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Hot TopicOil & Gas Tax Update

January 2013

Nothing is certain: changes in tax and fiscal regimes

are reshaping the way investors and companiesevaluate oil and gas investments

Despite the uncertainty in the current global economic environment, the continued

imposition of tax on income from oil and gas operations remains a certainty. The scope,

impact and makeup of such taxes, however, are far from certain, especially in a global

environment of constantly evolving tax and fiscal policy.

Over the past five years, oil and gas investors, international and national oil companies,

and sovereign and other governmental funds have ventured and are expected to continue

to venture into new markets, both established and emerging. The reasons behind this

trend include, in part, geographic and resource diversification, the discovery of significantreserves, and improvements in technology that have made and will continue to make

previously unrecoverable reserves now economically recoverable. Further, relatively high

oil prices and a decoupling of natural gas prices (and, in certain countries, a natural gas

demand that is exceeding local country supply), have prompted numerous investors to look

outside of their home countries for energy sources, either for pure supply reasons or as a

hedge on future commodity prices, or both.

With the globalization of investment has come an increased emphasis on global tax policy

and regime changes and the impact such changes can have on investments. Globally,

various countries have introduced or are contemplating to introduce changes in the way

oil and gas operations from exploration and production to retail operations are taxed. This

is being done to support the broader economic objectives of the country as well as, in

certain circumstances, to taper or otherwise reduce certain tax incentives for oil and gasexploration and production operations in an effort to subsidize renewable or other green

energy sources. Further, the global tightening of environmental standards and an increased

awareness of the sustainability of oil and gas as a primary fuel and energy source have

prompted a change in the way lawmakers think about tax policy. However, this is not new, as

energy tax incentives, and the methods employed by various countries to shrink or expand

such incentives, have undergone a substantial transformation over the past 20 to 30 years.

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So what does this mean for todays investor or for a company looking to invest either

domestically or globally or for an investor or a company that already owns oil and gas

assets domestically or globally? Anticipating and managing tax risks and changes in the

way oil and gas investments are taxed requires companies and investors to be proactive

in tax planning and in the evaluation of investments, both current and prospective. It

also requires them to be educated about the current and potential tax and fiscal regimes

that could affect or have an impact on such investments, and be vigilant in choosing the

right tax advisor with the experience, resources, and global reach to be properly apprised

of potential tax changes and the impact of such changes on current or prospective

investments.

This article highlights the potential effects of changes in tax law, identifies certain proactivemeasures that investors and companies investing in oil and gas assets should consider, and

discusses trends in the general oil and gas sector and fiscal regimes.

Changes in tax law can affect all facets of an investment and ongoing

operations

Tax changes and policy shifts can dramatically affect investments in oil and gas assets and

ongoing oil and gas operations. For example, a change in tax rates, an additional tax, a

modification of an existing tax or an elimination of a tax incentive could have an impact on

the following:

Any change in applicable tax law, even a slight change, could have a material impact on

the rate of return of an investment or operation.

Cash distributions to stakeholders could be negatively affected or a change in tax law

could result in an increased tax liability, which would generally result in less cash available

for distribution to stakeholders.

A change in tax law that negatively affects the balance sheet could have a material

impact on funds available for operating expenditures (payroll, maintenance, etc.), as well

as funds necessary for future capital expenditures and development programs.

Cash available to establish reserves or to service debt may be negatively affected by a

change in tax law that can impact the balance sheet negatively, with the result that credit

agreements and covenants may need to be examined closely.

At a time of economic uncertainty, rapid globalization and increased competition,

preparing for tax policy changes before they happen can give businesses and investors a

competitive edge. Whether the proposed or potential change is a shift to a different taxrate, an expiring tax provision, an effort to expand the taxable base, a change to inbound

or outbound tax provisions, a change to state and local tax, or tax law changes related to

climate change and sustainability, staying ahead of the curve and proactively analyzing the

potential effects of a change in tax law is a prudent course of action in todays uncertain tax

landscape.

Modeling the effect of proposed legislation or alternative decision scenarios; assessing

federal, international, state and local, and book-tax implications of proposed tax changes;

and planning for new tax laws and regulations are all critical and necessary tasks in

ensuring that investment decisions are thoughtfully considered, especially with tax

changes seemingly always on the horizon. Further, with respect to acquisitions and other

transactions, planning up front with the end game in mind can often significantly lower the

tax on exit.

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Despite global uncertainties, oil and gas investments continue to flourish

The past 12 to 18 months have been extremely volatile in the oil and gas industry. While

political risk remains a key concern, unexpected disasters have also sent oil and gas

companies back to the drawing board, with the focus being very much on alternative

options to nuclear power, and with a particular focus on natural gas. Additionally,

geopolitical upheaval has had an impact on oil prices, which have remained relatively high

despite major economic woes. And, although environmental and safety concerns continue

to intensify, the unconventional gas boom continues and has begun to internationalize.

The search for recoverable reserves continues to globalize. As long as recovery remains

economically viable, both established and frontier countries are expected to take

measures to develop such reserves and/or take certain measures to attract capital or

increase state revenue, or both. New frontier countries in which hydrocarbon reserves

have just been discovered, such as the African nations, Cyprus and Israel, are working

toward designing their national legal and tax legislation for the oil and gas industry.

Both unconventional oil and gas are attracting the attention of more governments as

they focus on forcing development of these reserves.

Shale gas development is increasing in North America, and large-scale development may

start in Europe too; for example, Poland is working on its tax regime for shale gas.

Arctic countries are competing to attract investments in cost-intensive offshore and

onshore projects and may revise their tax legislation; for example, Russia is in the

process of designing a new, attractive tax regime for Arctic offshore projects.

The discovery of natural gas in the Levantine Basin will drive Cyprus and Israel to develop

this block.

As the global search for recoverable reserves continues, taxpayers should pay attention

to the possible tax law changes and incremental costs of such changes for tax planning

purposes.

Conclusion

Anticipating and managing tax risks and changes in the way oil and gas investments are

taxed require companies and investors to be proactive in tax planning and in the evaluation

of investments (both current and prospective); educated about the current and potential

tax and fiscal regimes that could affect or have an impact on such investments; and vigilant

in choosing the right tax advisor with the experience, resources, and global reach to be

properly apprised of potential tax changes and the impact of such changes on current orprospective investments. Continued monitoring is necessary to determine the impact of

current or proposed changes on global tax and fiscal regimes.

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Assurance | Tax | Transactions | Advisory

Ernst & Young

Deborah Byers

+1 713 750 8138

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Greg Matlock

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greg.matlock@ey.com

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