The Importance of the Lebanese Petroleum Fiscal Regime and Why the Urgency to Approve the Tax Law for Petroleum Activities.

The Lebanese Government and the oil companies bidding on the Lebanese First Licensing round share one common objective as partners: the desire for their exploration and production project to generate high levels of return. However, their other goals are not entirely aligned. Lebanon aims to maximize its income over time, while achieving other developments and socioeconomic objectives. The oil companies’ aim is to ensure that the return on investment is consistent with the risk associated with the project, and with their corporations strategic objectives. To reconcile these objectives, more and more countries rely on transparent institutional arrangements and flexible, neutral fiscal regimes. The key elements of the legal and fiscal frameworks utilized in the petroleum sector aims to outline desirable features that should be considered in the design of fiscal policy with the objective of optimizing the host government’s benefits, taking into account the effect that this would have on the investment climate in the country.

Governments compete for capital and technology to develop their hydrocarbon sector. In order to apply the appropriate policies, strategies and tactics, each must assess its position in the global market and in the case of Lebanon, its regional marketplace and to evaluate its particular situation, boundary conditions, objectives as well as the geopolitical risk. Companies look for investment opportunities that suit their risk-reward profiles. The initial decision to invest and the resulting allocation of revenue and benefits are greatly influenced by the content of existing legal arrangements and fiscal policies. The fiscal regime can be used to convert a government’s policy into economic signals to the market, and influence investment decisions, provided that the framework is clear, stable, not to be changed retroactively, and does not discriminate among the actors. Several countries have used favorable taxation of oil and gas to support the development of the industry in addition to relevant sector reforms. The challenge of an efficient fiscal system is to induce maximum effort from the oil companies while ensuring that the host government is adequately compensated.

In designing a fiscal and legal system, a government has to answer the following questions:

·      What is the effect of the fiscal regime on oil/gas output?

·      Does it influence the pace of development?

·      Does it encourage the development of marginal fields?

·      Does it favor or discourage early abandonment?

·      Is it sensitive to oil/gas price and cost variation?

In other words, how flexible, neutral and stable is the fiscal regime?

Many fiscal systems around the world make use of sliding scales for the determination of at least one of the following parameters: royalty, bonuses, profit oil/gas split, cost recovery and taxes. Sliding scales introduce flexibility into the system by allowing it to respond to changes in project variables.

High risks and long project cycles are key elements of the oil and gas industry. As risks can differ substantially by project and over time, an efficient fiscal system needs to be flexible enough to allocate risks equitably, thus minimizing the need for negotiations or renegotiations.

In today’s competitive market, many diverging interests must be recognized and accommodated to establish an effective and attractive legal and fiscal framework for hydrocarbon exploration and production. No ideal regime is available for policy makers to adopt. Each country will have its own specific framework which may not necessarily suit everyone else.

The Lebanese fiscal regime and the proposed Lebanese Tax Law for Petroleum Activities which is to be approved by the Lebanese Parliament in the coming weeks answers all these questions and fits well into the economic, social and financial situation of Lebanon.

All the important points which protect and enhance the rights of Lebanon are present in the Decree 43/2017 and set a production sharing regime instead of a royalty regime or other.

As it is not possible to elaborate and explain all these points in this article, we can only list briefly the most important ones as follows:

1.    Corporate income tax: The tax rate to be paid by the oil companies will be higher than the standard rate applied in Lebanon. It will be set at 20% instead of the present 15% or 17% applicable on the Lebanese companies.

2.    Cost Recovery Limit: The Lebanese production sharing contract provides for limits on the percentage of production that can be used for cost recovery in every quarter. It is set at a maximum of 65%. A percentage of the revenues is used to recover costs. If costs exceed the cost recovery limit, the difference is carried forward for recovery in subsequent periods.  The cost recovery limit ensures that the Government will start having income –cost petroleum- as soon as the sale of the hydrocarbons starts. It does not have to wait till the companies recover their whole costs to start paying the Government’s share.

3.    Profit Oil Split: In production sharing contracts profit oil (or profit gas) is the revenue that remains after deduction of the cost recovery. The profit oil is split according to a sliding scale defined on the basis of the R-Factor, a common industry practice applicable in over 25 countries in the world. The R-Factor allows flexibility in the fiscal package and encourages the development of marginal fields.

The profit oil split between the host government and the oil companies is set in the bidding. However, it is not allowed to be less than 30%.

4.    Royalties: Although the Lebanese system is based on production sharing, the companies still have to pay royalties. The advantages of the royalties for the host country are that they ensure an upfront revenue stream as soon as production starts. As they are attached to production, they can be estimated with a reasonable degree of predictability and they are comparatively easy to calculate, collect, and monitor. The royalties’ rates are set between 5% and 12% for oil, depending on the produced quantity, and 4% for gas. They are not considered costs for the companies, hence cannot be deducted from their revenues.

5.    Ring Fencing: Ring-fencing is an industry-specific feature. This refers to the delineation of taxable entities. In the petroleum sector the taxable entity is often the contract area or the individual project which is the offshore block. When ring fencing applies to a contract area, income derived from one area cannot be offset against losses from another area. Thus, when one consortium of companies is working in two blocks, all costs associated with a given block will be recovered solely from revenues generated within that same block.

As the Lebanese Licensing round is approaching its deadline on September 15th, it is vital that the Lebanese parliament approves the Tax Law for Petroleum Activities as soon as possible in order to enable the oil companies to price their bids appropriately, thus avoiding later major complications if the bids were to be submitted on the basis of the present Lebanese Tax Law and not on a sector specific Law.

 

Abboud Zahr, Oil & Gas Specialist