28 November 2022

In the North Sea, the UK is slaying its golden hen


In Aesop’s fable of The Hen that Laid the Golden Eggs, a man blessed with such a creature gets greedy, slaughters it expecting to find gold inside and is left instead with a chicken dinner.

The North Sea is not a poultry farm, and the Treasury is not a purveyor of nuggets, gold or otherwise. However in introducing, then raising a third tax on the region in a matter of months, it has displayed similar wisdom to the fictional butcher. Little wonder, then, that a group of Tory MPs are warning of an ‘existential threat’ to the industry.

To recap, the new Energy Profits Levy (EPL) is a 35% ring-fenced (RF) profits tax. Combined with the RF Corporation tax (30%) and Supplementary Change (10%), it amounts to a possible 75% tax on drilling returns. Complex allowances can reduce this, and the Treasury claim nearly 92p in every 100p of the EPL is recoverable if firms continue to invest in the region. But this distortion is not retrospective. Firms who invested in the North Sea earlier this year will be at disadvantage to any that waited until next.

No one sensible believes high, complex, let alone ever-changing taxes are a boon to enterprise. In the North Sea this isn’t just a theoretical objection – on the two previous occasions that the Government entertained fiddly special taxes the 1980s and 2000s there was a lagged collapse in both investment and tax returns. By 2015/16 HMRC was paying out negative taxes forcing then Chancellor George Osborne into a humiliating U-turn on taxes he had only recently raised and phasing out the even older Petroleum Revenue Tax.

The EPL will go the same way, only this time more quickly. Both government and opposition have spent two decades signalling their hostility to carbon industries. From the Climate Change Act to technology bans and the fracking moratorium, Parliament’s message to the industries that provide 75% of our current energy needs is ‘go elsewhere’. Many have already taken that hint. The household name supermajors like BP and Shell have been small UK players for years. Yet they still find themselves vilified for ‘vast global profits’ – profits now beyond the reach of the Treasury. We’re lucky those companies are still listing in London, let alone employing Brits.

It is hard to overstate the self-harming stupidity of this approach. Sustainable development requires prosperity. There is a clear link between development, reducing pollution and innovation. Oil and gas are commodities we need and will continue to need until alternatives are ready and affordable, decades hence. Their prices whether global or regional are volatile and reactive to global events. Today’s high gas prices, for example, were preceded by record low prices during the pandemic, and huge losses and failures for many firms. None of which necessitated a tax-pay funded bailout or tax cuts, the logical corollary to imposing high taxes when times are good.

The sugar rush of temporary popularity that politicians think they receive for ‘sticking it’ to the ‘profiteering polluters’ has a flipside – the very real danger of blackouts and freezeouts. A serious risk next winter when the full impact of Russian isolation hits European markets, and everyone is competing for the same cargoes of LNG. It doesn’t take much in a global climate of protectionism for an over-reliance on imports to turn into a winter of discontent. If we accept we still need the North Sea, a different approach is required.

The US treats fossil fuel producers much as it does any company. The Federal Corporate Income tax is 21%, to which rates of 1-12% are added by the states, and this applies to drillers the same as drug stores. Attempts by President Biden to introduce special levies have so far proven ineffective. Clearly, America is a more attractive place to invest than the UK.

Norway conversely has a special tax regime at a higher rate of 78%. Oddly, this is also more attractive than the UK, given that rate hasn’t changed since the 1970s and the state is an active partner in investment through Equinor, 50% shares in assets, and a world-class sovereign wealth fund. Investors know what they’re getting in Norway – stability, and that everyone has a stake in their success.

The small producers who don’t want to give up on the UK just yet want to revisit an older idea that tries to marry aspects of both. Osborne justified raising the Supplementary Charge in 2011 by linking it to paying for freezing fuel duty.

He called the link the ‘Fair Fuel Stabiliser’ and suggested that when oil prices fell below $75 a barrel ‘for a sustained period’ the position would reverse. That link makes no economic sense. It was a political reaction to both fuel protesters and environmentalists lobbying in opposite directions. But the idea of a tax rates linked to prices, predictably and transparently, would address some of the problems created by endless tinkering.

In today’s money $75 is more like $100, which is conveniently also the oil price above which OPEC (the cartel of major producers led by Saudi Arabia) believe is reasonable for them to increase output. It is possible the UK could restore some confidence in North Sea investment by getting cross-party agreement to create a fiscal regime that is less arbitrary. For example 50% at $100, 75% at $150, but only 25% when prices fall to $50. The banding and rates mattering less than that they’re clear and don’t keep changing. A different gearing would also be required for gas profits, the prices of the two commodities no longer track each other, the latter being regional, the former global.

This alone would not be enough. The UK’s ideological obsession with solving global warming unilaterally (or ‘leading the world’) has led to a literal campaign of managed decline in the North Sea executed through the North Sea Transition Authority and hyper-regulatory controls such as the ‘Climate Compatibility Checkpoint’ that waste time and money on facile virtue signalling. To regain credibility, we need both tax reform and a more pragmatic overall approach – one that accepts that domestic production is desirable until displaced, and that a functioning streamlined market is better than central planning. That won’t be easy, given the way the climate blob clings to ‘leave it in the ground’ posturing.

But be in no doubt that the alternative is to simply pay others, including our progressive friends on the other side of the North Sea, to drill for us. Or, if that proves insufficient, shivering in the dark while we sacrifice chickens to the wind gods. Golden eggs, not entrails, is the way to pay for sustainable economic change, and perhaps being a little kinder to the hens if we want them laying in our coop.

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Andy Mayer is Chief Operations Officer at the Institute of Economic Affairs.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.