Progressive Royalty Framework for Oil and Gas Development Strategy: Lessons from Nigeria

Abstract Royalty is a mechanism by which mineral owners – usually host government – obtain upfront revenue as soon as production begins from a petroleum lease or block. It can be received in cash or in kind and represents a part of front-loaded cost of doing business; it is tax deductible in oil and gas tax calculations. Economic rents extracted through royalty payments are usually not based on profits. This dampens the progressiveness of a fiscal regime and would normally have effects on investments and resource development economics. This paper presents a progressive royalty framework and investigates the impacts of the various kinds of royalty schemes on oil and gas development economics. The conducts and performances of fixed, jumping and/or sliding royalty schemes are evaluated. Further, the paper reviews the different sliding scale specifications in fiscal systems and recommends the optimal boundary to ensure efficiency and effectiveness. The proposed royalty scheme recommended in the Inter Agency Team (IAT) memorandum on the 2008 Petroleum Industry Bill of Nigeria (PIB 2008), which was tied to terrain, geology and value forms the basis for the royalty design and modeling analysis evaluated in this paper. Logarithmic sliding scale royalty scheme is generally perceived to perform better than other schemes but our analysis shows that terrain and geology matter a lot. This implies that if the royalty scheme is tied to geology, then marginal field operators would prefer the linearly sliding scale mechanism to logarithmic scale. Flexibility to switch from one scheme to the other offers incremental fiscal regime progressiveness in the quest for efficient, effective, equitable, and ethical energy resource development. The paper recommends the use of sliding scale royalty scheme as a progressive bidding parameter and subsequent rent extraction instrument. The uncertainty in oil prices and its plummeting trend – plausibly discouraging exploration and exploitation of the not-easy-to-find hydrocarbons – requires progressive royalty schemes to create an equitable performance outcomes for all stakeholders in the emerging new petroleum era.