On the significance of low oil prices for Scotland

Much is being made by commentators of the falling price of oil and its impact on the plans the SNP had made for an independent Scotland. In Scotland’s Future the SNP (sorry, Scottish Government) assumed an ‘average cash price of approximately 113 dollars per barrel’ through to 2017/18 (Scotland’s Future p. 510). The price of oil quoted when I last looked today was $71.95 (all prices are per barrel of Brent crude). Commentators’ conclusion? Big problems for the offshore oil and gas industry and the SNP’s now-hypothetical plans for independence.

Let’s take these two things in turn.

The offshore oil and gas industry

I moved to Aberdeen in 1985. It was in the full flush of an oil boom. In November Brent crude was priced at nearly $30. By July 1986 it had plunged to under $10.

Aberdeen seemed to go from boom to bust virtually overnight. At one stage a dozen unwanted drilling rigs were stacked offshore, visible from the office building I worked in. One suburban street in particular, Lee Crescent North, became the living embodiment of a moribund residential property market, full of vacant properties that no-one wanted to buy. A locally famous BBC Panorama programme interviewed a woman who ran what was politely called a gentlemen’s club [2/12/14 – a correspondent reminds me her name was Honey de Chevette. Of course]. Business was dreadful, she confided. In an echo of the American technology and Texan skills that drove the offshore oil industry in its early days, people talked of sagebrush blowing down Union Street.

As this graph of oil prices over the last thirty years shows, the price had bounced back to a new peak of $36 by October 1990 (click to enlarge), coincidentally the year of peak UK offshore and gas production, and has since fluctuated widely. The graph incidentally shows prices in money-of-the-day. As an example of the impact of inflation, the $30 oil of 1985 would cost $66 today.

Brent spot price v2

Brent crude price in $ 1984-2014 Source: US Energy Information Administration

The purpose of this note is neither to explain those fluctuations nor to forecast future prices, which would take a better man than me. The point is, prices move up and down and have an impact on the industry.

Here are the sorts of things that happen when prices fall significantly and for a long period.

  • The industry examines its cost base in a way it doesn’t when the good times roll. It looks to cut ongoing costs and overheads. This can be done in many ways but it usually impacts on the size of the workforce and its terms and conditions
  • It defers investment in proven but undeveloped reservoirs
  • It cuts back on exploration (hence all those rigs parked off Aberdeen in 1986)
  • It looks to switch its efforts to cheaper oil provinces (offshore production, it need hardly be said, is always relatively expensive)
  • It rarely closes down producing fields because on balance restarting production or abandonment costs more than keeping the oil flowing in anticipation of higher prices (I have seen a price of $60+ quoted at which a field in 2014 starts to lose money but circumstances are so particular to individual companies and  fields that I would not give this figure much credence without evidence)
  • It looks to government for support through an easing of the fiscal regime and incentives to invest (posh for paying less tax).

Notwithstanding all these impacts, the good news is that there’s still the same amount of oil in the ground and when prices and confidence return activity is likely to increase.

The SNP’s plans for independence

The SNP talk of oil as a ‘bonus’, not essential for a viable economy after independence but as the icing on the cake.

Their planning, such as it is in Scotland’s Future, assumes an average $113 per barrel price until 2017/18 compared to the current $72 or less. Being generous and assuming that the industry keeps pumping oil at the current rate and an independent Scottish government would have maintained existing tax rates, their actual tax take would be 63% (72/113 x 100) or less than two-thirds of what the SNP previously assumed.

But then factor in that production is declining anyhow and might well dip further under the pressure of low prices. Factor in also that the industry is likely to put pressure on government for additional incentives (i.e. subsidies) to invest. Add in the wider costs to the economy and to the government’s finances of even a temporarily diminished oil industry. And finally, consider the impact this might have on the SNP’s already flawed plans to set aside oil revenues for a sovereign wealth fund.

At the very least, none of this would be helpful to an independent Scotland in its early years (it’s not helpful to the UK either, but the impact is proportionately less – an advantage of being part of a larger economy, and lower energy prices help the non-oil economy).

A conclusion

I’ve tried in this analysis to steer a course between two positions,

  • on the one hand, the SNP position (hypothetical since they lost the referendum) that none of this matters because, so Nicola Sturgeon claimed in a recent interview, prices will be back up to at least $100 soon (she cited industry and OPEC sources)
  • on the other hand, the voices of some ‘No’ critics who claim that the current low and falling oil price mean the SNP’s economic plans for an independent Scotland were fatally flawed and thank God they lost the independence referendum.

I think the SNP’s economic plans were fatally flawed but for a much wider range of reasons and I also thank God they lost the referendum.

However, much more important than the current low price of oil are the facts I set out in my earlier post on The SNP’s deceit (or naivety) about the UK oil and gas industry. If you don’t like the polemical bit of that skip the beginning and end and just read the parts on what drives investment in the industry and why North Sea oil and gas production is set on inevitable decline. That’s why the SNP are so wrong about the industry and its place in Scotland’s economy in future.

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