The UK Government has already shown itself responsive to the need to adapt the structure of taxes on offshore oil to meet the changing economics and patterns of activity which can be expected as the UKCS matures.
A gradual modification and relaxation of the UKCS tax regime should be seen as a vital ingredient in policies to ensure that the full hydrocarbon policies to ensure that the full hydrocarbon potential of the UK offshore is realised. potential of the UK offshore is realised.
Few people would deny that tax is a necessary evil. On the other hand its necessity and evilness vary greatly depending on the precise motivation of the taxing authority and the circumstances in which tax is applied. Thus, at its simplest, the imposition of taxes can be seen purely as a matter of raising money, as in the purely as a matter of raising money, as in the case of a poll tax; or as a money raising exercise with the qualification that the mechanism should be seen as ‘fair’ by society as a whole, as with the UK'S system of personal income tax; or yet again as a matter of raising money in a way that specifically encourages desirable behaviour, as for instance with proposals to impose fiscal penalties on the inefficient use of fuel. penalties on the inefficient use of fuel. In practice there will rarely be complete consensus within government about the purpose of taxation in any particular context. This will generally lead to tax policy being decided only after a complex trade off between potentially conflicting policy issues, including government's short term, as opposed to long term, desire for money. The UK government's approach to tax domestic oil and gas production provides a classic case study of this predicament which is still the process of unfolding.
The taxation of oil and gas extraction activity any specific area (and tax in this context is used in the widest sense embracing not only general and special oil taxes but royalty, carried participation interests and administered oil participation interests and administered oil prices) goes through three distinct phases: an prices) goes through three distinct phases: an exploration phase, when prospectivity has still to be established; a development phase when the potential for commercially exploitable discoveries potential for commercially exploitable discoveries is first confirmed; and a mature phase. Before assessing the current position in the UK it is worth looking at each of these stages in general terms.
The Exploration Phase: At this stage there is, on one hand, a government with potential but unknown natural resources which it would like to turn to account; and, on the other, oil companies with a desire for access to those potential natural resources on terms which will leave them with a reasonable prospect of deriving profit in the long term. Although the exploration phase in itself produces no taxable profits and may never lead to produces no taxable profits and may never lead to commercial discoveries, the parties have to reach some sort of understanding, mutually or unilaterally, as to the tax terms that are likely to apply to any commercial discoveries. In some circumstances it may be possible for the government to take tax in advance at this stage through signature bonuses or licence auction payments, but its ability to do so will depend on payments, but its ability to do so will depend on companies' view of prospectivity and of the credibility of the fiscal terms promised for any commercial development.
The Development Phase: At the time the actual development potential of the area is first established both government and companies will re-appraise the position. Whether the fiscal terms have to be changed at this stage will depend on the flexibility and appropriateness of the original package envisaged at the exploration phase. However, if the effect of that package is phase. However, if the effect of that package is to share the potential wealth created by the development activity in a way that is fundamentally unacceptable to either party, changes will be required.