Tax shelters are usually created by government to promote a certain desirable behaviour, usually a long-term investment, to help the economy; in turn, this generates even more tax revenue.
Well, that’s the idea and UK government has of course made use of this mechanism on many occasions. A current example is incentives offered to stimulate growth of renewables-based power generation.
However cast, they all add up to the same thing . . . tax breaks.
The North Sea oil and gas industry is no stranger to such treatment, not least the portfolio of allowances conjured by the Treasury following its notorious tax raid on the industry in 2011, which rightly drew an angry back-lash from oil companies.
Calls for tax breaks and reductions are a hot topic just now, as any reader of the Press and Journal will know. On January 23, we reported that the Treasury might offer more tax breaks in the next Budget.
Sir Ian Wood warned in the draft of his soon-to-be published strategic report about the UK offshore industry of the criticality of sustaining a reasonable pace of exploration if there was to be any chance of adding viable new finds to the now heavily depleted discoveries hopper.
Last year’s pathetic exploration programme is clear evidence that government has to get its finger out and do something. And an obvious thing to do is to restore and extend exploration drilling tax breaks cavalierly removed in the mid-1990s amid claims by the Treasury that the shelter system was being abused.
Here in Energy, we frequently refer to Norway’s approach, which we applaud as being more long-term, progressive and imaginative than the no longer fit for purpose, highly unstable fiscal mess that companies harvesting UK Continental Shelf resources are obliged to live with.
It seems the Norwegians got it right in 1999 with the introduction of a cohesive set of incentives to boost exploration, namely the mature licensing rounds and 78% exploration cost refund for companies.
Ask analysts at Wood Mackenzie and they will tell you that the Norwegian approach has been a great success, delivering value to government, the companies involved and, of course, host communities like Bergen and Stavanger.
In August 2012, Malcolm Dickson, NW Europe upstream analyst at WoodMac said: “The first key change was the mature acreage licensing round system brought in to ensure that mature areas are fully exploited. This was followed by an exploration tax refund which reimburses 78% of the exploration cost for companies, regardless of their tax-paying position.
“There has been much debate on the effectiveness of these measures, but our analysis shows they have been very successful.”
WoodMac’s comparison of the mature exploration rounds, introduced in 1999, against frontier rounds revealed that:
- The number of companies exploring in the Norwegian sector had more than doubled since the introduction of the mature acreage licensing round system, with many attracted by the exploration terms.
- Drilling increased as a result, and mature rounds generated an average 17 wells each, whereas frontier rounds averaged 11 wells each.
- Mature rounds accounted for 51% of total commercial reserves, or 3.2billion barrels oil equivalent (boe), over the period 1999-2012.
Furthermore, WoodMac’s assessment shows that both exploration incentives – the mature rounds and tax refund measure – benefited all types of companies.
- Niche explorers got the chance to grow that they were craving for, with cheaper exploration and easier access to acreage.
- The majors, although absent from some of the key discoveries of mature rounds, were able to develop their hub areas by drilling surrounding prospects on acreage gained in mature rounds.
- A strong farm-in exploration market emerged.
- Statoil has been able to enhance its portfolio by making big discoveries in mature and frontier areas.
There is no question that the 78% exploration cost refund was controversial and hotly debated. However, WoodMac’s Dickson said the exploration cost rebate had in fact “created substantial value”.
“We estimate $4billion has been created by qualifying explorers, which accounts for around 20% of total value created,” he said in his 2012 analysis.
“Looking only at small companies, regardless of tax-paying position, the share increases to 35%. Given that Statoil/Hydro was responsible for nearly 40% of the rest of the value, this is impressive.”
The prior year, in March 2011, Deloitte analyst David Valente also came to the view that Norway had the better system. He warned then that “levels of drilling activity on the UKCS are in serious decline”.
He observed how very different the drilling activity trends were in the UK versus Norway while acknowledging the big difference in maturity of these neighbouring provinces, a point also referred to by Tony Mackay on Page 11.
Valente clearly regards various of the measures implemented by the UK as having been effective and that the outlook for the North Sea looked good in 2010, but then changes launched in 2011 screwed that up, not least the hike in Supplementary Corporation Tax.
This increase was of course met with significant opposition from the industry, especially given that the decision was unexpected, taken without consultation.
Since then the Treasury’s approach has been palliative, relieving symptoms a little but not doing what it really ought . . . implement a thorough and lasting fiscal overhaul with incentives that really will promote late life vigour for the UKCS; not this sad tottering from crisis to crisis, band-aid to band-aid, foisting instability upon instability.
So what can the North Sea expect in the March budget? To quote that famous radio programme: “Sorry, I Haven’t a Clue”.