Mature Fields and Royalties

December 19, 2019

Royalties are the most traditional form of taxation of mineral resources in the world. It is compensation for the exploitation of a mineral resource designed to ensure that future generations enjoy the benefits that exploitation of the non-renewable natural resource provides to the current generation.

In the Brazilian case, according to Law No. 9,478 / 97, the Petroleum Law, royalties on oil and natural gas production are an ad valorem tax, ie, levied on the value of production, and which benefit the Union. These taxes are paid monthly by companies that produce oil and gas in the country according to the value of the field’s production.

Every 1% more in the mature fields recovery factor can generate investments of $ 26 billion

Royalties are regressive, ie the higher the revenue, the lower the proportional amount paid. Thus, they do not track the profitability of the field, that is, the smaller or less profitable a field, the greater the share of royalties on net revenue. Consequently, mature fields that already have a lower profitability due to their economic nature, end up being penalized from the beginning.

This structuring of royalties can have a deleterious effect on mature fields due to its impact on gross revenue, generating taxes even before the project earns any profit. Imposing a tax has an economic effect by creating a distortion between the cost of production and the market price of the good, impacting the quantity produced. If the tax is too high, it significantly reduces the amount produced. Thus, a tax reduction stimulates the economy by reducing this distortion, positively affecting production.

In the Campos Basin, post-salt production has declined by around 30% over the past five years due to lack of investments to mitigate the rate of decline in mature fields. Municipalities that confront it, such as Macaé, have lost large portions of their revenue. The rate of decline of 12% per year in the region is very high compared to, for example, the North Sea average rate of 5% per year.

It would be necessary to invest in the recovery of these mature fields to reduce this rate of decline. However, this makes no sense to Petrobras, the operator of many of these fields, as the company has much more lucrative pre-salt assets to develop. By reducing royalties paid, for example, other companies could invest in exploration and production, thus boosting the region’s economic activity.

This is the current discussion in Brazil. The reduction in the royalty rate paid by oil and natural gas companies in mature fields. It is a possibility that aims to stimulate production and, consequently, economic activity in the localities where these fields are located. Its objective is to enable new investments. But despite goodwill, little has happened so far.

The Brazilian oil industry is undergoing a moment of great transformation with the regulatory improvement that seeks to bring legal certainty to investors. Given the need to revitalize production in mature fields, CNPE, through Resolution 17/2017, delegated to the ANP to grant a royalty reduction, from 10% to up to 5%, on the incremental production of the fields, once a new investment plan. The agency regulated this request through Resolution 749/2018. The measure is expected to promote an incentive policy, via revision of the tax terms, that will help attract investments to brownfield projects, mainly.

To increase oil and gas production in mature fields, governments and operators can use economic and technical options. On the part of governments, policies such as contract extension, economic incentives and regulatory adaptations must be considered. An alternative would be to accelerate the sale of these assets, with Petrobras returning them to the ANP and the agency bidding them on new rounds. Already the operators employ techniques to include tightening the mesh of drilled wells, expanding the use of new recovery methods and technologies and promoting revamps in facilities and / or new production facilities, reducing costs and incorporating new exploratory opportunities, for example.

According to ANP calculations, each 1% more in the recovery factor of mature fields can generate investments of R$ 26 billion. Moreover, according to the ANP, such investments would result in an increase in reserves of one billion barrels of oil equivalent. It is estimated that this additional volume of reserves, when produced, will generate R$ 16 billion in royalties over the years.

A reduction in operating costs due to a lower royalty rate is likely to have a positive effect on revenue as the useful life of the fields increases and they produce over a longer period. In Brazil, the revitalization of the Campos Basin is capable of yielding U$ 12 billion of investments over the next 20 years. With this amount of investment in this period, it is estimated that it will be possible to increase the recovery factor of this basin to about 45%, from the current 14%, with direct effects on job creation and the raising of government revenues.

The economic development provided by the reduction of royalties is of great importance at this time. Brazil has experienced, in recent years, the largest economic recession in its history. The oil industry has been badly affected by the crisis, so the benefits of a tax cut on the oil industry can be a major boost to the economy of the affected municipalities.

As it is a tax incentive, it is important that this proposed reduction in the royalty rate is accompanied by policies to monitor and evaluate its effectiveness. In addition, taking into account the concept of royalties, it is essential to link their revenues to the promotion of investments that benefit socioeconomic development in the locations receiving these resources, considering the welfare of future generations.

Source: Valor