Essay4Business Investment
Print Сite this

Investments in Oil and Gas Sector

Introduction

It is seen that many countries in the world have rich and abundant deposits of oil and gas, but their domestic infrastructure, due to lack of necessary technical skills or knowledge, does not permit these countries to become self-sufficient in the technology needed to identify and drill these resources by use of indigenous methods. However, it is also seen that exploration in itself is a hazardous and time-consuming process and drilling and exploration is an expensive and lengthy process with a large degree of uncertainties and abundant risks both to humans and resources. It is seen that the deposits may be buried deep into the crust of the earth, several kilometers deep. Thus it is seen that the discovery of oil has been a stroke of luck for man. (Oil and Gas).

While fossil fuels are the predominant needs of mankind for energy sources and for his daily existence, he often tends to take fossil fuels for granted and often misutilises this vital source of energy. While fossil fuels are limited to what could be drawn from the earth, sent to refineries and exported to many countries of the world, it is imperative that the supply of fuels need to match demands, to provide cost and price parities and also consider the common good of foreign contractors who drill and draw forth crude, the marketers who market them, the host Government which arranges for its supply and a host of intermediaries in the strategic supply chain management route that the oil and gas products undergo to reach the final consumer.

Thus it is intrinsic that oil-rich countries in the Middle East, Latin America, Russia, and other OPEC/ non- OPEC nations form a common platform on which to strategize their goals and objectives as far as exploitation and consumption patterns of oil and gas products are concerned.

Need for strategic alliances and partnerships

Thus, they need to take recourse to strategic alliances or partnerships with other foreign companies who are experts in drilling and exploration technologies.

“Oil exploration involves lots of people with different skills, for example geologists, geophysicists, surveyors, mudloggers, computer scientists, marine biologists, drilling engineers, the drilling crew.” (Facts Figures and Appreciation: Field Appraisal. 2009). These strategic alliances or partnerships with foreign oil exploration and drilling companies allow natural resources to be drawn and produced commercially, in return for, perhaps, a share in the proceeds of production of oil /gas and also “to design a remuneration scheme that matches the objectives of the project.” (Integrated Project management. 2009).

Coming to the case of Angola, one of the major oil reserves in Africa, it is seen that in the case of Sonangol, it is seen that this African country started production of gas only as late as in 2008 last year. Further, Sonangol has been handicapped, due to lack of previous expertise and knowledge in exploration of hydrocarbons.

As a result of lack of local expertise, oil excavations were carried out by foreign companies and this could have affected the local economy in no small measure.

However, over time Sonangol has realised the need for striking agreements with other oil producing countries in African belt in order to foster and develop its own economic ties.

“On the African continent Sonangol has maintained business cooperation with oil producing countries in the Gulf of Guinea – Gabon, Equatorial Guinea, Nigeria and Sao Tome and Principe. These partnerships have greatly contributed to the development of Angola’s’ oil industry.“ (Upstream – Exploration and Production of Hydrocarbons. 2009).

Implications of technical expertise and experience

Thus, it is necessary for local and indigenous companies not to waste resources in the form of local efforts, because in most eventualities this would end in utter dismay and failures. Oil deposits identification, assessment, exploiting and drilling is best left in the hands of vastly experienced and expert professional oil companies who are the final judges of oil and gas reserves and their tapping. It is however, incumbent on the part of host countries to enter into production sharing contracts with foreign companies, which could significantly help in the exploration and production of oil and gas resources, and which determines the percentages of profits each country would receive after deducting expenses and costs.

It is also necessary for the host country possessing the necessary deposits or reserves, to offer attractive inducements and incentive schemes that could offer irresistible bait to foreign drilling and exploration companies to agree to carry out exploration on behalf of the host country.

However, on the flip side it is seen that rampant exploitation of natural resources would not be in the best interests of any oil producing country, no matter how robust its oil reserves and deposits may be. This stems from an aspect that, after all, fossil fuels are degenerative in nature, and once the asset has been extracted it needs to provide investment benefits to the government and host country, and should only be used for generating more and more investment benefits for the country and not for reckless spending.

It is often seen in the cases of certain oil rich countries, that the oil funds and incomes only benefit a prosperous minority, while the majority of the inhabitants are impoverished. In such cases, it serves only to enrich the wealthy reserve owners or the Government, to the detriment of poor sections of society, who also need to be empowered with the oil wealth. Thus, if oil assets are squandered in non productive and wasteful expenditures that part of the country’s assets is permanently used off, in a way, since hydrocarbon deposits are not renewable assets and decrease with extraction.

The agreements also need to serve the interests of the administration, local people, oil extracting companies, whether foreign or indigenous, and the oil well owners.

All their interests needs to be matched and protected, and the agreements need to look into the common good of all concerned interests, and not necessarily that of the wealthy oil companies or even the respective powerful governments, who could even sell off, or barter vital oil installations for political economic fiefdom and dictatorship.

Thus it would be necessary for local governments, to enter into strategic partnerships or agreements, by which all parties could be benefited. Government owned deposits could be given on rent, or lease to indigenous or foreign companies, on agreement that the proceeds would be shared by the govt and the contractor on proportionate terms, commensurating with their investments and other considerations. The joint proportion would be decided on mutual basis, and the profits would be shared, year after year, during the currency of the contract, after accounting for costs like depreciation, cost recoveries and other expenses.

Further, it is also necessary that thresholds also need to be maintained, in terms of production and extraction that could serve industry and national interests, in the long run.

Thus, it is seen that in the context of oil production and extraction, nations need to strike a finest of balance in the quantities in oil wells that could be commercially exploited for profits and government revenues, and also the need to keep reserves for future use. Oil is not going to last forever, and this needs to be kept in mind by all concerned, and assets reduce with every withdrawals, unless there are invested in robust investments that are more than capable of compensating for costs and expenses that they possess.

Economic Rents

It is necessary to come to the aspects of economic rents.

“Economic rents are the returns accruing to a factor of production in excess of its transfer earning.” (International Petroleum Tax. 2009). Generally speaking, use of resources necessitates certain rents to be paid to the rightful owner for services rendered in terms of allowing the land to be used by the driller, or tiller for stay or extraction of natural resources. It is quite natural that Government, or the rightful owner demand and receive rent for services rendered, which would be used for common good.

However, it is necessary that this does not misbalance the existing system in any way. However, considering the fact that petroleum exploitation does decline over time and usage, it is but natural that economic rent also needs to decline. Moreover, aspects of geological locations of fields are also important since some fields may be more productive than others within the same area. Thus the very basis of economic rents may be contentious in certain cases. Moreover, oil drilling and exploitation may not strictly come within the purview of pure competition. (International Petroleum Tax. 2009).

Mutual Understanding between government and contractor

Therefore it is possible that economic rents are allocated on other considerations, like the influence exerted by foreign drilling companies, etc. The perspectives of the concerned Government and also the drilling company may be different and need to be reconciled. Company would be interested in lowest dose of taxation, utmost profits, pricing autonomy and no long term obligations or commitment, especially after completion of operation.

They would also prefer quick and convenient currency transfers for repatriation of profits to parent company and also the option of investment partners. (International Petroleum Tax. 2009). The Government, on the other hand, would be more interested in seeking higher doses of revenues, whether through taxes or economic rents, securing local employment opportunities and in terms of regulating drilling and extraction according to its own rules, regulations and conditionality, irrespective of country of origin of drilling company.

Not only would local government be interested in regulating production and sale of extracted crude petroleum, but it would also try to regulate prices in local markets and seek higher doses of taxation. (International Petroleum Tax. 2009). In the case of petroleum products, it is seen that aspects could be seen in terms of short, medium and long term. In the short run, the concern is with regard to wells that have already been explored, medium term is with regard to wells that are in the process of being explored and the future exploration are a subject matter of long term exploration. (Students Notes 1: Economic rents in the petroleum industries, p. 4).

However, it could be said that in the initial development stages, or the pre-payback stages, the economic rents could be seen as the Net Present Value (NPV) at the rates prescribed by the investors. Again, at the exploration stage, it could be defined as the Net Present Value (NPV) from the work carried out, mainly digging or exploring, with due effect given to chances of discovery or not, from which the exploring costs need to be deducted.

While the aspects of NPV would depend upon a host of variables, directly or indirectly impinging upon petroleum, it is now necessary to take up the matter of how much cash flow is generated to both the Government and the contractor towards this exploration study. At the end of 5 years, the total cash flow for both Government and contractor could be considered, and the maximum cash flow generated would be considered as the more profitable option in this case the contractor for the First Option, which could be considered as more viable.

First Option

First Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 10% of Gross production) 10.00

——-

77.50

E. Depreciation (10% Straight line) 10.00

Profits 67.50

Break up of profits (Govt – 15%) 10.15

(Contract-85%) 57.35

Corporate Tax @ 35 % 20.00

———

Net Cash flow to contractor 37.35

Net income to government (B+F) 22.65

Second Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 10% of

Gross production) 10.00

——-

77.50

Depreciation (10% Straight line) 10.00

Profits 67.50

Break up of profits (Govt – 25%) 16.85

(Contract-75%) 50.65

Corporate Tax @ 35% 17.75

———

Net Cash flow to contractor 32.90

Net income to government (B+F) 29.35

Third Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 10% of

Gross production) 10.00

——-

77.50

Depreciation (10% Straight line) 10.00

Profits 67.50

Break up of profits (Govt – 50%) 33.75

(Contract-50%) 33.75

G. Corporate Tax @ 35%

11.80

———

Net Cash flow to contractor 21.95

Net income to government (B+F) 46.25

Fourth Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 10% of Gross production) 10.00

77.50

Depreciation (10% Straight line) 10.00

——–

Profits 67.50

Break up of profits (Govt – 60%) 40.50

(Contract-40%) 27.00

Corporate Tax @ 35% 9.45

———

Net Cash flow to contractor 17.55

Net income to government (B+F) 53.00

Fifth Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 10% of Gross production) 10.00

——-

77.50

Depreciation (10% Straight line) 10.00

Profits 67.50

Break up of profits (Govt – 75%) 50.65

(Contract-25%) 16.85

G. Corporate Tax @ 35% 6.00

———

Net Cash flow to contractor 10.85

Net income to government (B+F) 63.15

Next it is necessary to consider the 5 year effect for Option I investments

Serial Year Revenue
For Government
Cash flow
For
Contractor
1. First year 22.65 37.35
2. Second year 29.35 32.90
3. Third year 46.25 21.95
4. Fourth year 53.00 17.55
5. Fifth year 63.15 10.85
Totals 214.40 120.60

Now, it would be necessary to consider the viability and profitability for Option II.

There are two aspects in Option II which are different from Option 1 and they are in terms of cost recovery limited which is higher at 15% and the government’s share which is initially higher than that of Option 1.

Option II

First Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 15% of Gross production) 15.00

———

72.50

Depreciation (10% Straight line) 10.00

———

Profits 62.50

Break up of profits (Govt – 25%) 15.50

(Contract-75%) 47.00

Corporate Tax @ 35% 16.50

———

Net Cash flow to contractor 30.50

Net income to government (B+F) 28.00

Second Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 15% of

Gross production) 15.00

72.50

Depreciation (10% Straight line) 10.00

——-

Profits 62.50

Break up of profits (Govt – 45%) 28.00

(Contract-55%) 34.50

Corporate Tax @ 35% 12.50

———

Net Cash flow to contractor 22.00

Net income to government (B+F) 40.50

Third Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 15% Gross production) 15.00

——-

72.50

Depreciation (10% Straight line) 10.00

——-

Profits 62.50

Break up of profits (Govt – 65%) 40.50

(Contract-35%) 22.00

Corporate Tax @ 35% 7.70

Net Cash flow to contractor 14.30

Net income to government (B+F) 63.00

Fourth Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 15% of Gross production 15.00

——-

72.50

Depreciation (10% Straight line) 10.00

Profits 62.50

Break up of profits (Govt – 75%) 47.00

(Contract- 25%) 15.50

Corporate Tax @ 35% 5.50

———

Net Cash flow to contractor 10.00

Net income to government (B+F) 59.50

Fifth Year

£

Gross Production/ Revenues: 100.00

Royalty payment (12.5%) 12.50

Net Production /Revenue 87.50

Cost recovery (assumed at 15% of Gross production) 15.00

——-

72.50

Depreciation (10% Straight line) 10.00

Profits 62.50

Break up of profits (Govt – 85%) 53.00

(Contract-15%) 9.50

Corporate Tax @35% 3.50

———

Net Cash flow to contractor 6.00

Net income to government (B+F) 65.50

Next it is necessary to consider the 5 year effect for Option II investments.

Serial Year Revenue
For Government
Cash flow
For
Contractor
1. First year 28.00 30.50
2. Second year 40.50 22.00
3. Third year 63.00 14.30
4. Fourth year 59.50 10.00
5. Fifth year 65.50 6.00
Totals 256.50 82.80

It is now necessary to make a comparative analysis of the revenues that would be derived from each of the above options from the government as well as the contractor’s side.

Serial Description Govt.
£
Contractor
£
1. Option I 214.40 120.60
2. Option II 256.50 82.80

Comparative study and benefits – exercise better Option

Therefore, from the above study it is seen that Option II derives much more revenue for the Government and would thus need to be recommended.

However, when considered from the contractor’s point of view, it is seen that Option I would be a better option that brings in higher cash inflows.

While it is seen that there are many determinants for assessing the net worth or viability of the project, like NPV, cash flows etc, in the case production sharing “as a more flexible scheme relates the state’s share of profit oil to the contractor’s achieved rate of return on the investments.” (International petroleum Taxation. 2009).

It is seen that production sharing could be a win-win situation for both the host country and also the foreign company in that the necessary technical expertise and knowledge and knowhow could be gained, and also the natural resources could be explored and used for common good. Thus these are revenue generating experiences for both countries and augur well for both parties to the covenant.

However, it is necessary that necessary incentives be provided to the exploration company since they are taking high risks in terms of investments which may or may not bear fruits in the long run. Their interests need to be protected and the host country needs to take every effort not only to provide the necessary assistance and manpower resources but also the right kind of environment which fosters healthy work spirit and the will to produce results for the common good.

Conclusions

However it is necessary to state that “The degree to which a taxation scheme is inherently sensitive to changes in the operating environment is important, because this will determine the extent to which it can extract a given share of rents within a changing environment. This determines the degree of stability in a system over time.” (Students Notes 3: The Main Fiscal Devices Used in The Petroleum Industry and Their Effects).

Thus what is more important in the case of production sharing is the framework of common objectives and vision of the parties that would ultimately render the venture successful in the gain of its predetermined objectives and goal achievement. Thus the need for determining a common platform and working towards it is very important for success of drilling and exploration in the global context.

The aspects that are of main concern is that most foreign companies would be governed by their respective corporate guidelines and policies and would need to adhere to it, and local workforce are answerable to their top management in their country of origin. Under such circumstances, the conflicts of interests are a major area which needs to be considered.

While on the one hand, the government of the host country would be concerned about revenues, local employment opportunities, taxation and fund generations, and control over oil resources in terms of thresholds and profit sharing, laws and conditionalites governing sourcing, explorations, drilling, transportation and use of oil assets, the oil drilling company would be thinking in terms of Return on investments, (ROI), profit margins, stakes in oil wells and other issues. It needs to be seen that the role of the oil companies are more significant than that of the host investors, especially in the context of the uncertain climate that govern international oil bidding and contracting.

Thus, it is seen that international production sharing contracts do go a long way in ensuring a reasonable degree of equity, coherence and risk sharing in oil and gas exploration and is being increasingly used to streamline business opportunities in right direction.

Bibliography

Facts Figures and Appreciation: Field Appraisal. (2009). Oil and Gas UK. Web.

Integrated Project management. (2009). Schlumberger. Web.

International Petroleum Tax. (2009). Slide 6.

International Petroleum Tax. (2009). Slide 15: Application of Economic Rent.

International Petroleum Tax. (2009). Slide 17: The Investor.

International Petroleum Tax. (2009). Slide 20: Government.

International petroleum Taxation. (2009). Production Sharing: Slide 154.

Oil and Gas. Planete Energies.com: Understanding Energy. Web.

Students Notes 1: Economic Rents in The Petroleum Industries. P. 4.

Students Notes 3: The Main Fiscal Devices Used in The Petroleum Industry and Their Effects.

Upstream – Exploration and Production of Hydrocarbons. (2009). Sonangol. Web.

Cite this paper

Select style

Reference

Essay4Business. (2022, April 16). Investments in Oil and Gas Sector. Retrieved from https://essay4business.com/investments-in-oil-and-gas-sector/

Reference

Essay4Business. (2022, April 16). Investments in Oil and Gas Sector. https://essay4business.com/investments-in-oil-and-gas-sector/

Work Cited

"Investments in Oil and Gas Sector." Essay4Business, 16 Apr. 2022, essay4business.com/investments-in-oil-and-gas-sector/.

1. Essay4Business. "Investments in Oil and Gas Sector." April 16, 2022. https://essay4business.com/investments-in-oil-and-gas-sector/.


Bibliography


Essay4Business. "Investments in Oil and Gas Sector." April 16, 2022. https://essay4business.com/investments-in-oil-and-gas-sector/.

References

Essay4Business. 2022. "Investments in Oil and Gas Sector." April 16, 2022. https://essay4business.com/investments-in-oil-and-gas-sector/.

References

Essay4Business. (2022) 'Investments in Oil and Gas Sector'. 16 April.

This paper was written and submitted to our database by a student to assist your with your own studies. You are free to use it to write your own assignment, however you must reference it properly.

If you are the original creator of this paper and no longer wish to have it published on Essay4Business, request the removal.