SPE 82023

Comparison of LNG Contractual Frameworks and Fiscal Systems

Graham Kellas, Wood Mackenzie Ltd.

Copyright 2003, Society of Petroleum Engineers Inc.

Finally, the paper discusses the impact of both existing and
This paper was prepared for presentation at the SPE Hydrocarbon Economics and Evaluation possible fiscal incentives and considers the role of the
Symposium held in Dallas, Texas, U.S.A., 5–8 April 2003.
Government Take in determining breakeven LNG prices for a
This paper was selected for presentation by an SPE Program Committee following review of
information contained in an abstract submitted by the author(s). Contents of the paper, as
number of existing and potential LNG projects.
presented, have not been reviewed by the Society of Petroleum Engineers and are subject to
correction by the author(s). The material, as presented, does not necessarily reflect any
position of the Society of Petroleum Engineers, its officers, or members. Papers presented at The LNG Value Chain and Pricing Options
SPE meetings are subject to publication review by Editorial Committees of the Society of
Petroleum Engineers. Electronic reproduction, distribution, or storage of any part of this paper
for commercial purposes without the written consent of the Society of Petroleum Engineers is
prohibited. Permission to reproduce in print is restricted to an abstract of not more than 300
LNG projects consist of upstream production, transportation to
words; illustrations may not be copied. The abstract must contain conspicuous the LNG plant, liquefaction and storage, transportation to the
acknowledgment of where and by whom the paper was presented. Write Librarian, SPE, P.O.
Box 833836, Richardson, TX 75083-3836 U.S.A., fax 01-972-952-9435. market and re-gasification (Fig.2).

Fig.2 The LNG Value Chain

Introduction
NGLs
NGLs

There is an increasing number of competing existing and

potential suppliers of liquefied natural gas (LNG) (Fig.1).
LNG Off take
Liquid
Liquid
Agreement?
Stripping
Stripping
Oil, gas and
Which of these projects will succeed, in large part, be associated gas

Storage,
determined by their price competitiveness. Upstream
Upstream Storage, LNG
Liquefaction
Liquefaction LNG Shipping
Shipping //
Pipeline
Pipeline Loading
Loading ++ Market
fields plant
plant FOB Market
fields Utilities FOB re-gas
re-gas
Utilities
Dry gas

Fig.1 Existing, Probable & Possible LNG Projects

LNG
= = =
Upstream Pipeline Gas supply Plant LNG FOB Shipping
Market
economics economics economics economics economics economics
price

Norway Upstream Regime Downstream Regime

Snøhvit

The FOB price (market price less shipping) is generally

Russia
Alaska
Kenai regarded as the in-country value of producing LNG and it is
Egypt

from this price that governments will seek to capture a

Sakhalin Qatar
Iran Rasgas, Qatargas
Algeria
Malaysia
Bintulu Brunei
Lumut
Venezuela
Trinidad&Tobago
Atlantic
Libya
proportion of this economic rent through its contractual and
fiscal arrangements with the investors. It is noted that the
Indonesia Platforma Deltana Oman
Bontang Indonesia Eq Guinea Yemen
Tangguh Alba

Australia
East Timor / Australia
Bayu-Undan
Peru
Camisea
Brazil
Urucu
Nigeria
Indonesia
Arun shipping element of the project may also be profitable but a
discussion of LNG shipping economics is outwith the scope of
Angola
Sunrise
Bolivia
Australia

this paper.
Pacifico
North West Shelf

Existing LNG Plants/Expansions

Australia
Gorgon Argentina
Probable Greenfield Projects
Austral

LNG projects can be structured so that the upstream and

Possible Greenfield Projects

downstream operations are separate (i.e. ring-fenced) or

Many factors in the derivation of the minimum, or breakeven, integrated. The most important factors in deciding which
price for an LNG project are driven by technical and logistic structure is adopted is the government's attitude toward the
considerations - however, the price also needs to be sufficient project and the alignment of the interests of the upstream and
to cover government taxation and other fiscal impositions at downstream investors. Only if the former is positive and the
different stages of the project. latter are similar is it possible to integrate the entire project. In
particular, if the national oil company (NOC)’s equity interest
The fiscal arrangements for LNG projects are often complex in the upstream differs markedly from its interest in the
and misunderstood and this paper includes a review of downstream (e.g. Petronas in Malaysia) this can have a very
contractual and fiscal arrangements for existing LNG projects significant bearing on the pricing, financing and
and certain proposed LNG projects worldwide. fiscal arrangements.

Particular attention is paid to the different terms applicable to In some cases the structure of the project may be influenced
upstream and downstream components of each project and by the fiscal regime in place - if upstream operations are ring-
how transfer prices and the fiscal “ring fence” is established. fenced from plant and other downstream operations for tax
purposes this may preclude integration of the project.
2 SPE 82023

The FOB price needs to provide returns for both the upstream development of these reserves and taking account of the lower
producers and plant operators and fiscal terms for LNG equivalent value of gas vs. oil.
projects therefore depend critically on the pricing arrangement
between the two operations. When the upstream and By contrast, downstream petroleum profits tend to be taxed on
downstream elements of projects are ring-fenced, some form the same basis as other industries, normally at a much lower
of transfer price for the gas supplied is required in order to rate than upstream operations. This reflects the lower risk but
calculate the taxable income being generated in the different equally capital intensive nature of the operations compared to
components of the project. The transfer price simultaneously the upstream. Indeed, to encourage development of their LNG
determines the upstream producer's revenue and one of the business, some governments have provided additional fiscal
plant operator's main operating costs. Pricing options include: incentives for such operations, thereby lowering the
Government Take to below that from other industries.
• supply gas to the LNG plant at a flat price equivalent to
the breakeven required for upstream field economics - The following summarises the contract and fiscal
thereby creating all value in the plant; arrangements in existing and selected potential LNG projects.
• supply gas to the LNG plant at a price equivalent to the
breakeven required for downstream plant economics Alaska (Kenai)
(effectively a netback price) - thereby creating all value in
the upstream; Upstream
• hybrid pricing where the rent is shared between the
upstream and plant by varying the gas supply price with Producers receive a negotiated price at the LNG plant and are
the LNG price; liable to royalty, severance tax (an additional royalty), state
• tolling system where the plant charges a fixed fee for and federal income taxes. Royalty and severance tax rates are
processing the gas, thereby generating a fixed value in the generally lower for gas fields than oil.
plant and transferring all price risk to the upstream; and
• integrating the upstream and plant operations, potentially Downstream
removing the transfer pricing issue (although this will not
disappear if upstream-only or downstream-only taxes The LNG plant is subject only to state and federal income
are retained). taxes. No specific incentives are known to exist.

Current LNG Project Structures and Fiscal Terms Algeria (Algeria LNG)

Current LNG projects around the world are based upon both The National Oil Company, Sonatrach, solely owns both the
ring-fenced upstream/plant and integrated project upstream and downstream operations.
arrangements (Fig.3). In addition there are projects where the
state is the sole operator of the downstream operations or is Australia (North West Shelf)
sole operator of both upstream and downstream operations.
Integrated
Fig. 3 Contractual Arrangements for Existing LNG Projects
The upstream and LNG plant operations are integrated in the
NWS project. Royalty is payable on the FOB price less
USA (Alaska)
Kenai LNG certain deductions for transporting production from the field to
Algeria
Algeria LNG Qatar
the plant and processing the gas before delivery at the port.
Trinidad & Tobago
Rasgas

Libya
Qatar
Qatargas Project profits are taxed at the standard corporate tax rate of
30%.
Atlantic LNG
Libya LNG
Oman Malaysia Brunei
Nigeria Oman LNG Bintulu Lumut
Nigerian LNG
Indonesia Indonesia
Arun Bontang

Australia
Brunei (Lumut)
North West Shelf

Concession - LNG and upstream ring fenced

Concession - LNG and upstream consolidated
Upstream
PSC - LNG and upstream ring fenced
100% state owned

Producers receive a negotiated price at the plant gate, which is

linked to the LNG CIF price, and are liable to royalty, income
The norm in fiscal arrangements is for petroleum specific tax at a special rate of 55% and supplementary tax of 15%.
terms - such as royalty, windfall profits taxes or production Gas fields do not receive any incentives over oil.
sharing - to apply only to upstream operations, reflecting the
higher risks and rewards that are perceived to exist. In many Downstream
countries with a history of significant oil production and/or a
dependence on petroleum revenues, the total Government The LNG plant is subject only to corporate income tax but this
Take1 from upstream profits can be very high (>75%). is also at the special petroleum rate of 55% (the general rate is
Several countries - notably Indonesia - have reduced the currently 30%). No specific incentives are known to exist.
Government Take from upstream gas projects to encourage
SPE 82023
Indonesia (Bontang, Arun)
Upstream
Producers receive a netback price at the plant gate and are
liable to PSC terms that include royalty (FTP) and government
profit share. To incentivise gas production the government
has reduced its share of post-tax profits from 85% for
conventional oil production to 70% for gas in conventional
areas and 60% in frontier areas.
Downstream
The national oil company, Pertamina, operates the LNG plant
and retains only enough revenue to cover its costs. The plant
is, therefore, non-profit making and pays no tax.
Iran (Iran LNG (potential project))
Integrated
The National Oil and Gas Companies, NIOC and NIGC,
solely own the upstream and downstream operations.
However, under "buy-back" contracts foreign investors are
participating in the upstream operation.
The investors receive a fee, equivalent to the cost of
developing the field plus a nominal return, which is paid by
NIOC from sales of liquids in the first few years of
production. Once the investor has been reimbursed NIOC
assumes control of production.
Libya (Libya LNG)
The National Oil Company, NOC, solely owns both the
upstream and downstream operations.
Malaysia (Bintulu)
Upstream
Producers receive a negotiated price at the plant gate, which is
linked to the LNG CIF prices and are liable to PSC terms,
which include several taxes on top of royalty, and state profit
share, which ranges from 50% to 70% in most contracts. Gas
fields do not pay certain export and additional profits taxes,
which apply to oil production, but otherwise terms are very
similar to oil.
Downstream
The LNG plant is subject to standard corporate income tax,
currently payable at 28%. No specific incentives are known
to exist.
Nigeria (Nigeria LNG)
Upstream
Producers receive a negotiated price at the plant gate and are
liable only to standard corporate income tax on their operating
3
profits. As part of a major fiscal incentive package to
encourage commercial gas production, royalty was abolished
(it is charged at up to 20% for oil) and producers are allowed
to offset any capital expenditure incurred in exploiting
associated or non-associated gas against their oil income.
Thus, capital costs receive 85% tax relief while profits from
production are only taxed at 30%.
Downstream
The LNG plant is liable only to corporate tax at the standard
rate of 30% and also receives incentives in the form of a 5
year tax holiday, accelerated depreciation and exemption from
VAT and import duties.
Norway (Snøhvit)
Integrated
Upstream and downstream operations are consolidated and
taxed under the offshore fiscal terms, which currently has a
combined tax rate of 78%. As a special incentive, all capital
costs benefit from accelerated depreciation (3 years as
opposed to the standard 6 years). The fiscal structure is
unusual in that downstream operations would normally be
regarded as onshore and therefore only pay tax at 28%. By
placing all costs effectively offshore, the producers are able to
gain immediate tax relief at the higher rate through offsetting
taxable income from other oil and gas production in Norway.
Oman (Oman LNG)
Integrated
All gas reserves are owned by the Omani government and are
produced on their behalf by the upstream contractors at cost.
The contractors are partners with the government in the LNG
plant, which is taxed at a reduced rate of 15% and also
benefits from a 10 year tax holiday.
Qatar (Qatargas)
Upstream
Producers receive a negotiated price at the plant gate but are
liable to PSC provisions only on associated liquids production,
which include state profit share ranging from 35% to 90%.
Downstream
The LNG plant is only liable to corporate tax at the standard
rate of 35%. No specific incentives are known to exist.
Qatar (Rasgas)
Integrated
Investors have equal interests in the upstream and downstream
operations. There is a 50% royalty payable on production and
standard corporate tax of 35% is levied on net profits.
4 SPE 82023

2
Trinidad & Tobago (Atlantic LNG) Fig. 4 Average Government Take from upstream gas fields

Upstream Malaysia

Algeria
Producers supplying Train 1 receive a netback price and share
Brunei
fluctuations in the LNG FOB price approximately equally with
the LNG plant. Producers supplying Trains 2 and 3 receive a Norway

netback price that includes full price risk, with the LNG plant Vietnam

charging a fixed fee (or toll) for each mmbtu it processes. Indonesia - offshore

Timor Gap
Producers are liable to either concession terms (including a Egypt - offshore
royalty and 55% income tax rate) or PSC terms which include
Peru
state profit share between 40% and 80%, depending on price
and production levels. Malaysia-Thailand JDA

Myanmar

Downstream Bangladesh

Trinidad & Tobago

The LNG plant is subject only to corporate income tax at the Argentina
current rate of 35%. Train 1 income benefits from a 10-year
Bolivia
holiday but this was not provided for Trains 2 and 3.
Australia - offshore

Yemen (Yemen LNG (potential project)) Pakistan

Netherlands - offshore

Integrated USA (GoM deep water)

UK - shelf
Although unlikely to proceed in the near to medium term, the
contractual structure for the potential Yemen LNG project is Ireland

unusual in that PSC terms similar to upstream projects apply 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

to the entire project. All costs are recoverable from the FOB
revenue, a royalty is payable (after a holiday) and the state's
profit share ranges from 25% to 90% depending on the
profitability of the project.
Average Government Take from Upstream
Gas Fields
The fiscal regime in place for gas fields is, in many cases, an
adapted version of that historically introduced for oil
production. As highlighted above, some countries have
recognised the lower equivalent economic value of gas
production and lowered the royalty rate, state profit share or
tax rates as a result. At the extreme, Ireland has removed all
petroleum specific taxation from upstream projects and subject
profits from gas - and oil - production only to corporate
income tax.
Wood Mackenzie has analysed the impact of the Government
Take generated from commercial gas fields discovered
between 1991 and 2000 and a comparison of the average
Government take from a number of gas producing countries is
shown in Fig. 4. The analysis includes all upstream
developments, not just those feeding existing or planned
LNG projects.
Another trend - exemplified in Egypt and Trinidad and
Tobago - is a reduction in fiscal incentives previously allowed
to gas producers after the establishment of commercial gas
production. Once infrastructure is in place and future
discoveries can be brought onstream at much lower cost the
government attempts to reclaim a higher share of the
economic rent generated.
Average Government Take, (discounted@10% )
One feature of many upstream fiscal regimes is the linkage of
the overall Government Take to production levels. These are
often introduced for oil then converted for gas. Such links are
far less appropriate for gas production profiles, which tend to
be long and flat under long-term sales contracts.
It is clear that some fiscal terms for gas have been agreed on
the assumption that production would never generate
extraordinary profits. However, sustained high crude prices
often filter through to gas prices in contract indexation, and
such profits have been realised in a number of projects. The
benign fiscal regimes in place have become subject to intense
political scrutiny, which has led to governments wanting to re-
negotiate terms, sending very negative signals to
potential investors.
Consequently, in establishing fiscal terms for upstream gas
operations, linking the Government Take to fluctuations in the
profitability, rather than deliverability, of fields is even more
important than for oil. Terms linked to R factors or IRR are
more likely to generate a fair Government Take in both upside
and downside climates than production based or flat rate
fiscal terms.
Impact of the Government Take on Breakeven
LNG Prices
The probability of any LNG project getting off the ground is
going to be heavily influenced by the price the operators can
SPE 82023 5

offer which is, in turn, heavily influenced by the location of
the buyer and the potential seller. For example, Wood
Mackenzie estimates shipping costs to the US or Europe to
range between $0.6/mmbtu and $1.75/mmbtu for existing and
potential Latin American, African and Middle Eastern
LNG projects.
the 85% tax rate) and pay only standard tax on gas profits (at
30%) can result in the Government Take from upstream gas
production actually being negative. The reduced tax from oil
production can exceed the tax raised from the gas production
and the breakeven price could be lower on a post-take than
pre-take basis.

One yardstick of how competitive a potential LNG project will Fig. 5 Government Take impact on Breakeven LNG FOB Prices
4
for selected existing and potential projects
be is the minimum FOB price it could charge and still generate
a minimum required rate of return. Those projects at the high
end of the shipping cost range may need to deliver an LNG Malaysia Bintulu

FOB price at a dollar (or more) per mmbtu less than rivals Peru Camisea

which are nearer the markets. The breakeven FOB price for Qatargas Expansion
any LNG project will depend on many key technical factors: Egypt LNG

T&T Atlantic LNG 1

• the extent of existing LNG infrastructure determines Bolivia Pacifico
plant costs; Norway Snøhvit
• the size of the upstream resource base and extent of Australia Gt. Sunrise
infrastructure determines the upstream costs; and Australia NWS Existing
• the amount of associated liquids that can be produced Australia NWS Expansion
with the gas, which can transform the project economics. Venezuela Mariscal Sucre

Russia Sakhalin
The combination of upstream and downstream costs - and the
T&T Atlantic 2&3
extent to which these can be offset by revenue from associated
Nigeria LNG Expansion
liquids - is the major determinant of the breakeven price.
However, many fiscal regimes include elements where the Indonesia Bontang

Government takes a share of revenue, regardless of whether Australia Gorgon

the project has generated a rate of return for the investors or Papua New Guinea

not. Normally this is most evident in the upstream, with the Equatorial Guinea

applicability of royalty in many regimes. However, the slow Nigeria Brass River

depreciation of plant capital expenditures in downstream tax Nigeria LNG Existing

regimes will also generate tax for the government before an Indonesia Tangguh

investor has reached its rate of return. Consequently, both Oman LNG

upstream and downstream operations are likely to have a 0% 5% 10% 15% 20% 25% 30% 35% 40%
higher breakeven price once the Government Take is included.
Government Take % of Breakeven LNG FOB price

Wood Mackenzie has considered the breakeven prices for Upstream Govt.Take Plant Govt.Take

existing and potential LNG projects, assuming a required

nominal 12% rate of return. The range of breakeven prices (in
$/mmbtu) is very wide on a pre-take basis. Some projects -
Qatar, Equatorial Guinea - are so liquids-rich that the net cost
of developing the gas fields is, effectively, zero. Other
greenfield projects - Papua New Guinea, Peru - will require
significant expenditure in both the upstream and downstream.
In all cases the price required to cover both upstream and plant
costs accounts for over two thirds of the total breakeven FOB
price and these costs are the largest factor in determining the
breakeven - and potential sales - price in each project.
Fig.5 shows the additional FOB price element required to
cover the Government Take that would be generated in a
minimum rate of return scenario. This can be a relatively
minor part of the overall breakeven price if the regime is
geared toward allowing the early recovery of costs before the
various taxes start to apply. In Indonesia, for example, all
costs are recoverable before the state profit share applies and
thus the upstream take is minimal from greenfield projects (it
is higher from lower cost, brownfield projects). In Nigeria the
ability to offset upstream capital costs against oil income (at
There is virtually no Government Take in Oman - the low tax
rate and tax holiday that the downstream plant is allowed
ensures that the minimum project return would be generated
with a minimal inflow of revenue to the fiscal coffers3. At the
other extreme, producers in Peru have volunteered to pay a
37% royalty on all gas production from the Camisea gas field,
which increases the breakeven price by over 25%. Other
countries with a high upstream Government take are Malaysia,
Bolivia, Qatar, Russia, Trinidad & Tobago and Egypt.
Most countries generate a higher minimum Government Take
from the upstream operations, with integrated operations the
most notable exceptions. The very long depreciation
schedules for LNG plant expenditures in some regimes can
generate significant increases in the breakeven price, however,
and this has been targeted by some projects for special
incentives, given the very high levels of expenditure involved
(e.g. Australia, Nigeria, Norway).
6 SPE 82023

The impact of the Government Take on the Snøhvit breakeven
price is overstated here, as the project economics have been
calculated on a stand-alone basis. In practice the investors are
able to offset their costs against taxable income elsewhere in
Norway at the 78% tax rate, which significantly accelerates
cost recovery and, consequently, reduces the breakeven price.
The ability to offset downstream costs against upstream
income is limited to integrated projects and the ability to offset
such costs against upstream income from other projects which
is being taxed under a petroleum specific regime - including
oil production - is (we believe) unique to Snøhvit.
corporate tax. This approach has already been adopted in some
countries and may be given serious consideration by others if
they are to become effective competitors for future LNG sales.
It would be short-sighted, however, for the fiscal package for
an integrated project not to include some means of capturing a
higher share of the economic rent for the Government when
profits are particularly high. Thus, the application of some of
the sophisticated fiscal terms developed for upstream
operations around the world would seem appropiate for future
integrated LNG projects.

Conclusions Footnotes & References

Governments and investors contemplating LNG projects are 1. Government Take = Government Revenues / (Total Revenues -
faced with many technical constraints and logistics that will Total Costs)
2. Wood Mackenzie, "Global Oil and Gas Risks and Rewards",
largely determine their ability to compete for future sales.
February 2002
However, an innovative approach to the contractual and fiscal 3. The Government is, however, the major participant in the project
arrangements may result in projects being progressed that so although it benefits little from taxation it is the main
under current terms appear uncompetitive. beneficiary of the project as a whole.
4. Assumes a rate of return of 12% (nominal)
Incentives that have been introduced include lowering the tax 5. Oil and Gas Journal, Dec. 16, 2002
rate and accelerating depreciation for the downstream
operations and reducing the Government Take from upstream
operations, compared to oil. In one country - Nigeria - the
upstream has been further incentivised by allowing gas capital
costs to be relieved at a higher tax rate than the gas profits are
taxed, thereby enabling taxation from the existing oil business
to subsidise the emerging gas business. Other oil rich
countries wishing to become LNG players could consider this
holistic model of taxing the upstream component of
LNG projects.

The current divergence between the taxation of upstream and

downstream operations in most countries provides an
incentive to investors to minimise taxes through appropriate
transfer pricing. It will also encourage investors to allocate as
much of the cost of the operation as possible in the operation
that is most highly taxed - normally the upstream. A high
marginal Government Take always creates the potential for
"gold-plating" investments and these can be accentuated in an
LNG project. This is an ongoing concern for governments and
was recently reported as a potential obstacle to the planned
development of Atlantic LNG's Train 4 expansion in Trinidad
& Tobago, for example5.

Integrating the upstream and downstream operations can

overcome many of these concerns but is only possible if the
participants' interests are aligned. Integration enables the
fiscal regime to be based on the profitability of the entire
project, with fiscal terms normally used only in upstream
operations applying (as for Snøhvit and Yemen).

Where integration is impossible, similar taxation of the

upstream and downstream would remove the incentive to
allocate costs to one side or the other. As downstream
operations tend to be taxed as other industries, this would tend
toward introducing a similar regime for upstream, reducing the
Government take from upstream gas fields to the standard