Leading Artcle: Unpleasant surprises for North Sea explorers

UNTIL LAST month, exploring for oil in the North Sea was a low-risk business, at least financially. Companies dug holes and wrote off much of the cost against tax. Every dozen or so holes, they struck lucky and made a find with commercial potential. The oil was extracted and producers paid the Government a slice of their revenue. It was not a particularly efficient system, but exploration companies did not worry much about the other 11 holes: the Government was paying for them.

Then Norman Lamont gave the oil industry a surprise. Without consultation, he changed the rules overnight. In his Budget he announced that exploration would no longer be tax deductible. The sweetener was that he cut taxation on production. So the explorers were furious and the big producers laughed all the way to the bank.

The tax change means that the rate of petroleum revenue tax (PRT) on oil and gas production will fall from 75 to 50 per cent for existing fields and will be abolished on new ones. It is estimated that the windfall will add pounds 150m a year to BP's profits. Meanwhile, the Government's figures suggest that drilling activity in the North Sea could halve at the cost of 10,000 jobs. Explorers say they will not be digging many holes in the North Sea from now on.

So what started out as a few lines in the Chancellor's speech could have dramatic implications for a major British industry, a significant number of jobs and supplies of a strategically important raw material. It is impossible to ignore threatening noises from Sheikh Yamani that Opec might flex its muscles again if Western countries impose heavy energy taxes. Would sufficient domestic oil and gas - never mind coal - be available to deal with Opec restrictions? Ministers argue that they already know where much of the oil and gas in the North Sea is located. The key to maximising the benefits of deposits is, they say, to exploit discovered reserves. The cuts in production tax will certainly encourage companies to do that.

However the temptation of an extra pounds 700m in tax revenues gleaned by the changes has blinded ministers. First, there still may be large unknown oil deposits in the North Sea. The best hope is in the deep waters west of the Shetland Islands. Second, ministers have damaged their credibility by unilaterally changing the rules. There is still a tax incentive to search for a big find. But exploration companies worry that the Government might suddenly reimpose PRT on newly discovered fields to cash in on the bonanza.

This episode underlines the dangers of short-term thinking. The undoubted need to cut the budget deficit means that the Treasury is again driving domestic policy, putting revenue-raising ahead of long-term policy aims. The Government should work to restore confidence in an industry that requires certainty to make long-term investment decisions; and ministers should offer guarantees that the new tax regime will not be changed suddenly without consultation. If such reassurances are not enough to maintain serious exploration, the policy should be reconsidered.