Energy Policy ] (]]]]) ]]]–]]]
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Energy Policy
journal homepage: www.elsevier.com/locate/enpol
The strategic interaction between the government and international oil
companies in the UK: An example of a country with dwindling
hydrocarbon reserves
Bart J.A. Willigers a,n,1, Kjell Hausken b,2
a
b
Palantir Economic Solutions, 56 Buckingham Gate, London SW1E 6AE, UK
Faculty of Social Sciences, University of Stavanger, 4036 Stavanger, Norway
H I G H L I G H T S
c
c
c
c
The 2011 UK hydrocarbon tax increase is likely to cause overall value destruction.
Governments are unlikely to benefit from reducing their decommission liabilities.
Differences in payoff functions of producers and shippers control the game.
The distribution of reserves and decommissioning cost is a key factor in the game.
a r t i c l e i n f o
abstract
Article history:
Received 7 February 2012
Accepted 30 January 2013
The 2011 UK tax rise on hydrocarbon exploitation activities obviously increases short term tax
revenues however the longer term effects are less clear. The strategic interaction between the UK
government, a producer and a shipper has been analyzed in a game theoretical model. A complex
interaction between players is expected given (1) dwindling resources and large decommissioning
liabilities and (2) the fact that much of the hydrocarbons produced in the North Sea are exported
through an infrastructure with shared ownership.
The 2011 UK tax adjustment will most likely result in value destruction for the government,
producers and shippers. Our analysis suggests that governments are unlikely to ultimately benefit from
reducing their decommission liabilities at the expense of International Oil Companies. In countries with
unstable tax regimes, such as the UK, International Oil Companies will adopt their strategies in
anticipation of future tax changes. Their adopted strategy is a function of decommissioning liabilities
and remaining reserves as well as whether they are producers, shippers or producers and shippers. The
ultimate payoff of a government is a function of the remaining reserves and total decommissioning
liabilities, but also depends on the distribution of these value metrics between producers and shippers.
& 2013 Elsevier Ltd. All rights reserved.
Keywords:
Game theory
UK tax regime
Decommission liabilities
1. Introduction
In March 2011 the UK government announced a fiscal change of
increasing the tax burden on oil and gas exploitation activities. The
impact of the tax amendment is not identically felt by each of the
International Oil Companies (IOC) active in the UK. The type of
operations (hydrocarbon production versus hydrocarbon shipping)
and the exposure to abandonment liabilities are important differentiators regarding the impact experienced by an IOC. As a
n
Corresponding author. Tel.: þ44 118 9356940; fax: þ44 118 9353484.
E-mail addresses: [email protected] (B.J.A. Willigers),
[email protected] (K. Hausken).
1
Now at BG group.
2
fax: þ 47 51 831632; fax: þ 47 51 831550.
consequence of these differences one can expect a range of
reactions and changed policies from the IOCs operating in the
UK. In this study the strategic interaction between the government,
an oil producer and a player who produces oil and operates an
infrastructure has been analyzed in a game theoretic framework.
The UK tax amendment relates to an increase of the Supplementary Charge (SC) from 20% to 32% (see Appendix A for details
on the UK tax regime). This SC increase raised the headline rate of
tax paid by the industry on the profits of Petroleum Revenue Tax
(PRT) paying fields to 81%. Although the increased tax burden
adversely affects the profits of oil and gas producers, the greatest
concern expressed by the industry relates to the perception of the
stability of the UK petroleum fiscal regime (Muslumov, 2011).
Oil & Gas UK, a not-for-profit organization for the UK offshore oil
and gas industry, stated that ‘‘The tax increase was wholly
0301-4215/$ - see front matter & 2013 Elsevier Ltd. All rights reserved.
http://dx.doi.org/10.1016/j.enpol.2013.01.054
Please cite this article as: Willigers, B.J.A., Hausken, K., The strategic interaction between the government and international oil
companies in the UK: An example of a country with dwindling.... Energy Policy (2013), http://dx.doi.org/10.1016/j.enpol.2013.01.054i
B.J.A. Willigers, K. Hausken / Energy Policy ] (]]]]) ]]]–]]]
unexpected and completely at odds with the Government’s
assurances in public and private conversation that it understood
the industry’s need for a stable fiscal regime which provided
certainty for investors’’ and ‘‘after the third major increase in the
rate of taxation in 9 years, the UK is now regarded as one of the
most unstable oil and gas provinces in the world by many
investors.’’3
The development of the Laggan and Tormore gas fields west of
the Shetland Islands underscores the frustration of the oil and gas
industry with the UK government. In 2010 the UK treasury
introduced a capital allowance for the gas reserves under the deep
and hostile waters of the UK Atlantic margin that include the Laggan
and Tormore fields. In doing so the UK government recognized the
economic challenges that the industry faces when developing these
resources. When in March 2010 the UK Government gave consent to
Total and Dong Energy to develop the Laggan and Tormore gas fields
Business Secretary Lord Mandelson commented that: ‘‘The recent
initiative by the Treasury in extending Field Allowance to such fields
has been particularly importanty’’.
In an interview in July 2011 Patrice de Vivie s a Total senior
vice president, stated ‘‘We launched three gas investments last
year [2010] in the UK, and the Laggan-Tormore development was
decided in light of tax incentives received’’ and he added ‘‘The
Special Corporate Tax increase has fully offset the field allowances
received. Would it have been anticipated, there would have been
no project, with the consequences on the development of the
West of Shetlands.’’4
The industry is also worried whether the tax relief that
presently exists on decommissioning costs will prevail in the
future. In reference to decommissioning liabilities, Oil & Gas UK
stated t‘‘Contrary to what the Budget suggests, we believe that
such a measure [increasing the tax rate and not increasing the tax
relief) will only raise concern about further detrimental changes
to the regime and underlines industry fears that future Governments could renege on their obligations.’’ Nothing in the abandonment legislation mandates a payment from the Treasury
(Whyatt, 1991) and it is quite possible that the Government will
refuse to pay its part once it is presented with the enormous cost
of the abandonment of large numbers of fields and infrastructure
elements. With regard to the SC, the 2011 Budget indicates that
the Government will restrict tax relief for decommissioning to the
20% rate. Therefore the reliefs will not be available against the
12% increase. The aim of this measure is to avoid incentivizing
accelerated decommissioning. Losses attributable to decommissioning are also given special treatment.
The first studies that investigated the impact of decommissioning cost on late-life North Sea field economics appeared over
20 years ago (e.g. Griffith and Cox, 1986; Kemp, 1992). Since these
publications were written the importance of the decommission
cost as a value driver has dramatically increased. The North Sea
has become much more mature as an oil and gas producing basin
and the number of fields that approach their end of life has
increased (see Appendix B for details on the UK oil and gas
industry). In addition, the decommission costs of the oil and gas
infrastructure has escalated significantly. In 1988 the total cost of
abandonment was estimated at £4.4 billion (Kemp, 1992), the
estimated costs were increased to £30 billion in 2011.5 Oil and
Gas UK6 estimated that about 75% of the increase over the past
decade is the result of escalating cost whilst the remaining 25%
results from the employment of new infrastructure.
3
www.oilandgasuk.co.uk/knowledgecentre/Budget2011QA.cfm.
www.icis.com/heren/articles/2011/07/01/9474519/frances-total-eyes-nor
way-as-uk-tax-worsens-north-sea-gas-exploration.html.
5
www.oilandgasuk.co.uk/publications/viewpub.cfm?frmPubID=396.
6
www.oilandgasuk.co.uk/publications/viewpub.cfm?frmPubID=396.
50
Present value (£ billion)
2
Oil & gas tax revenue
40
Decomission liability
government
30
20
10
0
2010
2020
2030
2040
Year
Fig. 1. Development of the present value of remaining tax revenue and the
present value of the decommission liability of the UK government.
In the fiscal year 2010–2011 the UK government received
about £9.3 billion in the production taxes.7 Fig. 1 shows the
development of the present value of remaining tax revenue and
the present value of the decommission liability for the UK
government. The analysis assumes that tax revenue declines
annually by 10% as hydrocarbon production declines. It is
assumed that the government pays 62% of the total decommission
liability, amounting to £30 billion, in 2040. This simple analysis
suggest that in 2028 the present value of decommission liability
and tax revenue in the UK are equal at about £6 billion.
Most of the North Sea oil and gas production is exported from the
producing fields by a system of pipeline, hubs and onshore terminals.
In many cases, the players that own and operate the infrastructure
are different from those players who produce the hydrocarbons
(Willigers et al., 2010a). Infrastructure owners receive a payment
for the services they provide to the user-fields. The economic
importance of commercial agreements between the hydrocarbon
producers and shippers (those who transport and process hydrocarbons) has been widely recognized in the industry8 and although
several studies investigated the economic dynamics between userfields and hosts (Willigers et al., 2009, 2010a, 2010b), these studies
did not include the government as a player.
Several studies (Vernon, 1971; Moran, 1974; Smith and Wells,
1975; Hosman, 2009) investigated the relationship and bargaining interface between governments and multinational corporations. These studies investigate the early stages of the regional
development of a mineral exploitation industry. That situation is
very different from the mature E&P industry presently operational
in the British part of the North Sea which is analyzed in this study.
The game theoretic analysis developed in this study provides
insight in the impact of a perceived unstable tax regime in a
mature oil and gas producing basin such as the North Sea. The
proposed model illustrates the impact on the ultimately recovered reserves and realized value.
2. The model
2.1. Outline of the game
We consider two operational oil fields U and
include some or all of the following activities:
hydrocarbons, transportation and processing of
produced by player U, and transportation and
H. Operations
production of
hydrocarbons
processing of
4
7
8
www.oilandgasuk.co.uk/publications/viewpub.cfm?frmPubID=396.
www.oilandgas.org.uk/issues/brownfields/docs/brownfields-story.pdf.
Please cite this article as: Willigers, B.J.A., Hausken, K., The strategic interaction between the government and international oil
companies in the UK: An example of a country with dwindling.... Energy Policy (2013), http://dx.doi.org/10.1016/j.enpol.2013.01.054i
B.J.A. Willigers, K. Hausken / Energy Policy ] (]]]]) ]]]–]]]
hydrocarbons produced by player H. Player U, the user field, owns
and produces field U and exports its production using the
facilities of field H owned by player H. Player H, the host, owns
and produces field H and exports its production using its own
facilities. Player G is the government and receives tax payments
from player H and player U on the profit of their operations.
All variables and assumptions are captured in Table 1.
The three players can choose the following strategies in each
time period t, t ¼0,1,y,N.
Player U: Choose the last time period TU from the strategy set
TU ¼{0,1,y,N} in which to produce.
Player H: Choose the last time period TH from the strategy set
TH ¼{0,1,y,N} in which to operate.
Player G: Choose the tax rate tt from the strategy set tt ¼{tb,tr},
where tb is the base tax rate and tr is the reduced tax rate,
tr o tb.
We define T as the last time period where production occurs in
both fields U and H.
3
continue the transportation and processing of oil produced by
field U. Player U pays the total cost of operating field H plus an
uplift to this cost. The game ends in the period player U cannot
carry the total cost.
2) Player U terminates production. After the exit of player U, the
game ends in the period player H cannot carry the total cost.
A strategy in which the government increases tax has not been
investigated. In the recent tax ruling the tax rate increased but the
decommission allowance was left unchanged suggesting that it is
unlikely that future tax raises will increase the decommission
allowances. Without an impact on decommission costs we consider the strategy of tax increases trivial as it will clearly benefit
the player G at the expense of player H and U.9
2.2. Formal description of the game
Player U’s payoff is
fU ¼
TU
X
t
T
ðRUt P t C Ut SUt Þð1tt ÞdU DU ð1tt ÞdUU
ð1Þ
t¼0
If TU ¼TH ¼T, both fields are decommissioned in period t ¼T.
The three players are then active in periods t ¼0,1,y,T, and are
not active in periods t ¼Tþ 1,Tþ2,y.
If TU oTH, player U terminates production in period t ¼T. Player
U produces in periods t¼0,1,y,T, and does not produce in
periods t¼ Tþ1, Tþ2,y. Player H operates and player G
imposes tax in periods t ¼0,1,y,TH, and do not produce and
impose tax in periods t ¼TH þ1, TH þ2,y.
If TH oTU, player H terminates production in period t ¼T. The
three players produce and impose tax in periods t ¼0,1,y,T,
and do not produce and impose tax in periods t ¼Tþ1, Tþ2,y.
In periods t¼T þ1, Tþ2,y TU, player H operates exclusively as
a transportation-processing facility.
The decision by player G to change the tax rate impacts the
profits of players U and H and thus the strategic choices by
players U and G.
The game ends in the following manners:
where Pt is the oil price in period t, Cit is a cost for player i in
period t, tt is the tax rate and di is the discount rate per period for
player i. Di is the cost to decommission the field infrastructure
which is incurred by player i in period Ti. Ti is defined below. SUt is
the payment player U makes in period t to the host, player H, for
its services provided. The payment allows the host to recover its
expenses for the provision of services. Rit is the oil produced by
player i in period t.
Analogously, player H’s payoff is
fH ¼
TH
X
t
T
ðRHt P t C Ht þ SHt Þð1tt ÞdH DH ð1tt ÞdHH
ð2Þ
t¼0
where SHt is the payment that player H receives from player U.
Player G’s payoff is
fG ¼
TU
X
t
T
ðRUt Pt C Ut SUt Þtt dG DU tt dGU
t¼0
þ
TH
X
t
T
ðRHt Pt C Ht þ SHt Þtt dG DH tt dGH :
ð3Þ
t¼0
1) Player H terminates production and continues operation
strictly as an oil transportation and processing infrastructure.
After player H terminates production, player U pays player H to
Given that Rit and Pt are multiplied in the payoff functions for
all three players a proportional change in either variable has an
identical impact on each payoff.
The production in field i fully owned by player i at the time t is
Table 1
Parameters and assumptions for players U and H in period t.
Rit ¼ qi di
t
Parameter
type
Parameter
Symbol Value
Global
Oil price
Base tax rate
Reduced tax rate
Discount rate per period
Pt
Initial base production rate at t¼ 0
Production decline rate
qH
Player H
tt ¼ tb
tt ¼ tr
dt
t
dH
Abandonment cost hub
DH
Cost to be shared between players U CHt
and H
Uplift
M
Player U
Initial base production rate at t¼ 0
Production decline rate
Payment to player H
Abandonment cost field
qU
t
dU
SUt
DU
$1
80%
40%
10%
100 bbl/period
10%/period
$0 r DH r $5,000
$75/period
10%
100
10%/period
0r SUt rCHt
$0 r DU r$5000
ð4Þ
where qi is the production at time zero for player i and di is a
parameter, 0 rdi r1, that expresses how the production of field i
decreases over time.
The payment SUt is proportional to the total amount of oil
processed and transported by the host multiplied by a proportional profit margin M generally referred to as uplift, i.e.
SUt ¼ SHt ¼
ð1 þ MÞC Ht RUt
:
ðRUt þ RHt Þ
ð5Þ
The value of delaying payment of the decommissioning cost
for player i for one period is
DDi ¼ Di ð1tt Þ dti Di ð1tt þ 1 Þ dti þ 1 :
ð6Þ
9
NPV is used as the decision metric opposed to NPV@10%/I@10% used by
Kemp and Stephen (2011).
Please cite this article as: Willigers, B.J.A., Hausken, K., The strategic interaction between the government and international oil
companies in the UK: An example of a country with dwindling.... Energy Policy (2013), http://dx.doi.org/10.1016/j.enpol.2013.01.054i
4
B.J.A. Willigers, K. Hausken / Energy Policy ] (]]]]) ]]]–]]]
Assuming tt ¼ tt þ 1 Eq. (6) can be reorganized as
3.1. Fixed tax
t
t Þdi ð1di
DDi ¼ Di ð1t
Þ:
ð7Þ
Given that Di is constant for all periods, t can be rebased at
t
0
t ¼0. Replacing di with di ¼1 in (7) gives
DDi ¼ Di ð1tt Þð1 di Þ:
ð8Þ
Player i will be operational in all periods when the following is
true:
ðRit Pt C it Sit Þð1tt Þ þ DDi 4 0
ð9Þ
where the first term is the same as the first term in (1) for one
period, and the second term is the positive value of delaying
payment of the decommissioning cost one period. Inserting
(8) into (9) and simplifying gives
ðRit Pt C it Sit Þ þ Di ð1di Þ 4 0:
ð10Þ
Above we defined T as the last time period where production
occurs in both fields U and H, which means that both players earn
positive payoff. Applying (10) for both players thus gives
0X
1
1
1ðRUt Pt C Ut SUt þ DU ð1dU Þ 40Þ, C
B
Bt ¼0
C
C
T ¼ MinB
ð11Þ
1
B X
C
@
1ðRHt P t C Ht þSHt þ DH ð1dH Þ 4 0Þ A
t¼0
where 1(C)¼1 if C is true, and 1(C) ¼0 if C is false. As production
Rit decreases over time, while costs continue to be incurred, one
of the inequalities within the Min() sign in (11) will eventually
not be satisfied causing this player to terminate production.
Player U terminates production before player H when
To
1
X
1ðRHt P t þSHt C Ht þ DH ð1dH Þ 4 0Þ
ð12Þ
t¼0
which gives SUt ¼ SHt ¼0 starting from period t¼Tþ1. This means that
player U provides no payment to player H and impacts player H’s cost
CHt. Player H continues production as the sole player until period
TH ¼ T þ
1
X
1ðRHt Pt C Ht þ DU ð1dH Þ 4 0Þ:
ð13Þ
t ¼ T þ1
Player H terminates production before player U when
To
1
X
1ðRUt P t SUt C Ut þDU ð1dU Þ 4 0Þ
ð14Þ
t¼0
which gives RHt ¼0 starting from period t ¼Tþ1. Inserting RHt ¼ 0
into (5) gives SUt ¼(1þM)CHt. Player H now exports player U’s
production without being a producer itself. That is, the host field
is strictly a transportation-processing facility. Player U continues
production as the sole player until period
TU ¼ T þ
1
X
1ðRUt Pt SUt C Ut þ DU ð1dU Þ 40Þ:
ð15Þ
t ¼ T þ1
3. Results
The dynamics of the game has been analyzed by simulating a
number of scenarios. For each scenario three sets of results are
shown in Table 2. The data labeled ‘‘Fixed tax’’ are the results
assuming a fixed, i.e. constant tax rate. Data labeled ‘‘Variable tax
no reaction’’ show the results after player G optimizes the tax rate
prior to the strategic reaction of player U and player H. The third
data set labeled ‘‘Variable tax with reaction’’ represents the
natural outcome after player U and player H have had an
opportunity to react to a tax change imposed by player G.
A range of natural outcomes as a function of several selected
variables is shown in the figures below.
Scenario 1 shows (Table 2) that, given a fixed tax rate, both
player H and player U produce hydrocarbons for 18 periods and
each player produces a total volume of 1416.6 barrels. Scenario
1 differs from the base case, scenario 2, by the lack of decommissioning cost, DHi. The inclusion of $100 decommissioning cost
for player U and player H extends the number of producing period
from 18 to 31. This extension of production reflects that the loss
in each of the periods between periods 19 and 31 is less than the
present value of delaying decommissioning with one period. In
these periods Eq. (10) and the following is true for player U:
RUt P t SUt C Ut o0
ð16Þ
and Eq. (10) and the following are true for player H:
RHt P t þ SHt C Ht :
ð17Þ
In scenario 3 player H has a decommission cost of $400 and
player U has no decommissioning cost. Player U will abandon the
field in period 18, the first period that the cash flow turns negative.
Given that player U will not contribute to the shared cost, CHt, in the
subsequent periods player H would make a loss if its operations
would proceed. Hence player H will also terminate operations in
period 18. In scenario 4 player U has a decommissioning cost, DU, of
$400 and player H has no decommissioning cost. Given that player U
pays uplift, M, to player H, the payoff of player H is positive in
periods 19–31. Hence player H and player U remain operational till
period 31. Scenarios 5 and 6 demonstrate that the number of
producing periods for player H is extended if the decommissioning
cost for player U or player H is increased to $2000. Eq. (10) holds for
player U in all periods in scenarios 5 and 6 and decommissioning of
field U is indefinitely deferred. Eq. (10) holds for player H in scenario
6 causing an indefinite delay of decommission of field H. It is,
however, obvious that these are strictly theoretical scenarios.
The payoff for player G is not only dependant on the overall
production realized in the game but also depends on the distribution of total production amongst player U and player H. Fig. 4
shows the payoff for player G as a function of total abandonment
cost for three assumptions for initial production of player H, qH.
The initial production is used as a measure of production realized
in the game. The total initial production of players U and H is fixed
at 200 bbl/period (qU þqH ¼ 200 bbl/period). In all three scenarios
for qH the payoff for player G decreases as the total decommission
costs incrementally increases from $0. As the decommissioning
cost further increases the payoff for player G reaches a minimum.
This minimum has a different value in the three scenarios and is
also reached at different values for the total decommissioning
costs. As the decommissioning cost increases fields will be
producing for a longer period and the amount of oil that is
ultimately produced is increased. The payoff for player U is
reduced under the burden of increased decommissioning cost.
Although player H also pays an increasing decommissioning cost,
this increase is offset by a larger payment it receives from player
U (Fig. 3). The payoff realized by player G deflects from a
decreasing trend to an increasing trend once the increasing payoff
trend of player H offsets the decreasing payoff trend of player U.
As a higher proportion of total production is realized by player
U the minimum payoff for player G is reduced (compare the
scenarios shown in Fig. 2). In contrast to player U, player H does
not pay an uplift on the cost share, hence player H has a lower
cost base than player U. Given its lower cost base player U can
realize a larger amount of produced oil.
In scenarios with a very high total decommission costs the
players U and H will adapt a strategy of extending operations till
infinity (also see scenarios 5 and 6, Table 2). In this strategy the
players will not pay for decommissioning hence the payoff of the
Please cite this article as: Willigers, B.J.A., Hausken, K., The strategic interaction between the government and international oil
companies in the UK: An example of a country with dwindling.... Energy Policy (2013), http://dx.doi.org/10.1016/j.enpol.2013.01.054i
Scenario 1: Players H and U have no abandonment liability, Di
Assumptions
Hub
qi
di
CHt
M
DH
DU
0.03
100
qi
di
CHt
M
DH
DU
Field
Government
0.03
di
CHt
Field
M
DH
DU
200
Government
di
0.03
18
40.1
40.1
40.1
1416.6
1416.6
1416.6
18
18
18
452.1
452.1
452.1
73.7
70.7
71.2
2060.0
2060.0
1744.4
31
31
24
35.8
28.8
35.3
2060.0
2060.0
1744.4
31
31
24
438.3
448.4
425.9
58.5
58.5
58.5
1416.6
1416.6
1416.6
18
18
18
40.1
40.1
40.1
1416.6
1416.6
1416.6
18
18
18
394.52
394.52
394.52
75.8
76.9
75.3
2060.0
2060.0
1744.4
31
31
24
0
0.0
0.0
RU
0
0.0
2.5
RH
315.7
7
0.6
315.7
RU
7
fG
12.3
fH
0.0
RH
0.0
TH
Field
400
0
fU
P
0.2
0.0
0.0
RU
TU
Government
0.03
0
fG
0.00
fH
P
100
100
18
0.6
315.7
RH
TH
Field
fU
7
2.5
5
CHt
18
0.0
fU
P
Scenario 4: Player H has all the abandonment liability, Di
Assumptions
Hub
qi
1416.6
TU
100
0
1416.6
RH
fH
P
0.2
100
1416.6
Deltaa
0.0
TH
Scenario 3: Player H has all the abandonment liability, Di
Assumptions
Hub
qi
72.9
fG
P
100
200
72.9
TU
Hub
100
72.9
fU
P
0
Scenario 2: Base case
Assumptions
Variable tax with reaction
TH
0.2
0
Variable tax no reaction
fH
P
100
Fixed tax
B.J.A. Willigers, K. Hausken / Energy Policy ] (]]]]) ]]]–]]]
Please cite this article as: Willigers, B.J.A., Hausken, K., The strategic interaction between the government and international oil
companies in the UK: An example of a country with dwindling.... Energy Policy (2013), http://dx.doi.org/10.1016/j.enpol.2013.01.054i
Table 2
Modeling results.
6
M
P
0.2
0
DH
400
DU
Fixed tax
Variable tax no reaction
Variable tax with reaction
33.7
22.6
31.2
2060.0
2060.0
1744.4
31
31
24
438.3
448.4
425.9
RU
315.7
TU
Government
7
fG
Scenario 5: Player H has a large abandonment liability, Di
Assumptions
Hub
fH
qi
100
P
di
0.03
CHt
100
M
0.2
P
DH
2000
DU
0
Deltaa
12.3
53.3
14.1
14.1
3424.3
3424.3
3424.3
TH
N
N
N
fU
40.1
40.1
40.1
1416.6
1416.6
1416.6
TU
18
18
18
fG
373.6
412.9
412.9
39.2
RH
0.0
0
Field
0.0
RU
0.0
0
Government
39.2
Scenario 6: Player U has a large abandonment liability, Di
Assumptions
Hub
fH
81.1
92.9
92.9
qi
100
fH
3424.3
3424.3
3424.3
di
0.03
P
N
N
N
CHt
100
TH
28.6
7.2
7.2
M
0.2
fU
3424.3
3424.3
3424.3
DH
0
P
N
N
N
DU
2000
439.1
448.8
448.8
11.7
0.0
RH
0
Field
21.4
0.0
RU
0
Government
TU
9.7
Scenario 7: Players U and H have a three times larger initial production rate, qi
Assumptions
Hub
fH
qi
300
P
di
0.03
TH
CHt
100
M
0.2
P
DH
200
TU
Field
384.6
384.6
384.5
0.1
8960.1
8960.1
8602.7
357.4
69
69
61
8
344.7
344.5
344.7
0
8960.1
8960.1
8602.7
357.4
69
69
61
8
RH
fU
RU
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Table 2 (continued )
B.J.A. Willigers, K. Hausken / Energy Policy ] (]]]]) ]]]–]]]
7
460.0
fG (in USD)
0.0
7
314.7
0.0
7
314.7
0.0
0.4
450.0
440.0
430.0
420.0
qu = 200
qu = 133.33
qu = 66.67
410.0
400.0
0
1000
2000
3000
4000
Total decommisioning cost (in USD)
5000
11,591.0
102
32,649.4
1428.9
102
32,649.4
1468.9
2916.9
Fig. 2. The payoff for player G given a fixed tax rate, tb and the total initial
production rate of players U and H equals 200 bbl/period (qU þ qH ¼
200 bbl=period). Player U pays a third of the total decommissioning cost (DU/
(DH þ DU)¼0.333).
190
NPV (in USD)
11,591.0
109
32,964.2
1428.9
109
32,964.2
1468.9
2917.6
140
90
40
-10
Production revenue
-60
Operating cost
-110
Cost share revenue
-160
Decommisioning cost
-210
200
DU
500
1000
1500
2000
2500
Total decommisioning cost (in USD)
3000
Fig. 3. The NPV for player H decomposed in four elements. Player U pays a third of
the total decommissioning cost (DU/(DH þ DU) ¼0.333) and qH ¼ 66.67 bbl/period
and qU ¼133.33 bbl/period.
470.0
450.0
fG (in USD)
The delta is the value difference between the ‘‘Fixed tax’’ and the ‘‘Variable tax with reaction’’.
200
DH
0.2
M
a
11,591.0
fG
Government
TU
P
fU
100
CHt
di
0.03
Field
TH
RU
109
32,964.2
1428.9
109
32,964.2
1468.9
RH
P
1000
qi
Scenario 8: Player U and H have a ten times larger initial production rate, qi
Assumptions
Hub
fH
DU
200
Government
fG
2917.3
0
430.0
Du/(Du + DH) = 1
410.0
Du/(Du + DH) = 0.667
390.0
Du/(Du + DH) = 0.333
370.0
Du/(Du + DH) = 0
350.0
0
1000
2000
3000
4000
Total decommisioning cost (in USD)
5000
Fig. 4. The payoff for player G given a fixed tax rate, tb, an initial production rate
of 200 bbl/period for player U (qU ¼ 200 bbl=period) and an initial production rate
of player H of zero (qH ¼ 0 bbl=period).
game is not impacted by a further increase in decommissioning
costs. These conditions are met in the horizontal sections of the
graphs shown in Fig. 2.
The distribution of decommission cost between players U and H
also affects the payoff for player G (Fig. 4). The curves in Fig. 4
represent four different distributions of decommission costs between
player U and H. For a given amount of total decommission costs the
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companies in the UK: An example of a country with dwindling.... Energy Policy (2013), http://dx.doi.org/10.1016/j.enpol.2013.01.054i
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payoff for player G increases as the contribution of player U to the
decommission cost increases. The relationship reflects the incentive
and the ability of player U to share some of the benefits of continued
operations with player H by paying an uplift to player H (analogs to
scenario 4, Table 2). The consequential additional tax payment made
by players U and H explains the increased payoff for player G.
3.2. Variable tax no reaction
470.0
qu = 200
460.0
fG (in USD)
8
qu = 133.33
450.0
qu = 66.67
440.0
qu = 1
430.0
420.0
Player G will adjust the tax rate to its advantage hence the
payoff for player G, fG, is higher or equal when comparing the
‘‘Variable tax no reaction’’ scenarios with ‘‘Fixed tax’’ scenarios
(Table 2). On the contrary the payoff for player H, fH, and player U,
fU, is generally reduced (Table 2).
400.0
0
200
400
600
Total decommisioning cost (in USD)
800
Fig. 5. The payoff for player G given a variable tax with reaction. Player U pays a
third of the total decommissioning cost (DU/(DH þDU) ¼ 0.333).
3.3. Variable tax with reaction
Although player G has the option to change the tax rate,
players U and H can anticipate the strategic choice of player G
and adapt their strategic choices accordingly. Player U and H can
either opt for an early field decommissioning prior to when the
anticipated tax change occurs or they can choose to continue
production. The base case (scenario 2, Table 2) shows that
although the payoff of player G increases after the tax rate is
reduced (‘‘Fixed tax’’ versus ‘‘Variable tax no reaction’’) this
positive effect for player G is more than offset once player U
and H anticipate player G’s strategy and reduce the number of
producing periods (‘‘Variable tax with reaction’’). The natural
outcome of the game is that the payoff for all three players is
reduced and player G suffers the largest absolute loss in payoff.
Although accelerated decommissioning by players U and H can
also be observed in scenarios 7 and 8, the reduction in payoff in
this case is minimal. Scenarios 7 and 8 assume high initial
production rate, qi, three times and ten times as large as in the
base case scenario 2. Eq. (4) shows that high qi causes a high
amount Rit of oil produced by player i which, when RUt ¼RHt, is
equivalent to a high oil price Pt. As a consequence of high initial
production rate, qi, the impact of the strategic choices of the
players occurs far in the future. Hence the effect in terms of
discounted cash flows is minimal (scenario 8, Table 2). A game
with a natural outcome in which the payoff for player G increases
occurs when player U and/or player H pursue a strategy to delay
field decommission indefinitely (scenarios 5 and 6).
In the natural outcome of the game player G will switch the
tax rate in the first period in which its total tax income turns
negative. This situation occurs when the following is true
ðRUt P t C Ut SUt Þ þ ðRHt Pt C Ht þ SHt Þ o 0:
410.0
ð18Þ
As decommission costs are not considered in player G’s choice of
strategy the timing of this switch is independent of the decommission costs. Players U and H will pay a larger part of the decommissioning cost if they choose to maintain operational at the lower
tax rate, tr. Hence, unless Eq. (10) is true for player U and player H,
the individual players will choose to terminate operations and
decommission their fields in the period prior to the period in which
the tax change is anticipated. Figs. 5 and 8 show the payoff of player
G for the natural outcome of the game as a function of the
decommission costs, Di. The payoff of player G decreases as the
decommissioning cost for players U and H incrementally increases
from zero. The four curves qU ¼1qU ¼0 shown10 represent different
initial production rates for player U and a fixed amount of total
10
qU ¼1 is shown opposed to qU ¼ 0. Given that player U will exit the game
at t ¼0 if player U has no initial production we consider this to be a trivial
game.
production: qH þ qU ¼ 200 bbl=period11 (Fig. 5). The trend of
increasing payoff for player G with a decreasing proportional
production of player U is the same as shown in Fig. 2 and is caused
by the same dynamic (see Section 3.1). As the decommission cost
increases the differences in payoff of player G decreases and the
curves for the four qU values in Fig. 5 converge to a straight line with
a negative slope. This straight line closely corresponds to the curve
associated with qU ¼1. The points where the curves join this straight
line correspond with the decommission costs where the players U
and G will execute the decommisioning of their fields in the period
prior to the period in which player G reduces the tax rate.
The linear decreasing payoff for player G, as the decommission
costs increases, continues until the following is true:
RUt P t SUt C Ut ¼ DU ð1dU Þ:
ð19Þ
At this point player U will switch strategy from early abandonment to an indefinite delay of decommission. Although at this
point the both strategies have an equal payoff for player U the
prolonged payment SUt has a substantial positive impact on the
payoff for players G and H. This positive effect in player G’s payoff
is shown as an upward jump for each of the four values of qU
(Fig. 6). As the initial rate, qU, increases Eq. (19) will hold for
higher values of DU, hence the jump in payoff for player G will
occur at higher values of total decommission cost (Fig. 6).
The anticipation of players U and H that player G will pursue a
strategy of lower tax prevents player G, in general, from benefitting from this strategy (Fig. 7). The reaction of players U and H on
the anticipated tax change tends to result in a payoff reduction for
player G. Only in the situation in which decommissioning is
indefinitely delayed player G will benefit from this strategy
(Fig. 7).
4. Discussion
4.1. The impact of the Budget 2011 tax change
In the days after the announcement of the increased SC under
Budget 2011 shares of the UK oil and gas producers lost almost £2
billion in value and some experts believe that the ultimate cost
for these companies could be as high as £10 billion.12 It is a
11
Given that the decline rate is the same for both players the overall possible
production is identical in all four scenarios in shown in Figs. 7 and 8.
12
www.telegraph.co.uk/finance/budget/8402612/Budget-2011-10bn-oil-in
dustry-tax-grab-wipes-2bn-off-shares.html and www.guardian.co.uk/uk/2011/
mar/23/budget-fuel-duty-concession-oil-industry.
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B.J.A. Willigers, K. Hausken / Energy Policy ] (]]]]) ]]]–]]]
decommissioning date the incentive for the UK government to
change the tax regime and alleviate itself from the decommission
liabilities will increasingly grow. As the analysis in this study
suggest the UK government risks facing an early decommissioning of producing fields by players anticipating a tax ruling that
will increase IOC’s exposure to decommission costs. The pursuit
of this strategy by IOCs will result in a reduction of the hydrocarbon resources that ultimately will be recovered in the UK.
500.0
450.0
fG (in USD)
400.0
350.0
300.0
250.0
qu = 200
200.0
qu = 133.33
150.0
100.0
50.0
qu = 66.67
4.2. The impact of increased oil prices
qu = 1
Given that the amount of oil production, Rit, and oil price, Pt,
are multiplied in the payoff functions for all three players, a
proportional change in either variable has an identical impact on
each payoff. Thus a proportional change in hydrocarbon prices
has an identical impact on the game as the same proportional
change of the initial base production rate at time t ¼0 when
qi ¼qU ¼qH and di ¼dU ¼ dH, see Eq. (4). A three fold increase in oil
price will, just as a three fold increase of the initial rate (scenario
7, Table 2), delay the strategic interaction related to the abandonment liabilities. This delay causes the effect in terms of discounted cash flows to decrease. Apart from an increased payoff
for all three players the fundamental game dynamics do not
change with increasing Rit or Pt. The anticipation of players U and
H regarding player G’s strategy results in a loss of seven periods of
production in each of the three scenarios on Rit or Pt (scenarios 2,
7 and 8, Table 2).
In reality, however, the game dynamics are expected to be much
more complex. All equipments used in hydrocarbon recovery are
designed and built to deliver safe and reliable operations over a
certain life span. If the operations are to be extended beyond this
designed life span additional investments will be required. These
additional costs might offset the benefits of upward trending oil
prices. Future profitability is also expected to be negatively affected
by the positive correlation between hydrocarbon prices and costs
incurred by the operator (for example oil prices correlate with rig
rental rates and steel prices; see Willigers (2009)).
The results presented here suggest that (some) UK players might
consider an early abandonment of operations in the light of tax
uncertainty. Under these conditions it is hard to envisage that those
players would be willing to make pre-investments which would
enable them to capitalize on more favorable future market conditions.
0.0
0
1000
2000
3000
4000
Total decommisioning cost (in USD)
5000
Fig. 6. The payoff for player G given a variable tax with reaction. Player U pays a
third of the total decommissioning cost (DU/(DH þ DU) ¼0.333). The rectangle
indicates the area shown in Fig. 5.
460.0
440.0
420.0
fG (in USD)
9
400.0
380.0
360.0
340.0
Constant tax
320.0
Variable tax with reaction
300.0
0
500
1000
1500
Total decommisioning cost (in USD)
2000
Fig. 7. The strategic choices of players U and H tend to prevent player G to benefit
from the strategy of tax reduction. Player G’s strategy only results in an increased
payoff if player H and U delay the pay out of decommission cost indefinitely.
DU/(DH þ DU)¼ 0.333, qH ¼ 133.33 bbl/period and qU ¼ 66.667 bbl/period.
challenging task to estimate the impact of this tax change to the
value of producing assets, but it is still much more difficult to
evaluate the effect of the tax alteration on the progression of E&P
projects in the UK and the reduction in recoverable reserves.
If one would assume that Net Present Value (NPV) is the sole
decision metric and that any project with a positive NPV warrants
an investment from an economic perspective, one could argue
that the UK tax adjustment in 2011 should not have affected
investments in E&P development programs given that the sign of
an NPV, for a fixed cash flow, is independent of the tax rate.
However many IOCs use hurdle rates on the return on invested
capital as an additional decision metric. Using hurdle rates Kemp
and Stephen (2011) reported that the 2011 UK tax changes would
increase tax revenue with £51.6 billion but would also result in a
production loss of 2254 million boe.13
The results of this study suggest that even if NPV were the sole
decision metric used by IOCs the recent tax changes can have a
detrimental effect on the future hydrocarbon production in the
UK. The 2011 tax change is the most recent example of a large
number of fiscal adjustments that undermines the trust of
investors in the future stability of the UK tax regime. As a
progressively large number of producing fields approach their
13
Kemp and Stephen reported several scenarios, the numbers quoted here
refer to an investment criterion of NPV@10%/I@10%Z 0.5, a future oil price of 90$/
bll and a future gas price of 70 pence/therm.
4.3. Producers and shippers in the North Sea
The two player types, producers and shippers, investigated in
this study can be reconciled with the IOCs currently operating in
the UK. Large players that operate the largest pieces of infrastructure represent the shipper- or shipper and producer-type
players. These players have been modeled as Player H. Examples
of major infrastructure include Forties Pipeline System owned by
BP, SEAL Pipeline (Shearwater Elgin Area Line) owned by Shell and
Exxon and Frigg Pipeline System owned by Total. Much of the
infrastructure was installed to export hydrocarbons from the
largest fields in the North Sea. Declining production of these
fields resulted in spare capacity in these systems. This available
capacity created an opportunity for other producers to utilize
existing infrastructure and commence production from new
fields. These new entrants in the North Sea are typically smaller
players (Appendix B) and represent the producer-type player.
These players have been modeled as player U. Given this dynamic
in the North Sea a general distinction can be made between (1)
large players that ship and produce hydrocarbons and have large
abandonment liabilities and (2) small players that produce
hydrocarbons and have much smaller abandonment liabilities in
both absolute and relative terms.
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companies in the UK: An example of a country with dwindling.... Energy Policy (2013), http://dx.doi.org/10.1016/j.enpol.2013.01.054i
B.J.A. Willigers, K. Hausken / Energy Policy ] (]]]]) ]]]–]]]
1600
1400
1200
1000
800
600
400
200
0
Forecast
Small players
Medium players
Large players
Exxon
Shell
81
19
84
19
87
19
90
19
93
19
96
19
99
20
02
20
05
20
08
20
11
20
14
20
17
19
75
78
19
19
19
19
72
BP
69
Annual production (MMBOE)
10
Year
1600
1400
1200
1000
800
600
400
200
0
Forecast
<10 MMBOE
10-50 MMBOE
50-150 MMBOE
150-300 MMBOE
2017
2014
2008
2011
2005
2002
1999
1996
1990
1993
1987
1984
1978
1981
1975
1972
>300 MMBOE
1969
Annual production (MMBOE)
Fig. 8. Hydrocarbon production in the UK by different types of players. Large players ¼Total, British Gas, Conoco-Philips, Hess, Chevron, ENI, Talisman; Medium
players ¼ Nexen, Apache, BHP, Petro-Canada, Marathon, Maersk, Centrica, GDF, Statoil, Perenco, OMV, Lundin.
Year
Fig. 9. Hydrocarbon production in the UK by different sized fields.
5. Conclusions
In many mature hydrocarbon producing basins, such as the UK
North Sea, high decommission costs are expected to be incurred
in the coming decades. Given this situation governments will be
tempted to adjust tax regulations in order to alleviate themselves
from their decommissioning liability. However, particularly in
countries where petroleum tax rules have been changed frequently International Oil Companies are anxious about such
future tax rulings. Companies might opt for early decommissioning of their hydrocarbon producing fields especially of those
assets carry a large decommissioning liability. Such early cessation of production will ultimately result in a lower payoff for both
companies and governments. So in addition to the uncertainty
related to the value of remaining recoverable reserves, uncertainty regarding the stability of the local tax regime will become
an increasingly important driver in corporate decision making.
Economic dependencies that result from the sharing of oil and
gas export and processing facilities between different players
increase the complexity of the game. The payment structure for
provided services between fields as well as differences in remaining
reserves and decommission liabilities within a cluster of fields
introduces an asymmetry between players. This asymmetry impacts
strategic preferences of governments and International Oil Companies and hence affects the ultimate outcome of the game.
Appendix A. UK petroleum tax regime
The current UK fiscal regime has three main components14:
14
www.hmrc.gov.uk/international/ns-fiscal2.htm.
Petroleum Revenue Tax.
Ring Fence Corporation Tax.
Supplementary Charge on ring fence trades.
Petroleum Revenue Tax (PRT) is field-based and seeks to tax a
high proportion of the economic rent (super-profits) from the
exploitation of the UK’s oil and gas. PRT is currently charged at
50% on profits after a series of allowances. PRT for new field
development was abolished on 16 March 1993 hence current PRT
charges are limited to fields that were sanctioned before that
date. Ring Fence Corporation Tax (RFCT) is the standard corporation tax that applies to all UK companies with the addition of a
‘‘ring fence’’. The ring fence prevents companies to apply any form
of relief from other business activities to RFCT. The rate of
Corporate Tax (CT) is currently 30%.
Companies also pay a Supplementary Charge (SC) on their
profits from a ring fence trade. In the Budget 2011 the SC
increased from 20% to 32%. This SC increase raised the headline
rate of tax paid by the industry on the profits of PRT paying fields
to 81%.
Appendix B. Oil and gas production in the United Kingdom
North Sea oil and gas exploitation started in 1965 when BP
discovered the West Sole field. In 1975, just a decade later, the
giant Ekofisk-, Forties- and Brent fields had been discovered and
North Sea hydrocarbon production had started.
Hydrocarbon production gradually increased from the 1970s
to the mid-1980s. The vast majority of UK production in this
period was derived from a small number of giant fields. After 5
years of stagnating production, oil and gas production gradually
increased from the early-1990s till a maximum annual production of 1.4 billion BOE was achieved in 2002 (Fig. 8). In this period
an increasingly large proportion of production was derived from
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B.J.A. Willigers, K. Hausken / Energy Policy ] (]]]]) ]]]–]]]
smaller fields with recoverable reserves smaller than 150 million
BOE. The contribution of these smaller fields to UK hydrocarbon
production was insignificant in the 1970s but account for over
60% of production in 2002 (Fig. 8). Since 2002 production has
fallen and a production level of 0.8 billion BOE is expected for
2016.15
As an increasingly large part of production was derived from
smaller fields an increasing number of smaller-sized companies
started operations in the North Sea. In the 1970’s production by
BP, Shell and Exxon accounted for over half of UK’s North Sea
hydrocarbon production. Since 2002 their share of total UK
production has fallen below 30% (Fig. 9).
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companies in the UK: An example of a country with dwindling.... Energy Policy (2013), http://dx.doi.org/10.1016/j.enpol.2013.01.054i