The oil and gas industry stands at a crossroads. Producers are under fire on both fiscal and legal fronts – with eyes fixed firmly on quite how badly the Budget will be.

It seems clear it will be pretty bad. Increasing the headline tax rate to 78% may seem like only a small adjustment, but it feeds into the global perception of the UK as a tough place to do business.

The real pain, though, will be felt in the removal of investment allowances. The Labour government has deemed these to be “loopholes”, a point on which clearly industry disagrees.

However one sees them, the pain of their removal will be significant. Quite how many jobs will be lost in this uneven transition is not clear. But as work dries up in the North Sea, operators and supply chain will feel the heat.

A more pragmatic approach could unlock additional benefits. Wood Mackenzie has this week set out a best-case – albeit improbably optimistic – scenario of extracting more value from the basin.

The path the UK is on, though, will reduce domestic hydrocarbon flow and do little for revenues.

In the second quarter, oil production fell to a record low. Gas was also down on the previous quarter and is in structural decline.

To hear Secretary of State Ed Miliband speak, there will be no impact of reduced domestic hydrocarbon flow on the UK. This seems, at best, to be disingenuous.

Local flows

Allowing domestic resources to taper off, when demand continues to exist, in hope that the UK will always be able to pay the international price is folly. Such a view wilfully ignores the impact of geopolitics, for one, and removes a key bulwark against inflation.

Renewables can provide a means to meet domestic electricity demand, but export opportunities are limited.

Interconnectors can provide some limited flows and at some point in the future hydrogen may offer another export vector. But this still sees exports restricted to the UK’s neighbours. Oil, meanwhile, can be exported around the world.

Generating electricity is essentially a manufacturing process, Innes Auchterlonie, CEO of Imrandd, noted. “To export that, you can only compete on price. We would need to ramp up an exceptionally cost-effective production system and then compete.”

On the other hand, a country can export oil and gas as a high-quality good, he continued. “It’s a high value output, not everyone has it. It’s a product with inherent value from its rarity.”

Tax take

The government aims to raise around £10.8 billion from the Energy Profits Levy (EPL). Squeezing the industry too hard risks this sum. Rystad Energy warned recently that “at least” half of that amount was at risk, should brownfield activity reduce.

But there are additional costs that should also be taken into account.

Offshore Energies UK has forecast the EPL could cut 35,000 jobs directly. The broader figure could be 100,000 jobs, when considering indirect employment.

In addition, cutting investments in oil and gas will accelerate the speed at which facilities are decommissioned.

The Treasury has liabilities linked to decommissioning. Based on recent figures from the North Sea Transition Authority (NSTA), the total cost to the Treasury is estimated at £10.8bn.

The cost to the government of decommissioning would need to be paid at some point. But bringing costs forward, at a point when Chancellor Rachel Reeves has warned of a “fiscal black hole”, seems illogical.

A way forward

For Auchterlonie, the way forward would be to maximise recovery from the North Sea and protect infrastructure, while domestic demand continues. “No one disputes the need to change, but while we continue to consume hydrocarbons cutting off our own supply is ridiculous.”

To get there is a challenge, though. There have been calls for a truly independent regulator for the North Sea industry, akin to the Bank of England.

Another option to tackle some of the uncertainty is a move towards contracted sales to the government, at a set price. Producers would gain certainty about future demand, while the Treasury would be able to capture some economic certainty.

The challenge is the lack of political will. If one were to look logically at the practical impact of the higher EPL and the tough operating environment, it would be clear that oil and gas will decline precipitously.

But the government is focused on tackling on the short-term response to the “black hole”. Furthermore, taxing hydrocarbons is an attractive position to many of those outside Aberdeen.

The industry has failed for some years to show the benefit of domestic oil and gas to the UK populace. This has been a convenient fiction between companies and politicians.

There is no perception in the UK that hydrocarbon resources are a public good. Without this change, there is little prospect that politicians will risk taking on environmentalist interests.

Pragmatism

With the majors in retreat from the North Sea, and unwilling to put up a full-bodied response to the tax changes, the burden has fallen on the independents. These companies can make waves – such as Harbour Energy’s plans to shift away – but they do not carry the same weight as the larger companies.

There’s a need for balance approach, of course. The UK is rightly committed to decarbonisation and bolstering the green economy. For the time being, though, the country continues to rely on oil and gas. Cutting off this supply too early will have a negative impact on the economy and in particular those working in the industry.

There’s a need for collaboration. There have been some signs that the offshore industry and the government are exchanging ideas and more must come. There are options for ways forward, to support companies transition into the energies of the future.

Finding a way for the two sides to collaborate would provide rewards for the Treasury and the industry, helping deliver short and long-term energy goals.

But there’s a need for better outreach. The message from the oil and gas industry is simply not getting out to the broader public. Industry must do more, but so must politicians, if they truly believe in the balanced and pragmatic transition they espouse.

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