Regime for Exploration in India Anupama Sen Senior Research Fellow, - PowerPoint PPT Presentation

Out of Gas: An Empirical Analysis of the Fiscal Regime for Exploration in India Anupama Sen Senior Research Fellow, Oxford Institute for Energy Studies, United Kingdom JUNE 2014 IAEE INTERNATIONAL CONFERENCE, NYC

Outline 1. Natural Gas in India 2. Conceptual Literature on Resource Taxation 3. Empirical Literature 4. Method 5. Analysis 6. Results 7. Observations & Conclusions IAEE INTERNATIONAL CONFERENCE, NYC

1. Natural Gas in India • Gas forms 11% of India’s primary energy consumption • Relatively ‘young’ but growing sector • India’s gas reserves – 0.7% of world reserves – Range of estimates – Mostly offshore • Consumption • 60 Bcma (20-30% LNG) • 70% used in power generation, fertiliser industry, household use, transportation • Policy on gas • Substitute for coal, naphtha, fuel oil • Security of supply / mitigating energy shortages • Environment IAEE INTERNATIONAL CONFERENCE, NYC

Potential for gas in electricity and transportation Per Capita Emissions by Sector, 2010 (kg of CO 2 per capita) Other Manufacturing Total CO 2 Industries Energy Emissions Electricity Transport Residential Other Industry and from Fuel Own Use Construction Combustion OECD 4,007 558 1,423 2,699 797 1,408 10,096 UK 2,873 519 822 1,919 1,325 1,643 7,776 USA 7,448 845 1,893 5,229 1,038 1,897 17,312 India 748 52 342 138 64 108 1,388 China 2,659 205 1,734 382 225 416 5,395 Brazil 230 129 585 852 87 194 1,989 Africa 414 39 138 215 56 104 910 Middle 2,715 786 1,577 1,651 623 829 7,559 East Source: IEA (2008) IAEE INTERNATIONAL CONFERENCE, NYC

Pricing • Prices for domestically produced gas are controlled • To keep prices to consuming sectors low • Prices are set according to the fiscal regime governing a producing field • The fiscal regime has evolved over time; thus multiple pricing mechanisms • India’s 1999 liberalised upstream fiscal regime • Prices based on an ‘S curve’ formula with a cap and ceiling • SP = $2.5 + (CP – 25) 0.15 + C • Five year reviews • Formula rendered redundant by high oil price – Ceiling of $60/bbl breached very early on – Review of pricing currently underway; proposals to link it to Henry Hub, NBP and Japan LNG IAEE INTERNATIONAL CONFERENCE, NYC

India Gas Price vs International Benchmarks India LNG Imports Henry Hub Source: BP Statistical Review; Govt of India IAEE INTERNATIONAL CONFERENCE, NYC

Fiscal Regime for Gas • Liberalised regime launched in 1999 • New Exploration Licensing Policy • Based on a Production Sharing Contract (PSC) • Hybrid system (royalty + taxes on ‘rent’) • Main features 1. Royalty • 10%, 5% for first 7 years 2. Cost recovery • Opex, capex & royalty up to 100% pa 3. Profit Sharing • Based on a R-factor , or the ratio of cumulative income to cumulative capital expenditure. • Two tranches, 1.5 and 3.5. Shares in-between worked out using an extrapolation formula Z = a + [(b-a)*(X-1.5)/2] 4. Corporate Income Tax • 30-40% 5. Minimum Alternate Tax • 18.5% of ‘book profits’ if IT payable is < 18.5% of ‘book profits’ IAEE INTERNATIONAL CONFERENCE, NYC

Graphical Illustration of PSC Regime Gross Production (-) Royalty (-) Cost Recovery Total Profit Oil Government Contractor Share Share Taxable Income (+) (-) (+) (+) Tax (+) Government Take Contractor Take IAEE INTERNATIONAL CONFERENCE, NYC

Performance of India’s Fiscal Regime • Production • Large initial increase (2009) followed by dramatic decline in production; currently a third of original targets • Driven by private sector • NOC production has remained stagnant • No significant new discoveries since 2004 • Investments • Down from $4.7Bn in 2007 to $1.6 Bn in 2013 • Arbitration & delays • Companies accused of gold plating in the R Factor • Alleged loss of revenues to exchequer • Proposed Policy Solution • Replace the PSC regime with a simple Revenue Sharing Contract (RSC) Regime • Eliminate royalty, cost recovery and profit sharing (R Factor) • Companies simply share a percentage of their revenues from day 1 of production • Production slabs pre-specified by the government. Percentage revenue shares biddable by companies at the time of the auction rounds IAEE INTERNATIONAL CONFERENCE, NYC

Performance …( contd) Drop in Production Increase in Consumption & Imports Source: BP Statistical Review, PPAC India (2013/14) IAEE INTERNATIONAL CONFERENCE, NYC

2. Conceptual Literature on Resource Taxation How to Tax - The Instruments What to Tax - The Base • • Net income / rent / liberal regimes Net Income /rent – Pure rent = surplus or financial return – Resource Rent Taxes (R Factor, Rate- not required to motivate economic of-Return), Progressive Profits Taxes, behaviour Corporate Income Tax, VAT – Supply price of investment = costs of capital and operation plus risk premium. • Lower supply price, higher rent. Risk Gross Income premium affected by policy – Royalties, Bonuses, Fixed Fees, – Zero marginal fiscal take Minimum Work Programs – Requires information on production volumes, costs, prices, investments • • Gross income / proprietorial Other regimes – Government equal partner – Positive marginal rent, reservation Government/NOC equity ground rent, and excess profits participation, Brown Tax ( – Information on prices and volumes only – Most systems use a ‘hybrid’ or • Mommer (1999), Baunsgaard combinations of both elements (2001), Hotelling (1931)

Equivalencies in Fiscal System Design Royalties Corporate Resource Rent Brown Tax Income Tax Tax Production Royalty rate = Tax rate = Sharing cost oil cap government profit share Paid Equity Tax rate = equity share Carried Interest Tax rate = equity share Target real rate of return = interest rate Concessional Tax rate = share Tax rate = Equity of initial equity share concessional Target rate of investment return = interest rate Source: Baunsgaard (2001) IAEE INTERNATIONAL CONFERENCE, NYC

Desirable Features & Tradeoffs • Desirable features of a fiscal system (Nakhle, 2008) – Efficiency – Neutrality – Equity – Sharing of fiscal risk – Simplicity – Stability of fiscal terms and of revenues • Trade-offs between features – Neutrality trades off with efficiency and with revenue generation – Neutrality trades off with simplicity – Equity trades off with simplicity and efficiency – Stability trades off with fiscal risk sharing • Selection of instruments is contingent upon the government’s objectives in fiscal system design IAEE INTERNATIONAL CONFERENCE, NYC

Analogies with Price Cap versus RoR Regulation • PSC regime analogous to rate-of-return system; RSC regime to price cap system – PSC (RoR) necessitates information on volumes, costs, prices and investment – RSC (Price Cap) necessitates information only on volumes and prices • Under a price cap type system, the government will most likely need to accept a lower overall expected level of taxation and lower take but stable (yet lower) revenues – Conversely, investors face greater risks in sinking investments into difficult (offshore) areas • In utilities and resource taxation price cap systems almost always revert towards rate-of-return (Tapia, 2012; Helm, 2010; Liston, 1993) – The setting of appropriate caps ultimately necessitates information on cost functions – Governments may therefore be compelled to intervene ex post – There is a case for incorporating RoR elements into fiscal design ex ante IAEE INTERNATIONAL CONFERENCE, NYC

3. Empirical Literature Static Models: Key Studies: System Measures: Discounted cash flow models using • Goldworthy and Zakharova (2010) • AETR, IRR, sensitivity analysis data on production, costs & prices • Johnston (2003) • AGR/ERR, savings index, take stat under a high, medium and low case • Dongkun and Yan (2010) • Government take, front loading scenario. Fiscal terms used to • Daniel and McPherson (2010) compute economic measures. One or index • Nakhle (2008) • METR, AETR, NPV more of these are held constant to • Tordo (2007) • NPV, IRR, take observe the effect of changes in the • Al-Attair and Alomair (2005) • NPV, IRR, take others. Results anchored to initial • Dharmadji and Parlindungan • E&P costs conditions employed. Restrictions on • Contractor take, IRR, NPV graphical representation of (2002) • Iledare (2001) • Prices, production, NPV, take multidimensional data. Meta Models: • Kemp and Stephen (2011) • Prod, costs, invest., tax revenues A cash flow model of the system • Hong and Kaiser(2010) • NPV, IRR, GT, CT constructed and parameters of the • Adenikinju and Oderinde (2009) • NPC, IRR GT CT system are defined and bound • Iledare and Kaiser (2006) • NPV, IRR, GT CT through design intervals based on • Kaiser and Pulsipher (2004) • NPV, IRR, GT, CT historical data or reasonable assumptions combined with the given parameters in the fiscal system. Parameters of the system sampled from the design space and evaluated in the cash flow model. The results of the model and system parameters are then analysed and a linear model is constructed from the generated data. IAEE INTERNATIONAL CONFERENCE, NYC

4. Method Static Analysis • IAEE INTERNATIONAL CONFERENCE, NYC