UK chancellor offers incentives for challenging fields

Operators focused on small and challenging projects in the UK North Sea that are offered investment incentives by Chancellor Alastair Darling in his 2009 budget to unlock 2 billion bbl.

Apr 28th, 2009

Uchenna Izundu
OGJ International Editor

LONDON, Apr. 27 -- Operators focused on small and challenging projects in the UK North Sea that are offered investment incentives by Chancellor Alastair Darling in his 2009 budget to unlock 2 billion bbl and enhance indigenous production.

As oil prices have fallen from $147/bbl last July to a range around $50/bbl today, Darling has come under intense pressure to offer tax breaks to the industry. Recently published data by Deloitte LLP showed there was a 78% fall in exploration drilling in this year's first quarter compared with a year ago due to low oil prices, high costs, and financing difficulties. According to Deloitte, the government's tax receipts from the North Sea is expected to almost halve in 2009-10.

Darling will introduce a new "field allowance" to offset against the supplementary charge (reducing the tax rate from 50% to 30%) whereby operators would have a variable limit on tax-free income, with anything above that limit to be taxed. This measure would apply to small, and high-pressure, high-temperature, and heavy-oil fields that now can be economically developed at low oil prices. It is effective for qualifying fields given development consent on or after Apr. 22.

Jim Hannon, managing director of North Sea consultancy firm Hannon Westwood LLP, said the proposal has the "potential not only to sustain drilling on the current stock of over 300 discoveries but would have an indirect benefit on exploration drilling." Even if oil prices increase in the coming months, Hannon claimed the "field allowance scheme remained valid and capable of driving a more sustained level of investment, particularly so in a competitive world of oil and gas exploration, in which the UK has to maintain its attractiveness."

Highlights of the budget for UK North Sea operators included:

-- Removing any income from change-of-use activities from the scope of the petroleum revenue tax and allowing relief against corporation tax and the petroleum revenue tax for decommissioning costs for change-of-use assets.

-- Capital allowances available for cushion gas in gas storage projects.

-- Chargeable gains on North Sea asset disposals to be exempt if proceeds are reinvested in the UKCS or licenses of the same value are swapped, effective from Apr. 22

-- Measures to reduce the administrative burden of the petroleum revenue tax and repeal of obsolete associated legislation

Responses
KPMG said the tax changes will provide incentives to change the use of fields and provide for capital gains on license swap deals. But it raised concerns about the modified decommissioning rules where Darling pledged to "...ensure companies cannot access tax relief for decommissioning oil and gas infrastructure years in advance of the decommissioning actually being carried out." This approach is to stop tax avoidance schemes.

Derrick Parkes, an energy tax partner with KPMG, said: "Other detailed changes regarding change of use of existing field assets, capital gains on license swaps, and sales provide welcome clarity and relief, but the countering of arrangements to advance North Sea decommissioning relief will disappoint some."

Andrew Ogram, oil and gas tax partner at Deloitte, said although the announcements were welcome, the chancellor missed the opportunity to introduce additional incentives for exploration in the UK given the low prices and declining exploration activity.

Meanwhile, trade association Oil & Gas UK (OGUK), which has been lobbying for tax changes to stimulate investment, cautiously welcomed the package (OGJ Online, Apr. 23, 2009).

Malcolm Webb, OGUK chief executive, said the measures were a positive step for those companies trying to develop small and challenging fields in this mature, high-cost province. "However, we now need to direct our attention to sustaining and promoting investment in and around many of our older fields to prolong their lives, to stimulating exploration activity and to opening up the frontier areas west of Shetland and in that regard, we welcome the government's offer of a continued dialogue."

But OGUK was disappointed that there was no improvement for small companies to access equity markets, which is making it nearly impossible for them to continue exploration.

The government plans discussions with the industry to ensure the fiscal regime is attractive for the future of the UK North Sea. Full details on minor amendments in the budget will be explained in the finance bill, which was published on Apr. 27.

Environment issues
Darling has committed the UK to cutting carbon emissions by 34% by 2020 and offered £1.4 billion to address climate change by supporting low-carbon industries.

Darling wants the North Sea to become a hub for energy of the future—gas storage, carbon capture, and offshore wind. He proposes to achieve this by removing fiscal barriers and offering £405 million of new funding for low carbon energy and advanced green manufacturing in Britain—to drive the application of new technology and invest in small scale projects.

Some environmental and business groups dismissed the package as not going far enough to combat climate change. Adrian Wilkes, chief executive of the Environmental Industries Commission, which represents 200 environmental technology and services companies, said the budget "was timid and inadequate."

Friends of the Earth's director Andy Atkins said the targets were too weak to enable the UK to play its part in avoiding dangerous climate change. It is calling upon rich nations to cut their emissions 40% by 2020 through action at home, not offsetting: "The government has squandered a historic opportunity to kick-start a green industrial revolution and slash UK carbon dioxide emissions."

The chancellor announced support for as many as four demonstration carbon capture and storage projects instead of one. He has dedicated £90 million to pay for more research into the technology, with the European Commission likely to fund demonstration sites and a "new funding mechanism," Darling said. This is expected to be a levy on consumers' bills.

Analysts welcomed the support but warned that the government should not delay its selection of winners for the funding. Otherwise, other countries such as Germany and China would have a head start and create jobs in the sector. Key questions remain on how quickly and efficiently this funding can be made available and the conditions to secure it.

Public borrowing in the UK is to increase to £175 billion this year alone, and Darling said that he expected the economy to shrink by 3.5%. But business and economic commentators have criticized as "optimistic" his forecast of 1.25% on economic growth in 2010 and 3.5%/year of annual growth from 2011. This was because figures revealed on Apr. 24 that there was a 1.9% fall in GDP in the first quarter of this year. This was worse than analysts expected: in the fourth quarter of 2008, there was a 1.6% decline.

Contact Uchenna Izundu at uchennai@pennwell.com.

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