Oil investments and fiscal framework in AlbaniaALTax
Albania has significant potential to increase oil investment and production. The obstacles to investment are not in the legal or contractual framework, but in the regulatory and institutional credibility. Albania is one of the countries in the world in which a largest proportion of investors believe a change in the investment environment would bring an increase in oil investments
The oil sector in Albania has a long and relevant role in the country’s history and potentially a bright and even more significant future. Oil production reached its peak in the ’70 at about 40 thousand barrels per day (TBD) and thereafter had periods of very sharp decline reaching about 6 TBD by 2000. In contrast, during the last decade production significantly recovered, almost quadrupling to about 22 TBD (equivalent to close to 1 million tons per year).
Albania’s current production (about 20 TBD) does not cover its domestic consumption, so net oil exports are negative. However, few countries in continental Europe are net exporters of oil and if Albania develops its potential it could become a net exporter and one of the most significant onshore producers in the region, with reserves that are only behind Romania in the Balkans, and Italy in the onshore European Union (Norway, UK, and Denmark are large offshore producers in the North Sea). Moreover, in per-capita terms oil reserves and production are relatively more important in Albania given that the population is much smaller than its oil producing neighbors. For example, petroleum reserves in Albania estimated at 200 billion barrels by the US Energy Information Administration; represent 66 thousand barrels per person. In comparison, the per capita reserves of Italy are 23 thousand barrels and those of Romania are 28 thousand barrels. In addition, from a fiscal perspective and as a source of GDP the oil industry are more relevant for Albania and could be even more relevant in the future.
The Production Agreements signed during the last decade between National Oil Company ALBPETROL and some foreign companies to operate most existing production areas (mainly Patos-Marinza, a traditional large extra-heavy oil field) have proven a significant success in terms of production increase, allowing production to almost quadruple. It is important to emphasize that the increase in reserves and production has been in existing oil fields.
Despite the unfavorable current market prices and conditions, high oil prices before 2014 combined with relatively attractive fiscal conditions (and perhaps a good geographical location) have helped the recent revival of the sector.
Many developing countries have relatively simple taxation systems, based on royalties and other regressive instruments, which are easy to collect, but are not very effective at capturing the rents. Others, have more complex and progressive systems, but are not capable of effectively monitoring the producers, creating a source of conflict.
A country has to devise a taxation framework that is progressive, flexible, neutral, credible, and transparent, within the existing capacities of the state. The problem is that there might be tradeoffs between these desirable properties. In particular, systems that are progressive and neutral usually back-end the government-take, i.e. the bulk of rents accrues to government at the final stages of projects. This opens space for political pressures pushing the government to renege on contracts and collect and spend rents in the short term.
Oil production has high rents, but they are very volatile and heterogeneous. Rents are excess profits above those required to attract investment. In some oil fields rents can represent as much as 90% of the revenues, in others as little as 0-10%. This depends on a variety of factors, including: quality of oil, location, cost of extraction, transportation, etc.
The exploration and development phases carry much higher risk than extraction. In addition, there exists asymmetry of information between the State and the field operator regarding the cost profile of the project, which the operator can manage to his advantage. The combination of these conditions implies that oil taxation is potentially a source of very significant revenues, but requires a mix of instruments that adjust to the variability in the profitability of projects over time and space, and the state’s capacity to collect taxes.
Albania’s oil legislation and contractual framework is quite reasonable and some of its good features consist in: (a) it establishes all taxes that the oil producers should pay and exempts them from all other taxation, enhancing tax stability and credibility; (b) it establishes the principle that any new tax should not apply to existing contracts or in case it does apply, the existing operators should be compensated; (c) it is based on Production Sharing Agreements, a very useful framework, that adapts well to the development of the oil industry in a small country with an National Oil Company with limited capacities, and (d) it establishes that oil and gas can be fully exported and sold at world market prices.
Albania should have a more progressive taxation system, one that is better tied to profitability, but that is relatively easy to collect. One alternative maybe might be to design a progressive royalty with a scale that varies with the price of oil and maybe other variables related to profitability (e.g. quality of oil and/or level of production).
In addition to a more progressive taxation system, the country should build strong capacities to be able to collect the government shares and profit tax in the contracts.
To monitor profitability, it requires good monitoring of investments and costs, transfer prices, etc. In the long run, the only way to have a system that is progressive and encourages investment and efficiency is to make it progressive in the life of the contract as it is achieved by the increasing government-share in tandem with profitability.