The Importance of North Sea Oil & Gas to Britain’s Economy
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The Importance of North Sea Oil and Gas to Britain’s Economy
Introduction and Background to the Issue
The economic and social context to oil exploration has changed in a significant way in recent years. Growth in oil demand linked to population and global development has led to a lack in surplus production linked to declining fossil fuel fields and the need to resort to shale gas production (Dlugokencky, Nisbet, Fisher, and Lowry, 2011). At the same time, there are ongoing massive pressures for the exploration and exploitation of new sources of energy in places like the North Sea. The instability in the industry as a whole, however, has led to changes in the way that oil and gas resources are managed, which has had a deep effect on global revenue streams and economic benefits linked to production and distribution. As illustrated in Figure 1 below, oil production stopped growing in 2004 while demand continued to increase.
Figure 1: Excess capacity dwindles as demand increases
Source: Fantazzini, Höök, and Angelantoni, 2011, p.7866
At the same time, crude oil inventories have been able to be maintained. Nonetheless, the Organization of the Petroleum Exporting Countries (OPEC) has no longer been able to serve as the global buffer between production and required supplies (Dvir and Rogoff, 2009). Crude oil inventories need to be at least as high as they have been in the last twenty years because of demand in Europe, as illustrated in Table 1 below, which has not decreased in a significant way since 1995. By August 2008, for example, oil in 23 OECD inventories reached 68 million barrels above average, which amounts to only 53 days of oil reserves available to the world (Hamilton, 2009).
Table 1: European crude oil consumption, 1980-2011
Year Consumption Change
1980 12,994.45 NA
1985 11,154.98 -0.79 %
1990 12,021.76 0.46 %
1995 19,243.96 0.55 %
2000 19,032.38 -0.58 %
2005 19,882.42 1.14 %
2006 19,948.94 0.33 %
2007 19,669.51 -1.40 %
2008 19,727.97 0.30 %
2009 18,974.01 -3.82 %
2010 18,936.52 -0.20 %
2011 18,506.84 -2.27 %
Source: United States Energy Administration (http://www.eia.gov/)
To this end, production targets are strongly tied with the economy of not only the oil and gas industries, but also to the economy of countries like the United Kingdom (UK) which are dependent on the use of oil and gas for their broader production industries, transportation, and consumers. In this way, revenues from valuable mineral rights as well as from production and sale of oil and gas intertwine to have an impact on state and regional economies. This essay will examine the importance of North Sea oil and gas revenues to the British economy during the period from 1974 to 2014. The essay will offer a critical appraisal of how revenues from valuable mineral rights are invested and spent by the UK Government for the benefit of current and future generations of British inhabitants. The thesis of this essay is that because the viability of North Sea reserves has become more tentative no matter where and how the exploration takes place, British inhabitants may never benefit from mineral rights and oil production in this region. The reason that this is the case is that research has shown that most estimates of oil and gas potential are likely to be overstated (Jakobsson, Söderbergh, Snowden, Li, and Aleklett, 2011), and the short-term choices made by the UK Government for oil and gas revenues have not counted on this lack of potential.
Analysis of the Evidence
The political framework within which the current UK oil and gas policy operates, especially with regards to the North Sea and its reserves, can be said to be one of significant tension (Powell, 2014). The reason that this is the case is the UK’s policies with respect to the Arctic and sub-Arctic regions are ill-formed and still under consideration, but there is both a Scottish independence referendum and a referendum on the continuance of the current relationship with the European Union still to be decided in the coming years (Powell, 2014). Within this shifting macroeconomic and political framework, very recently in March 2011 the UK government announced a new fiscal policy that aimed to increase the tax burden on oil and gas exploitation activities from 20% to 32%, thus increasing “the headline rate of tax paid by the industry on the profits of Petroleum Revenue Tax (PRT) paying fields to 81%” (Willigers and Hausken, 2013, p.276). To some, this increase read like a last resort technique to garner as much revenue as possible before the likely changes to the UK’s political structure, both nationally and within the context of Europe.
In recent years, it has been argued that the North Sea’s capacity for production has reached peak status (Fantazzini, Höök, and Angelantoni, 2011). At the same time, because of the ongoing challenges in trying to reach new oil reserves in the North Sea, the price of doing business for the oil and gas industry is increasing at a significant rate (Hamilton, 2012; Willigers and Hausken, 2013). As noted by Fantazzini, Höök, and Angelantoni (2011), the Deepwater Horizon incident in the Mexican Gulf has shown that oil exploration companies need to be able to make a more concerted effort than ever before in order to guarantee the safety of not only their own investment, but the safety of the people, fauna, and environment in the region in which they are exploring and drilling. Although in 2010 “the UK treasury introduced a capital allowance for the gas reserves under the deep and hostile waters of the UK Atlantic margin that include the Laggan and Tormore fields” (Willigers and Hausken, 2013, p.277), the financial burden is significant on both the industry and the state (Austin, Cannon, and Ellis, 2014).
The research that this burden exists in the first place, according to the literature, is that the relationship between the state and the industry in the UK is a unique one. As noted by Hamilton (2011), this relationship shifted in 1974 after the world’s first global oil shock, because the UK had been relying on the Middle East for more than two thirds of its petroleum at the time. This was the reason for the development of OPEC, which was aimed at balancing out geopolitical factors from the production and sale of oil and gas, even if this new entity was not entirely successful at achieving this aim (Hamilton, 2011). A series of conflicts in the Middle East that followed this initial shock made it all the more necessary for the UK to develop its own sources of oil alongside other northern regional economies such as Norway. This occurred through the development of a state-controlled system over oil and gas resources in the UK that was implemented in the Continental Shelf Act of 1964 and was consolidated by Part I of the Petroleum Act of 1998 which ensured that all rights and revenues would be crown controlled (Peters and Kumar, 2013). Although, within this framework, there is a need for deep relationships between producers and exploration companies for oil and gas and the UK state, this policy favors the state almost entirely (Peters and Kumar, 2013).
Despite the opportunity for the state to access a significant level of revenue from oil and gas companies, as indicated both by the overarching policy framework and the tax revenue structure that was introduced in 2011 by the Cameron administration as detailed above, this has not been a successful venture for the UK Government. As detailed in Figure 2, below, the net present value of the oil and gas revenue in the UK is low, and the liability that is borne by the Government is growing. In other words, there is a need to recognize the fact that declines in overall hydrocarbon production combined with the realization of the debt incurred to invest in high-risk exploration on behalf of the state is likely to result in a negative economic potential for this kind of project. In addition, the more that the state seeks additional revenues from the oil and gas industry in the form of taxation, the more likely that the challenges involved in garnering a positive economic outcome for this kind of investment will be small over the long term.
Figure 2: Development of the present value of remaining tax revenue and the present value of the decommission liability of the UK government
Source: Willigers and Hausken, 2013, p.277
Given these factors, it is also important to note that there is the potential for additional difficulties in ensuring that any revenues from this process to be spent by the UK Government for the benefit of current and future generations of British inhabitants. As media reports have suggested, the budgets proposed by the UK under the Cameron administration have not necessarily targeted safe investments for these revenues such as pensions, alternative energy sources, or paying off debt, but have rather placed the funds from oil and gas income budgets towards short term challenges such as unemployment insurance shortfalls and personal tax cuts (Elliott, 2012).
Conclusions
This essay has made the argument that the viability of North Sea reserves has become more tentative and that British inhabitants may never benefit from mineral rights and oil production in this region because of the fact that most estimates of oil and gas potential in the North Sea are likely to be overstated and that it is evident that the short-term choices made by the UK Government for the use oil and gas revenues have been focused on short term political wins over long term investment potential for the British public. This claim is likely to be true. The fact that there is no policy framework for operations within the northern regions (Powell, 2014), and the upcoming referenda that may change the status quo for oil operations in the North Sea (Austin, Cannon, and Ellis, 2014) sets the stage for challenges on an overarching basis, since geopolitical aims are often key factors in developing clear revenue streams in the oil and gas industry (Hamilton, 2011). For example, new environmental laws and expectations from EU or international interventions in oil and gas exploration based on Scottish independence may have an effect on how the UK proceeds, whether or not the state is able to retain any control over its North Sea investments. It is difficult to predict or map for oil and gas in some regions of the world where there are heavy regulations and also limited means of accessing sample areas, even if these areas could be opened up for oil and gas production in the future. Nonetheless, with decreasing overall potential for production, more risk involved in exploration, and an increased tax burden on the oil and gas companies who are already in place in the North Sea (Hamilton, 2012; Willigers and Hausken, 2013), there is little chance that revenues from valuable mineral rights will be able to be invested and spent by the UK Government for the benefit of current and future generations of British inhabitants.
References
Austin, J. A., Cannon, S. J. C., and Ellis, D. 2014. Hydrocarbon exploration and exploitation West of Shetlands. Geological Society, London, Special Publications, 397(1), pp.1-10.
Dlugokencky, E. J., Nisbet, E. G., Fisher, R., and Lowry, D. 2011. Global atmospheric methane: Budget, changes and dangers. Philosophical Transactions of the Royal Society A: Mathematical, Physical and Engineering Sciences, 369(1943), pp.2058-2072.
Dvir, E. and Rogoff, K. 2009. Three epochs of oil (No. 14492). National Bureau of Economic Research.
Elliott, L. 2012. Britain has squandered golden opportunity North Sea oil promised. The Guardian, 29 March. http://www.theguardian.com/business/economics-blog/2012/mar/29/north-sea-oil-revenue-squandered.
Fantazzini, D., Höök, M., and Angelantoni, A. 2011. Global oil risks in the early 21st century. Energy Policy, 39(12), pp.7865-7873.
Hamilton, J. D. 2012. Oil prices, exhaustible resources, and economic growth (No. w17759). National Bureau of Economic Research.
Hamilton, J. D. 2011. Historical oil shocks (No. w16790). National Bureau of Economic Research.
Hamilton, J. 2009. Causes and consequences of the oil shock of 2007-08 (No. 15002). National Bureau of Economic Research.
Jakobsson, K., Söderbergh, B., Snowden, S., Li, C. Z., and Aleklett, K. 2011. Oil exploration and perceptions of scarcity: The fallacy of early success. Energy Economics, 34, pp.1226–1233.
Peters, M. S., and Kumar, M. 2013. Unique UK’s licensing policy favours the state than the industry: Contradicting conventional wisdom. Acta Juridica Hungarica, 54(2), pp.200-204.
Powell, R. C. 2014. Subarctic Backyards? Britain, Scotland, and the Paradoxical Politics of the European High North. Northern Review, (37).
UK Industry Task Force on Peak Oil and Energy Security. 2010. Report. Retrieved from https://www.google.ca/url?sa=t&rct=j&q=&esrc=s&source=web&cd=6&ved=0CFgQFjAF&url=https%3A%2F%2Fwww.gov.uk%2Fgovernment%2Fuploads%2Fsystem%2Fuploads%2Fattachment_data%2Ffile%2F43199%2F1781-itpoes-report-gulf-of-mex-spill.pdf&ei=QQC_U7SlL8vxoATinYGABQ&usg=AFQjCNF5VdKus4X3qE7lRxGUIUMgUTLITg&sig2=JeqCIV0yr1e6xhinLpdJYw&bvm=bv.70810081,d.cGU.
United States Energy Administration. 2014. Retrieved from http://www.eia.gov/.
Willigers, B. J., and Hausken, K. 2013. The strategic interaction between the government and international oil companies in the UK: An example of a country with dwindling hydrocarbon reserves. Energy Policy, 57, pp.276-286.
Introduction and Background to the Issue
The economic and social context to oil exploration has changed in a significant way in recent years. Growth in oil demand linked to population and global development has led to a lack in surplus production linked to declining fossil fuel fields and the need to resort to shale gas production (Dlugokencky, Nisbet, Fisher, and Lowry, 2011). At the same time, there are ongoing massive pressures for the exploration and exploitation of new sources of energy in places like the North Sea. The instability in the industry as a whole, however, has led to changes in the way that oil and gas resources are managed, which has had a deep effect on global revenue streams and economic benefits linked to production and distribution. As illustrated in Figure 1 below, oil production stopped growing in 2004 while demand continued to increase.
Figure 1: Excess capacity dwindles as demand increases
Source: Fantazzini, Höök, and Angelantoni, 2011, p.7866
At the same time, crude oil inventories have been able to be maintained. Nonetheless, the Organization of the Petroleum Exporting Countries (OPEC) has no longer been able to serve as the global buffer between production and required supplies (Dvir and Rogoff, 2009). Crude oil inventories need to be at least as high as they have been in the last twenty years because of demand in Europe, as illustrated in Table 1 below, which has not decreased in a significant way since 1995. By August 2008, for example, oil in 23 OECD inventories reached 68 million barrels above average, which amounts to only 53 days of oil reserves available to the world (Hamilton, 2009).
Table 1: European crude oil consumption, 1980-2011
Year Consumption Change
1980 12,994.45 NA
1985 11,154.98 -0.79 %
1990 12,021.76 0.46 %
1995 19,243.96 0.55 %
2000 19,032.38 -0.58 %
2005 19,882.42 1.14 %
2006 19,948.94 0.33 %
2007 19,669.51 -1.40 %
2008 19,727.97 0.30 %
2009 18,974.01 -3.82 %
2010 18,936.52 -0.20 %
2011 18,506.84 -2.27 %
Source: United States Energy Administration (http://www.eia.gov/)
To this end, production targets are strongly tied with the economy of not only the oil and gas industries, but also to the economy of countries like the United Kingdom (UK) which are dependent on the use of oil and gas for their broader production industries, transportation, and consumers. In this way, revenues from valuable mineral rights as well as from production and sale of oil and gas intertwine to have an impact on state and regional economies. This essay will examine the importance of North Sea oil and gas revenues to the British economy during the period from 1974 to 2014. The essay will offer a critical appraisal of how revenues from valuable mineral rights are invested and spent by the UK Government for the benefit of current and future generations of British inhabitants. The thesis of this essay is that because the viability of North Sea reserves has become more tentative no matter where and how the exploration takes place, British inhabitants may never benefit from mineral rights and oil production in this region. The reason that this is the case is that research has shown that most estimates of oil and gas potential are likely to be overstated (Jakobsson, Söderbergh, Snowden, Li, and Aleklett, 2011), and the short-term choices made by the UK Government for oil and gas revenues have not counted on this lack of potential.
Analysis of the Evidence
The political framework within which the current UK oil and gas policy operates, especially with regards to the North Sea and its reserves, can be said to be one of significant tension (Powell, 2014). The reason that this is the case is the UK’s policies with respect to the Arctic and sub-Arctic regions are ill-formed and still under consideration, but there is both a Scottish independence referendum and a referendum on the continuance of the current relationship with the European Union still to be decided in the coming years (Powell, 2014). Within this shifting macroeconomic and political framework, very recently in March 2011 the UK government announced a new fiscal policy that aimed to increase the tax burden on oil and gas exploitation activities from 20% to 32%, thus increasing “the headline rate of tax paid by the industry on the profits of Petroleum Revenue Tax (PRT) paying fields to 81%” (Willigers and Hausken, 2013, p.276). To some, this increase read like a last resort technique to garner as much revenue as possible before the likely changes to the UK’s political structure, both nationally and within the context of Europe.
In recent years, it has been argued that the North Sea’s capacity for production has reached peak status (Fantazzini, Höök, and Angelantoni, 2011). At the same time, because of the ongoing challenges in trying to reach new oil reserves in the North Sea, the price of doing business for the oil and gas industry is increasing at a significant rate (Hamilton, 2012; Willigers and Hausken, 2013). As noted by Fantazzini, Höök, and Angelantoni (2011), the Deepwater Horizon incident in the Mexican Gulf has shown that oil exploration companies need to be able to make a more concerted effort than ever before in order to guarantee the safety of not only their own investment, but the safety of the people, fauna, and environment in the region in which they are exploring and drilling. Although in 2010 “the UK treasury introduced a capital allowance for the gas reserves under the deep and hostile waters of the UK Atlantic margin that include the Laggan and Tormore fields” (Willigers and Hausken, 2013, p.277), the financial burden is significant on both the industry and the state (Austin, Cannon, and Ellis, 2014).
The research that this burden exists in the first place, according to the literature, is that the relationship between the state and the industry in the UK is a unique one. As noted by Hamilton (2011), this relationship shifted in 1974 after the world’s first global oil shock, because the UK had been relying on the Middle East for more than two thirds of its petroleum at the time. This was the reason for the development of OPEC, which was aimed at balancing out geopolitical factors from the production and sale of oil and gas, even if this new entity was not entirely successful at achieving this aim (Hamilton, 2011). A series of conflicts in the Middle East that followed this initial shock made it all the more necessary for the UK to develop its own sources of oil alongside other northern regional economies such as Norway. This occurred through the development of a state-controlled system over oil and gas resources in the UK that was implemented in the Continental Shelf Act of 1964 and was consolidated by Part I of the Petroleum Act of 1998 which ensured that all rights and revenues would be crown controlled (Peters and Kumar, 2013). Although, within this framework, there is a need for deep relationships between producers and exploration companies for oil and gas and the UK state, this policy favors the state almost entirely (Peters and Kumar, 2013).
Despite the opportunity for the state to access a significant level of revenue from oil and gas companies, as indicated both by the overarching policy framework and the tax revenue structure that was introduced in 2011 by the Cameron administration as detailed above, this has not been a successful venture for the UK Government. As detailed in Figure 2, below, the net present value of the oil and gas revenue in the UK is low, and the liability that is borne by the Government is growing. In other words, there is a need to recognize the fact that declines in overall hydrocarbon production combined with the realization of the debt incurred to invest in high-risk exploration on behalf of the state is likely to result in a negative economic potential for this kind of project. In addition, the more that the state seeks additional revenues from the oil and gas industry in the form of taxation, the more likely that the challenges involved in garnering a positive economic outcome for this kind of investment will be small over the long term.
Figure 2: Development of the present value of remaining tax revenue and the present value of the decommission liability of the UK government
Source: Willigers and Hausken, 2013, p.277
Given these factors, it is also important to note that there is the potential for additional difficulties in ensuring that any revenues from this process to be spent by the UK Government for the benefit of current and future generations of British inhabitants. As media reports have suggested, the budgets proposed by the UK under the Cameron administration have not necessarily targeted safe investments for these revenues such as pensions, alternative energy sources, or paying off debt, but have rather placed the funds from oil and gas income budgets towards short term challenges such as unemployment insurance shortfalls and personal tax cuts (Elliott, 2012).
Conclusions
This essay has made the argument that the viability of North Sea reserves has become more tentative and that British inhabitants may never benefit from mineral rights and oil production in this region because of the fact that most estimates of oil and gas potential in the North Sea are likely to be overstated and that it is evident that the short-term choices made by the UK Government for the use oil and gas revenues have been focused on short term political wins over long term investment potential for the British public. This claim is likely to be true. The fact that there is no policy framework for operations within the northern regions (Powell, 2014), and the upcoming referenda that may change the status quo for oil operations in the North Sea (Austin, Cannon, and Ellis, 2014) sets the stage for challenges on an overarching basis, since geopolitical aims are often key factors in developing clear revenue streams in the oil and gas industry (Hamilton, 2011). For example, new environmental laws and expectations from EU or international interventions in oil and gas exploration based on Scottish independence may have an effect on how the UK proceeds, whether or not the state is able to retain any control over its North Sea investments. It is difficult to predict or map for oil and gas in some regions of the world where there are heavy regulations and also limited means of accessing sample areas, even if these areas could be opened up for oil and gas production in the future. Nonetheless, with decreasing overall potential for production, more risk involved in exploration, and an increased tax burden on the oil and gas companies who are already in place in the North Sea (Hamilton, 2012; Willigers and Hausken, 2013), there is little chance that revenues from valuable mineral rights will be able to be invested and spent by the UK Government for the benefit of current and future generations of British inhabitants.
References
Austin, J. A., Cannon, S. J. C., and Ellis, D. 2014. Hydrocarbon exploration and exploitation West of Shetlands. Geological Society, London, Special Publications, 397(1), pp.1-10.
Dlugokencky, E. J., Nisbet, E. G., Fisher, R., and Lowry, D. 2011. Global atmospheric methane: Budget, changes and dangers. Philosophical Transactions of the Royal Society A: Mathematical, Physical and Engineering Sciences, 369(1943), pp.2058-2072.
Dvir, E. and Rogoff, K. 2009. Three epochs of oil (No. 14492). National Bureau of Economic Research.
Elliott, L. 2012. Britain has squandered golden opportunity North Sea oil promised. The Guardian, 29 March. http://www.theguardian.com/business/economics-blog/2012/mar/29/north-sea-oil-revenue-squandered.
Fantazzini, D., Höök, M., and Angelantoni, A. 2011. Global oil risks in the early 21st century. Energy Policy, 39(12), pp.7865-7873.
Hamilton, J. D. 2012. Oil prices, exhaustible resources, and economic growth (No. w17759). National Bureau of Economic Research.
Hamilton, J. D. 2011. Historical oil shocks (No. w16790). National Bureau of Economic Research.
Hamilton, J. 2009. Causes and consequences of the oil shock of 2007-08 (No. 15002). National Bureau of Economic Research.
Jakobsson, K., Söderbergh, B., Snowden, S., Li, C. Z., and Aleklett, K. 2011. Oil exploration and perceptions of scarcity: The fallacy of early success. Energy Economics, 34, pp.1226–1233.
Peters, M. S., and Kumar, M. 2013. Unique UK’s licensing policy favours the state than the industry: Contradicting conventional wisdom. Acta Juridica Hungarica, 54(2), pp.200-204.
Powell, R. C. 2014. Subarctic Backyards? Britain, Scotland, and the Paradoxical Politics of the European High North. Northern Review, (37).
UK Industry Task Force on Peak Oil and Energy Security. 2010. Report. Retrieved from https://www.google.ca/url?sa=t&rct=j&q=&esrc=s&source=web&cd=6&ved=0CFgQFjAF&url=https%3A%2F%2Fwww.gov.uk%2Fgovernment%2Fuploads%2Fsystem%2Fuploads%2Fattachment_data%2Ffile%2F43199%2F1781-itpoes-report-gulf-of-mex-spill.pdf&ei=QQC_U7SlL8vxoATinYGABQ&usg=AFQjCNF5VdKus4X3qE7lRxGUIUMgUTLITg&sig2=JeqCIV0yr1e6xhinLpdJYw&bvm=bv.70810081,d.cGU.
United States Energy Administration. 2014. Retrieved from http://www.eia.gov/.
Willigers, B. J., and Hausken, K. 2013. The strategic interaction between the government and international oil companies in the UK: An example of a country with dwindling hydrocarbon reserves. Energy Policy, 57, pp.276-286.