Special hydrocarbon tax: comments on the Act

On 25 July 2014 the Parliament adopted the Special Hydrocarbon Tax Bill. Its introduction will have significant effects on Poland's petroleum industry, in particular on the infant shale gas exploration industry.

In economics, theoretical Laffler curve is used to determine the relationship between rate of taxation and the government budget revenues from the taxes. According to that theory, the is an optimal rate of taxation at which tax revenue are the highest. If the rate is too low or too high, tax revenues must fall.

The latter case is of particular interest, as it explains the fact that higher tax rates do not necessarily translate into higher budgetary revenues. This is due to the fact that the higher government take, the less taxpayers are willing to raise their revenues and, consequently, taxable income tend to diminish. That mistake was made by the authorities of Alberta Province (Canada) where oil and gas industry slumped following the imposition of excessively high tax burdens. Therefore, it is important to apply appropriate fiscal tools so as to not prevent unconventional gas production before it has really started.

At existing oil/gas prices and geopolitical situation of Poland, it is vital to find new supply sources of these commodities. Unconventional oil and gas resources may help to diversify the supply, provided that their production is commercially viable. Only then international companies would commit the required expertise and funds to capital projects in Poland.

Today, domestic companies hold about 1/3 of all unconventional gas exploration concessions, but due to insufficient investment and technical capacity they are unlikely to play a leading role in the future. According to Energy Research Institute, all Polish oil & gas companies combined are capable of funding only a few percent of the projects that are required for an assessment of shale gas resources.

It should be emphasized that oil and gas industry bears significant investment risk, which in Poland is exacerbated by the following two factors: poorly investigated geology and uncertainty as to the future legal and fiscal framework. In order to address these two factors, the Parliament has adopted a legislative package intended to encourage companies to speed up exploration efforts while regulating all issues that are associated with that process.

The Bill is based on the assumption that the existing rates of the tax on energy mineables do not generate adequate revenues to the government budget and, therefore, they must be higher. The maximum level of the tax levies on hydrocarbon production was set at 40% with the introduction of two new taxes: on extraction of new mineables and a special hydrocarbon tax. The rates of the former tax are set at 3% and 1.5% of the value of natural gas and at 6% and 3% of the value of the oil produce, respectively for conventional and unconventional hydrocarbons. The rates of the special hydrocarbon tax are to range from 0 to 25% of the profit and will depend on the revenue to cost incurred ratio. The two aforementioned taxes are to be charged since 2020. According to legislator, this should encourage the companies to invest as soon as possible.

There are also other fiscal and quasi-fiscal levies in Poland. Limited liability and joint stock companies pay corporate income tax at a rate of 19%. Moreover, labour costs (which are not among the lowest in Poland), royalties, concession fees and real estate tax should be considered.

According to oil and gas industry experts and insiders, these fiscal charges have been set at an excessively high level and are unrealistic. The Parliament has adopted the Bill, but it is uncertain whether unconventional hydrocarbons will be ever produced. Poland's resources are still to be proved and drilling efforts have not yielded any spectacular results. Five years have passed since the first exploratory wells have been drilled, but none of them is commercially viable. Instead, there is a set of various fiscal tools for an industry that is still to emerge.

Quite probably, international companies will go to the countries that offer lower charges, as Poland is not the only one with shale prospects. U.S. companies have already expressed interest in the UK, Argentina, Brasil or China. Are the new laws on fiscal charges a blow to the competitiveness of Poland on the global market? It would be reasonable to set the rates at an initially low level as “an incentive”, and to increase them as soon as the tax base is there.

A positive aspect of the new law is that it may mitigate uncertainties as to future tax system, enabling  realistic estimates of return on exploration projects in Poland and allowing five years of tax breaks to the companies so that are able to assess the real gas potential of Polish shales.

It is extremely difficult to set a proper tax rate. Tradeoffs should be made between the desired revenues of the government budget and potential geopolitical gains from diversification of oil and gas supply sources. The interests of investors, especially international ones who possess necessary expertise but are profit-motivated and allocate capital globally, must be taken into account.

However, the signal that government profits are a priority has been just released.

author: Wojciech Labuda - Drilling, Oil and Gas Faculty, AGH University of Science and Technology in Krakow, Law and Administration Faculty, Warsaw University, Warsaw School of Economics. This paper is author's comment on Paweł Musiałek's article "Gaz łupkowy - jakie podatki i kiedy je wprowadzać"

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