The Global Oil Price Crisis - Essay Example

Azerbaijan and Kazakhstan: Oil Taxes Yvonne To alleviate the global oil price crisis, oil producing countries are enjoined to positivelyexert measures lower the cost of oil through effective taxation reform measures that will promote competitiveness without necessarily harming the economic goals. Azerbaijan and Kazakhstan has responded to this call. This paper intends to look into the different taxes imposed on crude oil according to the new tax codes imposed as an effective contribution to the global economy. Yvonne Marie Leyson Professor Doe Oil Tax 11 May 2006 Kazakhstan and Azerbaijan: Oil Tax In this modern era, the industrial economy around the world has relied so much on oil as the lifeblood of every nation's major source of energy. Crude oil, as the raw material in the world market has effected changes that have affected the economic stability of countries. While price changes has its usual negative implications, adverse supply shocks unexpectedly has created a critical scenario in the reduced aggregate supply in the world oil market thereby increasing its prices. In the early 70's, OPEC's control and reduction of oil prices according to Mankiw(1998)1 has aroused the world oil price instantly that has resulted to double-digit inflation and high unemployment rates. The changing prices of crude oil have its usual implications on the economy that often results to a world oil crisis. At the moment, the world is witnessing a major oil crisis with the current war in Iraq and the ensuing conflict with the other large oil producing countries in the Middle East. It is startling to note that material changes in the price of oil can rapidly cascade to the whole economy thereby affecting the price structures of consumer goods and services. The United States, as the highest consumer of the world's oil stands at the loosing end thereby carefully fielding studies to convince the Gulf and Europe to limit their cuts. Former US Energy Secretary Richardson2(2000)has suggested in a new measure to limit the drastic impact on world economic slowdown by discussing the relationship between the world oil price market and the heavy taxation imposed by the government of oil-producing countries on oil production. According to OPEC, the barrel of refined oil has been split in to three; crude oil price, industry margin and taxes. Governments who share the bulk of the profit are thereby enjoined to seriously observe their tax policies and exact measures to alleviate the prices of this main commodity. Mineral Taxation around the World The current moves to effective globalization aims to de-emphasize high tax rate, tie tax rate to additional profit or impose low but flat tax on all activities. Abu Dhabi, Dubai, Tunisia and Venezuela that have similar high tax rate do not share in production, while Qatar, Egypt, Yemen and Argentina that share in production have tax rate ranging from 0-40%.73 Most of these countries have done away with royalty while others have rates ranging from 1-12%, which is based on the sliding scale tied to production. Let us look into the different taxation measures imposed by Azerbaijan and Kazakhstan, two minor oil producers who have every potential for economic gains and their implementation of tax reforms. As international capital flows are guided by the prevailing fiscal regimes, there is a need for achieving some degree of harmonization. In this context, it is important to know what types of taxes can be expected on the oil sector industry. The dual nature further imposed on oil and gas as a special character of the mineral sector on other countries has equated the dual role of the government leading to the dilemma of whether taxation should be different in the mining sector and general system in terms of rate structure and administration. Taxes of general application may not always be suitable for mineral companies involving higher capital intensity and long-gestation lags. Further, it is difficult to prejudge whether the exemption of the mineral companies from general taxation can subject them to special taxes that promotes or detract from the neutrality of the whole taxation system. For their respective parts, the European Union countries have implemented tax reforms in an answer to these calls. In 2003, Kazakhstan's lower house of parliament according to Kelimbetov in AFP(2003)3 has approved the new oil export taxes pegged and intended to "perfect the extraction profits from oil companies". Azerbaijan for its part has exacted a number of bilateral treaties to avoid double taxation which will allow entities and buyer state to avoid being taxed twice from the same tax base in both countries. Kazakhstan and Azerbaijan's Oil Taxation To discuss, Kazakhstan with a 1.22 million barrels of oil production on a daily basis has hoped to increase its production levels of around 3.5million bbl/d by 2015. In January 2004, Kazakhstan stared taxing crude oil export for the first time whereby oil producers are mandated to pay taxes on oil exports in increasing magnitude as the world oil fluctuates. The three major laws in Kazakhstan govern the economic terms established in the Subsurface Use, Petroleum Law and the Tax Code. Tax ranges from 1% when the oil prices are around $19/bbl to 33% should it raise higher than $39/bbl or more. However under the Tax Code, a tax regime with a PSA Contract may be excluded on the following tax that is applicable to a non-PSA contract: Excise tax, excess profit tax, land tax and property taxes. Additionally, other exclusions under the taxation measures are those exporters whose prices are fixed and are tied to production-sharing agreements. The Tax Code Amendments4 adopted on November 29, 2003 which came into force on January 1, 2004 has included: A.)Taxation of subsoil users; where contractors operating under concession tax are commissioned to pay specific taxes in accordance with this legislation. The tax base for the crude oil export tax will be the value of the exported crude adjusted for the quality of oil minus the transportation expense. Depending on the world market, the tax rates shall vary accordingly from 1%-33%. Under this category, Excess Profit Tax is also imposed applicable to subsoil users whereby an amount exceeding 20% of the profit margin of up to 5%-30% or higher will charge 15%-60%. B.)Royalty rates are also charged depending on the amount of accumulated oil production for each calendar year. Contractors whose production has reached up to 2,000 tons under the new Tax Code will be charged 2% tax for the reposting period. Royalties in the form of specific or ad valorem duties on the amount or value of the product are among the most popular addition to the mining levies. Commonly, they are used as an element in the fiscal control in most petroleum and mining industries, all over the world. The attractiveness of royalty levies is their simplicity in administration. In the case of specific duty, the base of the tax is the quantity produced, which is easy to check. Royalties have less deterrent effects on the projects that are actually undertaken than a general fixed fee of the same expected revenue. Royalty levies have a distorting effect in the sense that it may raise the unit costs of extraction and tends to reduce the pace and extent of extraction. The result is that some deposits are left in the ground although their price exceeds the total social cost of extracting them. This is socially wasteful as capital investments. C.) Taxation of Non-resident companies under this mandate is exempt provided that such companies employ personnel exclusively in behalf and for the interests of the legal entities and non-residents are not held responsible for the work of such personnel as well. However if the company income exceeds that of their total personnel provision services, a different treatment is thereby imposed. In this regard, marketing services provided by offshore companies will no longer be treated to a 20% withholding tax. Under this Tax Amendment, financial leasing agreements are dependent on the 2000 Financial Leasing Law which may not affect the terms of taxation for oil companies whose definitions are not met under this new code. Social Taxes for managerial, administrative and engineering personnel in compliance with work permits are taxed at a lesser amount of 5-11% instead of the standard 7-20% whereby taxpayers acquire the benefit. Azerbaijan in its current desire to attract and maintain its foreign investors currently has no official legislation that specifically governs the oil and gas sector. Ownership of all petroleum resources existing under the natural state including within the jurisdiction of the Caspian Sea is vested in Azerbaijan with the State Oil Company of the Azerbaijan Republic (SOCAR) being given the opportunity to control and manage the country's petroleum resources. Under the current general tax legislation, tax terms of the Production Sharing Agreement (PSA) and Host Government Agreement (HGA) has negotiated tax relief agreeable to the investors. Other investors outside the above mentioned agreements are enjoined to pay the whole range of standard taxes under the statutory tax regime. Oil and Gas PSA partners are subject to a profit tax and social fund contributions of their local employees. The profit tax rate is 25-32% whereby the taxable income is derived in accordance with accepted accounting practices and procedures. Under this agreement, the PSA operating companies are not required to pay taxes but allocate income and expenses to their contractor parties in the production sharing agreement. In an effort to promote employment for Azerbaijanis, contractor parties are required to hire the citizens within the framework of need consistent with their operations. They are however enjoined to make contributions to the Social Insurance Fund in the amount of 22% of the gross local payroll. This is tantamount to the Social Security Benefit offered by US and other countries whereby employee share 3% of their salaries to the Fund. Bonus payments which vary for individual PSA's can be paid in three installments whereby an acreage fee of $1,200 to $2,000 is charged per kilometer. Under the PSA contracts, parties are not subjected to any royalties to extraction of resources in Azerbaijan. Foreign and legal entities are however treated as sub-contractors and subject to tax in accordance with the taxation rules of the country. Registered foreign sub-contractors are generally subject to withholding, and social fund payments in the same manner as contracting parties. Taxable profit of 20-25% is subjected to a withholding tax obligation at the rates of 5-8% depending on the particular agreement of the gross contractual profit. However this has to be relative to the terms and conditions in the agreement. Similar to contracting parties, social charges are charged to subcontractors for the employee's benefit. Azerbaijan recognizes the exceptional status of the PSA and other agreements and implements a different tax regime outlined for all companies operating under the statutory regime of profit, value added tax, excise tax, road tax, land tax, property taxes, customs duties, payroll, withholding and royalty taxes. However, the country has wisely recognized the importance of mineral fields' tax which is identified as acreage tax in Kazakhstan that is applied on the wholesale prices of mineral extraction such as natural gas, metallic mineral resources and other taxable minerals. Also, parties to production sharing agreements (PSAs) concerning oil and gas exploration and production in Azerbaijan are generally exempt from the requirements of the Azerbaijani Tax Code where the tax obligations of such entities are typically regulated by each particular PSA which is adopted into law by the Milli Majlis. Importance of the Tax Allowance Taxing is a way of achieving the governments of exercising right and control over its public asset. The government may impose high taxes to regulate the number of participants that serve to exploit the oil industry thereby discouraging its rapid depletion to conserve it for the future. It is also a successful investment and a source for satisfying government's objective of raising money for socio-political and economic obligations to the citizenry. Tax allowance is a form of incentive used to ameliorate the difficulties and high tax burden inherent in a fiscal regime in order to induce, promote and sustain investment in that fiscal regime. Morrisset(2003)5, provided that tax allowances are poor instruments for ameliorating negative factors inherent in a country's investment climate. In Kemp (1987)6, tax allowances give a picture of how much of the investment risks the government is willing to share with the investor. It is understood that where there is no incentive "there might be no attraction in exploring small fields"7, though they may not totally ameliorate the political risks of an investment, but it will definitely go a long way in addressing imbalance arising from high tax burdens. Tax allowance and subsidies on mineral reserve extraction attract potential investors that are achieved still on a complexity of factors. If the reserves are low or inadequate, no investor is going to be attracted for its extraction even if the taxes are of marginal rating. Conversely too, high taxation may not deter potential investors if the reserves are of good quality and easier to extract and sell. Therefore, a summary of factors correlate with one another to determine how best to deal with taxation on mineral deposits such as its geographic location and so on. In some countries, governments insist on the acquisition of equities in a project without paying what could be considered a fair market price. In this sense, it imposes a cost on the investor that is similar in its fiscal effect to some additional taxation. Equity to the government could be substituted for tax rights thus equity holding has an ultimate appeal for some governments because of the impression it gives of owner-ship. The fixed fee system appears to have been successful in collecting rents from US offshore oil and gas, at least over the 1950s and 1960s. The reason could be the comparatively large number of companies interested in petroleum extraction in the United States. Government equity in mineral projects is an important political symbol in many countries. Government equity thereby gives a sense of participation in the development of the country. However, there is a case for the government not taking an equity interest in mineral projects. But if at all the government decides to take an equity position in mineral projects, it should use a carried interest. Carried interest has implications for the timing of the company's after-tax cash-flows and the liquidity position of the company would be better if it is in lieu of taxes, the government is allowed to acquire Negative Impact on Allowance Oil taxation has become an instrument for wealth re-distribution in the wealthy and industrialized economies who own the technology, expertise and capital to develop the industry. While the poor and emerging economies from where the petroleum resources are extracted, excessive tax allowance may repatriate the earnings and often very huge profit to their own wealthy countries. The high potential for environmental pollution and degradation stemming from industry activities makes it worthwhile for an environmental taxation or depletion tax, as a way of regulating its activity and promoting government's quest for a cleaner and healthy environment. Taxing and penalizing pollution and environmental offenses will definitely serve to minimize this problem. Azerbaijan has currently been lauded for its tax allowances on profit; value added tax, excise, import and export taxes, road tax allowance afforded to contractors and sub-contractors under the protective umbrella of the PSA. Some regimes may treat royalty as a deductible expense for tax purpose while others don't but Azerbaijan is treating it as a deductible expense which has the effect of mitigating its full impact on firms according to Cordes.8 Under the existing double tax treaties the rate of withholding tax varies depending on the contents of particular treaties between states in the region. Evaluation of the Tax System According to Ernst and Young(2003)9, Kazakhstan has significant oil and natural gas reserves with an estimated 9-17.6billion barrels of oil and natural gas reserves of 1.84 trillion cu./m. Currently there are 202 oil and gas field in Kazakhstan which makes it the second largest provider next to Russia in the region. In the framework of international projects, all of its oil and gas fields are being explored and developed where foreign capital has attracted 27 large projects in the exploration, reconstruction, processing and transportation of oil and gas. Most of its products are exported to Europe and Asia. With Kazakhstan at the tip and the farthest among the three oil producing countries, it leaves enough room for explanation why taxes are imposed on much of its oil extraction process. To directly link itself to China, Kazakhstan needs to build an overwhelming pipeline structure that is currently non-existent. Taxation did allow more room for to Kazakh to acquire enough governmental budgets for domestic spending on new infrastructure projects that will allow Kazakhstan to supply its oil over the far-reaching countries unlike Azerbaijan and Russia who has close proximity to the other friendly nations in the Mediterranean and Europe. In Evans, Allen and Turkina(2004)10 the government's share of oil profits or minerals has the effects of lessening the taxes imposed on the extraction and supply and in effect will affect future investment and confidence which will greatly depend on the perception of the size and number of future prospects. Kazakhstan with its still burgeoning economic problems despite tax collection has lately gained the helpful advice of the WB Senior Economist Rodriguez to unilaterally commit to disclose the oil revenues received by the treasury from each of the 51 legal entities operating in the oil and encourage each legal entity operating in the sector beginning with all the companies under the umbrella of PSA's to any interested party the amount of tax being paid. No matter how huge collection has incurred if the lack of accountability and transparency exists within the offices may exacerbate poor governance and lead to corruption, conflict and poverty. With the needed social as well as local content initiatives Kazakhstan has to pursue the fulfillment of their Production Sharing or Operating Agreements with the State and revamp the information base available to the general public on the National Fund of the Republic of Kazakhstan. The lack of accountability and transparency can exacerbate poor governance and lead to corruption, conflict and poverty. The over-all impact in Kazakhstan's good fortune is due to the happy influence of a rapid increase in world oil prices since 1999 and the steady development of the country's considerable energy resources since the early 1990s. Oil production--which stood at 1.22 million barrels per day in 2004--now accounts for about 50% of Kazakhstan's export revenues, and approximately 30% of state budget revenues, and Kazakhstan is poised to become a major world oil exporter with production levels of as much as 3.5 million barrels per day projected by the government for 2015.11 The World Economic Forum's 2005 "Growth Competitiveness Index Rankings" report ranks Kazakhstan as the most competitive of the post-Soviet states, in 61st place out of 117 countries ranked and the next regional state, Azerbaijan, coming in at 69th, and Russia lagging behind in 75th place. Most likely in Ernst and Young(2005) results on a tax survey for Russian and other neighboring multinational companies revealed some disappointment at the slow progress in reforming Russia's inefficient tax administration. The respondents complain about the authorities' inconsistent application and interpretation of tax laws, they mention the high number of tax audits and disputes with the authorities. However, this survey has not included countries like Azerbaijan and Kazakhstan anymore in 2005. .. Conclusion Taxation for oil and mineral extraction has received wide attention in the recent years as a well-recognized fact that government intervention through tax policy instruments is essential for the optimization of the exploration of its mineral reserves. These taxes impinge on the mineral sector at various stages of prospecting exploration, trade and final consumption. As inter-sector and international capital flows are guided by the prevailing fiscal regimes, there is a need for achieving some degree of harmonization. As identified in each country's tax regime, the twp most important factors in the tax levy would include mineral composition or the quality of mineral; the nature and degree of governance and the level of economic development is considered heavily before any tax imposition is applied. Oil resources of Azerbaijan were justified in an IMF 2005 report with positive results. Growth objectives were largely achieved and poverty declined to 40 percent in 2004 from about 60 percent in 1994, and Azerbaijan's current fiscal and external positions are sustainable according to the IMF12. While most annual inflation was met, at times, deviations from program inflation targets were large, reflecting in part in some in the non-observance by the authorities of their commitments under the program. Looking forward, Azerbaijan faces a medium-term challenge of ensuring sustainable growth of output on other industries other than oil, export diversification, and poverty reduction in a stable macroeconomic environment at a time when oil revenues are projected to increase substantially. Oil output in Kazakhstan and the fiscal revenue has reflected an increased in recent years. In 2004 alone according to the IMF, the output of oil and gas condensate reached 59 million metric tons increasing about two-fold since 1999 and is estimated to account for about 30 percent of the country's nominal GDP and half of its export earnings. About 30 percent of total government revenues were derived from the oil sector in 2004, compared to 6 percent in 1999 based on the staff's definition derived on oil revenues include the sum of corporate income taxes, royalties, bonuses, and payments from production-sharing agreements. Although this reports do not exhibit the long-term results of tax reforms, but the good it brought in for the economy is clearly seen. Cited References Tehran Times. Kazakh Parliament approves new export taxes on oil investors. 11-24-03. Kriz, Margaret. Energy Richardson's Difficult Courtship. Nat'l. J Mag. 2000, Mar.18 Agence France Press. Kazakh Parliament approves new tax on oil investors. Nov.2,2003 RK Law, No.500-11 29, Nov. 2003. International Monetary Fund. July 2005. IMF Country Report No. 05/259 (on Azerbaijan).copy International Monetary Fund. July 2005 IMF Country Report No. 05/240 (on Kazakhstan).copy Morisset, J. Tax Incentives, Using Tax Incentives to attract Foreign Direct Investment. The World Bank Group, Private Sector and Infrastructure Network, January 2003, p.1. Kemp, A., Economic Considerations in the Taxation of Petroleum, in Petroleum Resources and Development, Economic, Legal and Policy Issues for Developing Countries. London: Belhaven Press, 1987. Andrew- Speed, P. Why is China's Onshore Acreage proving to be unattractive to Foreign Oil Companies 14 (3)OGLTR 126 14 (3)1996. Ernst and Young. Kazakhstan Oil and Gas Tax Guide. 2003, Ernst and Young. Tax Survey 2005, Hope and Disappointment. http://www.ey.com/global/content.nsf/Russia_E/Press- Release_-_12_10_2005 11, May, 2006. Mankiw, Gregory,2004, Remarks at the CNBC Financial Summit Economic Choices.< http://www.whitehouse.gov/cea/mankiw- cnbc.html> 11, May 2006. Evans, Huw, Allen,Olivier and Turkina, Dina. The New Kazakhstan Oil and Gas Taxation Regime. 2004. Cordes, J. An Introduction to the Taxation of Mineral Rent in The Taxation of Mineral Enterprises. Otto, J.,ed. London: Graham and Trotman 1995. Read More