North Sea O&G production favored as U.K. decides against tax hikes

(Bloomberg) -- The U.K. government went no further in toughening up the tax regime for North Sea oil and gas producers than measures already announced, keeping capital allowances in the windfall tax following protests from the industry. 

As the governing Labour Party faces intensifying challenges to fill a £22 billion ($28.6 billion) budgetary black hole it says it inherited from the previous Conservative administration, Chancellor of the Exchequer Rachel Reeves has turned to oil and gas as a source of extra revenue.

The government already announced tax hikes for oil and gas companies and had said further changes were possible, prompting warnings that production could decline faster than forecast. Reeves went no further than those initial measures in her budget on Wednesday. 

She confirmed the increase in the Energy Profits Levy, a windfall tax introduced in 2022, by 3 percentage points to 38% from November, bringing the headline rate for U.K. oil and gas producers to 78%. The period over which the EPL applies has also been prolonged by a year to the end of March 2030, the third such extension of the levy as the previous Сonservative government repeatedly used the measure to secure additional tax revenue. 

The government had already said it would remove a 29% investment allowance from the EPL, which a July policy paper deemed “unjustifiably generous,” and indicated that a capital allowance could also be reduced. Reeves said on Wednesday that the 100% first-year capital allowances and the decarbonization allowances will be preserved.

North Sea companies will be relieved that the government hasn’t cut the capital allowance in the EPL and “this is likely to allow minor near-term investments to proceed,” said Graham Kellas, senior vice president of global fiscal research at Wood Mackenzie Ltd. Prior to the budget, the consultant had estimated that an indefinite extension of the EPL with no capital allowances could have resulted in a “catastrophic scenario” where U.K. production dropped by half by 2030.

Tax allowances are seen by the industry as crucial for encouraging oil and gas producers to keep investing into North Sea fields, allowing them to offset some money spent on exploration and extraction against the windfall levy. 

Delivering the new labour government’s first budget, Reeves said the new tax regime will “ensure that the oil and gas industry can protect jobs and support our energy security.”

In a document posted on the Treasury website, the government said it will make no additional changes to tax relief available within the EPL and consult the industry next year on “how the oil and gas tax regime should respond to price shocks once the EPL ends in 2030.”

The decision to keep capital allowances offers some relief to the industry, which had been warning of an accelerating drop in output due to lack of investment. 

“We can now analyze our future investment opportunities with more confidence,” Serica Energy, one of the top 10 U.K. oil and gas companies, said in an emailed statement. 

Serica Energy shares jumped as much as 16%, the most since July 2020. Harbour Energy Plc, the largest independent producer in the U.K.’s North Sea, gained as much as 5.7%, the most since the end of August.

However, the previously announced tax increases that Reeves confirmed on Wednesday will still have an impact. 

“The U.K. remains taxed at too high rate and so uncompetitive for investment versus other countries, for example Norway,” said Chris Wheaton, an analyst at Stifel. “Investment, jobs and energy security for the U.K. therefore all remain at risk. But the industry has avoided — at least for now — the very bad or catastrophic outcomes.”

The headline tax rate of 78% is “fundamentally unsuitable for a mature oil and gas basin such as the U.K. North Sea, where continued investment is required to limit decline rates,” according to the statement from Serica. 

“The Energy Profits Levy creates a windfall taxation environment without the related windfall prices,” Harbour Energy said in an emailed statement. “We urge the Government to revisit the fiscal regime well ahead of 2030 to enable U.K. investment opportunities to compete for capital with opportunities elsewhere.”

After Wednesday’s announcements, North Sea oil and gas producers will be able to offset 84% of their capital expenditures against tax, compared with 91% prior to November, according to Stifel’s Wheaton.

While the changes in the tax regime are significant for the U.K. oil and gas industry, the impact on global energy markets is small. The country accounted for 0.7% of global oil production and 0.8% of global gas output last year, according to the Energy Institute Statistical Review of World Energy.