Taxation and Arctic Resource Development
Two recent developments have called attention to the role that taxation plays in oil and gas exploration and development in the Arctic. First came announcements by BP and ConocoPhillips of significant new investments in Alaska’s North Slope in response to the state’s recent reduction in oil taxes.1) Second came the decision by Statoil to delay its planned investment in the Johan Castberg field in the Barents Sea after the Norwegian government announced an increase in the tax rate on oil and gas producers.2) The prevailing interpretation of these events, plain to see in the headlines, is that tax increases stifle investment while tax decreases encourage development and exploration. While these maxims are partly true, a closer look at the similarities and differences between these two examples reveals that taxation is only one of many important factors that shape investment decisions such as these in the Arctic. While taxation will continue to play an important role in shaping Arctic energy development, this role should not be exaggerated.
First, let’s look at the Alaskan example. On May 21 Alaska Governor Sean Parnell signed into law Senate Bill 21. The bill, the result of lengthy deliberations in the Alaska legislature, seeks to correct the perceived deficiencies of the last adjustment to Alaska’s oil tax regime, the Alaska Clear and Equitable Share (ACES) Act which was passed in 2007 during the governorship of Sarah Palin. ACES established a 25% baseline tax and a progressive surcharge on net profits pegged to the price of oil. Under ACES, as prices rose, the state took a higher cut in taxes, approaching and exceeding 75% at high prices.3) ACES provided various credits, particularly aimed at increasing production in new fields. In spite of these credits, investment in the North Slope continued to lag and production declines continued. Industry complained that progressive surcharges severely limited upside profit potential on large projects, thus discouraging investment.4) Without significant investment, production levels were in danger of falling below 500,000 barrels a day, a development which would cause significant problems for the Trans-Alaska Pipeline.5)
The purpose of Senate Bill 21 was to establish a more attractive climate for investment on the North Slope. The bill did away with the progressivity of ACES and set a flat rate on oil profits at 35%, placing the total government take (including federal income taxes) at around 60-62%.6) The bill also sought to correct perceived imbalances in ACES subsidies and credits for new investment. ACES provided credits of up to 60% of the cost of production, but only on new fields outside of existing North Slope units.7) This acted as a disincentive for production improvements for existing fields. The new tax bill extends these credits to new developments within legacy fields, encouraging new investment that will increase efficiency and production at these fields. Will the bill have the intended effect? Both BP and ConocoPhillips announced new investments at legacy fields, rather than in new fields.8)
On the surface, Norway suffers from some of the same problems as Alaska: falling production from legacy fields and expansion into new fields in remote locations like the Barents Sea that require significant investments to bring on-line. Both Norway and Alaska depend heavily on oil and gas revenues. Oil and gas taxes make up between 80 and 90 percent of Alaska’s general fund budget on a yearly basis.9) While oil and gas revenues make up a smaller portion of Norway’s government revenues (26% in 2012), these revenues remain essential for funding the country’s generous welfare programs.10) There are, however, significant structural differences between the two countries’ approaches to the oil industry. First, Norway does not charge royalties on oil and gas while exacting higher overall taxes through corporate and production taxes, which together yield a 78% government take.11) Second, Norway derives additional profits from oil and gas through its 67% interest in Statoil and through participation in offshore oil and gas projects by state-run Petoro. All of Petoro’s revenues from shares in particular leases are either reinvested or transferred to state coffers.12) Third, Norway’s declining crude oil production has been tempered somewhat by increased production of natural gas which has continued to buoy revenues.13) Alaska is also rich in gas, but plans for a pipeline to bring North Slope gas to market have not come to fruition due to high costs, and the state’s production has languished.14)
Norway’s recent modifications to its oil and gas taxes were much more modest than Alaska’s, and reflect both different objectives and differences between Norway’s tax structure and Alaska’s. Norway intends to enact a 1% increase in the tax on oil company profits while at the same time balancing that with a 1% decrease in its corporate tax rate.15) Norway’s decision to raise taxes was not driven by the need to develop more revenue, or to stop exploration and development of new fields (though that may be a second-order impact), but rather to correct an economic imbalance brought about by continued growth of the oil sector in comparison to Norway’s other industries.16) The oil sector dwarfs Norway’s other industries in share of GDP (23%) and total exports (52%).17) This can tend to crowd out other industries by distorting the labor market, monopolizing investment and driving inflation. By raising taxes on the oil industry while dropping them on other sectors, the government hopes to cool the oil sector and provide more breathing room for non-oil sector growth. Norway’s tax decision, then, is driven by macroeconomic concerns, and not narrowly by concerns with oil production.
The industry’s response to the tax reforms in Alaska and Norway was swift and predictable. Oil majors that had lobbied heavily for tax reform in Alaska welcomed the new law. BP and ConocoPhillips announced new investments focused on increasing production at legacy fields on the North Slope,18) through skeptics say the timing of these announcements was more political than anything. And the controversy over the new law is far from over: a petition to submit the new law to a state-wide referendum is on track to collect the required signatures by 13 July.19) In Norway, Statoil announced that the 1% tax increase would cause it to rethink its development plan for the Johan Castberg project in the Barents Sea, though once again taxes are only part of the story. Statoil is still uncertain about resource estimates for the field and delays in development of shore-based infrastructure to support the project.20) In both cases, it is difficult to separate out what is political posturing on the part of industry and what the actual impact of the new tax rates will be.
A final and somewhat intangible element of the ongoing debate on oil and gas taxes in Alaska and Norway is the importance of a stable and predictable investment climate. Industry obviously likes stability as it allows them to more accurately predict the costs and revenues of large projects that can stretch over many years. The fact that a government can choose to modify tax rates at any time adds an element of risk and uncertainty. The larger and more long-term the project, the more the risk. A prominent industry critique of Norway’s tax increase is that the government’s decision to tweak tax rates undercuts the country’s reputation for a stable investment environment.21) While stability is certainly an important factor that investors must consider, it is also difficult to quantify and highly subjective. While Alaska’s oil tax reforms were much more radical than Norway’s, we heard little from the oil industry about how Alaska’s reforms undercut a stable and predictable investment environment.
What does all this mean, if anything, about the future of oil and gas development in the Arctic? First, these recent events show that the factors impacting development decisions in each Arctic state are diverse, highly contextual, and politically charged. Taxation and its relationship to overall fiscal policy is an important factor but hardly the only factor. However, because the development of Arctic resources will in the near term be characterized by high investment requirements and narrow profit margins, small changes in tax policy have the ability to make or break individual development projects. Second, political decisions on taxation will be made based mostly on factors that are in some senses exogenous to the issue of Arctic energy development. As such, it is important to understand the role that national and regional fiscal policies (and the politics that drive them) play in encouraging or inhibiting Arctic energy development. Third, the elephant in the room remains tight oil and gas. As unconventional resource extraction continues to expand around the globe, tight oil and gas plays are presenting more attractive investment opportunities for major oil companies and competing for a limited pool of global investment funds. Statoil has made significant investments in tight oil and gas development in Australia and the US, and is exploring similar opportunities in China and Argentina.22) The additional downward pressure on resource prices will continue to affect calculations on Arctic energy development in places like Norway and Alaska. Though taxation remains an important factor in shaping these calculations, it remains one among many and we should be careful not to exaggerate its influence. It is the complex interaction of all these factors and not one alone which will determine the course of Arctic energy development.
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