A tax increase on UK oil and gas producers might be said to fit a pattern if the existence of a pattern didn't imply predictability. If the latest tax hike was, in theory, predictable, it surely wasn't predicted.
In what the accounting firm Ernst & Young called "a shock announcement," the UK government raised an element of oil and gas taxation called the supplementary charge to 32% from 20% as of Mar. 24. The firm says the move, part of the annual budget, "demonstrates to industry in an unambiguous fashion that there is no real concept of fiscal stability in the UK."
For a mature producing arena, this is harsh condemnation. Instability raises financial risk, which must be accommodated in decisions about investment. The greater the risk, everything else staying equal, the lower the overall investment. Rising costs and falling hydrocarbon quantities of a mature producing region make this balance especially delicate. But the government needed revenue with which to offset the lowering of a fuel tax paid by consumers. So investment bit dust.
Rate rising
If this were the UK government's first raid on the producing industry, allegations of instability might be premature. But it is not. It's the second rate increase since the government in 2002 imposed the supplementary charge for producers atop the corporate tax paid by all businesses—another surprise move that John Browne, then chief executive officer of BP, flatly called "wrong."
In fact, the tax regime for oil and gas production off the UK has changed many times since its imposition in 1975—not always in ways that have hurt investment and production. The legacy is a patchwork of tax mechanisms, the application of which depends on approval date for field development. And the trend in the rate of taxation is decidedly upward.
According to the industry group Oil & Gas UK, producers last year paid taxes at rates of 50-75% of profits, depending mostly on field age. The average rate across the UKCS was 56%. The normal rate of corporate taxation for other large businesses in the UK was 28%. Even before the new increase, therefore, the tax rate on producers was high in comparison with that of other UK businesses. Andrew Lister, partner in the KPMG energy and natural resources practice, said in a report that the effective rate has been doubled in less than a decade for many fields and now will be 81% for some old fields. Calling the tax initiative "a huge blow to the oil industry," Lister said it "can only reduce the attractiveness of investment in the North Sea."
Taxation rate is just part of the problem. Surprise is another. Surprise raises uncertainty, which bedevils planning and discourages investment. A rate hike, moreover, wasn't the only nasty surprise in the budget announcement. The government also said it would introduce legislation to limit tax relief for future decommissioning expenses—estimated to total £26 billion.
'Constructed hurriedly?'
Members of Oil & Gas UK agreed at a meeting that the tax increase "looks to have been constructed hurriedly without rigorous analysis of its implications and has damaged investors' confidence in the UK as a stable destination for their capital," said Malcolm Webb, the group's chief executive. "The move has made companies rethink their plans to step up investment in the next few years, jeopardizing tens of thousands of jobs as well as indigenous oil and gas production, which will likely lead to an increase in the import of these fuels."
Webb's comment introduces the possibility that the government didn't act wholly out of disregard for the effect of its money grab on investment, energy supply, and jobs; it may have failed fully to consider all possible outcomes. To the extent that's so, the government is inept as well as heedless. Its fiscal regime for oil and gas looks newly unstable either way. For that perception, the UK will pay dearly for many years.
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