Shocking, short sighted, ill considered, naive; George Osborne’s tax grab from the oil & gas industry in his budget is all of these things.
Under pressure because of high fuel costs and the looming further 5p fuel duty, Osborne attempted a political masterstroke by reducing fuel duty by a penny and claiming that the cut was to be financed by a “raid on the coffers of the oil companies”, in the form of a 12% increase in the supplementary tax take.
That effort to curry favour with voters ignored data published at the beginning of March by the AA, which showed that the tax take from petrol and diesel had already risen by 5p and 6p respectively in the 12 months to January 4, 2011, as a consequence of the confluence of higher pump prices and the increase in the rate of VAT from 17.5% to 20%.
Consequently, there was more than ample scope within existing finances to reduce fuel duty, without levying extra taxes on producers.
Since the Budget, Osborne has attempted to defend the limited size of the reduction, by claiming that he has actually afforded a double benefit to motorists by postponing the planned 5p rise set for this month.
This measure was introduced by the last Labour government when fuel prices were much lower than today and the associated tax receipts were correspondingly lower, too. So, to have proceeded with another 5p duty rise now would have resulted in an effective doubling of the related tax burden.
Osborne is now claiming that he will be “watching the oil companies like a hawk” to ensure they pass on the reduction to the public. Quite how he proposes to do that, given the opaque nature of fuel pricing and the fact that petrol retailers are not regulated, remains to be seen.
It is clear that this was not our chancellor’s finest hour, as there are implications that appear not to have been properly analysed. Clearly, unhedged oil producers are benefiting from high oil prices that are partly driven by the unrest in the Middle East, but history tells us that crude prices are extremely volatile.
Little over two years ago, oil was $38 a barrel and large losses ensued. There is obviously a need to “fill the coffers” when times are good to compensate for a slump, but it is also true that the costs of finding and developing new oil fields are rising dramatically, and the oil & gas companies need high prices to allow them to reinvest, thereby maintaining or increasing production. For example, BP commits some $15-20billion every year in capital expenditure, yet has not grown production materially lately.
If additional taxes are levied when oil prices are high, then the reverse should apply when prices slump. There has been a suggestion that the additional tax should be removed when prices fall to $75 per barrel, but this looks far too low a base level, as profits from prices below $100 can hardly be deemed a “windfall”.
Was it really the intention that the Budget should raise taxes on mature PRT paying fields where the marginal take goes up to 81%? This is likely to accelerate abandonment of various older fields. As the PRT legislation is drafted, the UK taxpayer will pick up most of the abandonment costs, as these are deductible against PRT paid, so this move has the potential to shoot the chancellor in the foot by bringing forward the cost of abandonment spend from the public purse.
This will make the already sluggish market in mature assets less attractive to buyers and, without an active churn, the UKCS will die faster than it would otherwise do. At least the majors can take solace in the fact that they have the scope to recover some margin from their downstream operations.
They are also less exposed because the UK North Sea does not generate the bulk of their profits. In contrast, small and medium-sized operators are less diversified geographically, have higher base/entry costs, and their financing constraints make it much more likely that they have to sell forward (“hedge”) their production. This limits their ability to benefit from higher oil prices and, in effect, exposes them to higher tax rates on the same profits. But it is with such companies that the future of the North Sea resides, and anything which discourages them could reduce the life expectancy of the industry that already contributes more to the UK tax coffers than any other.
Osborne’s expectation that gas producers should pay the extra tax also looks likely to backfire. Gas prices have not risen like oil has, and therefore the super-profits that he seeks to tax simply do not exist for production companies leveraged to gas.
Commonsense would suggest that gas production should not be subject to a windfall tax when there are simply no windfall profits. Already, Centrica has made it clear that further investment in Morecambe Bay could be shelved, and that there will not only be other marginal gas fields which will now not be developed, but existing fields may be prematurely decommissioned.
The consequence of this is that the UK will become increasingly reliant on imports and electricity prices will increase. Recent events in Japan call into question the wisdom of the UK becoming reliant on nuclear power.
Gas-fired power generation is the logical solution along with renewables, so this is not the time to be strangling domestic gas production. Of course, the industry didn’t see the tax increase coming because there was no advance consultation. The consequence of this is poor legislation.
It also shows an alarming lack of respect for what is one of the few jewels left in the crown of British industry. Taken with Osborne’s “take from the rich” characterisation, I wonder if this Budget is a foretaste of more to come.
The industry urgently needs clarity on the message the government is giving here. If oil prices continue to rise, should we expect to see the rate of tax rise still further? In answering that question, the chancellor must heed the most basic of economic and investment realities: competition for capital.
Ours is a global industry and there are plenty of lower-cost regions competing for investment dollars. Unless assurances are made that the Exchequer will not make more surprise raids on our producers, companies and their shareholders will deploy their capital and resources in more stable and competitive geographies.
George Osborne’s expectations of being hailed as a Robin Hood figure have given way to a characterisation more akin to the bungling Inspector Clouseau, made famous by the late Peter Sellers. The problem is that no one is laughing and the rub is that Clouseau is in fact smarter than Osbourne.
Colin Welsh is CEO of Simmons & Company International