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Taxation and Investment Decisions in Petroleum

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  • Graham A. Davis and Diderik Lund

Abstract

When governments apply high tax rates targeted at natural resource rent, there must be generous deductions in order to avoid investment disincentives. How generous is disputed. Based on standard finance theory and recommendations from the OECD and the IMF, the value that firms attach to future deductions depends on the risks of these, and the companies' after-tax weighted-average cost of capital cannot be applied directly. As an example, a simple model quantifies the difference between pre-tax and post-tax systematic risk when tax deductions are less risky than pre-tax cash flows. Osmundsen et al. (2015) suggest that the difference must be ignored by oil companies, since they cannot find the separate market values of tax deductions. But companies operating in different jurisdictions cannot then appreciate differences in tax systems, not even approximately, which will lead to suboptimal decisions. Tax designers may instead assume that companies have gradually adopted more sophisticated methods of investment decision making.

Suggested Citation

  • Graham A. Davis and Diderik Lund, 2018. "Taxation and Investment Decisions in Petroleum," The Energy Journal, International Association for Energy Economics, vol. 0(Number 6).
  • Handle: RePEc:aen:journl:ej39-6-davis
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    Cited by:

    1. Babak Jafarizadeh & Reidar B. Bratvold, 2019. "Exploration economics: taking opportunities and the risk of double-counting risk," Mineral Economics, Springer;Raw Materials Group (RMG);LuleƄ University of Technology, vol. 32(3), pages 323-335, November.
    2. Mason, Charles F. & Wilmot, Neil A., 2020. "Jumps in the convenience yield of crude oil," Resource and Energy Economics, Elsevier, vol. 60(C).

    More about this item

    JEL classification:

    • F0 - International Economics - - General

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