In evaluating options to encourage oil exploration

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concerns and objectives. In evaluating options to encourage oil exploration and production activities, host governments should focus on measures that: (i) materially improve the eco- nomics and/or reduce the investment risk, (ii) involve low compliance and administration costs; (iii) address market deficiencies; (iv) minimize distortionary effects; and (v) are con- sistent with the country’s macro-fiscal policy and with local development objectives. Although not all countries have made the same legal and regulatory choices, nearly all have established sector specific legislation and regulation in line with their constitution and with the rest of the country’s body of laws. One advantage of this approach is its trans- parency and its objectivity: by establishing the boundary conditions for the award of petro- leum rights and defining the authority and procedures for such award, system inefficiencies and the scope for discretional behavior are greatly reduced. Whether contractual or con- cessionary systems are used, key elements considered by potential investors in comparing investment opportunities include clarity and simplicity of terms; objectivity of rules and their enforcement; and neutrality, equity, efficiency, and stability of fiscal terms. The fiscal regime, especially when complemented by broader sector reforms, has been used by many countries to convert government policy into economic signals to the market and influence investment decisions. Depending on its overall fiscal policy needs, the host government may seek different levels of front-loading at different points in time. In order to achieve its objectives while maintaining a reasonable level of investment incentives, the government would need to seek a tradeoff between regressive features (royalties, cost recov- ery limits, exploration tax) and progressive features (RoR, R-Factor-based taxes, or pro- duction sharing). 29
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One of the key challenges of fiscal policy is develop a system that is able to allocate risks equitably. To meet this challenge, policy makers need to take into account the diver- gent interests of companies and governments. As risks can differ substantially for differ- ent projects and countries and over time, a fiscal regime that provides optimal outcomes under all circumstances is not likely to be developed. Although this may justify a case by case approach, this would hardly be efficient given the usually large number of projects and the often limited administrative capacity of the host government. It is therefore desirable to build enough flexibility into a system to allow for automatic adjustments to unforeseen changes and to minimize the need and cost of negotiations and/or renegotiations. Intu- itively, this would imply the optimization of fiscal revenue at the country level as opposed to the optimization of fiscal revenue at the project level.
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