TAXATION ALONG THE OIL AND GAS SUPPLY CHAIN International Pricing Mechanisms for Oil and Gas ENERGY CHARTER SECRETARIAT Disclaimer Information contained in this work has been obtained from sources believed to be reliable. However, neither the Energy Charter Secretariat nor its authors guarantee the accuracy or completeness of any information published herein, and neither the Energy Charter Secretariat nor its authors shall be responsible for any losses or damages arising from the use of this information or from any errors or omissions therein. The work is published with the understanding that the Energy Charter Secretariat and its authors are supplying the information, but are not attempting to render legal or other professional services. © Energy Charter Secretariat, 2008 Boulevard de la Woluwe, 56 B-1200 Brussels, Belgium ISBN: 9789059480759 Reproduction of this work, save where otherwise stated, is authorized, provided the source is acknowledged. All rights otherwise reserved THE ENERGY CHARTER TREATY The Energy Charter Treaty is a unique legally-binding multilateral instrument covering investment protection, liberalisation of trade, freedom of transit, dispute settlement and environmental aspects in the energy sector. It is designed to promote energy security through the operation of more open and competitive energy markets, while respecting the principles of sustainable development and sovereignty over energy resources. The Treaty is the only agreement of its kind dealing with intergovernmental cooperation in the energy sector, covering the whole energy value chain (from exploration to end use) and all energy products and energy-related equipment. Based on the Energy Charter of 1991, which was a political declaration signalling the intent to strengthen international energy ties, the Energy Charter Treaty was signed in December 1994 and entered into force in April 1998. To date, the Treaty’s membership covers fifty-one states plus the European Communities, which together represent nearly 40% of global GDP. Twenty more states and ten international organisations have the status of observers. Members of the Energy Charter Treaty: Albania, Armenia, Austria, Australia, Azerbaijan, Belarus, Belgium, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, European Communities, Finland, France, Georgia, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Kazakhstan, Kyrgyzstan, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Moldova, Mongolia, the Netherlands, Norway, Poland, Portugal, Romania, Russian Federation, Slovakia, Slovenia, Spain, Sweden, Switzerland, Tajikistan, the former Yugoslav Republic of Macedonia, Turkey, Turkmenistan, Ukraine, United Kingdom, Uzbekistan Observers: States: Afghanistan, Algeria, Bahrain, China, Canada, Iran, Jordan, Korea, Kuwait, Morocco, Nigeria, Oman, Pakistan, Qatar, Saudi Arabia, Serbia, Tunisia, United Arab Emirates, United States of America, Venezuela (vertical stripes denote the countries of ASEAN) International Organisations: ASEAN, EBRD, IEA, OECD, UN-ECE, World Bank, WTO, CIS Electric Power Council, BSEC, BASREC FOREWORD Oil and gas are taxed heavily along the supply chain in various ways and for different reasons. Tax revenues from oil and gas exports are a major source of revenue for the governments of oil and gas exporting countries and serve as a compensation for the depletion of a finite resource. In consumer countries revenues from taxes on gasoline and other fuels are often used to develop and maintain road infrastructure and to compensate for environmental impacts. Beyond that, these taxes are considered as a stable source of the budget of the government in view of the low elasticity of demand for oil and gas. This study examines taxation along the oil and gas supply chain from upstream to downstream. In the upstream sector, taxes are only one – albeit an important – instrument of the rent sharing regime. Governments also receive rent through fees, rentals, bonuses, government takes / participations and other fiscal conditions in addition to taxes. In light of high oil and gas prices as well as the perceived implications of “peak oil theory”, the balance of power between governments and investors is tilting towards the government side. In the downstream sector, a range of different categories of downstream taxation are applied to both petroleum products and natural gas, which may vary substantially between different products. This report looks into the arguments both against and in favour of such taxes. It also discusses the relationships between downstream taxation and the international prices of oil and natural gas. The report was written by Professor Philip Wright and Dr Ian Rutledge of the University of Sheffield, and Miharu Kanai, Senior Expert, under the supervision of Ralf Dickel, Director for Trade and Transit. It greatly benefited from discussion with delegates from the Energy Charter member governments in the Trade and Transit Group meetings in February, June and October of 2008. This report is made publicly available under my authority as Secretary General of the Energy Charter Secretariat and without prejudice to the positions of Contracting Parties or to their rights or obligations under the Energy Charter Treaty or the WTO agreements. André Mernier Secretary General Brussels, November 2008 Taxation along the oil and gas supply chain TABLE OF CONTENTS EXECUTIVE SUMMARY .................................................................................................................................... 8 1. INTRODUCTION TO UPSTREAM TAXATION ................................................................................... 12 1.1 RENT SHARING .................................................................................................................................... 12 1.2. UPSTREAM LEGAL CONCEPT ............................................................................................................... 13 2 INVESTMENT FRAMEWORK AND TAXATION ................................................................................ 16 2.1 TAXATION IN THE US IN THE EARLY DAYS ......................................................................................... 16 2.2 TAXATION UNDER CONCESSION .......................................................................................................... 16 2.3 TAXATION UNDER LEASE ..................................................................................................................... 18 2.4 TAXATION UNDER PRODUCTION SHARING AGREEMENT ...................................................................... 24 2.5 TAXATION UNDER SERVICE CONTRACT ............................................................................................... 29 3 DOUBLE TAXATION IN THE UPSTREAM SECTOR ........................................................................ 32 4 RECENT DEVELOPMENTS .................................................................................................................... 34 4.1 CHANGING ENVIRONMENT .................................................................................................................. 34 4.2 VENEZUELA ......................................................................................................................................... 34 4.3 EXPORT TAX ........................................................................................................................................ 36 4.4 WINDFALL PROFIT TAX ....................................................................................................................... 38 5 CONCLUSIONS ON UPSTREAM TAXATION ..................................................................................... 40 6 CATEGORIES OF DOWNSTREAM TAXATION AND THEIR APPLICATION ............................. 42 6.1 TAXES ON GENERAL CONSUMPTION: SALES TAXES AND VALUE-ADDED TAX (VAT) ........................ 43 6.2 SPECIAL TAXES ON PETROLEUM PRODUCTS AND NATURAL GAS ........................................................ 46 6.3 ENERGY / CO2 TAXES ......................................................................................................................... 56 6.4 SUBSIDIES FOR PETROLEUM PRODUCTS AND NATURAL GAS ............................................................... 57 6.5 EMISSIONS TRADING............................................................................................................................ 60 7 DOWNSTREAM TAXATION IN ENERGY CHARTER COUNTRIES AND DOUBLE TAXATION ISSUES ......................................................................................................................................................... 62 7.1 DOWNSTREAM TAXATION IN A SELECTION OF ENERGY CHARTER COUNTRIES ................................... 62 7.2 DOUBLE TAXATION DOWNSTREAM ..................................................................................................... 68 8: RELATIONSHIPS BETWEEN DOWNSTREAM TAXES AND SUBSIDIES AND UPSTREAM OIL AND NATURAL GAS PRICES ................................................................................................................. 71 8.1 LITERATURE AND DISCUSSION ............................................................................................................. 71 8.2 SOME EMPIRICAL EVIDENCE ................................................................................................................ 82 APPENDICES .....................................................................................................................................................