CHAPTER 10 GOVERNMENT TAKE IN PACIFIC RIM MINING AND PETROLEUM DEVELOPMENTS: THE PAPUA NEW GUINEA EXPERIENCE

• Jurisdiction: United States

International Resources Law: A Blueprint for Mineral Development
(Feb 1991)
CHAPTER 10
GOVERNMENT TAKE IN PACIFIC RIM MINING AND PETROLEUM DEVELOPMENTS: THE PAPUA NEW GUINEA EXPERIENCE
Thomas L Reiner
Thomas Reiner & Co.
Port Moresby, Papua New Guinea

INTRODUCTION

GOVERNMENTS PERSPECTIVE

Aims and Objectives

The development and extraction of mineral and petroleum resources involves the exploitation of non-renewable resources.

In weighing up the costs against benefits of developing a particular resource governments are required to consider more than the financial bottom line. Sometimes the costs and benefits of a project are difficult to quantify in purely financial terms. On the cost side there is environmental degradation, social dislocation, the loss of the resource for the benefit of future generations and in some instances this can lead to political difficulties for the government of the day.

On the benefits side governments consider factors such as job creation, infrastructure development, build up of foreign exchange reserves, training and experience gained by their nationals and the maintainance or attainment of economic independence and sovereignty. Historically governments have used a variety of means to achieve their aims with varying degrees of success. These range from simple income taxation with no special treatment of resource extraction activities to the old form of concession agreements where a resource project was an enclave development that was in some cases virtually outside the sovereignty of the host state.

The primary aim of any government is clearly to maximise the benefits and to minimise the costs. What investor companies sometimes fail to appreciate is that governments think of such costs and benefits not only in purely financial terms but in terms of economic, social and political costs and benefits as well.

[Page 10-2]

Means to Achieve

Governments over the years have adopted various means to achieve their aims and objectives.

To achieve the financial benefits the methods have included:

(a) income taxes;

(b) resource rent taxes such as:

(i) taxes based on profitability e.g. additional profits taxes; and

(ii) flat rate taxes based on production irrespective of profitability such as royalties;

(c) production sharing contracts where the Government or more usually its nominee share the production of a resource development. These types of contracts are more common in the oil than in the mining industry;

(d) other taxes including:

(i) stamp duty;

(ii) customs duties, levies and excise taxes; and

(iii) land rates;

(e) licence fees and registration charges;

(f) equity in the project whether such equity is free or paid for out of the government's share of production or paid for up front;

(g) auctioning off prospective areas to the highest bidder either for cash or for work commitments;

(h) rents on exploration acreage and land used in production;

(i) concession agreements that used to be common in

[Page 10-3]

developing countries, but have virtually disappeared as a result of efforts by these countries to exercise sovereignty over their own affairs; and

(j) use and service charges where the government provides the infrastructure and charges a fee for the use of the facilities.¹

Other areas seen by the government as beneficial but not necessarily of pure financial benefit, are:

(a) creation of employment. This is usually high on the priority of any government. Resource industries are however normally highly capital intensive and although a large mining project may employ several thousand people, a petroleum project usually will not once the development is completed;

(b) information. Increases in geological and geophysical information by maximising expenditure on exploration;

(c) spin off industries. In order to develop their own capital base and expertise governments like to see as much of the spin off industries as is reasonably possible owned and operated by their own nationals. Examples of such industries are transport, catering, housing, construction and maintenance of roads and equipment, provisions of consumables;

(d) promotion of overall industrial development;

(e) provision of infrastructure; and

(f) training and "localisation" of the work force.

The Governments of various host nations use various combination of these means to achieve their economic, social and political aims.

[Page 10-4]

COMPANY PERSPECTIVE

Aims and Objectives

A resource company's primary aim is of course the generation of profit. The first step is the location of a resource in commercial quantities. Clearly the most important factor is geology. If the resources are not there, no amount of incentives will attract the explorer or developer. Even if the resources are present, the tax regime has to ensure a fair return on the investment given the high risks associated with exploration. Sometimes companies are prepared to forego immediate profits in return for the generation of long term goodwill and opportunities but generally speaking, the primary responsibility of management is to provide a good return for its shareholders. The other important consideration is security of the investment an important component of which is a rapid return of the funds invested.

Of the matters that are of primary importance to an investor the following are probably the most significant:

(a) Security of Tenure

Investors normally require good title to the property. This is not only important for the obvious reason but because without it, financing is difficult and project financing is likely to be impossible;

(b) Investment Recovery

Rapid recovery of investment is one of the most important factors affecting the investment decision. In the final analysis any company, no matter how big, is at the mercy of any sovereign government no matter how small. The longer the delay the greater the risk of a change of government or change of the rules. Another reason for this desire even ignoring the political or country risk is market risk. Minerals and Oil are commodities subject to sometimes dramatic price variations;

(c) Reasonable Freedom of Operation

No company or business enterprise likes to be buried in a sea of red tape and bureaucratic delays. Such delays are expensive and frustrating. Sometimes a country that may appear attractive in theory is considered simply too hard to do business in. Companies take the view that they are the experts in their own field. They do not like their

[Page 10-5]

decisions second guessed by civil servants or being told how to run their business;

While some regulation is obviously necessary for reasons of national security, the protection of the environment, minimum safety standards and to prevent adverse affects on other nearby operations, companies like to have and usually insist on a reasonable amount of freedom;

(d) Financial and Political Stability

The predictability of the financial and political regimes are crucial to the investor and their financiers. If the regime is unpredictable, an investment decision is difficult. If a decision to invest is made in a risky environment, the profits have to be higher to make up for the increased investment risk; and

(e) Tax Considerations in Home Country

Tax benefits in home country (e.g. credits and deductions) can be of crucial importance particularly in the exploration stage. Tax benefits in the country of operation are clearly important, but are not of much use if there is no taxable income to off-set them against. Many developing host countries have gone to great expense and have taken a lot of care to ensure that their regimes are creditable in the home country of potential explorers.²

Means To Achieve

Over the years companies have used many means to try to achieve their aims, ranging from seeking protection from their own governments by the "gun boat" diplomacy of the 19th century to a whole range of measures that have included:

(a) legislative entrenchment;

(b) enforceable "commercial" contracts;

(c) recourse to International arbitration;

[Page 10-6]

(d) political risk and other insurance;

(e) involvement of international organisations (e.g. IFC, and ADB's newly established equity investment arm); and

(f) passing as much as possible of the risk on to financiers through project financing.

CONCISE COMPARATIVE ANALYSIS OF THE DIFFERENT APPROACHES ADOPTED BY HOST COUNTRIES

Introduction

Most of the countries in the Asia Pacific region that have significant mineral or petroleum resources were at some stage in their history subject to colonial rule. In most cases the colonial rule was overt, in some cases it was a certain degree of economic domination. Governments generally had less control.

The host government had little bargaining power and the concession agreement created a virtually autonomous enclave that was sometimes outside the host country's legal regime. There was a payment of royalty but otherwise the companies extracting the resource had a free hand. The host country had little if any control or say in the running of the operation, or control over who came in or out of the enclave and hence its territory.

With decolonisation, this state of affairs was unacceptable to the host countries who wished to regain full sovereignty and control over their own affairs, often for reasons that went beyond mere financial considerations.

During this process numerous regimes of regulating industries and dividing the benefits evolved.

While the variety of regimes is considerable, for petroleum they can be, albeit very roughly, placed in two categories. These are the production sharing and the non-production sharing regimes.

The classes of course overlap and there are numerous features that are common to most regimes which fall completely outside the classification.³

[Page 10-7]

In minerals the risks, the timing of returns and even...