Mid-March, the UK Government made a headline grabbing announcement – taxes would be halved for the ailing North Sea industry.
Chancellor George Osborne said he would cut a supplementary charge on operators (a tax in addition to corporation tax) from 20% to 10%. This is following a previous cut from 30% to 20%, made in 2015. He also said he would effectively abolish Petroleum Revenue Tax (PRT), a tax on pre-1993 consented fields. This had also previously been reduced from 50% to 35% in last year’s Budget.
While the moves were welcomed, there were already questions on the day as to how much of an impact these cuts would really have and whether an opportunity had been missed to simplify the tax regime. Given that nearly half of North Sea operators are also currently operating a loss, having seen oil prices drop from US$110 in 2014 to $30 this year, how much of an impact would it really have?
The Treasury was making no money from PRT anyway. The government’s Office for Budget Responsibility’s (OBR) March 2016 forecast estimated government revenues of minus £10 million in 2015/16, down from £2.2 billion in 2014/15. The OBR is also forecasting negative revenues for the next five years.
Now the dust has settled, we take a look at what industry analysts make of the moves, now that they have had chance to scour the data.
Douglas Westwood questioned if the measures were too little, too late and suggests that only new investment will help dig the industry out of its hole – and that requires higher oil prices. The worry is that decommissioning hinders the ability to tie new fields into existing infrastructure, stranding those resources. On the plus side, the largest decommissioning opportunity in the coming decade could be opening up. DW’s 2016-2040 forecast predicts $44-50 billion spending on decommissioning on the UKCS – over half of that predicted for all forecast decommissioning in the North Sea, including Denmark, Norway, and Germany.
GlobalData says the cuts in headline taxes were larger than anticipated but skewed towards older existing assets and will vary in impact on a company basis, depending on what they have in their portfolios. While the tax cuts improve the UK’s globally competitive fiscal regime, they still do little to address the relatively high development costs in a mature basin. Further cost cuts will be required to improve project economics and producer profits on the UK Continental Shelf (UKCS), and in turn generate government tax revenue.
Hannon Westwood said the tax changes are unlikely to have a significant impact on near-term investment. With so few companies currently paying tax to the Treasury, the impact of post-tax relief is marginal in the short-term. Having zero PRT will level the playing field between late-life fields and new developments. But, with limited effect, as only 30 fields are liable to PRT right now, with two currently shut-in, or to put it another way, the impact only relates to 9% of current 2P reserves in the UKCS.
In addition to the tax cuts, the budget includes measures to extend an Investment Allowance to include tariff income on third party access, designed to help to prolong infrastructure life; as well as to provide greater certainty on decommissioning tax relief; which is intended to encourage late-life asset transfers.
Rystad Energy says while the supplementary charge cut would benefit companies under a high oil price environment, the effect could in fact be the opposite under a low oil price scenario. Essentially, only companies with the most competitive portfolios would benefit from the tax cut, while operators with more mature portfolios could be hurt by the current tax reduction and could see the value of their UK assets diminish.
Rystad has predicted 2016 net income from UK portfolios of the top five companies with headquarters in the UK. All of them already show a negative net income this year, and further reduction in taxes will not help improve their current free cash flow.
Douglas Westwood: “With production in decline, the UK oil and gas industry has been severely impacted by a longer than anticipated suppression in oil price,” DW said. “This has led to widespread job cuts, reducing the workforce by approximately 26% (65,000 jobs lost). Ultimately, a change in taxation regime is not going to dramatically alter the fate of production operations within the North Sea. What is required is substantially increased investment, this is only likely to occur as a function of higher oil prices. Operators also require support in ensuring that production infrastructure is maintained – and accessible – to allow future additions through satellite developments. Widespread decommissioning could put this under threat, potentially limiting future field activities and ultimate recovery in the UK Continental Shelf.
Hannon Westwood: “Ultimately these changes simplify the fiscal regime and reduce the headline tax rate. However, given that few companies in the basin are actually paying tax, and that nearly half of fields are currently loss making, the impact in terms of stimulating investment and activity, at least in the near-term, will be negligible. The OBR forecasts that decommissioning and carry back of trading losses repayments will exceed tax receipts by a £1 billion per year through to 2021 if oil prices stay in the $40s/bbl. Reducing industry costs and decommissioning in particular remain the biggest challenges facing both industry and Government.”
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Taxes halved for North Sea operators
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