By James Taylor Thursday, 02 June 2011

Centrica blames windfall tax for closure of UK's largest gas field

Centrica's confirmation that it won't re-open its Morecambe Bay field highlights the inevitable unintended consequences of the Government's tax on North Sea energy firms.

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British Gas owner Centrica says that it doesn’t make any financial sense to re-start production at its Morecambe South gas field, which it closed for maintenance a couple of months ago; thanks to the Government’s new tax regime for energy firms, it’s now cheaper for Centrica to import gas from elsewhere rather than do the dirty work itself. Some are suggesting that this is a political move, intended to put pressure on the Treasury. But either way, it’s hard to argue with the financial logic. This windfall tax no doubt seemed like a wizard wheeze to whichever Treasury mandarin dreamed it up – but given its possible effect on investment, it could end up doing more harm than good…

This is a big and important gas field; according to Centrica, it’s capable of producing about one-eighth of the UK’s annual residential demand. But the company says that as a result of the windfall tax on energy companies announced in the March budget, the field is now taxed at 81% - which means its profitability ‘can be marginal’. In other words, extracting gas from there – as opposed to buying it in – no longer makes any economic or commercial sense.  So from now on, it intends to operate the field ‘on a more intermittent basis’, i.e. if/ when the sums add up.

If this is true for Centrica, it’s presumably also true for various other UK production sites. And that’s bad news for the Government, for all sorts of reasons. For a start, rather than boosting the Treasury’s tax coffers, it might end up depleting them – since the Exchequer clearly won’t get any income at all from mothballed projects. Then there’s the issue of energy security: presumably the Government won’t love the idea of us importing all our gas from Russia et al, rather than producing it here in the UK. But you can understand why big energy companies might think twice about investing in the UK when the Government can arbitrarily swoop in and confiscate a chunk of their profits without any warning.

On paper, using energy firms’ fat profits (which have been boosted by the oil price) to make life easier for motorists probably seemed like a great idea. But the danger of sudden policy changes like this is not only that they make investors nervous; it’s also that it’s hard to plan for and avoid all the possible unintended consequences – which even a seemingly benign and straightforward policy will inevitably have. Incidents like this reinforce the sense that this idea just hasn’t been properly thought through.

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