Framework conditions

The world needs more energy

The global energy situation has recently been the subject of much debate. The greatest economic crisis since the Second World War broke out in several areas in 2009. Reduced economic activity resulted in a steep drop in oil prices. After the large fluctuations in the oil market, oil prices stabilized in 2010, and Brent Blend was throughout the year trading at between 70 and 90 dollars per barrel. The average for North Sea oil in 2010 was $ 80.3 per barrel, which is up 28.5 percent from the year before. During spring 2011 the oil price increased and in the middle of March it is over 110 dollars a barrel.

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The economic crisis also led to a dramatic fall in investment in the energy sector, including oil.

Statistics reports a decline in investment in oil and gas activities for 2010, for the first time since 2002. Meanwhile, the revised estimates for 2011 to a record high level.The International Energy Agency (IEA) expects the demand for energy will rise sharply in coming years. Non-OECD countries will account for the growth in demand, with China and India as driving forces. Fossil fuels will account for. 77 percent of this growth in consumption.Demand for oil will increase from 85 million barrels a day in 2008 to 105 million barrels a day in 2030. Much indicates that the world will not be possible to produce more than 90 million barrels per day. The IEA estimates that demand in 2011 will be just under 90 million barrels. IEA expects oil prices will rise markedly in coming years. Current oil prices are affected by the events in Libya and Japan.

Fundamentally, demand will increase in coming years. There are still about 1.5 billion people without access to electricity. Access to energy is, along with clean water and medicines, the most important factors to get people out of poverty. Giving the poor access to energy is one of the main challenges globally. However, it is necessary that the rich nations reduce energy consumption. It can be done without compromising the standard of living and welfare.

Det norske’s basic view is that the easily accessible oil has already been produced. The world must come to set out that the oil will come from more unconventional sources and from parts of the globe where it is difficult and expensive to operate. We therefore believe that oil prices will continue to rise over time, driven by high marginal cost of alternative forms of energy and few opportunities to substitute oil with other forms of energy in the transport sector.It is exciting to work in a sector where the value of the oil and gas in the ground is expected to rise in coming years. Finding the reserves, and to produce this in the most effective way is of course the goal we are working intensely towards.

The environment

The IEA’s scenarios for stabilizing carbon emissions are based on a daily production level of eleven million more barrels than in 2008. This means that the IEA assumes a significantly higher oil production than today to meet demand. More efficient energy use will account for much more than half of the contribution to stabilize carbon emissions by 2030.

The rest will consist of the coal cleaning (10 percent), nuclear energy (10 percent) and renewable energy sources and bioenergy (23 percent).

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Petroleum activities in Norway are subject to a carbon tax and a NOx tax. The carbon tax was introduced in 1991 as an instrument to reduce emissions from the petroleum activities. Pursuant to the Gothenburg Protocol, Det norske is obliged to reduce its annual emissions of nitrogen oxides (NOx), and a NOx tax was therefore introduced with effect from 1 January 2007. Det norske is a member of the NOx Fund. Through contributions to NOx the company contributes so that funds are made available for measures to reduce NOx emissions across sectors.

Norsk oljevernforening for operatørselskap (NOFO) works to combat oil pollution on the shelf on behalf of 25 operating companies. The Norwegian is an active member and participate with staff in NOFO resource pool and members of the board.

The Norwegian framework

The main laws governing petroleum activities on the Norwegian shelf, is the Petroleum Act of 29 November 1996 and the Petroleum Taxation Act of 13 June 1975.

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From the Petroleum Act, § 1-2
“The petroleum resources should be managed in a long term perspective for the benefit of the Norwegian society. This shall include providing resource revenues to the country and help to ensure the welfare, employment and a better environment and to strengthen the Norwegian business and industrial development having due regard to regional political interests and other activities.”

The Petroleum Act states that the Norwegian state owns all oil resources on the Norwegian continental shelf. Norwegian authorities have the exclusive right to grant licenses (production licenses) and to decide what terms should apply for each license.

A production license gives the licensees exclusive rights to carry out exploration for and production of petroleum from a specific area in a given period. The licensees in a production license have the right to the petroleum that is produced from the license.

Tax and Development

The tax system on the Norwegian continental shelf reflects the fact that the state is the owner of the subsea resources and the oil companies’ value creation of an industrial nature. The tax system is balanced in that projects that are profitable before tax will also be profitable after tax. However, the tax system has a negative effect on the companies’ financing costs in that the companies carry 100 percent of the development costs, while the state keeps 78 percent of the revenues. This is currently compensated for by the companies being entitled to depreciate 130 percent of the invested amount, a so-called ‘uplift’, which means that the net present value is as if the state had invested together with the companies. This system works well for companies with major petroleum revenues, but less so for smaller, independent companies that need to obtain external financing for their projects.

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If we exclude Statoil, most of the exploration activities are carried out by oil companies that are relatively new to the Norwegian continental shelf, with little or no petroleum revenues. It must be assumed that their exploration activities will be followed by considerable development and production activities conducted by the same companies. To ensure that these companies continue to develop, Det norske has proposed that the petroleum tax rules be amended so that the uplift is replaced by a system in which the state compensates for the tax effect of deficits created by investments in field developments on the Norwegian continental shelf. This will not increase the state’s exposure. The state’s net income from the activities will be maintained. Hence, such a scheme will not entail any form of tax subsidies. In practice, it is an extension of the scheme that is already established for exploration activities. It will ensure that a number of projects that have currently been put on hold, among other things as a result of the financial crisis, can be resumed. This will increase diversity on the Norwegian continental shelf, not only in the area of exploration – but also in field development.

Government and Development

Once commercially recoverable reserves have been discovered, the licensees must prepare and gain the authorities’ approval of a Plan for development and operation (PDO) before the development can start. An important part of the PDO work is to study potential positive and negative consequences of a development.

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The Petroleum Act requires that a program for environmental impact assessment (KUP) is prepared, and that an impact assessment report (KUR) is enclosed with the development application. Both KUP and KUR will be distributed to stakeholders for consultation.

Developments of a certain scope, normally NOK 10 billion, require approval by The Storting, while the Government (the King in Council) can approve PDOs involving smaller investments. The Ministry of Petroleum and Energy will decide whether the applicant is allowed to enter into material contracts or start construction work before the PDO has been approved.

In the same way that a development plan for commercially recoverable reserves must be approved by the authorities, a Plan for installation and operation must be prepared for new pipeline systems.

Licensing Round

License rounds are very important to Det norske and it is the most important way of gaining access to new areas. Since 1965, the authorities have completed 21 license rounds in new areas. In later years, such rounds have been conducted every other year, and most of the awarded areas are in the Norwegian Sea. In addition, the Norwegian authorities introduced rounds of awards in pre-defined areas (APA) in 2003. These license rounds include new call for applications for returned areas in mature areas of the continental shelf. APA rounds have been carried out annually since 2003. So far, the authorities have signaled that the APA scheme will be continued.

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These rounds have been very important to the building of Det norske’s license portfolio as they have given us access to extensive exploration areas in mature areas. The production licenses are awarded to a joint venture, which normally consists of several companies. The production license regulates the rights and obligations that the companies have in relation to the state. The partners in a license have joint responsibility for the commitments undertaken by the production license. Initially, the license is valid for a period of up to ten years. During this period, a pre-established work program will be completed in the form of geological and geophysical pre-studies and/or exploration drilling, plus environmental surveys in vulnerable areas.

When a production license has been awarded, the licensees must enter into a joint cooperation and accounting agreement, subject to conditions stipulated by the authorities. These agreements regulate many aspects of the relationship between the partners and the operator, and also the relationship with the authorities. The operator in each production license is appointed by the authorities, and this company is responsible for the day-to-day license operations.

The steering committee is the supreme authority in a production license. Each of the partners in the license is represented on the steering committee. The voting rules are normally designed so that a majority in terms of both interests and the number of votes is required for a decision to be valid. The way the voting rules work, an owner with an interest of more than 50 percent cannot adopt a proposal alone.

The licensees can buy, sell and swap license interests, but this is conditional on the approval of the Ministry of Petroleum and Energy, as well as by the Ministry of Finance in matters relating to tax.

Det norske and the Tax System

The taxation of oil companies in Norway is based on the rules that apply to ordinary company taxation. Due to the extraordinary profitability involved in the production of petroleum, this type of activity is also subject to additional special taxation. The ordinary company tax rate is 28 percent. The special tax rate is 50 percent, making the total marginal tax rate 78 percent.

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When the basis for ordinary tax and special tax is calculated, investments on the continental shelf are depreciated using the straight-line method over six years from the year in which the investment was made. All relevant costs can be deducted, including the costs of exploration, research and development, financing, operation and removal. A full consolidation of fields and licenses is permitted, something that is very important to Det norske in the company’s current growth phase.

To protect the normal return from special taxation, an extra deduction, called uplift, can be made from the basis for the special tax. It corresponds to 30 percent of the investment and can be deducted by 7.5 percent over four years as from the year of investment. Companies that are not in a taxable position, such as Det norske, can carry forward deficits and uplifts with the addition of interest. This is important to Det norske, as the company is in a phase of intensive exploration involving many wells, at the same time as it has limited income from production. In addition, the tax value of exploration expenses is reimbursed the year after the expenses were incurred, limited upwards to the amount of tax-related deficit. This means that Det norske pays approximately 22 percent of the company’s gross exploration costs.

In addition to ordinary tax, petroleum activities in Norway are also subject to a carbon tax, a NOx tax and an area fee. The carbon tax was introduced in 1991 as an instrument to reduce emissions from the petroleum activities. Pursuant to the Gothenburg Protocol, Det norske is obliged to reduce its annual emissions of nitrogen oxides (NOx), and a NOx tax was therefore introduced with effect from 1 January 2007. Det norske is a member of the NOx Fund.

Member companies are exempt from paying NOx tax to the customs region, but must make a payment to the NOx Fund instead.

The area fee is an instrument to ensure efficient exploration of the license areas, so that any resources can be put into production quickly and the life of existing fields can be extended. With a view to strengthening the function of the area fee, the rules were made more stringent with effect from 1 January 2007. Pursuant to the new rules, the companies must pay NOK 30,000 per square kilometre for the first year, NOK 60,000 for the second year and a maximum rate of NOK 120,000 as from the third year. Companies are exempted from payment of the area fee if a Plan for development and operation (PDO) is submitted to the Ministry of Petroleum and Energy. Such exemption is only granted for those areas of the field that are covered by the PDO. The regulations also grant exemption for payment of the area fee for two years if an exploration well is drilled.