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New oil-sharing deal to earn Kenya extra Sh50b in Turkana fields

BUSINESS
By Paul Wafula | April 25th 2016

Kenya has moved to shield itself from having to pay taxes for oil companies ahead of the much-anticipated commercial production of the liquid gold.

The new oil production-sharing model tips the scales in favour of the country and removes some of the clauses in the previous model that would have seen oil companies produce oil at a great advantage.

A report by civil organisation group Oxfam projects that the 2015 Model Production Sharing Contract will see the country earn at least an extra Sh50 billion from the Turkana oil alone.

“The 2015 terms would generate an additional $500 million (Sh50 billion) for the Government over the life cycle of the project,” the report released this week read in part. The report, Potential Petroleum Revenues for the Government of Kenya, authored by Don Hubert, looks at the implications of the proposed 2015 Model Production Sharing Contract (PSC).

The new model will also see Kenya shift the burden of paying taxes to the oil companies instead of the previous model where the country was to pay the taxes on their behalf from its share of oil revenues.

“The second main change between the 2008 and 2015 models relates to the applicability of corporate income tax,” the report dated March 2016 notes. The report argues that some analyses of Kenya’s petroleum fiscal system had mistakenly identified corporate income tax as an independent revenue stream for the Government. “If this were accurate, the impact would be a 30 per cent tax on company net income. However, the 2008 model PSC, as well as the signed PSC in the public domain, are clear that corporate income tax is paid on behalf of the company from the Government’s share of profit oil,” it notes.

The first significant difference between the 2008 and 2015 fiscal terms is the way in which petroleum production is shared. As is the case in most production sharing systems, oil is first allocated to allow the operator to recover its costs.

This is referred to as cost oil. What is left becomes profit oil. “Once the ‘cost oil’ has been allocated, the remaining “profit oil” is split on a sliding scale between the company and the government,” the report read in part. Under the terms of the 2008 model contract, profit oil is allocated based on the volume of production. This traditional approach for allocating profit oil is commonly referred to as “daily-rate-of-production” (DROP). For instance, unless the terms of Block 10A change, the Government would receive 55 per cent of production for the first 10,000 barrels of oil per day (bopd), while the company receives 45 per cent.

Tullow Oil was the owner of Block 10A in Marsabit but has since surrendered the block to the Government. For production exceeding 10,000 bopd up to 40,000 barrels of oil per day, the split changes to 60 per cent for the Government and 40 per cent for the company.

“One important objective of fiscal regime design is securing a higher proportion of after-cost revenues for the Government as profitability increases. While easy to administer, this traditional sliding scale is based on volume of production has begun to fall out of favour, as there is no relationship between production volumes and profitability,” the report notes.

It argues that small projects with low costs can generate high profits, while large projects with high costs may not generate much profit at all. The 2008 model contract however includes a “windfall tax” specifically designed to capture additional revenue when the price of oil rises.

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