Taxing oil

By Scott McCulloch on Mar 23, 11 04:33 PM in Energy

You have to wonder at the logic the Chancellor George Osborne applied to the Supplementary Rate of Corporation Tax for the North Sea oil and gas sector, pushing the rate up from 20 to 32 per cent in an attempt to appease the public on rocketing fuel costs.

For an oil and gas region which has already reached peak production, this could be a massive blow if the big players decide to mothball their UK North Sea operations until we reach the Chancellors hallowed $75 a barrel oil cut off.

Derek Leith, oil and gas partner at Ernst & Young believes the Government has backtracked on a commitment last year to ensuring investment in the North Sea by creating a stable and fair UK oil and gas tax regime.

Leith says, that script has been binned.

He said the rise from 20 to 32 per cent "demonstrates to industry in an unambiguous fashion that there is no real concept of fiscal stability in the UK."

Leith adds: "It is hard to comprehend that mature oil and gas fields, which already pay petroleum revenue tax as well as corporation tax, will now suffer a marginal tax rate of 81 per cent. Many companies will be frantically re-appraising their plans for capital investment in the UKCS in the coming days.

"The prospect that the rate will reduce if the oil price falls before a certain level, and the possibility of some measure of relief for new gas fields will carry little weight with oil companies in the light of such a significant increase in tax."

Analysts believe the tax hike will have little effect on the two biggest players in the North Sea - BP and Royal Dutch Shell - as they have both reduced their operations in the region over the years.

However, for the smaller firms, many of which are based in Scotland, the Chancellor's tax grab will undoubtedly have an impact, despite the rise being offset to some degree by a reduction in corporation tax to 23 per cent within the next three years.

Figures from the industry trade group Oil & Gas UK suggest North Sea output is still more than two million barrels a day, with a number of new North Sea finds yet to come online.

UK Brent is currently trading at $114 a barrel, so the chances of the oil and gas firms seeing this tax rate drop in the near future are remote at best.

But how poor a hand has been dealt to the oil and gas firms?

On the face of it a rise from 20 to 32 per cent on the Supplementary Charge seems almost oppressive until we look back to historical averages.

In 1975-76, Petroleum Revenue tax - which is a direct tax - stood at 75 per cent and corporation tax at 52 per cent.

The Petroleum Revenue Tax (PRT) was introduced under the Oil Taxation Act 1975 to ensure "a fairer share of the profits for the nation" and a suitable return for the oil and gas firms.

PRT is charged on top of corporation tax on what are called "super profits" oil and gas firms make from individual oil and gas fields, though losses from poorly performing fields could not be offset against the best performing ones.

PRT was abolished in 1993 for new fields given development consent, and the rate was reduced from 75 per cent to 50 per cent for those fields already producing which remained subject to the original levy.

HMRC historically took a flat 12.5 per cent Royalties Tax on the gross value of oil and gas extracted, which stood unchanged from 1975 until 2002, when the 10 per cent Supplementary Charge was first introduced.

The Supplementary Charge rose from 10 per cent to 20 per cent in 2005 and has remained at the same rate since.

In 1993, the Petroleum Revenue tax dropped from 75 per cent to 50 per cent, where it has remained ever since.

Corporation Tax fell from 52 per cent in 1975 to 50 per cent in 1983 and to 35 per cent by 1986.

Four cuts in corporation tax between 1983 and 1999 took the corporation tax to 30 per cent, where it has remained ever since.

So in real terms, Petroleum Revenue tax, Corporation tax and the Supplementary Charge hasn't changed since 2005, though the price of oil and gas most definitely has.

The price of a barrel of oil remained fairly stable from the mid-1980's until 2003 at $25 a barrel, but by 2005 the price of oil had more than doubled to $60 a barrel, and then climbed steadily to the peak of $147 a barrel in July, 2008.

So, between the mid-1980's to 2008, the price of oil rose 488 per cent whilst the rate of Petroleum tax fell from 75 to 50 per cent and corporation tax from 50 to 30 per cent.

Royalty rates remained at 12.5 per cent from 1975 to 2003 before the introduction of the Supplementary Charge at 10 per cent in 2002, rising to 20 per cent in 2005.

Corporation tax will fall from 30 to 23 per cent within the next three years which will offset the Supplementary Charge rise to some degree.

The Chancellor seems very keen to get the Treasury's hand in the pockets of the oil and gas firms operating in the North Sea.

While it is difficult to gauge how much of the current oil price spike is speculative rather than resource led, results from a Scottish oil and gas firm operating overseas posted today hints at the profits to be made in black gold.

Melrose Resource reported its profits on a barrel of oil rose from $6.64 in 2009 to $11.59 last year, a 74.5 per cent increase.

BP, before its disastrous management of its Gulf of Mexico drilling exploits, made a profit of £21.6 billion when oil prices peaked in 2008, which fell by nearly £5 billion 2009 as oil prices stabilised.

So, while the Chancellor may well have upset the oil and gas firms operating in the North Sea, the profits to be made in the present market still make extraction extremely attractive.

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I totally agree with everything you say Scott and if something doesn't change then we all gonna end up at the bottom of the barrel. Scott, please contact me. I have much more to say on the subject and if you reconize my name from the far west you will know why. said:

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