One of the big challenges facing the UKCS is the need to increase the amount of exploration activity – the eight exploration wells drilled in 2018 represented the lowest level of activity since 1965, although there have been some notable recent successes such as the massive Glengorm gas discovery announced by Total in January and the technical success rate over recent years has averaged more than 50%.
One suggestion often made to revitalise exploration is to adopt the Norwegian system of tax rebates for drilling expenditure.
In the UK, the costs of exploration, successful or not, can be set off against profits made in other oil and gas production activities in the UK, or if the company has no such current profits, carried forward and set off against future profits.
However, because of the time it can take to bring an oil or gas field into production, if the company is just starting out on building a portfolio, it may have to carry those costs forward for many years before it can obtain tax relief.
By contrast, in Norway, the tax system gives oil companies with losses the ability to get an immediate cash rebate from the government equal to the tax relief instead of carrying forward a loss.
Would this be a good idea for the UK? One question about such a system is whether it represents a form of illegal state aid.
State aid rules are designed to ensure that states do not give advantages to certain companies which may distort competition – the main aim is to outlaw states from subsidising national companies, but the rules are wider than this.
Both Norway and the UK are in effect subject to EU state aid rules (Norway is not an EU member, but is subject to equivalent rules under its EEA membership). A post-Brexit UK would likely be subject to the same rules under any future trading arrangement with the EU.
In preparation for this, the UK has announced that it will maintain the existing rules as part of UK law even on a no-deal Brexit, with the Competition and Markets Authority as the enforcement body. Other international trade agreements also contain similar rules.
To be state aid, a measure needs to have these features:
-An economic advantage for the receiver;
– Given by the state or by the state funds in any form (eg grants, interest and tax reliefs, guarantees, government holdings of all or part of a company, or providing goods and services on preferential terms, etc);
– Which is selective (eg to specific companies or industry sectors, or to companies located in specific regions);
– Which distorts competition or threatens to distort competition and;
-Has the potential to affect trade between relevant countries.
In Norway, a complaint was made by an environmental NGO in 2017 that reimbursement of exploration costs to companies that have no taxable income is illegal state aid as it favours oil and gas companies over other energy companies such as those investing in renewables.
Similar arguments have from time to time been made in the UK about decommissioning tax relief, although tax rebates in the UK are always given based on past tax payments and never in advance as in Norway.
As in the UK, the Norwegian tax system is designed to facilitate profitable oil and gas production in the long term so that the state and society can benefit from a share of the value generated from those national resources.
Also as in the UK, oil companies in Norway pay much higher taxes than other companies, with a marginal tax rate of 78%.
The refund system for exploration costs was introduced in 2005 to reduce the entry barriers for new companies and to promote exploration, and seems to have been remarkably successful in increasing the rate of exploration.
Under this system, companies with losses may choose between receiving an immediate refund of the tax value of exploration costs from the taxation authorities, or carrying forward the loss with interest to a future year when the company has a taxable income.
If a refund is paid, the costs will not be deductible against future tax assessments.
The refund system thus gives the same economic value of the tax deduction to all explorers and secures equal treatment of companies with or without taxable income.
■ CMS is grateful to colleagues at the Norwegian firm of Schjødt for their assistance with this article – Penelope Warne, the senior partner, CMS.