Orders of the Day — Oil Taxation Bill

Part of the debate – in the House of Commons at 12:00 am on 27th November 1974.

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Photo of Mr John Hannam Mr John Hannam , Exeter 12:00 am, 27th November 1974

The hon. Member for Dudley, West (Dr. Phipps), in an excellent speech, displayed his knowledge and understanding of the oil industry. He was the second speaker to express confusion at the complexity of the Bill. Perhaps that is why the benches around him are empty.

The debate is proving to be a searching examination of a potentially damaging piece of legislation, not in the sense of the principle of extending oil revenue taxation, but in the method chosen and the complexities of the proposed petroleum revenue tax and the field by field basis. However, I welcome the conciliatory approach of the Paymaster- General. He says that he has kept an open mind on the tax and I hope that in Committee he will accept the need for substantial changes in it.

We are all extremely concerned at the economic crisis facing the country and the whole of the Western world. There is grave danger of a world-wide recession in trade which would mean a difficult period ahead for our exports. Our home industry has been clobbered so hard by the Government that confidence and profits have dropped to an all-time low. Even the Chancellor of the Exchequer recognised that and made the biggest "U" turn ever. He has not done enough to save us from slumpflation over the coming year and possibly for a longer period. Therefore, we look to the productive capacity of our economy to produce as competitively as possible those products and goods which can be sold here and abroad to reduce our balance of payments deficit. Gas, coal and oil are obviously three such products.

Coal is in world-wide demand, yet despite massive pay increases since 1972, production is not reaching basic targets and we face grave shortages at home, let alone having coal available to export. Even the Central Electricity Generating Board is having to generate electricity uneconomically by oil-fired stations because of the shortage of coal.

However, we have oil—at least, we hope to have oil and should have it—in increasing quantities. It is represented as our nation's lifebelt, although whether by the time the lifebelt is thrown to the drowning Britannia it will prove to have been rotted away by over-taxation and State interference is part and parcel of what we are discussing today. The priority for Britain must be to attain maximum exploration now and to have controlled exploitation of the oil reserves in future.

Since 1964, when the first wells were drilled in the North Sea, a remarkable success story is evident. The physical conditions in the North Sea and the scale and cost of the equipment required make exploration and production operations very expensive. Nearly 700 appraisal and production wells have been drilled in the North Sea since 1964, each exploration well costing about £500,000 in the southern sector and over £1 million in the deeper water in the north. Winter drilling in the northern North Sea can cost between £2 million and £3 million a well.

The next phase will take the search into exposed waters of still greater depth and turbulence, for which a new generation of equipment is taking shape. Exploration expenditures will be dwarfed by the huge investment that will be required for fields found in these northern waters. These fields must be large enough to justify investment in pipelines at nearly £1 million a mile and costly offshore production facilities to bring the oil ashore. This kind of work has never previously been carried out at such depths anywhere in the world. The cost of developing under-sea fields in the North Sea will thus be measured in hundreds of millions of pounds for each field.

One of the many significant factors influencing the prospective return on such huge investments, is the very considerable "lead-in" time. The large production platforms may take up to three years from the decision to build to actual completion, and the development of a reasonable-size field could take between four and six years from drilling the first discovery well to bringing the oil ashore. For these reasons, the investment in productive capacity could be 10 times as much as would be required to produce the same amount in the Middle East. Operating costs will also be proportionately higher.

The financial implications are formidable. Even for the successful companies it will take several years to generate a cash flow sufficient to recover the very substantial initial high risk investments on exploration and production. To find the necessary capital, not only for the North Sea but for many other similar ventures around the world, the oil industry must maintain its profitability and will look for taxation policies by Governments that provide real incentives for the search to be pressed forward and investment levels to be maintained.

Of course, British involvement in these high-risk, deep-water technologies has been that of gradual progress in learning the skills of underwater drilling and assembly, oil-rig manufacture and servicing. We are now getting somewhere, although there are still many problems to overcome—rig construction sites, shortages of materials, labour difficulties and shortages of labour. Nevertheless, a massive investment by the international oil industry has resulted in this lifeline being thrown to the hard-pressed British economy. We can now look forward to self-sufficiency by 1980, or even surplus and substantial benefits to our balance of payments, but only if the full potential of the North Sea and other areas of our shelf can be developed.

The oil crisis last October has meant a major reappraisal of taxation policies, licensing and conservation measures. As far as conservation of energy goes, I regret very much the total inactivity of the present Government during the crucial summer period when many steps could have been taken to conserve fuel in this country.

However, the election is over, the pregnancy is nearly at an end and the Government's conservation baby is about to be born. I hope it is a more prepossessing child than the one we have before us today. We all wanted to see some kind of oil taxation change, but the PRT looks less attractive the closer we get to it.

No one really disputes the need for extra oil taxation. The oil companies themselves acknowledged that a year ago when the Conservative Government were drawing up plans to place ring fence around the North Sea and to tax excess profits which would accrue when the oil begins to flow next year. It was considered essential to raise taxation only to a level which would still leave a reasonable discounted cash flow for the oil companies of around, say, 25 per cent.

So I do not oppose the principle of extra oil taxation. Yet what a complicated nonsense the Government made of it. Instead of a graduated-rate excess corporation tax on the windfall profits fitting neatly on to our existing corporation tax structure, we have this complicated tax, with no rate established yet, strict and penal restrictions on secondary field "sideways" costs, and limitations on deductibility of interest.

The effect upon our smaller marginal companies, which are those with just the oil wells we shall want to see developed if we are to attain the production levels we need, will be to drive them out of business. The effect on the larger companies will be to make them reconsider their future plans for secondary explora- tion and development. American operators have already begun to reverse original exploration plans. They believe that there has been fundamental dishonesty on the part of the British Government in changing the rules so drastically halfway through the contract. They have had 12 months waiting for details of the Government's intention to be made clear. Now, very great concern is being expressed, not at increased taxation, but at participation threats, uncertainty over the rate of tax and the disallowance in the Bill of the real costs and interest incurred in genuine oil developments in our North Sea.

The Govenment's only reply to these charges is that other countries in the Middle East and Norway are doing it. Norway, with its 4½ million inhabitants and its need for conservation rather than exploitation, is a special case. The Middle East is an area of ridiculously low-cost established oil production. In any event, it is not the answer to beat your own child just because the bully down the road has been beating his. I suggest that the answer is to go and stop the other chap from beating the lad.

I should like to turn to some of the detailed provisions of the Bill which I hope the Government will revise before making it law. First of all, we have the concept of the petroleum revenue tax—a new tax on proceeds rather than profits requiring our oil companies to pay a rate of tax, as yet not defined, on their income after certain expenses have been allowed and the initial capital investment paid off.

It seems to me that the Government have opted for this complicated new tax system because they fear delays in payment of Government income if a simpler form of extended corporation tax were to be used. I think this is a fundamental error on their part, although I accept that it would be difficult initially to agree the levels of excess profits at which a sliding scale corporation tax would apply. But the flexibility inherent in the corporation tax system would allow early adjustment to the rates applicable to the smaller more marginal fields.

The more productive fields would be adjusted to a higher scale to cover the windfall profits of a prolific field. The problem of early payments of tax income to the Revenue could be overcome by use of an advance excess profits tax payment—a kind of oil PAYE system. In any case, under PRT the Revenue will not get its return until after the capital costs have been recovered.

The complications and restrictions on allowable costs in the Bill are unnecessary and will certainly have a serious detrimental effect on the North Sea oil developments. Surely the first priority must be to get the oil flowing as quickly as possible and then to increase and sustain further exploration. But this involves vast capital costs and, in this inflationary era, rapidly rising servicing and development costs.

It must be becoming obvious to the Government that the so-called profits bonanza which the much-maligned oil industry was about to experience at the nation's expense is fast disappearing out of the window. In the last year, development costs of winning the oil from the unfriendly depths of the North Sea have just about doubled. On top of that there is always the fear of a sudden drop in world trade followed by a sharp fall in oil prices. I fear a future OPEC weapon when we are all hooked on expensive oil production.

For months, the Opposition have tried to warn Ministers of the danger of a mass walk-out from what is becoming a high-risk financial gamble. Now, at last, it seems that warning signals are being received by the Energy Ministers as the major oil companies cut back on future exploration plans and the smaller companies withdraw altogether from their North Sea ventures. If that is so—and it seems borne out by the article in last night's Evening Standard headed North Sea oil—a change of heart in Whitehall —we welcome the realism creeping into the attitude of Ministers.

We have had the Chancellor of the Exchequer, the Employment Secretary and now the aggressive Energy Ministers, especially the noble Lord, Lord Balogh, changing tack and becoming more subdued in their accusations against the wicked oil companies. If that is the new situation the Bill should and ought to be radically redrafted to include a graduated excess profits extension of corporation tax and the fundamental inclusion of real costs in recoverable allowances.

It is wrong to tax the revenue from the oil flow from one field without regard to the fall in profit margins due to rising costs and to the losses incurred and the costs of company operations in other secondary areas and wells. The aggregation of results from marginal and successful fields should be allowed, or without doubt the doubtful fields will not be continued and the smaller man will be driven out. But, perhaps in line with their other industrial policies, that is what the Government want to see.

The 50 per cent. uplift on capital expenditure set out in Clauses 2 and 3 represents an arbitrary formula which will not help the small company which has financed its oil exploration by outside financing and therefore has substantial servicing and interest costs to bear. Surely these smaller operators must be allowed to deduct such interest payments. I believe that they should be given the chance—I hope that the Bill will be so amended—to give up the uplift allowance and instead to deduct interest paid for outside financing.

Under Clause 3 the disallowable expenditure items will crucify those companies which have negotiated arm's-length financing. Even good fields will be threatened.

A company borrowing on a non-recourse basis has to offer a reasonable interest rate plus a return on profits to cover the risk element. The banks providing this non-recourse finance do not gain super profits from the transactions, because the oil companies ensure that such a sacrifice is not made. Therefore, arm's-length financing at normal returns of interest and royalty should be allowable either as uplift allowance or as interest at commercial rate. I hope that the clause will be altered to allow these fundamentally reasonable development costs.

I turn to the field-by-field requirements of the Bill. The Government have stated that these field limitations are non-negotiable. I hope that the flexibility that has begun to creep into the Paymaster-General's attitude will allow this rule to be relaxed. My objection to the inflexibility of the rule is that, at a time when investment programmes are at risk anyway, this field-by-field basis of assess- ment will discourage investment by preventing profits from one field funding investment in another.

A company with four definable oilfields could have success with field A but suffer nine years abortive drilling on field B. The colossal interest costs over those nine years will not be allowable against field A revenue, so the result may be that the company will have to cancel the high-risk exploration programmes for fields C and D. In any case, the limit of 1,000 long tons laid down for the definition of a taxable field needs to be adjusted to take account of the abortive field which is lost after six months' operations due to one reason or another. By that time over 1,000 long tons of oil will have been extracted anyway, and I understand that the costs of that abortive field will not be allowable against the company's other fields. These losses will then be locked into that abortive field because it had run long enough to exceed the limit of 1,000 long tons of production.

As we look closer at the Bill it seems that we need to carry out substantial revisions. The nation and the oil companies want oil from the North Sea. We want a profitable oil industry with ever-growing British involvement. We want a businesslike method of taxing the windfall profits accruing to the oil industry. However, we do not want to create an unnecessarily complicated and unfair tax system which puts our exploration plans at risk.

I hope that the points that have been made in the debate will be taken into account, that by the time the Bill reaches Committee more drastic changes will have taken place and that other changes will be allowed by the Government in Committee.