Many fiscal regimes operate in a regressive manner with the State Take increasing from the same project when economic rent decreases as a result of lower prices, higher costs, or both.

Fiscal mechanisms which include a large component levied on gross revenue rather than on economic rent are most likely to operate regressively.

Royalty is the most obvious and widespread example of a fiscal mechanism that is levied on the gross production or gross revenue of a project, regardless of the project’s level of profitability.

A simple example how the State Take, in the form of a 20% royalty, from a marginal field (where costs are assumed to equal 80% of gross revenue) exceeds the State Take from an upside field (where costs are only 40% of revenue). The royalty, at 20% of gross revenue, accounts for the entire economic rent of the marginal field, generating an effective State Take of 100% (royalty of 20 divided by economic rent of 20). The same royalty, however, accounts for only a third of the economic rent of the upside field, generating a State Take of 33.3% (royalty of 20 divided by economic rent of 60).

In marginal cases, where the difference between the gross revenue and gross costs of a project is small, the amount of revenue retained by the state “off the top” is highly significant and can result in a negative After Take NPV for the investor. In these cases the State Take, as a proportion of the slight net cashflow increases considerably and may exceed 100%. The higher the royalty rate, the higher the likelihood of fiscal deterrence.

Another example of regressive fiscal regime is Production Sharing regimes that place a ceiling on the amount of production available for cost recovery produce an effect that is similar to that of royalty. With a ceiling on the amount of production available for cost recovery, an investor will not share in the economic rent until much later in the project life as it takes longer to recoup its initial investment.

Other features of fiscal regimes that produce similar effects to royalty and cost recovery ceilings include slow depreciation schedules for income tax purposes and/or cost recovery spread over several years and mechanisms based on sliding scales linked to daily or cumulative production (such as production sharing). Slow depreciation and cost recovery schedules delay the advent of economic rent for the investor.

A number of regimes incorporate royalty and profit sharing mechanisms based on sliding scales linked to average or cumulative production. Such mechanisms increase the state share when field production increases and not when field profitability increases. It is quite possible, however, for production increases to occur at the same time as significant increases in costs (enhanced recovery methods, for example, increasing the overall unit cost of production) or lower product prices. Thus, the State Take increases – because production has increased – but the economic rent may have actually decreased.