In the third part of his series on oil , Russell Bruce urges swift Government action
As Scotland worries about the fall in oil prices, it should be remembered that there is a view from the other side of the coin: lower energy costs also benefit the consumer, as well as businesses with high fuel overheads.
As a producer of oil and gas with a diversified economy, Scotland is well placed to ride out the present downward pressure on energy prices. But, whilst we have other eggs in our basket, a reform of the tax regime for the oil and gas industry is vital to maintain balance in the Scottish economy.
Consumers
The fall in oil prices is often described as moving advantage from oil companies to the rest of us. What we save on fuel and energy costs gives us more to spend on other items, providing a stimulus to other parts of the economy, therefore, acting in the same way as a tax cut.
Incomes have been squeezed since the financial crash of 2008 as Westminster government economic management and cuts have disproportionately affected lower income groups. Income levels and purchasing power for most of the population have been hit, whilst the top 10% has seen income levels continue to grow.
Consumer savings on fuel and energy is positive for other parts of the economy. Those sectors that gain from increased sales and lower costs will see profits grow and in turn contribute higher tax revenues.
Rural areas not connected to the gas grid are gaining from lower heating oil costs and also from lower fuel costs in travel for work and shopping – 20% of Scotland’s population live in rural areas.
Businesses
There is currently a lot of focus on the retail sector. Increased competition in the supermarket sector is producing discounts to attract customers to combat falling market share in an attempt to slow the ever increasing growth of Aldi and Lidl with their simpler and better targeted product offering.
The big supermarkets will see these pressures offset, to some extent, by falling distribution costs, but so will the smarter competition and it is consumers that stand to gain from this game play.
Scotland’s food and drink sector is a high export earner that has seen significant growth in recent years and will also benefit from lower fuel and energy costs. Lower diesel costs will help agriculture and forestry. Forestry lorries consume 1 gallon every 4 miles on forest roads. Lower felling and transportation costs, combined with energy savings for timber processors will help make Scottish timber and board products more competitive.
Cost advantage will also feed through to construction and building. Big winners are airlines and bus companies like First, Stagecoach and National Express.
Mining, quarrying and aggregate production will also benefit. Energy accounts for about 10% of mining costs and it is higher for opencast production. These are small sectors in Scotland, but as they are energy intensive an eventual upturn in global demand growth will help mop up surplus oil production. Only when global energy demand begins to rise will the oil price recover.
In 2013 the oil industry produced 86,754,000 barrels of oil every day. The amount production has been stepped up in OPEC countries, to drive out high cost US shale producers, is actually quite a small part of total world output, but it has been enough to trigger a dramatic price fall.
Import-export balance
Scotland has a healthy balance of trade compared to the rest of the UK. Lower distribution costs will help high value products like whisky, salmon and shellfish, but if oil prices stay low for too long, not only does it damage the sustainability of our oil and gas industry, but could mean lower margin manufacturers could potentially face increased competition from other countries because getting their products to our market is also much cheaper.
Oil and gas – a Treasury ‘cash cow’
We have a narrow window of opportunity for the Chancellor to act. For 40 years the treasury has raked in oil and gas revenues. The industry is faced with tax rates of up to 80% since George Osborne hiked the supplementary corporation tax rate in 2011.The cost base of oil production from the North Sea at today’s prices is on a knife-edge. We do not have the cost advantage of onshore producers in the Middle East although extraction of North Sea oil is around 40% lower than the cost of US shale or Arctic oil and gas. No other business sector in the UK faces such a tough fiscal regime.
It is time to bring to an end the additional supplementary corporation tax rate and improve allowances for exploration. About 20% of North Sea wells are not profitable at current prices.
Producers have been developing clusters round existing oil fields to benefit from existing infrastructure and pipeline connections. Just six months ago there was a record round of successful licence applications with a large proportion located in blocks adjacent to earlier finds. As flows decline from older fields and new wells are drilled, with some new finds discovered at the lower levels now accessible, the cluster complex model is a means of maximising short term potential and longer-term opportunity.
Tax incentives for clusters ?
Tax incentives for clusters are one way of protecting both production flows at sustainable levels and remaining reserves for the future. Decommissioning is expensive for both producers and government who would share the cost.
Once a field is decommissioned any remaining oil is permanently lost. With new technology enabling extraction of more oil from wells otherwise approaching depletion levels, it is madness to throw away that investment from the private sector and trigger decommissioning costs from both government and oil producer. Tax credits to guarantee sustainable production above marginal rates would help the industry stabilise until oil prices recover.
Oil analysts at Wood Mackenzie have also advocated the group approach, as reported by Investors Chronicle which says: “Wood Mackenzie makes the point that because of the relative complexity and inter-dependence of many North Sea fields, the economics of a group of fields will often have to be taken into consideration, as opposed to standalone assets.”
Smaller companies and those that concentrate on exploration face a tax disadvantage. Large companies can offset investment against profit from other fields now in production. Giving smaller companies immediate access to these tax allowances would place them on an equal footing with larger companies. This change, to support investment levels, has long been advocated by the Scottish Government and the industry.
Norway recognised this issue as far back as 2005 and introduced tax credits to stimulate the drilling of exploration wells. In 2008, 56 exploration wells were drilled in the Norwegian sector – a fourfold increase over 2005 levels.
Smaller companies have more reason to invest in the Norwegian sector when UK tax rules place the UK Continental Shelf (UKCS) at a disadvantage. Such a change would make a significant difference to smaller companies and free up the cost of carrying high levels of investment. Holding tax allowances that can only be cashed in against future profits is of no value to a company that runs out of cash before the payback from exploration is achieved.
The industry is making decisions now to protect themselves from the drop in oil prices. Only the Chancellor has the power to make the tax regime fairer and protect an industry that has paid in to its coffers for 40 years. Just introducing a level playing field, even if some tax changes are time limited, will go a long way to protect our share of the global market, save jobs and secure the future.
Renewables and the energy mix
The skills base in the oil and gas sector has transferrable potential to offshore wind, tidal and wave energy. Companies in contracting, engineering and support, currently working in oil and gas, have additional opportunities in renewables to take up any pull back in North Sea investment. It is vital we continue to invest in renewables to maintain a balanced energy mix and continue making progress on reducing our carbon footprint and dependence on fossil fuels.
It is also time to shift the focus. For too long, there has been too much emphasis on Scotland’s economic ‘dependence’ on oil, when in fact we have a broad energy mix that demands a holistic understanding of Scotland’s strength as a player in the energy market.
There is no lack of understanding of the need for a strategic approach on the part of the Scottish Government and its economic agencies, currently pursuing a range of new energy opportunities that Scotland is ideally placed to benefit from. But there is little understanding in the public mind that Scottish waters, as well as producing over 90% of the oil from UKCS also produces 50% of all the gas brought ashore from the entire UK Continental Shelf.
Whilst the Scottish Government has done much to develop our energy industry, energy is not devolved, leaving realistic and timely solutions in the hands of a UK government, always too slow to act. The hike in supplementary corporation tax in 2011, an idea dreamed up by Danny Alexander, has inflicted much damage on the oil and gas industry.
This hike was 6 years after Norway recognised the need to change their tax rules to help smaller companies. We are still waiting for the cumbersome cogs at the treasury to start turning. I am sure we could spare a little oil to lubricate the treasury’s cogs to get them moving in real time.
George Osborne has been diverted with the possibility of fracking to increase UK production. Given the problems the US is now facing with the high cost of producing oil and gas from fracking this looks an impractical dream for the UK. The flow rates from fracking fall dramatically in the second and subsequent years. Production can only be maintained by drilling more and more holes.
A mechanical/hydraulic drilling technology that turns the landscape into some kind of inedible Swiss cheese will not endear fracking explorers to a population already opposed to, and deeply concerned about the technology and environmental impacts.
Oil and gas production is essential to our long-term ambitions in renewable energy because the earnings, technology overlap and skills base must be supported and further developed in order to achieve what is a long-range transition.
Scottish oil and gas service companies are gaining contracts across the world. We must not put that at risk, but instead build on our achievements.
Scottish expertise in marine renewables is opening up a new energy frontier. We must remain at the leading edge of this potential because we have worldwide market opportunity to build on the success that our oil and gas sector has carved out.
