Romania´s petroleum tax regime is under review, with lingering uncertainty about its future design. The article discusses strategic considerations of this review, in light of the country´s expected (but equally unclear and overdue) long-term energy strategy. It argues for stronger incentives for exploration and sustained levels of investment in field development, where the Norwegian incentive structure could be of inspiration.
Domestic production – the cornerstone of Romania´s supply security
Despite a relatively low degree of energy import dependence among European peers, Romania needs to strengthen its energy security, and this is likely to become the key focus of the country´s upcoming energy strategy. An unchallenged way to strengthen supply security is diversifying import routes and supply sources, as well as modernising the country´s ageing energy infrastructure. However, the dream of “energy independence” hinges rather on a combination of energy efficiency and growing domestic energy supply.
Energy efficiency makes most sense to pursue (economic competitiveness, lower environmental impact), but it is most difficult to achieve. Most EU member states struggle to meet their energy efficiency targets, even with good governance. Apart from low-hanging fruits in some energy-intensive industries, Romania is unlikely to improve its energy efficiency significantly, due to low project implementation capacity and subsidised energy prices for residential users. The recently approved national plan for energy efficiency is unambitious, vague, and makes for disappointing reading. Energy demand is likely to rise only slightly less than the economy.
This implies that energy self-sufficiency relies on new domestic energy supplies – both fossil and renewable. There is large potential in rising renewable energy supply, particularly biomass, but the last years´ boom was not sustainable and future medium-term additions are likely to be limited. Therefore, the key contribution to a sustained low degree of energy import dependence will have to come from domestic oil and gas production.
Tough task: production increase in mature provinces, in a low-price environment
All of Romania´s onshore oil and gas provinces are mature and resources in current fields nearly depleted. During the past decade, high oil prices barely triggered sufficient investment to stabilise production from many small old fields and to put into production a few new ones. Against the background of rapidly rising oil demand, particularly for transportation, imports increased considerably and the trend is likely to continue in the medium term.
Natural gas demand has been falling for many years, roughly in line with supply, as inefficient industry restructured to meet liberalised prices and residential demand for heating fell due to mild winters. There is limited scope for further reduction in demand as residential prices liberalise, and likely rising demand on the medium term, in industry and power generation (where it should contribute to replace old, inefficient and polluting coal-fired generation, much of which is to shut down over the next decade). Unless modern exploration reveals new domestic oil and gas resources, Romania will gradually join the ranks of its neighbours to import most of its energy needs.
At a time of relatively low global oil prices and falling gas prices, oil majors are slashing their exploration and development budgets and smaller producers find it difficult to finance new activity. All over the world, there is hardly any investment in small petroleum finds, in marginal or declining fields. Focus is on low-cost petroleum provinces, streamlining to develop the largest/cheapest discoveries and hoping to find new giant fields in new promising areas. Enhanced oil recovery from some existing fields is also on the agenda, but not in the terminal stages of field decline, which are often expensive.
From a global and even European perspective, Romania is not at all an attractive petroleum province anymore, not even with its tentative offshore discoveries. Currently, the only positive outlook is the gradual liberalisation of gas prices, which increases the profitability of gas producers, incentivising and financing their investments in stabilising, even increasing conventional gas output.
Attracting the necessary scale of investment in the Romanian oil and gas sector, i.e. exploration for new reserves and life-extension of existing fields, will be extremely difficult. State-owned companies do not have the necessary technology or capital to drive the process and there are few international major or even mid-sized companies interested in the Romanian plays. This is particularly true for unconventional resources.
In February 2015, Chevron announced its decision to pull out of Romania, after unsuccessful exploration for shale gas in the Vaslui and Constan`E>a counties. Exploration results are secret, so it is difficult to assess how much the decision is due to the quality of the reserves and how much to the international oil and gas price context. In any case, it is unlikely Chevron will come back anytime soon, and almost as unlikely that any major comes in their stead.
It remains to be seen whether ExxonMobil sticks to the appraisal-drilling programme for its offshore concessions in the Black Sea, or defers/drops these in the near future, as well. Prospec`E>iuni S.A., a leading exploration company with long experience in Romania, sees a stable pace of exploration in 2015, but markedly fewer orders from next year on. Should the oil prices remain only slightly above the current breakeven price in mature Romanian plays, estimated at about $50/barrel, it is unlikely this outlook changes.
I turn now to the opportunity to use the petroleum tax review to boost domestic oil and gas production on the medium-to-long term.
Striking the right balance with the petroleum tax review
There may be a silver lining to the delayed petroleum tax review in Romania, which could have set in stone high taxation for the next decades, in line with a high price environment, and ring-fenced Romania against any significant petroleum investments once the prices fell. It is now possible to design a smarter, more flexible system, which incentivises exploration and development even in a low price scenario. Some lessons could be learnt from the Norwegian system, which is adapted for a mature province, despite considerable differences from the Romanian situation.
From the outset, it should be underlined that the current petroleum tax system is well suited for upholding production at the myriad of small old fields scattered around Romania. For current onshore fields, the system could remain largely unchanged, with regard to both the overall level of taxation and differentiation between fields according to their size, flow and age. There is discussion of different taxation regimes for onshore and offshore fields, but it may also be possible to design a hybrid system that works for fields both onshore and offshore.
Either way, it is necessary to incentivise exploration for new reserves. This can be achieved in several ways:
- Use part of the additional income from the gas producers´ profits (perhaps in connection with the gas price liberalisation) to finance/contract initial oil and gas seismic exploration throughout the country, with the most advanced available technology and seeking higher depths, at a steady pace. At current oil prices, prospecting and drilling is more affordable, so it is a good time to use the global idle capacity while it is available. The results should be made publicly available for free, or against a low administrative fee. If there is potential in some plays, this should elicit sufficient interest for exploratory and appraisal wells from current and new licence holders. The remainder of the “windfall tax” should still be allocated to support vulnerable gas users weather the liberalisation.
- Appraisal drilling is risky and expensive. To incentivise it, the petroleum tax review could provide for a partial reimbursement of exploration cost to companies in a non-taxable position (i.e. as long as they are running a loss, which is carried forward with interest at the risk-free rate). This should incentivise new players to enter Romania and drill for new resources in the most promising plays.
Once commercial reserves are found, the petroleum tax system could shorten the lead time to production and make marginal fields profitable. Again, inspired from Norway, this could be achieved in several ways:
- Drop the royalties and shift to a profit tax at a higher level than the current corporate tax level. The higher level could be set in a similar way as the current royalty level, depending on the size, flow, age and location (onshore or offshore) of the field. The profit tax would apply to individual fields/plays, rather than the entire corporation, requiring more detailed accounting and hence a higher degree of transparency from all players. All expenses would have to be deductible to a high degree, so there is a risk of pushing up production cost level. However, companies would be less reluctant to invest if they can also deduct their expenses from the current “royalty” pot.
- Allow for fast, uniform depreciation of all production equipment, such as Norway´s six-year straight-line method. Faster depreciation will incentivise a faster pace of large investments to take place, particularly offshore and at higher depths, where one requires expensive, advanced equipment.
The above suggestions should be modelled in a variety of price and finds scenarios, in order to stress test the impact on budget revenues from petroleum activity in Romania. Some of these incentives may prove too risky or expensive for the state, and it may be appropriate not to implement them. Nevertheless, the assessment should also include the cost of continuously falling domestic production and higher import dependence. Once oil and gas prices rebound as the cycle turns, which will certainly happen eventually, high import dependency for oil and gas would exact a high cost on Romania´s rate of growth, due to above average energy intensity.
While the world is still addicted to fossil fuels in the 21st century, Romania could design the petroleum tax system now to kick-start a domestic “golden age” of exploration. This would probably be a last dash for finding and potentially using up Romania´s oil and gas reserves, while there is still a market and a decent price for them. It is also possible to remain unaware of their existence, leave them in the ground, and import to cover domestic needs. With proper diversification, energy imports do not have to undermine security of supply, and may even keep the domestic environment pristine, but such a path would be expensive, damage trade balance and reduce employment in a traditional sector of the Romanian economy.
Dragos Tâlvescu is an EPG affiliated expert
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