Oil & Gas UK: Budget bareboat measure will drive drilling rigs out of UK

March 21, 2014

Industry trade body Oil & Gas UK welcomed the UK Government’s support for the recommendations of the Wood Report and the review of the industry’s tax regime announced by the Chancellor George Osborne in the Budget on Wednesday, March 19, 2014, to address the challenges and opportunities faced by the mature North Sea.

The consultation on a new allowance to encourage much needed investment in ultra-high pressure high temperature (u-HPHT) oil and gas field clusters is also very welcome.

However, Oil & Gas UK said it was perplexed by the move to change the basis for taxation of drilling rigs and accommodation vessels supplied using bareboat chartering arrangements to the UK’s offshore oil and gas industry, despite evidence that this new tax measure could prove damaging to exploration and development activity.

Malcolm Webb, Chief Executive of Oil & Gas UK, said: “It is increasingly obvious that the offshore oil and gas fiscal regime has become overly complex, burdensome and uncompetitive. The industry faces marginal tax rates of 62% – 81% on oil and gas production, which are unsustainable in a mature basin. The announcement of the review is a very welcome first step which we hope will lead to a simpler regime more attuned to the industry’s challenges and better able to secure international investment in the many, varied opportunities that remain.”

Oil & Gas UK estimates there could yet be up to 24 billion barrels of oil and gas to be recovered from UK waters. The proposed new allowance for u-HPHT clusters could be a game changer for technically challenging prospects in the North Sea. The allowance has the potential to attract £5 -6 billion of investment in the near term if it is pitched at the appropriate rate. The measure should also encourage broader collaboration around acreage near key infrastructure hubs.

However, Oil & Gas UK said it was concerned by the bareboat chartering tax measure.

The bareboat measure

“Oil and gas bareboat chartering – As announced at Autumn Statement 2013, the government is concerned about the use of specialised lease payments, known as bareboat charters, to move significant taxable profit outside the UK tax net, and has been holding informal discussions with industry. The government will cap the amount deductible for these intra-group lease payments by companies that provide drilling services or accommodation vessels on the UK Continental Shelf. The cap will be 7.5% of the historical cost of the asset subject to the lease, increased from the 6.5% cap previously announced at Autumn Statement. The government will also introduce a new ring fence to protect the resulting revenue. The changes will apply from 1 April 2014. The government will review the impact of the measure following its first year of operation,” reads the measure, published in the Budget 2014.

While the change may raise tax yield in the short term, Oil & Gas UK expects day rates for drilling rigs and floating accommodation vessels (known as flotels) will rise as a result, driving up costs and deterring much needed exploration.
Malcolm Webb said: “It is perplexing given today’s other good news that the Government has chosen to proceed with the bareboat measure. This can only increase costs on the UKCS where operating costs have increased sharply in recent years and last year saw a rise of 15.5% to an all–time record of £8.9 billion, and new developments are facing similar cost pressures.
“In addition, we fear that this move will drive drilling rigs, already in short supply, out of the UKCS. Exploration over the last three years has been at its lowest in the entire history of the industry in the UK, with only 15 exploration wells drilled in 2013.
“There is an overwhelming case to implement the recommendations of the Wood Report in full and without delay and so we warmly welcome today’s assurances of the Treasury’s unreserved support for that and for a new arms-length, well-resourced, regulator. We also applaud the oil and gas fiscal regime review and look forward to playing a full and constructive role in that.”

Other Oil and gas taxes in the Budget 2014

• Ultra high pressure, high temperature cluster allowance: The Chancellor announced that HM Treasury will consult on a new allowance for ultra-high pressure, high temperature (u-HPHT) clusters. This will be similar in structure to the onshore allowance announced at Autumn Statement 2013. It will exempt a portion of a company’s profits from the supplementary charge. The amount of profit exempt will equal at least 62.5% of the capital expenditure a company incurs on qualifying projects (though the exact rate will be announced following consultation). The consultation will be carried out over the summer.

• Bareboat chartering: Budget 2014 confirms that the government will proceed with the bareboat chartering measure announced at Autumn Statement. However, following a constructive consultation with industry i) the government will review the impact of the measure a year after its implementation; ii) the scope of the measure will be limited to drilling rigs and accommodation vessels (known in the industry as ‘flotels’; iii) the “hire cap” (the deduction available for the bareboat charter) will be 7.5% of the historical cost of the asset, up from the 6.5% announced at Autumn Statement; and iv) the pro-rata calculation will be based on worldwide utilisation of the vessel. Draft legislation will be published on 1 April, and will be open for technical comments until 9 May. The measure will come into effect from 1 April.

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Press Release, March 21, 2014