Petroleum development projects. Concept selection, taxation and recovery rate

Abstract

The paper models and discusses important dimensions when choosing development concept for petroleum projects, and the consequences it has for recovery rate and project economics. By means of case analysis, optimal concept selection is analysed from the perspective of oil companies and government, accounting for the difference in evaluation metrics. While government has emphasis on net present value, a key decision criterion for oil companies is breakeven price. There are two reasons why oil companies select development concepts that are suboptimal from a government perspective: 1) to attain a low breakeven price (capital rationing), a cheaper development concept is often chosen; and 2) conservative resource estimation is often applied. Underinvestment leads to low recovery rate. When oil companies are inclined to select suboptimal development concepts, it is optimal for government to combine cash flow tax and uplift. An uplift enhances marginal investment incentives and could also remedy the incentive for postponement inherent in the breakeven price decision criteria. Our topic, the effect of tax design on development concept and thus extraction ratio is generic, it applies also to the mining sector.