UK softens North Sea oil and gas tax hike, retaining capex allowance

UK Chancellor Rachel Reeves on Oct. 30 confirmed a three percentage point hike in North Sea oil and natural gas taxation along with the removal of an investment allowance, but refrained from a more draconian hike amid industry warnings of a hit to investment and a risk of accelerating output decline.

The chancellor in her first budget since the Labour Party took office confirmed the increase already announced in July to the Energy Profits Levy, lifting the headline rate of tax for the North Sea industry to 78%, and also removing an investment allowance that provided relief from the EPL at a rate of 29%. She said she was refraining from a more draconian reduction in a 100% "first year allowance" that also applies to the EPL. A "decarbonization allowance" is also being retained, at a reduced level.

Financial analysts confirmed the measures reduce overall tax relief for investment to 84.3% from 91.4%, with a higher rate of relief for "decarbonization" investment.

The changes in the oil and gas tax regime come into effect Nov. 1. The government previously described the allowances as overly generous "loopholes" and officials have noted the new headline rate is the same as Norway's.

Critics note UK oil and gas resources are more depleted than Norway's -- and less attractive for investment -- amid signs of reduced activity particularly east of the Shetland Islands, an area that supplies remaining Brent blend crude volumes.

UK crude and NGL production fell by 11% year over year in the first half of 2024 to 653,000 b/d, according to government figures. Overall UK oil and gas output is expected to fall by 10% annually in the near term, with a particularly pronounced decline for gas, according to a forecast by industry group Offshore Energies UK.

Industry reaction

The government "have realized that the industry has been taxed to the economic limit and beyond, hence the decision not to raise taxes even further," research analyst Chris Wheaton at investment bank Stifel said. While welcome, "it still leaves the UK North Sea industry paying too high a tax rate when windfall profits no longer exist," Wheaton said, pointing to reduced Q3 profits announced by BP the day before.

Upstream investment in the UK showed signs of recovering in 2023, reaching GBP5.2 billion ($6.8 billion), along with an uptick in drilling activity, however, neither investment nor drilling had returned to the pre-pandemic levels of 2019, according to official figures.

Rates of return on UK investment are less than half those for Norway, according to Wheaton. Some companies face an effective tax rate over 100% due to spending on decommissioning defunct assets, Neil McCulloch, CEO of Spirit Energy, the upstream arm of Centrica, told an industry event in September.

The tax hike comes amid a suspension in the issuance of environmental approvals for new oil and gas projects, and as two major projects -- Rosebank and Jackdaw -- face legal challenges from environmentalists.

Equinor CFO Torgrim Reitan -- whose company is developing Rosebank -- had hinted at a possible softening of the government's tax plans on Oct. 24, and added, "The decision and what comes through the Budget will define the attractiveness of future investments in the UK.”

“Today we heard the chancellor recognize the role of the oil and gas sector to support high quality jobs and strengthen the UK’s energy security," OEUK CEO David Whitehouse said. “However, with an increase in tax despite commodity prices at recent lows, there is no hiding that this is a difficult day for the sector."

The UK is a source for several crude blends used in the Platts Dated Brent price assessment process, used as a benchmark around the world.

Dated Brent was assessed at $71.40/b on Oct. 29, down 80 cents on the session, S&P Global Commodity Insights data showed.