Impacts of Fiscal Systems on Oil Projects Valuation

Abstract

Despite increasing demand for cleaner energy around the world, oil is still the main global energy source and this scenario will not change in the short term. Together with natural gas, they supply 57% of world primary energy demand (BP, 2018). Therefore, if a country wants to benefit from having its hydrocarbon reserves developed to generate wealth, it is crucial to enable economic conditions for such. This study aims to show the impact that distinct fiscal systems adopted by each country can have on the valuation of an oil field and its commercial feasibility, from an international oil company perspective. Fiscal terms define, among other things, how revenue from oil production is shared between operators and the host country. To investigate such topic, a deepwater offshore oil development project was valuated using discounted cash flow method. Sixteen scenarios were created, considering a combination of four distinct field sizes under four fiscal systems, selected from some of the world's top oil producing countries. For each scenario, internal rate of return (IRR), which indicates the project's economic return for the operator, and government take (GT), which indicates how much of the oil revenue is directed for the host country, were calculated. Findings show very distinct results in each scenario, with IRR for operators ranging between 8 and 21% and government take between 57% and 84%. Considering that project returns should always be higher than a company's capital cost, in some scenarios the discovery would not be declared commercial. Results also show that, in general, large oil development projects in countries with tax/royalty system present a higher return for the operators, while production-sharing contracts tend to generate a higher government take. This shows that the same oil field, under same geological conditions, can offer very different economic returns to the operators and host governments, depending on the fiscal system in place. In some cases, the fiscal system has such an impact on the economic feasibility of the project, that it may even prevent the discovery to be declared as commercial and, therefore, not be developed and booked as proven reserves. The main takeaway of this study is that understanding fiscal systems is an essential tool for operators to properly evaluate its projects and one of the most important features governments can adjust to attract private investment to their oil industries.