The recent slump in the global oil price has seriously impacted the UK oil sector. Thousands of workers have been temporarily laid off or have lost their jobs completely. Knock-on effects to businesses that service the oil industry have been devastating and Aberdeen, the financial centre of the oil sector is struggling.
In a global industry like oil, prices fluctuate constantly. The causes for this volatility are many and varied but usually centre on issues of supply and demand. If there is too much oil available to buy, the price drops. Conversely, if there is a shortage of available oil, the price will increase. To counteract the periods of low oil price, most prudent governments have an 'oil fund' they can utilise to protect their oil industry and their economy. This keeps things healthy by introducing a financial subsidy from the fund until such time as the market picks up again. The oil fund is grown by transferring a percentage of the oil revenue into the fund during periods when the market price is high.
Despite over 40 years of oil and gas extraction from the North Sea, consecutive UK governments have never created an oil fund. Consequently, we are now witnessing the economic impact caused by no financial protection against low oil prices.
Perhaps it would be useful to compare the UK track record in oil production with another country faced with similar challenges over the same period. Such a country is our near-neighbour Norway, and, as we will discover, the fortunes of both have turned out very different.
A Brief History of North Sea Oil
Long dismissed by many as a potential source of oil or gas, the North Sea has, over the last four decades, become the centre of one of the world’s most productive energy industries. Gas was first found in quantity in the Groningen area of The Netherlands in 1959. This was followed by the first British discovery of gas in the West Sole field, off the coast of East Anglia, by the BP jack-up drilling rig Sea Gem, late in 1965.
The excitement of the first British North Sea gas was overshadowed almost immediately when, only days later, on Boxing Day, the Sea Gem capsized with the loss of thirteen lives. This was an early reminder of the danger of the North Sea as an environment to work in.
The British industry in the Southern North Sea grew rapidly in the early years. The deepening economic crisis in the UK meant that there was enormous pressure on the industry to get gas, and later, oil flowing. For the oil and gas producers, there were great profits to be made. British self-sufficiency in oil and gas, hitherto an impossible dream, was becoming a possibility. Indeed, as exploration and investment moved further north, it became clear that there was oil to be found in great quantities. However, it was not until 1975 that a small entrepreneurial American company, Hamilton Brothers working in the Argyle field, brought the first British oil ashore, to be followed very soon after by BP in the massive Forties field.
Discoveries of oil grew in number as more companies, British, European and American, took out leases on sectors of the North Sea.
By the mid-1980s there were over one hundred installations. Through extraordinary technological innovation and human effort – and sacrifice – millions of barrels were being produced every day.
An oil and gas bonanza had occurred.
Concerns that safety was not a high enough priority in the race for oil and gas was eventually confirmed by the Piper Alpha disaster of 1988.
In this, the worst disaster in the North Sea, 167 men died.
The destruction of the largest and most prolific platform on the North Sea led to a major public enquiry under Lord Cullen and to a major review of safety procedures and standards.
While the early years of the industry were set in the political context of a Labour government, some of whose members wanted the maximum possible control of the new resource, it was the market-led Thatcher government that oversaw the growth years of the 1980s. As a consequence, by the early 1980s, Britain had become a net exporter of oil, and by the mid-1990s of gas.
Two of the key centres of the industry have been the Great Yarmouth/Lowestoft area, centre of operations for the Southern North Sea gas industry, and subsequently, Aberdeen, now regarded as the oil capital of Europe. Among other centres to have been central to the success of the industry have been the northern isles of Orkney and Shetland. The development of the Flotta and Sullom Voe terminals was critical to the success of the northern fields.
During the 1990s, like the rest of the world, the North Sea was vulnerable to the fluctuation of world oil prices. Nevertheless, production grew and peaked around 2000/1. Now, the North Sea is regarded as a mature province on a slow decline. However, thanks to ever more sophisticated technology, important amounts of oil and gas could be drawn for anything up to 50 years. New discoveries are still being made and the industry is now well established west of Shetland in the Atlantic.
The North Sea Oilfields
The UK and Norway have equivalent geology and a similar resource base – the North Sea Basin is effectively split down the middle between them.
The North Sea accounts for the bulk of UK and Norway production, but in addition, the UK also produces from the West of Shetlands and Norway has production in the Norwegian and Barents Sea.
Extracting oil and gas from the North Sea is a hazardous and expensive business. In such a large expanse, the wind has no obstacles to reduce its speed and storms can whip up massive waves. Rigs must be built to withstand the worst of weather and remain firmly located above the well head. The products are transferred to tanker or delivered to shore by pipeline. A complex supply system is required to cater for the day to day needs of the rigs and special accommodation platforms become home for the offshore workforce.
A Tale of Two Countries
Figure 1: North Sea Production since 1971 (boe billions)
Source: BP Statistical Review 2014 and Norway government data (www.norskpetroleum.no).
The UK and Norway both began offshore exploration and production in the mid to late 1960s.
Since then, both countries have produced similar amounts of hydrocarbons: the UK has produced 42.8 billion barrels of oil equivalent (boe) and Norway 40 billion boe (Figure 1).
Today, the UK has a population of approximately 64 million. Norway has a population of approximately 5.2 million (almost exactly the same as the current population of Scotland). The almost identical amounts of oil and gas obtained by each country would have a different impact on the economy of each due to the differences in population. However, what is more influential is the way the revenues were managed and to this end, the two countries have taken very different approaches to the governance of their oil sectors.
Following the privatisation of BNOC (BritOil 1982) the British Gas Council's oil assets (Enterprise Oil 1983) and gas assets (British Gas 1986) the UK government has had effectively no direct equity participation in the North Sea and has had a fully private upstream sector, with taxation as the only channel of government revenues from hydrocarbons.
Norway has taken a different approach, with over 50 percent of production coming through Statoil (of which the state owns a majority) and state ownership of assets via the State Direct Financial Interest (SDFI), held through Petoro (wholly owned by the state).
How much revenue has each country generated from its oil and gas production over the past 45 years?
Figure 2: North Sea Revenue in real (2014) terms since 1970 ($ billions)
Source: UK Statistics of Government revenues from UK oil and gas production, table 11.11 and Norway government data (www.norskpetroleum.no).
Analysis of official government statistics show that the UK generated $470 billion in revenues whilst Norway has generated $1,197 billion since 1971 in real (2014) terms (Figure 2).
These official UK and Norway government figures have been converted to US dollars at the prevailing exchange rates of the time, and adjusted for US inflation using data from the World Bank national accounts database via Index Mundi.
Taxes and fees include standard business taxes, environmental and petroleum specific taxes, royalties and fees.
The State Direct Financial Interest is the net return to the Norwegian State on its direct ownership interest in companies operating in Norway.
Prior to 1985, the State managed its interest via the state owned company Statoil. After 1985, the State's ownership interest was split: one part managed as the SDFI, and one part by Statoil. When Statoil was publically listed, the responsibility for managing the SDFI was transferred to a state-owned management company called Petoro.
The Statoil Dividend is the total dividends paid by Statoil to the state as the sole shareholder from 1982 to the present, it does not include net income from 1972 when Statoil was founded.
Figure 3: North Sea Revenue in real (2014) terms since 1970 on a boe basis ($)
Source: UK Statistics of Government revenues from UK oil and gas production, table 11.11 and Norway government data (www.norskpetroleum.no).
Normalising for production levels shows that the UK generated $11.0 per boe compared to Norway's $29.8 per boe in 2014 prices (figure 3).
In other words, Norway has generated $18.8 per boe more in revenue for the state than the UK has. Figures 2 and 3 show that the difference is due to a combination of $9.1 less tax take per barrel and $9.8 per barrel in state equity cash flow and dividends.
The $18.8 per barrel extra government revenue Norway enjoyed equates to $727 billion in money of the day terms. On the face of it, this is a staggering sum, equivalent to 35 percent of the UK's national debt stock in 2014.
Not included in these figures is the amount the UK state gained from selling its assets in the North Sea. This figure is not precisely known, but accounts suggest that UK earnings from the oil company privatisations in the early 1980s were: Britoil £549m, Enterprise Oil £392m and Wytch Farm £210m. (Source: David Parker. The official history of privatisation Vol 1 1970-1987. Routledge 2009). That's only around £1.2 billion ($1.7 billion) in money of the day terms, or around $3.76 billion in 2014 terms. This is perhaps an underestimate as it does not include income from the privatisation of British Gas beyond its oil assets.
Nonetheless, the income to the UK from privatisation of oil assets does not make up for the lower UK government revenues relative to Norway.
Why did the UK generate less revenue for the state than Norway from North Sea oil and gas?
There are three prominent factors:
the timing of UK and Norway's production relative to global oil and gas prices
lower average UK tax receipts from petroleum production
the Norwegian state's direct investment in the industry.
Figure 4. Oil and gas production and the oil price, in 2014 terms
Source: BP Statistical Review 2014 and Norway government data (www.norskpetroleum.no).
The UK produced more of its oil and gas in years when prices were low. Norway also produced during these low price periods, but their output was a lot less.
The UK's twin peaks of production in the late 80's and late 90's coincided with oil price lows resulting in less rent available to the UK state.
Norway's production peaked later, in 2004, when oil prices were higher (Figure 4).
More precisely, the UK produced 65% of its oil when prices were below $50 a barrel compared to the lower figure of 57% for Norway (Table 1).
This seemingly small difference in realised sales has meant that Norway sold its oil and gas for about $10 per boe more than the UK on average.
The average annual price of sales weighted by production has been $47 per boe for UK and $57 per boe for Norway.
Table 1: Oil and gas produced in years when oil prices averaged below and above $50 per barrel in 2014 terms from 1971
Norway earned $9 per boe more just in taxes. Part of this is a direct result of the difference in timing of sales, as already shown. In part it also reflects the field sizes in Norway, as 67 percent of their production has been from large fields (over one billion boe) and 17 percent from small fields (between 0.5 and 1bn boe). In contrast, 23 percent of UK production has come from large fields and 26 percent from small fields.
Norway's field size ratio has realised lower unit production costs and higher taxable profits.
It also reflects differences in the tax regime as Norway has maintained a higher effective tax rate on the oil sector, although these rates have varied over time.
The third factor in the success of Norway has been the involvement of the state. The Norwegian state benefited from direct equity investment in the upstream which generated an additional $9.8 per barrel in revenue. The Norwegian state, via Statoil and Petoro, has majority stakes in 11 of its 14 billion barrel fields.
This choice should be weighed against the fact that the Norwegian state risked public money. It is not clear how much this was. SDFI data shows negative cash flow from 1985 to 1988 of $21.4 billion in 2014 terms, but further public capital would have been invested before 1985. In hindsight this was a risk worth taking, but that could not have been known for certain at the time.
These figures suggest that Norway's governance model has been a key contributing factor. Direct state equity in oil and gas production and a higher tax burden has generated significantly higher revenues for Norway, while the British state appears to have failed to gain much value from privatising its North Sea assets.
The UK government's decision to end its direct participation in oil and gas equity was controversial at the time. In 1980, the Central Policy Review Staff with the UK cabinet office raised the following concerns “Privatising BNOC and selling £1 billion of BNOC's assets benefits the PSBR (public sector borrowing requirement) in the years in which the assets are sold, but the £1 billion gained is purchased at a high price in terms of the PSBR benefits stretching out into the future.” Oil assets “are almost certain to rise in price in the years ahead”.
This warning was prescient as our analysis shows that the UK government has missed out on hundreds of billions of pounds in potential revenue as a result of the privatisation path taken in the early 1980s.
How does the UK generate revenue from North Sea Oil and Gas?
Producers of UK North Sea oil and gas are taxed in three ways:
Petroleum Revenue Tax (PRT) – this only applies to fields operating, or with consent, prior to 1993.
PRT was introduced under the Oil Taxation Act 1975, soon after Harold Wilson‘s Labour government returned to power and in the immediate aftermath of the 1973 energy crisis. It was intended to ensure "a fairer share of profits for the nation" from the exploitation of the UK’s continental shelf, while ensuring "a suitable return" on the capital investment by oil companies.
PRT is charged on "super-profits" arising from the exploitation of oil and gas in the UK and the UK’s continental shelf. After certain allowances, PRT is currently charged at a rate of 35% on profits from oil extraction. PRT is charged by reference to individual oil and gas fields, so the costs related to developing and running one field cannot be off set against the profits generated by another field.
PRT was abolished on 16 March 1993 for all fields given development consent on or after that date, but continues in existence for fields established before that date. At the same time, the rate of PRT was reduced from 75% to 50% and from 1 January 2016, now stands at 35%.
Corporation Tax – this is normally at 30% of profits (after PRT has been accounted for). Note that this is higher than normal corporation tax, which is currently at 20%.
Supplementary Charge – this is an addition to Corporation Tax, and is set at 20%, calculated against the profit before Corporation Tax.
UK Offshore Oil and Gas producers pay a total of 75% in tax for fields that existed before 16 March 1993 and will pay a total of 50% in tax for fields that existed on or after 16 March 1993.
How does Norway generate revenue from North Sea Oil and Gas?
Producers of Norwegian North Sea oil and gas are taxed in two ways:
An income tax of 28% on profits. This is identical to the tax paid by every Norwegian Business.
An additional 50% tax on profits is applicable to offshore producers of oil and gas only.
Norwegian Offshore Oil and Gas producers pay a total of 78% in tax regardless of the age of the field(s) in question.
Conclusions and Inferences
The UK and Norway have produced almost identical amounts of oil during the last 40 years, but, from the preceeding data, there is clearly a difference of opinion in the management of each resource.
It is impossible to ignore the fact that the UK performance has been less than brilliant in stewarding this extremely lucrative energy resource. It is equally impossible to avoid the recognition of the outstanding results of the Norwegian stewardship of their resources.
In testament to this, Norway now has an oil fund, grown from North Sea oil profits, that currently (January 2016) amounts to a staggering $802.6 bn (£555.9 bn). This fund is used to provide a range of financial benefits to the citizens of Norway and foremost in this function is the provision of pensions. To put some sort of perspective on just how big this fund is, the Norwegian population of 5.2 million could ALL become instant (£) millionaires - and there would still be £35.9 bn left over for a rainy day. This also ignores the considerable assets due to the state investment in their offshore oil industry.
In stark contrast, the UK has absolutely NO accumulated wealth due to oil (no oil fund), it doesn't have a state investment in any offshore production and it generated only half the revenue that Norway did per barrel (this factor alone would have doubled the UK revenue from $470 bn to over $940 bn).
When actually considering how the revenue is exploited, comparisons between the UK and Norway are similar to comparing apples and oranges. The UK population is about 10 times that of Norway, so different priorities and costs will be evident in running both economies. This however does not explain why the UK didn't setup an oil fund or why they sold off their state owned involvement in the sector. It also doesn't explain why the UK squandered their oil revenue like there was no tomorrow and didn't put measures in place to maximise their profits.
Comparisons between Scotland and Norway are unavoidable. Both countries have similar populations and both share similar social aspirations. It is highly likely that an independent Scotland would have pursued an identical strategy to Norway in the management of its oil resources. Unfortunately, Scotland had no meaningful say in the matter - in fact, vital information about the potential size and value of the oil fields was denied to the politicians and population of Scotland (and the rest of the UK for that matter). See The McCrone Report
The reason for this was quite simple - the UK government feared the rise of Scottish Independence and the prospect of all that oil wealth belonging to Scotland was unthinkable. Such a scenario would elevate Scotland to one of the richest countries in the World. This would rapidly mean Scottish independence and the end of a Union dominated by England for 300 years. With the Union gone, the true extent of England's reliance on Scotland would become apparent and the prominent role of the current UK (essentially a front for the Westminster establishment) on the World stage would come to an end.
This was undoubtedly the prime motivation of the UK oil strategy and would dictate how the revenue would be utilised for short term gain. It also explains why prudent management of the resource would be counterproductive in the desire to thwart Scottish Independence - an issue that was constantly bubbling away just under the political surface.
So, with the oil flowing, successive Westminster governments set about spending the generated revenue as fast as it was produced. They threw money at everything, but despite that, many of their economic and social problems prevailed. Under Thatcher, most of the UK state owned assets were privatised. The North sea was no exception and all UK state owned interests were sold - again, reducing the potential for the oil to be beneficial for Scottish independence. None of the successive UK governments created an oil fund - to do so would mean amassing a large visible fortune attributable to North Sea oil and gas. This would eventually expose the true wealth flowing into Westminsters coffers. Once the Scots realised the extent of the oil revenues, which, up to that point had been deliberately played down, there would be a backlash - perhaps it was feared, strong enough to call for the breakup of the Union.
For over 30 years, Westminster squandered what revenue they could extract from the North Sea. It mitigated horrendous mismanagement of the economy by successive governments. It funded large infrastructure projects (mostly in England) - the Channel Tunnel and the M25 London circular being two major examples. It funded numerous military campaigns in Afghanistan and the Middle East. It subsidised the dismantling of most of the traditional UK industries and supported the prominance of London and the financial markets.
Despite Westminster's best efforts, in 1999, fueled by a growing desire for constitutional change, a Scottish Parliament was reconvened.
On the very eve of the Parliament, Tony Blair's Labour government secretly approved the moving of the Scottish Marine boundary in the North Sea to transfer 6,000 square miles of Scottish waters to England, including the Argyll field and six other major oilfields.
The change was specifically designed to disadvantage Scotland’s case for independence and at the same time, increase Englands North Sea assets. There was no opposition to the change, indeed only a select few knew anything about it and it was they who pushed the order through the various stages until it was passed in parliament.
This utter disregard for Scotland's interests is just another of the many decisions that are designed to advantage England and disadvantage Scotland. The fact that it was conducted behind closed doors and the knowledge of what was happening was kept secret from the electorate is proof enough that Westminster plays by its own rules when it perceives a threat - whether based on fact or not.
To this day, the boundary change has gone un-noticed by the vast majority of the population.
By the time an SNP freedom of information request was successful in releasing the McCrone Report in 2005, the output from the North Sea was in decline. The years of plenty were coming to an end and the financial crash was still to come - the worst impact of which would be mitigated by public finances to provide Bank Bailouts.
In recent years, the global oil price has slumped and (unlike Norway) our oil industry is in serious trouble. Every day see's more job losses and companies leaving the sector. This has a knock on effect to the extensive supply chain and impacts the Scottish economy in general. So far, all that the UK government has provided is £250 million (for the whole sector). This looks set to allow the industry to slip further into decline, corroborating the agenda to suppress oil as a credible asset for independence. With £6 trillion in UK national assets (with a sizeable portion in Scotland) they know it is better to lose the oil than to lose Scotland.
This may all seem a bit far-fetched, but it has to be acknowledged - the McCrone Report was commissioned to discover the impact the oil would have on the case for Scottish Independence. Once the facts were uncovered, ensuing panic meant the report was immediately classified as "Secret" and all access denied for 30 years. In that time, successive UK governments squandered the oil revenues, mismanaged the industry and failed to fully capitalise on the true worth of every barrel produced.
If the true worth of North Sea oil was known to the people of Scotland, there was a real fear that independence would follow. If that happened, the UK in its current form would cease to exist.
That would mean:
the UK position at the top table in Europe would be null and void
the UK position in NATO would also be in doubt
the UK position on the UN Security Council would probably be null and void
Scotland would demand the removal of Trident from her territory and there is no ready-made site to accept the system elswhere, so that would effectively remove the UK Nuclear Deterrent
The oil and gas would still flow, but only the fields in the English marine territories would feed the Westminster Treasury
Scotland would demand the return of the 6,000 square miles of marine territory without question.
The remaining UK debt would reduce as a consequence of Scotland's departure, but so too would all the hidden revenues that Scotland once paid without complaint - and of course all the visible revenues that were sent to the Treasury.
Perhaps re-negotiation would be required for continued membership of all the main organisations, perhaps not. One thing is for sure, the UK entered each one as the UK. With Scotland as an independent state, the original UK would in all probability cease to legally exist.
The 2014 referendum was an unfolding nightmare for Westminster. Despite their efforts with the oil, the referendum materialised anyway. The resulting victory was a hollow one, obtained by misinformation and scaremongering and to top it all, Devo Max was promised if Scots voted NO. Once the NO vote was secured, Westminster has gone back to its protectionist ways and the Union lives to fight for a little longer.
Ironicaly, Scotland's economy is strong enough to prosper without the oil. Westminster spin would have people believe differently, but the fact remains, Scotland is perfectly capable of success as an independent country.
North Sea oil and gas is a very welcome, (but not crucial) bonus.