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North Sea Oil Tax – Biting the Hand That Feeds?
Written by hydrocarbons-technology.com   
Friday, 12 August 2011


Article originaly posted here.

Significant oil tax hikes in the UK North Sea rocked investor confidence. Gareth Evans reports on the reasons behind the drop in investor activity and finds some compelling reasons for recovery despite negative initial reactions to increased taxes.

On 22 March 2011, a Second World War bomb was discovered lying in 300ft of water near the Forties pipeline, some 25 miles east of Peterhead, Scotland. In his budget a day later, many in the industry suggest that UK Chancellor George Osborne set an even larger bomb ticking under the future of North Sea offshore investment.

Unexpected changes in the budget raised the supplementary charge (SC) rate to 32% from 20%, taking the North Sea headline tax rate to 81% from 75% for fields that are subject to petroleum revenue tax, and to 61% from 50% for those that are not. As a final blow, tax relief on decommissioning was pegged at 20%.



Protest and concession

Predictably, protests flowed quickly in the wake of the announcement. Within days Statoil put the brakes on its development plans.

"The government's proposed tax change will have a substantial impact on the Mariner and Bressay projects," said company spokesman Bard Glad Pedersen. "We are evaluating this impact now."

Others in the sector followed suit, while all shades of the political spectrum - at both Westminster and Holyrood - argued over the likely eventual outcome of the move.

Despite the assurances of Robert Chote, head of the Office for Budget Responsibility, that there would not be any significant effect on investment, by early July it had become clear that the industry did not entirely agree. In response, the UK Treasury increased the Ring Fence Expenditure Supplement by four points to 10% to "support investment in marginal fields".

Statoil immediately stated its intention to resume development of the Mariner and Bressay field projects, and shortly afterwards, BP announced a £3bn investment in its Schiehallion and Loyal oilfields to extend production there to 2035 and beyond.

By then, however, commentators were observing that the damage had already been done.

Falling drilling activity

According to Deloitte's North-West Europe Review, during the three months to the end of June, drilling activity was down 52%, year-on-year, with a total of just 11 exploration and appraisal wells being spudded.

"It's probably too soon to lay this at the door of the tax hike," says industry consultant Richard Lightman. "But it hasn’t done much for confidence about the UK Continental Shelf. Norway has always been viewed as 'high cost', but a lot of people are beginning to look at that differently now."

The Deloitte report would certainly seem to bear this out, with the Norwegian side of the North Sea apparently recording a 10% increase over its ten-year second quarter average, and drilling activity offshore the Netherlands remaining consistent.

It is debateable how quickly companies would have been able to change their drilling plans, and it is also likely that BP's investment west of Shetland had been decided long before the March budget, but this latest, and apparently arbitrary, shift in fiscal policy nevertheless fits into a much older picture.

Deloitte's earlier Budget 2011 Response, observed that "the North Sea tax regime has suffered almost constant change over the last ten years and this ongoing instability is likely to be detrimental to investment".

It was a point made again in July by Andrew Moorfield, global head of oil and gas at Lloyds Banking Group in an interview for The Guardian, saying that repeatedly tampering with the tax system was leaking business away from the UK and strengthening the competition from developing markets such as Ghana and Egypt. The signs were there long before the £2bn windfall tax was announced.

"Eighteen months ago, while Darling [the previous government’s Chancellor] was tinkering around with the field allowance rules, Martin Findlay [head of oil and gas tax for KPMG Aberdeen] was warning that there was always the chance that the sector would be raided sometime in the future to balance the UK books," says Lightman. "Now, we can see he was right."

Jobs and GDP

Could this raid on profits actually lead to the loss of 15,000 jobs as Scottish First Minister, Alex Salmond, predicted? For the moment at least, the outlook undoubtedly looks bleak. According to a recent survey undertaken by Oil & Gas UK of 27 companies, which between them account for 85% of UK production, raising the SC alone instantly knocked 23% off the value of all prospective UK offshore investment.

Taken as a whole, it suggests, the changes could force an additional 1.5% decline in production, and cost the sector over $1.5bn of investment annually. In addition, analysts at independent research provider CreditSights link the windfall tax to the UK's poor second quarter increase in GDP - almost flatlining at just 0.2%, according to the latest figures from the Office of National Statistics.

Against this background, investor confidence will inevitably remain dented, particularly when the mature and relatively expensive nature of the North Sea is taken into account, unless of course, there are further concessions.

A temporary lull?

Many believe that more concessions will come. Taxing production has a serious flaw; it only works if the changes to taxation are widely seen to be permanent - and the UK has a long history of changing the regime, so there is a clear incentive for companies to leave oil and gas reserves in the ground if they think things will shortly improve. A number of commentators agree with CreditSights' European oil and gas analyst that the "lull in drilling should be transitory, a result of companies waiting to see if the tax will prove temporary".

There is an even more compelling reason why North Sea investment is likely to recover. With the price of oil around $100 a barrel, and world demand showing no signs of diminishing, otherwise marginal fields on the UK Continental Shelf clearly become increasingly profitable, and the value of currently untapped reserves rises, too.

A willingness to invest at say $50 per barrel and an SC of 20% gives the lie to the idea that major players would seriously balk at realising double that price against an SC of a mere 12 points higher.

It may come down to who blinks first - the government or the oil companies - but in the end, as First Minister Salmond put it, speaking on the issue at Bute House in June, "It is in no one's interest to kill the goose that lays the golden egg".

At the beginning of August, BP shut down the Forties pipeline for five days to allow subsea contractors and bomb disposal experts to remove the wartime German mine, calling a temporary halt to production at dozens of offshore fields. For the moment, the fiscal time-bomb poses a more tricky problem, but one way or another, it too will eventually have to be defused.


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