By OGJ editors
HOUSTON, Apr. 23 -- In a surprise move last week, UK tax officials applied the "stick" to offshore producers with an immediate new 10% supplementary tax on North Sea oil and gas profits, while hinting at a future "carrot" through possible abolishment of the 12.5% overriding royalty for older fields.
The new supplementary tax effectively raises the corporate tax rate to 40% from 30% previously, said officials at Deutsche Bank AG in London. Financing costs are not deductible from the supplementary tax and, like the corporate tax, there is a "ring fence" to prevent the reduction of taxable upstream profits by losses from other activities.
However, Deutsche Bank analysts reported, "Those companies that are reinvesting a significant portion of their North Sea cash flow into the UK will be least impacted by the tax changes, as the government has also increased capital allowances against the corporate tax and the new supplementary tax."
As part of the UK government's program to encourage continued investment in North Sea operations, 100% of most first-year North Sea upstream capital expenditures will be allowable for both the corporate tax and the supplementary tax for the year incurred, compared with 25% currently.
"Therefore, those companies that are involved in material development programs could significantly reduce their near-term tax payments, aimed at stimulating new, marginal developments," Deutsche Bank analysts reported.
Royalty burden
However, they said, "Until royalty is abolished, older fields will have to endure a fiscal take in excess [of] 70%. In our opinion, the companies will push hard to get royalty abolished as quickly as possible—especially the owners of older fields." Included among those owners are BP PLC, Royal Dutch/Shell Group, ExxonMobil Corp., and Talisman Energy Inc., analysts said.
Royalty was abolished in the 1980s for UK North Sea oil and gas fields that received development consents on or after Apr. 1, 1982.
In addition to the corporate tax and the new supplementary tax, many offshore producers also pay a special field-based petroleum revenue tax, currently at 50%, designed to give the UK government a proportion of "super profits" from offshore oil and gas production. Fields given development consents on or after Mar. 16, 1993, are exempted from that tax.
Deutsche Bank officials said the new tax is bound to be a disappointment to UK independents such as Tullow Oil PLC, Dana Petroleum PLC, Paladin Resources PLC, and Venture Production Co. Ltd., since it "inevitably reduces" the value of recently acquired assets in the UK sector. However, such companies "should be able to take full benefit of the capital allowance changes as they are investing heavily in the UK, officials said.
'Minimal' impact?
"While . . . changes to upstream taxation is unwelcome for those companies with UK operations, we believe its financial impact to be minimal," said officials at UBS Warburg, a business group of UBS AG in New York.
UBS estimated that Amerada Hess Corp., Murphy Oil Co., Conoco Inc., and Phillips Petroleum Inc. have the highest exposure to the tax changes, with possible earnings reductions of 5-7%.
Different view
Deutsche Bank analysts take a different view. The tax change, they said, "should result in an average 1.3% reduction in the 2002 net earnings of the UK's largest producers. BP PLC, the largest producer in the UK [accounting for 20% of UK oil production and 16% of gas production] is likely to be hardest hit."
They said, "Based on our initial analysis, we expect BP to pay around £160 million in additional taxes that would lead to a 2.4% reduction in its 2002 net income. ENI SPA's and BG PLC's 2002 earnings are expected by us to be reduced by around 1%, and the other companies, less than 1%. Enterprise Oil PLC benefits in 2002 from the higher capital allowance.
"Looking further ahead, the impact of the tax change will depend on the level of capital spending; however, reductions in corporate earnings of 1-2% seem typical."
"With the maturity of the UK Continental Shelf as an exploration province, most US integrated oil majors are utilizing their [UK offshore] operations for cash generation to fund other international upstream expansion," said UBS Warburg officials. "Consequently, for most US companies the impact of the higher taxation diminishes over time."
However, Deutsche Bank analysts said, "We believe those companies that are using the UK Continental Shelf to fund international expansion will be penalized." That, they said, could "catalyze the larger players" to invest in new developments, to consolidate, or to exit that sector.
