U.K. tax uncertainty
The U.K. government has responded to uncertainty over North Sea fiscal policy by declaring that taxes on oil and gas won't increase-at least not immediately.
Last week's announcement gave producers little to cheer. They have had to plan investments around the threat of a tax hike since July 1997, when the Treasury began a review of the offshore oil and gas fiscal regime. The tax uncertainty has combined with slumping oil and gas prices to chill exploratory drilling and stall several development projects.
"I have concluded that, at the current low level of oil prices, it would not be right at this stage to proceed with reform of the regime," said the announcement by Chancellor of the Exchequer Gordon Brown.
More assurance needed
He should have given offshore producers more assurance than that. He should have told them that the current North Sea fiscal regime would remain in place indefinitely, regardless of price.Brown's statement seems to have been designed to leave open the possibility for a tax hike once the price of oil rebounds. So producers still must plan for more taxes. They still must deal
with uncertainty. An industry that accounts for one fifth of total U.K. industrial investment and employs 330,000 workers remains under a cloud.
This is not the way to conduct North Sea fiscal policy. By failing to redress uncertainty in decisions about risking capital on offshore exploration and development, the government has discouraged activity of an economic sector crucial to U.K. national interests. And the apparent calibration of fiscal policy-making to oil and gas prices is discouraging. Producers should not have to brace for a tax change every time prices swing.
The government notes correctly that the U.K. offers fiscal terms for offshore oil and gas work that are among the world's most favorable to investors. But terms have to be favorable.
As an exploratory theater, the U.K. North Sea is well past its heyday. The province once yielded 1 billion bbl giants. Discovery sizes now average about 50 million bbl. And operating in the sector is expensive by world standards, notwithstanding a well-developed infrastructure. The U.K. Offshore Operators Association cites a Department of Trade and Industry estimate that average finding, development, and operating costs for a new North Sea field exceed $10/bbl.
With prospects low for mammoth finds and costs high by world standards, the tax bite must be moderate if North Sea projects are to attract capital. Companies can find richer prospects and less expensive operating environments elsewhere. Fiscal terms favorable to the investor are what keep the U.K. North Sea competitive in the worldwide contest for investment capital. They are the reason the U.K. offshore producing industry still can thrive on the marginal and satellite fields on which its work increasingly must focus.
The government must understand that to rank high on lists of attractiveness to investors is no sin against taxpayers in a country with a mature resource base. It also must understand that fiscal terms based on revenues and profits, such as those in the U.K., automatically account for oil and gas prices.
Governments that consider the step necessary can enhance the price sensitivity of fiscal terms with mechanisms such as sliding scales for royalty and tax calculations. But devices like that should be built into the terms so producers know what the tax rules are. On-again, off-again reviews of the whole regime breed uncertainty. In fiscal schemes, little can be worse than that.
Scottish politics
There has been speculation that the government withdrew its tax-hike plan to appease voters in Scotland, which depends heavily on offshore oil and gas work and where the Scottish National party lately has gained strength. The move thus looks all the more temporary.Too bad. The North Sea has been an economic jewel for the U.K. The government should not let tax uncertainty detract from its luster.
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