Oil, Gas Tycoons Still Come Out Ahead at Expense of the Public

Small investors in oil and natural gas exploration say they will be left with little if recommendations to increase taxation on oil and gas profits are adopted.

Small investors in oil and natural gas exploration shares have been waging an aggressive campaign arguing that it is average Israeli investors, not wealthy tycoons, who will be hurt most by higher taxes on oil and gas profits - and their efforts may be paying off.

The investors, who have been waging their campaign on the Internet and elsewhere for several weeks, say they will be left with very little if the recommendations of the Sheshinski committee to increase taxation on oil and gas profits are adopted. They say the big names like Yitzhak Tshuva will be left with most of the profits.

tycoons - Daniel Bar-On - November 29 2010
Daniel Bar-On

The Sheshinski committee, headed by economist Eytan Sheshinski, was assigned the task of studying Israel's fiscal policy on royalties and taxes on natural resources, and oil and natural gas in particular.

Sheshinski committee to aid small investors

The oil and gas exploration firms are set up as general partnerships, and small investors have bought participation units in the partnerships, rather than shares. What the campaign has not acknowledged is that the bias in favor of the general partners, the wealthy businesspeople, has nothing to do with the Sheshinski committee's recommendations but stems from the way the partnerships were set up.

Nonetheless, the committee understands the problem and is looking at ways of improving the lot of the small investor without sacrificing revenue.

The way the partnerships are set up, the general partners receive a share of the revenues in excess of the proportion of the partnerships they own. Such a "super-royalty" has nothing to do with the law or the committee's recommendations, but is part of the partnership agreement, and each firm is different. Sometimes the super-royalty comes directly from revenues and sometimes from profits, and often the general partner takes a much bigger share of the profits than does the state.

Not only does the state not set the super-royalty agreements, it also has no authority to intervene in such private agreements. The state allowed such terms in its exploration licenses to encourage gas and oil drilling.

Only themselves to blame

Ultimately, the private investors have only themselves to blame for agreeing to such conditions and buying the participation units. But the Sheshinski committee is aware that the state's increased tax burden will fall mostly on the small investor and not the wealthy businesspeople.

The committee is also worried that the general partners will take their shares out of the revenues at the wellhead and consider these sums to be part of the production expenses, causing the general partner's profits to rise even further, at the public's expense. As a result, the committee is considering changes in how the tax is computed to exclude such royalties, or to levy excess profit tax on the super-royalties.

Such considerations are still at a preliminary stage of examination.

In any case, the committee members are of the opinion that such partnership structures are no longer needed to encourage exploration and unfairly distribute the rewards at the expense of the general public. But it is unlikely the committee will explicitly deal with the issue in its final recommendations.