An independent Scotland

July 14, 2014
The next possible surprise for oil and gas producers working on the UK Continental Shelf (UKCS) is one that can be seen coming.

The next possible surprise for oil and gas producers working on the UK Continental Shelf (UKCS) is one that can be seen coming. On Sept. 18, residents of Scotland over the age of 16 will have the chance to vote on this question: "Should Scotland be an independent country?" Because much UK oil and gas production is in Scottish waters, the referendum raises many questions for the industry.

At first glance, independence—which is not certain to occur—might seem ominous. The campaign for it emerged from liberal politics—energized initially, according to some observers, in reaction against the UK's conservative swing while Margaret Thatcher was prime minister in 1979-90. And it receives strong support from the majority Scottish National Party, which pursues aggressive targets for renewable energy and greenhouse gas emissions and promises never to allow construction of nuclear power plants. So far, however, that strongly green tilt on energy hasn't morphed into official resistance to the production of oil and gas.

Encouraging report

Indeed, a new study conducted for the Scottish government is encouraging. Most impressive about it are principles the government asserted while asking the four-member Independent Expert Commission on Oil and Gas to examine problems confronting an independent Scotland. Derived from an existing oil and gas strategy, the principles are:

"• The fiscal regime must support and incentivize production.

"• There should be long-term stability and certainty in the fiscal and regulatory regimes, including the commitment to formal consultation prior to future reforms, and specific clarity on the fiscal treatment of decommissioning costs.

"• There are efficient fiscal incentives to maximize economic recovery rates."

The government further stipulated that an independent Scotland should ensure "appropriate incentives are in place to support exploration and field development and critical infrastructure is maintained and developed to maximize recovery." These guidelines reflect not only determination to sustain UKCS oil and production but also healthy attention to past errors.

The report cites as its starting point the Wood Report published earlier this year to general applause from the UKCS industry. That report, by a group led by former Wood Group Chairman Ian Wood, called for regulation oriented to "maximizing economic recovery (MER)" and heightening collaboration between the UK government, industry, and a proposed regulator for licensing, supervision, and stewardship. The new report proposes to place MER in the context of "total value added (TVA)," addressing what it calls the absence of "any real understanding of what overall value is generated by the production of hydrocarbons from the UKCS to the wider economy." It defines TVA as wages, profits, and taxes related to production, the supply chain, and "induced activity of the supply chain."

To capture total value, the report says, policy should address problems now creating an "unsustainable commercial environment": falling production, record-high operating and development costs, low exploration, high and rising wages, and a labor force growing in relation to production rates. The challenge: "To adapt quickly to the transition of the UKCS from a province where prospectivity attracted high levels of investment to one where investment in late-life fields and more technically challenging resources is rewarded by a reasonable rate of return for industry and for the nation."

Surprise and complexity

The report calls for a fiscal regime based on "stability, predictability, and international competitiveness" in support of long-term investment. And it notes that since 2000 the UKCS has had three major tax increases. "All of these took the industry by surprise" and were followed by adjustments once damage to the industry became clear to the government. "The result is a highly complex offshore tax system," the report says.

The oil and gas industry should welcome the report's clear-headed focus on encouraging oil and gas production in pursuit of maximum economic goodness. If a newly independent Scotland followed the advice, surprises for oil and gas producers caught up in historic change would be less drastic and less damaging than they otherwise might be.