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How Shell And BP Will Benefit From Tax Cut in North Sea

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By: MICHEAL KAUFMANPublished: Mar 22, 2015 at 9:56 am EST

As UK’s North Sea oil industry suffers from declining production and a prolonged slump in oil price, the government has given oil companies a good reason to rejoice.

George Osborne, UK’s Chancellor of the Exchequer, announced earlier this week the government’s decision to reduce tax applicable to energy investments made in the North Sea to help the struggling oil and natural gas industry. The Petroleum Revenue Tax will be reduced from its existing rate of 50% to 35%.

In his budget statement on Wednesday, Mr. Osborne said he would lower the supplementary rate of taxation from 30% to 20%, which is applicable on the profits of oil and natural gas companies who operate in UK’s North Sea. The downward revision has come three months after it was previously reduced from 32% to 30%. It is levied on top of the existing corporation tax. The lowered rate of supplementary charge will be backdated to January, effective immediately.

According to the trade association body Oil & Gas UK, effective tax rates on energy production from older fields in North Sea will be lowered from 80% to 75%, while newer fields will be subject to an effective tax rate of 50% as opposed to 60% previously.

Crude oil price has fallen to six-year low after being on a downward trajectory for nine months. From averaging over $100 per barrel, oil price has nearly halved. The US benchmark for crude oil, West Intermediate Texas futures for next month delivery are currently priced at $45.72 per barrel, while Brent crude oil futures, the global oil price benchmark, closed on Friday at $55.32 per barrel.

The recent downturn in oil price has run chaos in the oil and gas industry across the globe, with UK’s North Sea oil industry being no exception. “It is clear to me that the fall in oil price poses a pressing danger to the future of our North Sea industry,” Mr. Osborne said during his speech on March 18. He went on to say that the situation requires “bold and immediate action” from the government.

Major oil and gas discoveries were made in the North Sea four decades ago after test drilling in 1966, making it one of the most attractive energy exploration sites in the world. The quality of oil and its proximity to oil markets in Europe has seen major oil companies set up operations in the North Sea. However, most industry experts agree that North Sea region is past its prime and is maturing. Oil extraction has become relatively more expensive and production has been on a decline.

According to the Wall Street Journal, last year’s average production in North Sea of 1.4 million barrels of oil equivalent per day is around 70% lower than what the oilfields could produce 15 years ago. Falling production, coupled with record low oil price, led to major oil firms cutting back their capital spending budgets in the North Sea, including BP plc (ADR) (NYSE:BP) and Royal Dutch Shell plc (ADR) (NYSE:RDS.A)

The government had been under pressure to make North Sea attractive for oil producers once again. In January, Shell announced its plans to reduce its capital spending budget for fiscal year 2015 (FY15) by $15 billion. CEO Ben van Beurden said the company could sell off its assets in North Sea fields as part of the spending cut because the fall in oil price made it even harder to operate in the region. “We see falling production levels, rising costs, high tax and ageing assets, so it was a tough place and it just got tougher will the low oil prices,” said Mr. Beurden. Last month, Shell formally submitted plans to the government to decommission its Brent Delta oil platform.

Following the much-awaited tax cuts, the multinational oil and natural gas company might reconsider its decision to scale back from North Sea. Lower tax rates will most likely increase investment in the area, which could boost North Sea’s oil production. According to Mr. Osborne, the Office for Budget Responsibility estimated that the tax cut would increase oil output by 15% by 2020.

Similarly, British oil giant BP had been concerned about its North Sea operations, which began decades ago. The company admits that North Sea oilfields are maturing and announced to cut 200 jobs and 100 contractor positions at its North Sea operations in January, as a response to “toughening market conditions”. The oil company was in need of a relief and the tax cut seems to have arrived at the right time.

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