liquid fuels industry
6 August 2007
Introduction
In the February 2006 Budget the Minister of Finance Trevor A Manuel, MP,
announced the appointment of a task team to investigate whether windfall
profits were being generated by the liquid fuels industry, in particular the
synthetic fuels industry and whether a windfall tax should be imposed if such
profits existed.
The task team, headed by Dr Zavareh Rustomjee, also included Ms Almorie
Maule, Dr Grove Steyn, Dr Boni Mehlomakulu and Dr Rod Crompton. The task team
worked energetically to submit its final report to the Minister of Finance on 9
February 2007. The report was published on 23 February 2007 for further public
comment by 31 March 2007. After receiving comment from key stakeholders,
Minister Manuel asked the National Treasury to submit a formal response to the
fiscal recommendations of the task team.
Background
The investigation into windfall profits in the liquid fuels industry was
initially raised in the October 2005 Medium Term Budget Policy Statement
(MTBPS) in the context of a possible structural increase in the price of crude
oil, which had increased from an average of US$29/barrel in 2003 to a high of
US$60/barrel in the third quarter of 2005.
The task team's report documents in great detail the development of South
Africa's liquid fuel industry. In this respect the report will be of great use
to all those who wish to obtain a better understanding of the dynamics and
complexity of this industry. The task team makes a number of fiscal and
regulatory recommendations. This response deals only with the task team's
fiscal proposals, as the regulatory recommendations have been referred to the
Ministry of Minerals and Energy for consideration.
Government response to task team report
Definition of windfall
The National Treasury considered the definition of windfall profits as used
in the task team report. The report points out that the concepts "windfall
profits" and "excessive profits" are used loosely and interchangeably, as are
the concepts "economic profits" and "economic rent". The report defines
windfall profits as excess profits, of which conceptually there are two
possible types: those of a temporary or cyclical nature (called "quasi rent" or
"economic profits"), or more structural or permanent (called "economic
rent").
Using this definition, the task team concluded that there is evidence that
the synthetic fuel industry generates windfall profits of a cyclical nature
(economic profits or quasi-rents), but did not conclude it was of a structural
or permanent nature (economic rents).
South African corporate tax system
Generally, the inquiry raises the broader question whether additional profit
taxes are needed from an economic perspective. National government raised more
than 80 percent of its total tax revenue from four tax instruments (Personal
Income Tax, Corporate Income Tax, VAT, Fuel Levy) in 2006/07, which suggests
that South Africa has a well-functioning tax system. Government wishes to
reinforce this track record, especially since corporate tax collections remain
strong. We are mindful that in considering the imposition of a windfall tax,
the following principles that have guided tax policy after 1994 should not be
compromised:
a. simplifying the taxation of companies
b. providing predictability in tax policy
c. avoiding intervention in particular sectors, unless it is explicitly part of
approved industrial or economic (e.g. natural resources) policy
d. aiming for time consistency in tax policy avoiding perceptions of ex-post
taxation.
Cyclical or structural windfall profits
The report cites a number of international examples where taxes on windfall
profits were applied. In some cases these were once-off events, due to
regulatory failures and/or flawed privatisation procedures. In others, the
intent was to tax economic rent, especially in the crude oil extraction
sector.
Having established that there are instances where windfall profits are
generated, the question to consider is whether such profits are cyclical or
structural in nature. This is because although the taxation of pure economic
rent of a structural nature does not affect companies' behaviour, the taxation
of rents of a short or cyclical nature will affect companies' behaviour and
have an impact on resource allocation, resulting in distortions. In such
instances, windfall taxation is normally avoided. It is therefore essential to
distinguish between permanent and temporary rents.
From its analysis of the report of the task team, government believes that
the key question to be considered is: Does the current price of crude oil now
reflect a structural or permanent change that would justify a new fiscal
intervention? It is not possible to come to a definite conclusion at this
stage, which is an argument for not proceeding with a windfall tax on existing
synthetic fuel producers. We note that most oil-rich countries share in the
gains of their mineral wealth by way of royalties, production-sharing
agreements and/or state equity stakes or normal corporate income tax, rather
than through imposition of windfall taxes.
Strategic considerations
Government has also taken a range of strategic considerations into account
in considering the task team report, including:
* the negative effect any new tax might have on investment
* constraints on the supply of energy, both electricity and liquid fuel
* adherence to higher environmental standards.
A key policy priority is to reduce South Africa's dependence on imported
fuel. This will support the initiatives associated with the accelerated and
shared growth initiative (AsgiSA) and shore up fuel security at a time of
uncertainty in world oil markets. It is important that energy companies operate
in an environment of fiscal and regulatory certainty. Such certainty in a
competitive environment supports increased investment in production and
exploration, which in turn supports continued economic growth and
stability.
We accept that in the current scenario considerations should be given to
partnering with the private sector to kick-start investments in new oil
refining and/or synthetic fuel production capacity.
Sasol and South Africa's tax regime
It is a matter of national interests that Sasol's valuable intellectual
capital, co-financed by government over the years and acquired through
intensive domestic research, is further developed to keep South Africa on the
cutting edge of synthetic fuel technology. We have weighed this strategic
consideration against the possible benefits of a windfall tax.
The task team points out that during the so-called Pim Goldby protection
era, Sasol received R3,73 billion in tariff protection (subsidies) and
recommends "that the fiscal options in response to excessive economic profits
proposed elsewhere in this document be the preferred instrument for resolving
any uncertainties that may remain."
This recommendation of the task team, however, falls away, as we can confirm
that Cabinet effectively released Sasol from the obligation to repay any
outstanding subsidies received during the Pim Goldby era in 1998, provided it
continued to develop the petrochemicals sector.
Government is keen to signal a shift from a backward-looking approach to a
forward-looking one, where the focus is on new investments in the liquid fuel
sector by Sasol and all other players in this industry. In this respect,
Government welcomes the commitment made by Sasol to the feasibility of
investing in Project Mafutha, for a new coal to liquid (CTL) plant. The
possibility of a gas to liquid (GTL) plant is also under consideration.
Upstream oil and gas production
The task team also suggested amendments to the fiscal system pertaining to
offshore oil and gas exploration and extraction. It recommends that:
"The tax authorities should either introduce a linkage between royalty
levels and the respective commodity price curve in the Royalty Bill, or
incorporate a progressive tax mechanism into the schedule of the Income Tax Act
that ultimately replaces the OP26 mining lease currently in operation."
The task team correctly notes that in the event of major oil or gas fields
being found in South Africa's jurisdiction, it could trigger calls for windfall
profit taxes during times of high commodity prices. However, as government we
wish to point out that the OP26 lease was replaced in October 2006 by the tenth
schedule to the Income Tax Act, in line with changes in the mining and
exploration rights regime. The new legislation captures most of the fiscal
provisions in the previous OP26 lease agreements, but does so in a much more
transparent manner. We therefore do not see the need to change this approach,
given the need for policy certainty in order to encourage companies to continue
exploration, which is generally a high-risk investment.
Summary of task team recommendations
The task team makes a number of fiscal recommendations, including:
* the imposition of a windfall tax on existing synthetic fuel
producers
* an incentive regime for investments in the production of liquid fuel from
indigenous raw material (i.e. synthetic fuel and biofuel)
* a possible progressive tax regime for upstream oil and gas producers
* tax on the "must have volumes" of liquid fuel Sasol supplies to the inland
market
* investigating whether Sasol is still obliged to repay subsidies it received
between 1989 and 1995 under the so-called Pim Goldby subsidy regime.
All these fiscal recommendations are well-reasoned and deserved careful
consideration by government.
Conclusion
In summary, we note the complex nature of the delineation between cyclical
and structural windfall profits in the synthetic liquid fuels industry.
Secondly, we hold Sasol to its commitment to significantly expand its synthetic
fuel production capacity in support of the national interest in terms of fuel
security and macroeconomic stability. And lastly, given the broader tax policy
objectives, we recognise the need for fiscal certainty for the liquid fuels
industry.
It is therefore government's view, on the basis of evidence presented, that
although it agrees with the task team that a potential exists for the
generation of quasi-rents, the imposition of a windfall tax on existing
synthetic fuel producers is not appropriate. We accept that at this stage that
public interventions must focus on facilitating the expansion of liquid fuel
supply capacity in the interest of domestic energy security and macroeconomic
stability. Government has initiated an inter-governmental process to promote
the long-term development of the domestic liquid fuel industry. We expect that
the industry as a whole (including Sasol, PetroSA and all the oil majors) will
respond positively within an agreed timeframe to invest a significant share of
its profits in expanding capacity in South Africa and the region.
With regard to the fiscal recommendations of the task team, Government:
* agrees with the task team that windfalls have been generated in the
domestic synthetic fuel industry, though it cannot be concluded that this is
due to a structural or permanent change in the price of oil
* agrees to explore an incentive regime for investments in the production of
liquid fuel in new synthetic plants to reduce dependency and promote fuel
security and will consider biofuel and other options
* agrees to consider the task team's recommendation on royalties through the
process to finalise the Mineral and Petroleum Royalty Bill. Like all other
inputs into this process, Government will consider such proposals within its
policy framework based on gross sales as the tax base, whilst providing
appropriate relief for marginal mines.
Government has also decided:
* not to proceed with a tax on the windfall profits earned by existing
synthetic fuel producers in the interest of a conducive environment for
additional investments in domestic fuel security
* not to implement a progressive tax regime for upstream oil and gas companies,
given the recent enactment of the tenth schedule to the Income Tax Act
* not to consider a tax on the "must have volumes" supplied by Sasol to the
inland market, but to explore a levy on refined products to contribute to the
construction of excess capacity in relation to the proposed New Multi-Product
Pipeline.
On behalf of government, I would also like to thank the task team for its
sterling work and want to point out that its report will be seen as the
catalyst that helped government to finalise measures to create a climate of
certainty for the liquid fuel industry. It also lays the basis for government
to take appropriate measures to ensure the success of initiatives like Project
Mafutha and other projects and the role of the private and public sectors in
such projects.
For further comments or questions, please contact:
Thoraya Pandy
Tel: 012 315 5944
Cell: 082 416 8416
Issued by: National Treasury
6 August 2007
