Examination of Witnesses (Questions 20-39)
MR MALCOLM
WEBB AND
MR MIKE
THOLEN
20 JUNE 2006
Q20 Danny Alexander: What impact
does that sense of instability have, because what you are saying
is that it is not just the level of taxes but also the fact that
there is uncertainty about what is going to happen to tax next.
Mr Webb: Quite.
Q21 Danny Alexander: What impact
has that had on future investment decisions, given the importance
that you have outlined for investment decisions that are being
taken now?
Mr Webb: I think the answer is
that investors are more cautious. We know that some companies
now are testing projects against tax hurdles in the UK that are
higher than the current rate of tax here in the UK, so they are
judging the projects, not against today's tax rate but, cautiously
and prudently, I would say, in view of the recent track record,
against higher tax rates than that, so it induces people to put
in a sort of risk premium on tax when considering their investment
in the North Sea.
Q22 Danny Alexander: Could you estimate
the scale of that risk premium?
Mr Webb: I do not know whether
Mike has a feel for what risk premium they are loading at the
moment.
Mr Tholen: I imagine some companies
are taking the previous increase and saying that might happen
again simply because they base their experience on what they have
seen in the recent past.
Q23 Danny Alexander: So they might
be assuming a further rise of 10% as a basis for judging whether
or not it is a viable project?
Mr Tholen: They will certainly
test against a range of things, against costs and tax uncertainty.
That will certainly be priced in, not least on much of what we
are looking at in exploration in the future.
Q24 Danny Alexander: In your submission
you talk about the fact that oil and gas activity in the UK is
now 16% less attractive as a result of the last increase, so that
would be an assumption of, as it were, 32% less attractive overall?
Mr Tholen: That could be the assumption,
yes.
Q25 Mr Davidson: Can I follow up
that point? Are you saying to us that industry is pricing in a
further 10% increase in its estimates for future investment, from
which I take it that we could levy a further 10% tax increase
and not scupper any of the projects?
Mr Webb: No, because I think that
that increase will be scuppering some of the projects. There is
a limit to how much this can go on. I heard that, for the company
that was applying this extra hurdle, as a result of that the minimum
size of development it would look at had also increased quite
significantly.
Q26 Mr Davidson: Given that the oil
price has shot upwards, clearly that has been financially beneficial
to a substantial amount of the industry and it is essentially
windfall gains. Do you not think it is reasonable for the Government
to seek to have an element of that windfall gain come to Government
rather than simply remain with the companies, and that therefore
some form of tax increase, perhaps not this form but some form,
was entirely appropriate and indeed was popular?
Mr Webb: In our view what the
Government had done previously in the Budget of 2002 was having
that effect. We could perhaps show you some workings on this that
we have done. Post all taxes, we see the rate of return in the
North Sea, and this is before the last tax increase, falling,
not rising. In other words, the Government was getting an increased
share of the benefits from the North Sea before this latest tax
increase came in.
Q27 Mr Davidson: When you say the
Government's share was rising, not falling, are you saying that
the industry's share was falling?
Mr Webb: Post tax.
Q28 Mr Davidson: As a result of the
oil price increase the industry was worse off than it was before?
I find that difficult to believe.
Mr Webb: We have got very significant
cost inflation going on in this industry at the moment. The cost
of rigs, for example, has at least quadrupled over the last two
or three years. Some rigs have gone up six-fold over that period.
There is very significant cost inflation, some of this borne out
of the problems with Katrina, of course, in the Gulf of Mexico
which decides the global position on oil supply, so not everything
has been moving positively along with oil prices here for the
industry, and the tax take has gone up. Would it be helpful if
we showed you a graph we have?
Q29 Mr Davidson: While that is being
distributed can I clarify one point? You talk about inflation
in terms of rig rates and so on. Rigs are part of the industry
and presumably the fact that rigs are attracting higher costs
or higher prices is a bonus for that part of the industry. This
is rent that they are receiving which is at a much higher level
than it was before, so presumably those prices are being driven
up by scarcity, but they are not in turn being driven up by the
costs of the rigs themselves. It is just that the rigs themselves
are able to extract a much higher price than they were before,
so that is additional money going into the industry. Therefore,
if you are looking at the industry as a whole, the fact that one
section is charging more than another section is not an indication
that the money is going out of the industry overall.
Mr Webb: One could say that, but
if you look at it in a UK sense that can be happening, because
what is happening is that we are in international competition
for these scarce resources, so some of those resources are moving
outside the UK, and the costs with them, it is true, but they
are then not available to us in the UK to use, which increases
the scarcity here which pushes the price up and certainly reduces
the oil companies' margins. Would it help if Mike explained this
graph to you?[3]
Mr Tholen: What you see here is
work that refers to the ONS statistics on rate of return and it
is stuff that the Chancellor has quoted and is well known within
Treasury; we have discussed this with them. The blue line at the
top shows the pre-tax rate of return which, as you see, ranges
from about 15% in 1995 through to 35% in 2005. The data is straight
off the ONS website. What you see in the red line is the post-tax
rate of return because the numbers at the top exclude PRT, corporation
tax and the supplementary charge. Clearly, pre-tax rates of return
have pretty much followed the oil price, albeit they have not
risen as fast, because costs have gone up a lot in the last few
years. Post-tax, when you look at the impact of both costs and
tax, we see that, particularly since 2002, the rate of return
within the industry has declined. These numbers we have discussed
with Treasury, they are aware of them. We discussed them first
with the Paymaster General in November and have presented them
again to Treasury several times since. It shows that underneath
the industry is undoubtedly a healthy one but one that is having
to fight to remain as attractive as it was even three or four
years ago despite the current high increases in oil and gas prices.
Mr Webb: I am bound to say as
well that another element of disappointment with the Pre Budget
Report was when the Chancellor referred to 40% rates of return
in the industry but we are still not sure where the 40% number
comes from. The ONS number is somewhat lower than that, but also,
very significantly, return on capital employed is a calculation
that is done before tax, and this industry is unlike any other
industry in that it pays significant amounts of special tax. As
I say, our marginal rate on the older fields is 75%. There is
no other part of British industry that is paying tax at that level.
Therefore, to compare pre-tax rates of return of this industry
against any other is a meaningless exercise.
Q30 David Mundell: In the context
of stability, what I have picked up is that, whilst we may have
a superficial view that other parts of the world are politically
more unstable, is it not the case that in recent times they have
had a more stable tax regime than here in the UK in terms of the
predictions that are made in the context of investment?
Mr Webb: That is a recurrent comment
I have heard from my members, yes, that if you go into other parts
of the world the risk inherent in retrospective change to the
deal that has been done is very low indeed, much lower than it
would seem to be in this country now. I was speaking to somebody
the other day who was talking about, for example, Egypt, and they
were mentioning that their production chain contract in Egypt
has not been changed on terms of Government and industry take
since it was signed and they have great confidence that it will
not be. I have heard that in various other comments on other parts
of the world, so it would be a mistake to believe that the industry
does not take rather seriously fiscal instability that we do now
seem to have vested on us here. The Chancellor, in all fairness,
did say in his Pre Budget Report that he would not change the
tax rates on this industry again for the life of this Parliament,
but that again demonstrated a slight lack of awareness of this
industry. This is an industry where projects take normally two
to three years to bring on stream, so that comment, as one of
my members said wryly to me, just means, "I am not going
to be taxed whilst I am doing all the investment but all bets
are off once I start production". That much security, however,
I suppose was welcome. What we would like to see is that extended
somewhat beyond a period of just a few years.
Q31 Mr MacNeil: Mr Tholen, you mentioned
testing against a higher tax rate by companies and, listening
to Mr Webb's earlier comments about maximising the long term revenue,
between you both what effect do you think this is going to have
on maximising the long term revenue, the amount of money we can
get out of the North Sea, given that there seems to be a finite
time due to the infrastructure difficulties of rusting pipelines
and whatever? The reason I ask this is that any responsible finance
minister has to look for the maximising of the revenue as opposed
to short term gain and filling a real black hole in his economic
sums?
Mr Tholen: The best example I
can give you is, again, going back, you perhaps heard people mention
last night the "Tale of Two Futures" and the vision
of how industry can look if we keep investing at appropriate rates,
basically maxing out, compared with what happens if we just look
at what the current plans will deliver, or if we look at what
happens if investment dries up. There are three scenarios: fast
depletion, the current plans and what we can deliver based on
the potential in the basin. When you look at that, and again this
is work we have presented to Government, you see a tax capacity
that is close to three times as big as if you look at what happens
if you keep investing at the current rates compared with what
happens if we see investment drying up. That gives a good example
of the future opportunities, both for Government and for industry,
if we see the right level of activity delivering that right result.
Mr Webb: I do not think that is
something that the Government disagrees with because they put
that very graph in their Energy Policy Review document. If you
look at the document that launched the Energy Policy Review that
Tale of Two Futures graph was in there.
Q32 Mr MacNeil: Do you think the
tax increase helps maximise the revenue for the country or are
we jeopardising gains to future generations as a result of that?
Mr Webb: I believe that maximising
short term tax revenues risks damaging long term returns, and
not just financial returns. I do actually think that this precious
gift that we have of the UK offshore is of huge benefit to us
in terms of security of energy supply. Yes, we are not self-sufficient
in gas now but we are still a significant producer. Remember,
the UK is a larger oil and gas producer than Kuwait; it is a larger
oil and gas producer than Indonesia and Nigeria. It is still a
significant player on the world scene and can continue to be so
for years to come. We will still be self-sufficient in oil until
about 2010. After that, yes, again, we will be importing some
of our requirements but we can still be a significant producer
and that is very important in my mind in terms of energy security
of supply. To have that in the mix is very important, and that
is not to say anything about the jobs that this industry supports,
both in our companies but also in the supply chain.
Q33 Mr MacNeil: If you have a fear
of it drying up in any way because of what the Chancellor has
done, how much will we not extract as a result? Is that possible
to quantify?
Mr Webb: It is. Maybe we could
come back to you with a quantification of that but I can give
you a feel for it in the terms of that Tale of Two Futures. What
we showed there was that if we could maintain investment at the
current level going forward then in 2020 we could be producing
round about two million barrels of oil and gas equivalent a day.
If, however, we went on the scenario that the investment dries
up, then we could be down to producing something like half a million
or so barrels a day at that point. Then the basin gets into very
difficult territory because at those levels of production we will
see a lot of that infrastructure going away, never to be put back
again, and that will leave the smaller puddles of gas and oil,
if you like, that are around probably never to be recovered because
they are too small to justify the investment in the delivery infrastructure.[4]
Q34 Mr McGovern: Can I ask a question
on this graph here? The post-tax rate of return in my opinion,
and I am not an economise, still looks pretty healthy to me. It
is not as high as it has been but it is certainly not as low as
it has been. Could you comment on that? I know that these figures
are probably as recent as you can provide but could you say how
you feel the most recent increase would affect that? Also, in
answer to one of Angus's questions, you said that you felt that
it was a short term gain and there would be possible damage to
long term returns. Do you mean long term returns for people investing
in that industry?
Mr Webb: I mean long term returns
into the country as a result of that, what we could produce from
the whole basin. That is the potential damage. Who is to say a
significant price increase will not happen—and, by the way,
we are not predicting it and we will give no predictions on oil
and gas prices? I do not know if you saw it yesterday but I was
struck by, in the Financial Times, a comment about refining
capacity but it linked into oil and gas supply and I will just
give you two quotes: "Merrill Lynch expects global oil production
to rise by 2.6 million barrels a day next year, which would lead
to further increases in the global stockpiles", and then
at the end, "Oil inventories in countries of the OECD are
even higher than the very high levels seen in 1998 which triggered
an oil price collapse to $10 and demand started to slow".
Please, I am not suggesting that we are going to have any oil
price collapse. What I am saying though is that the oil market
is a market and prices can go down and we know that. It is a very
volatile market. If there is a price reduction now then very sharp
action is going to have to be taken by the Government to make
sure that the offshore does not go into meltdown. I do not think
that answers all of your questions. Can you remind me what they
were?
Q35 Mr McGovern: It was on the graph.
Mr Webb: I will hand over to Mike
to explain the technicals of that but maybe I will just say that
yes, let us not pretend this is not a profitable industry and,
frankly, a very successful industry. This is an oil and gas industry
that has invested £215 billion in the offshore so far; that
is capital investment, and has spent another over £100 billion
on operations in the offshore. To attract those sums of money
you need to be a successful and profitable going concern and we
have certainly got those, I am pleased to say, in the North Sea
and they are still coming here. Yes, it is a profitable industry
but I do not think it is a wildly profitable industry at those
sorts of return.
Mr Tholen: I do not know if I
can add much to that. The post-tax rate of return is on a par
with certain other sectors—pharmaceuticals, banking, which
also seem to be profitable industries and, as we all know, deliver
very good benefits to both society and to the economy in terms
of employment, tax paid and wealth creation for the nation. That
is what the industry seeks to do.
Q36 Mr McGovern: We have heard a
lot about fiscal stability. Could you clarify for me more precisely
just how a stable fiscal regime would help to promote maximising
production from the UK Continental Shelf?
Mr Webb: There are many risks
involved in this industry and most of those are not controllable
by Government. They are the significant technical risks that there
are in these hostile waters offshore the UK and bringing back
these more complex reservoirs. There is a significant price risk.
One only has to look back at the record of prices in oil and gas
in the world to see how volatile those markets are. These are
the risks that the industry has to accommodate and take on board,
let alone the engineering risk in some of these projects, which
is also quite significant. Those are risks that the industry has
to take on board and it can deal with those, but it is made much
worse if there is another wild card in the pack, which is the
fiscal rate changing with some rapidity over time and giving rise
to concerns of real fear of that happening again. That is a risk
that Government can control and if they control that for us correctly
it helps us greatly get on and manage the other very significant
risks that our companies have to manage. That is the core of it.
Q37 Danny Alexander: Mr Webb, can
I follow up what you meant in response to Mr McGovern's previous
question, which was in relation to—and I am not asking you
to make predictions—the impact of a fall in the oil price?
As a result of the tax change that has been made and also the
instability of us building in an extra premium in those investment
decisions, roughly to what level would the oil price have to fall
before you started seeing a marked impact on investment decisions
on the UK Continental Shelf and how does that differ from what
the situation would have been last year or three or four years
ago?
Mr Webb: That is a prediction
though, is it not, that you are asking me to make? I think I have
to be very careful. I think I have said it before, actually. I
think that the area of risk lies somewhere between $30 and $40.
Q38 Mr Davidson: Can I come on to
the question of opportunities for growth? If you had not had to
find this £0.9 billion oil tax what would it have been spent
on? Would it have just gone to lining the pockets of shareholders
or were there any particular projects that you can identify as
having been missed?
Mr Webb: As you rightly say, this
year it is £0.9 billion. If the industry had had that £0.9
billion what would it have done with it? I think it would have
invested a very significant amount of it. Part of the reason that
it is not £2 billion but £0.9 billion is that the industry
is investing so hard in the North Sea at the moment, so I think
some of it would have gone there and some of it would have gone
to pay returns to shareholders, no doubt.
Q39 Mr Davidson: What would the balance
have been? Given that the industry, from what you are indicating,
would appear not to have been deterred from investing by this
tax increase, are there any projects that you can identify that
were foregone as a result of the increase?
Mr Webb: No.
3 See graph Ev 19. Blue line is shown as a black unbroken
line and red line as a paler unbroken line. Back
4
Note by Witness: UKOOA reflected that the "Tale of
Two Futures" provided some indication of the volumes of oil
and gas which were at risk if investment were not be sustained.
This shows, by 2002, that 3 billion boe (barrels of oil and gas
equivalent) could be lost if investment were not sustained at
recent rates. Back
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