Tax certainty encourages window of opportunity

Shirley Allen and Richard Murphy explain how Ireland’s new licensing terms give clarity to investors as global competition increases.

On 18 June, the Minister of State at the Department of Communications, Energy and Natural Resources (DCENR) invited applications for Licensing Options over a number of Irish Atlantic Margin blocks in the Donegal, Erris, Slyne, Porcupine, Goban Spur and Rockall basins. The licensing round is the latest attempt by the Irish Government to attract investors to the country’s oil and gas industry which has arguably remained stuck in first gear despite several attempts to spur investment.

On the same day, the Government announced the conclusions of a review into the fiscal terms of the new licences following an extensive assessment and peer comparison by consultants Wood Mackenzie, whose report recommended Ireland amend its tax regime for producing fields – the impact of which will increase the potential government tax take from up to 40 per cent to a possible 55 per cent for new licences.

Whilst no explorer would welcome an overall increase in taxation, the move appears to be a sensible and pragmatic one. The existing taxation regime in Ireland – which consists of a 25 per cent corporation tax rate and a Profits Resource Rent Tax (PRRT) of up to 15 per cent dependent on field profitability (giving a maximum tax rate of 40 per cent) – is generous by international standards. Yet despite a relatively favourable fiscal regime, interest in Irish oil and gas opportunities has been muted, given poor results with the drill bit, spiralling international drilling costs and the long and difficult saga of bringing the Corrib gas field into production.

Though the Irish Government hailed the 2011 licensing round as a great success with 12 companies bidding for blocks in 13 regions, with the exception of Repsol all were relatively small public and private oil and gas juniors. While juniors traditionally play a vital role in frontier exploration, sentiment towards explorers since the Macondo disaster in the Gulf of Mexico has deteriorated and funding has been exceptionally hard to come by – especially for those firms operating in unproven waters. At the same time, costs have risen as a consequence of tight rig supply (a fall out from the credit crunch and the low oil price of that period) and the need for bigger rigs able to drill in ever deeper, more extreme environments.

Arguably therefore, given the limited interest of the majors at the last licensing round, a relatively modest increase in tax is hardly likely to be a significant deterrent in the 2015 round, especially given renewed interest arising from the discovery of the Barryroe oil field in 2012 and the recent arrival of larger players entering this market. On the other side of the coin, the rise may go some way to placating opponents of the previous tax regime who had argued vociferously that the low rate was selling Ireland short and could deprive the nation of potentially substantial revenue arising from discoveries successfully brought into production.

Clarity

Opponents to the oil and gas industry in Ireland will doubtless counter that the rate is still low, and others will claim the change does little to promote jobs or infrastructure in Ireland particularly if oil production is shipped to UK refineries, rather than brought onshore to Ireland.

However, this is to miss the point. Ireland will never have an oil city to rival Aberdeen – with all the associated investment, jobs and skills that such a concentration of industry can bring – unless the economics are right and the economics can only ever be right if multiple discoveries are made and the development time between discovery and first oil is shortened. Discoveries will only be made if exploration is encouraged. Thus the proposed increase should not be a significant deterrent to investors while going some way to appease opponents by ensuring a greater share of the profits from any discoveries goes to the State.

Aside from taxes, the other great deterrent for investors is uncertainty. By drawing a marker in the sand at the beginning of the licensing process, the Government is giving clarity to bidders and removing the uncertainty for investors who may have feared changes to the fiscal regime should commercial discoveries be made. Investors are right to be concerned. Changes to licences across tax, exploration rights or environmental terms are major deterrents and have happened even in mature oil and gas markets.

Whilst it is now 50 years since the first exploration licences were granted in the UKCS, the fiscal regime has arguably often been focussed on relatively short-term gains rather than demonstrating the stability which is desired by those considering investing significant sums into a region. When UK Chancellor George Osborne launched a surprise ‘windfall’ tax on North Sea oil in 2011, raising tax on offshore drilling profits from 20 per cent to 32 per cent, the effect was immediate with British Gas mothballing its Morecambe Bay gas field, claiming the shift in taxation rendered the field uneconomic.

An industry think tank claimed the change put £2 billion of investment at risk. Tax is not the sole reason (depletion, restructuring and asset allocation plays a part) but it is perhaps no coincidence that several majors have reduced or are reducing their exposure to the North Sea since the change. Whilst the UKCS fiscal regime has adapted since 2011, changes can still be welcomed with the Independent Expert Commission on Oil and Gas recently calling for a tax regime that demonstrates stability, predictability and is seen as being internationally competitive to help incentivise developments.

Global shift

So with fiscal certainty in place, a new licensing round under way, first gas from Corrib expected in 2015 and further appraisal of the Barryroe discovery planned, is this likely to be a new dawn for the Irish oil and gas sector?

The fiscal changes on their own are unlikely to make too much difference aside from providing welcome certainty and provide positive news for the naysayers. Over 150 wells have been drilled in Ireland since the 1970s and only 16 since 2003, with to date a poor chance of success, with only three commercial gas fields brought into production. And while the Government has contracted Italy’s Eni to shoot 18,000km of 2D seismic, there remain large gaps in our knowledge of Ireland’s offshore geology and a need to invest large sums in the latest 3D seismic surveys. Companies such as Providence Resources are continuing to do so over certain acreage but this type of investment can only be encouraged if we wish to have a greater understanding of the potential hydrocarbon reserves.

However, there is currently the prospect of a major shift in the current oil and gas exploration industry globally, and it is for global investment which Ireland is competing for. At the start of the year, analysts were forecasting a declining oil price as a consequence of increased US production from unconventional shales, expected increases in output from Iraq and more recently from the relaxation of sanctions against Iran. However, with the recent turmoil in the Middle East, potentially hitting production in Iraq and Kurdistan – and with growing civil strife in Libya, Venezuela and Nigeria, and potential disruptions to European gas supply from the dispute between Ukraine, Russia and the EU – prices have risen and the potential for turmoil in global oil and gas markets is at its highest for some years.

This is particularly significant for countries such as Ireland which are heavily dependant on other countries for security of supply. Additionally, with declining production in the North Sea, fewer wells being drilled and uncertainty over the impact of a possible Scottish vote for independence, Ireland has a strong hand to play in offering political and economic stability, regulatory and fiscal certainty, proximity to a skilled workforce and finally real evidence of offshore hydrocarbons. So, no new dawn but certainly a window of opportunity.

Shirley Allen is a Partner with Pinsent Masons’ Energy and Natural Resources Team in Aberdeen.
Tel: +44 (0)1224 377 922
Email: shirley.allen@pinsentmasons.com
Richard Murphy is a Partner with the Energy and Natural Resources Team in Belfast.
Tel: +44 (0)28 9089 4844
Email: richard.murphy@pinsentmasons.com