By Kiana Wilburg
Production Sharing Agreements (PSAs) normally include an accounting annex, which details the rules for cost recovery. The annex specifies, which costs are allowed to be recovered by an operator for an oil and gas project.
It also outlines the treatment of certain expenses such as services provided by affiliated parties and financing costs.
But after a review of Guyana’s accounting annex in its PSA with ExxonMobil, the International Monetary Fund (IMF) believes that there can be opportunities for abuse and profit shifting activities.
The IMF notes that in Guyana’s PSAs, exploration and even development costs can be fully expensed for cost recovery purposes. Moreover, the IMF noted with concern, that in any given period, unrecovered costs by ExxonMobil can be carried forward to subsequent periods without any limitation.
Taking this into consideration, the IMF said that the government needs to close fiscal loopholes in existing PSAs. Significantly, the IMF called for the government to undertake a policy review of fiscal terms contained in existing PSAs to ensure that these are implemented appropriately, and assess areas of improvement for future investment.
COST RECOVERY AND TYPES
Cost recovery is a fundamental part of any basic Production Sharing Agreement (PSA).
It is a method, which allows an oil company to recover costs from the petroleum produced. The various costs are subtracted from gross production. Only after costs have been recovered is the remaining “profit gas” divided between the company and the government.
Exploration costs are expenses incurred in the search for petroleum within the contract area. The period of exploration begins with the signing of the contract and includes the discovery of petroleum and its subsequent appraisal, up until the government approves the first Development Plan. Costs related to exploration can be recovered in the year when Commercial Production begins.
Examples of explorations costs, as set out in Annex C of most contracts, include: seismic surveys and studies; core hole drilling; labor, materials and services used in drilling wells; and facilities used solely in support of these purposes including access roads.
Often called capital costs, development costs are the money spent to build infrastructure to extract petroleum and send it to market. Putting in place the capital infrastructure represents the overwhelming majority of the costs of an oil and gas project.
Examples of such costs, as set out in Annex C of most contracts include drilling and completing wells; the costs of field facilities such as production and treatment units, drilling platforms; petroleum storage facilities, export terminals and piers, harbors and related facilities, access roads for production activities.
Operating Costs start from the beginning of commercial production. Operating costs attributable to petroleum operations can be recovered in the full amount in the year in which they were incurred.
These costs include all expenditures incurred in the petroleum operations including: operating and maintaining field facilities completed during the Development and Production Operations; and producing petroleum and gathering, storing and transporting the petroleum from the reservoir to the delivery point.
SERVICE AND ADMINISTRATIVE COSTS
Service costs are direct and indirect expenditures in support of the Petroleum Operations including warehouses, offices, vehicles, water and sewage plants, power plants, housing, community and recreational facilities and furniture, tools and equipment used in these activities. General and administrative costs are all main office, field office and general administrative costs.
The higher the cost recovery claims by the company, the smaller the pie to be divided between the company and host country.
The American state of Alaska provides a compelling example of the technical challenges of securing the full proportion of revenues owed to the Government. According to an analysis undertaken in 2003, over the 25-year lifespan of the petroleum sector, “one dollar out of every six that Alaska received from its oil development was obtained through legal challenges to the industries original payment.”
The majority (90%) of the petroleum production in Alaska since first exports in 1977 has been controlled by three companies now know by the names British Petroleum, ExxonMobil and ConocoPhillips.
Over the first 25 years of production, Alaska received approximately $70 billion in petroleum revenue from royalty payments of 12.5% of the value of the oil, and three principal taxes: corporate income tax, a petroleum production tax, and property tax.
Based on independent analyses and audits, Alaskan officials overseeing the petroleum sector claim that, “industry chronically reduced the bases for calculating royalty, severance, and income tax payments by underestimating the market value of a barrel of oil at the point of sale. Overstated pipeline shipping charges (tariffs) had the same result.”
In order to secure what Government officials believed to be a fair share of revenues from this petroleum development, they were forced to take prolonged and intensive legal action against the companies. Between 1977 and 1994, the Alaskan Department of Law reported that it had paid contract lawyers and accounting specialists from 30 different companies a total of more than $217 million to follow-up these legal claims. The money was well spent. Litigation resulted in additional company payments to government of $2.7 billon.
The issues in dispute were highly technical and in some cases based on a legitimate difference of opinion in the interpretation of complex contractual language and taxation law. However, in many cases, the differences were based on outright deceit and fraud.
By tracking the export and value of each barrel of oil being exported, Alaskan authorities demonstrated that overall revenues were deliberately minimized by misrepresenting the actual sale value of oil and by inflating the costs associated with transporting oil by pipeline and tankers.
By 2000, litigation had produced an additional $10.6 billion in revenue including $6.8 billion in direct payments for taxes and royalties, and an additional $3.8 billion in increased taxes and royalties related to reassessing pipeline transportation costs.
This pattern has continued with an additional $1.7 billion in oil and gas settlements over the past decade. The figures listed above substantially underestimate the scale of abuse. Many other claims were launched against companies by the Government but were settled out-of-court and are therefore not public.
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