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North Sea oil and gas investment

10/06/2011

UK Chancellor George Osborne was urged to act without delay to safeguard future investment in North Sea oil and gas today as First Minister Alex Salmond published a paper setting out options for the Treasury to reduce the impact of its recent tax hike across the industry.

North Sea operators and economists have warned that the increase in the Supplementary Charge (SC), from 20 to 32 per cent, will damage investment, particularly in the most challenging and mature fields, and could reduce expected employment levels by around 15,000.

An options paper, prepared by Scottish Government economists and based around analysis and proposals from Professor Alex Kemp of the University of Aberdeen which sets out how the tax regime could be made more progressive to reduce the tax levied on less profitable projects which may otherwise be permanently shelved.

The paper, UK Continental Shelf Tax Regime - Options for Reform, is being sent to the Chancellor and sets out details of how the following alternative approaches would work:

  • Investment Rate of Return Allowance: The Scottish Government's preferred option, this guarantees companies a minimum rate of return on their investment before the SC is levied. It allows companies to carry forward undeducted expenditures to set against future profits at an agreed interest rate.
  • Investment Uplift Allowance: Similar to the above, although the company's investment costs are up-rated by a fixed proportion, i.e. 10 per cent, rather than on an annual basis.
  • Extended Field Allowances: Indirectly linked to a field's investment costs, these reduce the amount of tax a company has to pay on its profits but are less flexible than the other options. For example, companies can only receive them if they are operating in very specific locations or are trying to extract specific types of oil or gas deposits.

The first two options would allow companies to be guaranteed a minimum rate of return on investments before the SC was levied. Both systems already operate in other countries and the principles behind them have previously been used by the UK Treasury in the North Sea.

Today's options paper coincides with the publication of 2009 survey data by Scottish Enterprise and the Scottish Council for Development and Industry (SCDI), which underlines the importance of oil and gas supply chain opportunities to Scotland - with a 3.7 per cent rise in overall revenues to £15.9 billion, driven by a 10.4 per cent increase in international sales.

The First Minister said:

"North Sea oil and gas makes a huge contribution to the Scottish and UK economies - providing jobs, investment and the majority of these islands' oil and gas needs. It has also provided over £300 billion worth of tax revenue to the UK Government, with the Treasury due to secure around £13.4 billion this year. With some 30 to 40 per cent of oil and gas reserves still to be extracted, it is essential that companies who are investing in the more marginal fields, where exploration and extraction is technically more difficult, are not penalised. Unfortunately the uniform hike in the Supplementary Charge does just that.

"Oil & Gas UK and Prof Alex Kemp, one of the world's foremost energy economists, have warned that the Chancellor's sudden and unexpected raid on North Sea oil and gas will lead to fewer new fields being developed, resulting in a greater level of expensive foreign imports, fewer jobs, a loss of investment and less tax income to future governments.

"I raised these concerns with the Chancellor last month and undertook to provide further details of how the emerging hiatus can be avoided, and investor confidence restored. Building upon Prof Kemp's analysis and suggested approach, Scottish Government economists have now prepared this Options paper. It details how the tax changes can be focused on those who take excess profits without innovating, while ensuring that the continued development of the most technically challenging and mature fields remains viable.

"We strongly favour an Investment Rate of Return Allowance as the most efficient system and the one that would be the most sustainable. I hope the Chancellor gives serious consideration to all three of the options. We have already seen several key projects put on hold in recent weeks so it is essential that the Chancellor heeds the warnings and the analysis of leading experts such as Professor Kemp and acts without delay to protect the long term future of North Sea oil and gas, to safeguard jobs and investment and reduce the prospect of increasing UK dependence on imports."

Over 39 billion barrels of oil equivalent (boe) have been extracted from the UK Continental Shelf (UKCS) since large scale North Sea oil and gas production started in the 1970s.

Oil and Gas UK estimate that around 900 million boe were produced last year - accounting for 94 per cent of UK oil demand and 68 per cent of gas demand. The oil & gas industry employs 440,000 jobs acrosee the UK, including almost 200,000 in Scotland.

In 2011-12, North Sea oil and gas is forecast to generate £13.4 billion in tax revenue, a record high in nominal terms. And over the five years from 2011-12 to 2015-16 it is forecast to raise £61 billion in tax revenue, 35 per cent more than during the previous five years.

The decision announced in the March 2011 Budget, without prior consultation, to raise the Supplementary Charge from 20 per cent to 32 per cent means North Sea operators face an overall tax rate of 81 per cent for fields given development approval before March 1993 and 62 per cent for fields approved after this date.

The uniform increase in the SC on all fields and investments, regardless of their potential profitability, means many marginal investments are no longer considered viable.

In recent weeks it has been reported that a number of key projects have already been put on hold, including Statoil's development of the new Mariner and Bressay fields to the south-east of Shetland.

The SCDI/SE Survey of International Activity in the Oil & Gas Sector 2009-10, also published today, shows Scotland's oil & gas supply chain posted sales of £15.9 billion in 2009. revenues in the domestic market during the survey period were at £8.7 billion in 2009 compared to £8.8 billion in 2008, while international sales increased 10.4 per cent to £7.2 billion.