North Sea Oil and Scottish Independence: where does the truth lie?

• How much oil and gas is left in the North Sea? 16 billion barrels oil equivalent (boe) according to Sir Ian Wood or 24 billion boe according to Oil and Gas UK? The correct answer for official proved+probable reserves is between 8 and 9 billion boe, a figure that both DECC and Oil and Gas UK agree on. With over 9 different classes of reserves, this debate is sterile and this is not the correct question to ask.
• How wealthy will oil make Scotland? In 2013, the direct tax take from oil and gas production for the whole of the UK was £4.67 billion and falling. This compares with annual spending of the Scottish government (plus UK spending on Scotland) running at £65.2 billion. Hence, direct taxation of oil and gas production may account for less than 7% of the Scottish budget. What we should be asking is where the other 93% is going to come from?

 

On 18th September this year people resident in Scotland be they Scottish, English, Irish or Polish will vote on Scotland’s continued membership of The United Kingdom. The debate is heating up. Oil magnate Sir Ian Wood suggests that remaining oil and gas reserves are about 16 billion barrels oil equivalent (boe). While industry representative Oil and Gas UK suggest a figure of 24 billion boe, a figure preferred by the pro-independnece lobby. As discussed below, both of these numbers as they stand alone are totally meaningless.

Voters are clearly confused and are pleading for real data upon which to base this most crucial of decisions. In this post I attempt to bring some reality to the debate about North Sea oil and gas reserves, production and finance.

Reserves Figures are a Sterile Debate

The Society of Petroleum Engineers provides a framework for the classification of reserves based on class and certainty [1]. There are three classes and three certainty levels giving at least 9 different classifications of reserves (Figure 1). And so, when a number of 24 billion boe is reported it is essential to qualify this with the classification terms. Are these 2P reserves? i.e. oil and gas known to exist with a high degree of certainty. Or are they 3P reserves + resources, i.e. oil and gas optimistically hoped to exist, but  yet to be discovered or a means of production economically worked out.

Figure 1 Classification of reserves according to The Society of Petroleum Engineers. The industry standard is normally to report 1P or 2P reserves (the middle of the green band).

Figure 2 UK North Sea reserves estimates from various sources [2]. The 2P figures from the Government (DECC) and Oil and Gas UK are actually closely aligned at between 9 and 11 billon boe oil + gas (updated to 8 to 9 billion boe). See note at the end of this section). With over 42 billion boe already produced it seems likely that 80% of UK oil and gas is already gone.

A year ago I conducted a review of reserves from different sources including my own back of the envelope calculation using industry standard methodology [2] (Figure 2). There is a degree of agreement where the proved oil and gas reserves category lies somewhere between 4 and 5 billion boe. Proved + Probable (2P) reserves stand at around 8 billion boe according to DECC [3] and about 9 billion boe according to Oil and Gas UK [4] (see note at the end of this section). How these figures become inflated to 16 and 24 billion is pure speculation.

Oil and Gas UK qualify their numbers with the need to spend £1 trillion to get their high end estimates out of the ground (Figure 3). Considering that current investment levels are running at around £20 billion per year it will take 50 years to reach that target. Most of the existing infrastructure will have fallen into the North Sea long before. Production growth is now negatively correlated with investment (Figure 4) and one needs to ask the question how likely it is that the industry will sink another £1 trillion into this ageing, mature province? It is of course Oil and Gas UK’s business to talk the industry up.

Figure 3 Excerpt for Oil and Gas UK’s 2013 financial report revealing how they get from 7.4 to 24 billion boe [4].

Figure 4 Despite rising and record levels of investment in the North Sea, oil and gas production has continued to decline [5].

At the current mature stage of North Sea development, oil price is vitally important. With Brent approaching $100 / barrel, companies in Aberdeen are preparing for recession. There are of course bright spots like Clair, Mariner and Laggan Tormore. But there are many black spots where companies can no longer afford to maintain rusting platforms producing a mere dribble of oil. The UK industry currently needs sharply higher oil prices to prosper.

[Note added 17:00, 25th August. I received a few emails from DECC providing more up to date figures than the ones I was using that were complied last December:

Last year we said P+P reserves were 8.9 billion boe. Which I guess explains where your 9 billion boe comes from. Oil & Gas UK were at 9.9 billion boe so I don’t see why you say between 9 and 11 billion boe. It would be more accurate to report DECC’s current estimate of 8 billion boe and Oil & Gas UK’s of 10 billion boe.

Oil & Gas UK now say 9.4 billion boe (see attached) so the range should be 8 to 9 billion boe rather than 9 to 11 billion boe.

The numbers in the post were therefore revised accordingly.]

The Harsh Reality of Production Decline

Combined UK oil and gas production peaked in 1999 (Figure 5). We have now experienced 14 years of relentless decline. This is not speculation but a fact. Production today is 32.4% of the 1999 peak value. Decline is a feature brought about by the depletion of reserves and pressure. At first a field will produce dry oil. But with the passage of time increasing amounts of water are produced with the oil. The industry fights decline 24/7. But it is rather like swimming upstream in a river against a strong current. You may want to get upstream but the current relentlessly wants to drag you down.

There are signs that declines are being stabilised for the time being. This has been brought about by record levels of investment that will not be maintained at current prices [5]. Some large new fields due to come on stream in the near future may arrest or temporarily reverse the long-term decline picture. But all of the fields represented in Figure 5 will still be there pulling production down.

Figure 5 The history of UK oil and gas production according to the 2014 BP statistical review of world energy.

With over 42 billion boe already produced from the North Sea [4], it seems likely that about 80% of the producible oil and gas has already gone. The industry will of course continue for many decades, but on current data it will be at a much lower level than in the past. However, one can never discount a new oil and gas province being discovered in the waters to the west.

The Financial Reality

Direct taxation of the UK oil and gas industry since 1968 is shown in Figure 6 [6]. Direct taxation is in the form of a Petroleum Revenue Tax and Corporation tax that oil and gas operators pay at a higher rate than other companies.

In 2013 the total UK direct tax take from Oil and Gas was £4.67 billion [6]. In 2012/13 total UK and Scottish Government expenditure on Scotland was £65.2 billion [7]. 9.1% of the UK total even though we have only 8.3% of the population. Hence direct tax revenues from oil and gas will amount to less than 7% of the total Scottish budget (the North Sea oil tax figure is for the whole of the UK). Important to be sure, but not nearly as important as the 93% (£60.6 billion) that will have to be found from other sources.

Figure 6 Data for total direct taxation of the UK oil and gas industry [6]. The roller coaster ride in tax income comes down to a combination of production rise and fall, oil and gas price rise and fall, changes in operating costs and changes to the taxation regime. The current environment is one where oil prices have more or less traded side ways since 2008, production has continued to decline and operating costs have gone through the roof. The industry in Aberdeen is preparing for a new cyclical recession. Contractors are being laid off or their rates cut and the operating companies are preparing to lay off staff.

Whilst important, the direct tax take from North Sea oil is by far NOT the most important aspect of the industry to the Scottish economy. The benefits to the economy comes from the economic activity that the oil industry creates. It creates jobs directly in the operating and service companies and in the supply chains. In 2012 this expenditure amounted to £22 billion spent on goods and services, not all of it spent in Scotland. A large amount is spent on salaries to people living in Scotland who then spend this money in local shops, pubs and restaurants. It is true that the tax revenue generated from this activity is shared with the whole of the UK. But it is the economic activity itself that is most important, and this already exists in a Scotland that is part of the UK.

Of similar importance is the fact that Scotland is now a hub for hemispheric oil and gas activity. US companies, based in Scotland, may employ staff here servicing the oil industry in Algeria, Azerbaijan or Nigeria. These companies want stability and certainty to continue their business in an increasingly uncertain world. Similarly UK (Scottish) companies that grew out of the North Sea oil boom like The Wood Group serve the global industry providing jobs and prosperity to Scotland. These companies too want fiscal and currency certainty looking forward. The focus on ethereal reserves is a mistake, the focus on direct tax income is a mistake. The focus should be on the continued  existence of a multi-billion £ industry that provides jobs and prosperity for many and a single minded focus on doing nothing that may jeopardise the present or the future.

euan mearns