Despite warnings that the oil and gas industry is not sustainable, either due to its environmental footprint or the disruptive impacts of the Covid-19 pandemic, those with a stake in the sector are not eager to see the industry fall apart. One such player is Norway, which supplies around a quarter of the EU’s natural gas demand, and where crude oil and natural gas exports accounted for 47% of the country’s total export value in 2019.
With oil and gas so entrenched into the Norwegian economy, the government has taken drastic steps to protect the sector in increasingly uncertain times for offshore operations. While the Norwegian offshore tax structure was once a picture of stability, the state has made radical, temporary changes to its taxation framework amidst the Covid-19 pandemic, which has seen oil demand collapse and companies struggle to make ends meet.
With tax rebates set at 100% of capital expenditure, the move aims to nurse the industry through the pandemic, and ensure new projects continue to be financed. Figures from Rystad Energy suggest that the plan could reduce breakeven prices for projects by an average of around 40%, and with such dramatic savings on the table, many are questioning whether such sweeping tax reforms could be implemented in other major oil and gas producers around the world.
New taxes in Norway
The country’s new tax rules aim to encourage continued investment in the offshore sector despite concerns over the industry’s long-term viability. The Norwegian oil and gas sector has been subject to two taxes, a standard company tax rate between 20% and 30% and a special tax rate between 50% and 60%, since 1975. The variation in both taxes is key, as they are frequently adjusted to ensure that oil and gas companies are taxed at a total rate of 78%, and provide overall stability in the sector; a Deloitte report found that these taxes were split 27% to 51% in 2014, while Norwegian Petroleum cited the ratio at 22% to 56% in June this year.
While this total tax rate of 78% is not to be changed, the uplift behind the special tax is set to increase, and a new exploration tax break will come into effect. Derek Leith, head of oil and gas taxation at analyst EY, called the move “really supportive of ongoing investment.”
“The key change that has taken place is that for the special tax, capital expenditure will now be expensed wholly as it’s incurred, so a 100% deduction in the year for capital expenditure in that year,” he said. “That’s quite a significant difference, and then the uplift of 20.8% has been increased to 24%.
“What we’ve seen is a massive acceleration of tax relief in the special tax for capital expenditure, and we’ve seen an increase in the uplift and an acceleration of the uplift to one year, rather than being spread over four years,” he continued. “For the special tax, there is a massive, massive [change to] cash flow off the back of these changes.
These changes are significant, not just for the sums of money involved, but that these changes are taking place in Norway, where stability has been such a priority that previous changes to tax structure have had to reach compromises so as not to disrupt the industry’s overall tax rate.
“Norway has stuck with the basic print of the regime,” said Leith. “For example, when the normal corporate tax rate has come down to 22%, they have had their special tax rate go up so that they have maintained their overall 78% tax rate.”
The primary motivation behind the changes is to encourage exploration, and the development of new offshore projects, despite threats to the viability of the sector. Leith noted that banks “routinely” give out loans for exploration projects in Norway due to the country’s generally favourable tax structure, a practice unheard of in other countries, and the new 100% exploration tax rebate is set to double down on this move.
This comes as no surprise, considering the number of large-scale oil and gas projects currently under construction in Norwegian waters. Proposed facilities such as Equinor’s three projects in the Johan Castberg field, with a value of $6bn that are expected to begin production in 2022, and the Wisting Central Oil field with a potential value of $5.9bn, highlight the importance of new offshore projects to the Norwegian economy.
“What the Norwegians have said as part of these temporary measures, is that to the extent you incur losses in 2020 or 2021, you can get a cash tax refund on that loss,” explained Leith, describing how the new tax rules could remove much of the financial risk associated with funding new projects. “These attractive investment depreciation rules apply for 2021 and 2022, and provided the projects being applied for by the end of 2022 are sanctioned by the end of 2023, the accelerated depreciation applies in both these years and then of course, for that project in future years until it gets to commencement of production.”
These timeframes are of particular importance, as they coincide with a resurgence in demand for ‘floaters’ in Norwegian waters, oil rigs that are not attached to the seafloor below. According to Rystad, the global demand for such floating platforms is set to fall from 40 in 2015 to 25 in 2022; Norway in particular will see a decline from 19 to 14 over this period.
Rystad’s figures, then, suggest that global and local demand for floaters will rebound, to 35 and 19 respectively by 2025. If correct, it suggests that the next three years will only be a temporary downturn in demand for new oil and gas facilities, one that the Norwegian Government aims to nurse its industry through with these temporary tax breaks.
“In other words, there’s a real incentive to continue with projects that you might be considering delaying and maybe, in some cases, advancing projects to that window to get that accelerated depreciation,” said Leith.
The changes in Norway have gained support from companies, industry bodies, and workers’ unions, and have led many in these groups in other countries to call for similar tax breaks for their own oil and gas industries. The UK, for instance, has been a net importer of petrol since 2006, with imported fuel accounting for 14% of energy supply as of 2018, despite the country’s history of offshore production, and significant investment in oil and gas infrastructure.
Yet Leith is pessimistic that the UK could implement such a sweeping tax reform to encourage new investment in domestic production, even on a temporary basis as Norway has done, due to the intricacies of the country’s existing tax structure.
“We don’t have an uplift per se,” he said, “but we do have something called an investment allowance, and that is an incentive given against supplementary charge rates. It is arguable that you could increase the investment allowance, [but] the supplementary charge in the UK started at a rate of 10% in 2002, went to 20% in 2006, to 32% in 2011, and then, post the oil price crash in 2015, it went back to 10%, where it is at the moment. Consequently, a reduction of the supplementary charge also results in a decrease to the benefit derived from the investment allowance.”
Furthermore, he pointed out that the maximum tax rate of 40% in the UK is far lower than the 78% in Norway, which makes such dramatic tax changes difficult, if not impossible.
“The Norwegians are prepared to introduce these changes because they’ve got a massive state fund that they’ve set up,” he said. “They can bear the cost of giving tax refunds [whereas] I think in the UK, it would be incredibly difficult politically to introduce into the North Sea tax regime tax-free funds for oil and gas companies that made losses this year and expect to next year, when there are other sectors in the UK that are really struggling.”
Norway, therefore, is something of a perfect storm of a country that relies heavily on oil and gas production for internal financial performance and foreign exports, and a tax framework with the flexibility – ironically given its reputation for stability – to enable such dramatic changes to be made. While the UK looks to alternative sources of power for its energy future, with renewable power production overtaking that of fossil fuels for the first time last year, Norway is taking advantage of its unique position to protect its oil and gas industry.
By JP Casey