Tax regime stability needed to secure future of North Sea oil and gas industry

Stability in the tax regime and measures to encourage further exploration are needed to secure the long-term future of the North Sea oil and gas industry, and it appears the politicians may be listening. Peter McCusker reports

Danny Lawson/PA Wire An oil rig in the North Sea
An oil rig in the North Sea

If it wasn’t for the tax allowances, first introduced five years ago, new oil and gas field developments in the North Sea may well have ground to a halt.

Following their introduction in 2009 only eight of the 89 new developments on the United Kingdom Continental Shelf (UKCS) since have proceeded without an allowance.

The picture would look even bleaker going forward, with industry body Oil and Gas UK saying none of 152 current planned projects will proceed without allowances.

The 2011 Budget raised the tax rate on North Sea profits for UKCS operators to 81% (from 62%) for some of the older fields and to 62% (from 50%) for newer ones.

This was set to net the Government an extra £2bn a year in tax revenues and was introduced by Chancellor George Osborne to offset a cut in fuel duties for consumers.

However, this caused uproar in the industry – leading to a major fall in exploration - and prompted a series of discussion with Government which led to the introduction of a raft of new allowances.

Developing from the first allowances for small fields, the new allowances have included; brownfield projects, West of Shetland allowances, deep and shallow gas, heavy oil and high pressure and high temperature fields.

These allowances have helped prompt a surge of new investment in the UKCS which totalled a record £14.4bn last year and will reach an estimated £13bn this year.

However there are fears that investment levels may fall dramatically from 2015 onwards - and operators are pressing for stability in the tax regime.

Last week the Treasury said it was look again at the North Sea oil and gas taxation by opening an industry-wide consultation, with many calling for a more favourable, and stable tax regime.

Michael Tholen, Oil & Gas UK’s economics director, said: “The current fiscal regime has become increasingly complicated and unpredictable with high tax rates combined with a multiplicity of allowances.

“While targeted allowances have successfully encouraged a wave of activity in recent years, temporarily halting the production decline, their impact is diminishing in an ever more expensive business climate. Investors are increasingly looking to invest elsewhere rather than in the UK.”

George Rafferty, chief executive of NOF Energy, said: “Despite the record levels of investment in the UK Continental Shelf, the recent prediction by the Office for Budget Responsibility that tax revenue from the North Sea in the future creates a level of uncertainty in the industry that has to be resolved. 

“The tax regime consultation has the potential to address this issue, but any review of the system needs to be actioned quickly to demonstrate that the North Sea is still an ideal location for investment.  

 “Essentially the tax system is too complicated and unpredictable and needs to be simplified to encourage investment. 

“In my view, tax incentives are needed to drive increased levels of exploration as the discovery of new reserves is a catalyst for the delivery of projects that generate considerable revenues for HM Treasury.  At the same time, incentives to prolong the lifespan of ageing assets will ensure that the industry can maximise North Sea resources.”

The North Sea is a major revenue stream for UKPLC but revenues have fallen from £8.8bn in 2010-11 to £4.7bn 2013-14 - the lowest share of GDP for a generation.

The damage caused by the 2011 tax hikes was highlighted in a report released earlier this month by the United States Energy Information Administration (EIA).

It said that as a result of the significant increases in taxes, the UKCS projects have become even less competitive.

“Increases in operating costs coupled with higher taxes have resulted in decreased investment in both brownfields and new exploration. Even without the increased taxes, operating costs in the UKCS were prohibitively high, exacerbated by the high decommissioning costs of old facilities,” it added.

The EIA said the tax rises has led to the suspension of Statoil’s Mariner and Chevron’s Bressay fields and other start-ups, and caused Centrica to launch a review of all of its exploration activities to calculate which projects were no longer viable.

The 2011 tax raid also saw operators pull back from further exploration with drilling activity plummeting and this still has not recovered, falling to a record low last year.

Dennis Clark, founder of NOF Energy and chairman of Newcastle-based fabricators OGN, said: “The fiscal regime must remain stable and predictable over the long term in order for the UKCS to remain a relevant and a credible investment opportunity for operators.”

Clark went on to say he believes no profits should be taxed at more than 60%.

He continued: “We need to prioritise exploration. Without increasing exploration, there can be no surge in production.

“Two key elements of encouraging exploration wi ll be a sympathetic fiscal regime that recognises the needs of smaller operators, and the availability of new seismic data. The Government has the key role in both elements.”

Clark is supporting calls for targeted tax relief to support exploration in a similar way to the Norwegians.

In Norway exploration is made more attractive for all companies, no matter their size, by enabling them to claim immediate tax relief for the costs of a well regardless of their tax paying position. 

While production taxes are high, at 78%, oil companies benefit from a 78% rebate on every dollar spent exploring in Norwegian waters.

This means they are able to offset the costs of drilling a dry well whether they have taxable income or not, whereas UK companies can only offset the costs of a dry well against taxable income.

The Norwegian scheme had led to a significant pick-up in exploration activity. This has translated into some spectacular discoveries, such as Johan Sverdrup, Johan Castberg and Havis, huge offshore oilfields that should underpin the industry’s future.

Clark added: “In the past, the UK has had a cash relief programme for exploration like that in Norway. Explorers were irresponsible and the regime was curtailed. A similar regime with better controls should be considered as part of a strategy to improve investment.”

The talks between industry and Government which followed the 2011 Budget tax raid have also led to further developments in the industry culminating in the publication of the Wood Review earlier this year - signalling the dawn of a new era for the industry (see panel).

Malcolm Webb, Oil & Gas UK’s chief executive, said: “The Wood Review calls for a tripartite approach to the UKCS between HM Treasury, the new regulator (the Oil and Gas Authority) and industry to maximise economic recovery (MER).

“The current fiscal regime is becoming a barrier to investment both in new fields and in the many mature opportunities. This will be the first instance of MER in action and we have high expectations for what the consultation will deliver.

“While our members will work closely with HM Treasury to respond in depth to the consultation this review must lead to early action. It cannot simply be a paper exercise. The tax regime must be simplified and the headline rates reduced to send a strong signal that the UKCS is open for business.”

“The North Sea continues to have a big impact on our economy. Crude oil and gas provide around three quarters of the country’s primary energy and this level of dependency is unlikely to change significantly for many years to come.

“Government policies to encourage investment that maximises domestic oil and gas production makes economic sense, in that this helps to minimise costly energy imports and strengthens the UK balance of trade.

“Promoting a strong indigenous oil and gas industry also has wider economic benefits. This industry was the largest industrial investor in the UK economy last year and its supply chain has a turnover of over £35bn, of which more than £14bn of goods and services were exported to a global market. The sector supports some 450,000 jobs in the UK.

“All of this is at risk if activity declines and there is no upturn in exploration.”

Despite the high tax rates the oil companies still make large profits, running in to billions of pounds annually.

This has left them exposed to criticism of greed for lobbying for tax allowances on North Sea developments

However Webb added: “Company profits from the production of oil and gas from the UK are subject to much higher levels of taxation than the rest of the economy. There are projects in the UK that simply cannot support that taxation level and would not be developed without help.

“Allowances reduce the marginal tax rate on a portion of the income from the field. All profits still suffer corporation tax (at a rate 10% higher than the rest of the economy), and some profits are taxed at the full 62%.

“It is better for the UK to get a smaller amount of the profit of these challenged fields than no tax at all. Undeveloped fields support no jobs, increase the reliance on imported oil and gas and pay no tax at all.”

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