Is Kazakhstan's Oil and Gas Tax Regime “fit for purpose” today and tomorrow?
It is not a surprise that the sustainable development of Kazakhstan’s oil and gas industry depends on foreign direct investments (FDI).
One of the major drivers for the attraction of FDI is a simple, fair, and predictable taxation system. In recent years, Kazakhstan has carried out a number of reforms of oil and gas industry taxation aimed at ensuring a reliable inflow of revenues to the state budget. However, such revenues ultimately depend on the long-term health of the oil and gas industry in the country.
The current oil and gas tax regime evolved during a period of rising oil demand, coming primarily from the emerging markets (e.g. China), and a relatively stable oil supply tempered by declines of production in certain areas (e.g. the North Sea). This environment resulted in a sustained rising price trend over the period. By historical standards, this period was unusual. The issue discussed in this article is therefore whether Kazakhstan now has an oil and gas tax system designed for a period that is uncharacteristic of both the past and, therefore possibly, the future. In particular, it appears to be a regime that does not function well when prices are at current levels.
The average oil price from 1946 to 2015 was USD 42. During this period oil prices peaked above USD 100 several times but also declined to close to USD 20 in 1986, after which (with one brief exception), it was range-bound between USD 20 and 40 until 2005. From 2005 to 2008 oil prices rose sharply peaking close to USD 140, and crucially it was during this period that Kazakhstan designed the oil and gas tax system it has today. Since 2008, the price has again subsided and has not exceeded USD 60 since June 2015.The Brent price at the time of writing (14 July 2017) is USD 48.88.
The period since 2014 may in fact be a “new normal” that will last for the foreseeable future. Shale oil production in the USA may put an end to any sustained rise in the price of oil in the medium term since rises in prices stimulate new production there. In the long term, the global consensus on climate change has resulted in many countries aiming to stabilize or reduce their consumption of fossil fuels with long-term implications for demand for oil, and so for oil prices. This situation poses a new level of challenge for Kazakhstan’s fiscal authorities. The question today is whether the current oil and gas tax regime is “fit for purpose” if indeed we are in a “new normal” of oil prices that are range bound between USD 50-70 with protracted periods towards the bottom end of that range.
Since the proclamation of independence in 1991, Kazakhstan has gone a long way in formulating a specific tax regime for oil and gas companies (referred to in the legislation as “subsurface users”):
Stage 1: 1991-2001
The taxation of subsurface users was regulated by the President’s Decree "On taxes and other obligatory payments to the budget" and by a number of subordinate legal acts and tax instructions. The tax regime envisaged two types of contract – regular subsurface use contracts and production sharing agreements. Both regimes were primarily profit-focused with the level of tax burden set during the process of contract negotiation, taking into account all relevant factors.
Taxation regimes were subject to approval (in particular to ensure they were consistent with the legislation in force at the time they were concluded) and were to be set out in detail in each subsurface use contract. The contracts provided for stability of the taxation regime as set out in the contract (so-called “grandfathering”).
Stage 2: 2002-2008
The Code "On taxes and other obligatory payments to the budget", which was introduced in 2001, contained a specific section entitled "Taxation of subsurface users". Generally, all tax instructions were abolished. Moreover, in 2004 the stability of the tax regime for newly concluded contracts was no longer available (while subsurface users operating under previously concluded contracts still enjoyed their stabilized tax regimes).
Stage 3: 2009 onwards
The new Tax Code introduced in 2009 repealed tax stability for almost all subsurface use contracts and the option to sign new production sharing agreements (although previously signed agreements were and are still respected). Consequently, nowadays most Kazakhstan subsurface users fulfill their tax obligations under the current tax regime.
The Aggregate Tax Take
According to the National Report on the Implementation of the Extractive industry transparency initiative (EITI), the contribution of the oil and gas sector to total state revenues in 2015 was 36%, whilst the share in 2014 was 62%. In KZT terms the tax take fell by 46% (this did not reflect the full extent of the USD price fall endured by investors as the KZT weakened against the USD in this period).
Approximately 50 of Kazakhstan’s oil and gas companies out of the 72 that submitted EITI reports for 2015, conduct their operations under the current (non-stabilized) tax regime. While some of the oilfields may be at the exploration stage, the majority of these subsurface users are operating at the production stage.
The illustration below for 2014 and 2015 shows that the tax burden of subsurface users is comprised of the taxes that apply to any business (such as corporate income tax (CIT)), and in addition a set of specific taxes aimed at capturing a substantial share of “resource rental / super profits” that are assumed to exist in this industry (such as excess profits tax (EPT)), the major component (more than 70%) being what we refer to as royalties (such as mineral extraction tax (MET), rent tax, export customs duty (ECD)), though as discussed below it might be more accurate to call them “semi-royalty” taxes.
1 - Here and further in this paragraph the oil prices are in USD of 2015, i.e. inflation adjusted
3 - Published on the official EITI website of the Committee of Geology and Subsoil Use of the Ministry for Investment and Development of the Republic of Kazakhstan: http://eiti.geology.gov.kz/en/national-reports.
4/a> - - Based on the 2014and 2015 data published on the official EITI website of the Committee of Geology and Subsoil Use of the Ministry for Investment and Development of the Republic of Kazakhstan: http://eiti.geology.gov.kz/en/national-reportsavailable. The data for 27 selected subsurface users was used.