UK Chancellor Gordon Brown didn’t even spin it well. He surprised the UK North Sea oil and gas producing industry with a tax increase and acted altogether untroubled by the need to make economic sense of it (see Newsletter and p. 35).
“With the tax on new development in the North Sea now lower than in the USA and the Gulf of Mexico, Norway, Italy, and Australia, and in order to strike the right balance between producers and consumers, I will raise the supplementary North Sea charge from 10% to 20%,” Brown said in a Dec. 5 budget speech after pointing out that North Sea investment returns have risen lately. To summarize the argument: Industry profitability is up, taxation rates are higher in some places than they are in the UK, and the government feels compelled to enforce a balance of some sort between producers and consumers. So the chancellor expropriates £2 billion/year from a productive sector of the economy.
Taxes and profits
Brown’s concern about UK North Sea investment returns echoes arguments in the US that producers should pay a “windfall profit” tax because they made money at the same time oil and gas prices spiked. If governments are going to calibrate taxation rates to profitability they should start paying attention when profits are low. Current levels of oil company profitability are not typical. Even if oil and gas prices stay relatively high, producers’ profits will decline in part because costs are leaping. While outsize profits won’t last, however, taxes imposed in response to them certainly will.
It’s not clear what Brown meant by “tax on new development,” but he seemed to imply that the UK should match oil and gas tax rates elsewhere. Applied to a mature producing region like the UK, this view ignores much. In the country comparisons that international operators make when deciding where to risk capital, taxation rates constitute only one parameter. Against other decision metrics, such as exploratory risk, prospect size, and finding and development costs, the mature UK North Sea doesn’t compare favorably with many competing opportunities elsewhere. The UK has to offer relatively low tax rates to compensate for its disadvantages. One of those drawbacks just gained weight in investment decision-making. The second surprise tax increase in 3 years can do nothing but harm to the UK’s standing in rankings of political risk.
Brown’s argument about striking the “right balance between producers and consumers” is hollow. Is the balance “right” only when oil and gas prices are low and producers are struggling to make money? If the government presumes to regulate such a balance, why doesn’t it impose special taxes on all industries for which returns on investment are high? What, exactly, is the “right balance,” anyway? If it’s to be a threshold for tax hikes, prospective taxpayers need to know.
What is more, if increased tax payment makes the balance “right,” the remedy should be at hand. For production from developments approved after March 1993, oil companies pay the 30% corporate tax other companies pay plus the 10% “supplementary charge” added in 2002. So if profits are up, tax payments should be up, too, maybe by enough to pay for the heating-bill subsidies Brown proposes. Alas, such revenue gains apparently don’t count in calculations of the producer-consumer balance. Brown still wants to double the supplemental charge.
Quick money
What he really wants, of course, is quick and politically expedient money with which to balance government accounts, which are not looking as rosy as he projected in his previous budget speech last March. He wants to succeed Tony Blair as prime minister. He needs to get the government’s fiscal affairs headed in the right direction-at least until the election.
The UK petroleum resource needs a steadier hand than this. The UK Offshore Operators Association estimates the country’s continental shelf has 8.5 billion boe on production or approved for development, 2.5-5.5 billion boe in “brownfields,” 3-5 billion boe in undeveloped discoveries, and 5-9 billion boe yet to be found. Those numbers represent considerable remaining energy supply, income, jobs, and tax revenue. But turning potential into real benefit in a chronically fragile economic environment requires careful management and close cooperation between industry and government. Surprise tax hikes don’t meet that standard.✦