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Tax rises a heavy blow for continental shelf investment - International Law Office

International Law Office

Energy & Natural Resources - United Kingdom

Tax rises a heavy blow for continental shelf investment

June 20 2011

Impact on investment by exploration and production companies
Unequal effects on gas and oil production?
Impact on mature fields
Next steps

On March 23 2011 the chancellor announced that the rate of supplementary charge on corporation tax paid by the oil and gas industry in the United Kingdom would rise from 20% to 32%. The government has stated that the increase reflects its aims of striking the right balance between oil producers and consumers, and of ensuring fairness for taxpayers. The announcement surprised many in the energy sector, given the government's position on the importance of continued investment in the North Sea and the industry's need for a stable fiscal regime that provides certainty for investments in the UK continental shelf.

Impact on investment by exploration and production companies

Some industry representatives have warned that the rate increase has made investment in the North Sea less attractive. This might not only deter investment, but also increase UK dependence on imported oil and gas, which in turn would have a significant impact on energy security in the United Kingdom. The tax increase also removes the benefit of the new field allowance introduced in 2009 to incentivise investment in qualifying small or technically challenging fields.

Shares in exploration and production companies that are active in the North Sea fell following the chancellor's announcement. For example, shares in Nautical Petroleum plc fell by 10% and shares in Premier Oil plc fell by 4%.

In February 2011 Oil & Gas UK's continental shelf activity survey identified £50 billion of potential new oil and gas development opportunities over the coming decades, many of which will need to be reassessed. Simon Henry, Shell plc's finance officer, has been quoted as saying: "The irony is we were just beginning to look at what opportunities there were in the North Sea again. We hadn't worked up the projects yet and that work now stops."

Unequal effects on gas and oil production?

The industry is particularly concerned that no recognition is made in the application of the rate increase between the market price of oil and gas (which accounts for 46% of UK production). The oil price has risen above $100 only since late January 2011; in 2010 it averaged $80. Gas prices have risen, but in oil terms are still less than $60 per barrel of oil equivalent.

Industry stakeholders argue that this divergence in oil and gas market prices is significant because it ultimately results in profits generated from gas production being considerably lower than those generated from oil production. However, under the new tax increase both commodities will be taxed in the same way, in effect penalising gas producers more heavily than oil producers and adding to concerns that North Sea gas production is steadily declining.

Impact on mature fields

The chancellor also announced a tax rise from 75% to 81% for mature fields (ie, those given development approval before 1993 and now approaching the end of their commercial lives). There are concerns that the tax rise will have a negative impact on investment return and cash flow for operators of mature fields, leading to decommissioning sooner than would have been the case before the Budget. Oil & Gas UK has stated that:

"[t]he oldest fields are often the ones providing pipeline and processing hubs for the more recent oil and gas developments and the removal of valuable infrastructure upon decommissioning will curtail the exploration for and development of reserves in the vicinity, discarding the opportunity to maximise recovery of the UK's remaining oil and gas and wasting a secure potential source of primary energy."

In addition, one of the tax changes announced in March 2011 reduces the rate at which tax relief can be claimed on decommissioning costs. This heightens the industry's uncertainty around the tax treatment of decommissioning costs and is also likely to speed up decommissioning.

Next steps

PILOT, the joint government and industry forum, met on March 30 2011 to hear the industry's views on the rate increase and the Budget more generally. Oil and Gas UK argues that:

"the government must find the means to rebuild confidence in [the United Kingdom] as a destination for international energy investment and wind back the current perceived damage to future investment."

PILOT representatives are due to meet the chancellor to work on making the fiscal regime more stable and to address broader decommissioning tax rules before Budget 2012. However, it is difficult to envisage a solution that will counteract the tax changes introduced in March 2011 and fully allay the industry's concerns.

For further information on this topic please contact Hannah Croft at Ashurst by telephone (+44 20 7638 1111), fax (+44 20 7638 1112) or email (hannah.croft@ashurst.com).

The author gratefully acknowledges the contribution of Sukhdeep Kaur, a trainee solicitor on secondment from Centrica plc to Ashurst LLP.

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