Serica Energy Plc (AIM: SQZ): Reflections on the UK fiscal regime changes

• As expected, the rate of the Energy Profits Levy (EPL) will increase from 35% to 38% and the 29% investment allowance introduced with the EPL will be removed. The changes will be effective from 01 November 2024 and run until 31 March 2030.
• The government has also signalled that capital allowances (including first year allowances) in relation to the EPL will be reduced, but has said that the extent of this will be established after consultation with stakeholders and published in the 30 October fiscal event.
• While the continued uncertainty is unhelpful for new investment decisions, the government did confirm that the permanent regime (CT of 40% plus SCT of 10%) would remain unchanged. This is a positive surprise as this implies that the 62.5% uplift on capex for SCT purposes will also be retained. This means that for each £1 of capex, £1.625 is deducted from taxable profits for SCT purposes. We had anticipated that this uplift would be removed. This feature together with statements that they would consult on a long-term replacement for EPL could be read as an intention to provide some stability to the industry.
• Assuming that the new oil & gas UK fiscal regime will be in line with Norway’s (which was the Labour party’s indication before the election) where 100% of capex is deductible against taxable profits, then the reduction in capital allowances for EPL purposes might only be changed so that it offsets the retained uplift on SCT. Our model and valuations are based on these assumptions.
• The Energy Security Investment Mechanism will remain and the decarbonation allowance is unchanged. Pending further details expected in the 30 October fiscal event, we have not changed our forecasts re-iterate our target price of £2.90/sh in line with our ReNAV.

Implications for Serica
• Notwithstanding the proposed fiscal regime changes, the fact that the 62.5% capex uplift for SCT purposes remains in place means that our valuation for Serica on a worst case scenario (of capex not being deductible for EPL purposes and no sunset date for the EPL) has increased to ~£1.90/sh from ~£1.80/sh. Under this scenario Buchan would however not be developed. This valuation still represents >50% upside to the current share price.
• Assuming a sunset date of 2030 for the EPL (in line with the government’s announcement) sees our valuation increase to ~£2.30 per share (=90% upside). This assumes that Buchan is not developed.
• Under a low commodity price scenario (GBp57/th for NBP UK gas prices and US$74.21/bbl for Brent, the level below which the EPL would fall away), Buchan is sanctioned and our valuation for Serica would be ~£4.00/sh.