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U.K. Government Offers Upstream Tax Breaks Amid Soaring Oil Prices

29 May 08

The U.K. government has exempted around 30 North Sea oil and gas fields from Petroleum Revenue Tax (PRT) in a bid to boost production as pressure builds from consumers over soaring oil prices.

Global Insight Perspective
Significance	The tax breaks could add up to 20,000 barrels a day (b/d) of new production, but, perhaps more importantly, the move signals a willingness on the part of the government to adjust the fiscal regime to ensure that oil and gas resources on the United Kingdom Continental Shelf (UKCS) are maximised.
Implications	In addition to announcing the tax breaks, the government has approved the development of two new oilfields that could add a further 50,000 b/d of production.
Outlook	The government's moves have been well received by the industry and a dialogue between the two will continue, raising the possibility of further relief measures in the future, although consumers are likely to be left less convinced.

Decisive Action

U.K. Prime Minister Gordon Brown met oil and gas industry representatives yesterday as pressure built on the government to respond to the relentless rise in global oil prices. In an indication of the seriousness with which he views the situation, Brown announced in a post-meeting press conference "I met the oil producers today because we are facing the third great oil shock in decades." Oil prices have continued their ascent to record levels of over US$130 per barrel in recent weeks, representing a more than twofold increase over the past 12 months. The price surge has now flowed through to the cost of petroleum products at the pump, leading to widespread protests this week, including in the United Kingdom, from truck drivers, fisherman, farmers, and other groups severely affected by the price rises. In a clear bid to show he was responding to the crisis, Brown announced new measures designed to boost oil and gas production from the United Kingdom's own North Sea territory.

Tax Adjustment

The central response announced by the government was to exempt a limited number of oil and gas fields from the additional burden of the PRT. Oil and gas profits in the United Kingdom are taxed at a rate of 50%, although fields that received development consent before March 1993 also have to pay the PRT. The PRT is levied at 50% of cash flow after capital expenditure and operating costs on oil produced above a specific allowance for each field, in some cases boosting the overall tax burden to around 75%. The government announced that it was now allowing new oil and gas fields to be carved out of unprofitable parts of some existing fields, allowing production from these new fields to be exempt from the PRT. The change applies to around 30 existing oil and gas fields. Malcolm Webb, the chief executive of industry body Oil & Gas U.K., said the proposal could have "a significant impact on the near-term production" with initial government estimates suggesting that the move could see additional peak production of 20,000 b/d.

New Fields Approved

At the same time, the government announced that it had given the go-ahead to the development of the Don fields in the central sector of the North Sea. Don Southwest and West Don will be developed jointly with a floating production unit, with output to be exported via offshore tanker for an initial period of about six months, before being switched to pipeline export via a subsea line to the Thistle platform and on to the Brent pipeline system. Development drilling is now expected to start in the third quarter of the year. Production from the fields is anticipated to come onstream in the first half of 2009, and will peak at 50,000 b/d. The fields are operated by Petrofac.

Outlook and Implications

The government has faced a growing tide of pressure from consumers over rising oil prices. With the price again reaching a new record high above US$135 per barrel last week, it has now been prompted to take action. Yesterday's announcements reveal that the government's first step in alleviating the impact of tightening global oil markets will be to ensure that the country's own oil and gas resources are maximised. The adjustment to the PRT coverage may have only a limited impact, but it has been well received by the industry and provides some indication of the government's willingness to consider changes to the fiscal regime in order to ensure that the 25 billion barrels of oil and gas thought to remain in U.K. territory are fully exploited. A dialogue between the industry and the government will no doubt continue in the wake of yesterday's meeting and the industry will surely use the opportunity provided by concerns over high oil prices to push its case for further fiscal reform, including continuing to pressure the government to adjust the offshore tax surcharge rate of 20% (over and above the standard company tax rate of 30%). Still, the government appears more likely to follow a programme of minor changes as it seeks to ensure that the North Sea remains a competitive development location, particularly given that the high price environment is seeing companies reap more profits than ever before from existing fields.

While the industry responded positively to yesterday's announcements by the government, consumers may be left less convinced. Ensuring that indigenous oil and gas resources are maximised may contribute to easing the long-term burden of a tightening global oil market, but in the short term consumers are unlikely to derive much relief. As such, the moves will do little to relieve pressure from businesses and motorists heavily affected by higher fuel prices and the government may now have to begin considering more direct relief, particularly if oil prices continue to reach new highs.

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