Priming the pumps

AMONG the tax cuts announced in his budget on March 18th, the chancellor of the exchequer, George Osborne, laid out big reductions for oil and gas companies operating in the North Sea. The previous tax rates for companies operating in the older fields sometimes amounted to a punitive 80%. Now the petroleum revenue tax will be reduced from 50% to 35%, and a supplementary corporation tax will come down from 30% to 20%. The government will also invest in new seismic surveys in the more remote areas of the North Sea. Altogether, Mr Osborne hopes that these measures will boost production there by 15% by the end of the decade.

Oil and gas companies lobbied furiously for these changes, and they will certainly be welcomed, not least around the industry’s capital of Aberdeen, where some 160,000 people rely on the sector. Mr Osborne should not expect much gratitude, though. Some firms have yet to forgive him for raising taxes in the first place.

In 2011 the chancellor surprised everyone by increasing the supplementary tax by 12 points to 32% (afterwards lowered to 30%). This might have netted the hard-up chancellor a windfall of about £2 billion ($3 billion) but, so argue many in the industry, the tax rise also deterred companies from sinking any more money into an ageing basin where it had already become very expensive to operate. With margins wafer thin, North Sea oil and gas production, which had been falling steadily since its peak in 1999, plummeted between 2011 and 2013, before recovering slightly last year. Just as importantly, new exploration has crawled almost to a halt. This year it is expected that as few as eight new exploratory wells might be drilled. One consequence is that the once mighty North Sea oil and gas sector has become increasingly marginal to the overall British economy. In 2011-12 North Sea tax revenues totalled £10.9 billion, but in 2013-14 they had shrunk to just £4.7 billion.

Furthermore, although there might have been a case for a windfall tax in 2011 when the oil price was high, averaging $111 for a barrel of Brent crude over the year, since last June the price has tumbled. It is now down to about $55 a barrel. This has put even more pressure on margins and profits, so much so that, over the past six months, companies have been cutting wages and laying off hundreds of workers in a rushed attempt to cut costs. Overall, according to Oil and Gas UK, an industry lobby group, the sector lost £5.3 billion last year, the worst performance since the 1970s, when the colossal investment in new platforms and other infrastructure preceded the flow of oil and gas.

With the price of oil expected to stay at its current level for some time, both employers and employees know that only by drastically reducing operating costs in the North Sea over the long term can the basin remain profitable enough to attract investment, let alone compete with less costly deep-water basins in the Gulf of Mexico and off the west coast of Africa. With oil over $100 a barrel, the industry got used to living high on the hog, but those days are gone. In this respect, the tax cuts are helpful, but hardly crucial. Cutting costs will prove far more important.