Major Developments in Turkey’s Oil & Gas Industry and Incentives under Turkish Oil & Gas Exploration & Production Legislation
Turkey has been historically highly dependent on oil and natural gas imports, due to low local production levels. The recent discovery of natural gas reserve in the Black Sea as well as extensive exploration activities in the Mediterranean Sea have increased foreign and Turkish investors’ interest in exploration and production activities. The recent conflict between Ukraine and Russia and Turkey’s dependency on Russian natural gas also stressed the importance for Turkey for diversifying its natural gas sources. In that context, we will first make a short recap of the Oil & Gas industry’s development in Turkey as well as major developments in 2022. We will then focus on the fiscal regime and the main incentives for investors under the Turkish Petroleum Law as well as the tax legislation, with a particular focus on incentives regarding exploration activities.
Brief Overview of the Oil & Gas Industry in Turkey and Major Developments in 2022
The first petroleum law was enacted in the early days of the Republic of Turkey and was later replaced with the Turkish Petroleum Law no 6326 in 1954 to encourage private and foreign ownership. The Turkish Petroleum Law no 6326 regulated upstream, midstream and downstream activities under one single law. As of today, upstream activities remain largely controlled by the Turkish Petroleum Corporation (“TPAO”), which is the state-owned oil company involved in exploration and production activities. Domestic production is limited; in 2021 Turkey imported approximately 92% of its crude oil needs from 13 countries and refined products from over 20 countries. Although the Turkish Petroleum Law provides some tax incentives (which are examined below), as well as low royalties, foreign investment remains limited in the upstream sector. TPAO owns almost 80% of all exploration licences (including all offshore exploration licences) and almost half of all production leases. Domestic crude oil production increased by almost 45% between 2013 and 2021 while natural gas production decreased by more than 25% during the same period.
Natural gas production is also quite limited; in 2021, Turkey imported almost 100% of its natural gas needs. Likewise, although the Natural Gas Market Law enacted in 2001 aimed to liberalise the natural gas market, midstream and downstream activities in the natural gas industry (i.e. imports, transportation and storage) are mainly conducted by BOTAŞ, which is the state-owned pipeline company. Although exploration activities are ongoing in the Thrace Basin and Southeast Anatolia Basin, potential discoveries in these areas are not expected to increase production in the long term.
2022 was marked by the upgrade in the estimate of natural gas reserves in the Black Sea (by nearly a third). The total volume of gas discovered in the offshore fields of the Black Sea was announced as 710 billion cubic meters (bcm). The first gas delivery is expected to be made by the end of the first quarter of 2023. Around 10 million cubic meters (mcm) of gas per day is expected to be pumped through the offshore gas pipeline in the initial phase, while the infrastructure has been set up to ramp up the production up to 40 million cubic meters until 2026.
With the aim of meeting the demand for energy and mitigate the effects of high energy prices, the country has also stepped-up efforts to secure gas supplies. Turkey has currently seven international natural gas pipelines, four liquefied natural gas plants, two of which are floating storage and regasification units (FSRUs), and two underground natural gas storage facilities. The country is on track to open its third FSRU in the northwestern Gulf of Saros.
The storage capacity of the Silivri Natural Gas Storage Facility was increased from 3.2 billion cubic meters of gas to 4.6 billion. The capacity increase of the Tuz Gölü Natural Gas Storage Facility is also underway and is expected to reach 5.4 billion cubic meters within this year.
As of 2021, Turkey has currently 3P oil reserves of approximately 8 billion barrels. Recent oil reserve discoveries in the southeastern Turkey are expected to increase the country daily output from 65,000 barrels to 100,000 barrels.
Taxes and Royalties Levied on Petroleum Right Holders
Exploration and production activities related to petroleum and natural gas in Turkey are governed by Turkish Petroleum Law no. 6491 based on the “tax and royalty” regime. A petroleum right holder is liable to pay a royalty corresponding to one-eighth of the petroleum produced. No royalty will be collected from the petroleum used in petroleum operations in relation to the exploration or production lease. The royalty payable by a petroleum producer is calculated:
- per barrel, for crude oil produced on a unit of petroleum, based on the market price; and
- for natural gas, based on the sales price applied to distribution companies or consumers.
The royalty accrues by declaration to the General Directorate of Mining and Petroleum Affairs (“GDMPA”) until the end of the 20th day of the following month after the production was made, and must be paid by the end of the month to the tax office where the related party is affiliated in terms of income or corporate tax. Where the Ministry of Energy and Natural Resources so requests, the royalty may be paid in kind.
The general withholding tax rate applicable to dividend payments is 10%; however, it may be reduced under bilateral double taxation avoidance treaties. The current general corporate income tax rate for 2023 is 20%.
Tax Incentives Available for Petroleum Right Holders
The general value added tax (VAT) rate is 18% in Turkey. However, the VAT Law no 3065 provides for a special VAT exemption in relation to petroleum exploration operations, as the delivery of goods and services to persons that conduct petroleum exploration activities is exempt from VAT. This exemption applies only with respect to petroleum exploration operations and production operations are not covered by the exemption. The VAT exemption applies to goods and services delivered to a petroleum rights holder or to any contractor which has been approved by the GDMPA as a ‘rights holder’s contractor’ and whose contract with the rights holder (in relation to the provision of registered exploration-related goods and services) has been registered with the GDMPA.
The Turkish Petroleum Law also provides for a customs duty exemption with respect to petroleum operations. The import of all materials, equipment, fuel and land, sea and air transportation vehicles approved by the GDMPA (excluding materials relating to the construction, erection or operation of buildings, installations and equipment; and to administrative activities) by a petroleum rights holder itself or a contractor approved by the GDMPA is exempt from customs duty.
Under the Turkish Petroleum Law, contracts executed in relation to exploration and production activities conducted by petroleum rights holders are exempt from stamp tax and the withholding tax applicable to foreign companies in relation to services provided for exploration activities is reduced to 5% instead of 20%.
Specific Aspects of the “Registered Capital” for Oil and Gas Operators
The registered capital of a petroleum right holder is basically defined as the payments made abroad by the petroleum right holder’s head office on behalf of the Branch office, for materials or subcontractors and the cash imported in Turkey by the Branch. Capital in Turkish Lira can be recovered by remitting the surplus revenues generated from exploration and production activities.
The Turkish Petroleum Law provides that the recovery of the registered capital will not be subject to any tax and can be remitted abroad freely. However, in order to apply this incentive, the Turkish Petroleum Law provides that the registered capital amount should be registered, and the recovery should be done following an audit by the GDMPA. The reason is that the imported capital should be spent for exploration and production activities and the revenue for the recovery should be made from the exploration and production activity.
The registered capital is part of the audit system that allows the GDMPA to monitor whether the other incentives from which the petroleum right holder is the beneficiary (such as customs, VAT and stamp tax exemptions, as well as reduced withholding tax applications) have been properly applied or not, i.e. whether the expenses to which the incentives apply relate to exploration and production activities.
Turkey has been prioritizing upstream oil and gas exploration and production, as domestic oil and gas production accounts for a small share of consumption. Although the Turkish Petroleum Law provides incentives to create an attractive upstream fiscal regime, the lack of transparency and foreseeability in license awards and license extensions, as well as the privileges granted to TPAO (such as the right of refusal for production licenses which have expired) has been deterring new investments by the private sector. Consequently, while domestic oil production has been steadily improving over the last decade, said growth has been mainly supported by an increased upstream activity of TPAO which owns most of the exploration and production licenses. Turkey’s dependence on natural gas imports is set to decrease in 2023 and onwards following the discovery of the Sakarya oil field in the Black Sea.
“This article has been prepared by Yazıcı Attorney Partnership by taking into account the legislation in force as of the date hereof. Since the facts and characteristics of each case, as well as their application and consequences, may differ in each case, this article has been prepared for information purposes only and does not constitute a legal opinion or recommendation and cannot be interpreted as such.”