In a few weeks’ time, the oil in the North Sea could suddenly be under the sovereignty of a new country.
Scotland is pushing for a referendum on independence from the United Kingdom, and the September 18 vote is quickly approaching. The nationalists hope to build an independent country on the back of North Sea oil, which they say will help them fund schools, infrastructure, and healthcare. Currently, as a member of the UK, revenues from North Sea oil production are collected by the British government in London. But, if Scotland becomes independent, around 90% of the oil in the North Sea will fall within Scottish territory.
Pro-independence nationalists claim that the tens of billions of dollars will bring economic growth to Scotland, and investment will halt the decline in production in the North Sea. How true is this? Can North Sea production be turned around? Let’s take a look at Scotland’s bid for independence and the role that the North Sea will play in it.
The North Sea has been the core of British oil and gas production for decades, accounting for more than 90% of the country’s output. So when talking about British oil production, we are really talking about offshore oil. Production temporarily peaked in the 1980’s, and after a brief recovery in the 1990’s, British oil production went into a sustained period of decline. In 2013, the UK only produced 820,000 barrels per day, a 62% decline from a decade earlier. From 2012 to 2013 alone, oil production declined by nearly 10%.
And there is no secret to the problem. The oil fields have matured and are in decline. Without major new discoveries, the oil industry is unable to replace lost production. In 2013, the UK hit a milestone – it became a net importer of petroleum products for the first time since 1984 as its fields continue to fizzle.
Moreover, as fields mature and production declines, the cost of extracting oil is heading in the other direction. According to The Economist, producing a barrel of oil in the North Sea is now five times more expensive than it was in 2002.
Scottish nationalists are trumpeting potential tax receipts from oil as a reason to push for independence. Critics of the nationalists say that they are relying on rosy projections. The oil industry generated 10.6 billion British pounds in revenues for the country in 2013. Scottish nationalists predict they will rake in 48 billion pounds over the next five years, however, a lot of factors – oil prices, production levels, and tax rates – make future projections hard to predict.
The Scottish government says 24 billion barrels could remain in the North Sea. More modest projections peg the figure at just 9 billion barrels. The difference is important.
Scottish nationalists also predict they will turn around production levels, and by the end of the decade, they believe they will succeed in lifting output to nearly 2 million barrels of oil equivalent per day (including natural gas). That is probably fanciful. The British government predicts output could continue its descent downwards, which is probably more likely, especially since investment is down and only a few dozen wells were drilled in 2013.
The nationalists want to setup a sovereign wealth fund modeled after Norway, but it faces a conundrum. If it cuts taxes, it will not have enough revenue to fill budget holes. If it maintains high tax rates, it will stifle investment.
But the trajectory largely depends on how the Scottish or British governments deal with tax rates going forward. Most agree that the tax regime would need to come down to stem the decline in production, let alone boost output. The top rate is 81% for fields that were approved before 1993.
A tax cut would definitely be good news for oil companies maintaining their positions in the North Sea, and would be a shot in the arm for new investment. Experts have called for lower taxes on profits. Also, energy experts call for more incentives for new drilling as well as for managing old wells that are in decline. Costs of decommissioning are too high, which are preventing sales between firms.
That means regardless of the outcome on Scottish independence, tax rates could soon change to reflect the declining importance of the North Sea. Despite low production levels, tax changes could have an impact on several companies operating off the British Isles.
Measured by output, Nexen (NYSE: NXY) is the largest operator in the UK North Sea, producing 188,000 barrels per day, or about one-quarter of North Sea production, according to the Energy Information Administration. More than 95% of the company’s North Sea production comes from one single site: the Buzzard field. The Buzzard produces 179,000 bpd and is the largest producing oil field in Britain. No other field comes even close – the second largest, the Forties field, produces just 41,000 bpd. Nexen is probably the firm to watch when it comes to changes in the North Sea.
Talisman Energy (NYSE: TLM) is another mid-sized operator in the North Sea. It produces just 33,000 barrels of oil equivalent from its North Sea fields. At this point it hopes to merely maintain production, and has indicated a desire to divest from its assets in the UK.
BP (NYSE: BP), once a giant in the North Sea, is obviously a massive multinational oil company. Its assets in the North Sea are thus no longer that important. Its fields in the North Sea produce just 72,000 bpd in 2013. BP’s production would be affected by changes to tax regimes in an independent Scotland, but it would also be just a blip on the oil major’s radar.
Similarly, Chevron (NYSE: CVX) has stakes in several producing oil fields in the North Sea. The Captain (28,000 bpd), the Alba (17,000 bpd) are its two main oil fields. The production is not trivial, but for a multinational producing 2.6 million bpd worldwide, the potential change of sovereignty in the North Sea will likely not matter much. On the other hand, Chevron has a 19.4% interest in a $7 billion oil project near the Shetland Islands. Known as the Clair Field project, it is expected to produce 120,000 bpd and enter into operation by 2016.
In the grand scheme of things, whether or not Scotland becomes independent or remains a part of the UK probably does not matter much to the firms operating there. The oil industry will likely receive similar treatment either way. On the other hand, billion dollar investments crave certainty, so the prospect of dealing with a new sovereign is likely causing some unease among oil executives.
The nationalists had been behind in the polls, and it appeared they would fail in the referendum. But in late August, opinion polls narrowed. The push for independence does consist of a lot more than a thirst for oil – nationalistic feelings, history, culture – but the prize of offshore oil fields in the North Sea is at the heart of the debate.
And the vote may come down to whether or not individual Scots think that the nationalists are right. Independence could keep billions of dollars in revenues within Scottish borders. On the other hand, if the nationalists’ projections on oil revenues are wrong and oil production continues to decline, as critics point out, Scotland could actually lose out – it would forgo the revenue sharing it receives from London in favor of a shrinking oil pie.
We will find out on September 18.