for security of investment until recent times. The fiscal regime has been near stable while the industry has experienced growth in real terms over time.
For Investors, the fiscal regime is a key factor in investment decision making. The Investors wants to have a rate of return commensurate to the risks. This encompasses the bookable reserve, cost recovery and the price of Oil in-situ. The bookable reserve is the amount of Oil in barrels that a company is expected to take in form of profits after production.
In a typical regime, the host government is expected to take a share of rent which is described as royalty. However, as a result of investment attraction some host government take little or no rent for exploration and exploitation activities. Dependent on the nature of agreements, royalties, form a major crux for fiscal regime especially for host government seeking early revenue for her economy. This translates that they are front loaded.
Royalty can either be advalorem meaning based on Volume of production or on a sliding scale rate. Average global oil royalty rates for oil are generally set in a range from 5 percent to 25 percent but most are nearer 10 percent to 15 percent of production however natural gas is often assigned a lower rate than oil. Most governments seek to use royalty for their regime because it is simple to administer, predictable and provides an early revenue stream as soon as production starts.
The optics of early revenues for the government minimises the political risk of further intervention. However administering royalty may daunt projects that are profitable on a pre-tax basis. Most analyst see royalty as being regressive since they are not profit related , hence higher royalty regimes can cause profit to become negative even when the pre tax revenues exceed extraction cost.
They also affect the bookable reserve which multinationals love due to its effect on global reserve accounting. Royalty especially higher ones tend to make investors quickly abandon ongoing projects due to foreseen negativity in project profitability. However, the prevailing royalty rate for onshore prospects in Nigeria is 20 percent and 18.5 percent for prospects in the swamp/shallow waters (1-100m).
The rate for Shallow offshore (100-200m) projects is 16.67 percent and the deep offshore rate is tied to water depth (200-500:12%; 500-800:8 %;> 800-1000: 4%; >1000:0%). The PIB in its fiscal change review stipulates that royalty would be based on a sliding scale rate especially to adjust for increase in Oil price.
The review stipulates a royalty rate that could be as high as 25% or even more depending on the price of oil. From the above premise, it’s imperative to state that the government view is to generate early revenue in any petroleum project phase. Another concept that comes to mind is the Effective Royalty Rate (ERR) generally being used by the Johnston’s, World bank and other fiscal regime analyst.
The ERR is the minimum rate a government is like to take during the early part of the project lifecycle, it is composed of the royalty, and other cost recovery mechanism. It is unlikely that any government would want to seek a zero percent ERR , However it is expected that government in its fiscal regime design should be careful in designing fiscal terms that very much front loaded cause of its effect on project economics .
Although most analyst view the proposed regime as being fiscally grieving, it is also important to state that Nigeria’s changing approach to royalty administration is not new in the global oil industry as we have seen such changes in other parts of the world. It is important to make readers no that global average royalty lies between 8-10%, while the ERR could be as high as 30%. However to be objective there is a need to change the offshore fiscal regime as its one of the most friendly deep offshore regime globally- an idea most analyst.
Does the proposed regime adequately meet international trend, the answer is subjective. For governments it is generating early and more revenues, for operators it is staying afloat on their rate of return (ROR). Balancing these intentions requires that governments take into consideration investor’s perspective in fiscal regime design.
By Segun Owen