Governments, especially those heavily dependent on oil-related revenue, are finding themselves in a tough spot as lower oil prices hit budgets.

Betting on higher prices, some could ride out the downturn by improving fiscal incentives to stay competitive. Others could negotiate, if regulatory frameworks allow, to prevent coffers from running dry. Yet some could cave to short-term temptations by increasing direct or indirect taxes and fees.

“The oil revenue ‘cake’ has shrunk and it is hard for governments reliant on oil tax revenue to agree to a smaller slice of what’s left,” Graham Kellas, vice president of global fiscal research for Wood Mackenzie, said in a prepared statement. “But if they don't offer better terms, the industry may simply stop investing.”

Whether the current price environment—with supply outpacing demand—forces countries into action will depend on several factors, according to Wood Mackenzie, which analyzed fiscal changes from 2014 to date in a two-part study. These include production trends, the level of dependence on oil taxation, legal constraints and whether existing fiscal terms make projects uneconomic among other factors.

Some regimes have already responded. The U.K. in March unveiled tax cuts to improve competitiveness in the North Sea. The reform package includes:

  • Reducing the petroleum revenue tax from 50% to 35% to support development in older fields;
  • Lowering the supplementary charge from 30% to 20%;
  • Introducing a new investment allowance to stimulate investment at all stages of the industry life cycle; and
  • Providing £20 million (US$31 million) of funding for a seismic surveys program to lift offshore exploration in underexplored areas of the U.K. Continental Shelf.

The move gives profit back to the companies, but the onus is now on the U.K. industry to make new oil and gas investments and bring new fields online, Kellas told E&P during a phone interview.

“Less than 1% of the country’s revenue comes from oil and gas, so it can afford to play a longer game in terms of promoting investment by reducing the tax rates and hoping the new investment that that will encourage with result in more production in later years,” Kellas said.

That is not the case in other places, such as Russia or parts of the U.S., where budgets have already dropped significantly due to falling oil prices—sliced in half since last summer. In these situations, Kellas said governments might seek a higher share of revenue at lower prices to bolster budgets. This would require some type of tradeoff. Governments secure a higher share of revenue now in exchange for giving oil companies a higher share of revenue when higher prices return, he said.

However, if a government “simply decides to change the terms in their favor without any kind of compensation, then it runs the risk of putting investors off,” Kellas continued, noting this could come in the form of royalty or export duty increases. “The investment community is struggling with the new world order in terms of the price-cost balance, and I think any government that is increasing its share of revenue at the moment when prices are low is really going to do damage to its chances for investment.”

So far, countries that have suffered the most are Middle Eastern countries, which rely heavily on oil revenue, he said. But the study focused more on countries where IOCs are active. Most governments have been watching oil prices, staying in a wait-and-see mode before deciding whether to make fiscal changes.

“It’s important to note that governments facing declines in oil production would be considering how they can stimulate investment in any circumstances, and depressed oil prices makes this task more difficult and more necessary,” Kellas said in the statement. “Indonesia, in particular, may need to offer more attractive terms to try and stem its expected decline in oil production. Fiscal incentives for new investment—particularly challenging projects such as unconventional resources—are likely to become common.”

Africa’s top oil producer, Nigeria, is a different story. The oil and gas industry accounts for about 75% of the Nigeria’s government revenue. The country is coping with not only lower oil prices but also lost business from the U.S., one of its top crude oil buyers. The U.S. had imported between 9% and 11% of its crude oil from Nigeria before 2012, but that sank to less than 1%, according to the U.S. Energy Information Administration, as the U.S. shale boom unfolded.

Since 2008, Nigeria has been trying to change its fiscal terms. But proposed changes have never made it out of parliament for a myriad of reasons. Now, Nigeria has a new president and it is unknown which direction he will take. The uncertainty has stalled investment plans for the last seven years, Kellas said.

Today’s market conditions have essentially created a buyers’ market, as governments launch more licensing rounds. The world already holds more opportunities for oil and gas finds than companies have money to pursue and develop. “The fiscal terms on offer will play a critical role in determining how attractive the opportunities are perceived,” Wood Mackenzie said.

Contact the author, Velda Addison, at vaddison@hartenergy.com.