Pulling the North Sea plug: The Government is accused of a tax blunder that could sink oil exploration and wipe out 30,000 jobs. Report by Russell Hotten and Jeremy Warner

NORTH of the border it is being put in the same league as the coal crisis: thousands of jobs are under threat from seemingly obscure changes in the way the Government taxes North Sea oil profits. If ministers do not back off, many executives are saying, most worthwhile North Sea oil exploration and development will cease.

This is Government idiocy on a grand scale, the North Sea operators say, an act of commercial vandalism comparable in scope and stupidity to its decision to close down more than half the British coal industry.

This week, the UK Offshore Operators' Association will ask the Department of Trade and Industry for support in persuading the Treasury to rethink the tax changes.

Outraged company executives are telling the Government that unless the Treasury sees the error of its ways, they will abandon the North Sea for good.

According to Jo Armstrong, an energy economist at the Royal Bank of Scotland, the Government has miscalculated, and failed to see the devastating impact of its policies. 'The Budget changes could help hasten the end of the UK oil and gas industry,' he said. 'I don't believe the Treasury could have properly thought through the consequences.'

The rate of petroleum revenue tax (PRT) on oil and gas production from existing fields is being reduced from 75 per cent to 50 per cent and abolished on new fields. At the same time, however, the Government proposes to get rid of tax relief that allows exploration and appraisal costs to be offset against PRT. This tax shelter has in the past been tantamount to a huge hidden Government subsidy on North Sea exploration, worth anything up to pounds 700m a year. Whereas it used to cost about 17p in the pound to prospect for oil, the industry estimates it will now cost four times that much.

The resulting downturn in exploration will cost more than 30,000 jobs, according to the International Association of Drilling Contractors, which represents North Sea drilling companies. Dennis Krahn, its director, said: 'There is no doubt that demolishing PRT reliefs is going to savage our sector of the industry.'

Even on the Government's own figures, drilling activity in the North Sea could be halved, with 10,000 jobs going. According to a survey published last week by the accountants Ernst & Young, two-thirds of 39 companies surveyed are considering cutting exploration activity, one-third of these in the next 12 months.

One oil executive said: 'I do not believe that the Government has really thought through the effects of these changes on revenues, on the balance of payments as we import more oil, and on employment levels. The reduction of activity could take out of the economy between pounds 800m and pounds 1bn of investment.'

Sam Laidlaw, managing director of Amerada Hess UK, one of the most vociferous critics of the tax changes, warned the company may halve exploration. 'Without the benefit of exploration and appraisal relief, the costs of the search for these fields will be disproportionately high in comparison to opportunities in the rest of the world.'

Industry sources say there are already signs that companies are having second thoughts about applying for the current round of DTI exploration licences. Those already committed under licence to carry out exploration have little choice but to press ahead, even though there will be no reliefs.

Other companies say they will now be looking to exploration in Russia, Africa, and South America. Enterprise Oil, Goal Petroleum and Clyde Petroleum are all reviewing their North Sea investment plans.

The UK Offshore Operators' Association has drafted a list of concerns to be sent to the DTI this week. It wants the changes phased in to give the industry time to adjust.

But not all its members will be losers under the new tax regime. BP, Texaco and Shell are far more involved in production than exploration and the changes will improve their cash flow. BP, for example, pays a hefty amount of PRT, but does comparatively little exploration and so does not claim much tax relief. Analysts estimate the changes could add pounds 150m to BP's profits.

Stephen Dorrell, the Treasury Financial Secretary, argues that as there are probably no more big North Sea fields to be discovered, the tax changes will encourage investment in existing fields.

PRT relief was introduced so the Government could help shoulder the burden of exploration of small oil fields, but it has now done its job, the Government believes.

Mr Dorrell said: 'By cutting the rate of tax on oil development in the North Sea, where we already know where the oil is, and cutting the rate of tax on bringing that into production, we expect to see jobs created in the development sector.'

Last week, Shell unveiled a pounds 1.3bn plan to extend the life of the giant Brent field by 10 years, providing an important knock-on boost to engineering suppliers. Although such an important decision would have been made before the Budget last month, the Government clearly hopes its tax changes will encourage similar moves.

Supporters of the changes argue that the balance was swinging away from production to exploration, with North Sea discovery rates lengthening. 'It was time to reverse the balance,' said an official of one oil giant. 'Many of the small oil companies were born out of the PRT tax shelter. They are not interested in exploration, just in drilling holes in the ground. I think the British public would be outraged if they discovered that 87p in the pound was being paid to US and Norwegian oil companies so they could drill holes in the North Sea.'

Only one in every four holes drilled strikes oil and, typically, less than one in three of these finds proves to be commercial. PRT relief is a highly inefficient fiscal stimulus, critics argue.

One independent consultant contacted by the Independent on Sunday says he has sat through numerous meetings where geologists have said, 'There is not much point in drilling this hole but since the Government is paying, we might as well; you never know.'

The Treasury estimates the changes will net pounds 700m (as much as Michael Heseltine needed to pay for his mining industry U-turn) over the next two years. PRT used to be a revenue earner for the Government, netting pounds 7.2bn in 1985 and pounds 6.4bn in 1986. But as the oil price collapsed and production came down, PRT revenues fell, and last year the Government actually paid back pounds 200m to oil companies. Even as a revenue booster, however, the measures are being challenged in some quarters. In a report out last week, Wood Mackenzie, the stockbroker which specialises in North Sea oil, said the changes would bring in only pounds 115m, far below the Treasury's pounds 700m estimate.

The report said the tax measures 'could be bad for the country in the longer term, both in terms of the balance of payments and Government revenues from the North Sea'.

Most new fields will be too small to produce much PRT for the Treasury, says the report, so 'the UK will have no fiscal means other than corporation tax to extract an appropriate economic rent for the nation from its oil and gas reserves. It would be better to have a system . . . which extracted extra tax based on unusally high profitability.'

Nor is it absolutely certain that there will be no new big oil discoveries in the North Sea. Some experts say there may be significant resources under the deep waters west of the Shetland Isles.

Paul Horsnell, of the Institute of Energy, tells an anecdote about a BP executive who said in the 1960s that there would be no big finds in the North Sea, only to eat his words when the Forties field was discovered soon after. 'If there is another big find, the oil companies will be laughing all the way to the bank and the Government will look pretty silly.'

What annoys many oil executives about the changes is the way they were announced. Companies were stunned that such radical measures were introduced without prior consultation. The oil industry accounts for 25 per cent of manufacturing investment and employs 300,000 people directly and indirectly, and usually it demands to be heard.

With their massive up- front investments, oil companies need fiscal stability to assess returns on capital. 'This industry does not like surprises,' said one oil company director. 'This decision was Treasury-driven and very much reflects the demise of the Department of Energy and its takeover by the DTI.

'If you are committed to investment and somebody changes the rules along the way, it does not give you confidence to invest in the future. Shareholders put pressure on you to invest somewhere safer,' he said.

(Photographs omitted)