Examination of Witnesses (Questions 1-19)
MR MALCOLM
WEBB AND
MR MIKE
THOLEN
20 JUNE 2006
Q1 Chairman: Good morning. We are delighted
to be in Aberdeen, the capital of the UK's oil industry. This
is our first meeting on our inquiry into the effects of tax increases
on the oil industry, and could I thank the staff here in the Town
House for helping with today's arrangements. Mr Webb, we know
that you were supposed to meet the Minister for Energy today.
Mr Webb: I do not think so. I
think I am relieved of that today.
Q2 Chairman: We thank you and Mr
Tholen for coming here this morning. Before we ask our detailed
questions do you have any opening remarks you would like to make?
Mr Webb: Yes, Chairman, I just
have a few and I will not keep you for long, I hope. Today the
UK relies on oil and gas for three-quarters of its energy supply.
The latest DTI projections show that that will grow to 80% by
2020, even allowing for strong growth in the renewables sector.
The UK offshore oil and gas industry has provided this country
with a secure supply of oil and gas since the mid 1960s and with
full self-sufficiency for the last 10 years or so. Today we still
supply the country with all its requirements of oil and over 90%
of its requirements for gas. The UK, however, is now a mature,
high cost oil and gas province in which production and discovery
size is falling, technical risk is increasing and cost inflation
a significant concern. Given the right moves by industry and Government
this industry could still be providing more than 50% of the UK's
total requirement for oil and gas in the year 2020. If, however,
we make the wrong moves the game could be more or less over by
then. UKOOA was and remains very disappointed by the latest tax
increase on UK oil and gas announced in the Chancellor's Pre Budget
Report. This, the third significant tax hit on our industry in
three years, not only clearly demonstrated the fiscal instability
of the UK to potential investors but also imposed a tax burden
on an industry which at this point of its cycle should be given
fiscal encouragement rather than yet more tax increases which
at the very best can be described as not encouraging. The current
very high oil price is masking the effects of this latest tax
increase and the UK offshore oil and gas industry is now dangerously
exposed to a downwards price correction. To fail to maximise the
potential of the UK offshore would not only be injurious to UK
security of energy supply; it would also result in the permanent
loss of economic benefit to the nation and foreshorten and possibly
kill off parts of the UK oil and gas supply chain. This centre
of global engineering excellence, which has grown up on UK oil
and gas, now employs well over 100,000 people in Scotland and
is one of this country's most remarkable industrial success stories,
providing not only high grade employment and technical expertise
for this country but also export earnings for Scotland alone of
£4 billion per annum and rising. In short, the PBR hike was
disappointing because it was inconsistent with the PILOT vision.
It seemed to demonstrate that the Treasury was more interested
in maximising short term tax receipts than the ultimate recovery
of the UK's oil and gas reserve which drives the PILOT vision
and we believed was the shared objective of industry and Government
and should in our view be a central plank of UK energy policy.
Q3 Chairman: Thank you very much.
Mr Tholen, would you like to say anything?
Mr Tholen: No, that is fine, thanks.
Q4 Chairman: As you mentioned in
your initial remarks, we are seeking to discover whether tangible
damage has been done to the industry by the tax increases recently
announced by the Chancellor, and if the more marginal fields have
become uneconomic. What effect do you think the tax increases
will have on the oil industry specifically and on the Scottish
economy generally?
Mr Webb: I think the immediate
impact of the tax increases is not likely to be particularly significant.
The industry was already heavily contracted for this year, plans
were set in place and we are enjoying a particularly high oil
price at the moment. We are aware that some marginal projects
(that were marginal before the tax increase) have become even
more marginal afterwards and possibly will not proceed but those
tend to be in the smaller range of projects and the immediate
impact of this latest tax increase is not likely to be seen right
now. As I said in my opening remarks, I think the danger is in
the medium to longer term. A very poor signal has been sent to
investors about fiscal stability in the UK and, furthermore, this
basin at the moment is facing a number of challenges in terms
of both technical risk and costs. This tax increase has not helped
on that and if we were to see a downward price correction then
very fast moves would need to be taken in my view by the Treasury
in order to avoid very substantial damage not being done immediately
to the industry.
Q5 Chairman: I have here a copy of
the report from Professor Alexander G Kemp at the University of
Aberdeen Business School, and he says in this report that the
oil tax change will have only a modest effect if oil prices stay
at $40-plus by 2030.[2]
What is your view on this?
Mr Webb: I think I would disagree
with Professor Kemp on that. Forty dollars is a number at which
I think this basin could be struggling. Why do I say that? When
I came into my current job three years ago I saw the basin, frankly,
not performing particularly well when the price was hovering at
round about $30. We have had a significant amount of price inflation
since then and we also have this latest tax increase, so therefore
I would not be so comfortable about $40. I think $40 could be
a slightly difficult price for this basin. I do not know if Mike
would like to add anything to that.
Mr Tholen: No, I think it shows
it pretty well. I know the paper you are referring to and it is
a good runner on what to perceive for the future but what he has
problems trying to capture is the big change in costs we have
seen in the last two years. Much of his data predates the rapid
changes both in prices and costs and the effects we have seen
then on the basin.
Q6 Mr MacNeil: Would you say 50?
Mr Webb: It is difficult to say
what that number would be, frankly. I should avoid predictions
on price as well, really, but my view is that at $30-40 this basin
is certainly going to be struggling, but that is a personal view.
Q7 Chairman: Professor Kemp also
mentions in his report that by 2035 another 24-25 billion barrels
of oil equivalent can be recovered but the great majority of these
fields will be small and this poses a challenge for the industry.
Do you have a view on this?
Mr Webb: On that I think we would
almost entirely agree with Professor Kemp's views. We see the
range of potential recoverable reserves from the North Sea as
somewhere in the range of 16-27 billion barrels yet to be got
and we believe that we can be optimistic and think about the higher
end of that range if all goes well. However, what is also very
clear is that these reserves that we are finding now are in much
smaller accumulations than they were previously. The early fields
in the North Sea were elephantine fields with recoverable reserves
in the billions of barrels. Today the typical field size is somewhere
in the 25-30 million barrels recoverable, so there are many more
small fields that will need to be brought on stream in order to
achieve the ultimate goal of maximising recovery at something
like 25 billion barrels or thereabouts.
Q8 Chairman: So there is the possibility
that huge oil reserves can be recovered which is very precious
to our economy and job opportunities, but what steps do you think
the Government should be taking to ensure that potential investors
make sure that we will explore those oil fields?
Mr Webb: I have said a number
of negative things. Maybe I could say a few positive things.
Q9 Chairman: I would like to hear
those as well.
Mr Webb: I think the Government
has done an awful lot that is extremely good. I do think that
the PILOT initiative and the things that have flowed from that
in a co-operative sense of joint venture between Government and
all parts of the industry have been tremendously successful. We
have had a very encouraging response to the 24th licensing round.
In part that has been born out of the strong co-operative work
that is going on between industry and the Government and the PILOT
initiative, so I think there is an awful lot going on that is
good at the moment, a great deal going on that is good, in co-operation
between all sides of industry—the supply chain, the operators
and Government. My concern is, and I think we expressed this also
in our submission to the Energy Policy Review, that we are not
entirely convinced that all of Government is joined up on some
of these policy initiatives. That is why we have been critical
about what the Treasury did and, as I said in my opening remarks,
it seemed to me that what the Treasury did was somewhat inconsistent
with the PILOT vision, and the PILOT vision is quite clear: it
is to maximise recovery from this basin in the national interest
for all the reasons that you have listed. We just think that there
is a need for a bit more joined-up Government on a number of these
issues. However, I would not want to be taken as saying that everything
this Government is doing on oil and gas is wrong. It is doing
an awful lot of right things, particularly around the PILOT initiatives.
Q10 Danny Alexander: You have talked
about, and you have talked about this in your written submission
as well, the co-operative spirit that there is with DTI in particular.
In advance of the tax change that took place was there consultation
from the Treasury? Would you say that the Treasury fits into that
wider positive consultative spirit that you were describing or
is it more removed from the interests and understanding of the
oil and gas industry here?
Mr Webb: I think it is more removed.
We have a regular meeting with the Treasury. Every six months
the industry leadership team has had a meeting at senior ministerial
level, which has been with the Paymaster General to date; I understand
it is going to be John Healey in the future, who has taken over
the remit in this area, and we have had a regular dialogue with
the Treasury. I am bound to say that to some degree we wonder—and
I should be careful here—whether all of our messages have
got through. The other point I would make is that we find it rather
regrettable that we have to have a series of separate discussions
on these issues. We would like to have one discussion with all
the parties in the room. We would like to see the Energy Minister
and the Treasury Ministers there so that we can discuss these
matters together instead of having a series of separate discussions.
That is not very efficient and, frankly, I do not think it is
very conducive to bringing all the parties together to have these
separate discussions. We would rather see that brought together.
Q11 Mr MacNeil: It seems you are
making a plea for joined-up Government there, which has been a
well used phrase over the last seven or eight years.
Mr Webb: It is, is it not?
Q12 Mr MacNeil: I wanted to return
to the maxim in your opening statement about fiscal incentives
when you said that the North Sea was perhaps dangerously exposed
and you talked about the Treasury moving to maximise the short
term tax take as opposed to maximising long term revenue that
could be got for the nations in total. What incentives do you
think the Treasury should be employing in the North Sea to ensure
that there are better fiscal incentives?
Mr Webb: I do not think the industry
is looking for tax handouts; it is not looking for incentives
of that nature. The way to incentivise this industry is to give
it fiscal stability and some security in that regard. There are
also a number of tax issues in the wings that need to be resolved,
and again I would not want to be taken as saying that we are not
engaged with the Government on these issues. The Treasury, after
the Pre Budget Report, first announced what seemed to us to be
a limited consultation on what they call structural issues. Further
discussions at one of those meetings at the Treasury has resulted
in that consultation being widened quite considerably. As we understand
it, we are now about to engage in a consultation with the Treasury
on all matters related to the fiscal scene in the UK bar the latest
PBR tax increase. I do not think that is up for consultation;
that is a done deal. It is important that we have that discussion
because there are a number of significant fiscal issues lying
out there in the wings which are causing problems for the industry
at the moment.
Q13 Mr MacNeil: Such as?
Mr Webb: One is the future of
petroleum revenue tax: what is going to be the position on that?
Petroleum revenue tax is a rather cumbersome tax to administer
and it will not be too long before it goes negative, frankly,
and therefore the industry believes, and the Treasury also probably
shares this view, that something needs to be done about petroleum
revenue tax. Our concern is that something is done about petroleum
revenue tax and ends up loading more cost and expense on the industry
rather than resolving the problem. There are also a number of
fiscal issues around the decommissioning area. They are linked
to some degree to PRT, but not exclusively, and to the whole fiscal
relationship on the retirement of the assets in the North Sea.
Frankly, that is a process that we do not want to see happen too
soon. There is an important point here. If that ring main of offshore
infrastructure is taken away too early a number of these small
fields will never be produced. That is why I said in my opening
remarks that if we get this right we have got a good future; if
we get it wrong there will be irrecoverable economic loss because
a number of these small fields will never be produced.
Q14 Mr MacNeil: You talk about a
ring main being taken away. I am not sure what you mean by that.
Mr Webb: I am sorry. It is my
shorthand for the offshore infrastructure that is out there at
the moment, the pipelines and the connecting platforms.
Q15 Mr MacNeil: Why will that be
taken away?
Mr Webb: If those platforms and
pipeline systems do not have sufficient volume of production going
through them to justify their continued maintenance then they
will be required to be taken away. That is the way the system
works. If they become redundant they will be taken away.
Q16 Danny Alexander: What changes
to that system could help?
Mr Webb: There are a number of
things around the decommissioning issues that could help. There
are problems at the moment with carry-back of decommissioning
allowances for tax. There are also problems around securitising
those abandonment obligations. I do not know if you know it, but
the way our tax system works for oil and gas in this country,
you cannot make fiscally efficient retirement provision for those
assets.
Q17 Mr MacNeil: What effect does
the £2 billion increase in tax from the Chancellor, the 10-20%,
have on what you have mentioned in the pipeline? What effect will
that have on the continued maintenance of that infrastructure?
Mr Webb: It does not help because,
of course, this is not just £2 billion one year; it is potentially
£2 billion and more for a number of years that will be taken
away and cannot be invested in the North Sea. I should make one
thing clear though. This year we are not expecting it to be £2
billion. The latest Treasury estimate is that the incremental
tax attributable to the PBR increase is £0.9 billion this
year. Why is that? It is in part because the industry is investing
so much in the offshore at the moment and therefore that has reduced
the effective tax take.
Q18 Mr Davidson: Can I follow up
one point you made? In your written submission there is a sentence,
"There is increasing evidence that high risk exploration
is less attractive and marginal developments are not being pursued",
yet in the Evening Express that we picked up yesterday
it says the offshore oil and gas industry is booming again, according
to the figures of yesterday, and applications for new UK oil and
gas exploration and production licences are at their highest level
for 30 years. It is in the newspaper so it must be true, and it
does seem to contradict the point that was made in your written
submission which perhaps, in the light of experience, looks as
if it was scaremongering. Can you comment on that?
Mr Webb: Yes. It was not scaremongering
and it was not intended to be scaremongering. It was meant as
an honest comment on the fears that we have in our association
for the medium to longer term future of the UK offshore oil and
gas industry. To take the point about what is happening in the
short term, as I have mentioned before, at the moment we have
very high oil prices. These are historically high oil prices.
That is encouraging an awful lot of short term activity within
the oil fields at the moment. I was looking at the UKOOA projections
for wells to be drilled this year. The good news is that those
look like they are going to be substantially up on last year,
and where that increase is most marked is in development wells.
There is a big increase in the number of development wells being
drilled, so infill and wells designed to capture production now
on existing or near existing fields. The exploration number, however,
that we are now projecting, and we have to be slightly careful
on this because it is based on the first quarter of this year's
activity, is a significant decline on last year's number of exploration
wells. That is not a good sign. If we are going to recover the
maximum from this province we have to keep up our exploration
activity and we are currently projecting something around the
fifties for the number of exploration and appraisal wells to be
drilled this year. That is somewhat low, so not everything is
without concern here. As far as the licensing round is concerned,
that, as I have said before, is testament to some excellent work
that has been done in the Department for Trade and Industry on
modernising the licensing system and making it more attractive
to a whole range of players, including a lot of small companies,
the so-called promote licensees, who come in and can pick up acreage
and try and build up a prospect of it for two years and then see
if they can get the wherewithal to drill later on. What I did
not see (and it would interest me to see) announced in the DTI
result was the number of firm exploration wells that were committed
in this round of licensing. I do not know what that number is.
That would be an interesting signal to see whether also there
is an increase in exploration appetite there.
Q19 Danny Alexander: Could you explain
how the tax changes have led to what has been described as the
UK attracting a reputation for fiscal instability within the industry?
Some would argue that having a tax rise on a particular industry
was an indication of its success and indeed the profits made by
it, and therefore it could be seen as a sign of health rather
than of insecurity.
Mr Webb: I am not sure other industries
in the UK would agree with you that they should be rewarded for
success with yet more tax. The example I would give for the instability
is those three significant tax hikes that I have talked about.
We had the introduction of supplementary corporation tax, which
moved the corporation tax level payable in the oil and gas industry
from 30% to 40% in the 2002 Budget. In the 2005 Budget we had
an acceleration of payments of oil taxation, which took another
billion out of the industry that year, and then in the 2005 Pre
Budget Report—and that was part of my surprise, that such
a significant tax increase was announced in the Pre Budget Report;
I do not think we have had its like before—we had a doubling
of supplementary corporation tax so that we are now paying corporation
tax at a rate of 50%, and on top of that we have petroleum revenue
tax at 50% on the older fields, giving us a highest marginal rate
of 75%. Frankly, I do not think that encourages success. I think
it slightly penalises it.
2 University of Aberdeen, North Sea Study Occasional
Paper No 10. Prospects for Activities in the UKCS to 2035 after
the 2006 Budget, Professor Alexander G Kemp and Linda Stephen,
University of Aberdeen. Back
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