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Taxation and Investment Decisions in Petroleum

When governments apply high tax rates targeted at natural resource rent, there must be generous deductions in order to avoid investment disincentives. How generous is disputed. Based on standard finance theory and recommendations from the OECD and the IMF, the value that firms attach to future deductions depends on the risks of these, and the companies' after-tax weighted-average cost of capital cannot be applied directly. As an example, a simple model quantifies the difference between pre-tax and post-tax systematic risk when tax deductions are less risky than pre-tax cash flows. Osmundsen et al. (2015) suggest that the difference must be ignored by oil companies, since they cannot find the separate market values of tax deductions. But companies operating in different jurisdictions cannot then appreciate differences in tax systems, not even approximately, which will lead to suboptimal decisions. Tax designers may instead assume that companies have gradually adopted more sophisticated methods of investment decision making.

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Energy Specializations: Petroleum – Policy and Regulation; Energy Investment and Finance – Public and Private Risks, Risk Management

JEL Codes: G31: Capital Budgeting; Fixed Investment and Inventory Studies; Capacity, H25: Business Taxes and Subsidies including sales and value-added (VAT), H32: Fiscal Policies and Behavior of Economic Agents: Firm, H71: State and Local Taxation, Subsidies, and Revenue, Q48: Energy: Government Policy

Keywords: Petroleum, Tax, Depreciation, Uplift, Investment, Risk, Evaluation

DOI: 10.5547/01956574.39.6.gdav

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Published in Volume 39, Number 6 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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