Kemp: Britain Should Privatize Onshore Oil & Gas

Oil and gas taxation has become a major source of conflict between producers and Britain's tax authorities.

But like other indirect taxes, the amount of attention oil and gas taxes draw is out of all proportion to the amount of money they raise for the treasury.

Britain raised less than 5 billion pounds ($8.5 billion) from taxes on oil and gas production last year, about 1 percent of all central government receipts, according to the authorities.

Oil and gas taxes raised less money than duty on alcohol (10 billion pounds) or cigarettes (9 billion) and only a little more than minor imposts such as insurance premium tax (3 billion), air passenger duty (3 billion) and landfill tax (1 billion).

Oil and gas revenues are tiny compared with income tax (152 billion pounds), national insurance (102 billion), value-added tax (100 billion) and fuel duties (27 billion).

Two-thirds of oil and gas tax revenues come from the ring-fenced corporation tax (1.6 billion pounds) and supplementary charges (1.9 billion) paid by companies operating in the North Sea and other areas off the coast and onshore, with the rest coming from petroleum revenue tax (1.1 billion).

Oil and gas producers no longer pay royalties on fields developed after 1982, even though the government, rather than private landowners, has owned all oil and gas deposits since the passage of the Petroleum (Production) Act in 1934.

In any case, royalty payments never amounted to more than a small share of receipts from oil and gas, and effectively stopped from 2003 with the exhaustion of older fields ("Statistics of government revenues from UK oil and gas production", June 2014).

MAJOR IRRITANT

In March, responding to heavy lobbying by the industry, the government promised a review - which was formally launched on July 14 - of North Sea oil and gas taxation.

"Exploration and production is becoming harder and more expensive, and the UK is facing competition for capital from other countries," the finance ministry admitted.

But the tiny amount of tax raised from Britain's oil and gas producers (other than payroll and sales taxes paid by all businesses) suggests taxation is not the reason behind dwindling North Sea oil production.

Many in the industry hope that improved fiscal treatment can restore the sector's fortunes, but that seems unlikely.

"Oil companies have welcomed the UK government's announcement ... that it is reviewing the North Sea oil and gas tax regime, amid concerns the fiscal burden is threatening the sector's long-term future," the Financial Times wrote, reflecting the industry line.

A tax overhaul could "slow down this precipitous decline we've been seeing in oil production", one producer told the newspaper ("Oil companies welcome North Sea tax review", July 14).

But with the entire industry paying just 4.6 billion pounds in direct and corporate taxes, it is unlikely taxation is the "burden" many claim.

The reality is that Britain's remaining offshore oil and gas deposits are relatively expensive to produce and investment is going to more promising areas such as North America's shale.

FISCAL STABILITY

The oil and gas industry is on firmer ground complaining about the complexity of the tax system and frequent changes made to tax rates and allowances, and the introduction and then abolition of various special levies.

Fiscal stability might help unlock more long-term investment - though the industry must accept its own share of responsibility for the complexity and unpredictability of the system. Much of it is the result of past tax avoidance and fierce lobbying for specific tax breaks.

The tax authorities have been playing an elaborate game of "whack-a-mole" with production companies to collect adequate revenue from Britain's offshore and onshore oil and gas fields.

"The regime has become too bespoke. It needs to be simplified and made more predictable," the head of the Oil and Gas UK trade association acknowledged to the Financial Times.

Greater stability will require a more open and trusting relationship between the operators and tax collectors, something that will not be easy to achieve.

MINERAL RIGHTS

The government's focus is now shifting towards encouraging more onshore exploration for oil and especially gas. Ministers have hinted that yet another special regime could be created to encourage the development of relatively high-cost onshore shale deposits.

Britain has extensive shale oil and gas deposits in three major onshore sedimentary basins, which policymakers hope could be brought into production.

There are many challenges but among the stiffest is intense opposition from some local communities and green groups to hydraulic fracturing in rural areas.

Part of the problem, as many analysts have noted, is that local communities will bear all of the costs of oil and gas exploration without capturing any of the benefits.

Unlike in the United States, landowners do not own any oil and gas that might be found beneath their property, so cannot claim royalties or other payments from producers.

The 1934 Petroleum Act nationalised all oil and gas deposits in Britain.

Public ownership makes sense for offshore oil and gas, since the state, in the form of the Crown Estate, has always controlled the seabed.

But it makes less sense for onshore oil and gas, for which private ownership was the norm until 1934.

The UK Onshore Operators Group, a trade association, has developed proposals for compensating communities that host shale wells by paying them for each well drilled plus a small share of the proceeds from any hydrocarbons from the well ("UKOOG Community Engagement Charter").

The government has taken this a step further by making payments to local communities a condition of future exploration and production consents.

But it would make more sense simply to transfer the ownership of oil and gas back into private or community ownership and enable operators to negotiate commercial agreements with communities directly.

PRIVATIZATION

There would be no significant loss of government revenue, and the prospect of a financial windfall might make local residents more willing to accept drilling in their community.

Landowners are already compensated (through royalties) for extracting other minerals except oil, gas, coal, gold and silver, according to the British Geological Survey ("Legislation and policy: mineral ownership").

The system works well for other substances found below ground. There is no reason why the same system should not now apply to oil and gas.

There would be complications. In some instances, the ownership of the surface land has been severed from ownership of the mineral rights beneath it. But that is not an insuperable obstacle.

While the rights to other minerals may be owned by other private owners, the rights to oil and gas are currently owned by the government, so they could be transferred to individuals or communities.

The bigger issue is how to handle conflicts between neighbouring landowners in which some but not all would receive a financial windfall.

But settling such disputes is the purpose of the local planning system. Local authorities are already involved in all aspects of the process from planning permission to traffic management and the regulation of noise and other nuisances.

Current proposals from the government and industry recognise that local landowners and communities have a stake in the oil and gas industry.

Why not go the whole way and grant them ownership and financial rights to participate in oil and gas production by privatising underground oil and gas deposits? ($1 = 0.5858 British pound)

By John Kemp