Tax by tax, spend by spend

Oil and gas revenues

UK oil and gas revenues consist of offshore corporation tax (which includes ‘ring fence’ corporation tax and the supplementary charge) and petroleum revenue tax. These taxes apply to the profits of companies involved in the production of oil and gas in the UK and on the UK continental shelf (UKCS) (“The North Sea”). In our latest forecast, we expect UK oil and gas revenues to raise £0.9 billion in 2018-19, representing 0.11 per cent of all receipts. The three streams of revenue are:

  • ‘Ring fence’ corporation tax (RFCT) is calculated in the same way as onshore corporation tax, but with the addition of a ‘ring fence’ and the availability of 100 per cent first-year allowances for virtually all capital expenditure. The ring fence prevents taxable profits from oil and gas extraction in the UK and the UKCS being reduced by losses from other activities. The current rate of tax on ring-fenced profits is 30 per cent.
  • The supplementary charge (SC) is an additional charge on a company’s ring-fenced profits (but with no deduction for finance costs). The current supplementary charge rate is 10 per cent. It was reduced from 20 per cent on 1 January 2016.
  • Petroleum revenue tax is a ‘field-based’ tax charged on the profits arising from individual oil and gas fields that were approved for development before 16 March 1993. The rate of PRT was permanently set at zero per cent effective from 1 January 2016 but it has not been abolished so that losses (such as losses arising from decommissioning PRT-liable fields) can be carried back against past PRT payments. PRT was deductible as an expense in computing profits chargeable to RFCT and SC

  • Recent trends

    The charts below show tax receipts in both cash terms and as a share of national income (GDP). Receipts measured in cash terms are a simple metric for analysing trends over time. But without putting the cash amount into context – by asking how much national income is available to be taxed – interpreting changes in cash receipts is difficult, particularly over long time periods.

    Trends in receipts as a share of GDP are useful to understand how they move in line with the underlying economic activity that is being taxed. In cash terms, both receipts and GDP will tend to rise over time because of economic growth and inflation. Receipts as a share of GDP is the most relevant metric when considering the sustainability of the public finances. Movements in this ratio can be thought of in two parts – movements in the tax base relative to national income (i.e. whether asset prices have grown faster or slower than the whole economy) and changes in the effective tax rate (i.e. the amount of tax raised per unit of the tax base).

    The movements in oil and gas revenues between the peaks and troughs since the early 1970s can be explained by drivers of taxable profits – the volume and price of production, which together provide a proxy for sales, and the implied profit margin on those sales – and the effective tax rate paid on those profits. In our December 2014 EFO, we showed that:

    • between 1979-80 and 1984-85 receipts increased by 420 per cent to £12.0 billion. That was driven by a 40 per cent rise in production, strong growth in sterling oil prices, higher profit margins and an increasing effective tax rate;
    • between 1984-85 and 1991-92 receipts fell by more than 90 per cent to £1.0 billion. While sterling oil prices fell sharply over that period, the largest driver was a reduction in the effective tax rate paid on North Sea profits. This reflected a cut in the main rate of offshore corporation tax from 45 to 33 per cent and strong growth in operating and capital expenditure; and
    • between 1991-92 and 2008-09 receipts increased strongly to £12.4 billion. Again, prices and the effective tax rate explained the rise, with oil prices hitting an all-time high in cash terms in mid-2008 and the introduction of the supplementary charge of corporation tax at 10 per cent in April 2002 and the increase to 20 per cent from January 2006.

    Since 2008-09 UK oil and gas revenues have fallen from £10.6 billion (0.7 per cent of GDP) to close to zero in 2016-17. The fall in receipts has been driven by falling production, much lower oil and gas prices and higher tax-deductible expenditure. The rate of petroleum revenue tax and the supplementary charge have also been cut substantially.

    CT receipts: ONS (ID: CPSB, includes onshore CT)

    PRT receipts: ONS (ID: DBHA)

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  • Latest forecast

    Our latest fiscal forecast was published in March 2018. Oil and gas revenues are expected to rise from below zero in 2016-17 (with repayments exceeding payments), but to remain less than 0.1 per cent of GDP by 2022-23. Over the earlier years of the forecast, this increase is explained by our market-derived assumption of rising oil and gas prices. Rising prices boost the value of production, increasing the tax base. Rising profits also boost the effective tax rate, as fewer losses (which can be used to offset tax liabilities) are generated.

    More detail on our latest forecast and how it was revised relative to our previous forecast in March was provided in paragraph 4.53 to 4.54 of our March 2018 EFO.

    Expand to read the extract from our March 2018 EFO

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  • Latest monthly data

    The monthly profile of UK oil and gas revenues is relatively volatile across the year. Both ‘ring-fence’ corporation tax and the supplementary charge are payable in three instalments each year, relative to the start and end of each individual company’s accounting period. The rate of PRT has now been set to zero, so no payments of PRT are made, although PRT repayments related to decommissioning costs are still paid out across the year, reducing net receipts.

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  • Forecast methodology

    Forecast process

    We commission forecasts of UK oil and gas revenues from HM Revenue and Customs for each fiscal event. The forecasts start by generating an in-year estimate for receipts in the current year, then use different models to forecast growth in receipts from that starting point. We provide HMRC with economic forecasts that are then used to generate the tax forecasts. These are scrutinised in a challenge process that typically involves two rounds of meetings where HMRC analysts present forecasts to the Budget Responsibility Committee and OBR staff. We also discuss determinants of the forecast with officials from the Oil and Gas Authority. This process allows the BRC to refine the assumptions and judgements that underpin the forecasts before they are published in our Economic and fiscal outlooks.

    Forecasting models

    The UK oil and gas forecast uses a micro-simulation model based on production and expenditure data from each individual oil and gas field. This field level data is collected through a survey now carried out by the Oil and Gas Authority. The fully disaggregated data in the model is subject to taxpayer confidentiality, so we only scrutinise the results of the model not the individual field-level inputs. Our forecasts of aggregate levels of oil and gas production and levels of expenditure, along with other determinants – oil and gas prices, the sterling/dollar exchange rate – are fed into the model to produce estimates of tax revenues. Our production and expenditure forecasts are informed by the central projections produced by the Oil and Gas Authority.

    Main forecast determinants

    The main determinants of our UK oil and gas revenues forecast are those related to the tax base and those that used by the Government in setting parameters of the tax system. See the ready reckoners section below for more information on the effects of these determinants on UK oil and gas revenues.

    • Dollar oil price
    • Sterling/dollar exchange rate
    • Oil and gas production
    • Operating and capital expenditure
    • Decommissioning costs

    Main forecast judgements

    We need to make several forecast judgements to generate our UK oil and gas revenue forecast. These include:

    • The level of oil and gas production – the tax base (the level of profits generated by the North Sea) is dependent on the quantity of oil and gas extracted. Our assumption on future production levels is informed by the central projections published by the Oil and Gas Authority. Levels of production are driven by a number of factors, including the amount of oil and gas remaining in the UKCS, levels of investment in previous years and the size and duration of extraction outtages;
    • oil and gas prices – we assume that these prices move in line with market expectations over the next two years, and then remain flat in real terms thereafter; and
    • levels of expenditure on the UKCS determine both the future path of production and the value of allowances that can be used to offset against tax liabilities. Our assumption is informed by the central projections produced by the Oil and Gas Authority.

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  • Previous forecasts

    UK oil and gas receipts in 2015-16 were below zero, compared to our June 2010 forecast of £9.7 billion in that year. Since that forecast, receipts underperformed against expectations in almost every year of every forecast, meaning that we repeatedly revised down our forecasts. Our November 2016 forecast was the first time we had revised up the forecast since March 2011.

    Prior to March 2013, higher-than-expected expenditure (particularly on capital investment, which can be fully offset against taxable profits) was a key driver of weaker receipts. Weaker production also explained some of these errors. And the unanticipated steep drop in oil prices during 2014-15 pushed receipts even lower.

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  • Policy measures

    Since our first forecast in June 2010, governments have announced 15 policy measures affecting our forecast for oil and gas receipts. The original costings for these measures are contained in our policy measures database and were described briefly in the Treasury’s relevant Policy costings document. For measures announced since December 2014, the uncertainty ranking that we assigned to each is set out in a separate database. For those deemed ‘high’ or ‘very high’ uncertainty, the rationale for that ranking was set out in Annex A of the relevant Economic and fiscal outlook.

    Key oil and gas policy changes announced since 2010 have included:

    • the rate of supplementary charge was increased from 20 to 32 per cent at Budget 2011. It was then reduced to 30 per cent at Autumn Statement 2014, then to 20 per cent at Budget 2015 and then to 10 per cent at Budget 2016;
    • the rate of petroleum revenue tax was cut from 50 to 35 per cent at Budget 2015 and was then cut all the way to zero at Budget 2016; and
    • investment allowances were introduced at Budget 2015.

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  • Ready reckoners

    ‘Ready reckoners’ show how our fiscal forecasts could be affected by changes in selected economic determinants. They are stylised quantifications that reflect the typical impact of changes in economic variables on receipts and spending. These estimates are specific to our March 2017 forecast and we would expect them to become outdated over time, as the economy and public finances, and the policy setting, continue to evolve. They are subject to uncertainty because they are based on models that draw on historical relationships or simulations of policy settings. More information can be found in the ‘Tax and spending ready reckoners’ spreadsheet we published alongside our 2017 Fiscal risks report.

    The table below shows that:

    • the profits of UK oil and gas companies – and therefore their tax liabilities – are directly affected by changes in the oil price (denominated in pounds). Receipts will also be affected by the level of production and expenditure, which will themselves be influenced by the oil price, although the simple ready reckoner presented below does not factor in any variation in production or expenditure relative to the baseline.

     

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  • Other information

    Supplementary information

    Our oil and gas expenditure assumptions can be found in our EFO supplementary tables.

    Chapter 4 of our June 2015 Fiscal sustainability report looks at the long-term sustainability of UK oil and gas receipts.

    Model review

    In our 2017 Forecast evaluation report we set out the initial conclusions of our review of fiscal forecasting models. This section sets out the conclusions of our review of our UK oil and gas forecasting model.

    UK oil and gas revenues consist of offshore corporation tax (which includes ‘ring fence’ corporation tax and the supplementary charge) and petroleum revenue tax. These taxes apply to the profits of companies involved in the production of oil and gas in the UK and on the UK continental shelf (UKCS) (‘The North Sea’). The North Sea revenues forecast uses a micro-simulation model based on production and expenditure data from each individual oil and gas field. These field level data are collected through a survey now carried out by the Oil and Gas Authority. The fully disaggregated data in the model are subject to taxpayer confidentiality, so we only scrutinise the outputs of the model, not the individual field-level inputs. North Sea revenues are relatively volatile due to the underlying volatility of prices, production and tax-deductible expenditure. The relationships between the aggregate cashflows of North Sea firms, their taxable profits and the amount of tax revenue are complicated by the deductions regime and the use of past losses to offset current liabilities.

    Fiscal forecasting differences for North Sea revenues are not meaningful in percentage terms as revenues have been close to zero in recent years. For offshore corporation tax, an equal number of March forecasts since 2012 have under- or over-predicted receipts at the two-year horizon. For petroleum revenue tax, three of the past four have over-predicted receipts.

    We moved to a new North Sea forecasting model in our November 2017 forecast. We have agreed the following priorities with HMRC for development work over the coming year to enhance this new model:

    • Develop modelling outputs to improve the transparency of the underlying structure and assumptions.
    • Develop the long-term forecasting capability of the model to inform our Fiscal sustainability report analysis.

     

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  • Boxset

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