Making projections of any economic activity over the next 30 years is an exercise fraught with risks: the range of plausible outcomes is high.
In the case of North Sea oil tax revenues the range is particularly wide. This is because the level of tax receipts depends on the interaction of production, oil and gas prices, investment, operating and decommissioning costs, and the tax system itself.
All of these determining factors are subject to substantial change over the medium and longer term, and thus tax revenues are particularly uncertain.
In making long term projections the extrapolation of historic trends is frequently undertaken. While this procedure may have common sense appeal it cannot guarantee an accurate picture of the range of outcomes and the associated risks.
This is particularly true in the oil industry where the dynamics of the industry can readily result in major changes from historic trends. In these circumstances there is merit in emphasising the range of possibilities rather than highlighting one scenario.
The Office of Budget Responsibility (OBR) has recently published its Fiscal Responsibility Report which makes long-term projections of the UK’s public finances. The section on North Sea revenues postulates a very steep rate of decline in tax revenues to 2022, followed by a more moderate rate of fall to 2042.
The overall levels of tax take are considerably lower than those foreseen one year ago, though lower levels had been foreseen in Budget 2012. In explanation the OBR emphasises the lower expected oil prices and the current high levels of investment (which result in larger tax allowances).
Total production is assumed to fall at around 5% per year.
While the results may have plausibility there are other defensible outcomes which give more emphasis to dynamic changes taking place in the industry. On the production side it is becoming clearer that there are prospects for a significant increase in oil production from the West of Shetlands region.
Phase Two of the large Clair field is a major development which in due course could lead to a Phase Three, given the very large size of the oil in place. The development of Rosebank should also add substantial production from the region. Certainly there is every reason to expect that the historic trend in output from the region will not be replaced over the next two decades.
The field allowances announced in Budget 2012 will also have a substantially positive effect in increasing investment and subsequently production across much of the UKCS. The near term effect of the allowances is to reduce taxable income but to boost it in the longer term from the increased numbers of new developments.
A forthcoming research paper by Linda Stephen and the present writer will highlight the longer-term strength of this effect on tax revenues.
The new study will also highlight the need for some further tax allowances, particularly for incremental projects in mature fields. Such reliefs could in turn enhance medium and longer term tax revenues.
It has to be acknowledged that the current high level of investment conceals some worrying features of activity in the UKCS. Thus production over the last 18 months or so has fallen much faster than the trend since peak output in 1999. In substantial part this has been the result of planned and unplanned field shutdowns which, of course, reduce tax receipts.
There could be very worthwhile national returns from increased investment in asset integrity in mature installations including the infrastructure. Again, government incentives through the stewardship scheme could produce significant returns.
Recently the exploration effort (in terms of wells drilled) has been at a very low level and well below the historic trend. The long term revenues depend in part on new discoveries.
The new tax allowances do increase the full-cycle returns to an explorer, but further recognition of the need to incentivise more exploration is probably required.
Taking into account the many uncertainties discussed above, the present author and Linda Stephen found that over the next 30 years a high but plausible level of activity could result in cumulative production of 23 billion barrels of oil equivalent. A lower, but still plausible level of activity, could result in cumulative production of 15 billion barrels of oil equivalent. The difference in tax receipts would be correspondingly enormous. Only by a very concerted effort by all stakeholders can the higher outcome be realised.
By Professor Alex Kemp, University of Aberdeen