2.1 The oil and gas extraction industry has had a major impact on the UK economy since substantial production of gas started in the late 1960s. The importance to the UK economy and National Accounts was soon recognised by a government review of the statistics required to monitor the virtually new and rapidly expanding industry. This review resulted, in 1976, in a quarterly inquiry covering all oil and gas exploration and production licensees and also contractors and agents providing services unique to the industry. Contractors include companies employed in drilling or operating platforms for the licensed operators, but not companies whose principal work is classified to other industrial sectors such as seismic work or construction.
2.2 UK National Accounts are changing during 1998 to conform to the European System of Accounts (ESA95). This system is obligatory for returns from EU member states to Eurostat from April 1999, and will eventually be used for EMU convergence criteria and GNP measurement. The new system is consistent with the worldwide System of National Accounts (SNA93), and the IMF Balance of Payments Manual (BPM95). The most noticeable effect on national accounts for the oil production sector is that exploration expenditure, which is considered as a running cost under the current system, will be considered as capital investment under the new system. This means that the new national accounts will show figures for recent years some billion pounds higher than under the old series for both capital formation and gross trading profits. Cash flow, of course, remains the same.
2.3 The contribution of the industry is affected by production and prices. The effects of these factors can be seen throughout this chapter.
2.4 Gas production rose steadily until the mid-1970s, remained fairly static until 1989, then increased each year to reach a record level in 1997. Oil was first produced, in any significant quantity, in 1976. Production climbed sharply between 1975 and the mid-1980s, but fell back because of the Piper Alpha tragedy in 1988. Oil production began to recover in 1992 and after a particularly good year in 1994, has remained since then at record annual levels. Trends in both oil and gas production are illustrated in Chart 2.1.
Chart 2.1 Trends in the Production of Oil and Gas, 1970 to 1997
2.5 Oil prices fell sharply from their peak in 1984. Prices rose in the latter half of 1990 due to the Gulf crisis, but were then affected by the weak world economy. The possibility of restoration of Iraqi production has provided uncertainty to the market, although the limited return of Iraqi production in December 1996 did not cause a permanent drop in price. Oil prices fell sharply at the end of 1997 in part due to troubles in Far Eastern economies. Oil and gas prices from UKCS sales are shown in Chart 2.2.
Chart 2.2 Average Oil and Gas Prices from UKCS sales, 1976 to 1997
2.6 The direct contribution of the sector to the UK Gross Domestic Product (GDP) rose steadily to reach a peak at some £19.4 billion, nearly 7 per cent of GDP at factor cost, in 1984. The contribution to GDP declined sharply with the fall in oil prices at the end of 1985, and fell again in 1988 due to lower oil prices and the loss of sales from Piper and associated fields. The contribution of the sector picked up after 1991 with rising oil and gas production. Despite lower oil prices in 1997, provisional figures show that it still accounted for just over 2 per cent of GDP. Chart 2.3 illustrates the contribution to GDP from this sector since 1976.
Chart 2.3 UKCS Oil and Gas Sector - Contribution to GDP - 1976 to 1997
2.7 Since the start of major development in 1965, the industry has generated trading profits of some £203 billion of which over £73 billion has been re-invested in the UK oil industry. Including licence fees, £86 billion has been paid to the Exchequer, leaving £44 billion for disposal by the companies.
2.8 The total income of the sector fell back after a good year in 1996 to some £19 billion in 1997. Proceeds from the sale of oil and natural gas liquids (NGLs) fell to £11 billion in 1997, after having risen each year since 1992. Proceeds from the sale of gas fell slightly to £5.25 billion in 1997, discontinuing the increase seen each year since UKCS gas production began. The total value of oil and gas produced onshore is estimated at £470 million in 1997, as compared with £490 million in 1996. Contractors contribution to the sectors gross trading profits was only 0.3 per cent, as their revenues fell from £1.9 billion to £1.4 billion. This fall is partly due to companies being reclassified to other sectors. Figures for sales and income since 1987 are shown in Appendix 5.
2.9 The average oil price received by producers from sales of UKCS oil was £87/tonne in 1997, compared with £97/tonne in 1996; this represents a decrease of some 10 per cent. The equivalent gas price was some 16.7p/therm compared with 16.6p/therm in 1996. These are the average annual prices shown in Chart 2.2.
2.10 The gross capital investment in the mineral oil and natural gas extraction industry as a whole, including contractors classified under the sector, rose sharply in real terms in the early 1970s. In 1976, at its peak, it formed nearly 27 per cent of total UK industrial investment (that is, investment in energy, water supply and manufacturing). Investment was buoyed by increasing oil prices from 1979 until their fall at the end of 1985, when investment declined in real terms until 1988. Investment reached near to £5 billion between 1991 and 1993 with the development of an unusually high number of large projects and fell, not surprisingly after these high levels, to some £3.75 billion in 1994, before recovering again to some £4.4 billion in 1995 and 1996.
2.11 Investment in 1997 remained steady at £4.4 billion. It formed around 16 per cent of total UK industrial investment, and nearly 4 per cent of gross domestic capital investment.
2.12 Operators and other licensees engaged in exploiting the oil and gas resources of the UKCS provide figures on development, exploration, and operating expenditures. Where possible, these expenditures are split between oil and gas fields. However, where gas is produced in association with oil, the joint nature of production can make it difficult to draw a meaningful distinction between oil and gas costs. Figures for the period 1987 to 1997 are presented in Appendix 5, together with the criteria used for splitting oil and gas costs.
2.13 Investment expenditure in 1997 on the construction and installation of platforms and associated equipment, and on related pipelines and terminals, is estimated at nearly £3 billion for the development of oil fields, and some £1.3 billion for the development of gas fields. This represents a small fall on the previous year of some 2 per cent for oil fields, and some 3 per cent for gas fields. Expenditure for both oil and gas fields fell on platform structures, but rose on development wells.
2.14 Total investment on the UKCS each year since 1976, together with investment on oil fields and on gas fields, is shown in Chart 2.4. This chart also shows some results from the latest annual survey into proposed capital investment on the UKCS which was conducted by the Department of Trade and Industry in the late summer of 1997.
Chart 2.4 UKCS capital investment, 1976 to 1997 with intended expenditure to 2000
2.15 The survey was designed to obtain a view of operators intentions to invest in oil and gas production over the current year and the next five years. The survey intentions are also illustrated in Table 2.1. The decline in intended expenditure in the later years of the survey period is normal, since the companies give intentions only where planning is at a sufficiently advanced stage to enable reasonable estimates of expenditure to be made. It is probable that other projects will come forward. It is also possible that the reported intentions may not be fulfilled for a variety of reasons
.Table 2.1 - DTI capital expenditure survey 1997
|£ million 1997 prices|
|Structures, decks, modules, equipment, facilities||2,489||2,284||1,864||1,792||1,620||983||11,032||47.6|
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2.16 The survey showed a rise in operators' optimism, with total investment intentions over the survey period some 10% higher than in the 1996 survey, following a steady decrease since the 1992 survey. The peak in intended investment slips to 1998 from the 1997 peak indicated in the previous survey. Operators intended to invest some £4.9 billion in 1997, followed by a rise of 15% to £5.6 billion for 1998, and a fall to £4.4 billion in 1999. The survey intentions for 1997 are now seen to be slightly higher than actual expenditure in 1997.
2.17 Investment intentions given in previous surveys have usually been optimistic for the first few future years and, as expected, to underestimate the last years of the survey period. In recent surveys, the intentions for the first few years of each survey have been useful indicators of the size and trend of actual expenditure. Chart 2.4 also shows that investment intentions for the early years of the new survey period compare well with recent actual expenditure.
2.18 The investment intentions in the last year of the survey period have declined for the last five surveys. This may be expected since shorter lead times, increased use of floating production systems, phased developments, and CRINE (Cost Reduction Initiative for the New Era) have all worked to shorten planning horizons. However, the decline may indicate increasing uncertainty and a real decline in future expenditure.
2.19 Analysis of the individual projects given by the operators showed that there is less dependence on a few big projects, and more projects with significant expenditure - the top 20 projects now account for some 48% of the intended expenditure in the period shown (against over 50% in last three surveys), with the top ten accounting for 33%.
2.20 Table 2.1 shows the intentions under various equipment categories. The somewhat arbitrary divisions of Structures and Decks/Facilities have been combined in this years survey to ease the burden on respondents. The table shows continued strength in production wells, so that this share has increased in each of the last five surveys. The shares of Structures... remain similar to last year, but for both Pipelines and Terminals have fallen back.
2.21 The total investment committed by operators to projects approved in 1997 was £3.7 billion at 1997 prices. This figure excludes the capital cost of hired equipment. The corresponding figure for investment in 1996 was £2.4 billion at 1996 prices. Total investment since 1965 (the start of major UK offshore development) to the end of 1997 is estimated to have been some £73 billion. Revalued to 1997 prices, this represents an investment of about £128 billion.
2.22 Expenditure on exploration and appraisal (E&A) in 1997 is estimated at £1.2 billion, some 9 per cent higher than in 1996. The number of well starts, excluding sidetracks, fell markedly from 102 to 81, largely due to high drilling rig utilisation and consequent costs.
2.23 In early 1998, the DTI conducted a survey of operators intentions to drill offshore exploration and appraisal wells. Operators were asked to assign to each well a probability that the well would be drilled. The survey showed that, after allowing for probabilities, operators expect to drill some 91 E&A wells in 1998 and 77 in 1999 - see Table 2.2. These intentions compare well with recent E&A drilling figures. The new survey is more optimistic, particularly for 1999, when compared with the forward three years of the previous survey. This is largely due to strong intentions for the Northern and Central North Sea, and for West of Shetland. Southern Basin expectations for 1998 are strong, but weaken for 1999. There are slightly less fears on rig shortage for the first two survey years, but expectations of shortage in jack-up rigs for the later years have risen.
Table 2.2 - Intentions to drill E & A Wells: from DTI 1998 Survey
|North & Central N Sea||67||50||53||47||28|
|West of Shetland||9||8||14||13||6|
Note: The fall in intentions for 2000 reflects operators natural uncertainty about drilling so far into the future.
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2.24 Operating costs for oil and gas extraction in 1997 are estimated at £4.1 billion, a rise on 1996 despite little change in production. Operating costs per barrel rose, after operators efforts had successfully reduced them since 1991. This is shown in Chart 2.5, which gives operating costs per barrel in real terms. The fairly continuous rise from 1976 to 1991 is not unexpected as unit costs of fields rise when production begins to fall. Also, new fields often pay to use existing infrastructure, so that their unit operating costs are relatively high but capital costs are reduced. A breakdown of operating costs by year is given in Appendix 5.
Chart 2.5 - Unit operating costs in 1997 prices - 1976 to 1997
2.25 To take account of both capital and operating costs, estimates have been made of the field life cost per barrel for all oil and condensate fields which have been approved, taking into account associated gas produced with oil - see Table 2.3. These overall estimates, which are rounded to the nearest £0.5/barrel, are based on the estimated production and costs of the fields together with their equity share of pipelines and terminals, before the payment of royalty and taxes. They include the costs of exploration, development and operation over the expected life of the fields, but exclude abortive exploration costs not attributable to individual fields. A real return on capital of 10 per cent is assumed. The figures can therefore be interpreted as the constant real oil price which would yield a pre-tax real rate of return of 10 per cent.
Table 2.3 - Unit costs of fields at 1997 prices
|Fields starting production before 1980||10||8|
|Field starting production 1980-85||15||23|
|Fields starting production 1986-90||13.5||19|
|Fields starting production 1991-97||9||14|
|All fields in production||10||13|
|Under development at year end||7||12|
* Including condensate fields - and oil equivalent of associated gas. Excluding tax and royalties, and costs of abortive exploration.
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2.26 The figures illustrate the success of efforts by industry to reduce costs in the light of lower oil prices, and the continuing need for cost reduction exercises such as CRINE. Most of the largest fields on the UKCS started production before 1981, so that the cost per barrel in this period is relatively low at some £10 a barrel. With oil prices more than doubling in 1979, it is not surprising that the cost of fields starting production in the period from 1980 to 1985 rose to near £15 a barrel. The industry responded to the fall in oil prices at the end of 1985, and brought the cost down slightly to £13.5 a barrel for oil fields starting production in the period 1986 to 1990, and, under continued weak oil prices, managed to reduce costs substantially, to £9 a barrel for the period from 1991 to the present. Continued efforts have resulted in further cost reductions so that the average costs of fields under development are estimated at £7 a barrel. The overall cost of all past and future production of all oil and condensate fields in production is around £10 a barrel.
2.27 The equivalent calculations for gas fields also show a large rise in costs for fields starting between 1980 and 1985, the success of efforts to reduce costs since then, and the need for continued cost reduction. The equivalent cost for all gas fields in production is some 13p/therm.
2.28 The offshore oil industry has been responsible for the creation of many new jobs. Revised Office for National Statistics (ONS) figures show that employment classified to the sector was some 27,000 in 1978, peaked near 37,000 in 1991 then fell sharply to 25,500 in 1995. ONS estimate that sector employment rose to stand at just over 33,000 in 1997. This is shown in Chart 2.6.
Chart 2.6 - Employment in the oil and gas sector, and employment offshore - 1978 to 1997
2.29 Many oil related jobs such as construction workers are classified to other industries and are not included in these figures. This means that these figures are not coincident with numbers employed offshore.
2.30 An annual survey of the number employed offshore on rigs and platforms was started in 1967 and showed just over 1,000 workers. The number rose steadily through the 1970s to 12,500 in 1978, before falling back in 1979. From 1980 onwards the survey included workers on pipe-laying vessels, crane barges, supply and standby vessels. The new survey showed 22,000 workers offshore in 1980, the number rising until 1984, then falling until 1986. Thereafter offshore employment rose to peak at 36,500 in 1990, after which there was a general downward trend as companies attempted to reduce offshore employment to reduce costs. However, the 1993 figure was unexpectedly high due to the number of large fields under development on the day of the survey. Again, in 1995, a relatively high number of gas fields was being prepared for production.
2.31 These surveys are co-ordinated by the Inland Revenue, with the support of industry provided through UKOOA, as the main purpose was to assist with tax compliance in the offshore oil and gas industry. Aggregated results are distributed to government and industry bodies and are used, for example, by the Health and Safety Executive and UKOOA to calculate accident and safety statistics. In recent years the Inland Revenue recognised that the survey was not fulfilling its main purpose of assisting with tax compliance offshore, and approached industry to seek their support for change. Support was forthcoming as the proposed modifications assisted an industry initiative to improve the accuracy of accident statistics, and the changes were introduced in the September 1996 survey. In their 1996 survey, the Inland Revenue estimated that the number of people employed offshore was some 26,850. Of this total, 1.6 per cent were women and 92 per cent were UK nationals. Offshore employment figures are shown with oil and gas sector employment in Chart 2.6.
2.32 The 1997 survey is still being processed. Initial estimates suggest that the number employed offshore remains at 1996 levels.
2.33 A survey by the Scottish Office and Scottish Enterprise estimated that in 1995 some 64,000 jobs were accounted for by companies in Scotland who were wholly or mainly involved in oil and gas production - mainly being defined as having between 80 and 99 per cent of activity related to oil and gas production. This was only slightly down on the revised figure given for 1994. Over half were in energy and water supply, and metal goods and engineering. Of the total, some 47,000 were in wholly involved companies. Aberdeen City and Aberdeenshire Councils estimate that in 1996 some 46,000 were in oil related employment in NE Scotland. Of this total 17,100 were employed by operators and in exploration.
2.34 The recent interim report of an academic study commissioned by UKOOA estimates that a total of 382,000 jobs depend on the offshore oil and gas industry, of which 126,000 are in Scotland - equivalent to 6.6% of total Scottish employment. Of the total 31,000 are directly associated with offshore activities, 219,000 are supported by development, operating and exploration activity, and a further 132,000 jobs are induced by these activities.
BALANCE OF PAYMENTS
2.35 The direct impact of oil and gas production has led to a considerable improvement in the UK balance of payments. By 1980 the indigenous production of crude oil began to equal demand from UK refineries, and the effect of this can be easily seen in the visible trade balance. In 1980 oil contributed £0.3 billion of the UK visible trade surplus of some £1.4 billion. By 1985 visible trade was in deficit by £3.3 billion, with oil contributing a positive £8.1 billion. The contribution of oil declined with the fall in prices, but has always remained positive. The contribution has risen each year since 1991, and is estimated at some £4.6 billion in 1997. Chart 2.7 indicates the oil balance and the total visible trade balance, both on a balance of payments basis.
Chart 2.7 - Visible trade balance, 1976 to 1997
2.36 The Governments objective is to maximise the benefits to the nation from the exploitation of its hydrocarbon resources. The fiscal regime is designed to extract economic rent and secure a fair share of profits for the nation, while offering stable, attractive and economically sound investment conditions to the oil industry.
2.37 Receipts to the Government from taxes on oil and gas production (including licence fees but excluding the gas levy, which is categorised as a tax on expenditure) reached a peak of £12.2 billion in 1984/85 (equivalent to £21.6 billion in 1997/98 prices). Receipts subsequently declined with the fall in oil prices but are estimated to total some £3.5 billion in 1997/98. Since 1964/65, the Government has received a total of £86.3 billion in money of the day or £147 billion in 1997/98 prices. Cash receipts since 1964/65 are given in Table 2.4 and illustrated, together with oil prices and total oil and gas production, in Chart 2.8; receipts and oil prices are both shown in constant 1997/98 prices.
Table 2.4 - Taxes and Royalties Attributable to UK Oil and Gas Production and Gas Levy
|Corporation Tac (CT)||£ million|
|Financial Year||Offshore Licensing Round||Licence Fees (1)||Royalty||SPD (2)||PRT (3)||CT before ACT Set-off (4)||of which ACT Set-off (5)||Mainstream CT (6)||Total Revenues||Gas Levy (7)|
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Chart 2.8 - Government receipts from UKCS - with oil prices, and production 1976/77 to 1997/98
2.38 No major changes to the North Sea fiscal regime were introduced in the July 1997 Budget, though the Chancellor announced that the rate of corporation tax would be cut from 33% to 31% with effect from April 1997 and that gas levy would be reduced to zero with full effect from April 1998. However, he announced a review of the North Sea fiscal regime, which was undertaken jointly by a team from the Inland Revenue, Treasury and the Department of Trade and Industry. The aim of the review was to ensure that the Government is taxing an appropriate share of North Sea profits while continuing to maintain a high level of oil industry interest in the future development of the UKs oil and gas reserves. There was extensive discussion with interested parties about the existing fiscal regime: oil industry representative bodies, oil and gas producing companies and others provided their views both in writing and at a number of meetings. The representations received were very helpful in establishing the industrys views and were considered along with the Governments own analyses of the profitability of North Sea oil and gas fields.
Government revenues from oil and gas produced on the UK Continental Shelf are made up of Royalty, Gas Levy, Petroleum Revenue Tax (PRT) and Corporation Tax. Royalty and Gas Levy are collected and administered by the Oil and Gas Royalties Office within the DTI. PRT and Corporation Tax are collected and administered by the Inland Revenue and responsibility for oil taxation matters lies primarily with them and the Treasury.
Royalty is paid at six-monthly intervals at 12.5 per cent of the landed value of the petroleum, less an allowance for the cost of bringing the petroleum ashore and treating it. Royalty is not payable for any field approved after 31 March 1982.
PRT was introduced by the Oil Taxation Act 1975. It is a tax on profits related to separate geological and technically determined fields, charged on the difference between income and expenditure. It is charged at six monthly intervals. A significant reform to PRT was introduced in the 1993 Finance Act. This reform was designed to encourage the further economic development of the UKs oil and gas resources by allowing companies to keep more of their rewards. The rate of PRT charged on existing fields was reduced from 75 per cent to 50 per cent with effect from 1 July 1993 and PRT was abolished for fields approved on or after 16 March 1993.
Gas Levy was introduced in 1981 to capture the rent accruing to the nationalised British Gas Corporation from purchasing PRT-exempt gas under long term contracts signed before the general rise in gas prices.
Corporation Tax (CT) is charged on the profits of oil and gas companies in much the same way as any other industry. In the case of new fields this is now the only tax on profits. The main rate of Corporation Tax is currently, at 31 per cent, one of the lowest company tax rates in the world. Both Royalty and PRT are deductible in computing profits for CT purposes, and profits from upstream oil and gas activities are ring-fenced so that they cannot be reduced for CT purposes by any losses or reliefs arising from any other activity, including downstream oil and gas operations.
2.39 As a result of the review, the Government believes that certain aspects of the current fiscal regime are unsatisfactory. In his March 1998 Budget, the Chancellor announced that the Government would formally consult the oil industry on specific proposals to change the fiscal regime for companies involved in the extraction of UK oil and gas. He announced that a consultative document would be published in mid April with the aim of legislation in the next Finance Bill. The industry had requested further consultation on any planned changes and the Government believes that this will be beneficial to the process of developing an appropriate fiscal regime for these activities. Consultation with the oil industry and other interested parties should help to ensure that uncertainty is minimised, particularly against the background of low oil prices, and that full account is taken of the potential impact on investment in both existing and new fields.
2.40 The March 1998 Budget also included proposals to cut the rate of corporation tax from 31% to 30%, to introduce in-year instalments of corporation tax for large companies and to abolish advance corporation tax from April 1999.
2.41 The Chancellor also announced in his March 1998 Budget that the Government proposed to implement the previously-announced reduction in the gas levy by introducing legislation in the Finance Bill to abolish the levy with effect from 1 April 1998 and to reduce the rate of levy for 1997/98 from 4 pence per therm to 3 pence per therm.
2.42 The Government announced on 4 December 1997 that it intended to make some technical changes to the legislation used to value North Sea gas for petroleum revenue tax purposes. The aim was to ensure that valuations would continue to reflect the price which would be fetched in an equivalent sale between unconnected parties. This corresponded to the way in which the legislation had previously been applied by the industry and the Inland Revenue and the changes were to apply to past as well as future disposals. A draft clause was attached to the Press Release and comments were invited. No respondent disagreed with the policy underlying the change and the clause used for consultation was included in the published Finance Bill.
| Table of Contents
Chapter 1 | Chapter 2 | Chapter 3 | Chapter 4 | Chapter 5 | Chapter 6 | Chapter 7 | Chapter 8 | Chapter 9
Appendix 1 | Appendix 2 | Appendix 3 | Appendix 4 | Appendix 5 | Appendix 6 | Appendix 7 | Appendix 8
Appendix 9 | Appendix 10 | Appendix 11 | Appendix 12 | Appendix 13 | Appendix 14 | Appendix 15 | Appendix 16 | Appendix 17
Plate 1 | Plate 2W | Plate 2E | Plate 3W | Plate 3E | Plate 4W | Plate 4E | Plate 5W | Plate 5E | Plate 6 | Plate 7
Plate 8W | Plate 8E | Plate 9W | Plate 9E | Plate 10W | Plate 10E | Plate 11 | Plate 12