Earlier this year as people around the world responded to the coronavirus pandemic, their demand for oil tumbled. At the same time, OPEC and Russia initially failed to agree to coordinate supply cuts. Consequently, the price of a barrel of Brent crude oil fell from $60 in December 2019 to $20 in April 2020. As of this publication, the price is $43.
If the price stays low, and if oil executives expect the price to remain low, companies may lobby governments to reduce taxes and other costly regulations. Payments to governments are often larger than costs for a company, so there is pressure on governments to reduce taxes to keep projects viable.
What is the impact on currently operating projects, undeveloped projects, and those that are yet to be discovered?
How should governments respond in changing oil and gas taxes?
Will governments try to “race to the bottom,” but then lose a race back to the top?
There’s no certainty over future prices. Some rise is likely in the next few years, even if an energy transition results in a structural decline in the oil price in the longer-term. Governments must consider this uncertainty and probable rise when taxing oil and gas.
Tax breaks on most currently operating projects are likely a waste of public money.
Some governments may be pressured into reducing tax on projects awaiting development. But they must identify which projects would become viable with lower taxes, and which do not need a tax break.
If in doubt, governments should consider whether a project that needs a tax incentive really will provide value for the country. For most countries, relative to total oil and gas produced, the production from projects that could be delayed or cancelled is small. But not so for the “new producer” countries like Senegal and Guyana.
Changing taxes to make a country more attractive has the most impact before companies have invested – e.g., in attracting investment in licensing rounds.
But setting low taxes now could force a government to raise taxes later if prices rise again.
If a tax break is unavoidable, governments could use a “sunset clause” to limit the duration of the tax break.
Ideally, governments should set progressive tax regimes that respond to changes in profit.
But as many taxing authorities struggle to measure profit, governments could set simpler tax regimes based on sales revenue or prices – but must prepare to change tax rates in the future, and be prepared for the repercussion for a government’s credibility with investors.
Governments should disclose contract terms detailing tax changes, tax exemptions, incentives and estimated break-even prices of projects to help government auditors, local think tanks, and the public check and support tax policy decisions.