George Kerevan: Oil relies on direct approach

An independent Scotland could follow Norways lead and invest public money in the oil industry. Picture: Getty

OIL is the very heart of politics. Energy content drives productivity, which drives economic growth. Without oil and gas, nothing moves. Without North Sea fossil fuel exports, the UK’s balance of trade would be even worse than it is. Oil equals tax revenues. No wonder, then, David Cameron and the UK Cabinet took a day off this week to visit Aberdeen to talk oil.

But here is what David Cameron did not say too loudly: He and the Cabinet are not so much concerned with poor, independent Scotland not being able to afford to run its own energy extraction industry. No, Mr Cameron is petrified that the remainder of the UK, following Scottish independence, would find itself in dire straits without oil. No, Monday’s jaunt northwards was about protecting London’s interests in the oil business.

As we keep being told, oil and gas production in the North Sea has slumped in the past three years. This is not what Chancellor Osborne wants to hear as he struggles to cut the budget deficit. Worse, after the 2015 Westminster General Election, the real public spending cuts will kick in. Osborne has little room for fiscal manoeurvre if he is to eliminate the structural deficit before the decade is out. Erratic North Sea revenues could complicate matters.

So last year the Coalition commissioned Ian Wood, grand old man of the North Sea industrial frontier, to come up with ideas for boosting output and tax revenues from the sector. This had nothing to do with the Scottish referendum and everything to do with saving Mr Osborne’s political bacon.

At the end of last year, Sir Ian delivered his verdict: there is a lot of oil left in the North Sea if only government stopped trying to tax it before companies got it out of the ground. Sir Ian also pointed out that the smaller, leaner firms that do the prospecting these days in the North Sea were finding it hard to access the proper equipment, as the big oil majors were keeping the technical stuff to themselves.

These problems have culminated in the drop in output in recent years. But note: various tax reforms, plus strong global demand, have already boosted investment in the North Sea energy sector, so output is slated to rise again (which is good news for Alex Salmond). However, Sir Ian’s point still holds – without a major reform of how the industry is taxed and regulated, the North Sea and Atlantic energy sector will not yield its true potential.

There is more. The North Sea oil business is about more than tax revenues. Westminster’s entire energy policy is in chaos. Desperate to meet carbon-reduction targets, Cameron and Osborne were unwise enough to cut a deal for new nuclear electricity generating plants with France’s EDF company – the only firm willing to build reactors in the time frame. Result: domestic energy prices are going to go through the roof.

Cameron and Osborne are now struggling to find alternative primary energy sources. Hence the recent talking-up of fracking to tap domestic supplies of natural gas. But public opposition is likely to delay the emergence of fracking. Back to square one. Hence Cameron’s desperation to keep North Sea oil. Hence his visit to Aberdeen to try and convince Scots that only his government can deliver extra output from the sector.

Of course, Cameron is now caught defending a contradiction. Either North Sea oil is running out and independent Scotland will find itself short of cash – Cameron’s first argument. Or (as Sir Ian Wood points out) there is plenty of oil left, if the correct fiscal incentives are provided – which seemed to be Cameron’s message this week. Take your pick.

Here is the question: why should we believe that London has suddenly discovered the key to growing the North Sea oil sector, when 40 years of short-termism and smash and grab tax policies by successive Chancellors of the Exchequer prove otherwise? Mrs Thatcher was content to give away prospecting licences in order to finance income tax cuts, creating our present casino economy. Gordon Brown was happy to use the North Sea as a fiscal cushion, while he replaced manufacturing industry with more banks. No one at Westminster seemed to notice when the big oil majors left the North Sea for pastures new.

I don’t see anything in Cameron’s new emphasis on the North Sea to suggest long-term thinking. But I see a Chancellor anxious to maintain revenues. And I see a UK Treasury that has dug a big hole for itself by rejecting a common sterling zone with Scotland – which would mean North Sea dollar earnings (not just taxes) would accrue to the Scottish central bank. That could give Scotland a £500 billion sovereign wealth fund inside a decade. Yet it would force rUK to seek more foreign capital inflows, driving up interest rates and London property prices.

Cameron’s only argument for keeping North Sea oil in the UK fold is that Scotland cannot afford the tax breaks necessary to reboot the industry. But neither can Westminster. Instead, there is a simple solution – which only an independent Scotland has the incentive to commit to.

In the next phase of developing the North Sea and (especially) the West of Shetland fields, the Scottish Government will need to become an equity investor. In other words, to provide the long-term continuity and investment capital, the state will have to become a direct partner in the industry. Tax yields can be delayed in return for some of the profits up front. With public involvement, much of the gyrations in investment can be avoided.

I doubt if Mr Cameron’s Tories are up for taking a direct partnership in developing North Sea oil and gas, as the Norwegians have long done. But such an approach would be popular in an independent Scotland. Overnight, the industry would cease to be a milch cow for the UK Treasury and become instead a resource to be cherished for the common good.