09 August 2023
Upstream Energy & Tax: Solace in a Sea of Uncertainty
It has been a turbulent time for energy in the North Sea. Windfall tax changes over the last year have hit the independent exploration and production (E&P) players hardest, but the oil majors have still felt their sting. In May 2022, the government announced a 25% Energy Profits Levy, which was increased to 35% in the Autumn Budget and extended by three years to 2028. Yet in June, the government said the windfall tax would end if oil and gas prices fell below a certain level for two consecutive quarters.
The future of the North Sea development and exploration is dependent upon the government’s stance. Labour has recently stated if it wins the next general election, it will ban all future exploration of the North Sea. Whether this pledge will translate into action is far from certain, leaving the industry unsure of the future viability of North Sea projects.
Deals involving developmental assets due to happen in the next year or two are particularly in the line of fire. This precarious environment has prompted an uptick in North Sea M&A activity. Energy companies both weary and wary of heavy taxes are looking to sell assets to focus on exploration elsewhere. At the same time, there are companies keen to take advantage of the volatility and acquire assets in the region. Within this M&A activity, a sizable portion of the value of these assets lies in the tax assets buyers stand to inherit.
What are tax assets?
At their origin, E&P oil and gas companies must first construct the oil rig and infrastructure necessary to explore for oil or gas. In the first three or four years, these companies will be operating at a total loss as they are yet to commence selling their product. Up to the point they start trading, they are accumulating tax losses arising from business or capital expenses. At the end of each year, a company’s profit and loss sheet will just be a loss column that can be carried forward. These losses are important for tax purposes; when the company starts to make a profit, they can use these prior losses (or tax assets) to offset tax on their profits. For example, if a company makes USD 100 million in losses in the first five years, it may be able to use that to offset tax on a substantial amount of its future profits. Therefore, these tax assets are very valuable.
How can we help?
Tax insurance provides cover in the event that the tax authority challenges the use of the losses (or assets) typically arising post-acquisition from a change in the nature or conduct of the trade. Without insurance, the buyer could be liable for the full tax exposure including interest and penalties. The insurance can provide a degree of certainty that the buyer isn’t going to lose the value of the asset.
Gallagher has a number of products that sit outside traditional E&P. Given the uncertain political background, providing some comfort in M&A transactions can make or break getting these opportunities over the line, and tax insurance is increasingly being used to provide this.
The Walbrook Building 25 Walbrook London, EC4N 8AW
Let's talk
Ian Picton
Partner - Energy, Power & Renewables
Ian_Picton@ajg.com
Arthur J. Gallagher (UK) Limited is authorised and regulated by the Financial Conduct Authority. Registered Office: The Walbrook Building, 25 Walbrook, London EC4N 8AW. Registered in England and Wales. Company Number: 119013.