Aspects of the three key fiscal regimes are outlined as follows.
1.Existing state-based revenue royalty. This applies a royalty rate between 10%-12.5% (depending on location) to field revenue, net of allowable production costs. The observable effect on financial results is for a royalty that approximates 5%-7% of well-head revenue. This is deductable for corporate tax purposes. A positive effect of this regime, is that the after tax effect is relatively low compared to alternatives. A negative effect is that royalties are paid from first production, and are not related to project profits. A project can incur accounting losses or negative cash flows and still be liable for cash royalty payments. A picture of how this royalty stream might look, for a typical LNG project at Gladstone is shown in Exhibit 1.
Exhibit 1 Cash Flows Under Existing State Revenue Royalty for CSG-LNG (2-train) - A$m [Refer to PDF for chart/tables] Source: Morgan Stanley Research. Cash flow model assumes 2 x 4 MTPA nameplate capacity LNG trains, 30 year project life, LNG price equivalent to A$12.65/GJ (real 2010$), project capex of A$15B initial, and A$13.2B thereafter. First production late 2014 and plateau production reached in 2018
2.The proposed RSPT is similar in concept to the existing PRRT but differs in key aspects. In common with PRRT, it has a "headline" rate of 40%, but the uplift factor for the recovery pre-production capex is the LTBR. Also, the recovery mechanism for pre-production capex is via depreciation (accounting depreciation signaled but not certain). Existing projects would have opening capital bases set at book value, and recovered via an accelerated depreciation mechanism (nominated as 36 / 24 /15 /10 /10 % in successive years). The RSPT would be considered as a deduction for corporate tax.
The practical impact on a long-life project is to smooth the tax payments, but they would still appear in early years unlike PRRT. Choice of LTBR for the uplift factor has drawn a strong reaction form the wider resources community, along with other issues such as transition effects (i.e. for mature assets, book value vs market ) and the choice of taxing point and determination of the taxable value of the commodity if not fully processed. The shape of cash flows is shown in Exhibit 2 for the same theoretical LNG project as proposed in Exhibit 1. A minor mitigating factor in tandem with the RSPT is the proposed reduction in corporate tax rate from 30% to 28%. While seemingly enhancing project returns, this would be irrelevant to Australian shareholders under an imputation system, where corporate tax could be viewed as personal withholding tax collected at the company level. In fact, the reduction in the corporate tax rate would be accompanied by a reduction in franking credits.
Exhibit 2 Cash Flows Under Proposed RSPT [Refer to PDF for chart/tables] Source: Morgan Stanley Research. Same project assumptions as for Ex1,
3. Existing offshore PRRT is a more akin to a returns based tax. The "headline" royalty tax rate is 40% of project net cash flows, after recovery of all current opex and capex. A key facet of this tax is that pre-production expenditures are carried forward and uplifted at differing real rates, to provide a risk-adjusted recovery of past costs. Exploration costs are carried forward at (LTBR+15%) while pre-production development costs are carried forward at (LTBR+5).
The historical costs are recovered in full before RRT is liable, which has the effect of back-ending taxes to later in field life and maximizing early cash flows. The shape of cash flows may be more amenable to project debt versus alternative royalty regimes. PRRT payments are treated like a corporate tax and shown in taxes (i.e. below the EBIT line) but are deductable for corporate tax.
The impact on the same generic project as per (1) above is shown in Exhibit 3.
Exhibit 3 Cash Flows Under Possible PRRT [Refer to PDF for chart/tables] Source: Morgan Stanley Research. Cash flows for same project as Exhibit1.
Returns and DCF
The different tax regimes have a material impact on NPV and returns for our theoretical Gladstone LNG project.
Exhibit 4 Returns & NPV Under Various Tax Regimes (2-train Gladstone LNG project) [Refer to PDF for chart/tables] Source: Morgan Stanley Research. NPV calculations assume a post-tax ungeared WACC of 9.2%
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