Making the Oil Companies Pay What They Owe

Timor-Leste is the most petroleum-export-dependent country in the world. In 2009, revenues from selling our nonrenewable oil and gas wealth were more than three times larger than the entire non-oil economy. Oil money pays for about 90% of everything the Government does.

But the oil companies cheat – they pay as little as they can get away with. After six years as a petroleum-exporting country, Timor-Leste is beginning to scrutinize their tax returns and enforce its laws, and has discovered what should have been expected – that foreign oil companies have not paid all that they owe. Processes are beginning to collect many tens of millions in back taxes and penalties from ConocoPhillips and other companies, and further investigation is likely to find more irregularities.

Background

Timor-Leste depends on international petroleum companies to extract and sell our non-renewable oil resources, and to pay us a fair price for the oil, as well as taxes on their profits. But the oil companies have different loyalties – their management feel obligated to make the most money possible for their shareholders, the owners of private-sector companies such as ConocoPhillips, Woodside, Inpex, Shell, Santos, Eni and the other global companies operating here. They didn’t become rich and powerful by giving money away the countries where they operate.

This is an inherent conflict of interest. The companies want to maximize profit and minimize taxes, while Timor-Leste wants to get the most money possible for its people, and to ensure that the companies are socially and environmentally responsible. Laws and contracts, written by the State, are intended to guarantee that Timor-Leste receives our fair share of the resources we allow foreign companies to extract and sell. The negotiation process starts with the contract bidding round, and continues through development and annual work plans approved by government regulators.

The companies are obligated to pay royalties and taxes to the National Petroleum Authority (ANP) according to their Production Sharing Contracts, and to Timor-Leste’s government under Timor-Leste’s tax laws, including Indonesian laws in effect here. The ANP and the National Directorate of Petroleum Revenues (DNRP) in the Ministry of Finance are responsible to see that the laws are followed and the payments are made. Those laws were not enforced effectively until this year, and the companies have illegally kept many millions of dollars that rightfully belong to Timor-Leste.

Petroleum taxes are complicated. In addition to paying a percentage of their sales of oil and gas, oil companies here pay tax on their income, tax on their profits, and an extra tax when a project becomes very profitable – usually after its capital investment has been paid off. Bayu-Undan, our only producing oil field, reached this point at the end of 2006, and currently pays about $150 million dollars to Timor-Leste every month. But it should be more.

When taxes are calculated, the oil companies are entitled to deduct the expenses of operating the project through a process called “cost recovery.” This means that Timor-Leste effectively reimburses the company for expenses related to the project. The contracts specify which costs are recoverable, and each month the companies supply a list of the expenses they have taken off their taxes. There’s a lot of room for cheating, especially if the regulators don’t carefully check to make sure that all the costs claimed are legitimate expenses of the project.

This is a highly technical, complex and challenging task, which increases conflict between the people working for the regulators and their “friends” working for the companies. Regulators and auditors alike fall victim to “regulatory capture,” where the regulator forgets his or her loyalty to the people of Timor-Leste because he/she interacts with colleagues from the companies on a daily basis. The company representatives rarely forget their loyalties – they continually try to keep more money for their shareholders instead of paying it to Timor-Leste.

During our eight years of independence, Timor-Leste’s petroleum regulators (the National Directorate of Petroleum Revenues, Timor Sea Designated Authority (TSDA until 2008) and National Petroleum Authority (after 2008)) have never effectively checked and audited the companies’ tax returns. We expect that the companies, having gotten away with dubious cost recovery claims, continue to take more questionable deductions every year. The total loss to Timor-Leste could be a billion dollars or more.

In recent months, the DNRP has begun reviewing company tax returns from the last several years, finding many irregularities. This article discusses two of them.

ConocoPhillips, Inpex, Santos: Pay $32.4 million for illegitimate cost recovery deduction.

In November 2010, after several months of investigation, Timor-Leste sent a $32.4 million bill to ConocoPhillips (USA) and its joint venture (JV) partners Santos (Australia) and Inpex (Japan) for a cost the companies wrongly recovered from the Bayu-Undan project in 2005.

The illegitimate cost was for an exploratory well named Firebird (red circle on map at right) which was drilled in 2005 and came up dry. Firebird (sometimes called Phoenix) has a long history.

The first exploratory well ever drilled in the Joint Petroleum Development Area was Flamingo-1 (to the right of Firebird) in 1971. Flamingo missed the Bayu-Undan field and didn’t find anything significant. In 2003 ConocoPhillips reassessed the data, concluding that there could be a commercially valuable natural gas field nearby, deeper under the seabed than the Bayu-Undan field. They asked the TSDA for permission to drill one more well to confirm their guess that Firebird could have as much as 1.4 trillion cubic feet of gas, about ¼ the size of Bayu-Undan.

Under Production Sharing Contract JPDA 03-12 (May 2003 amendment) signed between the JV and the TSDA in 2003, the companies are required to give back parts of the contract area that they are no longer interested in exploring, and the area under contract gradually shrinks. The pink hatched area on the map was scheduled to be relinquished in 2004, but the companies asked the TSDA for time to drill Firebird. The TSDA granted the extension in February 2004, but told the companies not to charge Firebird costs against Bayu-Undan revenues. The JV would only be able to recover these exploration costs if and when Firebird became a commercial project.

The drilling rig Ocean Bounty drilled 3,675 meters deep at Firebird at the end of 2005 but found only small amounts of gas, not commercially viable, and the well was plugged and abandoned. Contrary to their agreement with TSDA, the JV charged the $32 million cost of the well against Bayu-Undan revenues, reducing their tax payment by $9.7 million, even though the TSDA protested. The companies gave up on this area and relinquished it soon thereafter.

In 2010 Timor-Leste began to enforce its petroleum tax laws more effectively, and reopened this issue. On 24 November 2010 Timor-Leste ordered ConocoPhillips, Inpex and Santos to deposit a total $32.4 million into the Petroleum Fund before 7 December. This includes $9.7 in the back taxes, as well as a 100% penalty for gross negligence and 1% per month interest and penalties for late payment.

In early December, Inpex paid $7.1 million and Santos paid $5.1 million. ConocoPhillips has said it is paying $19.5 million, although the companies could still appeal within the Ministry of Finance.

Woodside and others: Pay capital gains tax when you sell your shares in contracts.

Around the world, oil companies often buy and sell their ownership in different projects. If they make a profit – getting more for selling their shares than they spent on developing them – they are responsible to pay capital gains tax, which is 30% under the applicable law in Timor-Leste. Although several such sales have occurred in the JPDA since Timor-Leste became independent, the companies have not paid this tax. Current investigations are likely to produce payments for overdue taxes from several companies.

One example is JPDA Production Sharing Contract 06-105, of which Woodside (Australia) sold its 40% share to Eni (Italy) in 2007. Although Eni paid Woodside more than $23 million for the project, Woodside has not paid capital gains tax that it owes according to law.

The western edge of the Joint Petroleum Development Area (JPDA) has long been a promising area for oil exploration. This geological formation includes Buffalo and Laminaria-Corallina (just outside the JPDA), from which Australia has made $2 billion over the past 11 years, and Woodside has made more.

Woodside began exploring here during the Indonesian occupation and found small oil fields with exploration wells Jahal-1 (1996) and Kuda Tasi-1 (2001). In 2003, the TSDA signed a new contract JPDA 03-01for this area with a joint venture consisting of Woodside Petroleum (40%), Inpex (35%) and Talisman Resources (25%). Later that year, the JV drilled the Kuda Tasi-2 test well and continued seismic exploration.

In 2005 Santos sold its 25% share in the joint venture to Talisman Resources (Canada). Timor-Leste is investigating this sale to see if taxes are due.

On 24 July 2006, the TSDA signed a new Production Sharing Contract for part of area 03-01, which was renamed 06-105. Woodside believed that Kuda Tasi and Jahal contain about 20 million barrels of recoverable oil, which they hoped to develop together with Laminaria, and they drilled another test well in 2006.

After that, Woodside decided that Kuda Tasi and Jahal were not commercial, and they sold their 40% interest in JPDA06-105 to Eni in September 2007, with the required approval from the TSDA. Eni paid $13 million initially, and $10 million more when Eni discovered the Kitan oil field less than six months later and declared it commercial.

Woodside should have paid capital gains tax on the money they earned from this sale, but they told the TSDA (which became the National Petroleum Authority (ANP) in mid-2008) that it was simply a change of name and that no tax was due.

Timor-Leste is currently asking about additional payments, and will probably send Woodside a bill soon. The government is also looking into sales of PSC shares by other companies, and will probably be collecting additional back taxes from them. In November 2011, the Ministry of Finance published Draft Public Ruling 2011-11 "to address the ambit of Article 11, Annex G to the Timor Sea Treaty and address the Timor-Leste tax consequences of transactions within the ambit of the said Article 11," to provide advice about "the tax consequences attendant to the sale of property, shares and or comparable interest in a company with a presence in the JPDA." Comments are invited through the end of 2011, and the final version will be published not later than 15 February 2012.

Keeping the companies honest

In December 2010, the National Directorate of Petroleum Revenues in Timor-Leste’s Ministry of Finance will begin to audit the tax returns from Bayu-Undan for 2005 through 2009, the first time Timor-Leste has audited petroleum tax returns. Although the statute of limitations prevents looking further back than five years ago, Timor-Leste can examine years before 2005 if fraud is discovered.

For the last four years, the TSDA and ANP have used Ernst and Young as an “independent” auditor of PSC reports, but the auditor has not questioned a single item on the oil companies’ documents. Since the auditor is paid by these companies, this is not surprising, but it does embolden the companies to make more questionable claims. Timor-Leste should be using a truly independent auditor who will identify and assess payment for past irregularities, leveling the playing field somewhat.

Until a few months ago, the oil companies insisted on keeping their files in Australia, and Australian laws about confidentiality of tax records made it impossible for Timor-Leste regulators to obtain documents from there. However, the companies are now required to keep copies of all their files related to JPDA oil projects in Timor-Leste, and to make them available as requested by Timor-Leste officials. This will enable much more effective regulation, auditing and tax collection. In 2010, about fifteen times as many audits were conducted has had been in 2008 or 2009.

However, the companies have far more resources, money and experience than the regulators. Here are a few numbers, from 2009:

Company or Agency	Year founded	Number of employees	Produces in how many countries	Oil & gas production Million barrels / day	Annual expenditures US $million
Eni (Italy)	1926	78,400 10,900 in E&P	40	1.77	$91,000 (operations)
ConocoPhillips (USA)	1917	30,000	30	1.85	$143,000 (total) $40,000 (operations)
Woodside (Australia)	1954	3,219	11	0.22	$1,900 (operations)
National Petroleum Authority (Timor-Leste)	2008	57	1	0.20 (Bayu-Undan)	$4
National Directorate of Petroleum Revenues in RDTL Ministry of Finance	2007	About 15	1	none	About $0.3

In other words, ConocoPhillips and Eni each produced nearly ten times as much oil and gas as Bayu-Undan. ConocoPhillips has 500 times as many staff as ANP, and spent ten thousand times as much money on operations.

In May 2011, a Government issued a press release said that the National Directorate of Petroleum Revenue collected $79 million in "audit payments" (in addition to $361 million in revenues) during the first quarter of 2011, but without details. However, it appears that the $79 million has not been deposited into the Petroleum Fund.

Timor-Leste is the owner of the oil and gas in the ground, and it writes the contracts and the laws. For our people’s sake, we are glad that they are finally being enforced effectively.