In 2016, decommissioning tax relief on the UK Continental Shelf (UKCS) exceeded government oil and gas revenues for the first time, a statistic that was widely reported, if not fully understood.
Energy research group Wood Mackenzie revealed that from 2017 onwards oil and gas companies are forecast to spend £53bn from this year winding down their North Sea operations. Almost half that sum is expected to be recouped through tax relief, more than the remaining net tax income from the entire industry.
So what is being done to prevent this drain on the public purse? In his Spring budget speech, UK Chancellor Phillip Hammond initiated a consultation on the treatment of decommissioning costs on asset sales to help incentivise investment in the UKCS and extend the productive life of the UKCS. He also made adjustments to the scope of the investment allowance, recognising the complexity of mature asset operations.
“The chancellor’s decision to also extend the scope of the investment allowance to certain categories of operating and leasing expenditure, that is companies’ productive spending that benefits the integrity and longevity of North Sea assets and improves oil and gas recovery, will also help encourage further investment,” states Mike Tholen Oil & Gas UK’s upstream policy director.
“It demonstrates that the government is delivering on its commitment, made in the Budget 2015, to broaden the scope of Investment and Cluster Area allowances to include expenditure on additional activities. The positive news is that the economic benefits of this extension are backdated, so companies can generate the allowance for any allowable expenditure since 8 October 2015.”
Scant relief: why tax rules deter asset transfer and investment
Under the current tax regime, oil and gas companies are permitted to claim back a proportion of the estimated £330bn of taxes paid since North Sea production began in the 1970s. However, the value of decommissioning relief depends on how much tax an operator has paid during their ownership of the asset. This means that the valuation of assets vary when they are bought and sold depending on their tax history, which distorts the market. Crucially, Industry leaders argue that this prevents the transfer of ageing assets from established companies to smaller investors, who are less reliant on economies of scale and better able to invest in extending the life of a mature field.
“In addition to the urgent need for fresh investment into the UKCS, tax history for decommissioning needs to be made transferable when assets are bought and sold to help the market function more effectively,” confirms Tholen.
“There are still areas where the tax regime can be improved so that the barriers preventing the transfer of tax relief between the seller and purchaser of oil and gas fields can be resolved, allowing new owners to realise the remaining potential of mature assets. The industry is working closely with HM Treasury and the Oil and Gas Authority (OGA) to identify the best way to achieve this objective.
“HM Treasury’s Driving Investment Plan to reform the oil and gas fiscal regime identified that aspects of the tax system make it harder to transfer late-life assets to new entrants and investors.
“The Chancellor’s announcement that an expert panel would be established to look into this is welcome. The industry will work together with Treasury and the expert panel to progress reform as soon as possible, and certainly with the aim of having measures in place by the Autumn budget.”
The issue didn’t deter Royal Dutch Shell, however. The Anglo-Dutch giant recently sold more than half its UK production assets to private equity-backed company Chrysaor for $3.8bn. The Financial Times reports that Shell kept a quarter of the estimated $3.9bn related decommissioning liability.
Key challenges: technology, access to finance and competitiveness
Hammond also pledged support for oil and gas research and development as part of an initial £270m investment in disruptive technologies under the Industrial Strategy Challenge Fund (ISFC).
“Appropriate support for innovation is more important than ever to move the industry forward due to two main factors,” says Tholen. “First, North Sea fields are now operated by smaller companies, often with limited research and development capability. This means that the sector is reliant upon an efficient innovation ecosystem in order to deliver the required technological advances.
“Second, much of the remaining potential resources located on the UKCS – up to 20 billion barrels of oil and gas − plus the identification of new accumulations will require innovative solutions, improved deployment of technology and, in many cases, application across multiple assets and licences.”
In addition to amendments to the decommissioning tax structure and investment in new technology, Tholen identifies access to finance and global competiveness as major challenges facing the industry.
“The oil and gas supply chain has been hard hit, with an average 30% fall in revenues over the last two years,” he says. “There is also the challenge of remaining competitive in a low oil price world.
“The oil and gas industry is working hard to improve competitiveness through its cost and efficiency focus. Not only are individual companies making big efforts but the industry is aided by its Efficiency Task Force, a group of experts tasked with driving pan-industry, high-impact initiatives to improve the international competitiveness of the UKCS and achieve a sustainable future for the industry.”
Final frontiers: the future of production on the UKCS
The Financial Times reports that oil and gas tax revenue forecasts between 2017-18 and 2021-22 were revised down in the Spring budget by £2.7bn compared with the Autumn Statement. Income during that five-year period is expected to total £4.6bn. Revenues for 2017 are forecast to be just £100m.
The content of a formal document on tax issues relating to late-life assets (i.e. transferable tax history) published on 20 March is currently under discussion by an expert advisory panel, as is the issue of how the full value of tax refunds can shift to new operators to avoid decommissioning.
“Oil & Gas UK had already written to the UK Chancellor of the Exchequer and met with the Finance Secretary to the Treasury to discuss the issue, which is still recognised as a significant barrier to asset trading despite some of the recently announced deals,” says Tholen.
Against a backdrop of spiralling costs and depressed oil prices, are the new tax proposals enough to maintain current production levels and attract new investment in the UKCS, while at the same time plugging wells and dismantling infrastructure, which could take 40 years? Tholen remains upbeat.
“The oil and gas supply chain is seeking support to improve access to finance for both their UK and international businesses,” he says. “We believe they would benefit from better access to measures such as those available through the government’s UK Export Finance department and want further dialogue with ministers to ensure it is straightforward for industry to utilise such schemes.”