North Sea oil industry still in danger from Tory-Lib Dem tax grab

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Energy Analysis by George Kerevan

THE Coalition Government at Westminster has backed down on plans to tax the North Sea oil industry for every worker it flies offshore on helicopters.

It emerged last week that Coalition ministers were going to apply the top rate of air passenger duty (APD) to all helicopter flights to rigs and platforms. But after a backlash from industry chiefs and the new SNP Government, the Lib Dem Secretary of State for Scotland, Michael Moore, has retreated.

The tax would have cost the industry another £165m per annum on top of the £10bn tax grab announced by Chancellor George Osborne in his March Budget. The surprise Budget levy was supposed to save the Lib Dems at the Holyrood elections by funding a fuel price stabiliser – a long-time SNP demand.

Mr Osborne’s cunning plan to assuage anger at the petrol pumps did not save the Lib Dems from electoral meltdown, in part because it only reduced petrol prices by a pathetic one pence.  Unfortunately, the levy also continues to threaten new investment in oil and gas production.

True, oil prices have risen shaply in the past 18 months, from around $70 a barrel to around circa $120. As a result, oil companies are making windfall profits. Shell recently announced its fourth quarter earnings had jumped from $1.2 billion to $5.7 billion.

However, Mr Osborne is taking a risk in upping taxes. Demand for oil is surging, driven by growth in Asia. But new sources are deeper down in the earth’s crust and more expensive to extract. As a result, the financial risks are huge – witness BP’s catastrophe in the Mexican Gulf last year.  And the returns are thin compared with other industries.

For instance, Shell generated revenues of $378 billion last year, but after the expense of getting oil and gas out of the ground, post-tax profits represent barely five per cent of total earnings. And that is after the oil price rise. On the other hand, Barclays bank generated profits equivalent to 19 per cent of its revenues.

In UK waters, the cost of finding and extracting new oil is even higher than in other parts of the world. This is because new discoveries are either small, or located deep in the treacherous Atlantic. As a result, attracting fresh investment is always problematic. Fortunately, recent higher oil prices have tipped the balance in favour of extra funding – just. This year, investment in the UK sector should rise to £8 billion, up from £6 billion in 2010. That means an extra 5,000 to 7,500 jobs for Scotland.

Before the March tax levy, investment in the North Sea in 2011 was forecast to rise by £2 billion. But Osborne now intends to grab an extra £2bn a year from the North Sea; i.e. effectively grabbing that investment cash for the Treasury. The big risk is that he will drain investment from North Sea just when it is needed most.

Can we quantify this risk? Mr Osborne’s new tax is a levy on profits generated specifically in UK waters. He has raised this “supplemental” levy from 20 per cent to 32 per cent. That’s a 60 per cent increase overnight. This is addition both to corporation tax and (in older fields) Petroleum Revenue Tax. The marginal rate on North Sea earnings is now between 62 percent and over 80 per cent, depending on the field.

But the bulk of new investment in the North Sea comes from small, independent oil firms – not giants such as Shell and BP, which have largely pulled out of the sector. These small companies will be hit hardest by Mr Osborne’s tax raid. If the rate of return on ventures in the North Sea becomes lower than in other parts of the world – as a result of the new tax – these firms will no longer be able to raise finance for UK operations. So they will go elsewhere.

That elsewhere could include Ireland. There are known oil and gas deposits off the Irish coast, in the Atlantic and the Celtic Sea. To date, they have been too difficult and expensive to access. But soaring oil prices and new technology have transformed the situation, and a cash-strapped Irish government scents an important source of revenue. For energy companies, Ireland’s low petroleum tax regime – a mere 25 per cent – could prove a strong incentive.

Additionally, if Mr Osborne lets Northern Ireland set its own (lower) corporation tax, as he hinted in the Budget, it could pay Scottish-based oil companies to relocate to Belfast if they want to explore the Celtic Sea.

Unless, of course, Scotland also gets to control its own corporation tax.