Scenario analysis for fiscal regime and stability
In our last publication, we highlighted the risks derived from an adjustment to the fiscal terms in Exploration and Extraction contracts and the available protection mechanisms to mitigate such risks. We said that fiscal elements can be defined by its legal stability (“stable” if they can be changed only with contractors’ consent and “unstable” if they can be changed unilaterally by the government). In this new document, we move a step forward as we analyze different scenarios to estimate the economic impact of a variable fiscal regime over a typical E&P project lifetime.
The following two graphs show government take distribution and its behavior in a License Contract (“LC”) and its fiscal elements. We marked with (*) the Additional Royalty (stable) and the Corporate Income Tax (“CIT”) (unstable) as they are the main fiscal contributions of an E&P project (38% and 29%, respectively).
1.- SENSITIVITY ANALYSIS
After modelling different scenarios of CIT rates, we found that changing the CIT rate by one percentage point, (from 30 to 31) impacts negatively the Net Present Value by 8% (see table). This same variation displaces the curve the cash flow curve to the dotted line (see graph).
2.- MITIGATING INSTABILITY
Contractors should be aware of the instability of CIT including its allowable deductions which are contained in article 32 of the Hydrocarbons Revenue Law. Any change in the tax regime that affects the original project economic balance (revenues – costs) at the time of awarding may be mitigated by the contracts’ stabilization clauses. However, as mentioned in the last publication, SHCP has not published yet the rules for applying the restoration of the economic balance.
Other sensitivity examples
1. The same scenario analysis was applied to the Additional Royalty (stable element), in which the impact on the net present value of the project ranges from -3% to -16%.
2. For the Exploration and Extraction Activity tax (unstable element) there is a lower impact applying the same scenari- os. The variation goes from -0.6% to -3.2%.
In Talanza we provide services of advance modelling for financial evaluation in the Mexican fiscal regime, developed by former officials in charge of the definition and evaluation of contracts’ fiscal behavior. This has benefitted our clients’ cashflow-related decision making processes.