A new study entitled The Effects of Budget 2011 on Activity in the UK Continental Shelf by Professor Alex Kemp and Linda Stephen of the University of Aberdeen published today highlights the substantial long term reductions in field investment and oil/gas production which will result from the increased tax rates announced in Budget 2011.
The rates were increased from 75% to 81% on the older, mature fields subject to Petroleum Revenue Tax (PRT) and from 50% to 62% on fields not subject PRT.
The study examined the economic effects of these increases on fields and projects which could be developed over the next 30 years as well as on existing sanctioned fields.
There are currently well over 350 undeveloped discoveries in the UKCS and very many potential incremental projects. These fields/projects cover a very wide range in terms of expected profitability. A range of oil/gas prices likely to reflect those used for long term investment by petroleum companies and financing institutions was employed, namely (1) $50 per barrel and 30 pence per therm, (2) $70 and 50 pence, and (3) $90 and 70 pence.
These are all in real terms and so increase yearly with general inflation. A threshold investment return reflecting the likely cost of capital was employed. The study highlights the effects on oil/gas production, field investment and other (field) expenditures, and tax revenues.
The results covering the whole period 2011-2041 and compared to pre-Budget 2011 terms are summarised as follows for the 3 price scenarios:
(a) $50, 30 pence case:
(i) Number of new field/project developments are reduced by 123 (36%) compared to pre-budget estimates.
(ii) Total oil/gas production is reduced by 2.7 billion barrels of oil equivalent or a reduction of 24.4% of that expected before Budget 2011.
(iii) Field investment is reduced by £19.2 billion.
(iv) Total field expenditures are reduced by £34.9 billion.
(v) Total tax revenues are reduced by £12.7 billion.
(b)$70, 50 pence case:
(i) Number of new field/project developments are reduced by 62 (9%) compared to pre-budget 3stimates.
(ii) Total oil/gas production is reduced by 1.7 billion barrels of oil equivalent or a reduction of 9.7% of that expected before Budget 2011.
(iii) Field investment is reduced by £19.5 billion.
(iv) Total field expenditures are reduced by £33.2 billion.
(v) Total tax revenues are increased by £23.2 billion.
(c) $90, 70 pence case:
(i) Number of new field/project developments are reduced by 79 (7.7%) compared to pre-budget estimates.
(ii) Total oil/gas production is reduced by 2.25 billion barrels of oil equivalent or a reduction of 9.5% of that expected before Budget 2011.
(iii) Field investment is reduced by £29.1 billion.
(iv) Total field expenditures are reduced by £52.2 billion.
(v) Total tax revenues are increased by £51.6 billion.
These changes are clearly substantial and will inhibit the attainment of maximum economic recovery from the UKCS.
There will be other effects. The reductions in post-tax returns from field investments will (1) reduce incentives to pursue exploration prospects and (2) reduce the ability of the industry to finance exploration and development projects.
The root of the problem comes from the structure of the tax system. It is essentially flat-rate or proportional (except when field allowances apply). When the flat-rate tax is raised substantially marginal projects can readily become uneconomic. The solution is to have a progressive tax structure with a return allowance whereby the percentage liability to the Supplementary Charge for new fields and PRT-paying fields is automatically reduced on fields of low profitability and increased when profitability increases.