expensive exploration period, and after the expenditure of very significant sums on development, the investor will become vulnerable to unilateral, unfavorable revision of fiscal terms, especially when circumstances have unexpectedly changed in the investor’s favor through resource price increases or the discovery of unanticipated large reserves (Tordo 2007, 2). The overall process in which this can occur has been described as the “obsolescing bargain.”7 This investor objective of stability can be and often has been addressed through legal or contractual assurances of stability, but recent writing on this topic suggests that contractual assurances are unlikely to be entirely effective in addressing this concern (Daniel and Sunley 2010; Osmundsen 2010). The government needs to be careful when accepting stability clauses or dedicated stability agreements. A modern approach to increasing fiscal stability is through the design of the fiscal regime: a progressive fiscal system that automatically adjusts the government take to actually achieved profitability would reduce pressures to renegotiate or unilaterally change fiscal terms. (For more information, see the section on “Fiscal Stability” under section 6.5, “Special EI Fiscal Topics and Provisions.”) Stability can become especially fragile in the context of price volatility. See figure 2.1 and figure 2.2 (chapter 2 of Oil, Gas, and Mining: A Sourcebook for Understanding the Extractive Industries) for an illustration of price volatility for hydrocarbons. 6.3 THE MAIN TYPES OF EI FISCAL SYSTEMS
Given the multiple objectives of fiscal design and the use of several categories of EI contracts, fiscal regimes invariably are constructed to include, for each category of contracts, several fiscal instruments under a “fiscal package.” (See the discussion of contractual forms in chapter 5.) The principal classifications that have typically resulted from this are (1) the tax and royalty system with licensing of areas, and (2) contractual systems, such as production-sharing contracts (PSCs) or risk-service contracts (RSCs). Each category may include state equity participation. Tax and royalty systems are dominant in mining. The alternative fiscal systems can be designed so that economic outcomes are virtually similar, but the respective legal, fiscal, commercial, and operational structures differ. The overriding consideration here is that any fiscal regime must be analyzed as a whole, not instrument by instrument, because of the economic interaction between those fiscal instruments. It is important to note that the production-sharing and risk-service agreements are characteristic of the hydrocarbons sector and absent from mining, where the fiscal regime comprises taxation and royalties.
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Tax and royalty systems
Tax and royalty fiscal regimes may primarily involve a corporate income tax on profits, a royalty on production, and an additional charge on profits or rents (often called “additional profits tax” or “resource rent tax”) to achieve progressivity and capture rent objectives. Other taxes or fees may be also payable, but their weight is generally secondary. Typically, these have been popular in North America and Europe, and in the hydrocarbons sector, at least, they are becoming less common in developing countries.
Production-sharing contract systems
Production-sharing contract fiscal regimes may include many of the same types of fiscal instruments used under tax and royalty systems. The major difference between the two packages is that production-sharing packages typically give the state a percentage of actual production in addition to any taxes or royalties that may be collected (see chapter 4). This is not the case under a tax and royalty system, in which all the production is taken by the investor. Since the state receives a percentage of production, the package of taxes, royalties, and fees will typically be lower than under a tax and royalty system. These PSC fiscal systems are common in the upstream hydrocarbons sector. Usually they are found in developing countries where the host government retains a strong interest in attracting foreign investment but where there is a preference for sovereignty over natural resources, expressed in the form of a contractual regime and getting access to a share of production.
Risk-service contract systems
A third contractual system, less common and confined to the hydrocarbons upstream sector, involves payments by government to the contractor in lieu of access to production. Under these RSCs, companies perform upstream activities at their risk in exchange for an agreed service fee, generally expressed per unit of production and defined so as to allow the contractor to achieve a predetermined, fixed return on its investment. RSCs are far from widespread (Baunsgaard 2001, 12). They are typically found in countries with large known reserve and production bases and low geological risk, such as the República Bolivariana de Venezuela and in certain Middle Eastern states, such as Iraq, where upstream activities were fully nationalized in the 1970s. Governments using RSCs see them as transferring maximum rents to the state.
