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CHAPTER 2 A REQUIEM FOR THE UK’S PETROLEUM FISCAL REGIME Juan Carlos Boué and Philip Wright Introduction If current newspaper headlines are anything to go by, thanks to the events of 2008/9 in world financial markets, free market fundamental- ism is apparently now on life support, if not necessarily as an ideology, then certainly as a guide for government policy. Indeed, Joseph Stiglitz has gone so far as to assert that ‘the fall of Wall Street is to market fundamentalism what the fall of the Berlin Wall was to communism’ (Stiglitz, 2008). That said, the glacial pace at which financial reform is progressing suggests that, as of the time of writing, reports of the death of free market fundamentalism, even within the banking sector, might have been overoptimistic. Outside the financial sector, the penning of obituaries looks even more premature, as the sort of approach to government intervention, regulation, and taxation that is now routinely denounced by politicians as anathema in connection with banks and financial markets (albeit with decreasing vociferousness and conviction with the passage of time), is still presented as non-problematic – even desirable – in many other walks of life, where free market fundamental- ism may nonetheless have wreaked a similar or even greater degree of damage (in relative, if not necessarily absolute, terms). The British policy towards oil and gas exploration and production activities can be used as an example. This policy, which we shall refer to as the UK North Sea Model, has been the standard-bearer for upstream liberalisation initiatives in the international oil industry for a long time, in much the same way as the British experience used to be a required reference point for anyone interested in pursuing the wholesale deregula- tion of financial markets. However, unlike financial liberalisation, the UK North Sea Model has lost none of its lustre, and is still consistently hailed as an all-too-rare example of enlightened governmental practice. This is remarkable, as the UK North Sea Model is a policy that embodies all the excesses of free market fundamentalism, and its consequences, as we shall show, have to be seen as resounding failures. 39 40 UK Energy Policy and the End of Market Fundamentalism In popular perception, the application of free market fundamentalism to energy industries in the UK is seen as being restricted to a set of transformations of ownership and industrial structure, which applied in the main to downstream activities. Liberalisation, in other words, is seen to have been the stuff of electricity and downstream gas, much more than of upstream oil and gas. This viewpoint, however, is misconceived. For one thing, upstream oil and gas assets – the upstream interests of both the British National Oil Corporation (BNOC) and British Gas and, arguably, the government shareholding in British Petroleum – figured prominently in the privatisation wave that swept Great Britain during the 1980s and early 1990s.1 Furthermore, the genesis and expansion of forward and futures markets for Brent crude oil were also at the forefront of a marketisation and financialisation process that radically transformed the international oil trade, which has come to hang on the price signals emitted from a small set of paper and cash markets whose joint trading volume is a significant multiple of daily global crude oil production (Mabro, Bacon, Chadwick, Halliwell, and Long, 1986; Horsnell and Mabro, 1993). Finally, if laissez-faire is indeed one of the hallmarks of free market fundamentalism, then there can be no question that upstream oil and gas was one industry where its principles were applied most dogmatically. Consider that corporations involved in downstream energy activities had at least to take account of the presence, and views, of a variety of regulators, whatever their shortcomings. The situation in the UKCS (United Kingdom Continental Shelf) was different: starting with the dismantling of BNOC in 1985 and culminating in the abolition of the Department of Energy in 1992 (and its absorption by the Department of Trade and Industry), the UK government quite explicitly abdicated its upstream oil and gas policy role in favour of oil companies, retain- ing a say only in matters related to industrial safety, decommissioning, environmental protection, and, nominally at least, taxation. Thus, throughout most of the 1990s and up until very recently, the UK provided the unusual spectacle of being among the very few countries belonging to the OECD and the IEA that did not have a cabinet-level post for energy.2 In this respect, the UK also differed from every other major oil exporting country in the world, bar none. Quite apart from the above, the clearest confirmation of the fact that free market fundamentalism has held sway unopposed in the UKCS can be found in the realm of tax. One of the central tenets of free market fundamentalism is that action undertaken by the state in pursuit of the public purpose should be predicated on ensuring that the returns received by corporate capital are as attractive as possible, A Requiem for the UK’s Petroleum Fiscal Regime 41 and not necessarily limited to a risk-adjusted rate of return sufficient to allow for the reproduction of capital. Among the panoply of policy instruments that governments were supposed to deploy in pursuit of this objective, fiscal incentives and tax cuts occupied pride of place, as the cost to the public purse that they entailed would supposedly be more than compensated through an eventual increase in tax receipts derived from the higher level of economic activity that would be induced by the tax break (the supply-side argument at the core of Reaganomics). Therefore, an unjustifiably generous level of taxation constitutes an excellent diagnostic tool to ascertain the strength of the grip on an industry or activity taken by free market fundamentalism. If one ap- plies this yardstick to the case at hand, and analyses the relaxation of the UKCS fiscal regime, it is apparent that a particularly intense form of free market fundamentalism gradually came to prevail in the UK upstream sector from 1983 onwards. As can be appreciated from Appendix 2.1, a fundamental shift occurred in the tax stance of the UK between 1983 and 1993. This involved significant reductions in tax, in particular the dismantling of special taxes on the UK’s oil and gas resources – successive downward adjustments in, and more generous exemptions from, Petroleum Rev- enue Tax (PRT), as well as reductions in royalties. These relaxations in the UK’s petroleum fiscal regime ostensibly sought to stimulate exploration and development, first by providing targeted tax breaks (1983, 1987, 1989), and then more general tax relief (1993). However, Rutledge and Wright (1998) established that the resulting laxness in the UK’s petroleum fiscal regime did not produce the desired outcomes. In addition, the generosity of the UK fiscal regime was not a reflection of relatively poor UKCS profitability (either in relation to the rest of the UK corporate sector or to oil industry investments elsewhere in the world), and nor could it be justified by generic criteria such as historical and international comparisons, or the particular risk associated with oil and gas industry investments. More- over, the conclusions of this analysis were echoed by the oil industry specialist Petroconsultants, which trenchantly characterised the UK’s petroleum fiscal regime in the mid-1990s as lacking the essential (and otherwise prevalent) correspondence between prospectivity and taxation: The regime which most notably does not fit into any of the general trends identified above is the UK. Geological prospectivity and the development of infrastructure in the UK is relatively good and recent exploration suc- cesses suggest that large profitable fields continue to be found. The potential returns from UKCS are, however, second only to Ireland [a country with very low prospectivity]. The State take comprises only Corporation Tax, having 42 UK Energy Policy and the End of Market Fundamentalism gradually abolished all ‘special’ petroleum levies for new fields since 1993. The risk/reward balance for the investor is therefore highly favourable under current terms. (Petroconsultants 1995, 9). From Table 2.1, one can summarise the effect of the weakening in the UKCS regime at this time in terms of three indicators: 1. In 1987 (that is after the dramatic fall in oil prices of 1986), fiscal revenues per barrel were £3.80, but by 1999 they had fallen to £1.50. 2. As a proportion of unit sales revenue, fiscal revenues were 39.5 per cent in 1987, but only 15.9 per cent in 1999. 3. In 1987 the government was claiming 67.6 per cent of company Net Operating Surplus, but by 1999 this had fallen to 36.4 per cent. Thus, in 1987, UKCS production of oil and gas was 1,229 million barrels of oil equivalent (mboe), unit sales revenue was £9.70 per barrel of oil equivalent and fiscal revenues totalled £4,685 million. Twelve years later, in 1999, unit sales revenue was also between nine and ten pounds per barrel, production was almost 40 per cent higher at 1,710 million barrels, but fiscal revenues were only £2,551 million. This dramatic fall in fiscal revenue, of course, went completely against the grain of the supply-side argument that had been used to justify the tax cuts in the first place; namely, that a lower rate of tax would stimulate activity in such a way that tax revenue would actually grow. During the decade of the 1990s, that argument was conveniently forgotten, with the UK government increasingly taking the fallback position that fiscal revenue sacrifices were essential if companies with activities in the UKCS were to continue investing, and output was to continue growing.

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