As exploration continues in frontier areas where adverse environmental conditions are the rule rather than the exception, the petroleum industry is faced with the enigma of success; i.e., the need to make development decisions – involving massive capital expenditures – despite technical, economic and political uncertainties. This decisionmaking problem is compounded by the inadequacy of the tax regimes under which management must operate – conventional tax schemes fail to conserve natural resources, they fail to maximize government revenues and they fail to consider the economic risk of the oil company (operator).

In this paper, three bases for optimizing the design of the production system in a newly discovered field are compared – operator's net cash flow after tax, government take and total net cash flow (all expressed in present-worth, constant dollars). The impact of the tax rate and of the royalty rate on both the optimal design and the specification of a marginal field is also discussed. Finally, a rational tax system is proposed for a specific play – to provide adequate incentives for the operator and to enhance the government take while assuring the recovery of a larger fraction of the reserves contained in the play.

To demonstrate the reasoning underlying the proposed tax system and to illustrate the implementation of the suggested procedure, several numerical examples are presented.

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