Sector News

Oil and gas industry bolstered by reduction in tax rates and new investment allowances

March 19, 2015
Tax rates on North Sea oil and gas production have been slashed in an attempt to save the industry from the “pressing danger” posed by low oil prices, the Chancellor has announced.
George Osborne said the new measures were worth £1.3bn over five years and would boost flagging North Sea oil production by 15pc by the end of the decade.
The effective tax rate on production from older oil and gas fields will be reduced immediately from 80pc to 75pc, while on newer fields it will be cut from 60pc to 50pc.
Both cuts will be backdated to January and serve to entirely reverse the tax grab on the sector in the Chancellor’s 2011 budget.
Further tax cuts which come into effect next year will reduce the overall tax rate on older fields to 67.5pc.
There will also be a new “simple and generous” tax allowance to encourage investment in the North Sea, following a patchwork series of allowances for specific kinds of fields and developments in recent years.
“While the falling oil price is good news for families across the country, it brings with it challenges for hundreds of thousands whose jobs depend on the North Sea,” the Chancellor said.
“The fall in the oil price poses a pressing danger to the future of our North Sea industry – unless we take bold and immediate action.”
Mr Osborne announced that the Government would also fund new seismic surveys to assess the potential in “under-explored areas” of the UK North Sea.
BACKGROUND: Why is the industry so keen for Government help?
The situation has become so desperate for some North Sea drilling operators that even the few perks that help rig workers relieve hours of boredom on remote platforms are being scrapped.
Talisman Sinopec Energy UK has cancelled its subscription to Sky television on its rigs and replaced it with Freeview and BT Sport, the company said, saving £600,000 a year. Like many North Sea operators, the joint venture between Talisman and one of China’s biggest oil companies is seeking cutbacks in every corner to offset a 50pc slide in the price of oil since June.
A spokesman said: “Our industry is operating in a mature environment, against a backdrop of a declining oil price and ever-increasing operating costs alongside falling production levels, reduction in exploration and asset integrity and maintenance issues. We are not immune to those challenges and are taking appropriate actions.”
But denying its rig workers the joys of unlimited weekend Premier League football matches will make only a small impact for operators such as Talisman, which is already having to cope with higher production costs in the North Sea. In some cases, the cost of producing crude in the cold waters hundreds of miles off the coast of Aberdeen can reach levels of around $86 per barrel, leaving some operators heavily in the red.
When George Osborne delivers the final Budget of the current Government this week, the entire UK oil industry will be praying the Chancellor throws it a lifeline. After months of lobbying, he is widely expected to provide some relief to a sector that employs more than 400,000 people across the UK and is estimated to be worth £35bn to the economy.
The big question is whether the package of incentives and tax breaks that a team of three officials from the Treasury is understood to have been working on for months will be enough to assuage industry concerns.
Oil & Gas UK has warned that the North Sea will need £93bn of investment to extract a further 10bn barrels of oil equivalent from the region, which is unlikely to happen under the current taxation regime. However, without significant concessions on taxation and field development grants, oil companies may choose to look elsewhere at new exploration areas in Africa, South America and the Arctic.
A clear sign of the decline and the growing reluctance of oil companies to invest is in the dramatic drop-off in exploration work. Exploratory drilling in the UK’s North Sea has fallen to just 12 wells last year, down from 44 in 2008.
Trouble was already on the horizon for the North Sea long before the Organisation of the Petroleum Exporting Countries launched its preemptive oil price war in November. Even when oil was trading comfortably above $100 per barrel last May, companies such as Wood Group were demanding a 10pc rate cut from its contractor workforce. US oil giant Chevron said in July it would be cutting almost a fifth of its Aberdeen staff.
Those job cuts have increased since the beginning of the year, with companies such as BP cutting hundreds more staff.
Clearly, if Mr Osborne is serious about boosting the North Sea’s prospects, he will have to make it a key pillar of his Budget. The problem he faces is twofold. Firstly, assuming that global growth remains on track, then oil prices could easily return to levels above $100 per barrel within two years.
Higher oil prices would remove the immediate need to support an industry that has enjoyed a decade of bumper profits.
Secondly, offering tax breaks to “big oil” isn’t an obvious vote-winner for the Chancellor in an election which is looking increasingly too tight to call.
Given the complexity of the issue, there are five areas which Julian Small, head of Deloitte’s oil & gas tax practice, believes Mr Osborne should address on Wednesday:
• Investment allowance: “An investment allowance is expected to be announced, following the release of a consultation document from the Treasury on January 23. It should provide an uplift on “capital” expenditure, most likely at a rate of 62.5pc, which brings it in line with the cluster allowance. This means a reduction in effective tax rate for many firms, potentially to 30pc, further simplification of the tax regime and increased certainty over investment decisions.”
• Tax rates: “North Sea operators want to see rates reduced to 50pc, with further decreases in the future. This may not happen in the Budget, but we anticipate a possible phased reduction over the next few years, probably through reducing the supplementary charge. However, the benefits to both the Treasury and industry could be limited in the short term due to companies’ current tax profiles.”
• Exploration credit: “Exploration is at very low levels and significant new discoveries are few and far between. While we don’t expect an imminent announcement on incentives for exploration, the Treasury does plan to carry out a consultation. It seems likely that the outcome of this will be similar to the Norwegian model of providing a credit for exploration expenditure, although we need to wait and see how this takes shape.”
• Ageing assets: “The North Sea is a mature basin, with many assets reaching the end of their production lives.
However, if much of this old infrastructure is decommissioned, then there are a number of smaller fields which will become economically unviable. The right assets therefore need to be put in the right hands to prolong their use, a process which needs to be underpinned by a supportive fiscal regime. Currently this isn’t the case, as tax histories do not transfer from buyer to seller, meaning full tax relief is potentially not available for future decommissioning expenditure. This needs to change if we’re to make the most of existing infrastructure.”
By Emily Gosden and Andrew Critchlow

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