Tax hike will clobber UK oil & gas investment, production
3 May 2011
Aberdeen, UK - UK tax hikes announced in Budget 2011 will cause substantial long-term reductions in field investment and oil/gas production, according to a University of Aberdeen study – backing the position of majors including Shell and Centrica, which have threatened to scale back some of their activities in response to the increases.
The study, entitled The Effects of Budget 2011 on Activity in the UK Continental Shelf, by professor Alex Kemp and Linda Stephen, examined the economic effects of the tax increases on fields and projects which could be developed over the next 30 years as well as on existing sanctioned fields.
Rates were increased from 75% to 81% on the older, mature fields subject to petroleum revenue tax (PRT), and from 50% to 62% on fields not subject PRT. There are currently well over 350 undeveloped discoveries in the UKCS and very many potential incremental projects, covering a wide range in terms of expected profitability.
Kemp and Stephen employed a range of oil/gas prices likely to reflect those used for long-term investment by petroleum companies and financing institutions: (1) $50 per barrel and 30 pence per therm, (2) $70 and 50 pence, and (3) $90 and 70 pence. (See factfile below)
A threshold investment return, reflecting the likely cost of capital, was then employed, to examine the effects of the Budget on oil/gas production, field investment and other (field) expenditures, and tax revenues.
These changes are substantial and will inhibit the attainment of maximum economic recovery from the UKCS, the report found. Moreover, it said, the lower post-tax returns from field investments will also reduce incentives to pursue exploration prospects and reduce industry’s ability to finance exploration and development projects.
“The root of the problem comes from the structure of the tax system. It is essentially flat-rate or proportional (except when field allowances apply). When the flat-rate tax is raised substantially marginal projects can readily become uneconomic.
“The solution is to have a progressive tax structure with a return allowance whereby the percentage liability to the supplementary charge for new fields and PRT-paying fields is automatically reduced on fields of low profitability and increased when profitability increases,” the report said.
Professor Alex Kemp’s research shows that the tax increases could reduce UK oil and gas expenditure by up to £50 billion, investment by up to £30 billion and production by up to 25% over the next three decades, according to Mike Tholen, Oil & Gas UK’s economics director.
“This kind of impact is wholly expected following the sudden change which resulted in producers paying between 62% and 81% tax on UK oil and gas production, said Tholen. “The tax change has damaged the industry’s confidence and trust in the tax regime and that trust will take a long time to rebuild.”
Oil & Gas UK has offered to work with the Government to find ways to minimise the effects on investment, production, energy security and jobs.
Factfile:
The results covering the whole period 2011-2041 and compared to pre-Budget 2011 terms are summarised as follows for the three price scenarios:
(a) $50, 30 pence case:
(i) Number of new field/project developments are reduced by 123 (36%) compared to pre-budget estimates.
(ii) Total oil/gas production is reduced by 2.7 billion barrels of oil equivalent or a reduction of 24.4% of that expected before Budget 2011.
(iii) Field investment is reduced by £19.2 billion.
(iv) Total field expenditures are reduced by £34.9 billion.
(v) Total tax revenues are reduced by £12.7 billion.
(b)$70, 50 pence case:
(i) Number of new field/project developments are reduced by 62 (9%) compared to pre-budget estimates.
(ii) Total oil/gas production is reduced by 1.7 billion barrels of oil equivalent or a reduction of 9.7% of that expected before Budget 2011.
(iii) Field investment is reduced by £19.5 billion.
(iv) Total field expenditures are reduced by £33.2 billion.
(v) Total tax revenues are increased by £23.2 billion.
(c) $90, 70 pence case:
(i) Number of new field/project developments are reduced by 79 (7.7%) compared to pre-budget estimates.
(ii) Total oil/gas production is reduced by 2.25 billion barrels of oil equivalent or a reduction of 9.5% of that expected before Budget 2011.
(iii) Field investment is reduced by £29.1 billion.
(iv) Total field expenditures are reduced by £52.2 billion.
(v) Total tax revenues are increased by £51.6 billion.
