From the editor: UK North Sea industry faces existential crisis [Global Gas Perspectives]

In the wake of the Labour party’s landslide victory at the UK general election in early July, the country’s already struggling oil and gas industry faces “irreversible damage,” from the new government’s planned tax policies, Edinburgh-based consultancy Wood Mackenzie warned in a report this month.

The UK was among a number of countries to impose a windfall tax on the profits of oil and gas producers at the height of the global energy crisis in 2022, taking a larger chunk of their then record earnings to fund subsidies to lower energy costs for businesses and households. But it stands out this year for proposing a further hike in the levy, even though energy prices have fallen significantly over the past two years.

The former Conservative government introduced the Energy Profits Levy (EPL) in May 2022, and it has already undergone several changes since then, heightening the sense of policy uncertainty that the North Sea industry feels. Initially, the levy was set at 25%. Adding to the existing 40% tax on profit, this brought the overall tax burden to 65% of income. However, it also included an investment allowance, by which companies could deduct 80% of investments they made from taxable profit. The levy was to remain in force until the end of 2025.

In November 2022, the EPL was raised to 35% and extended until March 2028. And then in July 2023, the investment allowance was slashed to 29%. In March this year, the levy was extended once more, by a year until March 2029.

Now, Labour has proposed increasing the tax rate once more to 38%o, bringing the overall tax on profit to 78%, and extending its duration until March 2030. They have also vowed to further limit the investment allowances which they have described as “overly generous.”

All this means that for more than the next five years, the UK North Sea will be saddled with one of the highest rates paid by oil and gas producers in the world. Indeed, the only way the levy can be ended prematurely is if oil and gas prices  both drop lower than $71.4 per barrel and £0.54/therm respectively for six consecutive months, which is unlikely to happen anytime soon.

An existential crisis

For a mature basin like the North Sea, this is an existential challenge. Numerous operators have already reported shelving projects or scaling back their presence in the region, and some have quit altogether.

WoodMac estimates in its report, a copy of which was seen by The Financial Times (FT), that UK North Sea oil and gas production could halve by the end of the decade because of Labour’s proposed changes, which will be finalised in the government’s October budget.

The investment allowances in the EPL are “imperative for investment to continue,” the Edinburgh-based consultancy said, “as the direct damage done to the industry and the indirect impact on its support services and energy security would quickly become irreversible.”

Many companies are currently basing their plans on assumptions that the investment allowances will be removed and that the EPL regime will remain in place indefinitely. In this scenario, WoodMac estimates that £19bn ($25.4bn), or 65% of the UK’s remaining development capex, would be eradicated, and industry cash flow would be virtually wiped out by the 2030s.

“The reality could be even worse. Smaller companies would likely fail through lack of cash flow, with implications for JV partners and the UK government in terms of decommissioning liability,” it continued. “We do not expect the government to select the worst case outcome, but having stated it believes UK oil and gas must be kept healthy and productive ‘for decades to come’, it is creating an investment environment where the industry is fatally wounded in less than five.”

Even if the EPL does end by 2030 and capital allowances are allowed, oil and gas output would still drop by 30% within six years, the consultancy said.

The frequency of changes in UK fiscal policy governing North Sea oil and gas contrasts greatly to the situation in neighbouring Norway, where successive governments that maintained stable taxation regardless of where the market is in terms of the boom and bust cycle. This is hardly surprising, given that the industry accounts for the largest share of Norway’s economy and is the biggest generator of government revenue. In fact, Norway’s biggest change to the fiscal regime was made in 2020, when Oslo provided significant tax breaks to ensure that investment continued flowing despite record low oil and gas prices.

Emboldened environmental challenges

Adding to its tax changes, Labour has also vowed to stop issuing new licences for oil and gas exploration. Furthermore, the government said last month it would not contest the judicial review challenging past development consents for two key North Sea projects – the Rosebank oilfield and the Jackdaw gas field. As a result these challenges, brought by environmental activist groups, have since secured approval to be heard by the Court of Session in Edinburgh on November 12.

Rosebank’s operator Equinor estimates that the field could contribute about 7% of UK oil production, while Shell estimates that Jackdaw could flow enough gas to heat 1.4mn homes. The fate of both projects is now in the air. Should the challenges be successful, the operators will have to reapply for planning permission from a government, which at the very least could cause multi-year delays, and could lead to their cancellation altogether.

By refusing to oppose such legal challenges, the government has likely emboldened future environmental challenges at the courts. Even those projects that are still feasible even with the challenges could therefore run into difficulties.

Despite all this, Labour has said repeatedly it recognises that oil and gas will continue to be needed for many years to come. It seems, though, that this need will have to be satisfied increasingly with imports, to the detriment of both the UK economy and the environment, as transporting oil and gas for thousands of kilometres, sometimes from countries with laxer environmental standards than the UK, will inevitably lead to higher emissions.