Despite the oil price being slightly more stable over the past three months, it is still significantly lower than the highs seen over the past few years. There is still a great deal of uncertainty as to the future price and the UK oil and gas sector is facing the challenge of re-basing costs and improving efficiencies to make the UKCS viable at a $60 oil price.
The fiscal regime continues to be a focus for the industry as it tries to attract capital investment and restore confidence. Despite that focus, the budget on Wednesday should be a pause for breath for the industry as no radical announcements are expected. This could make the Summer Budget one of the very few in the last 40 years to not include key changes for the industry.
Given the extensive coverage that the sector received in the last budget of the coalition Government in March, which included a lowering of the rate of Supplementary Charge and the introduction of the Investment Allowance for the oil & gas industry, this is to be expected. But that isn’t to suggest that there is no activity going on in the background at HMT. Quite the opposite. We know that after the budget, the Treasury will be working with the industry and the OGA to look at three ongoing thorny issues:
Exploration
Infrastructure
Decommissioning
Exploration is of course vital to discovering the resources that many believe are in the UKCS, but have yet to be found. Although the number of E&A wells in the first quarter of 2015 increased compared with the same period last year, the number of exploration wells has actually fallen from three to two. To discover the predicted “yet to be found” reserves probably between 30 and 40 exploration wells per year are needed- quite a contrast to current activity levels!
HMT has still to determine what, if any, fiscal stimulus can be brought to bear on exploration activity. A tax credit, like the Norwegian system, is favoured by some in the industry. This would have the attraction of enabling exploration activity to be partly funded by debt. Of course it would require the OGA to be sufficiently resourced to ensure that the investment in exploration by the State is money well spent. A more realistic aspiration for exploration, however, may be the extension of the Investment Allowance to enable the exploration generated Allowance to be activated in existing producing fields.
Infrastructure is also a critical issue as existing fields will not have all of the available hydrocarbons recovered if the infrastructure is “prematurely” shut down. Moreover any exploration within the catchment area of such infrastructure will also become untenable. Simplification of access to infrastructure and perhaps specialist infrastructure operators are also key themes.
Decommissioning has a direct link to the infrastructure issues above, and is probably the single biggest issue in the UKCS at the present time. As costs have increased in the basin the forecast decommissioning liabilities have also increased at an alarming rate. These liabilities are acting as a barrier to new entrants who cannot hope to generate sufficient tax capacity to absorb the decommissioning expenditure at the end of an asset’s life. Would-be sellers are going to have to consider wholly, or partially, retaining the decommissioning liability if they want to pass assets on to those companies who may operate them at lower costs and thus extend their economic life. This is an area where changes to the tax legislation could have a material impact on behaviour.
So, no big oil and gas changes next week but a lot of work to be done over the remainder of the year in preparation for the budget next year. Companies will need to invest sufficient resource to see these issues addressed in a manner that will prolong the life of the basin.
Having said all that, the Chancellor wouldn’t want the industry to feel left out. We do expect draft secondary legislation to be issued for consultation which would extend the definition of qualifying expenditure for Investment Allowance to include expenditure which is discretional but may not be capital expenditure, and to address issues with long leases on producing assets. Watch this space….
Derek Leith is the head of oil and gas taxation and office managing partner at EY Aberdeen.
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