When taxes increase on the rewards of work, the taxed work less. When taxes decrease on the rewards of work, the taxed work more.
The UK government raised taxes on the rewards of offshore work in 2011, and—sure enough—offshore work declined. Since then, the government has eased taxation of offshore work. Can anyone guess what's happening with work on the UK Continental Shelf?
In its budget announcement of early 2011, the government raised a special oil and gas tax called the supplementary charge to 32% from 20% of production income. As a result, the tax rate on profits from new investment rose to 62%. For fields developed before 1993, the rate jumped to as high as 81%. The budget also limited to 50% the costs of decommissioning offshore structures chargeable against the corporation tax and supplementary charge.
Investment value cut
According to a new study by Oil & Gas UK, the 2011 tax moves cut the value of UKCS investments by as much as 24%, reduced effectiveness of allowances intended to encourage development of marginal oil and gas fields, impaired the value of exploration, and raised the risk premiums of UKCS projects in assessments by overseas investors. Oil & Gas UK and many individual companies rightly protested. The government commendably responded. And drilling predictably has turned up. According to Deloitte, operators spudded 46 exploration and appraisal wells during the first three quarters of 2012, 10 more than in the comparable period of 2011. But the 2012 number remains below those of 2009 and 2010.
Since the tax shock of 2011, the government has taken these steps to restore the allure of UKCS investments:
• Expanded the small-field allowance. Earlier, new fields with reserves of 20 million boe received £75 million of allowance. Above 20 million boe, the allowance phased down to zero at 25 million boe. Now, fields up to 45 million boe qualify an allowance worth £150 million, with a phasedown to zero for fields with 45-50 million boe of reserves. Oil & Gas UK says its analysis "shows that, based on currently known developments, the increase in the allowance attracts sufficient new investment that it more than pays for itself" from the government's perspective.
• Added an allowance for new, large deepwater developments. The allowance shelters as much as £3 billion in production income from the supplementary charge for fields in more than 1,000 m of water with reserves of 188-300 million bbl, with a phaseout to zero for reserves of 300-412 million bbl.
• Added an allowance for new, shallow-water gas field developments. The allowance is worth as much as £500 million against the supplementary charge.
• Added a brownfield allowance. Designed to encourage marginal investment in existing fields, the measure applies to developments with capital costs exceeding £8/boe, with projects costing more than £10.67/boe receiving relief of £50/tonne of incremental oil or gas equivalent produced and projects with costs between those values receiving less relief on a sliding scale.
• Provided certainty on tax relief for decommissioning. In its 2012 budget announcement, the government said it would assure operators of the continued availability of tax relief for decommissioning. In July, it began formal consultation on proposals for a contractual mechanism to accomplish the goal.
Just improvement
These measures greatly improve the UKCS investment climate from the abyss into which it fell immediately after the 2011 budget announcement. And they hardly deprive the treasury. Oil & Gas UK points out that marginal tax rates remain as high as 62-81%, depending on the field.
Improvement isn't the same as full damage repair, however. Investors detest surprises, and the 2011 tax hike was a surprise. It wasn't the first. Imposition of the supplemental charge was a surprise when it was imposed in 2002. So were the two increases that have occurred in its rate. The recent adjustments, welcome as they are, offer no assurance that it won't happen again.
