The UK oil and gas industry has good reason to be expectant of further changes to the oil and gas fiscal regime in Wednesday’s Budget.
The past three years have been a torrid time for the oil and gas industry and the UKCS, a basin which entered the downturn with a relatively high marginal cost base, has suffered more than most. The collapse in oil price and the high cost base pushed the basin into negative cash flow and precipitated a huge fall in production taxes from the sector. Following significant cost reductions partly driven by cuts in headcount, a focus on production efficiency, the slashing of capital budgets, and reductions in petroleum revenue tax and supplementary charge the sector has staunched its cash outflow and stabilised its position. More recently the modest uplift in oil price has also provided further encouragement.
Nevertheless there remains a concern at the speed of recovery in terms of investment. While the past year has seen a small number of very material deals take place with a variety of assets changing hands, the underlying dynamics remain fragile.
Against that backdrop of low capital investment HMT launched a discussion document and set up an expert panel to consider late life asset transfers in the UKCS in March this year. One of the main perceived obstacles to late life asset transfers was the lack of tax capacity in a new, or recent, UKCS entrant to absorb decommissioning losses at the end of production. While the assets may be marketable on a pre-tax basis they became problematic on a post-tax basis unless the buyer has tax capacity. If this issue could be addressed then it is hoped there would be greater demand for mature assets from companies with a focus on producing incremental reserves by driving down costs and deferring, as well as reducing the cost of, decommissioning.
Conceptually the answer is straightforward – if part of the seller’s tax history could be transferred to the buyer then the buyer ought to be capable of being placed in the same post-tax position as the seller which would make a deal possible. However, the practicalities of introducing such an approach would be more complex and there is no precedent.
More importantly how can the transfer of one part of the corporate tax history of a company, during an asset transaction, to the buyer be done without creating the opportunity for companies to exploit these changes at the cost of the Exchequer?
Ultimately it is possible to achieve the policy goal of enabling late life asset transfer but the legislation will need to be carefully crafted to protect HMT. Clearly this is not an impossible task but neither is it achieved in the course of an afternoon.
Even if this is the direction of travel the government chooses, it is unlikely that the changes will be part of the legislative process following Wednesday’s Budget due to the detailed consideration that will be required. Instead we can expect to see a clear statement of intent to introduce the legislation as soon as is practicable, which probably means in a year’s time. Obviously, it would be preferable if it can’t be delivered in this Budget for the Chancellor to make provision for it to be backdated to say, 1 January 2018, when it is introduced. This may be overly optimistic, as such retroactive legislation is only likely to have a positive behavioural effect if sufficient detail is known for companies to take the changes into account. Given the likely complexity of the rules it’s not clear that the principles will be able to be announced in sufficient detail now that anyone could rely upon.
These changes are important for industry and should help to create more deal flow, and in turn stimulate more investment. Any temporary delay in introducing the changes should be seen as nothing more than that.
We don’t have to wait long now to see what the Chancellor has in store. Join me tomorrow when I will be tweeting live as the Budget Announcement unfolds from the Energy Voice Twitter account and providing my immediate thoughts on the Budget.
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