Lecture 4 - After-Tax Cash Flow Models and Taxation

ENCH 687 | ENPE 626
Petroleum Economics
Fall 2018 | Dr. Roman J Shor
Slide pack based on Chapter 4 and 5, M.A. Mian, Project Economics and Decision Analysis,
Vol 1
Calendar Reminders
• Midterm Exam: next class period
• Focuses on material in lectures 1 through 3
• May include DD&A and intangible costs, but not contracts / fiscal systems
• Homework
• This week’s homework will not be graded, instead problems will be posted today, solutions on
Friday
(c) Roman J. Shor, University of Calgary Oct 3, 2018 2

After-tax Cash Flow Models
• Accounting for taxes
• Income taxes
• Payments on Debt and Depreciation, Depletion and Amortization (DD&A)
• Pre-tax cash flow vs after-tax cash flow

Pre-tax and after-tax cash flow
• After-tax cash flows are simply pre-tax cash flows minus any applicable taxes
𝑁𝑁𝑁𝑁𝐹𝐹𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 = 𝑁𝑁𝑁𝑁𝐹𝐹𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 − 𝑇𝑇𝑐𝑐 𝑁𝑁𝑁𝑁𝐹𝐹𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 − 𝐷𝐷𝐷𝐷&𝐴𝐴 − 𝐼𝐼 − 1 − 𝑇𝑇𝑐𝑐 𝑁𝑁𝑁𝑁𝐹𝐹𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 + 𝑇𝑇𝑐𝑐 𝐷𝐷𝐷𝐷&𝐴𝐴 + 𝐼𝐼

Where
𝑇𝑇𝑐𝑐 is the corporate tax rate [fraction]
𝑁𝑁𝑁𝑁𝐹𝐹𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 is the after corporate income tax net cash flow
𝑁𝑁𝑁𝑁𝐹𝐹𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 is the before corporate income tax net cash flow
𝐷𝐷𝐷𝐷&𝐴𝐴 is the depreciation, depletion and amortization
𝐼𝐼 is the interest payment on debt

Calculating after-tax cash flows
1. Calculate the project’s net income by subtracting
• operating costs (OPEX)
• severance
• ad valorem taxes
• depreciation
• intangible drilling costs (IDCs)
• interest on debt
to arrive at the taxable income before depletion.
2. Subtract the allowable depletion allowance to arrive at the taxable income after
allowable depletion.
3. If the taxable income is negative (i.e., there is no tax payment), the loss is carried
forward to the following years.

Calculating after-tax cash flows
4. Calculate the tax liability by multiplying the positive taxable income by the applicable
corporate tax rate.
5. Calculate the after-tax income by subtracting the tax payable from the taxable income.
6. Add the DD&A, less carried forward, and then subtract the
• CAPEX
• loan proceeds
• principal payment on loan
to the after-tax income in step 5 to arrive at the net after-tax cash flow.

Calculations
• After-tax net cash flow projection

Depreciation
• Is a non-cash expense for income tax purposes. It is not a cash flow!
• It is used as a tax deduction to decrease tax liability.
• Definition:
• Loss of value of an asset over time it is being used. This includes:
• Wear & tear
• Age
• Deterioration
• Obsolescence
• The asset may either be a tangible asset or an intangible asset

• Depreciation begins when the asset is placed into service and ends when it is retired.
• The cost of a property is fully recovered when its depreciation deductions are equal to
the cost or investment in the project.

Depreciation
• Tangible Property
• Two main types:
• Real property – land, buildings and anything built or constructed on land. Land by itself cannot
depreciate.
• Personal property – cars, trucks, machinery, furniture, equipment, etc except for real property
• Intangible Property
• Any personal property that has value but cannot be seen or touched.
• Includes copyrights, franchises, trademarks, patents and trade names
• Must be amortized or depreciated using the straight line method

Depreciation
• For a property to be depreciated, it must:
1. Be used in business or held to produce income
2. Have a determinable useful life longer than one year
3. Be something which is subject to wearing out, decaying, degrading, becoming obsolete or
losing value from natural causes
• If repair or replacement increases the value of the property, the cost of repair or
replacement must be capitalized and depreciated.
• If repair or replacement does not increase the value of the property, then the cost of repair
or replacement is deduced as a business expense.

Modified Accelerated Cost Recovery System
(MACRS)
• Tax rules for recovering costs through depreciation deductions.
• Two main systems:
• General depreciation system (GDS)
• Generally used
• Alternative depreciation system (ADS)
• Allows for longer recovery period and uses a straight-line method of depreciation
• Calculation method:
1. Calculate the basis (ie, initial cost of the property)
2. Identify property class and recovery period (based on MACRS rules)
3. Record the place-in-service date
4. Identify the convention period
5. Identify the depreciation method

Depreciation: Property Classes
• 3-year property. This class includes tractor units for over-the-road use and any racehorse more than two years old when placed in
service.
• 5-year property. This class includes automobiles, taxis, buses, trucks, computers and peripheral equipment, office machinery (such as
typewriters, calculators, copiers, etc.), and any property used in research and experimentation. It also includes breeding cattle and dairy
cattle.
• 7-year property. This class includes office furniture and fixtures such as desks, files, safes, etc. Any property that does not have a class life
and that has not been designated by law as being in any other class is also a 7-year property.
• 10-year property. This class includes vessels, barges, tugs, similar water transportation equipment, any single-purpose agricultural or
horticultural structure, and any tree or vine bearing fruits or nuts. e.
• 15-year property. This class includes certain depreciable improvements made directly to land or added to it, such as shrubbery, fences,
roads, and bridges.
• 20-year property. This class includes farm buildings (other than agricultural or horticultural structures).
• Residential rental property. This class includes real property such as rental home or structure (including a mobile home) if 80% or more
of its gross rental income for the tax year is for dwelling units. The recovery period for this property is 27.5 years.
• Nonresidential real property. The recovery period for nonresidential real property is 39 years if it is placed in service after May 12, 1993;
otherwise, it is 31.5 years.

Depreciation

Depreciation

Depreciation

Convention Period
• The half-year convention.
• Used for property other than nonresidential real and residential rental property
• All depreciable property placed in service or disposed of during a tax year is treated as placed in service or
disposed of at the midpoint of the year, regardless of when during the year.
• First, figure out the depreciation for a full tax year using the method you select. Then apply the half-year
convention by taking only half of the total amount calculated for the first year.
• The mid-month convention.

• Used for both nonresidential real property and residential real property
• All depreciable property placed in service or disposed of during a month is treated as placed in service or disposed
of at the midpoint of the month, regardless of when during the month.
• First, figure out the depreciation for a full tax year using the straight-line method for residential rental or
nonresidential real property. Then multiply this amount by a fraction. The numerator of the fraction is the number
of full months in the tax year that the property is in service plus 1/2 (or 0.5). The denominator is 12.

Convention Period
• The mid-quarter convention.
• Can apply to any depreciable property (other than nonresidential real property and residential
rental property) in certain circumstances.
• These circumstances occur during any tax year when the total depreciable bases of your
MACRS property placed in service during the last three months of that tax year is more than
40% of the total depreciable basis of all MACRS property placed in service during the entire tax
year. When that happens, you must use this convention.
• First figure your depreciation for the full tax year. Then multiply by the percentages 87.5%,
62.5%, 37.5%, and 12.5% for the first, second, third, and fourth quarters, respectively, of the tax
year the property is placed in service.

Depreciation Method
• 200% declining-balance method over the GDS recovery period (for non-farm property in
the 3-, 5-, 7-, and 10-year property classes), which switches to the straight-line method
when that method provides a greater deduction.
• 150% declining balance method over the GDS recovery period (for property in the 15and
20-year property classes and property used in farming businesses), which switches to the
straight-line method when that method provides a greater deduction.
• straight-line method over the GDS recovery period used for nonresidential real property
and residential rental property, and, if you elect it, property in the 3-, 5-, 7-, 10-, 15and 20-
year classes.
• 150% declining balance method over fixed ADS recovery periods, which switches to
the straight-line method when that method provides a greater deduction. e.
• straight-line method over fixed ADS recovery periods.

Straight-line depreciation
• Depreciable cost (or cost basis) is equally distributed over the useful life of the asset
𝐶𝐶 − 𝑆𝑆𝑣𝑣
𝐷𝐷𝑛𝑛 =
𝑛𝑛
where,
𝐷𝐷𝑛𝑛 is the depreciation in the n-th year
𝐶𝐶 is the total cost of the asset
𝑆𝑆𝑣𝑣 is the salvage value (a.k.a. residual value, terminal value, scrap value)
𝑛𝑛 is the useful life of the asset

Example: straight-line depreciation
• A pumping unit is acquired for $35,000 and has a salvage value of $5,000 and useful life
of 5 years. What is the straight-line depreciation?

Example: straight-line depreciation
• A pumping unit is acquired for $35,000 and has a salvage value of $5,000 and useful life
of 5 years. What is the straight-line depreciation?
$35,000 − $5,000
𝐷𝐷𝑛𝑛 = = $6,000 𝑝𝑝𝑝𝑝𝑝𝑝 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦
5

Declining balance depreciation
• Also known as the accelerated depreciation method.
• Used if benefits from the use of an asset decline with time.
• Different percentages are applied based on asset
• 200% declining balance (a.k.a. double declining balance depreciation)
• 175%, 150%, 125%
• To calculate:
𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝
𝐷𝐷𝑛𝑛 𝑡𝑡 = 𝐵𝐵𝐵𝐵 𝑡𝑡 ×
𝑛𝑛
𝐵𝐵𝐵𝐵 𝑡𝑡 + 1 = 𝐵𝐵𝐵𝐵 𝑡𝑡 − 𝐷𝐷𝑛𝑛 𝑡𝑡

Example: declining balance depreciation
• A pumping unit is acquired for $35,000, has no salvage value, and useful life of 5 years.
What is the 200% declining balance depreciation?

200%
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 = = 40% 𝑝𝑝𝑝𝑝𝑝𝑝 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦
5
For year one, we can depreciate

𝐷𝐷1 = $35,000 × 0.40 = $14,000
And in year, the cost basis of the pump is
$35,000 − $14,0000 = $21,000

200%
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 = = 40% 𝑝𝑝𝑝𝑝𝑝𝑝 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦
5

Units of production depreciation
• If wear-and-tear is the dominating factor for depreciation, then it may be depreciated
based on units of service instead of units of time
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 − 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 =
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴

Example: Units of Production depreciation
• A drilling rig costs $1.3 million and it is estimated that it can drill 10 million feet in it’s
useful life. After drilling that much, it can sold for $150,000.
• In the first year, it drills 150,000 feet. What is the depreciation deduction?
• In the second year, it drills 100,000 feet. What is the depreciation deduction?

$1,300,000 − $150,000
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 = = $0.115 𝑝𝑝𝑝𝑝𝑝𝑝 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓
10,000,000 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓
𝐷𝐷1 = 155,000 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 × $0.115 𝑝𝑝𝑝𝑝𝑝𝑝 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 = $17,825


$1,300,000 − $150,000
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 = = $0.115 𝑝𝑝𝑝𝑝𝑝𝑝 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓
10,000,000 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓


Amortization
• Costs incurred to start a business (or project) – the capital expenses – may be deducted in
equal amounts over 60 months (5 years) or more.
• Must be paid before active business starts
• Does not include deductible interest, taxes, research or experimental costs
• May be deducted every month (or summed for the whole year)

Depletion
• Gradual exhaustion of the original amounts of resources acquired.
• Only available if there is a legal interest in the oil and gas in place.
• Two methods of calculating
• Cost depletion
𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 = 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 + 𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
• Percentage depletion
• The gross income from the property multiplied by a percentage for each type of mineral. Examples:
• 15% for small producers of up to 1,000 BOE per day
• 22% for fixed contract pricing for natural gas

Example: depletion
• It is estimated that a taxpayer has remaining reserves (net to his interest) at the end of his
tax year of 50,000 barrels of oil. His production share in the year was 6,000 barrels sold at
$18 per barrel. His net taxable income before depletion from the property was $80,000
and the taxpayer’s total taxable income was $450,000. Compute the appropriate depletion
charge for the year. The adjustable bases of the capitalized leasehold costs are $45,000.

Example: depletion
• It is estimated that a taxpayer has remaining reserves (net to his interest) at the end of his
tax year of 50,000 barrels of oil. His production share in the year was 6,000 barrels sold at
$18 per barrel. His net taxable income before depletion from the property was $80,000
and the taxpayer’s total taxable income was $450,000. Compute the appropriate depletion
charge for the year. The adjustable bases of the capitalized leasehold costs are $45,000.
Using Cost Depletion
6,000
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 = $45,000 = $4,821
50,000 + 6,000
Using Percentage Depletion
0.15 6,000 × $18 = $16,200

Intangible Drilling Costs (IDCs)
• US - specific
• May be expensed:
• In the year occurred for US
Independent Producers
• 70% in the year occurred for
Integrated Producers, remaining
30% over 10 years
• Over 10 years in straight line
amortization for Foreign Producers

Intangible Drilling Costs (IDCs)
• US - specific
• May be expensed:
• In the year occurred for US
Independent Producers
• 70% in the year occurred for
Integrated Producers, remaining
30% over 10 years
• Over 10 years in straight line
amortization for Foreign Producers

Example

Example

Example

International Petroleum Economics
• The fiscal regime refers to the financial and contractual arrangements between
companies, stake holders and governments.
• In the United States, mineral rights belong to the individuals or states.
• In the majority of the world, mineral rights belong to the national government.
• Generally, a host government grants a license or enters into a contract with a contractor
for a given contract area.
• A host government may be a country, an oil ministry and/or a national oil company
• A contractor may be an international oil company, a service company, a contractor or a
consortium.
• The terms license, concession, acreage position, lease, and block are used
interchangeably.

International Petroleum Economics
• Host governments enter into these agreements due to:
1. Lack of technological expertise of the national oil company (NOC)
2. Lack of manpower resources to execute a project
3. Availability of risked capital
4. Availability of financing
5. Sharing of risk
6. A need for expansion into new markets
7. A need for the use of patented technology
8. A need for diversification of operations

Typical Structure

Types of Contract Arrangements
• Concessionary systems.
• A.k.a. tax and royalty system.
• Can be for exploration and development or only for development such as enhanced oil recovery
• Production sharing systems.

• Can be for exploration, development and production (EPSA), or it could be for the development of a certain field (no
exploration), which is known as a development and production sharing agreement (DPSA). The combination is also
referred to as EPSA/DPSA.
• If the host government is also a joint venture partner with the contractor, then both partners will pay their proportionate
share of the costs and receive a proportionate share of the revenue.
• The contractor will also share a percent of its share with the host government. The production sharing contract (PSC) is also
referred to as the production sharing agreement (PSA).
• Joint venture contracts
• Service contracts.
• Further classified as pure service contracts and risk service contracts . The difference is primarily based upon whether the
fees are based upon a flat fee (pure) or profit (risk).



Concessionary Systems
• Hydrocarbons extracted by companies belong to the company
• The company pays a royalty and taxes to the host government
• Typical calculation steps:
1. The Royalties are deducted from gross / wellhead revenue
2. OPEX, depreciation, depletion (if allowed), amortization and intangible drilling costs are
deducted from remaining revenue
3. This remaining revenue is called taxable income and is subject to tax deduction. This may be
both at a federal and provincial level.
• In typical contracts, contract terms (including taxes) are fixed for the life of the contract
(25-30 years)

Example: Concessionary System



Example: Concessionary Systems
• A 30,000-barrel-per-year field is developed with a total cost (tangible and intangible) of
$250,000. The operating cost over the productive life of the field is estimated at $120,000
per year. Calculate the contractor and government share if the royalty is 20% and the tax
rate is 35%. Assume the crude oil price of $60/Stb.

Example: Concessionary Systems
• A 30,000-barrel-per-year field is developed with a total cost (tangible and intangible) of
$250,000. The operating cost over the productive life of the field is estimated at $120,000
per year. Calculate the contractor and government share if the royalty is 20% and the tax
rate is 35%. Assume the crude oil price of $60/Stb.
In the cash flow, the tangible costs are depreciated (straight line) over a period of five years. The intangible costs are expensed in
the year incurred.

Production Sharing Systems
• History: first PSA was signed in 1966 between Indonesian NOC and IIAPCO
• Provisions:
• Royalties – not typical, but sometimes range from 8-15% of gross revenue.
• Cost Recovery (CR) – costs are recovered as ‘deductions’ in concessionary systems or as ‘cost
recovery’ in contractual systems. Gross revenue (after royalties) is split into:
• Cost recovery oil. Recoverable costs include:
• OPEX, CAPEX, DD&A, interest on financing, investment credits, abandonment and carried over costs
• Profit oil (PO)
• Profit Oil Split and Taxation

Example: Production Sharing Systems



• Information for a typical EPSA is given in table 5– 6. Calculate the yearly net revenue (net
cash flow) for the contractor and the host government. Assume the price of oil to be
%78.79/Stb in 2011 and $81.15/Stb in 2012.

%78.79/Stb in 2011 and $81.15/Stb in 2012.

%78.79/Stb in 2011 and $81.15/Stb in 2012.

%78.79/Stb in 2011 and $81.15/Stb in 2012.

%78.79/Stb in 2011 and $81.15/Stb in 2012.

%78.79/Stb in 2011 and $81.15/Stb in 2012.

Basic Elements of Production Sharing and Royalty
Tax Systems
• Title
• The title typically remains with the host government
• Management
• The host government typically maintains management control and the contractor is responsible
for execution of the operations in accordance with the terms of the contract
• Type of agreement
• Production sharing, Concessionary system, Risk Service contract, or Joint Venture
• Size, shape and geographic limits of an area to be explored and produced
• Grant of rights
• Specifies depths and/or geologic age
• Oftentimes fluid (i.e. oil only, gas only)

Tax Systems
• Duration of agreement
• First Exploration Period (FEP) – initial period of time to explore and find resources
• Second Exploration Period (SEP), Third Exploration Period (TEP), etc
• Fees and bonuses
• Relinquishment or surrender
• If the contractor is unable to find hydrocarbons, then the contractor may have to surrender the
contract area.
• If the contractor does find hydrocarbons, then the area of the find is kept for appraisal and
development, but the rest of the contract area may have to be relinquished.
• Selection and convertibility of acreage
• Assignment or transfer of acreage, lease or concession

Tax Systems
• Royalty payments, profit sharing, cost recovery
• Investment credit and uplift
• Tax obligations
• Ringfencing
• Restricts cost recovery only to those costs directly associated with the project
• E.g. if a contractor has both blocks A and B, and oil is only found in A, the expenses of B cannot
be recovered from profits from A if the two blocks are ringfenced.
• Domestic obligation (DMO)

• Often a certain percentage of supplies, labor or sourcing must come from the host country
• Employment and training of nationals

Tax Systems
• Equity participation by government
• Financing and technology
• Annual work program
• Work commitment
• Both in the exploration and production phases
• Bonus payments
• R-factor
• Ratio of cumulative contractor revenue after taxes and royalty to cumulative cost. R=1 is
breakeven

Tax Systems
• Sliding scales
• To account for uncertainty, many financial terms may be on a sliding scale, where they are tied
to the average barrels of oil produced, recovery factor, oil price or some combination
• Rate of return (ROR)

Tax Systems

Government and Contractor Take
• Given by:
𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝑡𝑡 ′ 𝑠𝑠 𝑁𝑁𝑁𝑁𝑁𝑁
𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 =
𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝑡𝑡 ′ 𝑠𝑠 𝑁𝑁𝑁𝑁𝑁𝑁 + 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑟𝑟 ′ 𝑠𝑠 𝑁𝑁𝑁𝑁𝑁𝑁
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑟𝑟 ′ 𝑠𝑠 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 = 1 − 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇

Example: Takes
• Gross revenue from a field over its economic life is $500 million. The capital and
operating costs over the project life is $200 million. The contractor pays $129 million in
royalties and taxes to the host government. Calculate the government and contractor
takes for this concessionary arrangement.

Example: Takes
• Gross revenue from a field over its economic life is $500 million. The capital and
operating costs over the project life is $200 million. The contractor pays $129 million in
royalties and taxes to the host government. Calculate the government and contractor
takes for this concessionary arrangement.

Risk Service Contracts
• This, and Technical Service Agreement (TSA), are very similar to Production Sharing
Contracts, with the following differences:
• In a Risk Service Contract, the contractor provides all capital and the government keeps all the
oil if the contractor is successful. The contractor is paid a fee based on production.
• In a Technical Service Agreement, the host government bears the entire cost of the exploration
and development while the contractor is paid a fee.

Efficient Fiscal Regimes
• System B has more components
tied to profitability of the project
(ie, lower royalties but a sliding
scale for production)

Lecture 4 - After-Tax Cash Flow Models and Taxation

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Lecture 4 - After-Tax Cash Flow Models and Taxation

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ENCH 687 | ENPE 626

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• The asset may either be a tangible asset or an intangible asset

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• The mid-month convention.

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• straight-line method over fixed ADS recovery periods.

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For year one, we can depreciate

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𝐷𝐷1 = 155,000 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 × $0.115 𝑝𝑝𝑝𝑝𝑝𝑝 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 = $17,825

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𝐷𝐷1 = 155,000 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 × $0.115 𝑝𝑝𝑝𝑝𝑝𝑝 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 = $17,825

𝐷𝐷2 = 100,000 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 × $0.115 𝑝𝑝𝑝𝑝𝑝𝑝 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 = $11,500

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• Production sharing systems.

• Joint venture contracts

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