Budget 2011: Oil & Gas Tax changes
As many Stockopedia readers have investments linked to North Sea oil and gas assets, it seems worth examining the changes announced in the Budget in some detail.
Those details can be found in the 240 page budget overview (tax simplification, anyone?). Here is what I've found:
Starting with page 3:
Oil and Gas Taxes
1.13 Supplementary charge — Legislation, effective from 24 March 2011, will be introduced in Finance Bill 2011 to increase the rate of the supplementary charge levied on profits from UK oil and gas production from 20 per cent to 32 per cent. As part of the fair fuel stabiliser, if in future years the oil price falls below a set trigger price on a sustained basis, the Government will reduce the supplementary charge back towards 20 per cent on a staged and affordable basis while prices remain low. The Government believes that a trigger price of US $75 per barrel would be appropriate, and will set a final level and mechanism after seeking the views of oil and gas companies and motoring groups. A Tax Information and Impact Note for this measure is available at Annex A. Chapter 3 includes further information on North Sea oil taxation.
1.14 Oil and gas: intangible fixed assets — Legislation, effective from 23 March 2011, will be introduced in Finance Bill 2011 which will ensure that the scope of the corporate intangible fixed asset (IFA) rules excludes all goodwill and any intangible asset which relates to, derives from or is connected with an oil licence or an interest in an oil licence. The legislation is needed because some companies have interpreted accountancy practice in such a way that goodwill is recognised on the acquisition of an oil licence or an interest in an oil licence. This interpretation may bring this goodwill within the scope of the IFA regime which conflicts with what was intended when the legislation was introduced. Draft legislation has been published on 23 March 2011 on the HMRC website and a Tax Information and Impact Note for this measure is available at Annex A.
1.13 - Aarrghh!!!; 1.14 - needs a tax expert to interpret but suggests to me that companies may find it harder to recover costs of licences acquired against tax.
p14:
Oil and Gas Taxes
2.17 Oil and gas minor measures — Legislation will be introduced in Finance Bill 2011 to make minor changes to the regime for oil and gas companies that operate in the UK or on the UK continental shelf. One of these measures extends the scope of the chargeable gains ring fence reinvestment relief to allow the relief to apply, for disposals made on or after 24 March 2010, when proceeds are reinvested in exploration and development expenditure. As a result of the consultation on the draft clauses the legislation will now explicitly apply when proceeds are reinvested in exploration, appraisal and development expenditure.
Interesting: should encourage reinvestment...
p24:
Oil and Gas Taxes
3.27 North Sea oil tax — Legislation will be introduced in Finance Bill 2012, with effect from Budget 2012, to restrict tax relief for decommissioning expenditure to the 20 per cent rate of supplementary charge. There will be no restrictions to decommissioning relief beyond this level for the lifetime of this Parliament. The Government will work with the industry with the aim of announcing further, longer term, certainty on decommissioning at Budget 2012. Recognising the importance of continuing investment in the North Sea including in marginal gas fields, the Government will also consider with the industry the case for introducing a new category of field that would qualify for field allowance. Chapter 1 includes details about changes to the supplementary charge.
Very bad idea. Encore Oil's Alan Booth has mentioned that concerns about decommissioning costs were a major factor discouraging larger oil companies from investing in the UKCS. Restricting tax relief on decommissioning obviously increases the risk attached to operating fields with a limited life and will reduce their value and hence any incentive to invest in "squeezing out the last drop".
pA53 (details of Supplementary Charge changes):
Oil and Gas Taxation: Supplementary Charge
Who is likely to be affected?
Oil and gas companies that operate in the UK or on the UK Continental Shelf (UKCS).
General description of the measureLegislation will be introduced in Finance Bill 2011, effective from 24 March 2011, to increase the supplementary charge payable in respect of profits from oil and gas production in the UK and UKCS from 20 per cent to 32 per cent.
As part of the fair fuel stabiliser, if in future years the oil price falls below a set trigger price on a sustained basis, the Government will reduce the supplementary charge back towards 20 per cent on a staged and affordable basis while prices remain low. The Government believes that a trigger price of US $75 per barrel would be appropriate, but will set a final level and mechanism after seeking the views of oil and gas companies and motoring groups.
Legislation will be introduced in Finance Bill 2012, with effect from Budget 2012, to restrict tax relief for decommissioning expenses to the 20 per cent rate of supplementary charge. There will be no restrictions to decommissioning relief beyond this level for the lifetime of this Parliament. The Government will work with the industry with the aim of announcing further, longer-term certainty on decommissioning at Budget 2012.
Policy objectiveThe increase in the supplementary charge at a time of high oil prices reflects the Government’s aim to strike the right balance between oil producers and consumers, and to ensure fairness to taxpayers.
Background to the measureThis measure was announced at Budget 2011.
Detailed proposalOperative date
This measure will have effect on and after 24 March 2011.
Current lawA company operating in the UK or on the UKCS is liable to corporation tax on its profits. However the UK tax code puts a ring fence around profits from UK and UKCS oil and gas production to ensure they are not reduced by losses from other activities. This ensures the Government achieves its desired taxation from the exploitation of a national natural resource.
Section 279 Corporation Tax Act (CTA) 2010 details the ring fence treatment and provides that certain oil-related activities conducted as part of a trade are to be treated for the purposes of corporation tax as ‘a separate trade, distinct from all other activities carried on by the company as part of the trade’. These (‘upstream’) activities are:
• any oil extraction activities (section 272 CTA 2010)
• the acquisition, enjoyment or exploitation of oil rights (sections 273 and 274 CTA 2010).
In addition to ring fence corporation tax, profits derived from upstream activities are subject to an additional tax, the supplementary charge (section 330 CTA 2010). The supplementary charge is currently charged at 20 per cent.
Proposed revisionsThe proposed measure, which is effective from 24 March 2011, will be introduced in Finance Bill 2011. It will increase the rate of the supplementary charge to 32 per cent.
The rate at which companies obtain relief for decommissioning expenses will be changed by Finance Bill 2012, with effect from Budget 2012, to deny relief against the increase in the amount of supplementary charge.
Waiting another year to clarify decommissioning relief is damaging, but at least consultations are being undertaken.
pA57 - Clarification of tax treatment of intangible fixed assets
Oil and Gas: Intangible Fixed Assets
Who is likely to be affected?
Oil and gas companies that operate in the UK or on the UK Continental Shelf (UKCS).
General description of the measureLegislation will be introduced in Finance Bill 2011 to ensure that the Corporate Intangible Fixed Asset (IFA) rules apply as intended so that a deduction in computing a company’s profits, where a company acquires an oil licence or an interest in an oil licence from another company, is not available under the IFA rules.
Policy objectiveThis measure clarifies the scope of the IFA rules as they apply to an oil licence or an interest in an oil licence. The measure ensures that the IFA rules apply in the way that was intended when the legislation was introduced in 2002 and prevents a potential loss to the Exchequer.
Background to the measure• This measure was announced at Budget 2011 and is effective from Budget day 23 March 2011.
• The draft legislation published on Budget day will be discussed with industry stakeholders in the period up to the publication of Finance Bill 2011.
Detailed proposalOperative date
This measure will deem a new accounting period to start on 23 March 2011 and the measure will have effect in respect of this deemed accounting period and future periods.
Current lawA corporation tax regime for intangible assets was introduced by Schedule 29 to the Finance Act 2002, which is now Part 8 of Corporation Tax Act 2009 (CTA 2009). The regime allows intangible fixed assets, including goodwill, to be treated for tax purposes on an income basis. By following accounts’ entries the regime allows companies to obtain tax relief in respect of expenditure on intangible fixed assets charged to the profit and loss account: amortisation and impairment, or on a fixed rate basis of 4 per cent per annum.
Similarly, the regime imposes a tax charge for receipts in respect of intangible fixed assets that are reflected in a company’s profit and loss account. For example a tax charge might arise on the realisation of an intangible fixed asset when it is sold.
The legislation, however, specifically excludes a number of assets from the IFA regime. These exclusions include an oil licence or an interest in an oil licence (section 809 CTA 2009) as well as other rights over land (section 805 CTA 2009).
Proposed revisionsLegislation is being introduced in Finance Bill 2011 to ensure that the scope of the IFA regime excludes all goodwill and any intangible asset which relates to, derives from or is connected with an oil licence or an interest in an oil licence.
Some companies have interpreted accountancy practice in such a way that goodwill is recognised on the acquisition of an oil licence or an interest in an oil licence. This interpretation may bring this goodwill within the scope of the IFA regime, which conflicts with what was intended when the legislation was introduced.
Hmmm... still not a lot clearer to me. But it could be highly damaging to smaller companies if it means that acquirers of their oil & gas assets are not able to claim reliefs that they would otherwise be able to claim.
I hope that some of the posters who used changes to the UKCS tax regime to criticise the previous government will now appreciate that such tinkering is not a party political thing but something irresistible to governments of all stripes, especially in tough times when high oil prices prevail.
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42 comments
An even more disturbing statistic - I'm surprised its not been picked up elsewhere.
http://www.bbc.co.uk/news/uk-scotland-scotland-business-13575632
An Oil and Gas UK survey released on Thursday warned that its members suggested 60 out of 240 potential projects had less of a chance of going ahead since the chancellor raised the supplementary tax on North Sea oil production from 20% to 32%.
I hope Oil and Gas UK continue to monitor / firm up on this potential 25% attrition rate ( I already see Greenpeace /the Grauniad thiInk the industry is crying wolf) and make sure Osborne gets the message in advance of his prebudget report in November - which I guess is the earliest time he can begin to give something back .
You would like to think he realises he's thrown some of the baby out with the bathwater but I really do wonder..
Whats worse - speaking personally - is that I voted for this tw*t .
http://www.economist.com/node/18744139?story_id=18744139&fsrc=rss
On May 26th Oil & Gas UK, a trade body, having surveyed how the budget had changed its members’ plans, predicted that at least 25 developments with a total of more than 1 billion barrels of oil reserves were now less likely to go ahead, and that the closure of at least 20 ageing fields would be accelerated. This, over production lifetimes, would reduce tax revenues by £15-20 billion. It would also mean the loss of 15,000 jobs that would otherwise have been created, and a £50 billion increase in the cost of energy imports.
North Sea producers’ problem is that most of the remaining oilfields are small, or in deep waters, or contain heavy oils difficult to extract, making them expensive to develop. As the oil from cheaper fields has run out, the government has progressively extended a system of tax allowances to offset the extra costs of the more difficult ones. To mollify the oil firms, it now says it will discuss how these allowances might be extended further.
But this, says Alex Kemp, professor of petroleum economics at Aberdeen University, would complicate further an already complex system. To qualify for a tax allowance, an oilfield has to have precise physical characteristics: how far it is from land, how deep the waters, and so on. Mr Kemp reckons it is impossible to design a system of allowances which can deal with every problem without causing anomalies.
The present tax system combines this lumpy system of allowances with a flat-rate tax on output. Since the allowances are, in effect, proxies for the investment costs of an oilfield, it would be simpler to tax each field on a sliding scale according to its return on investment, suggests Mr Kemp. This would make it easier to encourage the exploitation of marginal oilfields while optimising the tax take.
Although this would mean higher taxes on their most profitable fields, the oil companies are cautiously interested in the idea, says Malcolm Webb, Oil & Gas UK’s chief executive. But he adds: “There is a difference between talking about such a tax regime and committing to the finer details.” The government, for its part, would want to ensure that any new tax system did not make it easy for oil firms to cut their tax bills by somehow understating their investment returns.
Mr Salmond was sufficiently encouraged by the oil industry’s response to give Mr Osborne a paper on Mr Kemp’s idea. The chancellor politely said he would look at it. Behind the civility, however, there are high stakes. Oil firms have until now quietly opposed Scottish independence, fearing it would cause upheaval and high taxes. But Mr Osborne’s tax rise, which he imposed without warning, has so angered them—an executive at a smaller oil firm grumbles that Britain’s tax regime has become less stable than Nigeria’s—that they may be warming to Mr Salmond and his calls for Scottish self-rule.
FWIW I've commented elsewhere on the UK tax proposal, partly in response to an FT editorial.
The US situation (which singles out the largest companies) is somewhat different IMO and seems unlikely to gain much traction once the political grandstanding is over, but the common thread is of course both governments trying opportunistically to grab a higher share of the economic rent from hydrocarbons extraction at a time when they are under financial pressure.
In that respect they are no different to the worst of the third world examples - but are probably much more short-sighted as both the UK and the US are much more mature oil provinces than, say, Uganda or Namibia - and so should be paying attention to the longevity of their fields from the perspective of security of supply (as well as future taxation potential).
ee
Now the USA is thinking of removing some of their tax breaks on oil companies:
http://finance.yahoo.com/news/How-the-oil-industry-saves-apf-1347874124.html?x=0&sec=topStories&pos=9
I forgot to add detail re expensive gas wells.
At the time of the consultation on Heavy oil and small fields,and the subsequent allowances,various companies also lobbied for relief for development of "alternative" (read difficult,tight) gas wells where they had to be fractured.
I dont recall any allowance being forthcoming.
FH
I also watched this but started to fall asleep.
I thought the" quality " of questions was poor and allowed to much wriggle room, use of OBR/Kemp and Woodmac.
I also got the impression from Hunhe that "we do what we want" "you tow the line".
Things that were not discussed/erroneous :
1)As oil price rises so does Capex and to a ,lesser degree opex (They are coupled unlike the bizzarre discussion on on & gas linkages) so the profitability(or not) on a new investment only increases after the taps are turned on and your cost of capex has been capped.
2)Size of developments affected -looking at number rather than total BBLs affected. Mariner and Bressay in volumetric terms are huge number of bbls,marginal developments are way smaller and the sad fact is thats mainly whats left in the North sea in both gas and oil.
3)Statement that gas developments cost less than oil. That may have been the case but tight gas fractured wells are very expensive
4)Irony is the big lending banks squeeze the smaller Oil co's to hedge-infact it can be part and parcel of getting a loan
5)One wonders if Centrica is not playing games-they now have a legitimate means of operating intermittently certain gas fields at times of high spot pricing whilst avoiding the gaze of the regulators.
FH
Yes - very good points. Some of the smaller oilcos who have been forced to hedge and offer other convenants on loans have been enormously frustrated at being over a barrel with the banks (eg Sterling Energy's US loans).
"...a Finance Manager..."
NB not "...THE Finance Manager...."
Bit "a" manager means absolutely nothing.
Yes - she used to work for British Gas who sent her on an Executive MBA course 10 years ago.
The Executive MBA at LBS is done whilst people are still working and has two days teaching time per fortnight over two years....so those of us who did the full-time "proper" MBA for two years get slightly sniffy ;-)
Nevertheless, it is true that employers don't pay up for people to go on that course unless they are being fast--tracked....so I've got no doubts at all that Greening is very bright - and indeed I'd think she probably knows a bit about the gas business.
I do suspect that the policy is wrongly-founded though, for the reasons that the industry and investors have been complaining about (not the least of which is tax predictability - which is positively at third-world standards or below thanks to three hikes in the last decade). Greening seemed content to blame the OBR and Wood Mac for having advised that there would be very limited impact on investment as a result of the changes - but I rather suspect that they would have been asked the wrong question*!!
*because the coalition will only have looked as far ahead as the end of the present Parliament in 2015!
ee
http://www.parliamentlive.tv/Main/Player.aspx?meetingId=8305
Todays Energy Committee on the North Sea tax changes.
Alan Booth amongst others.
Very interesting. I've just watched it through and lobbed my 2p into the committee.
http://www.justinegreening.co.uk/about-justine.php
Justine lives in West Hill in Putney. Born in 1969 in Rotherham, South Yorkshire, Justine attended her local comprehensive school, before studying economics at Southampton University. She has an MBA from the London Business School and was a Finance Manager at Centrica plc before being elected as the MP for Putney, Roehampton and Southfields in May 2005.
What none of them seem to grasp is that there is a limited supply of capital and an even more limited supply of talent competing on a global basis and that the tax increase has made the UK significantly less attractive.
Whether she has the weight to mitigate the adverse affects I very much doubt given the way she has bought into the rob the oil companies to buy the support of the motorist line.
repo
The above picture is linked through from Antrim's website and I think it shows the value of M&A deals in UK North Sea over the recent past. I posted it on this thread as it is related to the UK North Sea and it basically shows the wide standard deviation at which past deals took place...I'm hoping Encore's fields in Catcher and Cladhan will fetch the top range of this deviation despite the new UK taxes :)
Here's something to give our chancellor pause for thought: http://www.google.com/hostednews/ukpress/article/ALeqM5ipCXrhwdQS1ZW3qeHGlApuLcyw_w?docId=N0270901301347461474A
Note that Statoil is in parnership with Nautical Petroleum (LON:NPE) on Mariner. Xcite Energy (LON:XEL) has described its Bentley field as an analogue to Bressay, which is nearby. All, of course, are heavy oil fields.
Mark
Some interesting comment from Alan Booth in this morning's announcement regarding the Burgman success from Encore:
Let's hope our government sees sense on the field allowances. I also think his comment is very fair, recognising a certain element of "we're all in this together". ;0)
Mark
Mark, regarding Ocean Wilsons (LON:OCN) , have you considered the option of investing via Hansa Trust (LON:HAN) instead?
The Hansa Trust fund has a 43% holding in Ocean Wilsons Holdings and the fund itself currently trades at a discount of 14% to its NAV:
http://www.trustnet.com/Factsheets/Factsheet.aspx?fundCode=ITHAN&univ=T&pagetype=performance#disc
Also, personally, I would invest in its top-ten holdings which includes BG Group, Hargreaves Services, BHP Billiton, BRIT Insurance Holdings, Weir Group, Kofax, Andor Technology, Cape, and Herald Investment Trust...making up to 70% of the fund. The rest of other holdings from its last annual report are not too bad as well.
Hi uncommon13,
Thanks. O/T - but worth pointing out a certain "incestuousness" there. Ocean Wilsons' £164m investment portfolio is managed by Hanseatic Asset Management LBG (HAM), which shares William Salomon as a common director with Hansa Trust. ;0) In fact, HAM (or its parent organisation, "Hansa Group") is the investment manager for Hansa Trust!.
Hansa Trust holds 26% of Ocean Wilsons and William Salomon owns 26% of Hansa Trust (or is trustee of a trust that does?), according to Hemscott.
Cheers,
Mark
Every cloud....... the announcement probably raised a few frowns at KNOC ;-#)))
Looking very much longer term, I think that what we have seen in the UK today will be repeated in other countries over time as prices inevitably rise as supplies start to falter. Tax hikes may well be the least of our worries with nationalisation of "strategic reources" on the cards.
for now though, i have to take a view that its a knock on the chin for those NSea producers (or soon to be producers) that I hold (and obv that impacts the NAVs of the explos) but givent he NAVs are based on much lower oil prices and prices still didnt seem to reflect near term actions - IAE moving to 20k bopd by 2013 for instance) then there is reason to feel that prices have been beaten up and its worth looking at a few.
Obviously the non UK companies have just become a lot more attractive but then again, thats where Ive been allocating more money of late.
What I wouldnt rule out is more targetted small field and marginal field legislation in the course of time targetting the UK N Sea.
I agree with both those points. I was ruminating on the Budget's messaging effect to Brazil, for example, as I watched the BG share price accelerate away again.......and I suspect that ultimately there will unavoidably be some tinkering at the edges in the North Sea in order to maximise utilisation of resources.
In the medium to long term (7 years +) the investment landscape could look radically different to what we have come to assume as the norm for the last 15-20 years......but I've yet to work out what the short to medium term portfolio implications of that might be.....
ee
Hi ee,
Just a few contrasting (& interesting) points on Brazil vs UK situation:
a) 2010 Brazil debt:gdp is 61% vs 77% for the UK - and forecast to fall
b) Investment of over $200bn is required to develop Brazil's offshore oil fields (Petrobras alone plans nearly $175bn)
c) Petrobras being state owned, most of Brazil's oil & gas revenues will flow to the state anyway.
So that means that a) revenue is already flowing nicely into the Brazilian treasury's coffers, so (unlike the UK), no pressure to raise tax income beyond its natural (healthy) growth rate; b) they need to keep investors sweet for at least the next few years!
O/T While I'm on the topic of Brazil, I observe that Brazil has now overtaken the UK in terms of manufacturing output, climbing from 8th to 6th in the world, vs the UK declining to 9th spot. A good opportunity to ramp one of my favoured investments Ocean Wilsons (LON:OCN) :0). Ocean Wilson's SP has declined of late, making it something of a bargain IMO and is now trading at a ~30% discount to NTAV (I topped up earlier this week), the bulk of that NTAV comprising its Saõ Paulo listed controlling interest in Wilson Sons the Brazilian port and logistics operator. Wilson Sons recently launched its 11th offshore support vessel, out of a fleet of 24 it is building, all on long-term charter to Petrobras. Wilson Sons is due to report 4th quarter earnings today.
Cheers,
Mark
Mark,
I don't disagree at all with the bull points for Brazil and its economy....nor that they still have a vast need for inward investment. But at some point the investment will mostly be done - and the cash will start to flow....and THAT is when Governments are most likely to be tempted. And in Brazil's case, the Government has already tilted the playing field at least once since they started making discoveries.
As with the finds in the Falklands (where I'd fear Argentine claims again), I don't think one can assume that the locals won't try hard to get their hands on oil and cashflows - though it is certainly disappointing to see the UK keeping such unreliable company.
Re Ocean Wilsons (LON:OCN), its had a cracking run from the lows and has given a piece of that back. The question is whether there is more retreating to come. Guess you may find out later if your top-up was well-timed?
ee
Yup, but I see this as a long-term bottom-drawer style investment anyway. It pays a 2% divvy , to keep things ticking over, as value builds (hopefully!). My cash pot is continuining to build and is likely to grow further with a number of my holdings having either firm or prospective bids in progress (Lincat (LON:LCT) being the latest). If Ocean Wilsons (LON:OCN) is available more cheaply later in the year, I will probably be happy to pick some more up.
Looks like the announcement will be after-hours, Brazil time (i.e. this evening here). Wilson Sons shares up 1% today so far in Saõ Paulo.
Mark
http://www.oilbarrel.com/nc/news/display_news/article/north-sea-oil-producers-left-reeling-by-latest-tax-hike/1209.html
Hi Bugs.
We don't know that Statoil didn't make some informal approach. They may have tried one and been rebuffed. At that time Nautical had a 27% shareholder, who could have given protection from a low ball bid. That shareholder is now under 3% and the three biggest shareholders only hold a combined total of 16%. Thus Nautical is now much more vulnerable (and much more valuable), as well as having a depressed share price (on a $ per bbl basis).
Statoil has heavy oil expertise and operates Bressay and Mariner next door to Kraken. It might want operatorship of Kraken too. Also, being accustomed to Norway's 78% tax take, the new UK rate shouldn't frighten them off.
The Burgman result will be known in about one week's time. After that, things go a little quiet I think until the drilling and flow test of Kraken. If anyone is to move for Nautical, I'd suggest that their best time would be soon after the release of the Burgman sidetrack result (say, about two weeks from now).
I wouldn't buy into any company for bid prospects alone, but Nautical looks a good 'each way' bet, being well funded, having had operational successes, and appearing undervalued by the market.
Interesting point.
Seems like the market has remained persistently unimpressed with NPE, and gave up recent highs very quickly.
Either there really is some hidden problem with Nautical, or as you suggest, it is significantly undervalued now, and highly vulnerable to M&A.
Only question is, if you suggest Statoil, why didn't they try to buy when Nautical was at 20p - 2 years ago, since the synergy was fairly obvious then I think.
Bugs
The Supplementary Charge is applied after adding back financing costs. In contrast, Corporation Tax is applied with financing charges as an allowed cost, but ring fenced to financing used for relevant activity.
So, if an explorer/producer gears up, it will pay less corporation tax on its profits, but the same Supplementary Charge - which, as we know, is going up from 20 to 32 % - so giving less retained profit to cover financing charges.
Overall, it should roughly balance out.
As an aside, if the proposed reversal of the Supplementary Charge for oil < $75 pbbl is enacted, then it could make financing slightly less expensive, since there would then be some downside protection to post tax income.
As a further aside, I wonder if the setbacks in the share prices of those affected might trigger some m&a activity? Holders' price expectations will have been reduced. Acquirers might be prepared to take a longer term view on value? In particular, I think Nautical Petroleum stands out as vulnerable. If Kraken flows (as seems likely) later this year, then the oil in place (about 800 mmbbl net to NPE) can have a recoverabilitly factor applied (20%?) and begin the move to 'reserves' category. Market cap. now about $500 million for perhaps 160 mmbbl at Kraken (with heavy oil field tax relief), plus 18 mmbo at Catcher + Varadero, plus $180 million cash. Might tempt Statoil? (I added to my NPE holding on this fall.)
I fear that such thoughts are misplaced - at least in the short term. The latest tax hike (the third in a decade, the combination of has more than doubled the effective tax rate (AIUI) from 30% to 62%) merely tells the world that the UK is in fact one of the worst and least reliable places in which to do business.
I noted elsewhere yesterday that even some countries famed for their instability have shown more fiscal responsibility and business sensitivity than successive UK governments have shown......so in the short-term, the UK industry is rightly and justifiably very miffed indeed.
Medium term of course it might be different. If the UK economy picks up and Governments start looking more favourably on investment in the North Sea (though of course the Coalition appeared to be doing exactly that until Wednesday's bombshell!) then acquirors may take advantage of lower prices.....IF such lower prices actually materialise - and I don't see very much chance of that whilst marginal production becomes less and less economic and the general direction of oil prices remains upwards.
My take on the North Sea producers is that the risk/reward balance has been changed and even some of the smaller companies may struggle to get reasonable terms for developments.....though even higher prices may well bale them out.
Overall I think it is a very short-sighted move by the Government. Oil companies may appear to popular targets for tax-raising, along with the banks, but there are very real implications for the actual oil and gas assets of the UK - because the result will inevitably be that more oil and gas will be left in the ground and prematurely abandoned.
FWIW
ee
Not so sure that I agree with your take on the restriction of tax write offs on decommissioning costs Mark.
My impression over the last few years is that many of the smaller finds, which surely now constitute the majority of those in the North Sea, rely heavily on either existing infrastructure, or reclaimable floating infrastructure. So perhaps this tax benefit reduction for decommissioning provides some small incentive to the holders of that infrastructure to keep sqeezing a little more oil out of the basically depleted large fields which keeps it open for the small field additions.
To my mind the "sufferers" from this budget are the majors with the big older fields, who are in general deserting the UK for greener pastures (bigger prospects) anyway. It may well accelerate the transfer of their assets to smaller, more nimble, companies who actually are interested and capable of making a profit from the smaller finds.
Regards
PS. I think this is a temporary "desperate" measure which will be reversed in a year or two, and the oil companies will understand this. But I agree that constant tinkering, even if it is short term, is not good for an industry which has to plan long term with massive investment proposals.
Hi muckshifter,
It isn't so much my view as one I've heard expressed by Alan Booth. I understand that the problem is knowing whether a tax allowance can be booked for future decommissioning costs of new infrastructre investment made now.
I agree that the immediate impact will be largest for old fields - but it also weakens the negotiating position of those wanting to sell assets that will require considerable CAPEX to develop. ;0) [As the buyer can argue that there is a greater element of risk/unknown in the post-tax ultimate decommissioning cost.]
Cheers,
Mark
Why was this created as an NPE thread?
Buffy
There is an interesting quote here:
http://www.ukbudget.com/UKBudget2011/index.cfm
This quote has been picked up by the FT and newswires. But I can't figure out what he is talking about. Any clues?
Edit: Found it, I've written a note here: http://boards.fool.co.uk/here-is-his-more-detailed-note-12217181.aspx
Hi "Max",
I agree with your comment: a bigger deferred tax asset is created for E&A costs - but it still makes the ultimate tax charge larger. Perversely, what this does is to reward inefficient companies, who expend more on drilling per bbl found. Some of the extra value created by more efficient companies is destroyed by the extra tax charge. Whilst subsidiaries holding already discovered fields will be able to create a bigger deferred tax asset for their previously incurred costs, future cashflows will still be negatively impacted, as once the earlier CAPEX is fully offset against profits (which will happen at the same time, irrespective of te tax rate), the company will have to start paying the higher rate of tax.
Buffy - that was Stockopedia eds, I'm afraid - I'll change the header.
Cheers,
Mark
Interesting thought but could the changes to the taxation produce a scenario where the companies with production gear up, interest being tax deductible, and then use the debt to go outside the N Sea?
Hi djp,
I suspect not. The summary document says:
Surely such debt, taken on artifically, would fall outside the ring-fence? One for the tax experts to opine on.
Cheers,
Mark
Mark,
It looks like the article you reference has been updated:
Unfortunately I cannot read the article to see if you referenced it before or after the change.
I just ran a dummy NPV and tend to agree with Log that moving from 50% to 62% tax is equivalent to roughly a 25% reduction in after tax NPV10 for a light oil field.
Cheers, Max
Max - you're right. Thanks to doverbeach, on ADVFN, pointing out that the CT rate reduction doesn't apply to oil & gas profits (or is it just oil? ;0)). The budget document referenced in my article says (pA39):
And (next page):
[my bold]
ISTM that the combination of these changes could wreak havoc with the UKCS industry.
Here's what the trade body (UK OIl and Gas) has to say:
Regards,
Mark
Mark I'm puzzled by your comments as I think the effect might well be quite large as I posted on the Adfvn EO thread.
Suppose a simple model field has cappex of $10/bbl and oppex of $10/bbl and an suppose an oil price of $80. A company has thus a profit per barrel of $60. Under the old tax regime we saw a tax take of 30+20% giving a profit after tax of $30. Under the new regime this drops to $22.8/bbl. Now chuck in your NPV models and discounts etc. and I really can't see anyone paying $10/bbl for 2P reserves in the North Sea any more. In the above model we have seen a hit of 23% so taking this off we should probably price 2P at $7.5.
Since most exploration companies are priced on 2P reserves or something similar I think this is indeed material and the market hasn't properly absorbed this.
Perhaps though I've got my numbers wrong and I'd be very happy to be corrected.
Log
Ps I was under the assumption the corp ringfencing didn't apply and the tax take had just gone up 7% but I think that is not now true. If it was true then I'd agree the market declines today were about right.
Log,
The situation depends on whether what hannibal says is correct or not. AFAICS the "ringfencing" isn't to do with the rate of corp tax paid but rather concerns what it's payable on (see text in my original article). This article also concurs with djp's view.
My point is this: this higher tax rate is only supposed to apply if oil prices are high (over $75/bbl mentioned by the govt)... but most analyses (and valuations) don't assume such high oil prices. At $80 oil I doubt a seller would be prepared to sell 2P UKCS oil reserves @ $10/bbl, unless they were desperate (Dana's were sold for ~$12/boe IIRC - and that included a substantial proportion of lower valued gas AND was at a time of lower prices).
In reality, the $/bbl value will vary greatly from field to field (developed or undeveloped?; time & cost of development, time & cost to decommission; flow; fit with related assets - all have a significant impact on valuation). I observe that one analyst used nearly $20/bbl to value Cladhan oil - well, I'd agree that that sort of valuation will probably be impacted considerably because it must be assuming a pretty high oil price, but I wouldn't change my own more conservative $12/bbl figure much as a result of these tax changes.
Mark
Surely Im missing somethign here?
Current position is what 30% corp tax and 20% production tax?
By 2014 - Corp tax will have fallen to 23% and 32% production tax.
So a 5% difference?
Methinks that the market may have over reacted, especially when you consider those companies with large tax losses to be worked through over the coming years before they actually get into a taxable position.
So the likes of IAE, FPM and others have probably oversold.
I tend to agree, djp. Moreover, given the linkage to oil prices - if the government keeps its word - the impact of the supplementary charge on NPV models shouldn't be too great. The charge will have its largest impact where oil prices are above current assumptions, damping "excess profits" - but such a situation "isn't in the (undisturbed) price".
It will be interesting to see what impact this new taxation regime actually has on analyst $/boe valuations. I guess we'll see revisions and comment trickle out over the next few days. As you suggest, it'll probably be rather less than the market has discounted today.
DJ preston, as I understand it, coportation tax for the North Sea oil industry is being ringfenced and kept at 30%. So where talking about a 12% increase.