Capital allowances

Keywords economic model, shareholder s profit, project cashflow, gross revenue, discounted cashflow, opex, capex, technical cost, tax, royalty, oil price, marker crude, capital allowance, discount rate, profitability indicators, net present value, rate of return, screening, ranking, expected monetary value, exploration decision making. 

Prior to the calculation of tax, certain allowances may be made against the gross revenue before applying the tax rate. These are called fiscal costs and commonly include the royalty, opex and capital allowances (which is explained later in this section). Fiscal costs may also be referred to as deductibles. 

Fiscal allowances for investment in capital items (i.e. capex) are made through capital allowances. The method of calculating the capital allowance is set by the fiscal legislation of the host government, but three common methods are discussed below. 

It should be noted that a capital allowance Is not a cashflow item, but is only calculated to enable the taxable income to be determined. The treatment of capital allowance for this purpose is a petroleum economics approach, which may differ from the accountant s view of depreciation when calculating net book values and profit. 

Capital allowances may be accepted as soon as the capital Is spent or may have to wait until the asset is actually brought into use. In the case of the newcomer company or the ring-fenced project the allowance may only be able to commence once there is revenue from the project. 

A newcomer company Is a company performing its first project in the country, and therefore has no revenues against which to offset capital allowances. 

Each year the capital allowance is a fixed percentage of the unrecovered value of the asset at the end of the previous year. The same comments about when the allowance can start apply. 

YEAR CAPEX Unrecovered assets at year end Capital allowance... 

At the end of the project life a residual unrecovered asset value will remain. This is usually accepted in full as a capital allowance in the final year of the project. Hence the total asset value is fully recovered over the life of the field, but at a slower rate than in the straight line method. 

This method attempts to relate the capital allowance to the total life of the assets (i.e. the field s economic lifetime) by linking the annual capital allowance to the fraction of the remaining reserves produced during the year. The capital allowance is calculated from the unrecovered assets at the end of the previous year times the ratio of the current year s production to the reserves at the beginning of the year. As long as the ultimate recovery of the field remains the same, the capital allowance per barrel of production is constant. However, this is rarely the case, making this method more complex in practice. 

In the above example, where the ultimate recovery remains unchanged throughout the field life, the capital allowance rate remains a constant factor of 700/250 = 2.8/bbl. 

Note that capital allowances do not appear in the expression since they are not items of cash flow. Capital allowances are calculated in order to determine the fiscal costs and thus the amount of tax payable. 

Assume that the only previous capex had been 120 m, spent in the previous year, with 25% straight line capital allowance, thus capital allowance in this year = 0.25 x 120 m + 0.25 X 80 m = 50 m. 

Working capital, allow 5% of fixed capital to cover the cost of the initial solvent charge = 445,000 x 0.05 = 22,250. 

Discounted cash-flow rate of return DCFRR % Measures performance of capital allowing for timing of cash flows No indication of the resources needed... 

R D is a function of available investment capital, allowable risk, and projected profitability. Careful planning and management in this program phase is critical for minimizing costs and time to commercialization for the sensor. 

Capital allows industry to purchase the technological resources needed to produce a product or create new technology. These resources include people with certain skills and expertise. Large corporations use investment capital to help entrepreneurs start new businesses. Investment capital has become increasingly important. 

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