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UK Budget: how ‘peak oil’ plays out in practice

Buried beneath George Osborne’s cuts to disability benefits and his damascene conversion to a sugar tax was a measure that should alarm us all.  Osborne has made the tacit admission that energy is more important than the public finances.

Between 1979 and 1999, Britain had been self-sufficient in fossil carbon.  The UK still had vast reserves of coal, to which it had added North Sea oil and gas.  This allowed for the economic upswing in the 1990s that has wrongly been attributed to the policies adopted by the Thatcher government.  Indeed, the current UK government’s attempt to pull off the same trick without the income from oil and gas is failing dismally.

The North Sea peaked in 1999; by which time the UK coal industry had also been destroyed.  So the UK has had to rely on imported coal, oil and gas to meet a growing proportion of its energy needs.  Nevertheless, oil and gas extraction in the North Sea has continued – there is plenty of oil and gas, it is just harder to produce, and it comes in smaller amounts as time moves on.

So for 15 years after the North Sea peaked, it continued to provide a key revenue stream to the UK treasury.  In practice, this meant that the sale of UK oil and gas provided a part of the cost of running public services like schools, hospitals and care homes, and paying a part of pensions and disability benefits.

The crash in oil prices since June 2014 has all but destroyed investment in further oil and gas extraction around the world.  New “unconventional” (i.e. expensive) operations such as Arctic, deep sea, shale and tar sands have been put on hold.  Even relatively low-cost areas such as the North Sea have seen investment dry up.  The result has been that drilling rigs have been scrapped and key workers laid off.  In the North Sea, an industry that used to bring in billions of pounds to the UK Treasury is now worth less than Marks and Spencer.

Unlike steel, where the government has been happy to throw plant and jobs to the wind, the UK government has now written off the revenue that it used to derive from the North Sea in order to bolster the industry.  In practice, this means that the proportion of public spending that used to be met by taxes on oil and gas will now have to be met through additional taxes (e.g. sugar) or further cuts (e.g. disability support) or through further claims (borrowing) on future taxpayers.  At the same time, political giveaways (e.g. the rise in the higher rate tax allowance) will be harder to fund.

This situation is not going to get any better.  There is still oil beneath the UK continental shelf.  Indeed, it is one of the most explored areas on earth, so the energy companies know where the remaining oil and gas is.  But there is a reason why the remaining oil and gas deposits have not yet been extracted – they are in smaller fields and are harder (i.e. more expensive) locations.  At $40 per barrel, none of the energy companies is interested in any more drilling.  So for the time being, the UK economy is going to have to make do with shrinking production and increasing imports.

Nor will increased prices necessarily change the situation.  Investors dislike volatility.  So even if the International Energy Agency are correct, and prices rise later this year or early in 2017, prices may need to remain high for a year or more before sufficient capital can be generated to invest in new drilling.

This raises the prospect of the nest step down the post-peak oil slope – government subsidy.  The UK government is already providing subsidies of a kind to onshore fracking and nuclear power through a future price guarantees.  The same mechanism is less easy to apply to oil and gas, so it is more likely that the government will have to offer exploration grants to companies that agree to open up new oil and gas fields.

In practice, all of the public services and benefits that oil and gas revenues used to fund will become increasingly unaffordable as a greater part of our economic activity (through future taxes and energy prices) has to be diverted into securing future energy.  We can still argue about how the cake gets divided up… but the fundamental problem is that the cake is shrinking!

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