Insight: Brown drills deeper for taxes

Speaking on a radio interview some days after his £2bn raid on the North Sea
oil and gas sector, the Chancellor, Gordon Brown, gave a lofty dismissal to a
highly negative response from the UK Offshore Operators Association (UKOOA).

Responding to UKOOA’s prediction that his “astonishing” tax had gravely
damaged the long-term viability of the North Sea oil industry, the Chancellor
said that this kind of response was no more than one would expect from a
pressure group.
In the Chancellor’s eyes, the oil companies had benefited hugely from a stellar
rise in the price of oil. Return on capital for the sector was around 40% he
told parliament, and it was only reasonable for the British public to expect to
share in the oil companies’ good fortune. After all, there are few votes to be
lost by hitting oil companies.

But, as UKOOA chief executive Malcolm Webb points out, what public
indifference to a spot of oil company bashing by the Chancellor masks, is a
grave risk that his actions will cause a premature switching off of the lights
on the North Sea game.

“We told the Treasury repeatedly that it was by no means certain, even with a
stable tax regime, that the North Sea sector would be able to secure the
investment required to extract the best part of the UK’s remaining oil and gas
reserves,” Webb says. UKOOA’s best estimate is that there is at least as much
oil still in the ground to be extracted as has already been taken, which
situates us neatly at the start of the second, and more technologically
challenging half of the North Sea game.

Oil is a global game. As such, the UK Continental Shelf (UKCS) has to compete
for funds against other basins, many of which have better prospects and lower
exploration and production costs ­ and much more stable fiscal regimes. It is
also a long game and when investors work out the potential returns on a field,
they have to feel confident that their assumptions about the fiscal regime that
will apply from years five to 15, when the field comes on stream, have some
validity. This being the case, areas with stable fiscal regimes are preferred to
areas with unstable fiscal regimes.

Stability is key

Brown appears to have grasped something of this point, since he emphasised to
parliament that following the introduction of his new tax measure, the oil
companies could rely on a stable tax regime “for the remaining life of this
parliament.”

While this might sound wonderfully stable to politicians who have to survive
the vagaries of a general election, it has a different ring to the oil industry.
To oil company investors and executives, the Chancellor’s statement demonstrates
a frighteningly slippery grasp of the realities of investment in the oil sector.

What is worse, Brown’s statement sounds as if he is leaving room for the next
Chancellor to have a further pop at the sector three or four years down the
track. This is the very opposite of a stable fiscal regime.

If UKOOA members were anxious before, it is fair to say that many of them are
in shock now. “A doubling of corporation tax was at the far end of our worst
imaginings,” Webb says. The industry does not regard it as sensible practice to
shout rude things at government, which, after all, hands out E&P licenses.
UKOOA has gone further than any single oil company in its public statements
about the tax.

But an absence of loud protesting voices should not be taken as indifference
on the part of the oil majors. Shell has already cut its E&P activity in the
North Sea by a third, following the Chancellor’s pre-Budget speech. Others will
follow. What then happens to the sub-sea infrastructure in the mature fields?
This infrastructure is vital to the economic viability of smaller, more marginal
fields adjacent to the mature fields.

Long-term pain

Webb does not expect the impact to be felt particularly in 2006, simply because
many projects are already underway and it is too late, in many instances, to can
them. The impact of Brown’s latest tax raid is likely to manifest itself more
clearly in 2007 and 2008. “We will be monitoring developments very closely. We
will be doing our best to keep pressing our case with the Treasury,” he says.

As a final point, it is worth noting that the argument that the great British
public deserve their cut of a higher oil price is met by the fact that in 2005
the sector paid almost £11bn in tax. When the Chancellor gave his estimates in
2004 for the likely tax take from the North Sea in 2005, his estimate was
£3.4bn.

In other words, a higher oil price has already netted the Chancellor a £7bn
windfall. With his latest tax grab, Brown is gambling that the industry will
take the pain and go back to business as usual. If he is wrong, and his
unpredictable interventions hasten the demise of the UKCS, the biggest ultimate
loser will be the Treasury.