The UK government bowed to some intensive industry lobbying this week, and changed tack on taxing the North Sea. Corporation tax was cut by 10 percentage points, tax on revenues by 15 percentage points, and an investment allowance was introduced as a sop to new spending.
Only weeks ahead of a general election, it was notable that the moves were broadly welcomed by all major political parties.
A strong foundation for regional regeneration, said the sector’s main cheerleading troupe OGUK. Hopefully enough to make things better, said a cautious Deloitte. Public money being used to sustain private profit, said advocacy group Oil Change International. Who is right?
Certainly a low oil price environment is not good news for the UK’s coffers. As the OECD raised its expectations for economic growth in the eurozone and Japan for this year and next, its expectations were revised downwards for the UK, in no small part because of the fall in the price of crude since November. In the longer term, the UK’s independent Office of Budget Responsibility forecasts that the effect of lower oil prices on North Sea production is expected to reduce UK gross domestic product (GDP) by 0.3pc by the end of 2019-20.
Faced with this kind of hit, the government probably thought it had little choice but to incentivise North Sea operators through what could be a sustained period of below-cost prices. Because in the boom years, many were none too prudent.
The Bank of International Settlements (BIS) says the debt borne by the oil and gas sector has increased from around $1 trillion in 2006 to around $2.5 trillion in 2014 and this is creating strains as the oil price, which underpins the value of assets that back the debts, falls. This rise in debt has been aided by low interest rates which encouraged companies to take advantage of historically cheap money.
But at some point this year, the US Federal Reserve is likely to increase its benchmark short-term interest rate, with the aim of pushing rates higher across the board. If oil prices stay low, a sudden hike in the cost of borrowing will add to the risk of lower oil company profitability, increase the risk of default and lead to higher financing costs, BIS says. Also, lower prices reduce the cash flows associated with current production and increase the risk of liquidity shortfalls.
So where can a heavily-indebted firm go after it has sold as many assets as it can spare? BIS says such producers may attempt to maintain, or even increase, output levels even as the oil price falls, in order to remain liquid and meet interest payments and tighter credit conditions. German company Wintershall has already said the best way through a time of low prices is to pump much, much more.
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