Tax threat to the deep

Tax is only a small part of the oil and gas industry’s contribution to the UK, says Dai Somerville-Jones

In his July 1997 budget, the chancellor launched a new look at taxing the UK oil and gas industry. The aim was to carry out a review of the North Sea fiscal regime, ‘to ensure that an appropriate share of North Sea profits are being taxed while continuing to maintain a high level of oil industry interest in the future development of the UK’s oil and gas reserves.’

At the time, the Government had it in mind to get the ‘windfall that got away’. This may still be its intention but, after lengthy consultation with representatives across the industry, it concluded last month that the North Sea was no utility with excess profits. Unlike a utility, the North Sea industry is a high-risk venture without a fixed asset base. The high perceived returns are not real. Commentators had not looked at the bigger picture of full cycle economics, ignoring the costs of unproductive exploration.

A key difference is that the UK operators form part of a highly mobile global market, competing with other provinces for investment. This also has significance for UK contractors, which are much less mobile.

Relationships in the UK oil and gas industry are complex and the stability of the economic regime is very important. The industry believes it is not in the UK’s best interests to change the fiscal regime adversely.

It was, therefore, encouraging to hear that the chancellor’s overall objectives are generating long-term stability, highly skilled jobs and advanced technology opportunities.

The UK offshore industry is one of the biggest UK post-war industrial success stories, providing for more than 330,000 jobs in 5,000 firms and accounting for some 20% of total UK industrial investment annually. The industry not only contributes to the country’s balance of payments position through the export of oil and gas, but also exports world-class high technology and knowledge around the globe – expertise developed as a direct consequence of investment in the difficult environment of the North Sea.

Through the Crine Network, based on the UK industry’s cost reduction initiative for the new era, the industry is working towards a tripling of these exports in the global market for oil and gas supplies by 2002 to £3.75bn per annum by value.

It is accepted that much of the industry’s future performance in the North Sea depends on the application of technological advances and that these advances provide a basis for enhanced exports.

Expanding the export market is not, however, the driving force for innovative technology. Its prime function is to enable the industry to combat the decline in the revenue base of the North Sea, to maintain development momentum and to support the risk/return profile required for commercial success.

The North Sea industry is already compelled to place high demands on the unpredictable and costly process of finding performance enhancing technical solutions – successful innovation cannot be guaranteed. A key concern is that the Government might assume that technical innovation will provide scope for the industry to provide extra direct tax revenue in addition to its existing contribution to the finances of UK plc.

It is becoming apparent that companies’ decision-making processes are not fully understood. The nature of international oil companies is that they make long-term investment decisions by balancing risks with prospectivity and returns.

Britain’s fiscal regime is appropriate to continued activity and provides a balance to the high costs of working in UK waters. If the area to the west of Britain does not prove to be exciting and ultimately productive, and the investment process in the UK is slowed or stopped by negative fiscal pressures or uncertainty, the impact on the UK will be rapid and substantial. The UK would lose out as funds and expertise are moved to the emerging regions.

The scale and speed of this process is very significant. The level of uncommitted cumulative capital investment in the UK continental shelf amounts to more than £10bn by 2002. This translates into 120 projects and a significant number of jobs, perhaps as many as 40,000. These are jobs that, should the investment be moved overseas, must be at risk.

As with any focused community they are jobs which can have a multiplier effect on local and regional economies. This is of particular concern. Although the jobs are nationwide, many are concentrated in areas of potentially high unemployment, such as North East Scotland, the North East of England and the industrial Midlands.

The Government must take into account the balance of payments effects, employment, and other factors when considering fiscal change, as the tax take is only a small part of the overall contribution of the industry to the UK economy.

The industry’s message is clear and simple: the most efficient way of increasing revenue is to make the pie bigger, rather than to take a larger wedge of the existing one and risk significant damage to the UK economy.

In our sector, it would be easy for fiscal changes to turn the Government’s ‘Welfare to Work’ programme into a ‘Work to Welfare’ programme.