U.K. OPERATORS REACT TO PRT CHANGES

Offshore U.K. operators continue to digest major changes to the Petroleum Revenue Tax (PRT) disclosed in Chancellor of the Exchequer Norman Lamont's budget earlier this month (OGJ, Mar. 22, p. 31),

The emerging consensus is that the changes will boost prospects for current development projects and maintaining production from aging fields but damage the outlook for exploration.

Lamont slashed PRT on current producing fields to 50% from 75% effective July 1 and abolished PRT on fields approved for development after Mar. 16. After Mar. 16, however, allowances for exploration costs no longer can be reclaimed against profits of producing fields.

UKOOA'S COMPLAINT

U.K. Offshore Operators Association (Ukooa) said the new budget incorporated fundamental changes to a fiscal regime to which the industry had adjusted and were proposed without consultation.

"They are put forward at a time when industry uncertainty about the result of the current energy policy debate is starting to affect confidence in future investment offshore and halfway through a licensing round when industry applications have already been made," Ukooa said.

Retroactive tax burdens are unfair, the association said, and need to be mitigated by extending the relief available to committed wells.

"The implied switch to a high cost, high reward exploration regime will only benefit the industry if future budgets allow the industry to retain the results of successful exploration."

EFFECTS ON MAJORS

David Simon, chief executive officer of British Petroleum plc, said the reduction in PRT was a "long sought and fundamental structural reform, which ensures the tax treatment of U.K. oil production is on a more equitable footing, compared with the rest of British industry."

Besides improving profitability of taxable fields, North Sea operators would retain a greater share of benefits achieved through cost savings, Simon said.

In the long term, the reforms would encourage development of larger discoveries, such as BP's Block 204/24a find west of the Shetland Islands, where a high rate of return is needed to balance the increased risks and costs of development in a harsh environment (OGJ, Mar. 15, p. 31).

Fergus Macleod, analyst at NatWest Securities, London, estimated BP would be 130 million/year ($188 million/year) better off after the tax changes, while Shell U.K. Exploration & Production would gain 40 million/year ($58 million).

Simon said larger companies now have an incentive to develop peripheral reserves in mature fields. This could raise the recoverable reserves of some fields near depletion and thus extend their lives.

INDEPENDENTS' VIEWS

Ranger Oil (U.K.) Ltd., London, holds an 11.5% stake in Ninian field and 40% in the Columba potential development, both of which will benefit from the tax changes.

Last year Ranger recovered $33 million of PRT payments by carrying back exploration and appraisal costs incurred during the year. The company expects a similar refund in 1993 on its planned drilling program.

The company expects to cut planned spending of $18 million U.S. on North Sea exploration this year but will continue a $27 million development and appraisal program.

Cairn Energy plc, London, decided to reduce its North Sea assets before the PRT changes were announced. David Curry, commercial and legal director at Cairn, said the company saw changes were due and formed the view that North Sea exposure should be limited.

"There were broad hints from the Department of Trade & Industry that the North Sea would be opened up for small to medium operators," said Curry. "These changes are a prelude to the U.K. sector's mature phase, where the smaller operator will come into his own."

Curry said U.K. exploratory drilling would be reduced but it would be of better quality and lower cost. It is difficult to raise funds for North Sea drilling at the moment, he said, and would remain so until investors revised their opinion of the oil industry.

In the meantime, Cairn will keep a toehold in the U.K. sector. Tax changes would lead to assets being freed up in the next 2-3 years, creating opportunities for small companies.

Union Texas Petroleum Holdings Inc. said the PRT changes would have an overall positive effect on its North Sea operations.

"Based on our current understanding of these proposed tax changes, we believe that even taking into account the loss of deductions for exploration activities, Union Texas' net income and cash flow beginning in 1994 would benefit from the proposed tax revisions," said William M. Krips, senior vice president, exploration.

If the proposed cut in PRT rates is enacted, Union Texas would adjust its U.K. deferred tax liabilities accordingly. Such an adjustment would be expected to buoy its 1993 net income.

Union Texas Petroleum Ltd. has a 20% working interest in Piper, Claymore, Scapa, Saltire, and Chanter oil fields in the northern sector of the North Sea and a 25% working interest in the Sean gas fields in the southern portion of the North Sea. In 1992, the company's net North Sea oil production averaged 13,200 b/d of oil equivalent from Claymore and Scapa fields. By yearend, the company expects its net oil production from the North Sea to jump to about 45,000 b/d of oil equivalent as Piper, Saltire, and Chanter fields are placed on stream and achieve full production rates. Of that total, about 28,500 b/d of oil equivalent will be produced from the Piper and Claymore fields, which pay PRT, and would benefit if the PRT is reduced to 50%.

AMERADA HESS CAMPAIGN

Amerada Hess Ltd. (AHL) was the first operator to disclose a detailed response to the U.K. government PRT reforms.

Sam Laidlaw, managing director, outlined the effects of tax changes to Energy Minister Tim Eggar. He warned the reforms threatened small fields that will typify future U.K. developments. The U.K. government had managed to kill off fiscal stability, low cost exploration opportunities, and third party tariff benefits with one blow, making the U.K. less attractive for investment, he said. AHL took to the campaign trail, intending to persuade government to reconsider the changes and thus benefit U.K. as well as oil company balance sheets.

Laidlaw recommended that:

• Government consults with industry on ways to increase tax revenues while protecting exploration and appraisal outlays and provide incentive to reinvest in the U.K. offshore.

• Government ensures reasonable transitional relief for any changes.

• Government offers incentives for PRT reductions in place of Lamont's proposed cuts by having operators gain PRT benefits by committing to further work in the U.K. sector.

TRANSITIONAL RELIEF

Transitional relief is needed on drilling allowance cuts, said Laidlaw. The retroactive nature of the removal of relief particularly hits companies that showed the greatest commitment to U.K. licensing rounds.

"Exploration and appraisal relief was introduced in 1983 in order to encourage exploration activity against a background of declining field sizes, lower oil pieces, and reduced exploration activity," said Laidlaw.

"The measure was successful in increasing activity levels and allowing small fields to come forward for development, such as our Angus field (see related story, this page). Removal of this relief will be a retrograde step resulting in less exploration and fewer fields being developed to the long term detriment of the U.K."

In the short term one or two majors will gain, said Laidlaw, but every company will rethink its U.K. exploration and production plans. In the meantime, the government has generated mistrust amongst oil companies. AHL approached Eggar independently of Ukooa's push to canvass members before making statements. Laidlaw hopes Ukooa will reach similar conclusions and submit AHL's views as a member.

SMALL FIELDS HIT

Future small field developments will particularly suffer, said Laidlaw, because drilling costs are a large component of capital outlays. Appraisal well costs were suddenly quadrupled by Lamont's changes, while small fields would not gain from PRT removal, because they would not have been liable in any event.

There is no PRT compensation for increased drilling costs on small fields, said Laidlaw. He is also concerned that the removal of tax concessions applies retroactive from Mar. 16 to committed wells.

"We entered the 10th, 11th, 12th and 14th licensing rounds in good faith," said Laidlaw. "To suddenly discover we are liable to retrospective charges is a cause for grave concern.

"Commitments to drill wells under current licenses were made on the basis of the existing fiscal regime and the widespread acknowledgment that fiscal stability is essential for the long lead times involved in offshore developments."

Laidlaw told Eggar if U.K. exploration and appraisal are cut 50%, as AHL expects, companies will lay off staff, hitting drilling contractors hard. This was difficult to justify in what Lamont called a "budget for jobs."

AHL typically requires 5 rig years of drilling time each year. If the company cut its requirements by 2 rig years, some 400 people would be out of work. This would be multiplied many times across the whole U.K. sector.

GOVERNMENT THE LOSER

"In the long run, there would be fewer developments and less construction," said Laidlaw. "The government would be the big loser, because of the reduced long term tax take."

The U.K. stands out as one of the few regions without exploration and appraisal relief-"an unattractive anomaly." Now Norway, with larger fields than the U.K., also has a more attractive tax regime.

Another concern is that the changes would wipe out third party tariff relief allowances, introduced in 1983 to encourage operators to share infrastructure, in particular pipelines. Owners received third party income exempt from PRT.

Now PRT will be charged on third party volumes, which AHL fears will encourage pipeline owners to charge higher tariffs to retain their income.

Laidlaw said his company decided to campaign for changes in the proposed PRT reforms on grounds the changes would not benefit the U.K. offshore as a whole.

No oil companies will let the tax reforms affect their bottom line, warned Laidlaw. They will change the nature of their business rather than lose money in the U.K. sector.

The first effects may be seen in the award of 14th offshore exploration licensing round blocks, due in May. AHL predicted that if PRT reforms are not modified, many companies will pull out of the round. The company believes only about 25% of the blocks on offer would be viable for future development after PRT reform.

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