Budget Bashes North Sea Oil

Published in Investing on 28 March 2011

Should investors steer clear of North Sea oil companies?

Every year the budget produces some winners and losers, and it was no surprise to see that last week's edition continued this tradition. Smokers were hit particularly hard, with an extra 50p of tax on a cheap packet of fags, whilst beer duty rose by up to 10p a pint.

Since smokers and drinkers, along with motorists, are invariably hit with budget tax rises, it came as a bit of a shock when the Chancellor announced that petrol tax was actually being cut (by a mere 1p). But this was followed by the bombshell that this would be paid for by raising the "supplementary tax" paid on North Sea oil production from 20% to 32%.

Needless to say shares in companies with substantial North Sea oil interests fell sharply as a result, some by as much as 12% on the day.

Banana republic

With a stroke of the pen the minimum tax rate levied upon North Sea oil production has jumped from 50% to 62%, with a few oilfields being taxed at as much as 81%.

Jim Pearce of AT Kearney summed up what many oil companies and their shareholders are feeling, myself included, when he said that "Britain hasn't been considered a Banana republic where taxes change, but people may well think, if the Chancellor's going to blindside us like this, the stability of Britain loses its appeal."

This tax rise has effectively cut a firm's after-tax profits on their North Sea oil production by at least 24%. It's not been well received, to put it mildly, and it's been reported that at least one major North Sea asset sale has been cancelled as a result.

Playing politics with the North Sea

Some politicians have claimed that the tax rise is aimed at those firms which sell petrol. They're wrong; the vast majority of North Sea oil producers don't sell petrol.

The few firms which have North Sea production and sell petrol in Britain are the giant multinationals like BP (LSE: BP), ConocoPhillips, ExxonMobil (Esso) and Royal Dutch Shell (LSE: RDSB). Since the North Sea is a very small part of these firms' global businesses, this tax rise has very little effect on their overall profitability.

Instead it's the smaller companies with significant interests in the North Sea who are hit, such as EnCore Oil (LSE: EO), EnQuest (LSE: ENQ), Ithaca Energy (LSE: IAE), Premier Oil (LSE: PMO) and Valiant Petroleum (LSE: VPP).

All of these companies have made substantial investments in the North Sea in recent years. But the tax rise will put a big question mark over any future investments, which means fewer jobs and, ultimately, falling tax receipts.

Using allowances to reduce the tax burden

The supplementary tax doesn't affect each company in the same way because firms can always offset some of the rise by using tax credits which have been created by their exploration costs. For example, Premier Oil's CEO has said that its $1.1 billion of tax credits means the tax rise shouldn't affect its profits for several years.

Those North Sea companies with interests in heavy oil fields, such as Nautical Petroleum (LSE: NPE) and Xcite Energy (LSE: XEL), should be unaffected as they are able to benefit from more favourable tax allowances. But as Nautical's CEO has pointed out, "it's bound to affect investment in the industry."

It's also been argued that a few firms, most notably EnCore, won't be affected by this tax as they are still exploring and will most probably be sold to a producing company before they ever extract any oil. But any potential buyer will still be caught for the extra tax and so won't value these fields as highly they would have done a week ago.

Invest anywhere else

Arbitrarily raising taxes in this manner is akin to running an advertising campaign with the slogan "Don't invest in the North Sea. Go somewhere else".

Put yourself in the shoes of a multinational oil company. Thanks to this tax increase the project you were thinking of starting in the North Sea will now make roughly one-quarter less than you thought it would. Why not invest in another country which has a much more predictable tax regime?

Politically popular?

The Chancellor has said that the supplementary tax will be cut if the price of oil falls significantly. I'd be surprised to see this happen since the parlous state of our public finances means that Britain could do with the extra taxes!

Not to mention the fact that temporary taxes have a way of becoming permanent taxes. Income tax was introduced in 1799 as a temporary measure to fund the Napoleonic Wars and Parliament maintains this fiction by renewing it every year!

Investors look elsewhere

Investors in oil companies are a fairly resilient bunch. We have to be since the oil business means that these firms tend to operate in some very politically unstable and corrupt nations.

But the way in which successive British governments have arbitrarily tinkered with the tax code over the last two decades is starting to make countries like Nigeria, Turkmenistan and Vietnam seem like safe havens in comparison!

I'm not going to sell my North Sea oil shares, at least for the next few months, as I believe that there's plenty more to come from their current drilling programmes (EnCore in particular).

But the North Sea has dropped off my radar for any future investments.

More from Tony Luckett:

> Tony owns shares in EnCore Oil, EnQuest and Premier Oil

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tru2me 28 Mar 2011 , 12:26pm

Some politicians have claimed that the tax rise is aimed at those firms which sell petrol. They're wrong; the vast majority of North Sea oil producers don't sell petrol.

Couldn't agree with you more Tony.

Also as you say the tax increases, changes the global operating geography of oilies.

milkyjoe 28 Mar 2011 , 11:36pm

I think it's a good call in a way. It's just like how if the price of oil is higher, it becomes economical to start extracting from unconventional sources like shale oil, equally that means it'll be economical to extract it from conventional sources that are highly taxed. Therefore, if you got some oil fields you might as well demand higher tax rates for extracting it.

And even if it does discourage investment in the North Sea so what? The oil will still be there, in the ground, it will still be ours if we need it, and if the price of oil keeps getting higher - which seems likely - then eventually it will become economical to extract it again even at the higher rate of tax.

In fact the more I think about it, the more it seems like the most sensible thing George Osborne has done.

TonyTwoTimes 29 Mar 2011 , 9:15am

I should add that Norway's StatOil has stopped work on a £3 billion North Sea development as a result of the tax hike.


Yes, the oil will still be there. But getting it out is highly dependent upon the supporting infrastructure and if firms cut back or stop investing then this won't be there to the same extent in the future.

This would make it even more expensive to resume production.

But the worst signal it sends out is that success is punished, often on an arbitrary basis, in contrast to the banks' failures and negligence which has been rewarded with massive subsidies.

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