The importance of meeting future world energy demands and, at the same time, reducing carbon footprint is moving further up the global agenda. And to meet these challenges will involve a great deal of creativity from both our industries and our wealth creators.
It will also mean the use of carrots – as well as the all too familiar sticks – from governments around the world in order to encourage engagement from industry to produce the investment necessary to achieve the desired outcomes.
The decline in the rates of production of oil&gas in the North Sea creates an opportunity for new green projects. The infrastructure that was used for producing oil&gas could be put to another use. The potential is there for offshore windfarms or carbon capture from traditional power stations, for instance. Some early examples in this area are the DOWNVinD wind turbines trial in the Beatrice field and BP’s investigation into pumping carbon into the Miller field, though this project has been shelved.
Sadly, at present, the UK tax regime does not facilitate change of use for old infrastructure.
To address this point, and with the intention of stimulating further activity, Westminster has recently produced the latest review of its ideas for the change of use for existing infrastructure in the UK oil sector as an alternative to complete decommissioning. The aims of this paper are twofold:
To allow redeployment of oil platforms and other items of plant as vehicles for clean energy generation in the future.
To encourage offshore sites to be utilised for carbon capture.
When it comes to delivering green energy from renewable generation sources – most particularly offshore wind – European governments are equally ambitious. The UK, for example, is likely to overtake Denmark in the coming year as having the highest offshore wind generation capacity in the world at more than 400MW.
Furthermore, this lead is set to grow, with targets of 25GW set for the next decade under Round 3 of what is known as the Renewables Obligation (RO), which requires suppliers to use an increasing percentage of renewable generation sources. The UK Government is currently seeking ways of adding incentives for industry to encourage this process, and an examination of the tax regime should be high on the agenda.
It is intended that the new paper will provide the basis for the next phase of work to be undertaken by a joint industry and Government working group to assess, in greater technical detail, the key tax aspects for any change of use of North Sea infrastructure and consider the case for legislative change.
There is an opportunity for the skills and infrastructure that have been developed over the past 40 years by the oil&gas industry to play a significant role in the UK’s energy future beyond the natural life of oil&gas production.
In terms of reducing carbon emissions, a number of companies are already actively exploring the feasibility of North Sea fields as homes for sequestered carbon dioxide. Allied to this storage capacity is the possibility of using the injected CO as a method of enhancing the recovery of oil&gas from fields in the latter stages of their production cycle. Spent gas fields will also provide a potential home for gas storage, providing greater security of supply of gas into the UK.
Additionally, the offshore wind generation industry is already being used to power an offshore oil installation, as well as contributing power to the national grid.
There are a number of ways in which North Sea oil&gas infrastructure can be reused or modified to ensure it does not simply have to be decommissioned when production ends. Some projects may yet have to be proven on a commercial basis, and there could be other barriers to their development, but the Government has stated its ongoing commitment to exploring and encouraging the new role that North Sea pipelines and facilities can play in future decades.
Some of the specific changes in legislation industry would like to see are in the areas of decommissioning, capital allowance claw-back and deemed disposals. In all three areas, the legislation is, at present, too focused on revenue raising and the prevention of tax avoidance rather than on incentivising the environmentally positive actions which the Government now wishes to encourage. Particular, constructive suggestions include:
Further extension to the recently improved carry-back of “ring fence” corporation tax losses – thus allowing maximum flexibility to the industry.
All decommissioning costs to continue to be treated as “ring fenced” expenditure, even where these costs relate to new “energy related” activities – thus encouraging the implementation of renewable energy projects or the reuse of assets for storage.
Petroleum revenue tax (PRT) relief to be made available to cover costs of decommissioning qualifying assets, even after the expiry of the operating licence. This will break the rigid tie between allowable activity for tax purposes and the operator or licence-holder.
Capital allowances “claw-back” provisions to be removed – where new approved Change of Use (COU) projects are undertaken. This would provide a significant incentive to embark on suitable projects.
Rules on deemed disposals for both capital allowances and PRT to be changed to remove restrictions between types of activity for tax purposes, enabling approved COU activities relief from annual valuations and disposal charges.
Introduction of “environmental allowances” for capital investment in COU or renewable energy generation projects – this would extend existing reliefs to well-related costs not included in current capital allowances legislation.
The Government has pronounced itself sceptical about formal legislative change along the lines set out above, preferring informal project-by-project consideration within the existing tax framework. However, the industry contributors to the consultation process believe a more radical approach is called for, with clear incentives set out to encourage change of use and renewable energy projects.
Such projects would provide options to extend the economic life of existing infrastructure and address climate change in a range of practical ways, encouraging new investment in the North Sea.
The key question for the tax authorities is whether any changes to tax rules will result in a loss of revenue to the Exchequer. Perhaps a more enlightened view would be to see the removal of fiscal barriers as opening up new streams of tax revenue from successful new, environmentally-friendly projects.
The North Sea infrastructure can play a key role in making Britain a greener place. In order for the Government to achieve the ambitious goals it has set itself there needs to be a mindset change. There is a need to take bold steps to remove real disincentives to changes of use and provide a framework of incentives to encourage innovative solutions to what are complex problems. Such changes could provide a real boost to the renewables industry in the north-east and Scotland.
Derek Leith is an oil&gas tax partner with Ernst & Young