The North Sea oil and gas industry is undergoing significant changes as several companies have recently announced a series of mergers, strategically designed to mitigate billion-pound tax liabilities against future profits. This wave of consolidation has been particularly notable in the last six months, with several prominent deals that reflect the challenges and opportunities facing the sector.

In a notable transaction, Ithaca Energy, which reported an astonishing $4.5 billion in tax losses at the end of 2023, merged its assets with the Italian multinational oil and gas company Eni in October. This merger is expected to provide Ithaca with a much-needed boost by leveraging Eni's profitable resources. Similarly, Equinor, a major player in the North Sea, which was saddled with around $7.6 billion in tax losses, is set to merge its operations with Shell UK. Furthermore, Neo Energy, having reported tax losses of $3.7 billion by the end of 2022, announced a merger with Repsols North Sea business last month, signaling a broader trend of strategic realignment in the industry.

While these mergers are motivated by various strategic considerations, including the need to create larger and more agile companies within a shrinking oil and gas basin, many investment professionals, including bankers, lawyers, and accountants, have pointed to the favorable tax implications as a key reason behind these deals. A senior tax adviser specializing in North Sea operations at one of the big four accounting firms explained, If you are Group A and you have lots of tax losses and some oilfields at the end of their life and not making much money, and Group B has lots of oil coming online, by moving the assets around, and subject to various anti-avoidance rules, you can offset Group As losses against Group Bs profits. This clever maneuvering can provide significant financial relief for companies struggling with tax liabilities.

Tax rates on North Sea production have come under significant scrutiny, with the oil industry consistently voicing concerns over the high and fluctuating tax regime. Currently, companies face a headline tax rate of 78 percent on their profits, which comprises corporation tax, a supplementary tax, and the Energy Profits Levy (EPL). This windfall tax was introduced in response to soaring energy prices that followed the outbreak of the Ukraine war. This high tax burden is particularly challenging for companies, especially as oil prices have plunged to a four-year low of under $60 per barrel. Despite this downturn, producers remain liable for the EPL, which continues to apply since gas prices remain above the 59p-a-therm threshold for the current tax year.

Nick Davis, an energy partner at the law firm Haynes Boone, expressed concern over the current investment climate in the UK, stating, I have clients who feel more secure in the tax regime of sub-Saharan Africa than they do in the UK, which is frankly astonishing. He pointed out that while these mergers might provide a scale that could help companies navigate the turbulent waters of the tax regime, they offer little long-term comfort regarding the uncertainty of tax policies.

Additionally, the increase in merger activity may reflect a sentiment among companies that they are nearing the bottom of the market cycle. With the current government imposing a ban on new exploration licenses, stakeholders believe the outlook for North Sea production will ultimately improve, prompting these firms to consolidate their resources.

Tax revenues from the North Sea are on a concerning decline. The UKs Office for Budget Responsibility recently projected a striking 22 percent drop in tax receipts for the fiscal year 2024/25, estimating revenues to fall to 5 billion from the previous year. Looking forward, by the fiscal year 2029/30, they forecast that tax revenues could plummet to 2.3 billion due to depleting North Sea resources.

Gail Anderson, a research director at the energy consultancy Wood Mackenzie, anticipates that the trend of mergers and acquisitions in the North Sea will continue to accelerate in the coming months. There are still big risks in the industry, and companies are trying to think about how they mitigate those risks, she stated. I think its probably more likely than not that we will see more deals before the year is out.