Issue Number: 100   September 2013

Salmond Spawns Upstream Optimism

With the Scottish referendum on independence from the UK due in September 2014, the 'Yes' and 'No' campaigns are beginning to publish reports and put forward their arguments. In amongst the multiple issues at stake the principal concern for the voter appears to be the economics of an independent Scotland.
At the heart of these economic arguments are the North Sea and the revenue it brings in. How much of the UK Continental Shelf (UKCS) Scotland would inherit has not yet been decided, and is likely to be a key point of negotiation. If decided geographically, as is most likely, it would retain around 90% of total reserves. Therefore, the UKCS would be a key economic sector for Scotland. This article focuses on the North Sea, examining just how important the revenues the North Sea brings in would be to Scotland's economy, how consistent this income would be and for how long it might last. It will also look at Scotland's wider energy sector and policy.

The North Sea

Commercial production on the UK Continental Shelf took off in the 1970s, although it was not until the 1980s that the Government started receiving significant revenues. From this moment onwards oil and gas have been a key part of the UK economy. The UK never created a sovereign wealth fund like Norway (and many others around the World), and with the Norwegian fund now worth nearly $750 billion, it is a decision that Britons rue. When the oil runs out, that behemoth of a fund, which is reported to own on average, 2.5% of every listed European company, will continue to benefit Norway in numerous ways whilst even now George Osborne is struggling to rely on the North Sea to balance the books as production decreases. Scotland has viewed the use of North Sea revenues as a frittering away of money. Unfortunately, the past cannot be rewritten, but the question remains for an independent Scotland as to whether the horse has bolted on a fund or whether it is actually plausible.

BP, 2012

There is some disagreement as to the centrality of oil in an independent Scotland's economy. The Chancellor has suggested that the North Sea would be of vital importance to Scotland and that the creation of a fund would leave a gap to be plugged, unless tax receipts from oil and gas increased significantly. In reply, it has been argued that Scotland's economy will be almost identical to that of the UK with the Scottish Finance Secretary, John Swinney, stating that "North Sea oil is a bonus, not the basis for Scotland's economy."

The simple statistics, however, do appear to show the importance of the North Sea to the Scottish economy. In 2011-12 total Scottish non-North Sea public sector revenue (tax receipts) was estimated at £46.3 billion [1]. If a geographical share of North Sea revenue is included (circa 90% of total North Sea revenue) that figure rises to £56.9 billion. Therefore, if we presume these statistics to be indicative, if not identical, of an independent Scotland, North Sea oil revenues of £10.6 billion account for just under 19% of total revenue. With public expenditure for the benefit of Scotland by the UK estimated at £64.5 billion, this suggests that should non-North Sea revenue and spend remain fairly similar in an independent Scotland, the revenues from a geographic share of the North Sea would be important in ensuring the country did not run a large deficit. Therefore, it seems hard to argue, certainly in the medium term, that North Sea revenues would not be a vital source of income for Scotland. Moreover, this adds credence to the argument that an independent Scotland would struggle more than the UK with volatile production and revenue levels, as has been seen recently. In addition, if Scotland was running a deficit, it might be less inclined to set up a fund. Even Norway was unable to deposit oil revenues into its fund straightaway. A fund is a good idea but in practice may prove hard for an independent Scotland to administer. On the other hand, whilst it seems unlikely the UK is going to start a fund, the potential future production of shale gas could provide a good situation. Nonetheless, if the UK remains in deficit year-on-year, any fund may be unlikely, especially if economic growth remains sluggish.

Scotland's ability to set up an oil/gas related fund is obviously dependent on a continued high level of performance of the UKCS. If we argue that Scotland is fairly reliant on North Sea revenues, then its ability to function independently is partially reliant on the performance of the UKCS's production levels. Therefore, we must turn to the future of the North Sea.

In recent times the North Sea has been subject to wide and varying statements as to its ability to keep pumping out hydrocarbons. Swinney and Salmond recently stated that there is "up to 24 billion barrels of oil left" worth an estimated £1.5 trillion. This would apparently be worth £300,000 for "every man, woman and child" in Scotland following independence. Somewhat amusingly, this rather impressive figure appears to have been calculated merely by multiplying the remaining reserves - 24 billion - by a forecast price of $100 a barrel and then converting that figure into sterling. It does not even appear to distinguish between the different prices of oil and gas. As a result this figure has been widely discredited and the result of much criticism, with HM Treasury probably taking some pleasure in exposing its shortcomings. Unfortunately for the UK and Scotland, not only was the high-end estimate for remaining reserves used in this calculation, but also it does not take into account the various costs of extracting the remaining reserves, a cost expected to increase as reserves decline. Additional costs ignored include decommissioning, tax breaks and the fact that foreign ownership will mean some profits go abroad and will not stay in Scotland.

HMRC, National Statistics

HM Treasury offers a different, far lower, figure concerning the value of resources to the UK. It quotes the Office for National Statistics' (ONS) estimate that the remaining reserves are worth £120 billion. ONS uses a wholly more complicated method taking into account the various factors mentioned above, and more. The calculation is also made with a far more conservative estimate of remaining reserves, which estimates that proven and probable reserves total around 10 billion barrels of oil. This figure does not take into account undiscovered resources as it is contrary to international standards. The difference between the lower and upper range is quite significant, and if the figure for the upper range (2011) is taken, this would amount to around another 10 billion barrels of oil. Whilst it may be too simplistic to merely double the worth, the reserves would still not amount to £1.5 trillion, although it would be prudent to note that the UKCS does bring in valuable employment for Scotland and so any prolonging of production is good for the economy. Therefore, these figures suggest a slightly different picture of the UKCS where it can still contribute to the economy, but the percentage of its contribution may well decline over the years, as either the UK or Scotland's reliance on its revenues would also.

Wider Energy Policy

Away from the North Sea, it is worth noting that Scotland has an impressive amount of renewable energy. Interestingly, as part of Scotland's campaign for independence, the SNP has outlined that it would like to maintain a UK-wide energy market. This would effectively involve the continued subsidisation of the wind power through the contracts for difference system that creates an incentive for the constructors [2]. This would allow Scotland to continue to export power at a high price. This seems somewhat optimistic since Scotland is expected to have levels of surplus power at times, and no power at others. Without the integrated market, wind power from Scotland would be unable to command a high price. The UK is almost certainly not going to enter into a deal where it subsidises Scottish wind farms, paying for capacity even if it does not actually use the power. If Scotland has surplus energy, it will have to compete with other energy suppliers. Ed Davey has even suggested that the UK will consider energy from other countries. It should also be noted that the UK may well have more power generating from nuclear plants as well as the possibility of gas-fired plants fed by domestic shale gas resources.

Conclusion

At the heart of the 'Yes' campaign is a belief that Scotland will be better off economically on its own than as part of the Union. This article has merely focussed on the role the North Sea might play in an independent Scotland. With statistics estimating that the North Sea currently accounts for 20% of Scotland's tax receipts, if judged geographically, claims that control of the UKCS would merely be a 'bonus' appear false. In fact, it is likely to play a key role in the early years of an independent Scotland. Unfortunately for Scotland, suggestions that the North Sea oil and gas reserves are worth £1.5 trillion to Scotland are highly optimistic. Production levels have been declining over the last decade and even a revival may not bring in the large amounts of revenue expected as decommissioning costs are offset and cost of extraction increases. Revenues may remain solid, but there is no doubt that a larger UK economy has a stronger ability to absorb poor years, such as this year, where maintenance has been widespread. Additionally, the recent suggestion by the SNP that it would like to maintain the UK-wide integrated energy market is particularly optimistic and as with the UKCS where it does not want to appear reliant but at the same time put forward an argument of prosperity perhaps a case of wanting the best of both worlds.


[1] GERS, http://www.scotland.gov.uk/Publications/2013/03/1859. Accessed 6 Sept. 2013

[2] Financial Times, 'Alex in Wonderland - Scotland's energy policy', accessed 5 September 2013.


September 2013 MZINE