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The Observer (UK): The well of revenue that won't dry up: Sunday August 21, 2005


With British motorists paying almost 1 a litre, the government is set for a big tax windfall as the price of petrol stays resolutely high. Heather Connon reports


The government is doing very nicely out of rising oil prices, collecting at least 1.5 billion this year alone. If the price stays above $60 a barrel for the foreseeable future that figure could jump to 3.5bn next year.


Part of the windfall for the Treasury comes from Britain's motorists, who are paying more than 1.5 million extra VAT a day - or around 500m in a full year - compared with the start of 2005, as petrol prices have crept inexorably towards 1 a litre. But the biggest contributors have been the oil companies themselves, who could have to find an extra 1bn in corporation tax this year, according to the Institute for Fiscal Studies.


The National Audit Office has estimated that every 5 per cent increase in the oil price raises an extra 220m for the Treasury in the first year, rising to 270m in subsequent years. At the time of the Budget in July, Chancellor Gordon Brown was estimating that revenues from North Sea taxation would be 7.1bn in the current year, more than a quarter higher than the 5.2bn raised last year. But that was based on a forecast that the oil price would average $41: in fact, the average has already risen to $49 and, with oil having stayed above $60 a barrel for most of this month, the average is likely to rise still further.


The UK Offshore Operators Association (UKOOA) estimates that, if the oil price stays above $60 a barrel this year, the Chancellor's tax take will be 10bn - double that of last year. And tax experts think that the high oil price must be tempting the Chancellor to consider ways of raising more money, which could be disguised as a reform of the UK's oil tax regime.


Derek Leith, oil expert at accountants Ernst & Young, points out that older North Sea oil fields are still paying tax at 70 per cent, a legacy of the now-abolished petroleum revenue tax, while newer fields pay just 40 per cent. '[The Chancellor] could announce a reform of the system, describing it as the creation of a more modern tax regime for the North Sea. But it would also be tax raising.'


Alternatively, the Treasury could introduce a tax regime based on the oil price, so that it could take a bigger share of any profits generated from soaring oil prices.


Leith thinks the Treasury could already be working on reform proposals and may put them out for consultation with the pre-Budget report. 'In my opinion, with the oil price hitting $68, there has to be a significant risk of change.'


The Chancellor's challenge is to come up with a way to raise revenue without deterring investment in the North Sea. The precedents are not encouraging: when he shocked the industry by increasing the corporation tax rate for North Sea oil companies from 30 to 40 per cent in 2003, North Sea investment in the following year collapsed to its lowest levels since the mid-Sixties - and while it has recovered recently, that is largely because of the high oil price.


UKOOA estimates that there are still 28 billion barrels of oil equivalent that could be extracted from the North Sea - not much less than the 34 billion barrels already recovered - but it warns that the costs of recovering this oil will be far higher than in the past. Operating costs per barrel rose 13 per cent last year alone.


Of course, the government could protest that the industry is already treated leniently. Taxes on British corporations are lower than in Norway, for example, while consumers have benefited from the freezing of fuel duty at 47.1p a litre for the last two years. That has cut the rate of tax on unleaded fuel from around 74 per cent in October 2003, when the freeze was announced, to 69 per cent, according to the Automobile Association, costing the Treasury around 470m in a full year.


But that still leaves Britain near the top of the league compared with other countries: in the US, tax accounts for less than 30 per cent of the cost of a gallon. And the UK Petroleum Industry Association calculates that while Britain has the lowest fuel costs in Europe excluding tax and duty, when these are added on we come third behind the Netherlands and Belgium, and well ahead of countries like Spain and Ireland.


Rising taxes have not dented oil producers' profits, however: last month, BP announced a 28 per cent rise in first-half profits, slightly ahead of the 22 per cent increase at Royal Dutch Shell, while Goldman Sachs estimated that these two giants would generate $35bn (19.5bn) of cash between them this year - and that was based on oil being $50 a barrel.


Small wonder, then, that some more militant backbenchers think that Brown should be squeezing much more tax from the industry. Each profits announcement is invariably accompanied by the call for a windfall tax, along the lines of those levied on the banking industry by the Conservatives and the utilities by Labour.


However, Vince Cable, the Liberal Democrat's Treasury spokesman, thinks a windfall tax is 'not advisable'. 'There is already an element of windfall tax in the tax on the profits of the upstream [production] activities of oil companies,' he says. 'The question to those who advocate a tax is whether it would be reversed if the price falls back to the $10 a barrel level seen in the Eighties'.


In fact, Brown has already proved adept at milking the industry without resorting to a windfall tax. This year, he has changed the basis on which they have to pay their tax so that he can get the money in earlier, boosting his coffers by 1.1bn - although this is simply a matter of the timing of receipts, rather than an increase in the tax bill.


The Treasury estimated that the controversial tax increase it imposed three years ago would bring in 600m in the year to last March. Overall, the oil industry accounted for 5.2bn of the 34.1bn corporate tax take last year - and that percentage is likely to rise.


The buoyant oil price - which is high in part because of interrupted supplies from Iraq - means that the industry is still happy to invest; consumers, on the other hand, are starting to feel the pain. In the oil-hungry US, even mighty Wal-Mart is starting to complain about fuel prices, both because of the $130m it is costing to heat its stores and run its trucking fleet and because of the impact the prices are having on its - mainly lower-income - customer base. Analysts have estimated that rising fuel costs have added $31 a week to the costs of the average US household.


Here, fuel is a smaller part of the weekly budget, but the rises are still having an impact. The RAC says that the fuel bill for the average driver has topped 1,000 a year for the first time.


High fuel costs were the main reason for a rise in the inflation rate to an eight-year high last month and there are growing signs that companies are now trying to pass the increases on to their customers, spreading the inflationary pressure to other parts of the economy.


While many analysts believe that $60 a barrel is not sustainable and expect the price to fall back to $50 a barrel or below, due both to a slowdown in world economic growth and to a rise in production from the Opec countries, others expect the price to remain just where it is - or even rise higher.,,1553112,00.html


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