| LONDON, July 24
LONDON, July 24 UK government revenues from oil
and gas production will almost halve over the next four years,
as falling output as well as investment in new fields and the
cost of decommissioning old ones cut into tax receipts.
Shrinking revenues highlight the rapid depletion of North
Sea oil fields, but also the growing costs of plugging and
abandoning old wells that are no longer productive as the
province becomes more mature.
They have also triggered a bitter conflict between the
industry and the government over the tax regime and relief for
According to Britain's tax authority, tax revenues from oil
and gas production peaked at almost 13 billion pounds in the
fiscal year which started on April 6, 2008 (though in real terms
they were much higher in the early and mid 1980s when booming
North Sea oil output coincided with high oil prices supported by
the Iranian revolution and OPEC).
By fiscal 2011, revenues had shrunk to 11.25 billion pounds.
But in its latest fiscal outlook, released to accompany the
budget, the government's independent Office for Budget
Responsibility (OBR) forecast revenues would tumble to only 5.3
billion pounds by fiscal 2016, the lowest level in real terms
since the 1990s, even though crude oil and gas prices are now
much higher ("Economic and Fiscal Outlook" March 2012).
Projected revenues are highly sensitive to anticipated oil
and gas prices. Forecasts exhibit significant swings in response
to price changes. Moreover, because OBR bases its projections on
prices for futures contracts, they are biased downwards at
present owing to the backwardation in the Brent forward curve.
However, price effects explain only a small part of the
expected decline in tax revenues. Far more important is the
anticipated decline in production.
OBR forecasts oil output will drop 14 percent from 51.9
million tonnes (400 million barrels) in fiscal 2011 and 48.3
million tonnes in fiscal 2012 to just 44.7 million tonnes by
fiscal 2016. Gas is predicted to decline 7 percent from 16.1
billion therms in fiscal 2011 and fiscal 2012 to just 14.9
billion by 2016.
Some OBR projections and assumptions are set out in the
attached table: link.reuters.com/dew59s
But by far the biggest downward revisions to the OBR's
revenue projections stem from increased spending on the
development of new oil and gas fields, and the expense of
decommissioning depleted old ones, which the industry can offset
The UK Continental Shelf contains 470 installations, 10,000
km of pipeline and 5,000 wells, all of which will eventually
have to be decommissioned, according to Oil and Gas UK, the
offshore industry's trade association.
Higher oil and gas prices have encouraged operators to
extend the life of some wells that would previously have been
decommissioned. Nonetheless, as fields age, the number of wells
scheduled for plugging and abandonment is rising.
Oil and Gas UK estimates the industry will spend 3.3 billion
pounds on decommissioning between 2012 and 2016, and eventually
a total of 28.7 billion pounds (at current prices) from 2012
onwards decommissioning all the current wells and
Projected costs have tripled since 2005, reflecting the
extra decommissioning cost of new projects launched in response
to high prices, as well as the general uptrend in costs across
the industry, including for production and development
("Economic Report 2012" UK Oil and Gas).
In a separate piece of research, oilfield services firm
Schlumberger estimated that 500 structures with about 3,000
wells are slated for permanent abandonment in the UK sector in
the near future.
It is part of a wider phenomenon in maturing oil regions.
"By some estimates, as many as 12,000 wells are no longer
producing in the Gulf of Mexico, qualifying them as plugging and
abandonment candidates. In the Norwegian sector of the North
Sea, more than 350 platforms and more than 3,700 wells
eventually must be abandoned," according to Schlumberger
("Offshore Permanent Well Abandonment" Schlumberger Oilfield
Review, Spring 2012).
Schlumberger put the cost of plugging and abandoning
a well in the UK North Sea at between $1-2 million at the low
end and $5-6 million at the high one -- depending on whether the
abandonment is from a fixed platform or requires the use of a
semisubmersible drilling rig or support vessel with dynamic
Decommissioning in Norway is even more expensive, owing to
the country's more stringent industry standards and government
Decommissioning will become an ever more significant cost
for oil and gas producers as offshore fields which began
producing in the 1970s, 1980s and 1990s reach the end of their
productive lives. While some costs are incurred earlier, most of
the costs of decommissioning (and tax relief) tend to be
incurred at the end of a field's life, according to the UK tax
UK taxation of offshore oil and gas is a complex combination
of ring fenced corporation tax (levied at 30 percent), a
supplementary charge on profits (levied at 32 percent) and, on
fields permissioned before March 1993, petroleum revenue tax
(PRT) (50 percent). In total, the marginal rate of tax is either
62 percent or 81 percent depending on whether or not the field
is subject to PRT.
The regime is significantly tougher than for companies in
other sectors. The rate of corporation tax is specially ring
fenced to prevent taxable profits from oil and gas extraction
being reduced by losses from other activities or by excessive
interest payments (hence "ring fenced corporation tax").
Offshore petroleum producers have specifically been excluded
from gradual cuts in the main corporation tax rate announced in
recent budgets. Instead the government has bumped up the
supplementary charge from 20 percent to 32 percent in 2011,
basically to capture some of the windfall from higher prices.
In a bitter blow, which has left producers fuming, while the
supplement has been raised to 32 percent, tax relief for
expenditures (including decommissioning) has been capped at the
old rate of 20 percent -- introducing a highly unusual asymmetry
between the rates at which profits are taxed and the rates at
which legitimate expenses can be offset against tax.
The industry complains UK taxation is not competitive. While
Norway has a higher headline tax rate, the industry claims
discoveries there are more competitive because the fields tend
to be larger and there are more generous allowances for capital
and drilling costs. In the Netherlands, the tax rate is a flat
50 percent, far below Britain's 62 and 81 percent rates.
But what appears to have really incensed the industry is the
tax regime's instability. UK Oil and Gas lists more than 16
separate changes to the tax rules since 2002.
Fiscal instability, complains the association, "has blighted
the UK Continental Shelf during the past ten years as the result
of three separate tax increases since 2002 and a multitude of
other tax changes. Fiscal instability creates uncertainty in
investment decisions and makes the UK more costly by increasing
the fiscal risk premium, especially given the long-term nature
of most oil and gas projects".
The decision to cap tax relief from the supplementary charge
at the old rate of 20 percent led to widespread fears the relief
might be scaled back even further in future. Following intense
pressure, the government agreed in the 2012 budget to enter into
contractual commitments with operators from 2013 to guarantee
the future rate of relief.
The combination of near-record oil prices, falling
production, and looming decommissioning costs has triggered a
fierce fight between operators and the tax authorities to secure
their share of a shrinking resource and revenue base, as
everyone tries to avert the inevitable.
But even the government's fierce squeeze on the industry,
attempting to maximise its share of the remaining "rent", cannot
forestall the imminent reduction in revenues as output sinks and
aging fields incur more and more non-productive costs for
plugging and abandonment.
(Editing by Anthony Barker)