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The North Sea – how peak oil plays out in practice

The political row that recently broke out between the Scottish National Party and the Labour/Tory opposition obscures a far more troubling problem for the British economy.

The SNP were accused of lying about oil revenues in the run up to the 2014 independence referendum.  They had claimed tax receipts of up to £7.9bn in 2016/17 and up to £11.8bn in 2017/18.  However, the Office of Budget Responsibility now projects receipts of just £4.6bn for the entire period between 2017 and 2022 – and even this may be overly optimistic.

For all of the political theatrics around this issue, the fact that North Sea oil revenues have plummeted does not mean that the SNP were lying in 2014.  This is simply because the independence referendum campaigns would have been based on a 2013 average annual oil price of $91.17 per barrel rather than the 2016 average of just $34.39.  Indeed, even after the sharp drop in oil prices in mid-2014, analysts at the time saw low prices as no more than a temporary blip within a general rising trend toward an oil price of around $200 per barrel by 2020.

What really happened in 2014 was that the economic limit of high oil prices was reached.  The world’s consumer economies – primarily the USA, Europe and Japan – were so overloaded with debt that even with near zero percent interest rates, the additional cost of oil (and of everything made of or transported by oil) was simply too much to bear.  Spending slumped, economies slowed, and all of the additional global investment in oil made when prices were high began to produce the glut that persists to this day.

We can argue about exactly when global oil production will peak – i.e. reach maximum output.  But when it comes to the North Sea, we can put an exact date on it.  Both North Sea oil and gas production peaked in 1999.  Since then, production has fallen by 60 percent.  The big energy companies such as Shell and BP have all but abandoned the area, having sold their remaining assets to second-tier companies who struggle to turn a profit.

The problem for Britain is not so much that we have consumed half of the resource, but rather that we have produced the easy part.  Smaller, harder-to-access deposits remain.  But the cost of recovering them is no less than the cost of recovering a large easy resource.  So proportionately the cost of producing what remains is rising.  So much so that the UK government has come under increasing pressure to provide assistance to the remaining North Sea drillers.

As Carbon Brief reported; in the 2017 Spring Budget, Chancellor Philip Hammond announced:

“… new plans to help the fossil fuel industry maximise extraction of the last remnants of North Sea oil and gas. This comes after calls for the government to revise the tax treatment in order to allow firms to buy older sites from big players, such as BP and Shell, without becoming accountable for the huge sums involved in decommissioning them.

“Hammond said in his speech: ‘As UK oil and gas production declines, it is absolutely essential that we maximise exploitation of remaining reserves.’”

This is how peak oil plays out in practice.  Those who imagine that when the cost of recovering oil exceeds the price that people will pay for it – somewhere close to the point where an energy equivalent of one barrel is consumed for every three barrels produced – that the oil industry is going to cease are simply wrong.  In fact, Britain is about to do what every other country will also do – raid the wider economy to keep the oil and gas flowing.

After 2005, when global production of conventional crude oil peaked, the energy industry was “financialised.”  That is, with prices rising above $100 per barrel, investors around the world began to pump money into oil and gas.  This process accelerated in the wake of the 2008 crash, as low interest rates made the high potential returns from oil and gas look attractive.  It was this additional influx of investors’ cash that paved the way for the boom in US shale drilling, and in Canadian and Venezuelan tar sands that helped generate the glut that is now keeping prices down.

The crash in prices from 2014 caused that influx of private investment to dry up.  Some energy companies went bust.  Others have negotiated debt rescheduling with banks whose derivatives are underwritten by the returns from technically bankrupted energy companies.  Nobody wants the energy companies to go bust, but nor is anyone is about to come up with the kind of cash injection needed to get a declining region like the North Sea producing once more.  So, just as the government had to step in as the “borrower of last resort” to bail out the banks in 2008, so the British government is poised to become the “energy investor of last resort” in the North Sea.

This will probably manifest in the shape of tax credits that reimburse companies for prior losses; tax breaks for future production; and grants and subsidies of various kinds for opening up the remaining small oil and gas deposits.  But the money to pay for those tax breaks and grants has to come from somewhere.  The choices facing the government are some combination of:

  • Increasing taxes
  • Cutting public spending
  • Borrowing
  • Printing

Increasing taxes is difficult politically – as the chancellor found out within hours of his attempted tax raid on self-employed and gig economy workers, and as he had already acknowledged in cushioning business rates.  The government may find itself having to raise taxes on its wealthy donors as the only politically acceptable means of raising additional taxes in the near future.

Cutting public spending also has limits.  The NHS is in crisis and local authority social care is failing fast.  Prisons are in chaos and policing is becoming intermittent.  In many areas schools are laying off teachers and scrapping courses.  Public infrastructure is beginning to fray.  This suggests that in future the government may have to cut the subsidies that its donors enjoy, such as the UK’s lavish defence budget or the contracts handed out to the big accountancy firms.

Both tax hikes and public spending cuts also have the unfortunate consequence of removing cash from the wider economy with the result that the much sought-after goal of economic growth is thrown into reverse.  Quite simply, people who have to pay more taxes have less money with which to buy goods and services.  People who used to work in relatively good full-time public services jobs all too often end up on benefits or in insecure, part-time and zero-hours jobs; effectively leaving them with just enough money to feed and clothe themselves.

Borrowing would be an option, except that the government already owes more than £18tn.  Worse still, the UK current account deficit – the amount that Britain owes the rest of the world – was up to £25.5bn in the first quarter of 2017.  Although the current account looks tiny compared to government debt as a whole, it matters because either we have to sell assets or we have to lower the value of the Pound to bring the account back into balance (one reason why so much of Britain’s infrastructure is now owned by foreign governments).   Ultimately, of course, government borrowing has to be repaid from taxation and/or cuts to public services.  So indirectly, it has the same political drawbacks.

That leaves money printing.  This is superficially seductive, since it appears to have no impact on the economy.  However, when a government prints additional currency it effectively steals a proportion of the value of all of the currency already in circulation (in exactly the same way as a counterfeiter).  This also risks two unpleasant side-effects.  First, the value of the currency falls on international markets making it much harder for an importing country like the UK to afford its consumerist lifestyle.  Second, it is inflationary – the falling value of the currency is experienced as increasing prices.  And this, of course, has the same impact on consumer spending as a tax hike.

This suggests that there is no good solution to Britain’s desire to keep the oil and gas spigots open.  Since they will not allow the North Sea industry to fail, and since taxing their wealthy donors will be the very last resort, increasing austerity in the shape of rising taxes and cuts to public services will be the route they will follow.  In effect, this means further shrinking the non-energy sectors of the economy in order to keep the energy flowing.

So although peak oil is fundamentally an energy deficit problem, it actually manifests as an ongoing economic crisis. In the absence of someone discovering Dilithium crystals or some other equally implausible energy source, the question this raises is just how long our consumptive way of life can last.

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