Offshore oil and gas
Natural resources, including oil and gas, are often regarded as commonly
owned and, reflecting this, are subject to payments to government in addition
to ordinary taxes on companies. In this chapter, payments directly associated
with the extraction of natural resources are referred to as taxes (in
particular the Petroleum Resource Rent Tax). However, it is questionable
whether these payments should be considered taxes at all. That said, this chapter uses the word 'taxation' to apply to royalties, excise
and the PRRT. In general it will not discuss more general aspects of aggressive
tax avoidance and minimisation as these are dealt with in the previous chapters
and interim reports.
- presents an overview of the oil and gas industry;
- discusses taxation arrangements in the industry, with an outline
of the logic of resource taxation, including excise and royalties, and a
description of the design of the PRRT;
- summarises the outcomes of the system in terms of revenue and
- includes some background on public concern about resource
taxation and information on other reviews of the current system of taxation;
- discusses the issues that arise in the current system; and
- makes some recommendations for change.
Issues regarding the structure and administration of oil and gas royalty
schemes were highlighted in the 2016 Australian National Audit Office (ANAO)
report into the collection of NWS Royalty Revenue. The report found, among
other things, that there are some significant shortcomings in the framework for
calculating NWS royalties and there is a risk of significant errors in the
claiming of deductions.
The Treasurer announced a review of the Petroleum Resource Rent Tax,
crude oil excise and associated Commonwealth royalties on
30 November 2016, to be chaired by Mr Michael Callaghan AM PSM. Mr
Callaghan was asked specifically to:
...lead a review into the design and operation of the Petroleum
Resource Rent Tax, crude oil excise and associated Commonwealth royalties to
provide advice on the extent to which they are operating as intended.
In announcing the review, the Treasurer said:
The review will advise the Government to what extent the [PRRT]
is operating as it was originally intended, and shall address the reasons for
the rapid decline of Australian PRRT revenues. The Government will then refer
to these findings and recommendations to reform the PRRT.
The review dealt with both offshore and onshore operations. It received
77 submissions, which are publicly available on the Treasury website
(under the heading Consultation). The review report was released by the
Treasurer on 28 April 2017—incidentally, the day of the committee's first
hearing on this issue. The report is referred to here as the Callaghan report.
On 30 June 2017 (the last working day prior to the second hearing on
this issue), the Treasurer announced the Government's interim response to the
Callaghan report. Treasury published a consultation paper, Options to address the design issues
identified in the Petroleum Resource Rent Tax Review and invited
submissions from the public by 28 July 2017. The submissions have been published.
The state of the industry
The oil and gas industry is an important part of the Australian economy,
through the supply of energy to households and industry, the investment of
hundreds of billions of dollars of capital, the payment of taxes to
governments, the direct employment of thousands of Australians, and the
generation of significant amounts of export earnings.
It is worth noting that the industry is largely foreign owned, so it
does not pay large dividends to Australian shareholders. It is also capital
intensive, so once the initial construction stages are complete it is not
paying a large amount of wages or payroll taxes.
Oil and gas extraction constitutes about 2.0 per cent of Australia's
GDP. Industry revenue is approximately $34 billion. The decade from 2004 to 2014 saw an unprecedented resources boom in Australia.
In a time of high world prices for minerals and petroleum, there was a huge
inflow of investment funds for exploration and capital expenditure. Many of the
projects begun at that time are now only just beginning to produce oil and gas.
While industry output by volume increased at an average 7.6 per cent a
year over the last five years, revenue for the industry has fallen at an
average of 4.6 per cent a year, in line with reduced world oil and gas prices.
However some industry commentators project growth at over 10 per cent a year in
In recent years, seven plants to liquefy natural gas for
export have come on stream, with a further three in development. Liquefaction
makes export of gas feasible. Liquefied natural gas (LNG) is poised to become
Australia's biggest export. In 2016, LNG was Australia's fifth biggest export.
It constituted 5.4 per cent of exports by value, having grown at an average of
9.6 per cent a year for the previous five years. The value of LNG exports is
projected to increase from an estimated $23 billion in 2016–17 to $37 billion
in 2018–19. Growth in export earnings will be supported by higher export
volumes and, to a lesser extent, higher prices.
Crude petroleum accounted for another 1.6 per cent of exports in 2016,
but it has been falling rapidly.
Of the $34 billion in industry revenue in 2016–17, $28.5 billion (or
84 per cent) was associated with exports. While the high level of
exports is welcome economically, it is becoming controversial in the context of
rising domestic gas prices and fears that there will be insufficient gas to
power Australian industry.
While there are 384 businesses active in the oil and gas extraction
industry, over half of the market is accounted for by five companies: Woodside
Petroleum Ltd, BHP Billiton Ltd, Chevron Australia Holdings Pty Ltd, ExxonMobil
Australia Pty Ltd, and Santos Ltd. BP Developments Australia Pty Ltd, Shell Australia Pty Ltd, INPEX and
ConocoPhillips Australia are also significant players.
Woodside, BHP and Santos are Australian based. The others are foreign
The industry's performance depends on world energy prices and supply and
demand, exchange rates, and the supply of new oil and gas discoveries.
On a much smaller scale is the petroleum exploration industry. It has
revenue of $1.5 billion, and is very dispersed, with no dominant players. The oil and gas extraction industry is its principal customer.
Geoscience Australia states that Australia has approximately 0.3 per
cent of world oil reserves, noting that:
Most of Australia’s known remaining oil resources are
condensate and liquefied petroleum gas (LPG) associated with giant offshore gas
fields in the Browse, Carnarvon and Bonaparte basins. In addition oil resources
are identified in the Perth, Canning, Amadeus, Cooper/Eromanga, Bowen/Surat,
Otway, Bass and Gippsland basins.
The major Australian offshore oil and gas production and exploration
projects are located in the Bass Strait, and off the coast of the Northern
Territory and Western Australia. Onshore projects are in the area where the
borders of South Australia and Queensland meet. In addition, there are reserves
of coal seam gas in several locations, with the furthest developments being in
Queensland. (See Figure 1.)
The exploration stage of a petroleum project typically takes more than
six years, with up to a further 10 years in project development. Production can
last between 10 and 20 years, followed by decommissioning, which in itself is a
major undertaking over several years.
The Gippsland basin in Bass Strait was developed by BHP in partnership
with ExxonMobil in the 1960s. At the peak of production in the early 1980s, the
venture was delivering 10 per cent of total Commonwealth revenue. It now meets
40 per cent of Australia's east coast gas needs. The original fields are still producing but as indicated in Figure 1, the
reserves will come to the end of their life soon. Further projects are being
developed there, including the Kipper Tuna Turrum (KTT) project, which uses
some of the existing infrastructure, and in which Santos has a 35 per cent
share along with BHP Billiton and ExxonMobil. The joint venture is also
undertaking new exploration in the area. There is continuing exploration in the
Otway basin on the western side of Bass Strait.
Figure 1: Major oil and gas
Source: Geoscience Australia, Australian crude oil,
condensate and naturally-occurring LPG resources, infrastructure, past
production and remaining resources
North West Shelf
The Woodside-operated North West Shelf (NWS) Project in the Carnarvon
basin off the north-west coast was for many years Australia’s largest oil and
gas development. It is owned in equal shares by Woodside, BHP Billiton, BP
Developments, Chevron, Shell Australia and Japan-Australia LNG. It was first
explored in the 1970s and developed in the 1980s. It includes the Karratha Gas
Plant and other LNG processing facilities, and exports a large part of its
production to China and Japan.
Oil was discovered on Barrow Island in the 1960s, and it has been the
largest onshore oil field in Australia, operated by Chevron.
The Gorgon gas field is the largest single resource development in
Australia. It started LNG production in 2016. It is a joint venture between
Chevron (47 per cent owner), ExxonMobil, Shell and several much smaller
shareholders. Its LNG plant is on Barrow Island.
The Wheatstone project is 64 per cent owned by Chevron, with Kuwait
Foreign Petroleum Exploration Company and Woodside each holding 13 per cent. It
is a large project with a 30 year life span and began production in October
2017. Most of its product will be exported to Asia.
Woodside developed Pluto from discovery in 2005 to production in 2012.
The gas is piped to an onshore LNG plant. There are plans to increase production.
The Bonaparte Basin is off the north coast of the Northern Territory and
Western Australia. Darwin LNG began production in 2006 and is operated by
Conoco Phillips. Santos was a founding partner. The companies, who own further
exploration permits, are considering (with Origin and others) a multi-field
expansion to keep the plant running. Current reserves will run out in 2022.
The Browse basin is off north-western Australia. It is in very deep
water, so, despite good exploration results, it has been developed later than
The Ichthys project is being developed by INPEX, a Japanese company. It
will involve initial processing in a floating offshore facility. Most production
will then be directly shipped to global markets. Some of the gas will be piped
890 kilometres to onshore processing facility near Darwin. The project
will cost US$34 billion. Production was scheduled to commence in March
INPEX also owns 17.5 per cent of Shell's Prelude development. It will be
serviced by a floating LNG plant—'the biggest ship in the world'. The gas procecced
will be directly exported. It is envisaged that the plant can be used to
exploit other reserves when the current reserves run out. The Prelude project
is also expected to commence production in 2018.
Large coal seam gas reserves have been discovered in Queensland and to a
lesser extent New South Wales. At present the gas is being processed for export
at the Curtis LNG, Gladstone LNG and Australia-Pacific LNG projects in
Gladstone, Queensland. There are also several other proposals for Coal Seam Gas
CSG-LNG plants under consideration for Gladstone and potentially other areas of
Summary—Year of project entry into
The Callaghan report lists projects which are producing or near
The logic of taxes on oil and gas
The characteristics of a good tax system are generally said to be:
- equity—those in similar economic circumstances pay similar
amounts, and those with greater resources bear a greater burden
- efficiency—in terms both of its effect on economic activity
(including stability and certainty for taxpayers) and in terms of the resources
required to administer the tax
- simplicity and transparency
- sustainability—which means that it is perceived as fair, and that
'the structural features of the system should be durable in a changing policy
context, yet flexible enough to allow governments to respond as required'
- policy consistency—within the tax and transfer system and with
the broader policy objectives of government.
Any system of taxation of resources attempts to balance the right of the
owners of the resources—the general public—to a fair return for the finite resources
against the right of the resource developers to a fair return on their risky
investment. The balance is said to be necessary to ensure that exploration and
development continue. This is desirable not only because of the return by way
of resources taxes but also because of the economic benefits of resources activity.
These benefits include direct employment and taxation of profits, and
downstream and spinoff benefits from the activity.
In general, ownership of minerals including petroleum in Australia rests
with governments on behalf of the community. The states and territories own
minerals onshore to the three mile territorial limit, and the Commonwealth owns
resources beyond the three mile limit and in the external territories. Governments impose charges on oil and gas extraction to ensure that the
community receives a benefit from their development. Charges on the extraction
of resources in Australia have historically included specific Commonwealth and
state government taxes.
Conceptually, there are three different ways of thinking about taxes on
petroleum—excises, royalties and resource rent taxes.
An excise can be charged by the Commonwealth on the volume
of the resource extracted. This approximates to the community charging a price
for the resources. It has the advantage of simplicity. It has the disadvantage
that it has to be set at a level where it will not discourage exploration and
development if prices are low, which means that if prices are high the
community will not share in the windfall.
Some variations on excise include an element of price. The Australian
Government imposes an excise on eligible crude oil and condensate production
from coastal waters, onshore areas, and some North West Shelf projects in
Australian waters. Excise liability is worked out by applying the relevant
crude oil excise rate to the volume weighted average price. The first 30
million barrels of crude oil and condensate from a field are excise exempt. The
'relevant rate' depends on factors to do with when the project was developed.
5.40 Royalties are usually based on the value of petroleum
extracted. They can be levied by the Commonwealth or the states or jointly. Onshore
royalties are levied by the states, generally at a rate of 10 per cent of value
extracted. In 1967, the Commonwealth and the states agreed on an Offshore
Constitutional Settlement. The agreement includes a 60:40 revenue sharing of a 10
per cent royalty on the well-head value. Any royalties exceeding 10 per cent go
entirely to the State.
It is possible for the Commonwealth to waive excise in return for a
revenue sharing agreement with a state known as a Resource Rent Royalty.
Currently such an agreement exists only for Barrow Island. The revenue is
Like excise, royalties can be simple. In some cases, however, they are
complicated by the rules governing what can be written off against the value of
production. Because they are calculated without regard to profitability, they
could be a disincentive to investment in marginal projects.
A resource rent tax has a different basis. In economics, a
rent is a profit made over and above the return that is necessary for an
activity to continue. Thus it makes sense to tax rents because the tax will not
distort economic activity. Petroleum prices can vary widely, so it is possible
that any one project in some years is highly profitable and in other years only
breaks even. While excise and royalties are taxes on production, and company
tax is a tax on current profit, a rent tax is a tax on excess (or super)
A rent tax has the advantage of being counter-cyclical: when the economy
is booming and prices are high, the tax taken is high and may dampen production
and investment activity slightly. When the economy is sluggish and prices are
low, less tax is taken and there is less dampening effect from the tax.
How the PRRT works
The Petroleum Resource Rent Tax (PRRT) was introduced in 1987 to replace
Commonwealth excise and royalties in offshore developments. In 2012 it was
extended to apply to apply to all Australian onshore and offshore oil and gas
projects, including the North West Shelf and coal seam gas projects.
It is project based (rather than company based)—although some trading
off among projects owned by an entity is possible. Any entity with an interest
in a petroleum project is liable for its proportion of the PRRT on that
Two or more projects may be treated as a single project if the Commonwealth
Minister for Resources considers the individual projects are sufficiently
PRRT applies to products as they are extracted, and not to value added.
Thus it does not apply to LNG, only to the original gas.
It is levied at 40 per cent of the net revenues (sales receipts less
eligible expenditures) from a project. The basis of this calculation is
somewhat different from, and more generous than, the basis for company tax. The
amount of PRRT paid is deducted from company income for company tax purposes.
Eligible expenditures include exploration expenditure and all project
development and operating expenditures, but some different treatments apply to
these different classes of expenditure.
Closing down expenditures
Closing-down expenditures, including offshore platform removal and
environmental restoration, are also deductible in the year in which they are
incurred. If receipts during the year the project is closed down are less than
the closing down expenditures, a credit is available, depending on whether the
project has previously paid PRRT, for offset against other liabilities owed to
the Australian Government.
Carrying forward unused deductions
Undeducted exploration expenditure incurred after 1 July 1990 is
transferable to other projects with a taxable profit if, at the time the
expenditure was incurred, the projects were held by the same entity. Similar
rules apply in relation to the transfer of expenditure between projects held by
companies in a company group.
In years where eligible deductions are greater than revenue, the
undeducted amounts are compounded annually at set 'uplift' rates. The
compounded amount is then deducted against assessable receipts in the following
year. The compounding with 'uplift' is intended to offset the risk that a
company will not be able to use the deduction.
The uplift rate for exploration expenditure is 15
percentage points above the Australian Government long term bond rate (LTBR),
except that exploration expenditure incurred more than five years before the
issue of a production licence is uplifted at the inflation rate.
The uplift rate for other expenditure, including capital and operating
expenditure, is 5 percentage points above the LTBR.
All exploration expenditure incurred in areas covered by the PRRT is
deductible against all PRRT liable projects held by that entity subject to
compliance with anti-avoidance provisions. In the case of a company in a
company group, the expenditure will be deductible against all PRRT liable
projects held by the group. This ensures that the pattern of exploration is not
affected by taxation arrangements. Non-exploration expenditure is not
transferable between projects.
Where exploration expenditure has been transferred between projects,
compounding is set by reference to the date of the production licence of the
receiving project. If there is more than one project to which exploration
expenditure can be transferred, the expenditure must be transferred to the
project with the most recent production licence.
Exploration expenditure in areas designated as frontier between 2004 and
2008 are eligible for 150 per cent uplift under the PRRT.
There are expenditures that are not deductible. These include financing
costs, private override royalty payments, income tax, goods and services tax,
cash bidding payments and certain indirect administrative costs.
There is an order of deduction for different categories of expenditure.
General project expenditure is deducted first, then exploration expenditure
incurred within the project, closing down expenditure, and finally exploration
expenditure that is transferred from another project.
Royalties and excise payments are credited against PRRT liability.
2012 starting bases
With the extension of the PRRT on 1 July 2012 to onshore petroleum
interests and interests in the North West Shelf project, projects that existed
as at 2 May 2010 (when the new arrangement was announced) were given a ‘starting
base amount’. The starting base is intended to provide a shield against a PRRT
liability in respect of projects that were not subject to the PRRT when they
were established. Once a petroleum interest becomes a petroleum project, the
starting base amount is immediately deductible. Any unused amounts are uplifted
by the LTBR plus five per cent each financial year. Starting base amounts are
not transferable between projects.
Revenue from taxation of oil and gas companies
The Australian Petroleum Production & Exploration Association
(APPEA) has estimated the level of company and resource tax payments made by
the Australian oil and gas industry. APPEA notes that tax payments generally
averaged between $7 billion and $8 billion per annum between 2007–08 and
2013–14 but were lower in 2014–15. It notes that the industry paid $5 billion
in tax in that year even though it operated at a loss because of a significant
reduction in commodity prices and the continued decline in petroleum liquids
This figure has now been updated to a combined loss of $4.5 billion,
with taxes paid of $4.25 billion. Total revenue fell from $29.99 billion to
$23.73 billion. This was partly due to lower prices and lower production, but also included non-cash
depreciation and amortisation costs. These have increased in recent years
because of the massive investment during the boom. One commentator noted:
So operating cash profits were still coming in, even after
interest and tax payments were made. When non-cash depreciation and
amortisation costs are taken out, the industry made an after-tax profit of
$5.11bn in 2015–16, down from $9.83bn in 2014–15 and the lowest since 1999–2000.
The Treasury in its Issues Note for the Callaghan review tracked the
fall in PRRT takings from an average of 0.2 per cent of GDP through the 1990s
and early 2000s, to an average of 0.12 per cent of GDP from 2002–03 to 2015–16,
and around 0.05 per cent over the forward estimates. Crude oil excise
collections averaged 0.05 per cent of GDP from 2000–01 to 2012–13, but
have been declining since and are now very small. Commonwealth royalties have
tracked similarly, from an average of 0.04 per cent of GDP for the period
from 2000–01 to 2011–12 to less than half that now.
There is some volatility in the estimates, because of fluctuating world
energy prices and exchange rates. For example, the estimate of PRRT revenue for
2016–17 varied by $130 million (14.1 per cent) between the 2016–17
Mid-Year Economic and Fiscal Outlook in December 2016 and the 2017–18 Budget in
May 2017; for the estimate of revenue for 2017–18, the variation in the two
estimates (that is, between MYEFO and Budget) was 11.2 per cent.
There has been a change in the mix of production. Resources from older
projects, which had deducted all their expenses and were paying PRRT, are
becoming exhausted. New LNG projects, which have incurred a lot of deductible
expenditure, are now coming on stream, but they are not yet paying PRRT.
Issues in the taxation of oil and gas
Public concern about the level of taxation
The taxation of resources in Australia has been controversial at least
since gold miners' monthly licence fees were a precipitating factor in the
Eureka Rebellion of 1854. The resources are regarded as belonging to the
community at large, but those extracting them have to go to considerable effort
and expense, at risk, before they have any returns that can be taxed. A part of
the solution to the unrest at Eureka was the replacement of the licence fee
with an annual miner's right and the imposition of a tax on the value of gold
Interest in the management of petroleum resources is not confined to
Australia. There is a large economic literature on the 'resources curse' which
suggests that resource wealth can damage an economy directly through
macroeconomic effects and indirectly through corroding its institutions. Some of the interest is more specifically focused on lobbying by the mining
industry: for example, Publish What You Pay Australia is part of a global
initiative campaigning in 40 countries for transparency and accountability in
the mining and oil and gas industries.
Concerns about the structure and operation of oil and gas taxation
schemes in Australia have been voiced by various stakeholders. For example, the
International Transport Workers' Federation (ITF) claims that of the top five
LNG exporters in 2014, Australia has the lowest government revenue from oil and gas (table 1). The ITF released several briefing
papers in 2015 and 2016 that outlined the oil and gas taxation issue.
The ITF notes that, with the exception of the North West Shelf (NWS),
Australia has no royalty payable on offshore oil and gas production in
Commonwealth waters. The PRRT is not a royalty payment but a profit-based tax.
While the tax rate is set at 40 per cent, significant investments in
development and exploration mean that the PRRT is not forecast to collect any
revenue on LNG production for decades.
Table 1: Top Five LNG Exporters in
2014—Government Revenue from Oil and Gas
Rank among LNG exporters, 2014
Oil and gas production ('000 oil-equivalent barrels
Government revenues from oil and gas (US$m, 2014)
Government revenues as % of production values, 2014
1 838 018
1 104 559
Source: International Transport Workers' Federation, An International
Comparison of Australian Government Revenues from Oil and Gas Production,
November 2016, p. 2.
The Tax Justice Network Australia (TJN-Aus) has conducted a sustained
campaign arguing that the industry does not pay its fair share of tax. It too notes the Australian Government's revenue from oil and gas production,
adjusted for volumes, is significantly lower than other large LNG exporters.
TJN‑Aus contends that the PRRT was designed for a very different
petroleum industry, and suffers from design flaws that make it excessively
generous and not fit for purpose in an industry dominated by integrated
gas-to-LNG production. However, even removing opportunities for profit shifting
and incentives for inefficient allocation of capital is unlikely to generate
PRRT revenue for some time given the industry has already accumulated
$238 billion in PRRT credits (see below).
The advocacy organisation GetUp! has also campaigned on the issue of
taxation of petroleum companies. It commissioned academic work, which it
furnished as an attachment to its submission, which suggested that faults in
the design of the PRRT and inappropriate debt loading of Australian operations
meant that petroleum companies were not paying a fair share of tax.
Oxford academic Dr Juan Carlos Boué
has calculated that if Australia had applied the same effective tax rates to
its petroleum resources as did Denmark or Norway, it would have reaped an
additional US$71 billion or US$84 billion respectively in the period 2008–15.
Dr Boué concedes that the
cost structures are not identical—unit costs are actually higher in Denmark—so
the comparison is not simple. But he suggests that the onus of proof should be
on those who suggest the comparison is not reasonable.
Several submissions have pointed to the revenue effects of the PRRT
arrangements. For example, the Community and Public Sector Union, referring to
modelling by forecasting group Macroeconomics, said:
There is a growing and widespread acceptance that Australia
did not receive the full benefit it should have from the recent mining boom and
this mistake should not be repeated. The CPSU notes modelling that shows if
Australia had used the windfall from the mining boom to create a sovereign
wealth fund, it would now have a $290 billion dollar fund.
Various commentators have argued that the benefit Australia gets from
its oil and gas is too little. On the other hand, Dr Craig Emerson, one of the architects of the original tax,
I think the story has been a pretty good one. I calculate
that over its lifetime petroleum resource rent tax has collected around $33
billion for the people of Australia.
To some extent the question of taxation of the industry has been seen in
the context of domestic price rises and threatened shortages resulting from
over-ambitious export contracts.
Compliance with the PRRT
The Australian Taxation Office reports that compliance with the PRRT is
very good. This is consistent with the view in the industry that the tax is well designed
and functions well:
For 30 years, the Commonwealth's approach to taxing the oil
and gas industry has been based on some fundamental and, we think, pragmatic
principles. It is more efficient and, over the life of resource projects, more
lucrative to tax profits than production. Giving investors confidence they can
achieve an appropriate risk adjusted rate of return will maximise investment
and therefore, over time, tax revenues. Once projects recover their costs,
achieve appropriate returns, resource taxation can be applied at far higher
rates than a crude royalty or excise without deterring investment. In a
nutshell, the most effective approach is to tax heavily economic rent rather
than tax lightly production.
Similarly, companies support the tax:
From Woodside's perspective, the PRRT is operating as
intended, delivering $200 billion worth of projects and a fair return to
Australians for their resources, ensuring projects are developed, jobs are
created and taxes are paid. The current regime has supported, and continues to
support, the development of economically challenging projects. Under more
onerous fiscal settings, these projects would likely not be developed...
Dr Juan Carlos Boué
agrees that the PRRT is working as it is designed to, but is less sanguine:
...the alarming downward trend in petroleum fiscal revenues
that has featured so prominently in Australian public debate of late...is not
necessarily a consequence of tax avoidance and optimisation practices... Rather,
the paltriness of the fiscal receipts that the Australian government is
currently getting (and is likely to get in future) in connection with the
exploitation of the country’s hydrocarbon resources should be seen as a design
feature of the Australian fiscal regime currently in force...[It] is producing
exactly the sort of fiscal outcomes that it was designed and intended to
produce, and will continue to do so in the future unless the Australian
government changes tack by radically overhauling this fiscal regime.
Design of the PRRT
Issues of the design of the PRRT have been canvassed thoroughly in the
Callaghan report and in submissions to that review as well as to this inquiry.
It is beyond the capacity of this inquiry to deal with them in detail. What
follows is a high level summary which attempts to explain the dimensions of
Deductions: uplift rates
Undeducted expenses are carried forward with an 'uplift factor'. For
project expenses, the uplift factor is the long term bond rate (LTBR) plus 5
per cent; for exploration expenses, it is the LTBR plus 15 per cent. As a
witness observed, this means that the value of undeducted exploration expenses
can double in four years.
The original rationale for the uplift factors was to compensate the
companies for the risk that they would not be able to use the deductions. However, there was some ambiguity at the time the tax was introduced. Uplift factors are understood by the sector as a compensation for the riskiness
of the industry. For example:
The principle is that the companies need that assurance, if
you like, that there is a reasonable risk adjusted rate of return on the costs
that they have accumulated, because there is a very long payback period, so for
many years the costs that you have incurred are not recovered, so they are carried
forward. To ensure that there is that risk adjusted rate of return available to
the businesses, there is an uplift factor applied...The compounding rate is there
to, in fact, reflect the risk of the activity.
The idea that companies should be protected from risk is contested by
the Uniting Church:
The [Justice and International Mission] Unit’s concern is
that it makes the community share the risk with the corporations no matter how
badly they manage their exploration activities. Many other businesses take
risks and if they fail and make no profit, then they have to carry their loss
as there is no profit to claim deduction against. It is unclear why it is so
important that gas corporations be able to get tax deductions for all
exploration activities, no matter how poorly conceived or carried out.
Exploration costs are also transferable between projects within a
company or group. This further reduces the risk that the deductions will not be
used—although it can also mean that the deductions are used earlier, instead of
This transferability of exploration deductions is one of the
factors that is holding PRRT payments down now, but one positive out of it all
is that it is helping take the deductions out of the system before they
continue to compound and can hold down and lower future PRRT payments.
Transferability has become more significant in the light of the starting
bases created with the 2012 legislation (see below).
Order of deductions
The order in which expenses are deducted can make a big difference to
tax liability. As a project comes on stream and generates profits:
...the general order of deductions is that you deduct own
project expenditure first and then when you become cashflow positive you have
got a PRRT liability. But if you have exploration in other projects then that
transfers to that profitable project to be deducted and, under the rules, it
transfers to the project with the most recent production licence that is
Thus the deductions with the highest compounding rate can be kept for
There is a large stock of deductions that will be acquitted ahead of
PRRT payments. It has increased very rapidly recently, from $18 billion in 2011–12
to $188 billion in 2014–15 and $237 billion in 2015–16. A good part of the
increase is due to the extension of the PRRT to the North-West Shelf and
onshore projects. The deductible expenditure includes royalties and excise
already paid and past exploration expenditure, as well as starting base
expenditure. Of the total, almost half are non-transferable to other projects,
although they can be carried forward at the relevant uplift rates.
There has been a good deal of criticism that the starting bases
allocated to existing projects being drawn into the PRRT in 2012 were too
generous. The starting bases began with the market value of the projects,
including the value of resources: this was a proxy for capital costs. They were
calculated at a time when the oil price was high, so they were very large. In
effect they mean that the North-West Shelf and the onshore gas projects will
not pay PRRT, unless the oil price increases dramatically.
One reason for the generosity of the starting bases was the need to
allow for the fact that onshore projects would still be subject to state
government royalty charges. It was not intended that projects would pay both
royalties and PRRT.
There is an anomaly in allowing the project valuation, including the
value of the resources, as part of the tax-free starting base, since the value
of the project includes the future income stream from the resources and it is
thus by definition PRRT free, even if it generates an otherwise taxable profit
after royalties. The Callaghan Report says:
The review’s modelling confirms that transitioning projects
are not expected to pay PRRT under existing arrangements even at average oil
prices of $US100 per barrel to 2050.
Gas transfer pricing
Gas is usually converted to LNG in an integrated operation. The PRRT is
levied on the value of the unprocessed resource. This cannot be the sale price,
as it is the LNG that is sold. This means that a notional point of transfer and
a method for attributing a price have to be identified. This is a highly
The consultation paper released on Friday on options to
address the design issues in the PRRT notes that numerous parts of system are
opaque. For example, there is no transparency on how the gas transfer price is
Similarly, Mr Lance McCallum from the Australian Council of Trade Unions
expressed concern regarding how the gas transfer price is calculated:
To further increase the transparency of the PRRT, we think
that the value and calculation method of wellhead gas should also be made
public and that the current practice, where prices are calculated behind closed
doors and where there is no market really to compare with these is
The method currently used is the residual pricing method. Dr Diane Kraal
of Monash University has summarised the calculation as follows:
- Downstream: uses the Net Back method to determine a gas
price. A price is calculated by taking the LNG sales price and multiplying by
gas volumes, less downstream costs that include the liquefaction plant. The net
result is divided by gas volumes.
- Upstream: uses the cost plus method to determine a gas
price. A price is calculated by adding all upstream costs from the wellhead to
the boundary of the liquefaction plant, and dividing by gas volumes.
- The final step is to add together the calculated gas
prices from upstream and downstream, and divide by two to derive the ‘gas
There appears to be agreement that gas is being undervalued for tax
purposes and the issue needs to be addressed:
...the gas transfer price method as
prescribed by the PRRT regulations should be put under scrutiny. The gas
transfer price method is flawed, leading to an underpayment of PRRT, thus
disadvantaging the community.
Mr Michael Callaghan warned that this could entail a significant change
to how the tax works:
The arrangements that have been developed
under the PRRT now for the gas transfer-pricing point are very complex. Looking
at them, the conclusion is that they do need to have another hard [look] at [them]
to ensure they are consistent with getting this equitable return. But the
nature of those changes could be very substantial in terms of the impact on the
Dr Diane Kraal discusses the gas pricing mechanism in some depth. She
concludes that the current method, the residual pricing method, should be
replaced by the net back method. This would start with the LNG price and deduct
the costs that had been incurred. It would be simpler and more transparent. She
suggests that this method should be applied to all gas extracted in future, not
just that from new projects. This is the method that is used in the North West
Shelf royalty calculation.
A central theme in the development of the PRRT is the balance between a
proper return to the community and maintaining incentives to discover and
develop Australian resources. In particular, arrangements for uplift and
transferability of deductions were intended to reduce risk and encourage
That is the very reason that we say transferability of
exploration is important for Santos. It gives us an incentive to explore and we
are able to recover that exploration in other projects.
There was a huge investment in resources in the period 2002–2012, which
resulted in big deductions to be carried forward. However, Mr Graham Salmond of
BHP observed that although the deductions regime appears generous there is in
fact little current investment in exploration, and this does not bode well for
the future of the industry:
We talk about the attractiveness of some of the uplifts and
the transferability associated with exploration. While it may appear attractive
on the face of it, it is not actually attracting exploration activity, which is
It is possible that transferability creates a distortion such that firms
already in the PRRT system actually have lower costs than newcomers, and this
could deter some exploration by new participants in the industry.
The impact of the design of the tax, which smooths the effects of
commodity prices for the firms, could be to encourage production which was not
timed to deliver the best return for the community:
The [Justice and International Mission] Unit fears the
current design of the PRRT is to stimulate exploitation of Australia’s
non-renewable oil and gas reserves as soon as possible, rather than across a period
of time when the return to the Australian public would be greatest. Based on
the best available long-term predictions of demand for natural gas and natural
gas pricing, the PRRT appears to dud the Australian public in favour of foreign
Designed for oil, not gas?
The original design of the tax was for oil projects, which are very
profitable for a relatively short period. Today's major projects are gas
projects, which have longer lives but smaller profits. This makes a difference
to the existence of rents:
The PRRT was designed for the oil industry. If you look at
the production profile of oil, it spikes up and that is where the secondary
tax, the PRRT, comes in. It grabs the super-profits. That is the nature of the
production profile of the oil industry. With the gas industry, it is a flat
production profile. There are no spikes and, generally speaking, there are no
It also magnifies the impact of the uplift factors:
Why the change in the industry is very important is oil
projects are not as capital intensive. They have much faster turnaround
periods, so they become cash positive a lot quicker. The uplift rates are not
as significant in determining how much and when PRRT is paid. When you move
into the world of gas, it is much more capital intensive. The size of the
investment is much larger. These projects can go over a decade. It can take a
long time before a project becomes cash positive and would start to pay PRRT...Over
that long period, the size of the uplift rate, the size that the deductions are
being augmented each year can compound and can have a significant impact on how
much PRRT is going to be paid.
Excise and royalties
The Callaghan Report examined excise and royalties, although, as a
witness to this inquiry remarked, there had been less attention to that part of
the report. This is despite total excise and royalty payments generally being higher than
PRRT payments. Crude oil excise revenue is no longer separately reported in the Commonwealth Budget
papers. The royalty payments largely go to the states.
Crude oil excise is levied by the Commonwealth on condensate from
onshore projects. It may be in addition to state royalties on the same project.
It is not applied to gas (although royalties may be). The amount of excise
varies depending on when the oil was discovered. Generally, there is a
threshold quantity of oil which may be extracted before excise is payable.
Several submissions suggested that a Commonwealth royalty would be a
useful addition to the Commonwealth taxing regime because of the certainty that
it will be collected. It could then be deducted from PRRT if any became
otherwise payable. Dr Diane Kraal proposes that royalties be applied specifically to
natural gas-to-liquids projects as a partial solution to the problem that the
tax was designed for oil rather than gas.
Mr Jason Ward, spokesperson for the Tax Justice Network Australia, noted
Most of the companies involved in the new offshore LNG
projects are already paying a 10 per cent royalty. In fact, Chevron's
submission may unwittingly make the most compelling argument for extending a 10
per cent royalty to new offshore LNG projects. Chevron's submission shows that
the royalty and excise payments from its one-sixth interest in the North West
Shelf have produced more than 5½ times as much revenue as it has paid in
corporate income tax over the last seven years.
Dr Craig Emerson argued that imposing a royalty would create sovereign
risk, and also be a disincentive to future investment:
...the application of a royalty effectively reduces the price
that the investor gets for continuing to extract the gas then that means they
are not maximising the resource rent, and the whole genesis of the resource
rent was in response to these distorting taxes that lead to disincentives for
exploration and development and the full recovery of the resource.
Administration of the taxation of
oil and gas
The PRRT relies on companies involved to keep their own records and make
their own assessment of tax liability. Some submitters and witnesses suggested
that the self-assessment of the tax left it open to abuse. For example, Mr Ward
The opportunities for transfer pricing in this situation are
phenomenal. This system, the PRRT system, is based on self-reporting and
voluntary compliance—so, I am determining what the price is at this point
before I run the gas through my manufacturing process. If I am a company and
looking to reduce my tax liability, I am going to say that this is a worthless
product that I took out of the ground and that all of the value is created in
my manufacturing process.
Mr Ward even suggested that it made compliance 'voluntary':
There is a complete lack of transparency in the whole PRRT
system. It is self-reporting and voluntary compliance.
However, a spokesperson for the ATO pointed out that self-assessment is
a normal part of the tax system:
Under the self-assessment regime, which now applies to all
income tax returns from everybody in this room in their individual capacity,
all the way to the largest taxpayers and indeed to the PRRT, the base of the
self-assessment regime is that people will take due care in preparing their
returns and lodge returns. If they are uncertain, they have access to a ruling
system, to ask for rulings before they lodge. Equally, with the benefit of not
having the ATO do a full assessment on your return before you lodge it, the ATO
has the ability to review the return after lodgement, and if you have made
incorrect statements to levy appropriate penalties as well as late-payment
It is worth noting that an Australian National Audit Office reported on
the conduct of the ATO's external compliance assurance process pilot. It
concluded that the process for large business taxpayers:
...was conducted effectively and demonstrated the potential for
better client experiences, cost reductions and increased efficiency, by
satisfactorily verifying factual matters in company tax returns.
There was also a good practical effect of self-assessment in that the
amount of tax was owing from when a return was lodged, rather than from the
date of the ATO's assessment. In any event, because there are so few firms
involved, the ATO has a close relationship with them which is effectively the
same as assessment:
[There are] so few taxpayers that it is possible for us to
have a very detailed, one-on-one relationship with each of the significant
participants in the industry. So we do not struggle in obtaining information.
Industry representatives similarly spoke of a close relationship with
The relationship we have with the tax office is real time and
it requires us to raise issues of technical or administrative uncertainty. We
address them at the time. The tax office is fully aware then of our tax profile
and our tax affairs, and that negates the need for audits of prior transactions
because we have dealt with them in real time.
One observer noted that the fact that most projects were owned and run
by joint ventures increased the level of transparency:
...it is perhaps easier for the ATO to be confident that it is
being administered kind of correctly, just because the degree of suspicion
amongst the joint venture operators is enough to ensure that the information is
there for the project operator and, therefore, for the ATO.
The change in the industry from oil to gas has had an impact on
administration. For oil projects, the period from the beginning of exploration
to liability for PRRT is relatively short. For gas projects, it can be 10 years
between the incurring of expenses and the need to report them. This can create
problems in the accuracy of reporting and the possibility of auditing.
Publish What You Pay Australia observed that it was hard to find out
just how much tax was being paid, and that the public was entitled to better
information in order to be able to assess the system of taxation. It further
argued that any rules about transparency should be aligned with the European
Union and Canada, so that comparisons can easily be made.
North West Shelf Royalty
The Australian National Audit Office (ANAO) was highly critical of the
Department of Industry Innovation and Science's role in the administration of
the North West Shelf Royalty regime. DIIS is responsible for collecting the
royalty, which is then shared with Western Australia, with the Commonwealth
retaining about a third of the revenue.
The ANAO found that there was no formal agreement as to the respective
responsibilities of DIIS and the Western Australian Government. There was no
comprehensive procedure manual. There were shortcoming in calculating the
royalties, and the meters that were relied on had not been properly tested.
Deductions had been allowed without proper checking, and some deductions that
were claimed were not in fact allowable.
Prospects for change
Greenpeace Australia Pacific distinguishes between changes in taxation
of companies already in the system (which it does not object to) and measures
which it argues subsidise the discovery and exploitation of further fossil fuel
Aspects of the PRRT, including the uplift rates for
exploration, constitute a clear subsidy. Australia (along with all other G20
countries) has committed to ending fossil fuel subsidies.
The Callaghan Review proposed a number of changes to the PRRT regime.
The proposed changes were divided into two groups: those that would alter the
design of the tax, and procedural rules. The former group includes changing the
uplift rates, the order of deductions, the rules for transferability, and the
gas transfer arrangements. The latter group is concerned with such issues as
rules for combining projects and lodging single returns, and when companies
should start lodging annual returns.
Essentially, the first group of recommendations would make the biggest
difference to the tax liability of companies. The Callaghan Report proposed
that these should apply only to future projects, while the second group could apply
to all projects. Mr Callaghan told the committee:
...with the fiscal risk of these things investors need to have
confidence in the way the government is setting the tax regime—it is well
designed, it is coherent and it is set on a coherent, comprehensive basis. One
of the concerns of fiscal tweaks is that once a government starts to tweak
things, they are trying to tweak things to get more money and an investor will
ask when it is going to stop—there are going to be more tweaks...[A]rbitrary
tweaks...can really influence an investor's confidence in a country.
Dr Craig Emerson similarly argued that the uplift rates were perhaps too
high but could not be changed for existing projects.
...[The uplift rate] was very much a reflection of the
perceived riskiness of petroleum exploration in Australia. I think it would be
damaging to investor confidence to just put a line through that for
pre-existing investments. But for investments in the future it may warrant a
reconsideration, and perhaps reducing that to the bond rate, plus 5 per cent.
There has been a huge flow of investment funds into Australian oil and
gas on the basis of the existing tax regime. It is often argued that that
regime cannot be changed for existing players. To do so would be to breach
trust, and to increase the level of sovereign risk which Australia is perceived
to present. Dr Malcom Roberts, Chief Executive of the Australian Petroleum
Production and Exploration Association, argued:
To date, we have compensated for high costs with low
sovereign risk. Retrospective changes to our tax regime means high sovereign
risk. We cannot hope to attract investment and jobs as a high-cost, high-risk
BP Developments Australia pointed out that:
Investments in this 'wave' [of investment in 2006–2017] were
supported based on, amongst other things, Australia's stable fiscal terms and
the understanding these would essentially apply over the life of the projects.
The prospect of any material change would therefore cause alarm given the scale
of recent investment.
More specifically, examples of the results of tax changes in similar
jurisdictions were recounted:
There is research linking the decline in economic activity
and the loss of investor confidence in both Alaska and Alberta to adverse
changes in taxes specific to the oil and gas industry.
However, Mr Ward was sceptical of these arguments:
While some companies have suggested that changes to the tax
regime will deter future investment, this is a scare tactic to preserve the
status quo, which is overly generous to the industry and short-changing
Australians...Even with the extension of a 10 per cent royalty to new offshore
gas, Australia will continue to have one of the most generous fiscal regimes in
the world for the oil and gas industry. The extension of a royalty to these
five offshore LNG projects does not fundamentally change the economic returns
on these projects over their long life spans.
Dr Diane Kraal gave a historical example:
Put it this way: go back to the Whitlam government, which
introduced excise. Oil prices were at record levels and the Australian
government needed to get a share of those super profits. The Fraser government
came in and carried on the excise—not only that, but increased it—and the
companies kept coming. The oil kept being extracted. Bass Strait has been very
successful, as have other oil projects...both governments wanted a decent return
for the Australian community. You could say that is the sovereign risk situation,
but investment continued.
Clearly, there will always be an interaction between the competitiveness
and the stability of the tax system:
...it is important to distinguish between having a competitive
tax regime versus other jurisdictions which have similar resources, as well as
sovereign risk, which is often used to describe the effect on future investment
if past rules are changed—the view being that it would affect future investment
at a general level of uncertainty in the country. I would say that I rarely
hear the phrase 'sovereign windfall' when laws change the other way...
Not surprisingly, views on how real and how important is the risk
involved in changing policy depend on the interests of those holding them.
The committee notes the importance of the oil and gas industry and the
goals of taxing resources: to give the community a fair return on the resources
which belong to them, and to encourage—or not discourage—investment in
The committee further notes the broad range of work recently done in
this area, and particularly the Treasury's Review of the Petroleum Resource
Rent Tax, the submissions to it and the Treasury's subsequent consultation
The committee stresses that it is important that the government deliver
on its commitment to an equitable return on petroleum resources, and notes the
long time that has elapsed since the announcement of the Callaghan Review. As
such, the committee is particularly disappointed that the 2018–19 Budget did
not contain any measures relating to the PRRT, as the government has had the
findings of the Callaghan Review for over 12 months and the subsequent Treasury
consultation process was due for completion by the end of September 2017.
The committee believes that there is a broad consensus among
non-industry players that the arrangements surrounding the PRRT are too
generous. It notes the possibility that compounding of deductions can
completely offset potential revenue.
The committee endorses the direction of the Callaghan Review's
recommendations. In particular, it concludes that:
- uplift rates should be lowered
- the ordering of deductions should be rationalised and
- the residual pricing method should be scrutinised.
The committee agrees with the conclusions of the Callaghan Review, that
changes are necessary but that, in order to maintain certainty for the sector,
they should apply only to future projects.
The committee notes that the ATO already maintains close contact with
companies in the PRRT system. It believes that consideration should be given to
establishing a specific body, possibly within the ATO, to monitor
administration of the PRRT, and to ensure that the self-assessment processes
work appropriately. Whatever arrangements are in place, it is essential that
they be adequately resourced.
The committee notes the arguments for a royalty on all projects. It sees
a good deal of merit in them, but believes that a properly functioning PRRT, in
conjunction with the base erosion and profit-shifting measures discussed
elsewhere in this report, would meet the objectives of ensuring the oil and gas
companies appropriately contribute to government revenue.
The committee recommends that the government finalise and release its
response to the Callaghan report into the Review of the Petroleum Resource Rent
The committee recommends that the government overhaul uplift rates for
future Petroleum Resource Rent Tax eligible projects, so as to make them less
The committee recommends that the ordering of deductions be rationalised
for future Petroleum Resource Rent Tax eligible projects so that those with the
highest compounding rates are used first for tax deduction purposes.
The committee recommends that the gas transfer pricing method for Petroleum
Resource Rent Tax eligible projects be reformed to make it simpler and more transparent
so as to ensure that it delivers a fair return to the community.
Senator Chris Ketter
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