Executive Summary
1 Combinations of Incentives
This report summarises the conclusions reached by the MED project group in the course of evaluation possible combinations of changes to the royalties regime.
2 Options
The project team has considered three options:
Option 1| | Gas% | Oil% |
| AVR | 1 | 5 |
| APR | 10/15 | 10/15 |
Option 2| | Gas% | Oil% |
| AVR | 1 | 1 |
| APR | 20 | 20 |
Option 3 - Combined with Relaxation of Ring Fencing| | Gas% | Oil% |
| AVR | 1 | 5 |
| APR | 20 | 20 |
3 Reducing AVR
The reduction in AVR on its own will not have a significant impact on project economics and therefore would not be expected to positively influence the amount of exploration occurring in New Zealand. The most significant influence on project economics occurs where the APR is reduced or deferred.
4 Reducing the APR Rate
It is possible to positively discriminate in favour of gas production, by reducing the royalty rate for gas only. However, this distinction would require far more prescriptive rules in terms of cost allocation. It would therefore require greater audit and negotiation resources within Crown Minerals. It would be far more straightforward to reduce the rate across the board but to prevent the reduction being of open-ended application by providing that the lower rate applies only so long as total volume or revenue does not exceed a threshold amount.
A lower APR rate potentially has a more material impact on project economics than a lower AVR rate, though the relative significance of each measure will vary across projects. For example, in this report we present a comparison showing that the relative significance of reductions in the AVR and APR rates depends to some extent on field-specific features. For our sample offshore project, an APR reduction has a broadly equivalent impact to the selected AVR reduction. However, for our onshore project, the value impact of a lower APR rate is around three times the value impact of a reduced AVR rate.
5 Deferring APR
The removal (or relaxation) of the exploration cost ring fencing rules is one means of deferring the APR royalty, while at the same time ensuring that, to get the benefit, the producer must incur additional exploration expenditure. There are a number of design features that can be adjusted. The most favoured features appear to be:
- restricting deductibility to future costs only;
- allowing the deduction of exploration costs in calculating an APR liability on any future (but not existing) discoveries;
- applying an interest adjustment to carried-forward exploration costs; and
- allowing a deduction for exploration costs incurred anywhere in New Zealand, irrespective of the location of the discovery against which the costs are deducted.
These features were favoured as they appear to minimise any discrimination in favour of current producers and potentially adverse effects in terms of distorting exploration decisions.
6 Revenue Implications
It is not possible to accurately assess the aggregate revenue impact of the various proposals, either in present value terms or on a year by year basis. Any estimates rely critically on assumptions about future exploration activity, oil and gas prices and the characteristics of as yet undiscovered fields. However, in this supplementary report, we do provide some illustrative calculations, which point toward an annual revenue cost (in present value terms) of no more than $30m over the period during which any package remains in place. We emphasise, however, that this estimate is very imprecis.
Ernst and Young Limited
May 2004
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