MARKET dynamics in 2016 and going forward will be very different from 2012 when the federal government announced the existing petroleum policy.

A review of regional fiscal regimes shows that Pakistan is not competitive place for international oil companies (IOCs) nor is it in a position to compensate for its lack of fiscal competitiveness by offering greater proven reserves as that has not been discovered.

Under the prevailing market conditions of cost cutting, layoffs and curtailed exploration activity, IOCs are not interested in prospectivity and geological analogues to oil producing regions that indicate hydrocarbon plays and potential. The oil companies are in a ‘race to be second’ to a frontier oil province, and to attract IOCs, an oil province has to have found the reserves to attract them; such as India has.

And that is a job primarily for the national oil companies (NOCs) to find proved reserves both offshore and onshore. In other words, IOCs will not invest in the offshore potential of the Indus and Makran basins or in Zone 1 onshore unless they see active NOC participation along with proven success.

To illustrate Pakistan’s lack of policy intervention in view of changed market conditions, one could learn from the UK. In order to boost investment and profitability in their rather mature oil basin, Britain last year reduced tax by 10pc, provided a capital expenditure uplift of 62.5pc and committed to invest 20m pounds in new seismic surveys of under-explored regions of North Sea.

In Budget 2016, another 10pc tax cut has been announced while Petroleum Revenue Tax applicable to older fields is being abolished. The UK has also revamped the oil and gas regulation function by introducing a new Oil and Gas Authority which will function as a government company rather than a government department.

Pakistan has not realised the changed petroleum market dynamics and will have to rely increasingly on imported oil and gas to fuel economic growth.

Pakistan has not realised the changed petroleum market dynamics and will have to rely increasingly on imported oil and gas to fuel economic growth

We will now critically evaluate the current fiscal regimes governing the upstream sector in view of their effectiveness and international competitive standing. Pakistan currently has separate contracts for onshore and offshore exploration and production.

The onshore contract, called the petroleum concession agreement, is primarily based on a system of flat royalty, income tax, standard production bonuses and windfall levy along with social welfare contributions. Offshore exploration is governed by a production sharing contract which is based on a phased royalty regime, income tax, a maximum cost oil/gas ceiling of 85pc inclusive of royalty, sliding sharing scale of profits, standard production bonuses, given depreciation schedule and social welfare contributions

To attract foreign investment and exploration efforts into frontier basins such as Zone-1 and offshore areas, the fiscal regime has to be progressive with government tax take responsive to market pricing and overall production levels. Pending detailed financial modelling, based on international experience one can argue that flat royalties as incorporated in the onshore contract are regressive elements and will probably deter investment from coming into the under-explored onshore regions, especially Zone-1 which comprises major areas of Balochistan.

Furthermore, the income tax regime apparently does not allow any special depreciation allowances and is a standard 40pc rate. The Windfall Levy has become almost irrelevant under the changed oil and gas pricing dynamics.

We fail to see any progressive elements in the onshore fiscal regime which would attract oil majors to invest and operate in Pakistan given that recently there have not been any major huge hydrocarbon discoveries. The geology may be impressive but oil majors look for strong evidence of recoverable reserve in the ground before committing capital given the competitionfrom regional high production provinces and upcoming opportunities.

As far as the offshore fiscal regime implemented under the 2012 policy is concerned, the phased royalty regime is probably a correct step, however, given the huge capital spend involved in offshore projects and the particular dynamics of Pakistan’s frontier offshore basins, the unattractive depreciation schedule inhibits the ability of companies to improve initial project cash flow management and makes the basin unattractive from an investment perspective.

Furthermore, production sharing contracts, though very common in prolific producing provinces, are by their very nature regressive instruments and adversely affect the tax takes and investment attractiveness in low price low production scenarios.

We can argue that both onshore and offshore fiscal regimes introduced in the 2012 policy are regressive and unattractive for foreign investors in view of the competitive upstream sectors, changed dynamics of petroleum markets and significantly altered demand and supply situation and international trade flows.

We could also further argue that once the new Iranian petroleum contract opens up, foreign investment interest will further decline in onshore and offshore Pakistan given our acute numbness and lack of policy response to changes in petroleum market dynamics.

However, the Iranian market itself would offer excellent opportunities for Pakistan’s NOCs to expand and grow their businesses and reserves.

The following actions should be taken, among others, as soon as possible by the policymakers to revive the fledgling fortunes of Pakistan’s upstream oil and gas sector:

• Undertake steps to revise the petroleum policy and fiscal regime in light of policies being followed by India and Bangladesh with a view to offer better and progressive terms than both — action for concerned ministry (India does not ask for production bonuses, has no cap on cost oil and companies bid on government’s share of profit oil. Bangladesh offers a production sharing contract where both cost oil and profit oil ratios are biddable)

• Examine the possibility of implementing a resource rent, tax based fiscal regime as opposed to production sharing system by developing detailed deterministic and probabilistic financial models to account for a range of field sizes and market pricing conditions (very successful Australian model).

• Work towards optimising economic rent collection with a view to attracting foreign investment as opposed to maximising economic rent collection measures on paper while repelling foreign investment.

• Engage with NOCs to develop shale exploitation strategy in view of recent USAID report — action for concerned ministry and NOCs

• Participate in upcoming Iranian auction of 18 E&P blocks to enhance exposure to working in international oil provinces as operator or JV partner with a view to taking advantage of prolific oil production zones and low cost operations — action by local NOCs such as OGDC, PPL.

(It may be mentioned here that ONGC Videsh Ltd [India] is negotiating with Iran to develop and invest up to $7bn in the Farzad-B gas field in the Persian Gulf that was also discovered by them in 2008 and contains 12.8 TCF gas reserves.

• Significantly invest in 3D seismic surveys to enhance related data for use by NOCs and IOCs — action by concerned ministry

• Develop effective marketing material, related information memoranda and comprehensive marketing strategy while initiating networking with IOCs to properly present the story of hydrocarbon prospectivity of frontier basins of Pakistan — joint effort by concerned ministry and NOCs

• Work towards developing a locally sourced supply chain for upstream sector — action by NOCs.

mustafa.amjed@gmail.com

Published in Dawn, Business & Finance weekly, April 11th, 2016