Natural Resource Wealth Optimization: A Review of Fiscal Regimes and Equitable Agreements for Petroleum and Mineral Extraction Projects

Abstract

This review highlights the challenges of fiscal system optimization considering both the host government and extraction company perspectives. Countries around the world face an arduous task in determining the optimal fiscal system to maximize the capture of economic rents of natural resource extraction activities. The extraction industry is equally challenged to meet global commodity demand because the capital investments required for developing new hydrocarbon fields and ore mines are on the rise, while tax takes on extraction activities tend to rise too in many frontier jurisdictions. Normal profit must remain for the extraction companies, and returns must be large enough to replace for resource depletion. Companies use the benefits of resources produced in one country to finance capital investments for future field development in another country. One viewpoint is that profits are expatriated to the detriment of the host country and to the benefit of another country or the world supply chain as a whole. Another viewpoint is that all resource holders benefit because a foreign entity always starts in a new resource holding nation by investing in the development of an oil field or solid mineral mine using the profits from previous projects in other countries. A key question is What is a fair taxation regime for natural resource extraction in a particular geological setting and a given geographical location, taking into account subsurface uncertainty about the quality and volume of the resource, infrastructure needs and proximity to the world’s major markets and trade centers? Tax distortion could go both ways: either incentivize, attract and stimulate or des-incentivize, repel and deter resource development. Additional factors to consider are external uncertainties such as political and fiscal stability, sovereign risk and even local weather conditions (mostly in offshore and Arctic petroleum operations). Governments must tax the upstream rents of petroleum and mineral resources, but not to the level that suppresses extraction activities. All stakeholders want at least an equitable share of the profits. Defining what is equitable is a matter of intensive negotiations, renegotiation of prior agreements and sometimes litigation and international arbitration. Several case studies, covering both petroleum and solid mineral extraction projects, are included to highlight the key points involved in fiscal policies designed to optimize the utility of geological resource endowments. For example, the offshore tax regime employed in the US pivots the trade-offs between fiscal incentives and long-term resource supply to ensure energy security. This review concludes with a call for further research.