A great Budget for the oil industry

Chancellor George Osborne has vowed to back oil industry
Opinion by Energy Voice

After the debacle of the UK’s 2011 Budget which contributed to a significant fall in activity over the last year, it’s great to be able to report on the positive developments for the industry coming out of the 2012 iteration.

By Oil & Gas UK’s analysis certainty on decommissioning tax relief alone will unlock new investment of circa £40billion, generate an additional 1.7billion barrels of oil and gas and, over the next five years alone, the Exchequer could receive an extra £1billion in tax revenue.

Over the last year, a working group established by Oil & Gas UK has been working with HM Treasury and DECC to find a means of providing long-term certainty on decommissioning tax relief.

The cost of decommissioning security has been recognised for years as a major barrier to asset trading in the UKCS and to investment by owners of mature fields, so this was a key issue for industry but it has been quite a complex one to address.

Under UK legislation, owners of infrastructure at the end of its useful life are jointly and severally liable to decommission it. That means that any one of them can be obliged to pick up the whole decommissioning bill if the others default.

If all the owners default then the Government can bring in a wide range of people including former owners to pick up the bill.

To protect against this liability field owners enter into decommissioning security agreements (under which partners in oil fields and purchasers of oil assets provide security against the risk that they may default on their decommissioning obligations).

Tax relief is currently available to owners or former owners for decommissioning costs (subject to the cap on relief against supplementary charge introduced in budget 2011) but as tax reliefs can be withdrawn at any time, there is no certainty that such reliefs will continue to be available.

Therefore, when requiring security from their partners or from purchasers against the risk of default, owners and sellers will require security “gross”, without any allowance for tax reliefs.

This significantly increases the funds tied up in security which would otherwise have been available to invest and prices some parties out of the market for assets.

Effectively, the industry is in many instances providing security for government’s share of decommissioning costs.

My partner Judith Aldersey-Williams, alongside the oil and gas tax policy team at Ernst & Young, supported the Oil and Gas UK working group that developed the proposal on decommissioning tax relief.

The novel solution proposed is for government to offer any industry player potentially exposed to decommissioning liability a contract in which government commits to provide in future the same tax relief which is currently available under the UK fiscal regime.

The Cameron-Clegg Government has accepted the industry’s proposal and announced that it will consult later this year on the introduction of such a contract and expects to introduce the necessary authorising legislation in Finance Bill 2013.

Under these contracts, if the tax relief regime changes, government would be obliged to compensate the affected companies. However, if the tax relief regime remains unchanged, the Exchequer will pay little more in tax relief than it is expecting to pay today.

At minimal cost to the Exchequer, therefore, this measure will encourage investment by existing owners of assets, increase asset trades and free up capital currently put aside to provide security, thereby extending the productive life of many fields.

However, in order to achieve the full extent of these benefits both existing and future DSAs will need to be amended to provide for security to be given net of tax relief.

There is some residual risk even after these new Deeds of Assurance are in place given but this risk can be quantified and built into the purchase price for future transactions.

For existing DSAs, negotiations may be trickier.

The chancellor also announced a number of changes to the field allowances, which reduce the amount of profits on which the supplementary charge is imposed.

These are designed to increase investment in fields which would otherwise be uncommercial to develop, and address small fields, developments in the deepwater area West of Shetland and extend allowances to some existing fields not previously eligible.

These changes are expected to take effect following the enactment of secondary legislation and the Finance Bill 2012 later this year.

The changes announced in relation to decommissioning tax relief and also the improvements in field allowances, will go some way to restoring the UK’s position as an attractive place to invest.

These developments are the outcome of a much more positive engagement over the last year between the Government and industry to tackle the issues of working in a mature basin – long may that continue!

Penelope Warne is head of energy at international law firm CMS Cameron McKenna