DRILL NOW, PAY LATER - Australian Conservation Foundation


DRILL NOW, PAY LATER - Australian Conservation Foundation

Executive summaryThis report analyses the fiscal and environmental impacts of special tax breaks for oil and gas investmentsin Australia. Specifically, we examine the accelerated depreciation (or capped effective life) rules for manycategories of oil and gas assets provided in section 40-102(5) of the Income Tax Assessment Act 1997 (Cth).In 1999, the Ralph Review of Business Taxation recommended lowering the company tax rate from 36% to 30%, inexchange for removing a wide range of accelerated depreciation rules benefitting some industries. This packageof reforms was broadly intended to improve the efficiency of the tax system by removing arbitrary preferences forcertain assets over others.The company tax rate was reduced accordingly, but following industry lobbying, the Australian parliamentenacted special legislation on three occasions to override determinations of the Commissioner of Taxationregarding the depreciation rules for various asset classes. The first of these, passed in 2002, preserved the specialtreatment of assets in the oil and gas sector, among others. The legislation reduces the length of time that variousoil and gas assets must be depreciated over, which in turn increases the deductions available for those industriesto offset other income. In effect, this is a “drill now, pay later” scheme – one that allows oil and gas companies todefer significant tax liabilities for many years after a project begins operating.Our analysis shows the following:1. The cost to the taxpayer of accelerated depreciation for oil and gas assets will grow substantially, due tothe surge in investments in this sector. Approximately $340 billion in oil and gas investments is alreadyplanned for the period 2012 – 2018.2. We estimate that accelerated depreciation for new oil and gas investments will cost the Australian taxpayerbetween $1.65 and $2.05 billion annually by 2018. This amounts to around $6 billion over the period 2012-2018. This range is based on relatively conservative assumptions and on the existing pipeline of plannedinvestments. (See the main body of the report for a full description of the methodology).$ bn2.001.801.601.401.201.000.800.600.400.200.002012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19Financial yearFigure 1: Estimated annual cost of accelerated depreciation for the oil and gas industry (medium case scenariobased on 65 per cent of capital expenditure qualifying for accelerated depreciation)drill now, pay later3

2. Why does investment in oil and gas assetsreceive preferential treatment throughaccelerated depreciation?Through the 1970s, 80s, and 90s, a range of accelerated depreciation rules were introduced to benefit variousindustries, on a more or less ad hoc basis. By the late 1990s, this approach had led to an inefficient tangle ofarbitrary rules, with no principled justification for differences between various kinds of assets and industries.The Ralph Review of Business Taxation recommended a sort of “grand bargain”, under which the company taxrate would be reduced from 36 per cent to 30 per cent, and in return the hodgepodge of accelerated depreciationrules would be removed in stages following a rolling series of reviews by the Commissioner of Taxation todetermine the real effective life of the affected assets.The reduction in the company tax rate was passed, and the Commissioner of Taxation commenced the effectivelife reviews. Investments in oil and gas assets were among the first categories of assets to be reviewed, and theCommissioner proposed substantial increases in the length of time over which these assets should be depreciated.The petroleum industry actively lobbied against the changes, and in 2002 persuaded the Government to overridethe Commissioner’s determination through a special amendment to the Income Tax Assessment Act 1997. 2At the time, there was almost no Parliamentary debate or scrutiny. The Government introduced the legislationwith a perfunctory explanation that it was needed to address the “impact on investment decisions in particularindustries or the wider economy” that the Commissioner’s determinations could have. 3However, the Opposition voiced serious misgivings. Senator Stephen Conroy (ALP) put the case against thespecial treatment for particular investments this way:… As part of business tax reform, a whole raft of accelerated depreciation provisions for particular sectors, along with arange of other sectoral subsidies, were replaced by a lower corporate tax rate across the board.A central part of that trade-off was that the old underlying depreciation schedules would be reviewed by theCommissioner of Taxation on an “effective life” basis.As the Ralph Report said: The accelerated depreciation/company tax rate reduction trade-off is the key issue.Labor supported this sound reform. We argue that investment should be driven by economic return, not tax advantage.We are pro-market, not pro- any particular business interest. It is a good reform and we supported it.…Some of those companies that will benefit from this Bill are flagrantly double dipping. Some of those companies told theGovernment, the Opposition, and indeed through the Business Coalition for Tax Reform they told the whole countrythat they supported a cut in the corporate tax rate to be funded by getting rid of accelerated depreciation.Well here we are, just a few years later, and who would have thought it. Capital-intensive companies are walkingaround these corridors pleading for accelerated depreciation to be reinstated under the new badge of effective life caps andthreatening to quit the country if they don’t get their way.… 4drill now, pay laterDespite these misgivings, the Opposition voted in favour of the legislation, largely because it supported otherunrelated proposals in the same bill.The oil and gas industry has not been the only one to succeed in getting the Commissioner’s determinationsoverruled by special legislation. The same has occurred for aircraft, most heavy vehicles, some light vehicles andcertain agricultural machinery. While those concessions are arguably just as inefficient, we have not focused onthem in this report, because we do not expect the same surge in investment.The following table summarises the oil and gas industry assets that currently benefit from capped effectivelife provisions. The full detail on the Commissioner’s determinations can be accessed on the website of theAustralian Tax Office (ATO). 562. See Taxation Laws Amendment Act (No.4) (2002)3. Second Reading Speech, Sen. Ian MacDonald, Senate Hansard, 19 June 20024. Sen. Steven Conroy, Senate Hansard, 27 June 20025. http://www.ato.gov.au/businesses/content.aspx?doc=/content/20522.htm

Asset typeStatutory effectiveLIFE CAPCOMMISSIONER’sDETERMINATIONGas transmission and distributionassets (eg pipelines)Oil and gas extraction assets(excluding electricity generationassets and offshore platforms)Oil and gas production assets(excluding oil refinery assets)20 years 30-50 years15 years 20-30 years15 years 30 years (for most assets)Oil and gas offshore platforms 20 years 30 yearsTable 1: Statutory effective life caps for oil and gas assetsAs this table shows, the benefit of the statutory effective life caps is substantial, in some cases halving the amountof time over which an asset must be depreciated. The statutory effective life caps maintain the same acceleratedschedule that was in place before the Commissioner’s determination.In short, the oil and gas industry has enjoyed the benefit of a large reduction in company tax rate, but has notbeen subject to any offsetting increase through applying more realistic depreciation schedules.Not everybody is happy with the accelerated depreciation concessions. The Australia’s Future Tax Reviewreport noted that the statutory effective life caps “may result in significantly lower effective marginal tax ratesfor eligible investments relative to assets whose capital allowances are based on effective life.” 6 Its correspondingrecommendation was as follows:Recommendation 28: The capital allowance arrangements should be enhanced and streamlined to ensure effectiverates more closely match rates of economic depreciation, and to reduce administration and compliance costs overall.This should include… reviewing the impact of special provisions applying to different investments in agriculture andstatutory effective life caps…” 7While this recommendation stops short of advocating removal of accelerated depreciation, the call for a reviewof the “statutory effective life caps” signals, plainly enough, that these provisions at face value appear to beeconomically inefficient.The Australian Treasury has also voiced reservations. In a briefing to the Treasurer, Treasury noted that thestatutory caps could be considered to be within the scope of Australia’s commitment to the G20 to review andremove inefficient fossil fuel subsidies:It can be argued that this measure [capped effective life] is a fossil fuel subsidy (as defined by the IEA/OECD). This isbecause it provides preferential tax treatment to fossil fuel producers through accelerated depreciation (compared withthe arrangements that would apply in the absence of the statutory cap)…… It can be argued that this measure is inefficient as the substantially lower effective life for some assets has thepotential to distort investment decisions. … 8While the Australian government did not list the statutory caps as a “fossil fuel subsidy” in response to thisadvice, neither did it contradict the advice that the policies may be inefficient and distortionary.The Australian Conservation Foundation has called for the repeal of these tax expenditures in recent years. 9drill now, pay later76. AFTS Final Report, p.170. See: http://taxreview.treasury.gov.au/content/Content.aspx?doc=html/pubs_reports.htm7. AFTS Final Report, p.173 ibid8. Treasury Executive Minute no 63 Op cit9. See ACF budget submissions for last 2 years and Henry review submission.

3. What are the fiscal implications of accelerateddepreciation for oil and gas assets?3.1 Current impactTreasury has estimated the cost of statutory effective life caps as part of the annual Tax Expenditure Statement(TES). The latest statement estimates that the cost of all such concessions to the Australian government in 2009-10was $805 million, more than double the cost in 2006-07. They project that this will increase further, reaching$1 billion by 2011-12 and continuing to increase thereafter. 10B95 Statutory effective life capsTransport and communication ($m)2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14375 530 680 805 915 1000 1030 1055Tax expenditure type: Accelerated write-off 2009 TES code: B87Estimate Reliability: Medium - LowCommencement date 2002Legislative references Section 40-102 of the Income Tax Assessment Act 1997Table 2: Treasury estimates of cost of statutory effective life caps 2010 statementIt is notable that the Treasury estimates for the annual cost of effective life caps have been revised significantlyupward in recent years. The 2008 Tax Expenditure Statement projected the cost of the measure in 2011-12 wouldbe only $460 million, whereas the 2010 Statement excerpted above has more than doubled that projection.Unfortunately, Treasury does not calculate a breakdown by asset class of the total estimated cost of the statutoryeffective life caps. Thus, the figures above cover all categories of assets given preferential treatment, includingaircraft, oil and gas assets, and a range of vehicles.However, at the time the effective life caps for oil and gas assets and aircraft were introduced, they wereestimated to cost $1.9 billion over ten years. This has no doubt increased with the greater investment in oil andgas assets in recent years. Thus, an educated guess might suggest that the oil and gas concessions representperhaps one quarter to one third of Treasury’s total cost estimate given above.drill now, pay later3.2 Impact of new investmentsOil and gas investment in Australia is projected to increase dramatically over the coming decade with a numberof major projects in development, such as the Gorgon and Curtis projects. Data from the Australian Bureau ofAgricultural and Resource Economics and Sciences (ABARES) indicates current planned capital expenditure inthe oil and gas sector of $340 billion for the period 2012 - 2018 11 .Coal seam gas projectsOil and natural gas projectsPipeline constructionPetroleum processingTotalTable 3: Investment pipeline on major projects 2012-18$3.185 billion$331.359 billion$5.118 billion$0.525 billion$340.187 billion810. Tax Expenditure Statement 2010 Treasury Jan 201111. ABARES List of Major Minerals and Energy Projects (April 2011) http://adl.brs.gov.au/data/warehouse/pe_abares99010544/MEprojectsApril2011_LISTING.xls Estimates were updated with business reports. Where no expenditure data was listed estimates werecalculated based on capacity.

5. Assessment and recommendationThe original justification in 2002 for maintaining accelerated depreciation for the oil and gas industry was thatit was needed to maintain investment in this sector. It is open to question why government should seek toencourage investment in this sector in particular, of course. One of the principal justifications for removingaccelerated depreciation benefits following the Ralph Review of Business Taxation was that it is generallyeconomically inefficient to preference investment in one industry over another.But whatever the merits of the special legislation at the time, it is hard to maintain the position that governmentsupport is needed for the oil and gas sector at a time when global prices for these commodities are at all-timehighs. The original justification for the special tax break is no longer tenable.Arguments against the tax break include the following:As suggested by the AFTS review and the Australian Treasury, it is potentially distortionary and economicallyinefficient, by preferring some investments over others.It is costly, with a total price tag of $6 to $7 billion over the period 2012-2018.It is not clear what benefit, if any, the public receives in return for this expenditure. Given high commodityprices, the major projects being supported in this way would in all likelihood still proceed without accelerateddepreciation.It supports environmentally risky investments. The oil and gas industry has caused several majorenvironmental disasters in recent years, including the Montara and Deepwater Horizon spills. Further,community opposition is growing to certain developments, including coal seam gas developments and majorprojects in sensitive areas, such as at James Price Point in the Heritage-listed Kimberley region.Taxpayer-subsidised investment in oil and gas may be seen as contrary to Australia’s goals to reduce climatepollution and shift to an economy focused more on renewable energy technologies. In light of these impactsand concerns, the tax break for oil and gas assets is inconsistent with sound environmental management.And finally, there are better uses for taxpayer funds. By repealing this tax break, the government wouldgenerate sufficient funding to double Commonwealth funding for biodiversity protection, including the full$500 million needed to complete the establishment of an effective network of large Commonwealth marinenational parks, and still have money left over.Recommendation: Accelerated depreciation for oil and gas assets in Australia should be removed, byrepealing Items 1 through 6 in the table in section 40-102(5) of the Income Tax Assessment Act 1997 (Cth).The repeal of the relevant provisions in the Income Tax Assessment Act 1997 is all that is needed to remove thetax break, since the determinations of the Commissioner of Taxation regarding the effective life of oil and gasassets would automatically come into force.Finally, it is important to proceed with the reform soon. The surge in investment in the oil and gas sector in thecoming years raises the stakes significantly. Unless the proper tax treatment of these investments is set now, thereis a risk that accelerated depreciation will be locked-in for several hundred billion dollars worth of investment.This would result in a long-term loss to the Commonwealth budget, and a long-term distortion in our economy.drill now, pay later11

MethodologyOur estimate of the cost of the capped effective life provisions relating to the oil and gas industry was calculated by:Identifying the relevant capital investment per major project projected by ABARES for relevant investment (fromABARES figures, industry analysis or capacity data);Calculating for each project the amount deductible if the capped effective life did not apply and theCommissioner’s determination applied instead;Multiplying each deductible amount by the current company tax rate (30 per cent) to determine the tax benefitthenSubtracting the benefit available without the statutory cap from that available with statutory cap.Key assumptions and sensitivities:The percentage of capital expenditure that benefits from accelerated depreciation is a key parameter. Forpurposes of our estimate of the total value of the subsidy, we have assumed that between 60 per cent and 75per cent of capital expenditure falls within scope of the accelerated depreciation rules. For all more specificvalues (such as the benefit for individual companies), we assume 65 per cent of capital expenditure benefits fromaccelerated depreciation.We assume that all capital investment identified by ABARES with known capacity goes ahead on schedule andno capital investment not identified by ABARES goes ahead. This assumption may result in an overestimate insome respects, if some currently planned projects do not proceed or are delayed, but an underestimate in otherrespects, if new projects are identified and proceed between now and 2018.Total capital expenditure for each project is assumed to be spent entirely in the first year of production, anddepreciated over each following year for the effective life of the asset. This simplification is not likely to affectthe total value of our projections. However, it may mean that the increase in the total value of the tax break isnot as rapid as projected.Depreciation is calculated on a ‘prime cost’ basis, not a ‘diminishing value’ basis. Note that the taxpaying entityis entitled to choose which of these two bases to use. Diminishing value allows a greater deduction up-frontwhich diminishes over time. Prime cost allows equal deductions for the life of the asset. The flat rate was usedbecause it is less variable with respect to start date and so is easier to compare across scenarios, but it is alsomore conservative in its projections of tax foregone in the initial years of a project. Current calculations foraccelerated depreciation in these industries create a higher rate of depreciation within the initial 6-7 years ofoffsetting the investment. 15Deductions are attributed to the same financial year as the project’s current production date (start up date). Inreality some investment will occur earlier but deferred deductions may be available to allow for the lack ofincome during the initial investment period until production commences.Each project was determined to fit within one relevant asset category and effective life allocated according to thefollowing table:drill now, pay later12AssetcategoryStatutoryeffectivelife1. Gas transmission and distribution assets (eg pipelines) 20 years 40 years2. Oil and gas production assets used in oil and gas extraction(excluding electricity generation assets or offshore platforms)15 years 25 years3. Offshore platforms used in oil and gas extraction 20 years 30 years4. Assets used to manufacture condensate, crude oil, domesticgas, LNG or LPG (other than in an oil refinery)Table 4: Asset categories15 years 30 yearsCommissiondetermination(approx)15. See ATO calculation tools available at http://www.ato.gov.au/content/46124.htm

Project Company State StartdateCapacityCap-ex($bn)Narrabri CSG Eastern Star Gas / NSW 2015 20 - 150 PJ pa 1.3 2SantosSurat Gas Project Arrow Energy Qld 2017 180 - 360 PJ pa 1.5 2Coniston (tie back toVan Gogh)Apache Energy /InpexWA 2013 22 kbpd 0.554 3Gladstone LNG Santos / Petronas Qld 2015 7.8 Mt LNG 16.5 4Gorgon LNG Chevron / Shell / WA 2015 15 Mt LNG, 110 PJ 43 4ExxonMobilpa domestic gasKipper gas project(stage 1)Esso / BHP Billiton Vic 2012 30 PJ pa gas, 10 kbpdcondensate1.9 3Macedon BHP Billiton / WA 2013 75 PJ pa gas 1.55 3Apache EnergyNWS CWLHWoodside / Chevron WA 2011 60 kbpd oil 1.5 3/ BHP Billiton & OrsNWS North Rankin B Woodside WA 2013 967 PJ pa gas 5.3 3Pluto (train 1) Woodside WA 2012 4.3 Mt LNG 14 4Queensland Curtis BG Group Qld 2014 8.5-12 Mt LNG 15.5 4LNG ProjectReindeer gas field /DevilApache Energy WA 2012 78 PJ pa gas 1.08 3TurrumExxonMobil / BHPBillitonVIC 2013 11 kbpd condensate,77 PJ pa gas2.8 3Arrow Energy LNG Shell / Petro China Qld 2017 8 Mt LNG 14.6 4Australia Pacific LNG Origin /Qld 2015 9-18 Mt LNG 35 4ConocoPhillipsBonaparte LNG Santos / GDF Suez NT 2018 2 Mt LNG 5 3(floating)Browse LNG Woodside / Shell / WA 2017 15 Mt LNG 35 3Chevron & OrsBrunello / Julimar Apache / Kufpec WA 2016 120 PJ pa 3 3Gorgon LNG (t4) Chevron / Shell WA 2017 56 Mt LNG 10 4Ichthys gasfield (inc Inpex Holdings / WA 2016 8.4 Mt LNG, 100 20.6 2Darwin LNG Plant) Totalkbpd condensatesNewcastle LNG Eastern Star Gas NSW 2016 1-4Mt LNG 2 4ProjectPluto (t2 & 3) Woodside WA 2014 2 x 4.3 Mt LNG 28 4Prelude (floatingLNG)Scarborough Gas ExxonMobil / BHPBillitonSunrise Gas Project Woodside /Conocophillips /Shell & OrsTimor Sea LNGProjectShell WA 2016 3.6 Mt LNG, 32 kbpdcondensate, 0.4 MtpaLPG11.8 3WA Na anddoubtful6 Mt LNG 15 3NT 2017 4 Mt LNG, 28 kbpd 10.3 3condensateMEO Australia NT Na 3 Mt LNG 2.2 3Wheatstone LNG Chevron / Apache WA 2016 8.6-25 Mt LNG 29 4NotionalassetcategoryTable 5: Major projects with projected capital expenditure of over $1 billion. Data updated from ABARES Major Minerals andEnergy Projects (April 2011)

PANTONE 383 UPANTONE 462 UThe Australian Conservation Foundation (ACF)is committed to inspiring people to achievea healthy environment for all Australians.For 40 years we have been a strong voicefor the environment, promoting solutionsthrough research, consultation, education andpartnerships. l ogo ruleWe swork with the community,business and government to protect, restore andsustain our environment.xxACF is Australia’s leading national not-forprofitenvironment organisation and is fundedalmost entirely by individual membership andxdonations. Since 1966, we have focussed onthe most important and urgent environmentalxproblems, seeking X HEIGHT . CLEARANCE change AROUND LOGO with lasting SPACE BETWEEN political,SYMBOL AND TYPEeconomic and social support. ACF has playeda key role in increasing protection fo some ofAustralia’s most outstanding natural assetsMINIMUM SIZEincluding the Franklin 2cmRiver,Kakadu, theDaintree Rainforest and Great Barrier Reef.xAustralian Conservation Foundation,Level 1, 60 Leicester St, Carlton VIC 3053.Telephone 03 9345 1111www.acfonline.org.auFront cover images iStockphoto.

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