Trade industry body Oil & Gas UK, along with Scottish Minister Fergus Ewing and industry veteran Algy Cluff, have called for a quicker response to a call for further reforms to the UK fiscal regime for offshore oil and gas companies operating in the UK Continental Shelf (UKCS), insisting that the current situation is "not sustainable".
Oil & Gas UK stated that data from the Office for National Statistics shows pre-tax returns for the UKCS have fallen to levels last seen in 2005, when the oil price was less than $50 per barrel and tax rates were 22 percentage points lower. Furthermore expenditure exceeded post-tax revenues and revenues have fallen by almost two thirds in three years, with further decline predicted, it said.
These fiscal challenges have so far manifested themselves in jobs losses from majors, such as Shell and BP, and exploration actively coming to a standstill.
In the autumn statement of 2014 UK Chancellor George Osborne, acknowledging calls for a reform in October, introduced a 2% reduction to the rate of the supplementary charge from 32% to 30% from 1 January 2015. As well as promising to provide further support to industry in his upcoming March 2015 budget.
Currently, companies operating on the UKCS are subject to tax rates of 62 – 81 %. Notably in 2011 a supplementary charge on corporation tax was introduced and then increased by 12% to a total of 32% (now 30%) when the oil price was averaging $100 a barrel.
What can the offshore oil and gas industry expect in terms of CAPEX spending, regional hotspots, oil prices and potential challenges in 2015?
Oil & Gas UK’s chief executive Malcolm Webb has said the treasury’s response to decline of UK CS oil and gas industry isn’t urgent enough.
"The Treasury’s promise in last year’s Autumn Statement of a simplified tax allowance to encourage new investment must be delivered by budget 2015 if it is to have any impact. However, with the continued falling and potentially sustained low oil price, this is no longer enough."
If oil prices have not recovered by the Chancellors upcoming budget, the trade body are calling for abolition of the supplementary charge introduced in 2011. This would still leave oil and gas producers paying corporation tax at 30 per cent, a tax rate 50 per cent higher than the rest of British industry.
Besides the 2% tax reduction starting in January 2015, the Treasury has pledged an immediate extension of the ring fence expenditure supplement to 10 years, financial support for seismic surveys in under-explored areas, a new streamlined investment allowance to simplify the existing regime of field allowances and a commitment to open discussions with industry in 2015. However, exact details of these plans have yet to be released.
In response to our questions the Treasury replied with the statement: "The government is working with industry leaders as a matter of priority to address the challenges the industry faces as quickly as possible and to maintain Britain’s energy security by maximising the economic recovery of our domestic oil and gas resources, offshore and onshore."
The main problem seems to be that Treasury’s tax hike, though unwelcome, was at least manageable back when the oil price was hovering above $100 a barrel. Whereas in today’s market – with an oil price around less than half of what it was then – it’s a far greater burden.
This is especially true for smaller companies that are responsible for the majority of exploration in the North Sea.
Companies are not offered tax incentives for exploration and cannot claim back capital expenditure for exploration even if a drilled well is dry. Meaning if a company drills several dry wells it could go out of business. This is unlike in Norway where companies can claim an 80% rebate on every exploration dollar spent.
"Much of the exploration activity is carried out by small AIM Exploration Companies, and the confidence in that sector has fallen out of favour, with many share prices falling by 50 to 90%," says Adrian Pocock a Private Investor in oil stocks and director at Asset Management and Improvement.
"Understandably, the ability to raise cash for drilling projects is almost non-existent. The banks aren’t interested and there is little or no ability to raise cash by share issues."
An example is Trapoil which dropped several North Sea oil exploration projects after failing to find farm-in partners.
Julian Turner talks to Malcolm Webb, chief executive of Oil & Gas UK, about tax allowances and more.
Cluff, who has interests in UKCS, has suggested a ten-year tax holiday for any existing discovery not in development or for any future discovery. He adds that government should follow the 80% rebate model of Norway for small and independent companies with no existing North Sea discovery.
Weathering low-price pressures
Tax breaks for exploration are one thing, but dropping tax rates for current operations could be premature. Should government be prepared to react every time there is a prolonged shock to the market? Oil and gas is a cyclical business by nature, shouldn’t companies be prepared for such shocks?
After a long-period of high oil prices companies should have had a chance to build cash reserves, buying themselves some time in this economic downturn.
Dougie Youngson, an oil and gas specialist at broker finnCap, speaking to Proactive Investors, says: "Ultimately firms will have adjusted capital expenditure and sit round the table and work out their investment case."
Adding that "as we move further into 2015 we’ll begin to get a sense of how bad things are."
The trouble is that cost for the UKCS seem to be rising – according to Oil & Gas UK costs rose by 26 % last year. Add to this the 2011 30% tax hike and $40 – $50 oil price. These factors have created a perfect storm with the only controllable factors being finding ways to reduce costs and lowering tax.
Although, no one can predict what will now happen with the oil price, the general consensus seems to be that it will remain low for the foreseeable future. Already the industry is seeing a succession cost cutting measures and a reduction in investment is thought to be imminent, neither of which is good for the Treasury or the industry. On the contrary, the Treasury has been keen to encourage investment in the North Sea.
BP in December 2014 announced a major reconstruction of its North Sea operation as a result of the falling oil price and in January said it will cut 200 jobs and 100 contractor roles. Tullow Oil and Shell have also said they intend to cut jobs in the UK for the same reason.
And a Wood MacKenzie report states that oil prices averaging below $60 per barrel would result in levels of upstream investment in the North Sea plummeting by around half compared with levels in 2014 to $10m.
"The UK Government Tax Regime would now appear to be designed to kill the goose that laid the golden egg and has not responded quickly enough to the fast-moving environment of oil exploration," Pocock says.
"Unless the UK Government has a volte-face (turn of face) on how investment is to be encouraged rather than how to spend future Revenues that don’t exist, the North Sea faces a bleak future, and our home-grown Oil Companies are extremely vulnerable to takeover by oil rich nations that may see the opportunity to buy the UK reserves at bargain-basement prices," he adds.
Companies should be prepared
It’s likely Osborne will keep to his commitment to support the UK CS oil and gas industry with further reforms to his fiscal regime or face seeing the already aging oil field, which is one the UK’s biggest tax earners, deteriorate further. But how far he will go is unknown and the impending May election creates further uncertainty for industry.
2015 will be an interesting year for the UKCS oil and gas industry and what happens in the coming months is literally anyone’s guess. Industry knows it must prepare for many uncertainties – will Osborne move with the markets and provide substantial tax relief? And if he does, will it be undone if his party fail to win the election? And will OPEC move to ease supply in order to increase the oil price? Or will it remain at current levels?