British Chancellor of the Exchequer Gordon Brown has kept a promise to abolish royalty on the UK North Sea's 30 oldest oil and gas fields. The move boosts investor confidence weakened by the surprise enactment in April of an extra tax on North Sea producers.
In a Nov. 26 budget statement, Brown set a long-awaited date for royalty abolition: next Jan. 1. Fields approved for development before Mar. 31, 1982, now pay royalty of 12.5% on the gross value of oil and gas, adjusted for costs of transportation, treatment, and initial storage. Royalty-paying fields include such venerable producers as Brent, Forties, Buchan, Claymore, Frigg, Heather, and Viking. Fields receiving development approval before Mar. 16, 1993, pay petroleum revenue tax (PRT) at the rate of 50% of profit, field by field. Some fields pay both royalty and PRT.
Like all British companies, oil and gas producers also pay corporate tax at the rate of 30% of company profits. The supplementary tax imposed last April lifted the corporate tax rate for oil and gas producers to 40%.
Producer objections
UK producers objected to the supplementary tax partly because the extra cost discouraged investment needed to extend production from large, mature fields. When the tax hike was announced, the UK Offshore Operators Association (UKOOA) reported an estimate by a University of Aberdeen professor that the extra cost to producers would approach £8 billion ($12.8 billion) through 2010. That's about how much the industry spent last year on all UK North Sea exploration and development. UKOOA said the new tax load might cut exploration and production spending through 2010 by 20%.
Producers objected to the change also because it came with no warning. A government needing money simply hit them with an extra tax. Developments like that shatter investor confidence.
It was especially important, therefore, for Brown to follow through on royalty abolition. Until he acted, producers were especially anxious. The promise about royalty was contingent on the type of consultation that didn't happen with the corporate-tax hike.
The consultancy Wood Mackenzie Ltd. of Edinburgh, Scotland, called cost to the government of royalty abolition "comparatively low for the benefit of restoring investor confidence in the North Sea fiscal system." It estimated the action returns about £790 million ($1.3 billion) in asset value to the oil industry but noted that the supplementary tax eroded value of the same North Sea assets by £5.1 billion ($8.2 billion).
The Exchequer will receive about £530 million this year from North Sea royalties. But deductibility of royalty payments in calculations of liability for the PRT and corporate tax reduces the true contribution to the government by a net 70% from most royalty-paying fields. Wood Mackenzie thus estimated the net cost to the government of royalty abolition at £161 million in 2003, £165 million in 2004, and £154 million in 2005.
Continuation of royalty, the consultancy said, might have led to premature abandonment of mature fields such as Auk and Thistle, both of which are likely to cease production in the next 5 years. It also would have discouraged enhanced recovery programs in old fields and prolonged the high costs to companies and the government of administering the levy.
"When the increase in taxes paid and the reduction in administration costs are taken into account, the true net cost appears to be a relatively small price to pay to provide the positive message the UK industry badly needed," Wood Mackenzie said.
Unpleasant surprise
Restoration of investor confidence is far from complete, however. Elimination of the royalty just fulfills a commitment by a government official. It doesn't nearly offset the cost to producers of the supplemental corporate tax. And it doesn't much ease concern that a government that can unpleasantly surprise an essential industry once might someday do so again.
UKOOA Director-General James May told Oil & Gas Journal recently that the current government has promised to limit supplemental taxation to the imposed rate of 10%. But there's nothing in British law to keep a future government in fiscal trouble from raising the rate.
Since last April, the oil and gas industry has had unfortunate reason to make that risk a weightier factor than before in decisions about investing in the UK North Sea.
