Sunday, December 11, 2005
Squeezing the last drop of tax from the barrel
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

It isn’t easy to feel sorry for Gordon Brown. He is not one of the world’s most sympathetic characters, which could be a problem when/if he eventually becomes prime minister. He has a reputation for being brutal and ruthless, although I’ve never witnessed it at close quarters.

But last week I did indeed feel a pang of sympathy. The economic story he had to tell in his pre-budget report was not great, but it wasn’t that bad. The growth forecast of 1.75% this year was disappointing but not disastrous, coming after the economy’s record run of growth, and in time may be revised higher.

The increase in public borrowing, £5 billion this year, was smaller than most economists would have predicted a couple of months ago. Inflation at 2.3% after the trebling of oil prices in the past three years is a minor miracle. Commentators who think this is disastrous should remember how it used to be.

But the chancellor had a tough time. Normally the opposition adopts a sullen silence when listening to him. This time the Tories chatted away as if on a holiday outing, which to Brown was about as disrespectful as telling jokes during a church sermon. When this was followed by a shrill but effective attack by shadow chancellor George Osborne his discomfiture was complete.

The effect was like watching a David Attenborough film of the African savannah and seeing a dignified wildebeest set upon by a pack of hyenas. Or a middle-aged man trying to preserve his equilibrium while being attacked by a bunch of posh kids wearing hoodies.

Did he deserve it? Brown’s recent wretched run of form suggests his legendary luck has run out. When he attacked Lord Turner’s pension proposals as unaffordable he was portrayed as the enemy of reform.

When he told the CBI he was slashing red tape and abolishing the requirement for quoted companies to publish operating and financial reviews, he was lambasted from several quarters, most notably the firms that spent money ahead of their intended introduction next April. The u-turn on the inclusion of houses and other assets in self-invested personal pensions (Sipps) produced even more of a backlash.

The style of his pre-budget report certainly invited criticism. The downgrading of his growth forecast was slipped out as an aside. He attacked the Tories for their policy of holding public spending below the growth of the economy, which his figures show will soon become his approach. Strange.

Like the chancellor, oil companies do not generate much sympathy. They were the target for the main tax-raising measures in his pre-budget report. Even more than him, they are entitled to feel hard done by.

There are three facts to bear in mind about Britain’s oil. The North Sea has been a cash cow for successive governments, bringing in £203 billion, in 2004 prices, since the first fields came on stream three decades ago. It has also propped up the balance of payments. But production is now in decline. The output of oil and gas, expressed in barrels of oil equivalent, peaked at 4.5m barrels a day in 1999 and has been falling since. Last year it was 3.5m.

The third thing is that, after a long consultation between the industry and the government three years ago, the oil companies thought they had a settled regime for the North Sea that would balance the needs of the exchequer with extracting the maximum amount of Britain’s remaining reserves. Rounded, 34 billion barrels have been taken out and there are up to 28 billion left.

The oil companies should not have been surprised that they were hit with higher taxes last week — Brown will always tax business rather than individuals and they were an obvious target. What they were shocked about was that this hit came in the form of ripping up the existing deal on North Sea taxation.

Brown announced a doubling of the supplementary corporation-tax rate on UK oil and gas producers from 10% to 20%, increasing their overall corporation-tax rate from 40% to 50%. Older, larger fields also pay petroleum-revenue tax and so face a marginal tax rate of 75%. The changes will bring in an extra £6.5 billion in the next three years.

But, surely, the game has changed. If high oil prices are here to stay, shouldn’t the oil companies expect to pay more? The Treasury is assuming an average price of $56 a barrel for Brent crude next year, and that it remains at this level in real terms subsequently.

Even if you believe that, which I do not — more likely is that the price will drop back below $40 — was there a case for increasing tax? Existing tax rates were giving Brown a tax bonanza. A year ago he expected North Sea revenues of £5.9 billion for 2005-6, this fiscal year. The new estimate is £9.1 billion, even without the new tax regime that takes effect in April. It smacks of an opportunistic tax hike that has won Brown no friends in industry, or in his native Scotland, where the oil firms are already warning about the threat to jobs.

It could also rebound on the Treasury in the longer term. The UK Offshore Operators’ Association (UKOOA) points out that the remaining oil in the North Sea has become more difficult and more expensive to extract than oil from the old, giant fields. There is a national interest in getting as much of that oil out as possible, particularly at a time when security of energy supplies is a rising concern. The abrupt change of the tax regime is likely to have the opposite effect.

UKOOA’s analysts have sketched out three scenarios for future North Sea output. In each of them production declines but the greater the investment in exploration and production now, the slower that decline. Under the gloomiest scenario, future tax revenues from the North Sea are £40 billion in today’s prices; under the most optimistic they are £120 billion.

If Brown’s tax raid last week has the effect of discouraging investment, as the industry warns, future production will be towards the bottom of the range. Brown’s raid will have produced a short-term gain at the expense of an eventual, possibly enormous, loss of revenues.

And this from a chancellor who is supposed to think only of the long term. Perhaps he deserved that hard time after all.

PS: The golden goal was introduced into football in the 1990s to bring games to a speedier conclusion. The first team to score during extra time won the match. It settled the final of Euro 96, before being eventually abandoned by the football authorities last year.

The golden rule was introduced into British fiscal policy in 1997, with the aim of bringing clarity into macroeconomic management. The rule itself is simple enough; borrow only for investment purposes over the economic cycle. In practice, it is as complicated as explaining the offside rule — in Norwegian.

The problem is the never-ending economic cycle, which Robert Chote, director of the Institute for Fiscal Studies (IFS), likens to a stretch limo. That’s a bit unfair on stretch limos, which are exactly defined by their front and back bumpers.

Until last summer, the current cycle was said by the Treasury to have begun in 1999-2000 and would come to an end in 2005-6. Then the start of it was backdated to 1997-8. Now the end of it has been stretched to 2008-9. As Chote put it: “The goalposts have been moved so far they are barely still on the pitch.”

The IFS’s analysis shows the cycle came within a whisker of ending last year. But no matter. The chancellor appears determined it will run and run. It may outlive his golden rule.

From The Sunday Times, December 11 2005

Comments

The oil company tax change just looks like a mistake. But it’s possible the large, multinational oil companies that control the older North Sea oil fields had no intention of putting in the development investment needed to extract the last drop from these fields anyway. The multinationals have limited technical resources and they will concentrate their efforts where it will give the best return – definitely outside the North Sea.

A possible beneficial outcome could be that the multinationals will sell their interests in North Sea fields to smaller oil companies. Other companies may be in a better tax position than the multinationals. Gordon could encourage UK employment and R&D by giving tax breaks to these smaller, start-up oil companies. But he will have to be very lucky indeed for this to work out in the UK’s favour.

Posted by: Sandid at December 12, 2005 01:38 PM

A good speech this week by Governor Ian MacFarlane about global interest rates, exchange rates and 'the Australian model':
http://www.rba.gov.au/Speeches/2005/sp_gov_131205.html

Posted by: Sandid at December 15, 2005 06:37 AM

Sorry to quote this article from The Business but:

"Shell blames Brown for its new North Sea cuts

ENERGY giant Shell has slashed investment in its future North Sea oil drilling programmes by a third, blaming the doubling in oil production taxes announced by Chancellor Gordon Brown in his recent Pre-Budget Report.
...
Graham Tran, regional organiser at trade union Amicus, said: “I will be writing to the energy minister Malcolm Wicks on Monday to ask him to use his department’s power to make Shell identify which licence blocks the company is now no longer planning to drill.

“If there are any blocks that fall under the government’s new initiatives to protect North Sea investment, we should set the clock ticking and get them out of Shell’s hands as soon as possible.” The DTI strengthened its powers over North Sea oil companies earlier this year.

The new system means any block undrilled for two years has to be handed back to government. The process was designed to ensure older North Sea blocks would be developed to their full potential by speeding up the programme of UK asset sales that the majors began several years ago."

Perhaps Gordon has a cunning plan to start the sales early.

Posted by: Sandid at December 18, 2005 06:52 AM