PRT CHANGE IN U.K. A LIQUIDATION POLICY

Changes in U.K. North Sea oil and gas taxation give a powerful lift to exploration-elsewhere. They are not part of some political salvo aimed at cleansing the seascape of drilling and production equipment. To the contrary, changes announced this month by Norman Lamont, U.K. chancellor of the exchequer, actually cut production tax rates.

March 29, 1993

3 min read

It's true. The petroleum revenue tax (PRT) falls to 50% from 75% on production from fields now on stream. And PRT disappears for fields receiving development approval after Mar. 16. This part of the tax change will help progress in the region's heavy slate of development projects, extend the lives of mature fields, and improve development economics for the many marginal discoveries that have been made in recent years.

But here's the catch: The initiative cancels PRT deductions for exploration and appraisal costs. On balance, the U.K. has strengthened incentives to produce and weakened incentives to explore. In a world that offers more exploratory opportunities than exploratory capital, the British move won't hurt the upstream industry. Companies will produce in the U.K. and use profits to explore for replacement reserves somewhere else. What the government has implemented, therefore, is a policy of protracted liquidation of the U.K. offshore producing industry.

BUDGETARY SWEEP

The government made the oil tax changes in a broad budgetary sweep that aims at reducing a troublesome deficit. PRT, according to Lamont, cost the exchequer an estimated 200 million in 1991 and 1992. This is good reason for a change; after all, taxes are supposed to make money for governments. But repairs at hand buy short term production and revenue stimulus with long term depletion of oil reserves.

By discouraging exploration, the government will keep industry from replacing current production with new reserves; total reserves will shrink. That's a lot to pay for temporary budget relief. Like all governments with chronic deficits, Britain has been living off its future. Cashing in oil reserves to pay bills amounts to the same thing.

There has been some official mumbling about the U.K. North Sea's being a mature province that doesn't need much further exploration anyway. According to this line of thought, the disincentives don't matter because there's not much future exploration to discourage. Yet there already have been reports of operators withdrawing license bids and pulling out of group seismic surveys in response to Lamont's announcement. There seems to have been something to discourage, after all. A comparison of future licensing rounds with those immediately preceding the PRT change will be revealing. If to any extent at all the government used official pessimism about U.K. exploration to justify the tradeoff between PRT rates and deductions, it made a serious mistake. In matters such as these, company judgments are the ones that should count.

REGIME WORKED WELL

What's perhaps worst about the PRT move is the harm it does to a tax regime that worked pretty well. In the past, the U.K. has been able to adjust its oil taxes to changing economic conditions and thus preserve economics of one of the world's premier drilling theaters. Lamont's categorical move looks out of character in the U.K. and caught companies by surprise. The government could have rationalized PRT tax deductions without eliminating all of those related to exploration. Reducing the 75% rate, thereby easing the incentive to shelter incomes against PRT, was a good start. Offsetting the rate cut with elimination of exploration cost deductibility will prove to have been a horrible finish.