North Sea oil and gas firms eye growth after tax row

Twelve months after the Government caused outrage by raising the rate of the windfall tax, which was introduced in May last year, some firms appear to be learning to live with the change. However, the prospect of a general election within 14 months could leave some sitting in their hands.

“There’s been some pretty positive noises made,” said James Reid, senior research analyst at Wood Mackenzie energy consultancy, who noted signs the importance of the industry is winning fresh recognition amid the spike in energy prices fuelled by Russia’s war on Ukraine.

While prices have fallen from the peaks reached last year, North Sea firms are making plenty of money.

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“I think there’s an understanding that the oil and gas industry is going to be part of the energy mix for a long time and that a lot of those companies involved in the energy transition are also involved in oil and gas, and that’s where the revenue comes from for them to be able to support decarbonisation projects,” said Mr Reid.

The change in sentiment has been reflected in the Government’s recent decision to hold annual exploration licensing rounds as it aims to “max out” the North Sea’s resources. The round held this year drew a strong response. It was the first since 2020.

Oil and gas firms have shown increased readiness to invest in increasing output.

“There does seem to be a bit more positivity around of projects being sanctioned,” observed Mr Reid.

The most obvious sign of this was the decision made by Equinor and Ithaca Energy to proceed with the bumper Rosebank field development West of Shetland.

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Mr Reid noted that Serica Energy has just decided to back a plan to restart production from the venerable Buchan field developed by Jersey Oil & Gas. Norwegian investors bought into Buchan in June.

The firms involved were probably encouraged to act by the generous investment allowance that was introduced alongside the windfall tax.

By contrast, firms that are in “harvest” mode and focused on maximising short-term profits have been hit harder on balance.

These include Harbour Energy which curbed exploration work and slashed 350 jobs. US giant Apache axed UK drilling plans in a move which cost jobs.

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“Companies who rely on debt funding for projects … have been hit quite hard, which has led to some plans potentially being re-baselined and pushed out by a couple of years,” said Mr Reid.

KPMG tax partner Deborah May observed: “We have seen three changes to oil taxation in just over a year, meaning fiscal uncertainty for those investing in the UK oil and gas sector remains a challenge for an industry whose future depends on long term investment decisions.” 

Wood Mackenzie’s Mr Reid said firms had hoped the windfall tax rate would be reduced in the Autumn Statement in November. Trade body OEUK reiterated calls for a cut following the statement. This may have been more in hope than expectation.

“There will be sentiment around saying this is a bad thing, but we didn’t really expect it to be removed. Our assumption was that it was going to remain in place until 2028,” said Mr Reid.

He added: “Although it’s a higher tax people do now know from an investment perspective that until 2028 this will be the tax rate, so it gives a level of certainty in the short term.”

Mr Reid cautioned: “What people are really looking for is long term fiscal stability.” The 78% tax rate in Norway is higher than the 75% payable in the UK but has remained unchanged for years. This has helped the country out-compete the UK for investment.

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The prospect of Labour winning the general election that must be held by late January 2025, complicates the picture amid concerns it might ban exploration or scrap the investment allowance.

“Some companies we’ve spoken to have said they will delay major investment decisions until after the general election,” said Mr Reid.

Others are proceeding, on the assumption that new developments could be in production for decades.

Mr Reid noted: “Whether there’s a Labour Government next year or a Tory Government it [the tax regime] is probably going to change several times over the project’s lifespan. It depends on a company’s attitude to risk.”

Companies may feel more optimistic about the outlook following the release of the results of the review of the North Sea fiscal regime launched by the Government following criticism of the windfall tax. The results were published last month.

The review concluded the Government needed to design a better mechanism than the windfall tax for responding to market swings. It indicated ministers could take until 2028 to come up with such a mechanism.

Wood Mackenzie has suggested the Government introduces a royalty system, under which the relationship between price levels and taxes would be clear.

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Mr Reid said the review included positive elements, such as a commitment to hold twice-yearly consultations with the industry. This could address concerns that industry issues are not understood at Westminster.

The Government also said the price floors applicable to the windfall tax will increase in line with inflation. The windfall tax will cease to apply if oil and gas prices fall below the levels set.

Wood Mackenzie does not expect prices to fall below the thresholds, suggesting it reckons the macro outlook is fairly good.

Sector watchers do not seem to have changed their forecasts for North Sea exploration and production activity following news that Grangemouth operators Ineos and PetroChina plan to cease refining at the site in 2025.

The Forties Pipeline system, which is operated by Ineos, will remain in place to ship North Sea output to market. In 2019 Ineos announced a £500m investment which it said would keep the pipeline active until 2040 and beyond.

While Ineos owner Sir Jim Ratcliffe has been critical of the Government’s energy policies, the Grangemouth closure decision was driven by economic issues affecting the refining sector globally.

Alan Gelder, Vice President of Refining, Chemicals and Oil Markets at Wood Mackenzie, said: “Earlier this year, the Grangemouth refinery was not considered at high risk of closure in our regular analysis. However, since April this year, the hydrocracker, a key process unit for the production of diesel, has not been operational. This severely impacted the refinery’s profitability.

He added: “Next year looks to be more difficult, as refining margins are expected to be weaker than this year and Grangemouth was scheduled to undertake a planned turnaround, which would require a significant investment.”

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The energy supply chain may receive a boost following Government moves to stimulate investment in offshore wind and other renewables. The Government increased the support provided for offshore wind under the Contracts for Difference system this month. In the Autumn Statement Chancellor Jeremy Hunt said new projects would be exempt from the windfall tax imposed on renewables generators. He introduced an investment allowance for projects similar to the one for oil and gas projects.

Aberdeen-based KPMG transaction services director Rob Aitken said such changes sent a positive signal to the market that the Government is listening to what investors need.