The UK's changing taxes

March 28, 2016
Tax relief for oil and gas produced on the UK Continental Shelf surprised no one in a struggling industry that has desperately sought it. The same cannot be said for past changes to the British tax regime.

Tax relief for oil and gas produced on the UK Continental Shelf surprised no one in a struggling industry that has desperately sought it. The same cannot be said for past changes to the British tax regime.

Declaring it "believes in making the most of the UK's oil and gas resources," the government's budget this month made several changes lowering headline tax rates from 50-67.5% of profits related to production, depending on field age, to 40% across all fields. Here's a summary:

• The Petroleum Revenue Tax (PRT) rate falls to 0% from 35%. Introduced in 1975, the PRT applies to individual fields approved for development before Mar. 15, 1993.

• The Supplementary Charge (SC) rate falls to 10% from 20%. The SC applies to company profits subject to the Corporate Tax (CT) after deductions for financing costs and allowances. The CT rate for upstream oil and gas profits is 30%. Oil and gas extraction is isolated from other activities-or "ring-fenced"-for CT calculation.

• Investment and "cluster area" allowances are extended to tariff income. The allowances, introduced in 2014 and 2015, reduce the amount of ring-fence profits subject to the SC. The reduction amount is 62.5% of investment expenditure. According to budget documents, including tariff income will "encourage investment in key infrastructure maintained for the benefit of third parties."

Complicated taxation

Obviously, the UK oil and gas taxation is complicated. That's a problem. A larger problem is related. UKCS taxation has changed, substantially and by surprise, several times since 2000. Introduction of the SC in 2002, for example, jolted UKCS producers. So did an increase in the rate to 20% in 2006 from the inaugural 10%. In 2011, the government raised the SC rate again, to 32%, and limited tax relief for decommissioning expenditures. After oil prices began their plunge in mid-2014, the government lowered the SC rate to 30% and followed that action 4 months later with a cut to 20% along with a reduction in the PRT rate to 35% from 50%.

For oil and gas producers, changeability is not an alluring attribute for a tax regime. Surprise changes are deadly. In a Mar. 17 analysis, Gaffney, Cline & Associates said the new tax pullback "does little to reassure investors who have witnessed over the last 25 years the frequent tweaking of taxation in response to the rise and fall of oil price, which has created a legacy of uncertainty in the UK fiscal regime."

Unpredictable taxation isn't the only reason UKCS oil production has fallen from its peak of 2.6 million b/d in 1999 to below 1 million b/d last year, which was up slightly from 2013-14 rates. The region is mature. Old giant fields are in advanced stages of depletion. The average discovery size has shrunk. Costs remain high.

Still, taxation is a problem. It's a reason integrated operators have given for trimming UKCS work or withdrawing altogether.

In a December report published by the Oxford Institute for Energy Studies, Virendra Chauhan and Amrita Sen, of Energy Aspects, and consultant Maarten van Mourik documented the pattern. The share of total UKCS production operated by international oil companies has fallen to 37% from 70% in 2001, they wrote, noting, "Almost the entire decline between 2001 and 2015 is accounted for by IOCs, while independent operators…now produce 52% with small companies accounting for the remaining 11%."

Investment surge

The analysts attributed last year's uptick in UKCS production to an investment surge stimulated by the oil-price elevation that ended in 2014. After 2017, project starts will be few and small, unable to offset declines in existing fields. The analysts cited Department of Energy and Climate Change projections for output declines to 600,000 b/d in 2020 and 400,000 b/d in 2030 from 850,000 b/d in 2015.

The new tax changes will help. They would have helped more, however, if history gave producers no reason to expect reversals the next time oil prices jump.