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Urgent action to support oil and gas sector

Published: 15 Feb 2016 09:10

DFM sets out key UK Government responses required to support industry.

The UK Government must immediately consider options to reduce the headline rate of tax for the oil and gas industry as part of a package of measures to support the industry, the Deputy First Minister has proposed to the Chancellor.

In a letter to Mr Osborne, the Deputy First Minister said that without urgent action there was a risk the low oil price could lead to the premature decommissioning of North Sea assets and further job losses as he called for the creation of an internationally competitive tax regime for the North Sea.

Mr Swinney set out four key actions that the UK Government must take to improve the fiscal regime and support the long-term future of the industry. These are:

• A substantial reduction in the headline rate of tax, with the primary objective of creating an internationally competitive tax regime in the North Sea
• Removal of fiscal barriers for exploration and enhanced oil recovery (EOR)
• Fiscal reforms to improve access to decommissioning tax relief and encourage late life asset transfers. This will reduce costs and help prevent premature cessation of production
• Urgent consideration of additional non-fiscal support, such as government loan guarantees, to sustain investment in the sector

Mr Swinney said:

"The North Sea oil and gas industry is facing substantial challenges. The industry, unions, and the Oil and Gas Authority have all raised concerns about the loss of highly skilled workers, and confidence levels are now at their lowest since records began in 2009.

"The Scottish Government will continue to do all it can to support the sector. It is clear, however, that the UK Government must take urgent action to reduce the headline rate of tax at the March Budget. The fiscal regime must not be a barrier to investment and activity in the North Sea."

"I believe there is also a real risk that the low oil price could lead to critical infrastructure being decommissioned early. That is why I have called on the Chancellor to use his March Budget to improve access to decommissioning tax relief and encourage late life asset transfers. "

"The UK Government must also consider all options available to facilitate new investment in the sector, including the potential for additional non-fiscal support, such as government loan guarantees."

Notes to editors

The full text of the Deputy First Minister's letter is below:

You are familiar with the very substantial challenges faced by the North Sea Oil and gas industry. You made a number of welcome fiscal changes last year but the continued low oil price could lead to the loss of critical hub infrastructure, the premature cessation of production of viable fields, and the loss of highly skilled workers.

The Scottish Parliament's Economy, Energy and Tourism Committee published a report on 18 January, which included a recommendation for governments, the industry and the trade unions to work closely together in order to ensure that the objective of maximising economic recovery is achieved.

The Scottish Government is keen to work with the UK Government, our agencies and industry itself to do everything possible to address the problem.

The recent announcement of the Aberdeen Region City Deal will make a positive impact on the local area, though we are disappointed at the scale of the UK Government's offer. That is why the Scottish Government agreed to fund a further package of support to the North East outwith the City Deal. I believe this will help meet the ambitions of the Aberdeen regional partners and make a much more significant impact on the economy of the North East.

The First Minister held a special meeting of the Scottish Cabinet on 26 January, where the Chair of the Energy Jobs Taskforce, Lena Wilson, provided an update on the challenges facing the sector. The First Minister asked the Taskforce to continue its work to coordinate support for those made redundant, and to work with industry leaders to secure a long-term future for the sector.

At the beginning of February, the Scottish Government also announced two further funding packages. Firstly, the creation of a new £12 million Transition Training Fund, which will provide financial support to individuals as they retrain or undertake new education to allow them to take on specialist roles in the oil and gas sector or wider energy and manufacturing sectors. Secondly, the announcement of £12.5 million funding for oil and gas innovation, which will enable firms to reduce risks associated with carrying out research and development, as well as providing access to specialist experts who will help to kick-start innovation projects. This fund will also allow firms to implement targeted support from senior industry experts to troubleshoot problems through bespoke business resilience reviews focused on strategic, financial, operational or market issues.

The Scottish Government will continue to do all it can to support the sector through our devolved powers. However, it is clear that urgent reform of the fiscal regime by the UK Government is required. This is the critical policy lever which will positively impact on investment and confidence.

Support for the Oil and Gas Sector

Ahead of last year's Autumn Statement, I wrote to you calling for further support and a timetable for policy reforms. I believe the measures that I called for would have helped mitigate the effects of the current oil price shock.

Regrettably no measures were announced at the Autumn Statement, and it is now clear that the outlook for the sector has deteriorated further. The oil price has fallen by a third since you delivered your Statement and Spending Review – dipping below $30 per barrel last month. Industry, unions, and the Oil & Gas Authority (OGA) have all raised concerns that further job losses can be anticipated, and it is reported that confidence levels are now at their lowest levels since records began in 2009. The Secretary of State for Scotland commented publically that further support for the sector is important.

Within this context, the UK Government must take urgent action, with further fiscal support announced at the 2016 Budget. It is critical that your government's tax policies are not a barrier to activity and investment. Policy should be reformed to ensure that projects which are commercially acceptable before tax remain commercially acceptable after tax. I therefore believe there are four key actions which must be addressed:

1. a substantial reduction in the headline rate of tax, with the primary objective being the creation of an internationally competitive tax regime in the North Sea;
2. removal of fiscal barriers for exploration and enhanced oil recovery (EOR);
3. fiscal reforms to improve access to decommissioning tax relief and encourage late life asset transfers should be implemented, this will reduce costs and help prevent premature cessation of production; and
4. an urgent consideration of additional non-fiscal support, such as government loan guarantees, to sustain investment in the sector.

Headline Tax Rates

A reduction in the headline rate would be consistent with the approach outlined in the HM Treasury's "Driving Investment Plan", which committed to keep the Petroleum Revenue Tax (PRT) and headline tax rate under review. The report stated that the UK Government would base any changes to the tax system on an assessment of the commercial conditions.

The UK Government must recognise that the outlook for the sector is now even more challenging, with the rate of return on oil and gas activity falling to a record low. The latest data from the Office for National Statistics (ONS) shows that UKCS companies' net rate of return fell to just 3.2 per cent during 2015. This is the lowest level recorded since the series began in 1997.

There are a range of options for lowering the tax burden and sustaining investment. Immediate discussions must take place with the industry and the Oil and Gas Authority to consider the most appropriate option.

I therefore call on the Treasury to immediately consider options to reduce the headline rate and deliver these at the March Budget.

If the stated aim of your government is to Maximise Economic Recovery, this must be reflected in the design of the taxation system. The North Sea must be considered a competitive international region for investment, with fiscal stability and predictability at the centre of the tax regime over the longer term. In addition to addressing the tax burden, a commitment must also be provided that there will be no tax increases over the course of this UK Parliament, with mandatory industry consultation on all significant policy proposals.

Removing Fiscal Barriers

Alongside a more competitive headline rate, there are also a range of specific fiscal barriers in the current regime which should be addressed.

Exploration activity remains at historically low levels. Recently published analysis by Professor Alex Kemp outlines a number of interventions that could be made to improve the way the tax system incentivises exploration, including improvements to the investment allowance. Additional support for exploration should be announced at the 2016 Budget.

The Investment Allowance should also be expanded to include expenditure on the activities required for Enhanced Oil Recovery (EOR). The allowance does not cover purchases of injectants such as polymers for EOR. Expanding the allowance to include this expenditure could kick start some EOR projects in the North Sea, which is essential if maximising economic recovery is to be delivered.

HM Treasury also committed to develop options to improve access to decommissioning tax relief and work with the OGA to reform the fiscal treatment of infrastructure. I believe that addressing the barriers to decommissioning should be a priority at the 2016 Budget. Indeed, such an intervention may prove to be cost-effective as it could encourage innovation and efficiency by enabling a greater use of decommissioning specialists.

Supporting Investment

The declining oil price has resulted in a number of North Sea projects being removed from company investment plans. There is a serious risk that these resources will be permanently unrecoverable. There is also a significant portfolio of discovered reserves which cannot attract capital for development. The fall in oil price has also reduced asset values and constrained operator cashflow. As a result, some companies will be finding it difficult to renegotiate debt. This could have a significant impact on some joint ventures and their developments.

Within that context, the UK Government must consider all options to facilitate sustained investment in the sector. Operated by Infrastructure UK, the 'UK Guarantees Scheme' is designed to avoid delays to investment in UK infrastructure projects that may have stalled due to adverse credit conditions and provides a sovereign-backed guarantee to help projects access finance.

The Scottish Government believes that a strong case could be made to address the credit constraints in the sector through a mechanism such as this. I therefore call on the HM Treasury to bring forward options, such as loan guarantees, to sustain investment.

JOHN SWINNEY