OH, FOR some oil price volatility – only this time upwards. By any standards we have witnessed an extraordinary collapse in the price of oil. It will bring gains for consumers and benefits for thousands of companies. And in pushing inflation down to 1 per cent it has removed any immediate prospect of a rise in interest rates.
But it is far from gains all round. A collapse of more than 40 per cent in the price of Brent crude to below $60 at one point last week spells deep trouble for the North Sea industry. For the past three years the story has been one of rising investment, strong production and a boom in employment both directly and indirectly across the oil supply and services sector in the north-east of Scotland.
That picture has changed dramatically, with cancelled investment, cutbacks and lay-offs as firms adjust to a sharply lower oil price in a sector already having to contend with rising production costs. At $60 a barrel many of the marginal North Sea fields are now bleakly uneconomic, forcing wells to be capped and investment to be curtailed.
The industry is now desperately hoping for relief on two fronts: first, that the UK government will respond with tax cuts markedly more bold than the small reduction announced in Chancellor George Osborne’s Autumn Statement; and second, that there is now oil price volatility in the opposite direction.
The stunning $56 price plunge in barely three months may well be an over-reaction. An upward bounce in the next few weeks would provide hope for a more stable “floor” price well above today’s level. Commodity markets are just as liable to overshoot as stock and currency markets. But longer-range forecasts still point to an average oil price across 2015 of $80 a barrel – forcing major retrenchment in the North Sea.
There are signs that the Treasury may be working on a response more reflective of the scale of the crisis than the token cut announced by Osborne: a reduction in the supplementary charge on profits from 32 to 30 per cent. The tax break, effective from January, lowers by a fraction the 12 percentage point increase in the rate of the supplementary charge introduced by Osborne in his 2011 Budget. He maintained the basic rate of ring-fence corporation tax on offshore operators at 30 per cent and petroleum revenue tax levied on operators whose fields were sanctioned before 1993 at 50 per cent.
“Too little, too late” was the widespread reaction. Now industry pressure for action is markedly more intense for an early move on the Autumn Statement hint that the government would “aim to reduce the rate further in an affordable way”.
That’s not easy for a cash-strapped government: in 2012-13 the North Sea offshore oil industry poured £6.5 billion into the government coffers. But on Friday the Treasury chief secretary admitted that the Treasury must accept “significantly lower taxes from the North Sea in future to create jobs and boost investment”.
He described industry warnings that plummeting oil prices could render some North Sea projects unprofitable as “a big concern” and said the government must keep improving regulation of the North Sea, drive down taxes and continue with supportive measures such as decommissioning, investment and exploration allowances.
The past week has brought a chorus of warnings. Robin Allan, chairman of the independent explorers’ association Brindex, warned that the North Sea industry was “close to collapse”. With a price below $60 a barrel, almost no new projects in the North Sea are profitable.
“It is a huge crisis,” he said. “The industry adapts, but the adaptation is one of slashing people, slashing projects and reducing costs wherever possible … In terms of new investments – there will be none, everyone is retreating, people are being laid off at most companies this week and in the coming weeks. budgets for 2015 are being cut by everyone.”
Earlier, veteran oil industry figure and government adviser Sir Ian Wood predicted a wave of job losses in the North Sea over the next 18 months.
US oil giant ConocoPhillips is already cutting 230 out of 1,650 jobs in the UK and is planning a 20 per cent cut in its worldwide capital budget. Goldman Sachs analysts suggest that $930bn of projects worldwide could fail to get the go-ahead next year. And the North Sea is seen as one of the higher-cost, lower-return regions for investment.
On Wednesday, Aberdeen-based Wood Group announced a pay freeze for staff and cut rates for its contractors. Apache, one of the North Sea’s biggest producers, has followed suit and will impose a 10 per cent reduction on its contractors’ wages from 1 January.
The hope throughout the independence referendum campaign was that high investment would continue, with Holyrood’s health and welfare spending plans funded by gushing oil revenues predicated on a price of $113 a barrel. All this has been blown to pieces with the price now at $61.81 and many fields uneconomic below $80. And given the contribution of the North Sea sector to Scotland’s economy, it is likely that overall growth, measured by GDP, will lag the 2.7 per cent growth forecast for the UK overall next year.
Unrelieved gloom? Of course not. The fall in fuel costs will act as a tax cut for households and businesses. Cheaper oil should also help mitigate the slowdown in global growth and thus be of help to exporters. Business confidence and investment should gain from the further deferment of an interest rate rise well into the second half of 2015.
It will take time for the full effects of the oil price drama to work through. But there are upsides here as well as downsides. Continuing low inflation, likely to fall below 1 per cent in the coming months, should bring – at last – an acceleration in real household incomes. And that in turn should help government tax receipts and mitigate the loss of oil revenues. «