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UK Announcement has Repercussions for the Oil and Gas Industry

Two days after Russia’s President Vladimir Putin announced that the South Stream project was to be abandoned UK Chancellor George Osborne made his own announcement that will have repercussions for the oil and gas industry. This article will briefly examine the two policies Osborne unveiled during the Autumn Budget Statement: the trimming of oil tax and the creation of a Sovereign Wealth Fund for the North.

Oil Tax Cuts

Oil remains a central part of many economies, and the UK is no different. For the average consumer it is a benefit. The fuel price has dropped allowing more money to spend on other things. However, for the Treasury, the opposite is true. Despite strong investment in the last two years North Sea output levels have fallen considerably since 2010, and the current low oil price is limiting those tax receipts.

As the North Sea has matured producing oil and gas has become more expensive. A low oil price quite obviously reduces the incentive to attempt production. This has the effect of limiting investment. In the Budget Osborne announced a 2% cut on the supplementary charge (North Sea exploration and production companies’ profits) reducing the tax from 32% to 30%. Additionally, the government also extended the ring fence expenditure supplement, allowing investors to offset their costs against future production for up to 10 years instead of the current six. It also announced a new ‘cluster area allowance’ which is intended to encourage E&P companies to invest in ultra-high pressure and temperature clusters at difficult offshore prospection zones.

Although it seems counter-intuitive to encourage investment when the industry is suffering from over-supply, the maturity of the fields and the expense of producing from those fields has increased. In fallow years this has the effect of endangering investment and even the future of the industry as companies assess the balance sheets of the projects. Although the industry still remains bitter over Osborne’s use of the budget to raid North Sea profits four years ago, the Chancellor does appear to have gauged the mood of the industry even if he has not slaked their thirst. Whilst the policies implemented are fairly minimal it shows Osborne’s commitment to preserving the industry and to extract ‘every drop of oil we can’ even if that is at the expense of lower tax rates.

Sovereign Wealth Fund

Many UK governments have decided that the creation of a sovereign wealth fund would be akin to closing the gate after the horse has bolted. This was an issue that came up repeatedly during the referendum campaigning. Of course, the No campaign in the main did not differ too far from that point of view, not to mention the fact that the UK could not really afford to establish one.

Nevertheless on Wednesday, perhaps channelling some of the Yes campaign’s optimism, Osborne announced that he intended to set up a sovereign wealth fund for shale gas for the North of England. The fund would be created by collecting tax revenues from shale gas production. Osborne claims that this would ensure that 'shale gas resources of the North are used to invest in the future of the North.'

Given the current rate of shale gas extraction (0) the policy will have no effect on the economy as it stands. Additionally, it is clearly an idea in its early stages. Although there is a clear economic principle to the creation of such a fund, and successive UK governments' (including Scottish) wish they were able to draw from such a fund in the way the Norwegian government is, Osborne’s pledge, vague as it currently is, appears to be politically rather than economically motivated. It may help to increase support locally, which is needed for planning application approval, and it shows that the government is taking an active interest in the North of England’s economy.

The UK’s shale gas industry is still very much in its early stages and many doubt whether it will ever take off. The announcement of the intention to create a wealth fund is not a game changer. Shale gas remains controversial and the public will likely never warm to it. However, with that in mind, the industry certainly needs all the help it can get, and the US has certainly shown that money talks. Whether the industry takes off, or the wealth fund is actually implemented remains to be seen, but future UK governments would certainly be grateful if one like Norway’s did exist should the shale gas industry boom.

November 2014


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