The oil and gas industry already contributes substantially to the economy, but this is only a fraction of the potential of the industry and we could be making it much easier to tap into that potential. BY GREG BISHOP AND MICHELLE DUSTOW, KPMG.
You only need to look at the Norway success story to understand the potential of the oil and gas industry to completely reform a nation’s economy.
It wasn’t until 1969 that it became clear there were significant oil and gas reserves on the Norwegian Continental Shelf. Since that discovery, Norway shot from a ranking of 18th in the OECD (in terms of GDP per capita) to second, where it has comfortably sat since the mid 1990s.
New Zealand, on the other hand, has slipped from eighth to 23rd over the same period. Norway is now the largest producer of oil and gas per capita outside the Middle East.
To put some perspective on the financial impact of this, Norway’s sovereign wealth fund, originally termed the “Petroleum Fund”, is now in excess of $1 trillion (or $200,000 per citizen), deriving most of its financial backing from oil profits.
Compare this to the New Zealand Superannuation Fund (our “Cullen Fund”), currently sitting at $25 billion (or $5500 per citizen), and you can begin to visualise the ability of a successful oil and gas industry to financially secure the future of our country.
What many Kiwis don’t realise is that the country is a submerged continent with sovereign rights over more than 5.7 million square kilometres of seabed.
The three small islands in the South Pacific that most typically associate with “New Zealand” account for only six percent of our territory. With the fourth largest exclusive economic zone in the world (much larger than the North Sea), we can reasonably expect to have continental scale resources. In fact, geologists have identified that there are potentially 17 sedimentary basins capable of producing commercially recoverable quantities of hydrocarbons in the wider economic zone.
The difficulty is that these resources, with the possible exception of shale oil clay on the East Coast, are more likely to be found in deeper water. The smaller oil and gas companies that have typically been attracted here in the past simply do not have the capital to invest at least US$100 million to drill a deepwater exploration well, so it is important for us to attract investment by the larger international players.
This becomes even more important in our case as these sedimentary basins are significantly underexplored, which means the existence of the petroleum resource (outside of the Taranaki basin) has not yet been proven.
Combine all of this with the fact that the country is geographically remote and must almost always source drilling and support equipment from offshore, and we quickly become a high cost, high risk jurisdiction relative to other more mature and “competitive” destinations.
To compete on the global stage for the large exploration dollars required to prove our oil deposits, we need to go that one step further – we as a country need to positively invest in the industry and provide international players with a reason to choose New Zealand. To even make the short list of investment opportunities we need to bring down the cost of exploration.
One way we could go about this is to offer a fiscal incentive through the tax regime which, somewhat perversely, currently operates to disadvantage new entrants.
Petroleum miners with an existing tax base here are able to offset the cost of new exploration against income derived from other activities, reducing their New Zealand tax liability.
Compare this to new entrants who have no New Zealand income against which they can offset the cost of exploration. Rather, they accumulate tax losses that can, in theory, be carried forward and offset against income that may be derived in future years.
We say “in theory” because, in the event that the company does make a commercial discovery, the cost of development often requires capital raising, a process which tends to result in those losses being forfeited under the current tax system. This means that, in many instances, the cost of exploration is effectively 28 percent higher for new entrants.
A simple fix could be to introduce a refundable tax credit for exploration costs whereby tax losses are refunded in the year they are incurred, rather than accumulated and carried forward. This is not a new concept – Norway, the great oil and gas success story, has had a similar regime in place since 2005. And, in fact, this is not an entirely new concept here either – we have recently implemented a refundable tax credit system to encourage expenditure on research and development.
Such a change would considerably reduce the risk associated with exploratory drilling and would provide a fiscal incentive for new players to invest here. Once the existence of the petroleum resource is proven this in itself will attract international investment, a point at which the position could (and should) be reconsidered.
The Government has publicly acknowledged the importance of the oil and gas industry and the potential for it to play a very significant role in the future of our country. Perhaps not surprisingly, when you consider the statistics and impact of a major discovery here, opposition leader David Cunliffe recently confirmed that Labour, too, is not opposed (at least in principle) to deep sea oil exploration. There is little doubt in our minds that the prize would be a game changer.
Of course, introduction of any financial incentive will require a reasonably substantial investment by the Crown.
While NZ Petroleum and Minerals is doing an excellent job of promoting the country, the direct investment by the Crown has been approximately $20 million over the past three years. That is, around $6.5 million per year or, as a percentage of total Crown revenue from the industry (annually in the order of $750 million to $1 billion), a reinvestment of less than one percent – not exactly the level of reinvestment you would expect from any business in basic research and development. In our view, the reinvestment needs to be more reflective of the potential prize at stake.
While we do not necessarily advocate a return to the days of a National Oil Company where the Government had a direct interest in exploration activity, one thing is certain – we cannot simply sit back and wait for the international investment to come to us.
We need to proactively go out and bring it here.