Tax relief for the decommissioning of UK oil and gas assets is an issue that has attracted much attention in recent times. The fall in oil price in late 2014 changed decommissioning from a future consideration into a present reality for a number of UK offshore fields, and there are numerous high profile examples of fields ceasing production in the past couple of years with a view to the commencement of decommissioning work.
Earlier this year the Oil & Gas Authority published its latest estimate of the total future cost of decommissioning all UKCS infrastructure, and its objective is to reduce the central estimate of £60billion down to around £39billion through various cost reduction initiatives. Whether or not the OGA is successful in achieving this reduction, the cost to the Exchequer of tax relief for those costs will be significant – potentially up to 50%-60% of the cost. It is therefore in the interests of both oil companies and the taxpayer to keep the cost of decommissioning as low as possible.
It is worth pausing to reflect on calls for tax relief on decommissioning costs to be withdrawn. Some commentators suggest oil companies should bear the full brunt of the decommissioning cost, so that the taxpayer does not share the burden. In my view, such commentary is ill-informed and misleading. As one might expect, the tax regime that applies to oil and gas companies sets out to tax the profits earned from exploration and exploitation of the UK’s oil and gas reserves. The measure of profits for tax purposes takes account of operating and capital costs over the full life cycle of each project, and just because cash happens to be laid out on decommissioning at the end of a project does not make it any less a necessary cost of producing oil or gas from the field.
From the outset, oil and gas exploration and development projects have been evaluated and undertaken on the premise of tax relief being available for decommissioning costs. Any attempt to tax income arising during the life of a project, and then change the law to deny relief for costs incurred at the end of a project, would amount to a fundamental breach of trust. This issue was brought into sharp focus in 2010, when there was clear evidence that the perceived threat of decommissioning tax relief being withdrawn was creating a barrier to investment in the UKCS. The government responded by introducing the decommissioning relief deed (“DRD”). One primary purpose of the DRD is to guarantee that tax legislation will not be changed so as to limit or remove tax relief for decommissioning costs. In effect, the DRD provides industry with tangible evidence that a key principle underlying the oil and gas regime – the ability to obtain tax relief for decommissioning costs – will be honoured.
As a result, calls for tax relief on decommissioning costs to be withdrawn are somewhat futile; the real focus has to be on industry and government working together to ensure costs can be minimised in a way that does not compromise safety or the environment.
Notwithstanding the existence of the DRD, decommissioning tax relief remains in the spotlight. In recent months I have participated in the discussions of the expert panel, set up by HM Treasury primarily to consider the effect the current system of decommissioning tax relief has on deal activity in the UKCS.
The current system only permits effective relief for decommissioning costs where companies have earned sufficient profits (whether current, historic or future) to absorb the cost – simply incurring decommissioning expenditure does not create any entitlement to cash tax refunds. As such, a new entrant taking on a mature, late-life field might not be able to guarantee that it will make sufficient profit to set the decommissioning costs against. Given that many of the current owners of UKCS fields have been around for a number of years, and will have paid a substantial amount of tax in those previous years, the incumbent may well stand in a much better position from an after-tax perspective than the new entrant. This difference in tax profile could be significant enough, on its own, to prevent a deal from happening.
It is clear, in my opinion, that the tax system should not create a barrier to entry for potential new investors. It is commonly understood that a liquid market in oil and gas fields is important in enabling maximum economic recovery to be achieved. Mature oil and gas fields will often present investment opportunities that are marginal, at best, for larger incumbent operators, but very worthwhile for a smaller, more nimble operator. While concerns might be raised as to the impact of larger, well capitalised companies reducing their exposure to the North Sea, and smaller, arguably more risky ventures taking their place, it should be for the regulator to decide whether a particular transaction is in the interests of UK plc – not the tax regime.
Industry has proposed a solution that removes this barrier, by transferring some of the incumbent’s tax history to the new entrant in a way that makes the transaction neutral from HM Treasury’s perspective. In other words, HM Treasury should not pay out any more in decommissioning tax relief than it would have done if the asset had stayed in the hands of the seller – and indeed HM Treasury stands to benefit if the newcomer can increase profits in the remaining life of the asset or reduce the cost of decommissioning compared to the incumbent. There is no precedent within the tax system for the transfer of tax history in this way, and inevitably there is be a degree of complexity in relation to the precise mechanics needed to mitigate any risk to the Exchequer.
However, introducing such a change could only be beneficial for the UKCS, by widening the pool of potential buyers for any assets that have remaining investment potential – in particular for new entrants that may have, or be able to develop, a particular expertise in running very late-life assets.
HM Treasury are expected to report back on the discussions of the expert panel at the Autumn Budget on November 22. The industry is waiting to see how HMT intend to take this issue forward, and to what extent government want to seize the opportunity to help those looking to invest in late-life UKCS assets.
Recommended for you
Read the latest opinion pieces from our Energy Voice columnists
- OPEC decision: how much more oil will this bring the market?
- OPINION: Decom giveaway laudable, but surely better to leave in place
- OPINION: Microsoft data centres – why Orkney?
- Propelling innovation through gender diversity offshore
- Opinion: Firms must strive to attract workers back to sector as skills shortage looms