The Guardian newspaper recently published an article by Aditya Chakrabortty entitled ‘Dude, where’s my North Sea oil money?’ (13 January 2014), which drew a comparison between Norway and the UK in terms of what approximately four decades’ worth of fiscal income from oil and gas production has meant for each country. The main thrust of the article was to suggest that the reason why the UK does not have a colossal nest egg like Norway’s is that the UK government effectively squandered its windfall in tax breaks. That is true, but not in the way Chakrabortty thinks.
Starting in 1981, once the Falklands conflict (and the need to pay for it) was over, the UK government led by Margaret Thatcher embarked on a process (which accelerated greatly under John Major and even more so under the Blair-Brown Labour governments) of levying progressively less and less taxes on oil and gas exploration and production activities. In other words, Chakrabortty is right in saying that most of the windfall was squandered in tax breaks but, overwhelmingly, the main recipient of these tax breaks was the UK oil and gas industry. As oil prices have skyrocketed from 2000 onwards, the differences in the amounts that the UK levies compared to other large North Sea producers (and not only Norway) have reached astonishing proportions.
A straightforward way of appreciating this point consists in calculating the effective tax ratio (“ETR”) for petroleum exploration and production activities in all the jurisdictions producing oil and natural gas from the North Sea. The ETR is defined as the sum of tax revenues divided into the value of gross production (in the UK, tax revenues come from Petroleum Revenue Tax (“PRT”), levied on a very small number of fields, ring-fenced Corporation Income Tax at a non-standard 30 per cent rate and the Supplementary Charge (“SC”) at 32 per cent). Unlike the marginal rate of tax, which is a forward looking measure that relies on assumptions about prices, revenues and production profiles, ETR is a retrospective indicator calculated on the basis of observed data for all of these parameters (this is a useful feature, as the taxes that companies liquidate may be a very small fraction of what they would have theoretically had to pay had the marginal rate of taxation applied, as the cases of Starbucks, Amazon and other companies so poignantly demonstrate). Thus, ETR is a device that allows the comparison of the real incidence of taxation across jurisdictions, not least because it makes it unnecessary to track and itemise the myriad exemptions, incentives, special features (and tax bases) granted against the various taxes faced by the oil and gas industry in different countries, at different times. ETR, in other words, permits the translation of dynamic tax policy into a tractable analytical form. However, since ETRs incorporate no information on industry costs, a disparity in ETRs cannot necessarily be taken as diagnostic that the tax burden in one jurisdiction might be too light in comparison to that of some other jurisdiction, because it is costs that ultimately determine the share of gross revenues available to be divided between taxes and industry profits. But ETRs can give a good idea of just how large differences in cost structures (exploration, production and so on) would have to be in order to account for a given tax gap between jurisdictions.
As shown in the Figure below, the UK ETR is currently the lowest observed for any of the four major North Sea hydrocarbons producers (the other three being Norway, Denmark and The Netherlands). Indeed, at 24 per cent in 2012, it is considerably lower even than the ETR observed for the fifth North Sea hydrocarbons producer, the German Federal Land of Schleswig-Holstein, whose government has been increasing the statutory royalty rate in line with rising oil prices in recent years – from 12.5 per cent in 2003 to 21 per cent as of the time of writing – with the result that the ETR in the German sector of the North Sea in 2012 came to 33 per cent.
This datum is counterintuitive for a number of reasons. First, German North Sea petroleum production only started in 1987, whereas hydrocarbons production in the UK sector began twenty years earlier, when the West Sole gas field came on stream. Second, German North Sea hydrocarbons output has always been minuscule in comparison to UK output: the former peaked in 2003 at around 40 thousand barrels of oil equivalent per day (KBOED) and is currently running at around 26 KBOED, whereas the latter peaked in 1999 at 4.6 million barrels of oil equivalent per day (MMBOED), and is currently running at around 1.4 MMBOED (i.e. thirty five times more than Schleswig-Holstein production at its peak). In light of the above, the Germans getting a better deal from their hydrocarbons than the British is tantamount to a pub team beating the All Blacks in a rugby match.
The comparison between the ETR for Schleswig-Holstein, on the one hand, and that for the UK Continental Shelf, on the other, is highly revealing precisely because it implies that both unit costs and geological prospectivity in the UK are higher and poorer, respectively, than they are in Germany. The exact opposite happens to be true. This makes it possible to conclude that the UK fiscal regime for hydrocarbons is indeed much too generous (and has been for a very long time now). This generosity is put into an even starker perspective when one analyses the fiscal yields of North Sea producers whose production volumes, unlike those of Schleswig-Holstein, are in the same league as the UK’s.
Consider the following: in the five years going from 2008 to 2012 inclusive, UK government receipts from taxation on petroleum exploration and production activities came to £44.62 billion, representing an average ETR of 27 per cent on a gross industry income of £165 billion (the fiscal years of other North Sea producers run concurrently with calendar years, so UK fiscal data has to be annualised to make it properly comparable to that of other North Sea producers). If the quantum of gross income generated in the UKCS oil and gas activities during these five years had attracted the ETRs which oil and gas activities attracted in Denmark and Norway during this same period (51 and 57 per cent, respectively), then the UK would have received an additional £38.88 or £49.84 billion sterling more in fiscal income (i.e. an average of £7.7 billion or £9.97 billion, respectively, per year). Indeed, since 2002, when the UK fiscal regime was supposedly “toughened” with the introduction of SC (amidst a predictable and enduring outcry from the oil industry), the difference between the hydrocarbons taxes levied by the UK government and the fiscal yield that would have obtained at an ETR comparable to that of Norway over this same period comes to a staggering £118 billion.
The differences highlighted above take account of production levels: for instance, in 2011, observed Norwegian fiscal income (£39 billion) was actually 3.7 times greater than the annualised UK fiscal income for that year (£10.5 billion), because Norwegian production is significantly larger (mainly because Norwegian resources were exploited with a more conservative depletion profile than UK ones). Observed Danish fiscal income in 2011 (£3.5 billion), was considerably less in absolute terms than UK income (albeit higher in relative terms), because Danish production is a fraction of that of the UK (which also means, incidentally, that Danish unit costs are higher).
Comparisons such as these are very pertinent in light of the UK Government’s recent call for evidence seeking views on the future of the country’s oil and gas fiscal regime. In the run up to the deadline for submissions of evidence to the review (3 October 2014), doubtless much will be said about the high and rising costs of production in the UK North Sea, and about the need to ensure that ultimate recovery is maximised, and about the competition for investment capital from other jurisdictions. (Or about how a simple analysis such as the one presented here betrays no understanding of how the various and highly complex reliefs and cost deductions, interactions of fiscal instruments, their timing, and so on, work.) But it is a safe bet to predict that nothing will be said about how, given that the tax systems in other jurisdictions are similarly complex and address similar issues, the UK happens to be the sole outlier, and by a massive margin – or how jurisdictions where unit costs are significantly higher nevertheless manage to sustain higher relative fiscal takes. Iin Schleswig-Holstein, for instance, production is not only volumetrically modest but also has to be carried out in an area of exceptional environmental fragility, through long horizontal wells from which is extracted a poor quality crude with a relatively low market value. Nor will anything be said about how The Netherlands has very effectively managed to incentivise the exploitation of small natural gas fields while maintaining an ETR as high as Norway’s (58 per cent in 2012), or about how Denmark re-structured and part-nationalised the Danish Sole Concession in 2003 (the latter measure effective in full upon expiry of the original term in 2012). This essentially doubled its relative fiscal take as a result. Nor will they talk about the fact that among the ETRs of all the large North Sea hydrocarbons producers, the UK’s has been the only one not to increase very significantly over the ascending oil price cycle that began in 2000.
Since the three main Westminster political parties all endorse the conclusions of Sir Ian Wood’s recent review on how to maximise the economic recovery of oil and gas from the UK Continental Shelf (Search for UKCS Maximising Recovery Review Final Report, here), and its tacit underlying fiscal premises (namely that there is a need for a simplified fiscal regime to incentivise investment and drilling activity, as well as to ease the burden upon the new regulator of the upstream sector), it does not take the gift of prophecy to appreciate that the ultimate outcome of this subsequent review on the shape of the UK fiscal regime seems foreordained; namely, a return to the situation that prevailed before the introduction of SC, whereby the only levy on income from oil and gas fields is to be Corporation Income Tax at the standard rate levied on the likes of Starbucks and Amazon. For good measure, it seems highly likely that the review will recommend the phased abolition of PRT (which currently accounts for about a quarter of fiscal receipts). Shockingly, the UK political establishment looks poised to loosen further what already looks like a very lax fiscal regime, at a time not only of straitened public finances and austerity (and a high burden of personal taxation), but also of extraordinarily high petroleum prices (2011 was the first year in history when the international price of crude averaged over 100 dollars per barrel, 2012 was the second, 2013 the third, and 2014 looks dead set to be the fourth).
The implications of these figures for Scotland are, of course, immense. Paradoxically, one of the sticks that the Scottish National Party has used to denounce the Westminster parties has been the excessive burden of taxation placed on North Sea oil and gas activities. In taking such a stance, the SNP has denied itself access to economic arguments that would have put the question of whether Scotland could afford independence beyond all reasonable doubt (at least at current crude oil price levels). Despite this, Alex Salmond has been blessed with antagonists of such maladroitness, and burdened with so much past baggage, that a “Yes” vote in the referendum has become a distinct possibility. If Scotland were to choose to go down the independence route, not only would there be more than enough oil income to make every single Scot better off by considerably more than £500 a year, but also for its new government to close down the submarine bases in the Clyde without having to submit to any form of blackmail on currency issues, to increase the gap in health and education funding relative to the rest of the UK, to keep the ship yards open, and a great deal more besides.
This post is part of “A Separate or United Kingdom“, our blog series analysing the issues surrounding the Scottish referendum.
A Note on Sources
The Netherlands: Annual petroleum fiscal revenues since the start of production: Natural resources and Geothermal Energy in the Netherlands – Annual Review (http://www.nlog.nl/resources/Jaarverslag2013/Annual_review_2013_version_0_NLOG.pdf). Annual gross oil and gas production income: National Accounts of the Netherlands at Statistics Netherlands (http://www.cbs.nl/).
United Kingdom: Petroleum fiscal revenues by Fiscal Year since the start of production: Statistics of Government Revenues from UK Oil and Gas Production (https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/323371/140620_UK_oil_and_gas_tables_for_publication_in_June_2014.pdf). Annual gross oil and gas production income: Income from and Expenditure on UK Continental Shelf Exploration, Development and Operating Activities (https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/251931/UKCS_Income_and_Expenditure_including_annual_estimates_to_2012.pdf).
Norway: Annual petroleum fiscal revenues and gross oil and gas production income since the start of production: Facts. The Norwegian Petroleum Sector (http://www.regjeringen.no/upload/OED/pdf%20filer/Faktaheftet/Fakta2014OG/Facts_2014_nett.pdf).
Denmark: Annual petroleum fiscal revenues since the start of production: Oil and Gas Production in Denmark – and Subsoil Use (http://www.ens.dk/sites/ens.dk/files/ dokumenter/publikationer/downloads/danmarks_olie-_og_gasproduktion_2013_uk.pdf). Annual gross oil and gas production income: national accounts in Statistical Yearbook (http://www.dst.dk/).
Schleswig-Holstein: Annual royalty income and royalty rate: Wirtschaftsverband Erdöl- und Erdgasgewinnung e. V. (WEG), Jahresbericht (http://www.erdoel-erdgas.de/Medien/Publikationen/Jahresberichte). Annual income tax payments as a percentage of gross income derived from BASF A.G. Annual Report, Supplementary Information on the Oil & Gas Segment (Unaudited) for Wintershall Holding GmbH., available from 1997 (http://www.basf.com/group/corporate/en/investor-relations/news-publications/reports/ index).