Petroleum laws, otherwise known as “upstream fiscal systems” in the industry, are known to \frequently cause conflicts of interest between the host government and the contracting oil company. These conflicts arise after major changes in oil price, fiscal regime, or production rate. As a result, host governments frequently resort to revision of the fiscal system (in the “middle of the game”) to the displeasure of the contracting company; or the contracting company pleads for changes in the terms to accommodate “changing circumstances.” The petroleum law suffers instability, and neither the interests of the host government nor those of the contracting company are served. Such situations arise either from poor understanding of the objectives of a petroleum law or, more frequently, form insufficient flexibility of the petroleum law. Apart from generalities such as “meeting national interests,” an ideal petroleum law is one that: (1) encourages exploration, (2) promotes development of small as well as large petroleum reserves, (3) allows special incentives for difficult-to-explore or difficult-to-develop situations, and (4) enables equitable sharing of economic benefits between the host government and the contractor under different circumstances including oil-price and field or production outcomes. Equitable sharing of economic benefits is the most contentious issue. It is best judged from the relationship between the Government Take and the investor’s Internal Rate of Return (IRR). Equitable sharing will materialize if the Government Take and the contractor IRR show positive correlation under different scenarios of profitability. The best way to achieve an ideal petroleum law is through economic modeling. Economic models constructed to represent various scenarios, e.g., reserves, capex, oil price, can be evaluated under the proposed contractual terms. The inefficiencies can then be removed by adjusting the fiscal terms, e.g., income tax rate. The approach can be viewed as a form of fiscal simulation. The models should depict host-country situations (mainly “geology” and cost structure) as realistically as possible. The Production Sharing System, but not Royalty/Tax or Service System, is best suited for economic modeling to achieve flexibility. As an example, it will be shown that Turkey’s Draft Petroleum Law No. 5574 is economically inefficient, hence far from ideal.


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