Environmental charges, taxes, development plans and the oil shale sector

Tarmo Olgo | 10/20/2014 | 1:25 PM

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Memo: Environmental charges, taxes, development plans and the oil shale sector

 

 

Opinions of the National Audit Office

TALLINN, 20 October 2014 - The total amount of the environmental charges received by the state in 2013 was 84 million euros. 74% of these charges (62 million) were paid by companies operating in the oil shale sector. 83% of the charges paid by the oil shale sector came from AS Eesti Energia, 11% from Viru Keemia Grupp, 3% from Kiviõli Keemiatööstus and 3% from other companies.
The environmental charges can be divided into two categories: a pollution charge, which is paid for polluting the environment; and a charge for use of natural resources, which is paid for using natural resources that belong to society.

Environmental charges do not serve their purpose and neither the changes in nor the amounts of the charges are based on substantive analyses
Ideally, the state should tax the extraction and use of oil shale in the manner that generates the greatest value for society in the long term (50 years), considering the tax revenue earned from the oil shale sector, the environmental damage caused and the direct and indirect expenses the state and society incur as a result of oil shale extraction and processing, both during such activities and upon their termination.
The Ministry of the Environment has promised that the amounts and dynamics of the amendment of environmental charges will be established for the next five years as a minimum. The National Audit Office presumes that the state’s activity in changing/increasing/decreasing taxes is purposeful, is based on evidentiary argumentation and helps to implement the national development documents that direct the extraction and use of oil shale.
The environmental charges have three main objectives: 1) to determine a fair price for natural resources; 2) to motivate entrepreneurs to use natural resources sustainably; and 3) to compensate for the damage caused to people and the environment by the use of natural resources.
The audits carried out by the National Audit Office in the oil shale sector have shown that the current environmental charges do not serve their purpose and have failed to motivate entrepreneurs to use natural resources more sustainably. The environmental impact of oil shale extraction and use had increased across a number of indicators instead of decreasing as expected in the development plan. For example, in 2012 the oil shale sector generated 12% more oil shale bottom ash, 8% more fly ash and 2% more semi-coke in absolute quantities compared to 2007. No successful options for recovering the large quantities of waste generated have so far been found.
Neither have the state and the oil state industry managed to arrive at a common evidentiary understanding of whether the amount of the environmental charges is optimal for compensating environmental, health and socioeconomic damage at present and in future.
No studies that would be accepted by both the state and entrepreneurs and carried out using methods agreed on between the parties have been commissioned. Determining the fair price of oil shale has not yet been placed on the agenda, as keeping the price of oil shale electricity low was of primary importance prior to the opening up of the electricity market.
The objectives of environmental charges have not been considered in the establishment of the current environmental charges for oil shale, but these charges have been arithmetically increased without any assessment of the income and expenses that the use of oil share creates for society.

All in all, the current amounts of the environmental charges give no evidentiary reassurance of whether society will earn income or incur expenses on the use of oil shale in the long term.

The present system of environmental charges must be updated when the development plans of the oil sector are renewed.

The National Audit Office is of the opinion that the preparations made by the Ministry of the Environment in order to increase environmental charges have remained superficial and incomplete. Although the ministries are due to complete preparations for the new long-term national development plans that direct the oil shale sector, the issue of taxation has been dealt with separately from the development plans.
The National Audit Office is of the opinion that the current system of oil shale extraction and taxation has become outdated and does not consider the shift from electricity generation to oil production that has occurred in the use of oil shale. A specific feature of the current system of environmental charges in the oil shale sector is that four-fifths of the burden of environmental charges falls on the companies that produce electricity and heat from oil shale and one-fifth on the shale oil industry.
The data of the Ministry of the Environment indicate that in 2013, electricity and heat producers paid 83% of environmental charges; the remaining 17% was paid by shale oil producers.[1] In other words, taxation of the oil shale sector is characterised by the fact that the least profitable branch of the sector has the biggest tax burden.
The reason for the disproportionate distribution of the environmental charges is that electricity generation creates a lot of pollution subject to environmental charges, whilst such pollution is emitted in small quantities by oil producers.

Due to the disproportionate distribution of the burden, increasing the environmental charges is first and foremost restricted by the impact of the environmental charges on the competitiveness of oil shale electricity. Unfortunately, establishing different environmental charges on the production of electricity and on oil from oil shale is impossible, as this would be regarded as unlawful state aid.
Although the effective system of environmental charges treats companies in the oil shale sector unequally depending on their areas of activity, the Ministry of the Environment and the Ministry of Finance have not wanted to modernise the historical system of environmental charges.
The National Audit Office has advised the Ministry of the Environment and the Ministry of Finance to consider taxing the production of shale oil with a royalty based on the value or sale price of the oil or income earned therefrom and payable to the state as the owner of the natural resources.
The establishment of a royalty would allow the state to earn revenue on highly profitable[2] oil shale production in a manner that would not paralyse the competitiveness of oil shale electricity or shale oil production.

The Ministry of Finance completed an analysis of the taxation of oil shale in spring 2013, but the taxation of income earned on the use of oil shale was precluded from the start, as it allegedly does not comply with the principles of the Estonian tax system. The Government has said that the possibility of establishing a royalty will not be discussed before 2016, i.e. after the establishment of the new environmental charges and the approval of oil shale development plans.

As taxation of oil shale is an issue that influences the fate and investments of the entire oil shale industry, then rushing through approval of a new oil sector development plan before the taxation issues are resolved would be unreasonable. The National Audit Office has advised the state to postpone the approval of oil sector development plans and make the taxation decisions that both the state and the companies need for security and clarity about the future.

The state’s knowledge of the impact of environmental charges is rather superficial
The National Audit Office is of the opinion that the establishment of environmental charges and carrying out constructive discussions with entrepreneurs is made difficult by the shortage of adequate information about the justification of the amounts of the environmental charges and their actual impact on the oil shale sector.
The state’s knowledge of the production and financial indicators and investment plans of the oil shale companies that do not belong to the state is rather superficial. The state operates largely with the consolidated data and studies submitted by the entrepreneurs themselves, the validity of which is difficult to check. Also, the environmental impact assessments commissioned by the state itself do not consider the changes in the use of oil shale that will occur in the coming years.

The lack of adequate information has made shale oil producers anxious and dissatisfied with the state, and the Federation of Estonian Chemical Industries has initiated a campaign wherein the state is accused of causing a social catastrophe in Ida-Viru County.[3] The Ministry of the Environment finds that the accusations made by the representatives of the oil shale sector are not justified.[4] In the given situation, the National Audit Office considers it important to steer the discussion back to rational ground and feels that all of the parties should make efforts to return to constructive dialogue.

Other factors, such as the volatility of the oil price, the cost of capital and the sales conditions of shale oil influence the profitability of shale oil producers considerably more than environmental charges do.
In the event of the intended increase in environmental charges, shale oil producers would pay the state in 2015 environmental charges in the amount of USD 3.90 for the production of one barrel of shale oil, i.e. 4.5% of the sale price considering the current price level of a barrel of crude oil (USD 85.30 per barrel).
If the state increased the environmental charges by 10% every year, the environmental charge would grow by ca USD 1.60 per barrel over five years and reach USD 5.50 per barrel in the fifth year of the increase. At current production volumes, shale oil producers would have to pay 4.35 million euros more in environmental charges after five years.
In comparison, the price of a barrel of oil changed by USD 29.90 in the last three months, dropping from USD 115.70 to USD 85.80 per barrel.[5]
The environmental charge paid by shale oil producers also includes the charge for the use of natural resources belonging to society (oil shale and water) as well as for the pollution caused by the production process.

The National Audit Office is of the opinion that the state should proceed as follows in the establishment of environmental charges:

1. Postpone the adoption of the new Energy Sector and Oil Shale Development Plan (2016-2030) and, in cooperation with entrepreneurs in the oil shale sector, develop contemporary taxation principles which take into account the changes taking place in the oil shale sector and generate the biggest value for society in the long term (50 years), considering the tax revenue earned from the oil shale sector, the environmental damage caused as well as the direct and indirect expenses the state and society incur as a result of oil shale extraction and processing both during such activities and upon their termination.
Taxation should be balanced: if the taxes are too high, investors will invest their money in alternative opportunities to earn money; and if taxes are too low, permitting the use of natural resources will not make society wealthier.
2. In order to establish the evidentiary amount of the environmental charges, the Ministry of the Environment should commission a study, based on methods agreed with the oil share sector that are acceptable to all parties, whose purpose would be to comprehensively ascertain and assess the health, environmental, socioeconomic, security and employment impact of the oil shale sector and the consequences of various decisions in terms of their monetary value.
3. In order to assess the impact of environmental charges, the Ministry of the Environment should commission an independent impact assessment report based on verified data submitted by entrepreneurs and taking into account the development of the oil shale sector.


Prepared by Tarmo Olgo
Audit Director
Performance Audit Department
National Audit Office
+372 640 0776
[email protected]


[1] Analysis of the Impact of the Act for Amendment of the Environmental Charges Act, p 80. Praxis Centre for Policy Studies, 2014

[2] The analysis prepared by the Competition Board in 2013 indicates that the profitability of oil shale mining companies is 13%, the estimated profitability of electricity generation on the open market 33% and the profitability of oil production 83%. Analysis of Competitive Situation in Oil Shale Sector. Competition Board, 2013

[3] The Union of Estonian Natural Resources has submitted a petition to the Security Police to question the lawfulness of the campaign of the Federation of Estonian Chemical Industries. In the petition of 17 October 2014, the Union of Estonian Natural resources points out the messages of the media campaign carried out by the Federation of Estonian Chemical Industries, which in the opinion of the petitioners incite hatred and may become a threat to the security of Estonia.

[4] According to Minister of the Environment Keit Pentus-Rosimannus, the ministry suggests increasing the oil shale charges by 3-5 per cent per year, which means that no jobs will be lost. “The thorough analysis carried out by Praxis indicates that such a scenario could even increase the number of jobs in Ida-Viru County: the increase is moderate, companies manage to make investments and these in turn create jobs,” explained the Minister. Delfi, 17 October 2014

[5] Prices for ICE Brent Crude as at 19 June 2014 and 15 October 2014 http://markets.ft.com/research/Markets/Tearsheets/Summary?s=IB.1:IEU

  • Posted: 10/20/2014 1:25 PM
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