House of Commons - Scottish Affairs

Select Committee on Scottish Affairs First Report

3 The fiscal regime

5. The Government has a crucial role to play in ensuring that the regulatory and fiscal regimes are fit for the future.[19] The Treasury told us that the Government was committed to a "strong and vibrant" UK oil and gas industry. This commitment is reflected in its twin policy objectives of promoting investment in the UKCS and ensuring the UK receives a fair share of the revenues from a national resource. The overall aim is to maximise economic recovery of the UK's oil and gas reserves. The interests of the producers and taxpayers have to be carefully balanced;[20] oil and gas companies need to receive a fair post-tax return on their investment, which recognises the risks they face, and the UK taxpayer needs to get a fair share of the revenue derived from the exploitation of its natural resources.[21]

6. The current fiscal regime is complex. Profits arising from extraction potentially fall within three regimes:

Petroleum Revenue Tax—a field based tax, which does not apply to fields given development consent on or after 16 March 1993 (non-taxable fields);
Ring-Fenced Corporation Tax—Corporation tax in the North Sea is subject to special rules so that profits from oil extraction activities cannot be reduced by losses from other trading activities; and
The Supplementary Charge—introduced by the Finance Act 2002, the Supplementary Charge is an additional 10% charge on adjusted ring-fenced profits. The Supplementary Charge was increased to 20% from 1 January 2006.[22]

7. Mr Blackwood told us the UK had had a reputation for fiscal stability but alleged that this had been quickly destroyed over the last three to four years.[23] The major tax increases since 2002 are:

2002—introduction of the Supplementary Charge at 10%;
2004—advanced phasing of corporation tax payments for the oil and gas industry; and
2005—doubling of Supplementary Charge to 20%.[24]

8. Mr Blackwood gave his view that the latest tax increase was "ill-judged and in defiance of the realities".[25] UKOOA argued that the increase in Supplementary Charge was the third significant tax increase in three years and claimed the UK oil and gas sector was the most highly taxed sector in the UK.[26] However, the Treasury have told us that the increase in the rate of Supplementary Charge restored "the balance between producers and consumers in light of the significant increase in oil price since 2001".[27]

9. The Treasury told us that the UK fiscal regime was broadly comparable to the fiscal regime in countries that were our main competitors for investment, such as the Gulf of Mexico and the Netherlands, and was more favourable than the fiscal regimes in Sweden, Denmark and Italy.[28] Before the 2005 increase in Supplementary Charge the UK had the fifth lowest tax take of 65 different oil regions around the world. The increase in Supplementary Charge moved the UK down to about the eighth or ninth lowest tax take. The Treasury argued that the UK's favourable position is a result not only of the modest tax take but also of the other incentives and allowances, such as the 100% first year capital allowances for North Sea investments.[29]

The effects of tax increases

10. Tax increases have the potential to damage future investment[30] and shorten the life of the industry.[31] They also have the potential to affect development of fields, reduce exploration, and increase investment uncertainty. Professor Alexander Kemp of the University of Aberdeen, noted that undeveloped gas discoveries that were marginal as investments became even more so after the tax increase in December 2005.[32] He concluded that the tax increase would have a marginal effect on investment and changes would be needed in the tax regime if oil prices fell. He recommended linking the Supplementary Charge to oil prices.[33] The Treasury felt that index linking the rate of Supplementary Charge in this way would introduce too much volatility, unpredictability and complexity into the fiscal regime.[34] Mr Blackwood said that there was little appetite for it from industry.[35]

11. UKOOA said there might have been an expectation that the tax burden on the industry would fall as production declined in order to extend the productive life of the UKCS.[36] They believed that the latest tax increase would have a detrimental long-term impact on recovery from the UKCS and that the fiscal and regulatory regime was unsuitable for the remaining life of the North Sea. Malcolm Webb, Chief Executive of UKOOA, claimed that projects that might have gone forward before the tax increase might now not happen,[37] and that the tax increases had made the UKCS less attractive to investors.[38] No evidence was presented to the Committee of projects that had not been realised. Shell agued that the UKCS was a maturing province, where industry faced increasing difficulty of access, high costs, rising supply chain costs and increased competition for global investment funds.[39] They said fiscal stability was key to attracting investment and called for a review of the increase in Supplementary Corporation Tax.

12. One of the effects of the tax increase had been to reduce the net present value of investments, that is, the revenue generated from exploitation of the reserves held in the ground extrapolated into the future and discounted back to present values.[40] Maersk Oil described how, in their calculation, the tax increase had eroded the value of its investment in the UK by about 15%. They concluded that the tax increase and the threat of further tax increases affected how their company viewed the UK in terms of future investment.[41]

13. Mr Blackwood, Director BP North Sea, said,

The unfortunate truth, therefore, is that on almost every possible measure the UKCS is becoming a much more difficult place in which to operate. Common sense would dictate that this is possibly one of the last provinces of the world to have warranted a tax increase, and possibly the only redeeming factor is the current high oil price which, although disturbing for many other reasons and irrelevant in terms of UKCS competitiveness, it does help to disguise some of the things I have been talking about.[42]

He described the additional fiscal burden as compounding the difficulties of attracting investment to the UKCS.[43] Some witnesses stated that there had been adverse impact on investor confidence.[44]

14. Scottish Enterprise expressed the view that reduced investment would pose a serious threat to the supply chain (the human and technical resources deployed by the oil industry).[45]

15. OGIA, the Oil and Gas Independents' Association, said that the supply chain was an important factor and any damage to it could make it more difficult to attract investment.[46] There is some evidence of resources, such as rigs and other equipment, leaving the North Sea, which might be hard to win back.[47] Mr Blackwood stated that the tax increases also had an impact on exploration; new drilling in the UKCS has tended to be adjacent to existing infrastructure rather than in undeveloped oil and gas fields.[48]

16. Other witnesses offered a different view of the scale of any impact the tax increases might have had. Amicus did not believe there was any detrimental impact due to the increase in Supplementary Charge as the current high oil price made it affordable. However, they were concerned that a drop in oil prices might lead to a loss of jobs. They called for a simpler tax regime for the oil and gas sector that would be more responsive to fluctuations in oil prices.[49] Professor Kemp has reported that he envisages only a modest impact on investment.[50] The Treasury told us that the twenty-fourth licensing round had shown continued strong interest in UKCS.[51] The Treasury's analysis was that the latest tax increase would only have a small impact,[52] with only two of sixty-eight projects becoming marginal.[53]

17. Several of our witnesses argued that it was difficult to see the effects of the latest tax increases immediately because of the long lead times in the industry.[54] The full impact may not be visible for three to four years.[55] We conclude that it is impossible to isolate with certainty the impact of tax increases from that of other factors such as price or initiatives designed to stimulate investment or increase recovery, including the PILOT programme or the brown field initiatives.[56] In our view, the fiscal regime is unlikely to be the most important factor driving investment decisions in major fields. Although tax is clearly significant, the nature of the oil and gas fields, the underlying geology and future oil and gas prices are more likely to be the dominant drivers,[57] but the fiscal regime may be a factor affecting investment in older, more marginal fields.

18. There is a need to balance the return on investment and the return to the UK taxpayer for the use of its natural resource. In this context, it is important to consider the effects of the current high oil price. Malcolm Webb described how high oil prices in the North Sea masked the effects of the latest tax increase;[58] a view shared by Mr Blackwood.[59] When the prices of oil and gas rise, companies' profits from their investments increase considerably.[60] The latest tax increase will have a greater impact on investment decisions if the price of oil falls. Industry would like an undertaking from the Government that the tax will be reassessed if prices soften.[61] Given the long lead time on investment decisions, the greatest risk to jobs would come from a rapid fall in price and slow action on taxes.[62] Several witnesses spoke of the need for the Treasury to take prompt action on tax if the price of oil falls.[63]

19. We spent a good deal of time talking to our witnesses about the price level below which there would be serious consequences; much of this discussion focused on what would happen if prices fell below $30-40 per barrel.[64] There does not seem to be much prospect of a fall in the price of oil to those levels. The price of oil recently pushed past $95 per barrel.[65] Prices have more than quadrupled since 2002 and are currently 40% higher than at the start of 2007.[66]

20. The Treasury told us that all taxes were kept under review.[67] A dramatic change in the price of oil would have implications for most of the UK economy and it is difficult to imagine that a dramatic shift in price would not lead to some change. In its consultation paper on the North sea Fiscal Regime, the Treasury said "all taxes are reviewed on a Budget-by-Budget basis and changes in oil prices are factored into such reviews".[68]

The need for fiscal stability

21. The industry made clear its view that fiscal stability was key in attracting investment.[69] UKOOA argued that instability damaged the UK's competitiveness.[70] They believed that the effect of several changes within a short space of time had earned the UK a reputation within the industry for fiscal instability. It was also clear from the evidence provided to us that these were wider concerns than just the latest change to the Supplementary Charge.[71]

22. Mr Blackwood told us that any tax increase made it harder for him to attract capital and people to the UKCS.[72] However, while fiscal stability is important, witnesses from the Treasury suggested that the UK's fiscal regime was "broadly comparable with our main competitor regimes" despite the recent changes.[73] While there was some disagreement about what stability meant, with industry wanting taxes to fall as the price of oil falls but not to rise when it rises, OGIA suggested that what was most important was predictability.[74] We conclude that a simple fiscal regime that is consistent and predictable would be of most benefit to the industry and the UK in the long term.[75]

23. The Government has made a commitment that there would be no further changes to the fiscal regime for oil and gas companies in the remainder of this Parliament.[76] The industry seeks even greater stability and predictability than this commitment offers. Professor Kemp argued that the assurance from the Treasury that Supplementary Charge will not be increased for the rest of the Parliament was of limited benefit where investments had to be considered over a much longer time frame.[77] However much such guarantees might be desirable, and despite industry's claims that there was greater fiscal stability in the past, no government has ever been able to make a commitment that binds its successor.

19 H M Treasury, The North Sea Fiscal Regime: a discussion Paper, March 2007 Back

20 Qq102 and 167 Back

21 Qq167 and 180 Back

22 H M Treasury, The North Sea Fiscal Regime: a discussion Paper, March 2007 Back

23 Q127 Back

24 Ev 53 Back

25 Q91 Back

26 Ev 1 Back

27 Ev 63 Back

28 Q184 Back

29 Ev 38 Back

30 Qq104 and 115 Back