Sombre reflections on the North Sea oil tax system

The tax system on British North Sea oil and gas has altered in each of the five years since 1979. It was stiffened considerably in that year, further in 1980, and again quite considerably in 1981 when a whole new tax with its own rules added further complications to the existing maze. Then in 1982 the new tax was dropped from the end of that year, some other rearrangements were made, and again this year there was a further relaxation, though mainly relating to new leases. The general outline of the system was established only in 1975 as the first oil was due to start flowing. So there have altogether been six changes in nine years. If certainty in the fiscal treatment is to be desired as an encouragement to investors, then this record is a rather gloomy one. Admittedly other oil-producing nations also changed the rules repeatedly in the 1970's. Such was the case with the United States and Australia. The Americans also introduced a new oil tax in 1981. Yet the United Kingdom starting virtually afresh after the shock of the first oil crisis, and, since it was free of many of the political constraints that hamstrung oil policy in America, might have hoped to build a set of arrangements that could last. The immediate reason for the frequent changes was obvious: the erratic course of world oil prices since the early 1970's. But is it inevitable that the rules should change each time the prices change, with new taxes coming out like new models of cars? Is there not some way of making rules that themselves take account of changes in the price of the product? This article will suggest that the solution to the puzzle lies in a combination of indexation and a discounted-cash-flow basis for the tax, while auctioning of extraction rights would provide a very useful supplement. A brief discussion of principles is needed to make the point clear