Emergency Tax Cut Needed to Rescue North Sea Oil January 14 2015

Based on an article by Danny Forston: The Sunday Times – 11/01/15

The oil price collapse in December 2014 has led to a sharp drop in North Sea drilling and a flurry of job and pay cuts.  The industry employs 375,000 people and is one of the biggest contributors to the exchequer - remember the Independence for Scotland debate?

Production last year averaged just 1.2m barrels a day - a 75% drop from the 1999 high.  Companies say one of the biggest challenges facing small or depleted oil fields is the tax take, which can still run to 80% for old fields. The basic levy is 60%.  Further, the cost base for exploration and production has soared out of control.  After decades of production, only small and, at these prices, barely economic fields are left.

A supplementary corporation tax charge was introduced in 2002 by Gordon Brown.  Osborne lopped 2% from the basic rate in the autumn statement but the industry says this is not enough.  The proposals under discussion include removing the supplementary tax altogether for new developments, and creating a simpler regime to replace the jumble of allowances and tax breaks that govern North Sea work.

Burgate, a little oil company run by a trained geophysicist Tim Boycott-Brown, was among the 60 or so companies the government chose, in November 2014, to receive exploration and development permits in the North Sea.  It came at a critical juncture.  North Sea production had fallen to a low of 1.2m barrels a day, down more than three-quarters on its 1999 high.  Exploration has slowed to levels not seen since the industry's founding.  The exchequer's take was at a 10 year low, and that was before the oil price collapsed.  Its drop from $114 a barrel in July 2014 to $49 in January 2015 has thrown the industry into chaos.

Big Oil has largely abandoned the North Sea.  Most of the companies handed new licences in the recent round do not have the expertise, money or even the intention to develop their acreages.  That is because most of them were handed "promote" licences.  These were introduced in 2003 to open up the industry to smaller players which lack the financial clout to develop a prospect, but are willing to expend the effort to find those geological gems that Big Oil has missed.

Of the 130 or so publicly traded oil companies, 55 have no reserves on their books.  Their bosses are just like Boycott-Brown: big plans but no cash to back them up and the future of the North Sea lies in the hands of companies such as these.

Big Oil has steadily sold out in recent years as its focus shifts to new basins that offer bigger returns and larger reservoirs, from east Africa to offshore Brazil.

The huge rise in government tax-take has whittled away profits.  Gordon Brown introduced the supplementary corporation tax on the North Sea in 2002.  It was increased twice thereafter before Osborne introduced a 2% reduction last year, taking the basic rate back to 60% - still three times that levied on other industries.  The chancellor said this week that the budget in March "may well involve further reducing the burden of tax on investment in the North Sea."  That will only help so much.

Even though oil has more than halved in price, average earnings estimates have fallen by 25%, cashflow estimates have fallen 12% and the stocks have fallen 20% on average.  If today's crude prices persist, these numbers will trend towards 50%, 22% and 50% respectively.

It has been years since any North Sea explorer found a big new field.  Anthony Lobo, head of oil and gas at KPMG, said: "The question is whether they take their losses and sell out now, or wait and hope for an increase in the oil price or improved exploration success - neither seem likely in the short term".

Could this be the time that the gloomsters are finally right? Probably not.  There are possibly still billions of barrels to be recovered, money to be made, tax to be collected.  And oil represents one of the last bastions of Britain's shrinking industrial base, one that fosters skills which are exportable around the world.  However, to squeeze out those last drops will require the Treasury to do some painful tax gymnastics, and sub-contractors to lower their charges.