As the UK offshore industry anxiously awaits news from the Treasury regarding changes to the North Sea fiscal regime, let’s look at the historical context of a province where frequent change has been the norm.
I write as a result of discussions with industry tax expert Phil Greatrex, MD of CWEnergy. Phil has been kind enough over many years to teach high level petroleum taxation at our annual UK Oil and Gas Law teaching week for CEPMLP of Dundee University.
The special regime for North Sea taxation was first introduced in 1975, just as the first big offshore fields were coming on-stream.
Since then the regime has changed many times, largely with a view to refining the mix of ensuring government obtains maximum economic rent from its natural resource, and ensuring that the industry continues to thrive and bring all of the, not insignificant, secondary benefits to the UK economy, including employment and employee taxes from both the upstream and supply sectors.
These secondary benefits have not always been sufficiently well emphasised by the industry to either government or the public but it is interesting to see the Treasury recently stating that all future North Sea tax regime changes will be considered not only in terms of the fiscal effect, but also the impact on the wider economy.
Prior to 1975, there had been oil & gas production in the UK, but only on a relatively minor scale onshore and, from the mid-1960s, gas production in the Southern North Sea.
Economic rent from the SNS was effectively controlled through the government in the form of the British Gas Corporation (now part of the Centrica group) purchasing all of the gas.
With the discovery of the Northern and Central North Sea oil fields the tax regime needed to change to ensure that economic rent was captured for the state.
In 1975, a specific North Sea regime was introduced under which UK oil & gas exploration and production companies were subject to three tiers of government take; government royalty (royalty), petroleum revenue tax (PRT) and corporation tax (CT).
However, this initial regime has changed significantly over the last 40 years.
The early years saw changes happening on a fairly frequent basis, which can be seen as the new regime “bedding down”, once production started to get up and running.
For example, the rate of PRT, which started off as 45%, increased first to 60% in 1978, and then 70% in 1979.
Also, in 1981, a new, supplementary petroleum duty (SPD), was introduced (to be abolished two years later), together with a further imposts, Advance Petroleum Revenue Tax (APRT) which was predominantly a cash flow mechanism to collect revenues earlier and lasted for five years, and gas levy, payable, at that time, only by the British Gas Corporation on Southern Basin gas production.
1983 saw the first fundamental change whereby the rate of PRT was increased, again, to 75%, the taxation of tariffs from use of infrastructure brought within the PRT net, immediate PRT relief being granted for all exploration & appraisal costs and, for new northern North Sea fields, PRT oil allowance was doubled, and royalty was abolished.
The period up to the mid-1980s could be viewed as the golden years, with government revenues peaking in the 1984 to 1986 years, and a time when the government was focusing primarily on extracting maximum revenues from the industry.
Government revenues fell dramatically in the following years, brought on at least in part by the 1986 crash in the oil price.
This led to some amelioration of the regime in 1988 when the abolition of royalty was applied to Southern North Sea (Southern Basin) and onshore fields although the PRT oil allowance was halved for those fields at the same time.
Throughout this period there had been no special CT rates with the “normal” 52% rate applying. From 1983 the rate of CT steadily reduced down to 33% by the year 1992.
The next major change to the regime occurred when PRT was abolished for all new fields receiving development consent after March 15, 1993.
At the same time, the rate of PRT was reduced from 75% to 50%, but various reliefs from PRT for expenditure on exploration and appraisal were withdrawn.
This reflected the more difficult times that the industry was experiencing. As royalty had already been abolished for fields receiving development consent after April 1, 1982, post 1993 fields were only subject to corporation tax on their profits.
Fields that had received development consent before that time continued, however, to be subject to a mix of royalty, PRT and corporation tax depending on when they received development consent and where they were located. The rate of CT continued to decline down to 30% by 2000.
Many people now believe the abolition of PRT for new fields in 1993 was a mistake, introduced in the belief that there would be no more new large fields, something which was proved wrong fairly rapidly with the Britannia field in 1994 and then subsequently by the Buzzard field.
This change left the regime with no effective means of capturing true economic rent from the North Sea for new investment, a state which arguably still exists today.
In 2002, there was another significant change, with royalty being abolished for all fields, but a new “supplementary charge” (SC), initially of 10%, levied on the profits from all fields, old or new regardless of profitability.
This supplementary charge was based on the company’s profits, as computed for corporation tax purposes, but with the significant difference, certainly for companies that were investing heavily, that no relief was given for financing costs.
Supplementary charge was doubled to 20% in 2006 and then increased again to 32% in 2011.
This 2011 change was introduced as a last minute measure to help pay for maintaining fuel duty at the same level, as was thought politically imperative at the time.
It was, however, very quickly recognised by government that the SC increase had pushed the risk reward balance too far to the detriment of the industry.
Government has, since that time, introduced a plethora of “field allowances” which eliminate certain amounts of profit from the supplementary charge, in order to try and redress that balance. However, due to the huge uncertainty as to whether, and at what level, such allowances might be available, these incentives were failing to encourage the necessary levels of investment.
Through this process the supplementary charge regime was also amended to provide that relief for decommissioning costs, was only available at 20% despite profits being taxed at 32%, thereby seemingly failing one of the fundamental principles of taxation that it should at least be “fair”.
The regime now seems to satisfy neither the requirement of the government to extract true economic rent, nor the requirement to sufficiently encourage the level of investment needed to maintain a robust oil & gas industry, with all the secondary benefits to the UK economy that this brings.
One could say the regime is not fit for purpose.
There was a major review of the regime last year on what was needed to obtain maximum economic recovery (MER), as promulgated by the Wood Review, and in many people’s view, when asking the question as to where you wanted to be, the reply of “well, I wouldn’t start from here” seems to be quite apt.
However, Treasury seem to want to simply tinker with the current regime, the main change being proposed being to abolish all existing field allowances and replace them with a new investment allowance.
Given the recent dramatic fall in the oil price it is not clear whether this will be sufficient to maintain the necessary levels of investment. There have, however, been oil price crashes in the past and up until now the industry has proved to be very resilient.
Penelope Warne is senior partner & head of energy at international law firm CMS Cameron McKenna. With thanks also to Phil Greatrex, MD CWEnergy