Offshore Oil & Gas production is an infrastructure intensive activity. The UK North Sea is estimated to be home to around 10million tonnes of steel and concrete making up the 470 installations, 5,000 wells, and 6,000 miles (9,656km) of pipeline laid to date.
Ultimately, there will be a need to “pull up the stumps and leave the field of play” – to use a cricketing analogy. Decommissioning will be big business in the UKCS, estimated to cost around £30billion over the next three decades. Indeed Shell have recently indicated that in the “near future” they will begin decommissioning certain assets in the Brent Field, which has been producing since the mid 1970’s.
Over the last few years, the trend has been for the integrated oil majors to progressively withdraw from the North Sea, with smaller operators moving in, focusing exclusively on upstream activities.
A combination of high oil prices and lower fixed costs mean that these smaller explorers can continue to exploit mature fields, and smaller acreages, whilst still remaining commercial.
When licences change hands the vendor may potentially remain on the hook for decommissioning costs should the new operator ultimately be unable to foot the bill. In such a case DECC (the Department for Energy & Climate Change) could potentially pursue previous licensees on that block by way of a “section 29 order”.
As a result, in any such transaction, it is vitally important to be able to put a realistic estimate on the eventual decommissioning costs, even where this may be many, many years in the future.
As such, the sector has widely welcomed George Osborne’s provisions in the Budget for the creation of “contractually binding agreements” between the Treasury and Industry around the issue of fixed rates of tax relief on decommissioning.
Such fiscal certainty is expected to facilitate sales of late-life assets, and to free up billions of pounds of capital for investment in further exploration, and also production on existing fields.
Following the controversial tax measures in last year’s Budget, 2011 saw a slump in North Sea production.
Trade body Oil & Gas UK estimated that overall production fell by 18%, with 50% fewer wells being drilled than the year before. The proposed new decommissioning tax breaks, and extensions to certain field allowances including smaller fields, should go some way to reversing this damage. Indeed, Oil & Gas UK estimate that up to £40billion of extra investment may ensue, resulting in the recovery of an additional 1.7 billion barrels of oil and gas.
Certainly there is the potential for a more attractive tax regime to fuel further consolidation in the North Sea. Since the turn of the year, we have already seen EnQuest, Centrica, and Premier Oil acquire additional North Sea assets.
In terms of existing assets Premier’s decision to proceed with its Solan project was reportedly subject to the terms of the 2012 budget. This will now benefit from extended field allowances, as will three similar fields which Premier is currently understood to be assessing.
Ithaca Energy, itself a bid target, recently confirmed its intention to proceed with joint development of the Stella and Harrier fields which will both benefit from the new small field allowances. In addition, DEO Petroleum said it expects its tax bill to fall by roughly £25million following the changes to the tax regime.
Valiant Petroleum is a further beneficiary on field allowances, with certain smaller fields which may have been marginal, now becoming commercially viable. Similarly, Faroe Petroleum got a possible shot in the arm from extended allowances for the West of Shetland area, its share price rising 8% just after the Chancellor’s speech.
Continuing with my cricketing theme, one of the most famous sporting narratives came from veteran commentator Brian Johnston during the 1976 England v West Indies test when he remarked: “the bowler’s Holding; the batsman’s Willey . . .”
To a large extent there is a similarly “symbiotic” relationship between the Treasury and Industry on the subject of field allowances and decommissioning – a critical and potentially very painful pairing, whereby if one side squeezes too hard (on taxation) the other will retaliate, by cutting investment, which in turn constricts fiscal revenue – as evidenced by what happened last year.
The UKCS is predicted to continue in production for decades to come, and tax revenue from the Oil and Gas industry will remain vital to the Treasury’s coffers. It is inevitable that the day will eventually come when Government pay-outs on decommissioning tax reliefs will exceed tax receipts on production, but with careful management and a sensitive “fiscal grip” it should be possible to defer crossing this line for some considerable time.
David Barclay is divisional director at wealth management specialist Brewin Dolphin in Aberdeen
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