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UK Chancellor George Osborne announced major tax cuts for the country’s energy industry last week, in hopes of propping it up amid the continued price depression.
At first glance, this is the best news UK oil companies have gotten since last year, when the Petroleum Revenue Tax (PRT) was slashed from 50 percent to 35 percent, and the corporate profit tax was reduced from 32 percent to 20 percent. But below the surface, there is a different story.
Now, the PRT has been completely dropped—effective retroactively as of 1 January 2016--and the profit tax (supplementary charge) has been cut to 10 percent—again with implementation backdated to the beginning of this year.
These measures reduce the headline rate paid by oil companies to 40 percent, for both new and mature fields, from 50 percent and 67.5 percent, respectively.
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Osborne defended the decision by arguing that the energy industry employs a lot of people, many of whom have already been laid off as a result of the price slump. He said the measures were aimed at ensuring the long-term sustainability of the industry.
That may well be, but how successful the measures will be is questionable.
For starters, their direct positive effect on the companies’ performance is doubtful, as suggested in an analysis by Rystad Energy. The analysis is based on the UK oil asset performance of the five biggest sector operators in the country for the first two months of this year, factoring in the tax reduction. None of these performances is positive. According to the author of the analysis, this clearly indicates that high taxes are not the problem. The problem is low oil prices, and it is more serious in the UK than elsewhere because this is the country with the highest production costs per barrel of crude.
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Outside the energy sector, there is also environmentalist pressure to consider. Osborne’s announcement was immediately met with strong opposition from green groups. Though this pressure could be ignored, at least for a while, the obligations that the UK signed up for under the Paris Agreement cannot be. It has pledged to reduce carbon emissions, as have 194 other countries.
Stimulating hydrocarbons extraction is not the best way to do this, so it’s likely that last week’s tax-relief decision will have potentially serious repercussions for the government, and could lead to a change of heart (or government) in three years.
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Finally, there is the public reaction to the tax cuts. The energy industry contributes 16.4 percent of the total corporate tax revenues of the UK, according to PwC. This is about £30.1 billion, or $43.27 billion. The tax cuts have been calculated to cost £1 billion in lost government revenue over the next five years. This cost is most likely to be passed on to the public, which, again, is unlikely to be a popular move.
So, although a tax break is always welcome, it cannot do what UK energy companies need: raise the price of oil and reduce production costs, which are so high because most oil fields in the country’s North Sea continental shelf have crested the peak of their productive lives. They will just have to outwait the price rout and enjoy the lower taxes while they last.
By Irina Slav of Oilprice.com
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Irina is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing on the oil and gas industry.