UK Taxation on Oil and Gas Extraction is Cut Again, but Remains Volatile

UK Taxation on Oil and Gas Extraction is Cut Again, but Remains Volatile

17th March 2016

The UK Treasury’s announcement in the 2016 budget of abolishing much of Petroleum Revenue Tax (PRT) and reducing the Supplementary Charge from 20% to 10% will be a welcome relief to many Oil and Gas companies. However, it does little to reassure investors who have witnessed over the last 25 years the frequent tweaking of taxation in response to the rise and fall of oil price, which has created a legacy of uncertainty in the UK fiscal regime. 

To highlight just how volatile the UK fiscal regime has been, Figure 1 is a comparison of UK and Norwegian marginal tax rates for oil and gas fields approved in a given year. For the sake of comparison, these plots only consider the relevant business tax[1] and the tax supplement specific to petroleum extraction activities[2]. There are tax concessions in each country related to certain fields or activities that are not represented, but need not be considered when comparing a base level of taxation across the industry.

The difference between the two marginal tax rate distributions is stark. The UK government has pursued a policy of increasing and decreasing taxation in line with changes in oil price. This policy is understandable as it maximises government take in the short term, but the consequence is strong fluctuations over time – just like oil price variations. On the other hand, although Norway has experienced some structural changes in its fiscal regime, the net effect has always been a relatively stable and predictable government take. This affords more certainty to businesses even if the rates have sometimes been higher than in the UK.

Underpinning these two different patterns are two differing approaches to managing a national resource. For most of its history the UK has relied solely on private enterprise to discover and produce hydrocarbons with state involvement only occurring at the regulatory level. On the other hand, Norway has continued to ensure a high degree of state involvement in exploration and production with 67% Norwegian state owned Statoil acting as Operator responsible for 70% of all oil and gas production on the Norwegian Continental Shelf (source: GCA Analysis).

This higher degree of state involvement in Norway is because it is more dependent on its hydrocarbon resources for revenue. According to the Norwegian Ministry of Finance, government revenues from oil and gas activities in 2014 made up 30% of the national budget. This compares to 0.3% in the UK in the same period (source: Her Majesty’s Revenue and Customs). Therefore, Norway cannot afford to take a short term approach to managing its hydrocarbon resources if it is to protect future government budgets.

The flipside of the UK policy is that until the release of the Wood Report in 2014 taxation policy has not taken into account diminishing production and has arguably accelerated the decline of the UK North Sea. Figure 2 shows that despite a rapidly declining production rate the marginal tax rate has continued to rise encouraged by rising oil prices. There are stronger forces at play driving production down such as the maturity of the province and rising costs, but increasing rates of taxation despite these problems has only hampered the issue. As a less mature province, Norway will have to consider how to manage its taxation with declining production and could learn much from the UK experience. 

Since the publication of the Wood Review and the formation of the OGA (Oil and Gas Authority), there has been a public recognition that the UK must change how it manages remaining North Sea hydrocarbons. “Stewardship” and “Maximising Economic Recovery” are now synonymous with the new outlook. Short term opportunism can no longer be sustained and the newly defined tripartite (Industry, the OGA and the Treasury) most work together to extract the most value from the North Sea over its remaining lifetime.

In an attempt to prevent decommissioning costs stifling asset sales the UK Chancellor is providing reassurance that asset owners who retain abandonment liability will access tax relief on their costs. Exactly how decommissioning tax relief will encourage late-life asset transfers is something that asset sellers and purchasers will be keen to understand.

Although the UK Treasury acknowledges that simplification and stability is required in the UK fiscal regime (“Driving Investment: a plan to reform the oil and gas fiscal regime”, 2014), it will take time to reverse the UK’s reputation as a fiscally volatile country amongst the global oil and gas community. In the meantime investors will be obliged to carefully test how swings in taxation such as those seen in the past could affect oil field economics. Unless the current and future budgets buck the trend, history tells us that taxation will go up again if the oil price recovers.

[1] Ring Fence Corporation Tax in the UK and General Income Tax in Norway
[2] Implemented as Petroleum Revenue Tax and Supplementary Charge in the UK, and Special Tax in Norway 

Authors

UK Taxation on Oil and Gas Extraction is Cut Again, but Remains Volatile

Séadhna Wilson

Commercial Business Advisor - seadhna.wilson@gaffney-cline.com

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