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Clause 83

Finance Bill – in a Public Bill Committee at 2:30 pm on 18th June 2009.

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Capital allowances for oil decommissioning expenditure

Question proposed, That the clause stand part of the Bill.

Photo of Greg Hands Greg Hands Shadow Minister (Treasury)

I mentioned earlier that the post of Exchequer Secretary is currently a sort of revolving door at HM Treasury: since the clauses on oil were included in the Bill just a few weeks ago, we have gone through three Exchequer Secretaries, none of whom are present today to explain them. Yet again, I congratulate the Financial Secretary on being so multi-disciplined and able to answer on these clauses. These are important clauses on North sea oil, and it seems that that important area has been badly served by the Government, particularly in recent weeks with the rapid change in Exchequer Secretaries. Such a major part of our economy deserves better treatment.

Clause 83 is the first of eight clauses relating to North sea oil, each of which gives 83 relates to schedule 38. It is a shame that my hon. Friend the Member for Fareham and the hon. Member for Taunton are not currently in their places, because this is my first opportunity to introduce the word “smĂśrgĂĽsbord” into our deliberations. One of them said that I might know something about the word’s pronunciation, but I am not an expert on Nordic or Scandinavian pronunciation. The only thing that I know about that is that the last consonant should normally be softened, so “smĂśrgĂĽsbord” should sound more like “smorgasburgh.” I digress slightly.

Each of the smĂśrgĂĽsbord clauses is extremely short, but many of the schedules are almost interminable—in places, they are very complex indeed. Clause 83 and schedule 38 deal with the extremely important topic of decommissioning. In general, the UK faces some important challenges in maintaining revenue from North sea oil while at the same time getting the last drops out of existing fields and extending our reach to the many smaller pockets of oil and gas that are yet to be tapped.

Taxation plays a crucial role both in companies’ decisions to invest and in their decisions to decommission. It is important that the Government get a fair return on a national asset, but neither in the case of decommissioning,  nor in the case of exploration, is it in the national interest to have oil in the ground, not least because unexploited oil produces no tax.

That is not an anti-green statement. As important as bringing forward alternatives and becoming more energy-efficient remains, we are likely to be dependent on oil and gas for some decades to come. It is financially stupid and less green to import more oil and gas than we have to. It also raises serious problemsabout energy security, as anyone who has observed Russia’s relationships with its eastern European neighbours may have concluded. For as long as we are stuck with fossil fuels, our own reserves are preferable in every sense. I hope that all of that is stating the obvious and is widely accepted. Therefore, we need to take great care in how we handle decommissioning. Our aim must be to recognise properly the cost in decommissioning a field effectively and safely. However, we must also do what we can to ensure that the remaining pockets of oil in a field can still be economically exploited. So the debate about schedule 38 is set in that context.

Although we have ceased to be self-sufficient, UK oil and gas still accounts for about 70 per cent. of our primary energy demand. The industry talks in terms of “barrels of oil equivalent” when it lumps oil and gas together. Using that measure, it is estimated that the equivalent of up to 25 billion barrels of oil is still recoverable across the UK continental shelf, which is sometimes abbreviated to the UKCS. The Department of Energy and Climate Change estimate is more modest than that, but it still thinks that there are between 17 billion and 20 billion barrels of oil equivalent left under the UKCS, which extends slightly beyond the North sea, as we will discuss when we debate a later clause in relation to oilfields west of the Shetland isles.

Those figures—17 billion to 20 billion from DECC or 25 billion from the industry—can be compared with the 39 billion barrels that have been recovered so far over the lifetime of the North sea fields. In other words, and to put decommissioning in context, we are just under two thirds of the way through our own North sea oil. As the UK currently produces about 1 billion barrels a year, the potential for the future is still clear. Oil & Gas UK, which represents the oil and gas industry, estimates that North sea gas could still meet 20 to 25 per cent. of our gas demand in 2020. Regarding oil, it believes that as much as 60 to 65 per cent. of UK oil demand could still be met from the North sea. That is where the decommissioning regime, which is referred to in detail in schedule 38, has the potential to come into its own.

A decline in overall annual production is inevitable, but it need not be as steep as is popularly imagined, if we can get the decommissioning regime right. Furthermore, declining production does not necessarily equate in any way to a declining industry in the manner that was previously familiar with elements of UK manufacturing. Let me explain that point: we host world-class expertise in offshore engineering, and we lead the way in subsea technology. More than 34,000 people are directly employed by the major companies and contractors on average earnings of £50,000 per annum.

I notice the curious absence of the Scottish National party spokesman from our deliberations this afternoon. I would have thought that the elements of part 6—

Photo of Robert Syms Robert Syms Conservative, Poole

I understand that the hon. Member for Dundee, East has a problem with a daughter who has a broken arm, so there is a reason why he is not here.

Photo of Greg Hands Greg Hands Shadow Minister (Treasury)

I thank my hon. Friend for that intervention. I must say that I was genuinely unaware of that family problem. Therefore, I want to put on the record the fact that I do not impugn the integrity of the SNP’s spokesman or that of the SNP as a whole in not being here to express an interest in North sea oil, on this occasion at least.

Aberdeen is renowned as a centre of excellence and is home to a number of vibrant specialist companies that export their services across the world. However, the future challenges are also considerable. On current plans, of the 25 billion barrels of equivalent reserves, according to UK Oil & Gas, or the 20 billion barrels, according to DECC, that remain in the UKCS, only 10 billion barrels will be recovered—I think that that is the Government’s own estimate. That means that half of what is left, or 15 years’ worth of barrels at current annual production levels, will remain in the sea bed.

It is very important that we get the decommissioning regime right. We need to incentivise companies to get out as much as they can from beneath the North sea. That is where the high costs of decommissioning really come into play. If any members of the Committee doubt its value, they should reflect that in 2008-09, oil and gas accounted for 28 per cent. of corporate taxation in the UK, with receipts of more than £13 billion. Put slightly differently, taxation from the North sea paid for last year’s transport budget.

Clause 83 and schedule 38 are, we are told, anti-avoidance measures, which we broadly support, as long as care is taken that the measures have no, or minimal, side effects. New fields need first to be explored and then developed, and the easy targets have long since been exploited. What is left is smaller, more difficult to get to and, in the case of the west of Shetland, located in fairly inhospitable regions. About 7 billion barrels are in the form of so-called heavy oil. As someone in the industry put it when they came to see me a couple of weeks ago, heavy oil is called heavy because, if one pours it into a cup and then turns the cup upside down, it does not come out.

The existing fields present different problems, and getting the last of the oil and gas out involves not only additional investment, but also deferring decommissioning. We need to be extremely careful about how we structure the tax relief available for decommissioning as laid out in clause 83 and schedule 38. The costs of decommissioning are huge—they are far greater than the annual and diminishing returns from fields near the end of their lives—and they are met by offsetting the costs against previous tax receipts. In other words, HMRC provides a sizeable tax rebate for decommissioning. Naturally enough, the rules under which fields qualify for the rebate become the determining factor, as well as whether there is still oil or gas to be had, in the decision to cease production. In other words, companies make a logical, economic decision based on the oil and gas that might still be in the field, the costs of decommissioning, the relief that they will get and the time span over which they will get it.

Now, nothing that I have said so far is meant to suggest that the Government are not aware of the issues. Governments of both main parties have a long  track record of discussions with the oil and gas industry, which recently culminated in this Government’s paper, “Supporting investment: a consultation on the North sea fiscal regime”, last November. The paper summarised last year’s round of discussions and prepared the ground for the proposals under discussion, which include schedule 38.

The paper describes the general situation quite well. For example, it states that the continental shelf is

“facing increasing challenges due to its nature as a maturing basin. The easy to recover hydrocarbons have been exploited and the remaining opportunities are, increasingly, either smaller in size or require the use of cutting edge technologies to enable extraction. One result of this is that many potential projects have become commercially marginal and unable to compete with other projects around the globe. These challenges are exacerbated by the current uncertainty over future oil prices and the high cost levels faced within the North Sea.”

That was the conclusion in response to the consultation.

The financial environment in which companies operate has changed considerably since the proposals under discussion were first conceived. Oil prices collapsed before recovering sharply but partially, and difficulties in the capital markets have caused big problems, particularly for the smaller companies that the Government have quite rightly encouraged to operate in the North sea. At present, annual investment may drop from £5 million to £3 million by the end of the year, and warnings have been sounded about an irrevocable loss of production from the fall in capital and exploration investment. While the proposals might have been well received when oil was trading at more than $100 a barrel and capital was relatively easy to come by, the Budget has done little to allay the industry’s fears in the current market. Even if the oil price returns to higher levels, the relative attractiveness of the UK continental shelf vis-Ă -vis other oil fields will remain a problem.

The Treasury’s conundrum, as ever, is to find the balance that maximises revenue, which provides the immediate backdrop to the four-page schedule under discussion. The Treasury also needs to set down a stable, predictable framework in which companies feel safe to plan. One complaint in this policy area, which I am afraid we have heard made all too often of this Government over many Finance Bills, is the level of short-term chopping and changing that characterises their approach.

Turning to decommissioning, and the substance of clause 83 and schedule 38, the Government appear to be moving to reinforce the rule that decommissioning costs can only be written off when they are actually run up. The consultation paper puts it thus:

“Virtually all capital expenditure incurred in the North Sea, including putting the plant and machinery in place, or in dismantling it at the end of the life of an oil field, now qualifies for one hundred per cent First Year Allowances (FYAs), allowing the cost to be written off for tax purposes in the accounting period in which the expenditure is incurred.”

That is the rule that they set out, but this rule is, in turn, under attack. The explanatory notes accompanying the Bill include this rather coy remark:

“The Government has become aware of arrangements that have been entered into which seek to establish a claim for tax relief for decommissioning costs several years in advance of any decommissioning work actually being carried out. This undermines  a fundamental general principle that relief is given in the accounting period, for costs incurred in respect of the work actually carried out in that accounting period”.

As I understand it, these “arrangements” are the much gossiped about arrangements of one particular company, and in the tradition of anti-avoidance stuff, these companies do not tend to be mentioned in debates on the Finance Bill. I was not intending to do so anyway. However, this company, has, I understand, sought to circumvent the principle by creating some intra-group structures intended to justify an early claim for the relief on decommissioning. The principle as it stands is proper and appropriate, as it is only when actual costs are being incurred that the true cost of decommissioning can be known with certainty. We therefore support the intent of the Government’s proposals, but I would like some reassurance from the Minister that the way schedule 38 is drafted will not inadvertently create problems around so-called mid-life decommissioning.

Decommissioning is actually a legal requirement and the costs involved are huge, greatly outstripping the annual revenue that a declining field will generate—I return to the point about the equation of what is left to exploit vis-Ă -vis decommissioning costs and the relief given against them. Hence, the rules governing the relief of decommissioning costs against the tax previously paid on the income from a field assume far greater importance near the end of the life of a field than getting all the remaining oil out. As I understand it, in the Government’s proposals there is a danger of prompting the total closure of a field to secure, beyond doubt, the capital allowance for the full cost when, in fact, a limited number of platforms within the field could have continued to operate. Again, it is about trying to get as much out of the UKCS as we possibly can within a reasonable tax framework.

While oil companies would lose some revenue by doing this, guaranteeing the full capital allowance is, for them, the overriding priority. For the Exchequer, this approach makes no sense at all. The more oil that can be extracted for the Exchequer, the more tax HMRC will collect. I would appreciate the Minister’s comments on whether schedule 38 runs the risk of leaving too much oil behind.

To summarise on clause 83 and schedule 38, companies producing oil and gas in the UK and on the UKCS have a statutory requirement to decommission oil and gas fields at the end of their life. They are able to obtain relief for such decommissioning costs in the form of 100 per cent. capital allowances against ring-fenced profits once they have been incurred. The Government have stated that it has become aware that some companies—I thought it was only one company—have entered into intra-group arrangements designed to enable a claim for tax relief to be made before the actual decommissioning work is carried out. It is unclear whether the 100 per cent. ring-fenced abandonment relief, which was introduced in 2001 for corporation tax, had the intended effect that relief for decommissioning costs were only available when the decommissioning actually took place, particularly following the relaxations of the conditions for relief made in last year’s Finance Act. Certain companies have therefore entered into contracts for decommissioning services and claimed relief in respect of payments made under these contracts even though the actual decommissioning may be some years away.

The proposed changes to the legislation here apply to decommissioning expenditure incurred on or after 22 April 2009. It provides that expenditure must be incurred and paid out in respect of an approved abandonment programme and it will be allowable only in the accounting period in which the decommissioning period is carried out or undertaken. If the expenditure in respect of which a claim is made is disproportionate to the decommissioning carried out, the claim can be reduced by HMRC proportionately. We have a few concerns, which we have outlined, but nevertheless we will support clause 83 and schedule 38.

Photo of Stephen Timms Stephen Timms Financial Secretary (HM Treasury) (also in the Department for Business, Innovation and Skills) 2:45 pm, 18th June 2009

I start by reassuring the hon. Gentleman about the seriousness with which we are dealing with this part of the Bill. I certainly relish the opportunity to debate this area of policy, having first had responsibility for it almost 10 years ago. I am probably not the best qualified member of the Committee to debate this part of the Bill. That is probably my hon. Friend the Member for Waveney, because of his long experience as chair of the all-party group on offshore activities. I can certainly reassure the hon. Gentleman that we have consulted widely and put a great deal of work into the clauses in this part of the Bill, which my hon. Friend the Economic Secretary and I will be addressing.

The package of changes as a whole could assist in unlocking up to an additional 2 billion barrels of oil and gas from the North sea. That is an increase of 20 per cent. on the production that is currently planned. This is a vitally important resource from the point of view both of our energy security and the economy. The extra production that these changes will unlock can play an important role in the UK economy. As my hon. Friend the Member for Waveney knows better than anyone, we have extremely good links with the offshore industry. We have had those for a long time. We have forums—the Pilot forum in particular—in which we can discuss these matters and make sure that we can take full advantage of the industry’s expertise and advice in coming up with a regime that can do the best possible job for the UK economy.

The first clause deals with an avoidance problem, addressing arrangements under which companies claim tax relief for the cost of decommissioning oil and gas infrastructure in the North sea many years in advance of the work actually being carried out. These arrangements are deliberate avoidance. Schedule 38 amends the rules that provide tax relief for decommissioning costs with effect from the Budget. The rules will make sure that companies can claim tax relief for decommissioning costs only during the accounting period in which the work is carried out.

I can give the hon. Gentleman the reassurances that he was seeking. The changes proposed by this measure will not prevent companies obtaining tax relief for their decommissioning costs when the work is carried out. It is important to note that oil companies have access to a very generous regime for tax relief for decommissioning expenditure. That tax relief is there for a good reason and this change does absolutely nothing to reduce the access that companies have to that. Oil and gas companies come to the North sea under the terms of licences, which require them to decommission their installations and infrastructures at the end of an oilfield’s productive life. Companies understand that obligation. They make  arrangements to meet it knowing that tax relief will be available for those costs when the work is carried out. Nothing here will diminish that access. The arrangements that the clause and schedule address are undermining those activities and seeking to obtain advantage over other companies who are not prepared to enter into an avoidance scheme of this kind. This avoidance scheme is not a consequence of last year’s changes. It provides companies with the certainty that they will receive relief for their decommissioning costs for the period in which the work is actually carried out, which up until recently was the position that everybody thought obtained.

Question put and agreed to.

Clause 83 accordingly ordered to stand part of the Bill.

Schedule 38 agreed to.