The British government proved its responsiveness in the weeks before Scotland's Sept. 18 vote on independence. Alarmed by polls showing majority support for independence, it initiated a campaign of advocacy and political promise that carried the day. Scottish voters rejected independence, 55.3%-44.7%. In a related matter, Whitehall now must attend to oil and natural gas.
Independence and oil and gas policy are related because of Scottish domination of production. More than 95% of UK Continental Shelf (UKCS) oil output occurs off Scotland. The gas share exceeds 50%. While those percentages will increase, they'll be growing shares of a shrinking whole.
Morsel of cheer
Economic Report 2014, newly published by Oil & Gas UK (OGUK), offers a morsel of cheer about a province well past its heyday. UKCS oil and gas production, which peaked in 2000, fell last year by only 7.7%. The decline rate was 14.5% in 2012 and 19.2% in 2011. Accomplishing this relative flattening of output required record spending and start-up of 13 fields.
The problem isn't an absence of geologic promise. Recoverable oil and gas volumes on the UKCS are estimated to total 15-24 billion boe. But new-field sizes are shrinking while costs are expanding. Exploration is flagging.
According to OGUK, fields under development are on average 5 million boe smaller than those of 10 years ago. Meanwhile, the average development cost per unit of reserves for projects under consideration for investment, adjusted for inflation, has more than tripled since 2004. Unit operating costs since then have quadrupled. Last year operators drilled only 15 exploratory wells on the UKCS. During 2009-13, the average exploratory-well count per year was 20. During 2004-08 it was 35.
At odds with these hard realities of resource maturation is the UK fiscal regime for exploration and production, which the government can't be said to have ignored. It has, in the past, adjusted taxation to encourage production from old fields and development of small ones. According to some critics, it also discouraged exploration. More damagingly, it has surprised producers with tax increases in times of unusual fiscal distress.
After replacement of royalty with a supplemental charge (SC) on production atop the corporation tax in 2004, the taxation rate on development of new fields was 40%, OGUK says. But the government unexpectedly increased the rate to 50% in 2006 and to 62% in 2011. In 2009, it began providing SC relief in the form of fixed-value field allowances to boost marginal investments. Once a field has exhausted its allowance, though, the tax rate rises to 62%. The marginal rate on production from old fields can be 81%.
For a producing region with its future defined increasingly by high reservoir pressures and temperatures, deep water, diminishing scale, and other costly challenges, the UK fiscal regime represents a hindrance. The marginal tax rates are too high. The patchwork of field allowances is tenuous. UKCS development can't compete successfully for investment and achieve its full potential under this complicated system, especially after the disturbing surprises of recent years.
To its credit, the government has begun to respond. It has accepted the Wood Report, a study concluded early this year recommending that oil and gas regulation be oriented to "maximizing economic recovery" (MER). The report called for collaboration among the government, oil and gas companies, and a new agency to oversee licensing, supervision, and stewardship. The agency, Oil and Gas Authority, is being formed.
Scottish recommendations
That's a start. The government also should consider recommendations of a study done by an independent commission of experts for the Scottish government in anticipation of independence. That study introduced "total added value" as a broad economic context for MER and stressed the need for regulatory and fiscal stability.
Whitehall has all the information it needs to understand and solve problems impeding the fulfillment of UKCS potential. What it must do, as it did once it fully appreciated how serious Scotland was about independence, is respond.
