THE ECONOMICS OF NORTH SEA OIL TAXATION

THE ECONOMICS OF NORTH SEA OIL TAXATION

Also by Danny Hann GOVERNMENT AND NORTH SEA OIL Also by Chris Rowland THE ECONOMICS OF CHOICE BETWEEN ENERGY SOURCES (co-editor)

The Economics of North Sea Oil Taxation Chris Rowland Financial Analyst BZW Securities, London and Danny Rann Economist with the Central Electricity Generating Board Palgrave Macmillan

ISBN 978-1-349-08719-8 ISBN 978-1-349-08717-4 (ebook) DOI 10.1007/978-1-349-08717-4 c. Rowland and D. Hann, 1987 Softcover reprint of the hardcover 1st edition 1987 978-0-333-41682-2 All rights reserved. For information, write: Scholarly & Reference Division, S1. Martin's Press, Inc., 175 Fifth Avenue. New York. NY 10010 First published in the United States of America in 1987 ISBN 978-0-312-23678-6 Library of Congress Cataloging-in-Publication Data Rowland, C. (Chris) The economics of North Sea oil taxation. Bibliography: p. Includes index. 1. Offshore oil industry-taxation-great Britain. 2. Offshore oil industry-north Sea. L Hann. Danny. II. Title HD9560.8.G72R69 1987 336.2'783338232'(1)41 8&-13721) ISBN 978-0-312-23678-6

To Barbs and Hanna

Contents Acknowledgements x 1 Area for Concern 1 2 Government Policy: Targets and Instruments 4 2.1 Introduction 4 Economic rent 4 The development and production decision 5 2.2 The Oil and Gas Industry in an Unregulated Market 11 Licensing 11 Exploration 13 Development 14 2.3 Desirable Policy Targets 17 Efficiency 17 Distribution 20 2.4 Government Intentions 21 Interpretations of policy intentions 21 2.5 Policy Consequences 24 Policy instruments 24 Policy impacts 25 Licensing 26 Oil depletion controls 31 Collecting gas profits 36 Collecting oil profits 39 2.6 Conclusion 40 Tax policy and oil profits 41 3 The Economics of Oil Taxation 4S 3.1 Absence of Progressivity 45 Definition 45 Relevance to development decisions 46 Evidence 48 Lessons 53 3.2 The Return on Capital 54 Definition 54 Relevance to development decisions 55 Evidence 56 Lessons 58 vii

viii Contents 3.3 Risk 60 Definition 60 Relevance to development decisions 60 Evidence 67 Lessons 69 3.4 Taxing Incentives 70 Definition 70 Relevance to development decisions 71 Evidence 72 Taxing incentives in the North Sea oil industry 77 Lessons 81 3.5 Instability 81 Definition 81 Relevance to development decisions 82 Evidence 83 Taxing incentives and instability 84 Lessons 92 4 The Impact of Taxation on Recoverable Reserves 95 4.1 Modelling the Suppy of North Sea Oil Reserves 95 The nature of our behavioural model 95 Supply curves and producer surplus 96 4.2 Comparative Statics Analysis of North Sea Profits Taxation 97 4.3 Dynamics of Taxation 99 4.4 Have Recent Tax Changes Resolved the Problems of Taxation? 101 4.5 Conclusion 102 5 Petroleum Profits Tax: An Alternative Proposal 104 5.1 An Alternative to Current Tax Policy 104 5.2 The Resource Rent Tax 105 5.3 Impact on Government 108 Aggregate tax revenues 109 5.4 Inter-Field Burden of Taxation 110 5.5 Impact on Recoverable Reserves 113 5.6 Conclusion 114 6 A Desirable Solution 116 6.1 A Mistaken Policy 116

Contents ix 6.2 Extent of Damage 116 6.3 Hidden Costs 116 Bureaucratic needs in the public sector 117 Bureaucratic needs in the private sector 118 Intra-industry effects on portfolio values 118 Costs relative to potential gains 119 6.4 Private Sector Perception of Government Requirements 119 Industry perceptions 119 Consequences of false perceptions by industry 120 More realistic attitudes 122 6.5 The Outcome of Tax Deliberations 123 The 1982 Budget changes 123 The 1983 Budget changes 124 The 1984 Budget changes 124 The structure and dynamics of taxation: problems resolved? 124 6.6 A Recurring Issue 127 Finding a solution 128 Implementing a solution 128 Onus on government 129 Appendix A: Description of the North Sea Fiscal Regime 130 Appendix B: How Much Oil is There? An Econometric Analysis of Oil Reserves on the U KCS 134 1 Introduction 134 2 Methodology: General 135 3 Methodology: Specific 137 4 Estimating Recoverable Reserves 141 5 Forecasting Procedure 152 6 Econometric Results 155 7 Model Weaknesses 156 8 Use of Model 159 Notes and References Index 160 168

Acknowledgements We would like to thank Professor Colin Robinson for providing both the opportunity to undertake this project and the guidance crucial to its completion, and our colleagues both past and present in the Surrey Energy Economics Centre of the Department of Economics, University of Surrey, for providing a stimulating academic environment by continually questioning our findings. We would also like to acknowledge our parents, and Jon, Sue, Christine and Barbara for their support and encouragement. CHRIS ROWLAND DANNY HANN x