Treasury's oil and gas investment incentives to "substantially enhance" production, researchers say

A report by Professor Alex Kemp, the University of Aberdeen's Professor of Petroleum Economics, and his colleague Linda Stephen found that the incentives had reduced the gap between the expected rate of return for investors in a full taxpaying position at the time of exploration and appraisal, and those who were not yet paying full tax. Many companies exploring the UK Continental Shelf (UKCS) are not yet in a taxpaying position, he said.

Kemp said that the "substantial difference" in the likely returns of an exploration company depending on whether it was in a taxpaying position was part of the reason behind the introduction of new 'field allowances' for operators of small fields, large shallow-water gas fields, older 'brown field' sites and certain unexplored fields in the north west of Scotland. This was made particularly clear after the supplementary charge (SC) on ring-fenced profits was raised to 32% from 20% in the 2011 Budget, he said.

"The presence of field allowances for SC plays a noteworthy role in facilitating the development of high cost discoveries which in isolation can often reduce the overall return to the exploration effort," he said in his report.

"Historically, the explorer who is not already in a tax paying position has been at a major disadvantage compared to an existing tax payer. The increase in the interest rate for the [Ring Fenced Expenditure Supplement] to 10% from 6% significantly improves the relative position of a project investor though, of course, he may receive no relief for unsuccessful exploration," the report said.

Field allowances are deducted from the ring-fenced profits on which the SC payable by an oil or gas company operating in the UK or on the UKCS is charged. This effectively reduces the amount of tax that they have to pay. Profits from companies operating on the UKCS are ring-fenced to ensure that companies cannot reduce them by offsetting their losses from other activities, as they may normally be able to do under the usual corporation tax rules.

The UK Government has previously said that although the UKCS is past "peak production", the equivalent of at least 20 billion more barrels of oil (boe) could still be produced. It has estimated that oil and gas will continue to provide up to 70% of the UK's primary energy supplies in 2030. Since January 2012 it has proposed or introduced a range of new field allowances, as well as the introduction of Decommissioning Relief Deeds to give businesses certainty over the tax relief that they will receive when decommissioning their assets.

The researchers studied rates of return from exploration between 2003 and 2012, in the latest of a series of papers dating back to 1973. They found that although the rate of return had fallen in recent years, exploration over the past decade had remained "worthwhile". In addition, they noted that the overall exploration and appraisal success rates were slightly higher between 2008 and 2012 than they had been over the full decade.

"In the modelling it was found that the various field allowances for Supplementary Charge substantially increase investment incentives on the very high cost (per barrel) discoveries," Kemp said. "In the long run they should cause a substantial enhancement to production and should help to modify the lower expected returns from the exploration effort incurred in more recent years."

The research follows the publication of the annual report from industry body Oil and Gas UK, which noted that the Government and industry's recently renewed commitment to maximising return from the UKCS will help to push annual investment to an all-time record of £13.5bn this year. However, it said that output from the UKCS was continuing to fall and revised down its production estimates for this year to 1.2 - 1.4 million boe per day from its previous estimate of 1.45 - 1.5m boepd.