This story was originally published in The West Australian on 27 February 2017 with the headline "LNG tax changes in the wind." © Peter Milne.
Australia is coming to the end of a $200 billion LNG investment boom, but analysis from the oil and gas industry’s lobby group indicates that the largest project, Chevron’s $70 billion Gorgon, will not pay anything for the gas it extracts if current oil prices persist.
In November, Treasurer Scott Morrison launched an inquiry to “better protect Australia’s revenue base and ensure that companies are paying the right amount of tax on their activities in Australia”. The inquiry must navigate the complex petroleum resource rent tax before it reports in April.
Canberra levies PRRT on the profits from all oil and gas production in Australia. Production is soaring due to more than $200 billion spent on 14 LNG trains starting up between 2014 and 2018. However, there are concerns this will not result in significant PRRT revenue.
For an oil price of $US60 a barrel (yesterday’s Brent crude price was $US56.60), the analysis shows no PRRT payments. The work by industry consultant Wood Mackenzie formed part of the submission by oil and gas industry group APPEA to the PRRT inquiry.
If the oil price rises to $US80 a barrel no PRRT revenue is predicted from Gorgon until 2028, after which it pays about $1.7 billion a year.
Production-based royalties are paid by the three LNG plants in Queensland and the North West Shelf project. PRRT is then paid if there is a taxable profit after the royalties.
However, LNG projects fed by offshore gas, apart from the NWS, only pay for their gas if they make a profit. These projects — Pluto, Gorgon, Wheatstone, Ichthys and Prelude — are most exposed to PRRT changes.
PRRT is levied at 40 per cent of a project’s PRRT taxable profit, but deductions for capital spend are very different to company tax where the depreciation rate limits the annual deduction.
For PRRT, the deductions for capital expenditures actually increase in value each year.
The deductions used in a year are not capped so no PRRT is paid until all the capital deductions are exhausted, but then payments jump quickly.
The Wood Mackenzie analysis of Gorgon with a $US60 oil price did not separate the government revenue into company tax and PRRT, but the absence of a pronounced kick in total government take makes clear no PRRT is paid.
Uplift of deductions was intended to compensate the producer for the risk that a project may never get to use its losses and for not getting a refund if they made a loss, according to the PRRT inquiry’s issues note.
The Henry tax inquiry in 2009 said the uplift rates overcompensated investors and a 2013 ACIL-Tasman report for the Federal Resources Department described the selection of some of the uplift rates as arbitrary.
With 10 categories of deductions, the system is not simple, and the tax effect of various expenditures varies widely.
Exploration costs in the five years before project construction starts are uplifted by the long-term bond rate plus 15 per cent, an increase of 17.6 per cent in 2016. Until 2014, the Australian Taxation Office treated front-end engineering and design as an exploration activity, contrary to common industry understanding of exploration.
The result is that $1 spent on Gorgon FEED in 2005 is worth $7.12 in deductions today and will keep rising in value.
Earlier exploration is uplifted by a factor known as the GDP deflator that last year resulted in negligible adjustment. Exploration costs from 2005 have more than six times the ability to reduce tax payable as costs from the year before.
A dollar spent in the first year of Gorgon’s construction, 2009, is now worth $1.82 in deductions. Of course, LNG projects do not spend single dollars; they spend tens of billions.
Cost blowouts have increased the pool of deductions, and schedule delays give the deductions more time to escalate.
The PRRT inquiry is investigating more than uplift rates.
Revenue raised can be hugely affected by the transferability of deductions between projects, the order of deduction and how the gas price is determined. Also, the tax treatment of decommissioning costs can result in the Federal Government effectively paying 58 per cent of costs that may be in the billions when large projects close down.
The toughest question for the Government is will it apply any recommended changes to existing projects?
APPEA chief executive Dr Malcolm Roberts said this month that retrospective changes would kill confidence and therefore investment, jobs and exports.
But with any expansions until mid-2020s likely to be a fraction of the size of the current construction boom, there will be negligible new revenue if Canberra does not.
Main image: First LNG cargo leaves Gorgon . Source: Chevron Australia Pty Ltd