These are dark times for oil and gas exploration in the U.K. sector of the North Sea. The mature hydrocarbon basin, which already had an onerous tax burden, saw things take another turn for the worse following a change of government in July.
The country’s Labour party and its Chancellor Rachel Reeves made sure North Sea operators felt their share of the highest tax hikes instituted by any British government in recent memory, as part of her now widely derided autumn budget delivered on October 30.
It included an increase in the so-called windfall tax on North Sea oil and gas producers to 38% from 35% and an extension of the levy by one year to March 2030. It brought the U.K.’s headline tax rate on oil and gas operations to 78%, among the highest in the world.
The changes also included scrapping the levy’s 29% investment allowance, which lets hydrocarbon explorers offset tax from capital that is re-invested. The new fiscal framework has triggered widespread fears of a decline in investment and exits from the North Sea.
The increase to the windfall tax, formally known as the Energy Profits Levy, and other new measures took effect on November 1. Barely a week later explorer Apache Corporation announced its decision to cease North Sea production at its U.K. assets and as well as a corporate exit by 2030.
Given that leaks and briefings to the media had largely put what Reeves and the Labour Party had in store for the North Sea out in the public domain, many others actually put their plans in motion to reduce their exposure ahead of the government’s plans being actually revealed in the British parliament.
A week before the budget, Reuters reported that another operator Harbour Energy wanted to sell stakes in its North Sea holdings to reduce its exposure as well as move its stock listing from the U.K. to the U.S.
Japex, Neo Energy and Deltic Energy were also among those looking to reduce or remove exposure and / or cut their respective investments in the basin.
As for the oil and gas majors, most have already left or are calling time on their decades-old U.K. North Sea adventure. They include Chevron and ExxonMobil. TotalEnergies, another supermajor and a huge North Sea operator, is halting fresh exploration for now.
The tax hikes have come in near tandem with a suspension in the issuance of environmental approvals for new oil and gas projects. Additionally, two major projects – Rosebank and Jackdaw – are facing legal challenges from environmental groups.
At ADIPEC 2024, the world’s largest energy exhibition and conference which concluded on Abu Dhabi on November 7, behind the smiles at market presentations, the mood among U.K. oil and gas operators was pretty somber.
What Windfall?
The Labour government points to channeling higher tax takings from the North Sea towards decarbonization and renewable energy. But many reckon the objective is unlikely to be achieved if investment continues to take a nosedive.
The new fiscal framework may even backfire as lower North Sea natural gas production can potentially leave the U.K. exposed to higher international imports.
Furthermore, the windfall tax – initially levied in 2022 following Russia’s invasion of Ukraine – appears to have outlived its purpose following recent oil price declines.
A spokesperson for industry lobby group Offshore Energies U.K. said it welcomed the deployment and acceleration of renewable energy supported by tax takings, but that the North Sea was a strategic asset capable of providing oil and gas that will be needed for decades to come.
“Therefore, windfall taxes extended on oil and gas producers when no windfall exists deter the very investment that we need across our energy transition.”
Several attendees at ADIPEC also pointed to recent analysis by Wood Mackenzie that noted up to £10 billion ($13 billion) of U.K. North Sea oil and gas pre-tax value could be unlocked from existing assets if the country’s government was to implement a fiscal system that encourages investment – and restores trust with the industry. What has been put forward doesn’t fit that description.
A Most “Unstable” Fiscal Regime
Instead, another round of politically motivated tinkering has reinforced the perception that the U.K. North Sea fiscal regime is one of the most unstable in the world, according to Dr Carole Nakhle, Founder and CEO of Crystol Energy, and an expert on international oil and gas taxation.
“Traditionally, that instability was compensated for by offering a lower fiscal take by the U.K. government from investors and operators, and lower prospects of geopolitical upheaval,” she added.
“However, today we are seeing high marginal tax rates [in the U.K. North Sea] which are not common in jurisdictions like it, but typical in countries where fields are larger and the sector is dominated by big companies including state-owned enterprises.”
That said, the fiscal framework remains profit-based, i.e. progressive unlike other regimes that rely heavily on revenue-based mechanisms such as royalties and are therefore regressive because the government take increases when profitability decreases.
“Also, despite the latest changes, the government has provided clarity for the next few years thereby compensating to a certain extent for the higher take. On balance, what Reeves has put forward is far from ideal for a shrinking sector but still has some attractive features compared to what is offered elsewhere,” Dr Nakhle concluded.
Problem for the U.K. North Sea is that with the majors having all but gone from the basin, independents packing up and leaving, and those left behind curtailing their investments – there may not be much left at this rate within a few years.
All things considered, not many in the market would have thought that politicized taxation – and not economics coupled with declining production volumes – would accelerate the North Sea’s downward spiral as it currently appears to be doing.