Schumpter’s Cayman Island holiday

Schumpter was an economist who theorised on the creative destruction of capital, replacing activity in old industries with activity in new ones. I’m not an economist, but to me it is an interesting time now because it all seems to be a bit broken – the oil industry is being knocked down by external (temporary) market distortions and governments are unable to enact public policies that might help because they don’t have access to the tax base they once had – and have been busy expanding the spending of what they do have on other things.

Today’s FT was a classic issue – with stories exploring some hot topics:

Accelerated Decommissioning in an article titled – “North Sea fields face end of production” [Link]

A piece examining the dynamics of adjusting to low oil prices – “Oil Producers retool for lower prices” [link]

A call for support and regulatory intervention into the North Sea shared infrastructure – “Premier Oil urges action to maintain North Sea fields” [link]

A story about BP’s accounting profit – “BP Shares tumble after $2.2Bn fourth-quarter loss” [link]

The WoodMac analysis says that 50 North Sea fields could cease production this year. Of course they will need to apply for COP (Cessation of Production) agreement from the government:

Prior to permanently ceasing production from a field, Licensees will have to satisfy the department that all economic development opportunities have been pursued. To ensure that all issues are addressed thoroughly before agreement to CoP is required [link].

The article goes on to speculate that some of the lost revenues for exploration service companies might be replaced by decommissioning revenues. While this might be true on an aggregate revenue basis, it’s unlikely that you can use a seismic survey vessel in this process so there will be capital assets that become worth a lot less, even if employment has some life-lines.

The dynamics of low price adjustments are explored by Amrita Sen and Virendra Chauhan from Energy Aspects [link] – they make a great point that one of the cause of high costs in the last up-cycle was shortage of skilled labour (sometimes referred to as the big crew change [link] ). Many of the current workforce (upwards of 250,000 people [link]) have been laid off and many will leave the industry permanently. This may set-up a cost-dynamic that will increase input prices and damp capacity for the inevitable upturn, potentially leading to even larger commodity price spikes and surges in service company profits?

The call from Tony Durrant, Premier CEO asking the regulator to step in to protect shared infrastructure in the North Sea is one that I’ve supported on this site for a while. It’s not just power that they need (the CoP mechanism may already mean they have it) it is one of public policy, subsidy and – ultimately – courage. We saw David Cameron promise £250m to Aberdeen (aiming it in entirely the wrong direction). But that is really small potatoes, which – to mix a metaphor, and pay homage to John Major – will butter no parsnips.

This is not really subsidising or investing in infrastructure: For instance if we look at Indonesia:

The government’s plan includes constructing power plants that would supply 20,000 megawatts of electricity in the next 10 years and 1,095 kilometers of new toll roads to move goods faster across the vast archipelago. The projects will be concentrated in six “economic corridors” or growth centers: Sumatra, Java, Kalimantan, Sulawesi, Bali-Nusa Tenggara, and Papua- Maluku. The price tag: $150 billion over the next five years. But the government can only finance 30 percent of the cost; the rest would have to come from the private sector. [link]

If we look at Cross-Rail, a train to move people slightly faster from Maidenhead to Lewisham has a budget of around £15Bn [link] (which is 60x the subsidy for the North Sea)

In the 1970’s the Oil industry was seen as a way of providing tax revenues to the UK – you might argue that much of the Thatcher-era economic achievement was predicated on Britain becoming a net exporter of oil which, combined with the sell-off state industries, increased the tax take and enabled the unwinding of the debt accumulated by previous governments.

Most people don’t realise that Oil companies don’t pay just normal corporation tax – PRT is charged on “super-profits” arising from the exploitation of oil and gas in the UK and the UK’s continental shelf. After certain allowances, PRT is charged at a rate of 50% (falling to 35% from 1 Jan 2016) on profits from oil extraction. PRT is charged by reference to individual oil and gas fields, so the costs related to developing and running one field cannot be set off against the profits generated by another field. PRT was abolished on 16 March 1993 for all fields given development consent on or after that date. [Link]

Corporation tax supplementary charge manual here [link]

It’s perhaps as well that these sort of measures are in place because Oil companies (and service companies) are very well practiced in the art of reducing corporation tax – either by legitimately moving costs to high tax areas and profits to low-tax ones, or by – as BP has done today – booking as big a loss as they can (when it’s expected – a practice called “taking a bath”). They do this to provide a shield for future profits against tax. A practice similar to that used by the banks to shield their current earnings from the losses of the financial crash of 2008 [link]. Many of today’s tax “dodges” have been heavily utilised by our industry.

We’re seeing a situation where an industry (one of our few industrial and engineering success stories of scale left in the UK) being decimated by a temporary market swing and there is nothing that the government can do about it because the new industries which are very profitable pay little tax and where disruptive industries are supported by the “subsidy” from investor’s tax free cash piles sitting offshore.

Take for example UBER and it’s disruption of local tax-optimising (sorry mate only cash) taxi drivers:

A recent article in The Information, a tech news site, suggests that during the first three quarters of 2015 Uber lost $1.7bn while booking $1.2bn in revenue. The company has so much money that, in at least some North American locations, it has been offering rides at rates so low that they didn’t even cover the combined cost of fuel and vehicle depreciation.

An obvious but rarely asked question is: whose cash is Uber burning? With investors like Google, Amazon’s Jeff Bezos and Goldman Sachs behind it, Uber is a perfect example of a company whose global expansion has been facilitated by the inability of governments to tax profits made by hi-tech and financial giants.

To put it bluntly: the reason why Uber has so much cash is because, well, governments no longer do. Instead, this money is parked in the offshore accounts of Silicon Valley and Wall Street firms. Look at Apple, which has recently announced that it sits on $200bn of potentially taxable overseas cash, or Facebook, which has just posted record profits of $3.69bn for 2015.

[Link]

Interesting times indeed.

Subsidy on the agenda?

Last year I suggested that there were strategic reasons to maintain North Sea production. The system of interconnected assets and their cross-reliance on each other means that it will be in the common good for “UK PLC” to maintain key infrastructure despite it being a poor proposition for individual operators.

For goodness sake – we subsidise the tracks that our trains run on, I can’t see any argument for the creation of economic value there that does not apply to our North Sea processing and export network. [Link]

So I was heartened to see that David Cameron is in Aberdeen with what the FT called an emergency investment package. I was less pleased to see what the promised £250m investment was to be spent on:

The prime minister will promise a new “oil and gas technology centre” in Aberdeen to fund future research, including into innovative ways to extract oil and gas.

The package will also help expand the harbour and support the city’s pharmaceutical and agri-food industries to try to help Aberdeen diversify from its reliance on oil and gas. [Link]

Well that’s not exactly the response I was thinking about – seems to be a rather poor investment case for UK PLC. Luckily we’ve formed another task force.

His visit coincides with the first meeting of a new task force of senior ministers set up to deal with the issue, chaired by Amber Rudd, energy secretary. The group will include Anna Soubry, business minister, and David Mundell, the Scotland secretary.

Together with the OGA there seems to be plenty of civil servants looking at the issue.

True to form – the FT actually got to the nub of the issue with its parting shot:

Many in the industry are also urging George Osborne, the chancellor, to relax the rules around who pays to decommission oil platforms when they reach the end of their lifespan. Many argue that the strict laws making anybody who has ever owned a particular platform potentially liable for its eventual dismantling are discouraging companies from buying up ageing assets and investing in them.

One energy banker said: “One of the things that could really help is if we see more takeover activity, with companies buying either struggling rivals or older rigs.”But the main thing stopping that right now is that nobody wants to take on potentially massive decommissioning liabilities.”

The BBC covers his visit here [Link]

Despite the decline in oil prices there is risk capital available but to take this opportunity irequires a few critical pivots. They are:

  1. Decommissioning liabilities stopping the trade in assets to lower-cost operators
  2. Un-certainty surrounding enabling infrastructure operated by others
  3. Mis-alignment of interests between partners meaning operating committees stopping development plans

Perhaps rather than expanding Aberdeen Harbour we could change the rules and use this £250m to help sort these out? At least it would be a start.

What do you think, is the proposed disbursement the best use of the money?