§ Mr. SalmondI beg to move amendment No. 13, in page 522, line 9, leave out '6%' and insert '12%'.
§ Mr. Deputy SpeakerWith this it will be convenient to discuss amendment No. 14, in page 523, line 33, leave out '6%' and insert '12%'.
§ Mr. SalmondI understand that the Economic Secretary will reply to the debate on behalf of the Government. I am interested to note that on amendments relating to oil taxation, the Government seem to abandon their area-marking role and adopt a man-to-man approach, so the Economic Secretary finds himself replying. I welcome that, as it has been productive in a number of discussions in the past and I hope it will be productive this evening. Some people may find this last debate of the Finance Bill detailed, but it is of huge importance to the oil industry and those who work in it.
Schedule 36 contains a measure to give tax relief of 6 per cent. on capital investment to encourage exploration and appraisal drilling in the North sea. That is to be variable by Treasury order. The amendment seeks to raise that initially to 12 per cent., which we think is a much more realistic rate, allowing the welcome tax change to have the impact that everybody wants.
The oil and gas industry is still a vital natural resource industry for Scotland and for the whole country. Only half of the available resources—perhaps much less than half—have thus far been extracted. It is recognised across the industry that the oil and gas industry will need to change to meet the challenge of extracting the other 50 per cent. or more that is available, but for a number of years oil and gas exploration has been slowing down. Unless exploration and appraisal drilling is done today, it is highly unlikely that the enhanced extraction of resources will occur tomorrow.
It is worth looking at the figures for exploration and appraisal drilling. In the last full calendar year, about 40 exploration and appraisal wells were drilled in the North sea. Unfortunately, that is the lowest number since 1999; in contrast, as recently as 1996, 112 such exploration and appraisal wells were drilled. Paradoxically, despite the decline in the number of wells drilled, the exploration success rate has increased substantially. In 2002, it went up to 31 per cent., which, compared with oil provinces internationally, is an encouraging strike rate.
Recently, some significant finds have greatly encouraged us in the belief that large discoveries can still be made in the waters around Scotland. In June 2002, it was estimated that the Buzzard field would produce 1.1 billion barrels—the biggest such discovery for 25 years. More recently, a small independent oil company, Oilexco, said that tests showed that its new Brenda field in the Moray firth could give 150 million barrels or more.
The exploration and appraisal drilling that has been carried out shows some encouraging trends, but the amount of such drilling is far from satisfactory. That greatly concerns me and, I am sure, the Government, as well as the 300,000 people directly or indirectly employed in the industry and the 6,000 companies that work in or produce for it. The oil industry provides about 6 per cent. of total employment in Scotland.
938 This much is agreed: there is a huge reservoir of oil and gas still to be extracted from the waters around Scotland; the present rate of exploration and appraisal is unsatisfactory; and one of the challenges is to persuade some of the larger companies to relinquish acreage to some of the smaller ones, which are keen to pursue an aggressive drilling and exploration programme—a point discussed last week when the all-party offshore oil and gas industry group met the Minister for Energy, E-Commerce and Postal Services.
I am delighted that some of the most aggressive explorers, Talisman and Apache, have found facilities at Peterhead bay in my constituency, where they want to centre much of their operation. I hope, too, that some of the other small independent companies whose representatives I have shown around Peterhead bay will locate themselves at that excellent facility, which has the strategic advantage of being the nearest to most of the oil and gas fields, so there would be substantial cost advantages for independent companies that want to be based there.
The future offers an exciting perspective. The question for us this evening, however, is whether the Government's initial moves will be substantial enough to bring about the change that we all want to see. My contention is that they will not.
The current taxation system is inherently disadvantageous for new companies and the corporation tax changes in 2002 have compounded that situation. Existing operators share with the Government the risks of exploration, because they can offset those risks against current liabilities, but new players have to cover the full cost without tax relief until the field is on stream. The Government's proposals would counter that, but the question is whether the allowance, which covers both capital expenditure and the losses incurred in the initial phases of exploration and appraisal before the field comes on stream, is adequate to deal with the disadvantages that would be experienced by smaller, new companies coming into the sector without tax shelter.
The 6 per cent. that the Government propose is a risk-free rate, but for new players the average cost of capital for exploration and appraisal is about 17 per cent. and can be as much as 20 to 30 per cent. The increase suggested in our amendment of an initial 12 per cent. against the likely cost of capital to new players is modest and realistic.
§ Mr. TyrieThe hon. Gentleman has made several interesting allusions to the state of the industry and I do not disagree with those points, but I am not sure how connected they are to the measure that he proposes. As I understand it, the 6 per cent. rate that he wants to alter is a proxy for interest; it is a measure intended to preserve the real value of the tax losses, but he appears to be converting it into some form of tax allowance, which I do not think was ever the intention. Perhaps I have misunderstood his proposal. Could he explain?
§ Mr. SalmondI am not certain that the hon. Gentleman is as much in command of the subject as he thinks he is. All I am doing is changing the initial allowance, because I think that 12 per cent. is a much 939 more realistic assessment of the cost of capital expenditure to bring about the increase in exploration and appraisal that we want to see.
§ Mr. SalmondI have explained that my intention is simply to double the initial allowance to 12 per cent. The hon. Gentleman will have to take me at my word, because I now want to make some international comparisons.
§ Mr. SalmondNo, the hon. Gentleman must sit down.
The issue of the interest rate is important. It is arguable—indeed, I think it is beyond argument—that it should reflect the relevant cost of capital. That will involve a risk premium, given that exploration is a particularly risky activity. The conceptual basis of my argument is recognised in countries that have moved to resource rent taxes. Typically, an interest rate used for compounding forward tax loss will involve a risk premium and a risk-free element.
I think the Economic Secretary should pay close attention to recent experience in Australia, where the conceptual framework is highly developed. It has a petroleum resource rent tax, a cash-flow tax levelled on pre-corporation tax cash flows at a rate of 40 per cent. Allowances for all expenditures are 100 per cent. on a first-year basis. There is generally a ring fence for the tax, but the compound interest rates for expenditure vary substantially between exploration and appraisal and development.
For exploration and appraisal, which is inherently risky, the rate is 15 per cent. real plus a long-term Government bond rate. For development expenditures, which are inherently less risky, the rate is 5 per cent. real plus long-term Government bond rate. The difference reflects the extra risk, and the higher cost of capital for exploration and appraisal. A further feature is the breach available in the ring fence for exploration and appraisal expenditures. These can be relieved against any—that is, company-wide—PRRT income. The compound interest factor of 15 per cent. plus thus represents the effective compensation to the new player, compared to an established one for exploration and appraisal activities.
I find the Australian example interesting. The Australians have made a concerted and developed attempt to devise an allowance that matches the difference in experience of a new player in the sector, compared with the tax shelters available to an existing player. Notwithstanding Tory-Front Bench scepticism, that is what the amendments are designed to do. I could talk about the Norwegians, who have also made provision for the tax disadvantages experienced by new players, but as I do not think the Norwegian system is as established or as thought through as the Australian one, I shall submit the latter to the Economic Secretary's undoubted interest in these matters.
Last year's Finance Act looked favourably on an argument advanced during the passage of the previous year's Bill, when the issue arose of whether it was 940 possible to ensure more equitable treatment of existing infrastructure and pipelines in the North sea in order to allow new developments, particularly of gas, with the use of that infrastructure. I do not know whether the Treasury has yet had an opportunity to make a proper assessment, but early indications from the tax change are that we may well have achieved the magic bullet of taxation changes: that is, a tax reduction may well be about to increase Government revenue in the medium term. For instance, the entry of the major Statfjord field into St. Fergus strikes me as a direct and early result of that sensible tax change, with other fields perhaps very much in the pipeline.
I hope that the Government will also look favourably on my attempt to suggest that the welcome 6 per cent. on offer is not enough to bring about the change that is desired—that is, to match the real risk to new players with a tax allowance to equalise their position in relation to established players
6.15 pm
It is not enough to persuade the existing major companies to relinquish the vast acreage and the many fallow fields that lie an-drilled or undeveloped in the North sea, although that certainly needs to be done. Given that there is a generation of new companies willing, able and anxious to come into the environment, it is also necessary to give them the opportunity to do so. For that to happen, we must make sure that the tax incentive matches the risk that they will have to bear. Given that we want high-risk activity in the North sea and in the waters around Scotland, that tax incentive, which would not cost the Government a great deal in global terms, could provide a tremendous payout by way of increased revenues in the medium term, and increased jobs and activity in the short term. The Government achieved that virtuous circle through last year's sensible taxation change; hopefully, they are prepared to consider a further such sensible change in future.
§ John HealeyI am very pleased to respond to the hon. Member for Banff and Buchan (Mr. Salmond). He is right: although this is the last, it is certainly not the least of the debates on this Finance Bill. The issue that he raises is indeed important, relating as it does to an industry that is of great importance to the UK economy. I pay tribute to him fir championing its interests and consistently coming up with fresh proposals. I am particularly grateful to him for his welcome for the change that we are making through clause 280 and schedule 36.
The Government share the hon. Gentleman's desire to encourage new entrants into the UK continental shelf, so that the recovery of our national oil and gas resources can be maximised wherever doing so is economically viable. The introduction of the exploration expenditure supplement complements the action being taken on other regulatory matters, and it reinforces the Government's aim to encourage new firms to enter the North sea. That policy is showing some signs of success. The response to the Department of Trade and Industry's recent 22nd licensing round has been very encouraging. Twenty of the 68 companies applying for a licence are potential new entrants, which shows that the North sea is still attracting worldwide interest.
941 As the hon. Gentleman said, the purpose of the EES is to deal with a tax disadvantage that might impact on new entrants wanting to undertake exploration. The tax disadvantage arises because companies new to the North sea might not have the taxable income against which to set their 100 per cent. exploration and appraisal allowances—a point made by the hon. Member for Chichester (Mr. Tyrie). The full economic value of those allowances could be significantly eroded over time if there is no stream of profits against which they can be used in year one. The purpose of the EES is to deal with that tax disadvantage. It compensates for this loss in value by providing an annual uplift of 6 per cent. compound on the pool of unused allowances.
The hon. Gentleman posed the question: why 6 per cent.? Six per cent. is currently judged to be the right rate to compensate for the loss in value of the allowances over time. The rationale is that the rate is consistent with current medium-term high-grade commercial borrowing rates, and with the Government's social time preference rate—in other words, the discount rate applied in evaluating the use of public funds, with an allowance for inflation. The hon. Gentleman argues for a doubling of the rate, but to do so is not currently justified. according to those comparators, without going beyond the purpose of the EES, which is to deal specifically with the tax disadvantage faced by new entrants. A higher rate risks giving new entrant companies an advantage over existing North sea companies with a taxable income.
§ Mr. TyrieSo far, I agree with everything that the Economic Secretary has said, but will he confirm that the purpose of the existing 6 per cent. rate is to create a level playing field between new entrants and existing operators, and that coming to some other figure—removing the 6 per cent. or doubling it—would create a bias in favour of the new entrants?
§ John HealeyI thought that I had already made that clear. The purpose of the special provision is to compensate for the loss in value of allowances and to put new entrants on a par with ether companies that may have year one profits against which to use those allowances. To go further than 6 per cent. would be wrong in principle in relation to the purpose of the clause and would distort the market in favour of new entrants. As I said, that is not the purpose of the measure. However, we have taken the opportunity to ensure that we have the power to amend the rate quickly if the economic factors change, making it right to do so.
§ Mr. SalmondI do not think that there is any disagreement between the Economic Secretary and me that a 12 per cent. increase would substantially increase the advantage for new entrants, but I am not certain that that view is shared by the Tory Front Benchers. My problem is with the justification for the 6 per cent. rate, so will the Economic Secretary tell us more? It is effectively a risk-free rate, but the average capital cost for new players in respect of exploration and appraisal is at least 17 per cent.—and it can be much higher. Will the Economic Secretary run over again the justification for the 6 per cent. rate, given flat informed views—certainly more informed than the views of Tory Front Benchers—would suggest that it is too low?
§ John HealeyAs I explained to the House, the 6 per cent. rate is consistent both with medium-term, high-grade commercial borrowing rates and with the Government's own social time preference rate—the discount rate that we use for evaluating the use of public funds, with an allowance for inflation. Just to be absolutely clear, the purpose of the special relief is to compensate for the loss in the value of the capital allowance for companies that do not have profits against which to use it. It is not to compensate for additional risk or to cover the varying capital costs that different companies may have.
The hon. Gentleman made some interesting points about policy changes in Australia. I should be grateful if he would send me the details and I will certainly look into them further. I am aware that a tax incentive for exploration was recently announced in Australia, but the country has a corporation tax rate that does not allow this sector of the industry to have 100 per cent. cover in capital allowances. In reaching an assessment, it is important to take account of the total tax system that applies to the oil and gas industry in Australia.
§ Mr. SalmondCan the Economic Secretary help me further by explaining what factors the Treasury will take into account, given that the provision is variable by Treasury order? In deciding whether 6 per cent. is the right rate now and whether it should be changed in the future, what factors will influence the Treasury? Unless we show some appreciation of the fact that, because it carries a very high-risk premium, oil exploration is not similar to other forms of capital investment, it seems to me that any future assessment will not be up to the job.
§ John HealeyOur point of difference here is that the hon. Gentleman wants to make this particular relief more generous for wider purposes. His case for doing so, however, goes beyond the purpose of the relief. As I said, it is designed to compensate for the loss of value of the available allowances. The factors that we will take into account are precisely the financial market factors that, as I have already explained, underlie our judgment that 6 per cent. is the right rate now. Those factors do not take account of the economics of the oil industry and its work in the North sea, nor the risks that it faces. I understand why the hon. Gentleman wants me to take them into account, but they fall outside the purpose of the relief in clause 280.
§ Rob MarrisMy hon. Friend the Economic Secretary puts forward the proposition that the relief is somewhat akin to an indexation measure, such as would apply under the RPI or RPIX. However, the hon. Member for Banff and Buchan (Mr. Salmond) wants it to be related to risk. Is not that the point of dispute?
§ John HealeyThat may be one way to put it, but one could also explain that the operation of the relief, at 6 per cent. compound interest over six non-consecutive years, means that it could be worth 41 per cent. In other words, £100 of expenditure on investment could become £141 worth of allowable tax relief.
To summarise, the EES rectifies a specific disadvantage due to the way the tax system works in the special situation of the offshore oil and gas companies. 943 By dealing with this issue in this way, we hope to encourage more new entrants into the North sea. This measure will ensure that such companies invest in the UK continental shelf.
We have had a useful debate on this matter, and the hon. Member for Banff and Buchan and I are likely to have more discussions about the Australian experience. Therefore, I hope that he will be prepared to withdraw the amendment.
§ Mr. SalmondYes, I look forward to that continuing dialogue. There may be conceptual differences between me and the Economic Secretary on this matter, but I am one of those who represents a constituency with a huge investment of jobs in this sector. The waters around Scotland display some of the welcome trends that the hon. Gentleman has identified, but the vast majority of development remains in the hands of a very few companies. That might be no bad thing if those companies were the best way to develop smaller accumulations. However, there is plenty of evidence that, although smaller companies want to develop accumulations in the North sea, they are unable to get the acreage or potential out of the larger companies' hands.
To be fair, some of the larger companies have made substantial moves in that direction recently, but there remains untapped potential. Many companies want to develop the acreage but are not given the opportunity to do so. I suspect that there is no economic incentive to ensure that that acreage is developed.
One of the difficulties of developing the North sea taxation like Topsy—that is, manipulating and changing it over time—is that that gives a big advantage to companies that have tax shelters and established production in the area. I hope that the measure proposed in the Bill will be enough to redress the balance.
The Government and the Treasury have received vast revenue from the North sea over the past 25 years, and they may well expect a windfall this year. I hope that they will be sufficiently open minded to ensure that the show is kept on the road, so that future revenue streams are guaranteed.
I welcome the suggestion from the Economic Secretary that he and I will continue to talk about Australia and other matters. I hope that I can persuade him that more needs to be done, and that he will keep the matter under review to see how entrants match their hopes to their economic position.
§ I beg to ask leave to withdraw the amendment.
§ Amendment, by leave, withdrawn.