Feature Articles

LNG Industry Feature–LNG Boom

After US$194 billion investment in the Australian LNG industry, the country is set to out-produce Qatar by 2021. Contrasting fiscal regimes means the projected government take will be 33 times greater for Qatar, Australia’s is forecast to receive only US$800m. This reflects the high capital costs of Australian projects and generous tax treatment of upstream producer profits, but the disparity masks benefits for the Australian labour market and infrastructure sector. Australia’s lower level of dependence on hydrocarbon sector revenues, contrasts with Qatar whose economy is underpinned by production from its single giant gas field.

LNG Production:

Australia will produce more LNG than Qatar from 2019 onwards, combined production from two countries will be more than 160Mtpa which will be about 50% of global LNG production.

LNG Production

Source: AME

Tax Regime for Oil & Gas sector in Australia and Qatar:

Profit based Resources Rent Tax (PRRT) for Oil and Gas was originally introduced in Australia in 1987 by replacing Commonwealth royalties in Commonwealth waters, except for the Northwest Shelf project. From 2012 it was extended to include all oil and gas projects, including Northwest Shelf and Coal Seam Gas (CSG). However, the offshore projects in the west and some in the north of Australia are subject only to PRRT and not to the royalties. While, CSG projects in the east are subject to both royalties and the PRRT. Companies operating the massive WA offshore LNG projects, don’t pay for petroleum resources via a royalty (except North West Shelf), and it seems unlikely that a PRRT will be paid soon.

In Qatar, exploration, production and development permits are granted in the form of Production Sharing Agreements (PSA’s) or Development Fiscal Agreements (DFA’s). The DFA’s pays royalty on the total sales however there is no royalty payable under PSA’s. Apart from royalties, corporate income tax in the range 35% to 55% applies to all oil and gas operations as per agreed terms with state represented of Qatar Petroleum. It also receives signature bonuses and production bonuses.

How PRRT and PSA’s affect Government Revenue:

PRRT applies only if the accumulated cash flow from the project is positive. The net negative cash flow (in the early years of a project) is accumulated at an interest rate that, in theory, is equal to the company’s opportunity cost of capital. Therefore, if the only tax imposed is the PRRT, the government’s revenue stream becomes back-loaded, and for less profitable projects, the government may not receive any revenue at all. However, for profitable project it automatically increases the government share.

Under the PSA’s, the ownership of the resource remains with the state, and the companies are contracted to extract and develop the resource in return for a share of the production. Here, the government is appointing the companies (contractors) to assist in development of the resources. Instead of paying the contractor a fee for this service, while the government bears the risk, cost and expense, the parties agree that the contractor will meet the share of exploration and development costs in return for a share of any production that may result. The contractor will have no right to be paid if discovery and development does not occur. In principle, the government retains and disposes of its own share of petroleum extracted, though joint-marketing arrangements may be made with the contractor. PSA’s are adjusted to suit individual project circumstances to ensure the government generates stable revenue stream.

LNG Projects and Government Revenue:

LNG is the value-added product of natural gas for which PRRT is already considered for the sales gas fed to the LNG plant, therefore LNG as a commodity is not separately considered for PRRT. However, LNG production is indirectly related to the PRRT through sales gas delivered to the plant. Sales gas price at the well head is calculated using a netback formula based on LNG sales price, a lower LNG price means a lower profit at the well head.

Oil and Gas Tax Revenue in Australia

Source: ATO

Australian LNG projects were proposed and approved by considering an LNG price in the range of US$15 to US$18 per Mbtu, which was calculated based on corresponding oil price forecast at that time, however in current circumstances it is highly unlikely to achieve even 50% of initial estimated price. That reduction in revenue means a significant drop in the underlying gross profit for projects and will impact specifically on netback pricing realised by upstream producers. Since the PRRT is a profit based tax, the government revenues from this tax will not be forthcoming for many years.

US$800m in revenue forecast in 2021 through PRRT from LNG projects is compared with the US$26.6B in royalties received from oil and gas resources in Qatar for that year.

The Australian Federal Government as well as state governments receive royalties and PRRT from oil and gas projects, under various agreements for individual licenses. Below is the data from the Australian Taxation Office (ATO) for last three years for PRRT and royalties paid (A$M) by Australian oil and gas companies.

Oil and Gas Tax Revenue in Qatar

Source: Oxford Business Group, Qatar Energy Overview

Transfer Pricing and Ring Fencing

Since the PRRT is a profit based tax, the taxpayer seeks to minimize income earned and maximize deductible expenditures in high-tax jurisdictions through transfer pricing. To avoid transfer pricing, governments have introduced ‘ring fencing’ of tax accounts which limits consolidation of income and deductions for tax purposes across different activities, or different projects, undertaken by the same taxpayer. Ring fencing limits upstream, midstream and downstream activities for tax purposes, however the LNG projects which incorporate extraction, processing and transportation activities tends to shift profits to the lightly taxed downstream activities outside the PRRT regime. In response, the Australian Government has introduced a netback price calculation methodology which allocates fair price to upstream activities. In an Australian Federal Court case last year, Chevron failed to defend its profit shifting actions to evade payment of interest on loans served by associated overseas entities. This case sent a message to the oil and gas industry about observing the intent of local tax laws.

Significance of ring-fencing rules:

  • If there is no ring fencing rule, then the company that undertakes a series of projects will be able to deduct exploration or development expenditures from each new project against the income of projects that are already generating taxable income, this means no tax revenue for the government.
  • Also, the absence of ring fencing may discriminate against new projects that have no income against which to deduct exploration or development expenditures, making them hard to compete with existing players.

Despite these rules a very restrictive ring-fence can also have adverse impact on the government’s tax revenue. More exploration and development can only be promoted if taxpayers can obtain a deduction against current income, generating more government revenue over time by increasing the taxable base. The correct choice is one which achieves an appropriate balance within the fiscal regime, the preference is for early modest revenues over greater revenues.