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Robbing Peter to pay Paul

Image: Philippa McKinlay

Among the various announcements in tomorrow’s UK Budget is likely to be an apparently innocuous change to the North Sea tax regime.  The BBC carried the story in about as bland a manner as possible:

“The oil industry has asked the Chancellor to consider a tax break which they claimed could extend the life of mature oil and gas fields.  Industry body Oil and Gas UK said allowing the tax history of North Sea assets to be transferred when they are sold could help keep them productive.”

With the UK economy coming apart at the seams, and with the government’s internal polling putting it 12 points behind the opposition Labour Party, any change in the North Sea tax arrangements is most likely to go by unnoticed.  It should, however, be of concern to anyone who cares about the environment and, indeed, to anyone interested in the finances of the next UK government.

At issue is the decommissioning of the North Sea oil and gas infrastructure; and, crucially, who gets to pick up the tab.

In September, I set out the decommissioning problem:

“The exact costs are unknown.  However, the cost could rise to £60bn to remove around 470 platforms, 5,000 wells, 10,000km of pipelines and 40,000 concrete blocks from the North Sea.  That’s a little over 1.5bn barrels worth of oil at today’s prices.  So, in effect, 1.5bn of the 2.8bn remaining proven reserve will have to be sold just to cover the cost of decommissioning, leaving just 1.3bn barrels (a little above £50bn at today’s prices) to cover operations, return investment to shareholders and pay taxes.

“It doesn’t take a genius to work out that the energy industry will not be paying for decommissioning.  Instead, as is the wont of private corporations, they will continue drilling for as long as there is an income to be made before filing for bankruptcy and leaving taxpayers to clean up the mess.  The real question is how much longer they can persuade investors and politicians to keep throwing funds at an industry whose demise is already visible.”

On the same day as I wrote this, the Tax Journal published a brief report of Exchequer Secretary Andrew Jones’ presentation to the Society of Petroleum Engineers in which he confirmed the upper estimate of £60bn for decommissioning costs; £24bn of which were to be covered by decommissioning tax relief.  That is, the final half billion or so barrels of oil to be extracted from the North Sea will be exempt from tax provided that the companies involved are engaged in decommissioning.

The trouble is that as the final dregs of the North Sea are looming ever closer, it will be more profitable to decommission early rather than risk trying to extract the last – and hardest to recover – oil and gas.  As Simon Johnson reported in the Telegraph in January:

“Research group Wood Mackenzie warned taxpayers are facing a £24 billion bill for decommissioning oil and gas fields, 50 per cent higher than the official Treasury estimate of £16 billion.

“Oil companies are forecast to spend £53 billion from this year winding down their North Sea operations and almost half that sum is expected to be recouped from the Treasury through tax relief.

“The analysis predicted this burden will exceed the remaining net tax revenues, meaning the North Sea will become a net drain on the public purse, and warned of a “domino effect” as fields begin to shut.”

One policy response to this situation would be to accept that fossil fuels have had their day and, instead, provide the grants and tax breaks necessary to converting the UK into a renewables/nuclear-powered economy.  That option is wholly unacceptable to the UK government (not least because nobody knows how to do it using current technologies).  Instead, both the industry and the government have been seeking a means to attract new investment even as the final drops of oil and gas are making a slurping sound as they are sucked along the pipe.

The main problem for the industry (but not for the Treasury) is that the original North Sea regime assumed that the same multinational corporations that began exploration and recovery in the 1970s would be around at the end to clean up the mess.  As a result, the amount of tax relief available for decommissioning was designed to be a proportion of the tax a company had already paid.  But since the big players have mostly packed up and left, remaining recovery is in the hands of a crop of much smaller newcomers that have yet to pay much in the way of tax, and so attract a much smaller relief for decommissioning.

Derek Leith at Energy Voice sets out the way forward:

“Conceptually the answer is straightforward – if part of the seller’s tax history could be transferred to the buyer then the buyer ought to be capable of being placed in the same post-tax position as the seller which would make a deal possible.”

That is, in addition to counting their own tax records against decommissioning relief, the small companies currently operating in the North Sea would also be able to count the taxes paid by multinationals like BP and Shell over several decades.  Oil and Gas UK – the industry trade body – argue that:

“The UK Government has a limited window of opportunity to introduce a tax change with the Budget that could save the UK taxpayer millions of pounds by deferring the decommissioning of mature oil and gas fields…

“Enabling transferable tax history in the upcoming Autumn Budget would attract new investors and help unlock more deals in late life assets in the UK North Sea.”

Although Oil and Gas UK argue that this will also provide an income for the Treasury, this is mendacious.  It is true that extending the life of the North Sea will provide extra tax receipts from the additional production while putting off the losses from decommissioning tax reliefs.  However, the reform also makes the government – i.e. you and me – liable for a greater share of the decommissioning cost when the fateful day arrives when no more oil and gas can be profitably recovered from the North Sea… probably less than a decade from now.

By then, of course, the current government will have become a mere historical footnote in the story of Britain’s economic collapse.  This, of course is why the proposed tax reform is so attractive – it will provide a temporary boost to tax receipts for this government while leaving the next with a big decommissioning headache.  Not that the UK government – already foundering on the rocks of Brexit – is going to get such potentially complex legislation through Parliament as part of the Budget tomorrow.  As Leith argues:

“The practicalities of introducing such an approach would be more complex and there is no precedent.

“More importantly how can the transfer of one part of the corporate tax history of a company, during an asset transaction, to the buyer be done without creating the opportunity for companies to exploit these changes at the cost of the Exchequer?

“Ultimately it is possible to achieve the policy goal of enabling late life asset transfer but the legislation will need to be carefully crafted to protect HMT [the Treasury]. Clearly this is not an impossible task but neither is it achieved in the course of an afternoon.”

We will be able to measure the competence of the official opposition by the degree to which they scrutinise and amend the legislation when it finally does come before Parliament.  There will no doubt be many short-sighted opposition MPs (particularly among the Scottish Nationalists) who will place the allure of North Sea jobs ahead of the likely environmental impact of the tax changes.  On this, I stick to my September prediction that when the last profitable barrel of oil and Btu of gas has been rung from the North Sea, the oil companies will declare themselves insolvent and leave the decommissioning to the British government… a government that, by then, will be unable to afford to pick up the tab.

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