A Wood Mackenzie study on project cost overruns shows wide variance in tax treatment. Some countries ‘pay’ virtually all excess cost out of tax.

A study from Wood Mackenzie, ‘Cost hyperinflation: all is not lost…’ investigates the true cost to investors of project overruns. Woodmac VP Graham Kellas explained, ‘Oil and gas hyperinflation has resulted in billions of dollars of cost overruns in field development.’ The report investigates the tax situation of increasing oil field costs asking ‘does an extra dollar spent reduce the value of the project by a dollar?’ In general, an extra dollar on Capex does not reduce the value to investors by a dollar, due to its deductibility or recovery in production sharing. Kellas explained, ‘For a 100 mmbbl development, with a $200 million cost overrun, the post-tax NPV ranges from a reduction in the NPV of between $152 million (Iran) to an actual increase in the NPV of $26 million (Angola).’

Production sharing

The report concludes that in general, Production Sharing Contract regimes offer higher levels of protection from cost overruns than royalty/tax regimes. In Azerbaijan, Libya, India and Angola the government assumes virtually all of the impact of the cost overrun. Countries offering the least protection from cost overruns are Iran, Yemen and Brazil.

See also our ‘mash-up’ of the Woodmac data with Transparency International’s 2005 Corruption Index in this month’s editorial.

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