Response to a surprise tax hike on UK oil production has been swift and predictably ominous. In its 2011 budget announced in March, the government announced changes that will raise the effective tax rate on UK oil and gas production to 62-81%, depending on field age. According to the industry group Oil & Gas UK, the move raised the average tax rate on North Sea profits to 68% from 58%. The government further said it would cap tax relief for expenses incurred in decommissioning offshore facilities.
As a brazen raid on one industry's wealth, the move is comparable to a push in the US to extract billions of dollars from the oil and gas industry through increased taxation. It has shaken the confidence of oil and gas producers, who are rethinking investments in UK oil and gas work. Inevitably, it will lower UK oil and gas production. The US can expect similar responses if money-grabbers in the White House and Congress succeed.
Lost confidence
Lost confidence among UK producers and service providers is evident in Oil & Gas UK's first-quarter index of business conditions, conducted after the budget announcement. The index assesses economic indicators including changes in business confidence, activity levels, revenue, and investment in the UK offshore producing industry, focusing on the immediately following quarter. For the whole industry, the index dropped to 51 in first-quarter 2011 from 63 in fourth-quarter 2010 on a 100-point scale, with any score below 50 being negative. "The index has not been at such a low since third-quarter 2009," Oil & Gas UK said.
Among exploration and production companies, the index dropped to 46 from 71 quarter to quarter, its lowest value since the assessment began in January 2009. Among major E&P companies, the indexed dropped to 39 from 60 and among independent producers, to 48 from 75. In the service industry, the index dropped to 54 from 61. Half the respondents attributed their fallen optimism to the tax hike. One fourth of the respondents noted that activity remains high due to project commitments but expected a slowdown beyond the quarter under assessment.
Another annual survey of UK business expectations, conducted by the University of Strathclyde's Fraser of Allander Institute for the Aberdeen & Grampian Chamber of Commerce, reflected a sharp contrast between responses received before the announcement and those received after. "This is the first empirical data I have seen to demonstrate the very tangible damage which the Westminster government's so-called 'tax raid' has had upon investor confidence around the North Sea," said Bob Ruddiman, head of energy at the law firm McGrigors, which sponsored the survey. "The research clearly highlights the divergence in attitude between respondents who completed the survey before and after the changes were announced." Robert Collier, chief executive of the chamber, also noted the midsurvey shift in industry attitude, adding, "Trust between the industry and government is now at an all-time low."
Reduced investment
At the University of Aberdeen, Alex Kemp and Linda Stephen published results of a study showing "substantial long-term reductions in field investment and oil-gas production which will result from the increased tax rates announced in Budget 2011." Depending on future oil and gas prices, the researchers found, the tax changes will lower the number of new-field and project developments over the next 30 years by 79-123 out of more than 350 undeveloped discoveries and "very many potential incremental projects." It will cut oil and gas production by 2.25-2.7 billion boe, according to the study. In the low price scenario, total tax revenue over the assessment period falls by £12.7 billion; in the high-price scenario it rises by £51.6 billion. "These changes are clearly substantial and will inhibit the attainment of maximum economic recovery from the UK Continental Shelf," says a university press release.
The UK government will regret its shock strangulation of an industry crucial to the national economy. Other countries contemplating similar mistakes should watch and learn.
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