Scotland-means-business-oil-gas-part-one-24-jul14

OIL & GAS Par t O ne

Scotland Means Business

The Scotland Means Business reports have been prepared for N-56 by a study team that includes:

This report, on the oil and gas sector has been based on the work of Tulloch Energy (the sections the Scottish oil and gas sector) and DAMVAD (the sections on oil and gas in Norway). The summary has been prepared by BiGGAR Economics, which also had overall editorial responsibility for the report. www.n-56.org

CONTENTS

PAGE

1! EXECUTIVE SUMMARY

1!

2! INTRODUCTION

4!

3! CONTRIBUTION TO SCOTTISH ECONOMY

6!

4! OIL AND GAS IN NORWAY

11!

5! GLOBAL ENERGY SUPPLY AND DEMAND

20!

6! SCOTTISH HYDROCARBON RESERVES & VALUE

22!

7! A PIVOTAL MOMENT – THE INDUSTRY IN 2014

25!

8! OPPORTUNITIES FOR THE SECTOR

27!

9! RECOMMENDATIONS AND POLICY MEASURES

29!

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EXECUTIVE SUMMARY The oil and gas sector has been making an important contribution to the Scottish economy for 40 years and will continue to do so for decades to come.

The oil and gas sector accounted for 13% of Scottish GDP in 2012, a significant contribution, although Scotland is less dependent on its largest industry than the UK (where financial and business services account for 15% of GDP) and considerable less than the 26% contribution that the sector makes to the Norwegian economy.

Around 90% of the UK’s oil and gas production and reserves are in Scottish geographic waters.

The oil and gas sector supports at least 450,000 jobs across the UK, with more than 200,000 of these jobs in Scotland, representing around 10% of all private sector jobs in Scotland (for the UK as a whole the sector provides less than 2% of private sector jobs).

The oil and gas supply chain is an economic success story for Scotland, with strengths in areas such as project management, subsea, drilling and well services, health & safety, training services and logistics. There are an estimated 2,000 supply chain companies in Scotland, based in the North East and elsewhere in Scotland, including the central belt and the Highlands and Islands.

Scottish oil and gas services have been a global success story, with sales in overseas subsidiaries and exports at £10 billion, accounting for half of total sales (more than double the value of Scotch whisky exports). In addition, in 2012, Scottish exports of oil and gas were estimated to be worth £30.3 billion.

Between 1970 and 2013, total production, of more than 42 billion barrels of oil, has been valued at £1,081 billion, of which £313 billion has accrued to HM Treasury.

However, the sector has not benefited from the policy focus and stability that it might have expected, given its contribution to the economy and to public finances.

Scotland could learn much from the more strategic approach taken by Norway, where policy has been developed by government, the industry and others working collaboratively to identify the measures required to maximise the sector’s long term economic contribution.

The policy making for the UK oil and gas sector is generally undertaken remotely from the industry itself, with political and civil service decision makers based in London. This contrasts with competitors such as Norway where policy makers tend to be co-located with the industry; Om Oljedirektoratet, the petroleum directorate is headquartered in Stavanger.

There are a number of more specific lessons that Scotland could learn from Norway. The key features of the policies in support of the development of the oil and gas sector in Norway include: • when oil was first discovered in the 1960s, a decision was made that the whole of society should benefit and high rates of tax were set, initially 60%, (based on royalties of 10%, less than the UK’s 12.5% royalties at that time, rather than profits) rising to 78% in the 1970s; • however, the tax system was also used to incentivise investment in R&D, exploration and new production sites; • the tax system was also used to encourage partnerships with foreign

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companies to ensure knowledge and technology transfer to Norway; • in the 1970s, consideration was given to ensuring the Norwegian firms had monopoly or dominant positions. Instead, a requirement for 50% national participation was set (including the state-owned Statoil, the partially state owned Norsk Hydro and the private Saga Petroleum); • other early policy priorities were the development of a strong Norwegian supply industry, the regulation of safety and environmental responsibility, encouraging strong unions and limiting the rate of production (so as to avoid dominating other industries and securing future production); • Statoil’s preference for Norwegian suppliers has also assisted the development of a strong Norwegian owned and headquartered supply industry; • the Norwegian Government also owns a share in several oil and gas fields and facilities, which secure large cash flows in addition to the tax revenues; • in 2012, the Ministry of Petroleum and Energy published “Oil and Gas in the 21st century (OG21)” a joint technology strategy for oil and gas developed with oil companies, universities, research institutions and the supply industry; • another example of collaboration and cooperation is INTSOK established in 1997 to facilitate cooperation between representatives from the petroleum industry, the Norwegian Government and universities on several issues concerning the competitiveness of the industry including costs, increased effectiveness of petroleum operations and internationalisation; • the Government Pension Fund – Global (SPU) was established in 1990 (with the first payments made in 1996) with the purpose of ensuring future generations’ level of welfare and as a measure to stabilise inflation. As of 2013, the SPU had assets of 5.110 trillion NOK (£511 billion), more than £100,000 per Norwegian.

This is a pivotal moment for oil and gas sector. The need for prompt action is obvious. As time passes more and more North Sea infrastructure will be decommissioned. Although novel technologies are being developed to tap small remote reserves, losing productive infrastructure greatly increases the probability that reserves will be stranded and not developed.

Collaboration is going to be of critical importance across all of the areas that the North Sea oil and gas industry must tackle to ensure that the economic potential of Scotland’s remaining reserves is maximised. This is true for exploration, infrastructure, enhanced oil recovery, skills and many more challenges. No matter what the result of the referendum it is imperative that operators, the supply chain and government (both the Regulator and the Treasury) work together towards a common goal.

A range of macro and industrial development policy measures will be required to address the challenges and take advantage of the opportunities.

Macro level policy measures • Exploration incentives - There can be no doubt that Scotland’s yet to find potential will not be realised with current levels of exploration. A range of measures is proposed including taxation incentives, building a better shared understanding of the basin-wide geology, sharing exploration experiences and reducing drilling costs.

• Devolution of regulation and taxation powers to Scotland - No matter the outcome of the independence referendum, regulation and taxation powers Scotland Means Business: Oil & Gas

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should be devolved fully, thus moving responsibility for regulation and taxation closer to the people whose jobs and businesses depend on the continued success of the sector.

• Fiscal stability is essential, as is a fiscal regime that matches the challenges of a mature basin - A thorough review of the taxation system and wider fiscal framework should be undertaken in conjunction with industry to ensure that the regime is competitive and fit for purpose.

• Stimulating research and development - As part of a comprehensive review of the taxation system, consideration should be given to better incentivising at corporation level the development and deployment of new and existing technologies to enhance recovery, extend asset life and increase production in a mature basin.

• New financing solutions - The establishment of a Hydrocarbon Investment Bank should be investigated. It would be tasked with both a domestic and an international remit and would be able to support exploration companies, operators and the wider supply chain.

• Attraction of HQs - Operators and service companies should be incentivised to relocate their corporate headquarters to Scotland.

Development and delivery of a long-term oil and gas sector industrial development plan • Funding an oil and gas industrial development plan - A small percentage of oil taxation receipts should be ring-fenced and used to fund R&D, skills development, international business expansion support and other activities designed to foster economic growth.

• Education and skills - The framework exists to deliver the enhanced skills development programme needed; what is required urgently is a much greater effort between government, industry and the education sector to develop and implement an industry-led long term national skills development programme.

• Scotland the engineering brand - Scotland has earned a reputation for high quality engineering and efficient project delivery and the power of this brand could be better harnessed and developed in a cross sector initiative.

• Entrepreneurial environment - Reducing the taxation burden and incentivising companies to grow Scottish headquartered businesses is crucial and something that could be addressed should additional fiscal and policy powers be gained via additional constitutional change.

• Contracting culture - Clamping down on the abuse of the taxation system, while simultaneously incentivising genuine spin-off and start up activity, could help address the cost burden in the basin, stimulate entrepreneurial activity and increase the rate of new technology development.

• National champions and international opportunities - Creating a Scottish equivalent of INTSOK, the Norwegian industry/government partnership dedicated to expanding Norwegian businesses into international markets, would build on the excellent work that Scottish Enterprise and Scottish Development International currently undertake.

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2

INTRODUCTION The oil and gas sector has been making an important contribution to the Scottish economy for more than 40 years. While predictions that the oil is about to run out have been made regularly since even before production started, there are still considerable reserves in the UK Continental Shelf (UKCS) and so the sector will continue to be an economic driver for decades to come.

However, despite the contribution that the sector has made, and continues to make, to the economy, it has not benefitted from the policy focus and stability that might reasonably be expected. When oil and gas becomes a subject for political debate, the focus tends to be on how much tax the sector contributes to the Exchequer, and how much it might contribute in the future. The success of the oil and gas sector gets overlooked.

As Malcolm Webb, chief executive of Oil & Gas UK, the trade association for the offshore energy sector has said1: “The oil and gas industry is certainly Britain’s biggest and brightest industrial success story of modern times. There is no other industry that comes close to the contribution it has made for the health of this nation… The industry still remains vibrant and important, it employs almost half a million people in the UK. The industry is still the county largest industrial sector and the largest corporate taxpayer.”

The Scotland Means Business reports produced by N-56 (available at n-56.org) argue that Scotland requires a new approach to economic policy development and implementation, with government working more collaboratively with business and others to identify and pursue competitive advantage. In the oil and gas sector, Scotland could learn much from the approach that has been taken in Norway.

New oil and gas industrial strategies have been launched by the UK Government2 in 2013 and by a leadership group set up by the Scottish Government3 in 2012.

While these strategies were welcomed by the industry, it is disappointing that it has taken 40 years, and the existence of two strategies does emphasise the lack of policy co-ordination.

In contrast, Norway provides a case study in co-ordinated policy development and shows what could be possible if such an approach were taken in the UKCS sector. Norway has taken a long-term and co-ordinated approach to policy development for the sector since oil was first produced in the 1970s.

The most recent example is the O&G21 strategy, which was part of a wider initiative, Et Kunnskapsbasert Norge (A Knowledge Based Norway). The policy was developed following at extensive investigative commission that involved all relevant interests (including government, universities, international and domestic companies and trade unions). The context for the policy development was recognition that domestic oil production and associated economic and tax impacts would decrease over time and that diversification would be required.

A target was set to increase the recovery rate of oil reserves from 46% (similar to the level in the UKCS) to 60%. This implies additional production of 15.7 bn boe

1

Quotes taken for interview with Malcolm Webb to Global Business Reports, 18 September 2012.

UK Government (March 2013), UK Oil and Gas: Business and Government Action 3 Scottish Enterprise (May 2012), Oil & Gas Strategy 2012-2020, Oil & Gas Industry Leadership Group 2

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from the Norwegian sector, with a wholesale value of between £1-2 trillion. The strategy included more than 40 separate measures, covering all areas of policy making. These included new arrangements for licencing, simplified arrangements for moving exploration and production facilities to and from the Norwegian sector and a new approach to promoting research and development (R&D).

The promotion of research and development included both the focusing of public sector research funding on solving the industry’s problems and tax incentives that encourages the global oil and gas sector to concentrate R&D investment in Norway. As a result, R&D investment has had a direct economic impact, the sector’s R&D effort has focused on solving the problems that will help Norway to increase the recovery rate and a new technology-based exporting sector is being created.

The net results of the Norwegian approach, in a sector that could have been characterised as in long term decline, have been development of a knowledge based economy, an increase in oil recovery rates, additional tax revenues secured and a growing oil product and service technology sector.

Scotland and the UK could learn much from the Norwegian approach to the oil and gas sector.

This document is Part 1 of a report on the Oil and Gas sector and focuses on the policy approach that is required to maximise the sector’s contribution to the Scottish economy.

Part 2 will consider the impact of the Oil and Gas sector on the public finances and Part 3 reviews longer-term opportunities for the sector.

This report is structured as follows: •

Chapter 3 summarises the contribution of the oil and gas sector to the Scottish economy;

•

Chapter 4 reviews how the oil and gas sector has developed in Norway and the approach to policy that has been taken there;

•

Chapter 5 contains analysis of global energy supply and demand trends;

•

Chapter 6 quantifies production and remaining reserves;

•

Chapter 7 highlights that 2014 is a pivotal moment for the sector;

•

Chapter 8 identifies domestic and international opportunities for growth; and

•

Chapter 9 sets out a series of policy recommendations.

Chapter 3 has been drafted by BiGGAR Economics, which was also responsible for the editing of the report. Chapter 4, on the Norwegian oil and gas sector, was prepared by DAMVAD, an economic consultancy with offices in both Oslo and Tromso. The other chapters have been prepared by Aberdeen based Tulloch Energy, based on its own research and expertise and on extensive consultation with the oil and gas sector.

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3

CONTRIBUTION TO SCOTTISH ECONOMY While there is much more to the Scottish economy than the oil and gas sector, it has loomed large in the constitutional debate since the 1970s. While the long-term future of the Scottish economy will be based on building competitive advantage in growth sectors (for example, renewable energy and life sciences), North Sea oil and gas is important for a number of reasons:

3.1

•

the sector is a significant employer and contributor to the Scottish economy;

•

revenues from oil and gas production have made a significant contribution to the UK Treasury and mean that Scotland makes a net contribution to UK public finances; and

•

the sector has the potential to continue to make an important contribution to the Scottish economy and to public finances, from continued domestic exploration and production and from the export of services and technology.

Contribution to the Economy The oil and gas sector makes an important contribution to the Scottish economy.

In 2012-13, the output from the Scottish geographic share of the UK oil and gas sector accounted for £18.4 billion, 13% of Scottish GDP4.

However, it is difficult to argue that the Scottish economy is overly dependent on the oil and gas sector. It accounts for a lower proportion of GDP than the UK’s largest sector (financial and business services accounts for 15% of the UK), and is a much lower proportion of the Scottish economy than the Norwegian economy (Figure 3-1).

Figure 3-1 – GDP of Largest Sector as Proportion of Total GDP 26%$ 25%#

20%#

15%#

15%$ 13%$

10%#

5%#

0%#

UK#(Financial#&#Business#Services)#

Scotland#(Oil#&#Gas)#

Norway#(Oil#&#Gas)#

Source: Government Expenditure and Revenue in Scotland, Statistics Norway, The City UK

4

Scottish Government (March 2014), Government Revenue and Expenditure Scotland, 2012-13

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The performance of the Norwegian economy has also demonstrated that the oil and gas sector does not necessarily crowd out the development of other sectors (known as ‘Dutch Disease’ after concern at the decline in manufacturing in the Netherlands in the 1960s and 1970s following the discovery of the Groningen gas fields in 1959). The GDP of the onshore (non-oil and gas) economy in Norway is around £100 billion higher than the onshore Scottish economy (Figure 3-2).

Figure 3-2 – Scotland and Norway: Onshore and Offshore GDP, £bn (2012) 300"

Offshore(GDP,((80(( 250"

200"

150"

Offshore(GDP,(19( Onshore(GDP,((228(( 100"

Onshore(GDP,(126( 50"

0"

Scotland((2012)(

Norway((2012)(

Source: Government Expenditure and Revenue in Scotland, Statistics Norway

As Figure 3-3 shows, Scottish GDP including the oil and gas sector is more variable than Scottish GDP excluding the oil and gas sector. However, Scottish GDP has varied only in the region of 9% to 10% of UK GDP since the mid 1980s and such volatility could be described as up-side volatility since the without oil and gas, Scottish GDP per capita is almost identical to the UK.

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Figure 3-3 – Scottish Economy and Contribution of North Sea Oil & Gas Sector Scotland's+Economy+as+%+of+UK,+With+&+Without+North+Sea+Oil+&+Gas+ Excluding#North#Sea#

Including#North#Sea#

PopulaBon#share#

16%#

14%#

12%#

10%#

8%#

6%#

4%#

2%#

19 80 / 19 81# 81 / 19 82# 82 / 19 83# 83 / 19 84# 84 / 19 85# 85 / 19 86# 86 / 19 87# 87 / 19 88# 88 / 19 89# 89 / 19 90# 90 / 19 91# 91 /9 19 2# 92 / 19 93# 93 / 19 94# 94 / 19 95# 95 /9 19 6# 96 / 19 97# 97 / 19 98# 98 / 19 99# 99 / 20 00# 00 / 20 01# 01 /0 20 2# 02 / 20 03# 03 / 20 04# 04 / 20 05# 05 /0 20 6# 06 / 20 07# 07 / 20 08# 08 / 20 09# 09 /1 20 0# 10 / 20 11# 11 / 20 12# 12 /1 3#

0%#

Source: Scottish National Accounts Project GDP Estimates for Scotland and UK

Figure 3-4 – Scottish Onshore & Offshore GDP, 1980-2012 (Current Prices) Onshore!GDP!

Offshore!GDP!

!140!!

!120!!

!100!!

!80!!

£bn%

!60!!

!40!!

!20!!

19 80 19 % 81 19 % 82 19 % 83 19 % 84 19 % 85 19 % 86 19 % 87 19 % 88 19 % 89 19 % 90 19 % 91 19 % 92 19 % 93 19 % 94 19 % 95 19 % 96 19 % 97 19 % 98 19 % 99 20 % 00 20 % 01 20 % 02 20 % 03 20 % 04 20 % 05 20 % 06 20 % 07 20 % 08 20 % 09 20 % 10 20 % 11 20 % 12 %

!"!!!!

Source: Scottish National Accounts Project GDP Estimates for Scotland and UK

The oil and gas sector supports at least 450,000 jobs across the UK5 including 36,000 directly employed by oil and gas companies and major contractors, 200,000 in the wider supply chain, 112,000 in jobs induced by the economic activity of employees and 100,000 in jobs exporting goods and services. Around 45% of these jobs, that is 200,000 jobs, are in Scotland, representing around 10% of all private sector jobs in Scotland (for the UK as a whole the sector provides less than 2% of private sector jobs).

5

Oil & Gas UK (2013), Economic Report

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While the sector is most closely identified with Aberdeen and the North East of Scotland, the jobs are distributed across Scotland, including in the Central Belt (Figure 3-5).

Figure 3-5 – Distribution of Oil and Gas Jobs

Source: Oil & Gas UK

The oil and gas supply chain is an economic success story for Scotland, with strengths in areas such as project management, subsea, drilling and well services, health & safety, training services and logistics. There are an estimated 2,000 supply chain companies in Scotland6, based in the North East and elsewhere in Scotland, including the central belt and the Highlands and Islands.

The oil and gas sector is perhaps the most globally connected sector of the Scottish economy. Supply chain companies are increasingly exporting their goods and services, now to more than 100 markets. In 2012-13, international activity (exports and subsidiaries outwith the UK) accounted for £10.0 billion, just over half of the sector’s total sales7. To put this in some context, this is more than twice the 6

Scottish Enterprise (May 2012), Oil & Gas Strategy 2012-2020, Oil & Gas Industry Leadership Group Scottish Development International, Scottish Enterprise and Scottish Council for Development and Industry (May 2014), Survey of International Activity In The Oil And Gas Sector 2012-2013 7

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£4.3 billion value of Scotch whisky exports8, which have also been growing, by 87% in the last decade.

In addition, in 2012, Scottish exports of oil and gas were estimated to be worth £30.3 billion (£12.8 billion to the rest of the UK and £17.5 billion to the rest of the world)9. This included £18.0 billion of crude oil and natural gas, £5.9 billion of refined petroleum products and £6.5 billion of natural gas.

3.2

Tax Revenues from the Oil and Gas Sector The oil and gas sector makes an important contribution to tax revenues. While Scotland’s share of the UK’s non-oil and gas tax revenues is close to its population share, when North Sea revenues are included, Scotland makes a net contribution to UK public finances.

In 2011-12 oil and gas tax revenues collected from Scottish geographic waters contributed £10.6 billion to the UK Treasury, around 19% of all taxes collected in Scotland and in 2012-13 this fell to £5.6 billion, 11% of taxes collected10. At the UK level, oil and gas production taxes accounted for just 2% of all tax revenues.

As Figure 3-6 shows, while revenues vary from year to year, the long term trend is still upwards.

Figure 3-6 – Trends in UK Oil & Gas Taxation Revenues Offshore"Tax"Revenues"

Average"

Linear"(Offshore"Tax"Revenues)"

14,000"

12,000"

10,000"

8,000" £"million"

6,000"

4,000"

2012/13"

2011/12"

2010/11"

2009/10"

2008/09"

2007/08"

2006/07"

2005/06"

2004/05"

2003/04"

2002/03"

2001/02"

2000/01"

1999/00"

1998/99"

1997/98"

1996/97"

1995/06"

1994/95"

1993/04"

1992/93"

1991/92"

1990/91"

1989/90"

1988/89"

1987/88"

1986/87"

1985/86"

1984/85"

1983/84"

1982/83"

1981/82"

0"

1980/81"

2,000"

Source: Government Expenditure and Revenue in Scotland, Scottish National Accounts Project

8

Scotch Whisky Association (April 2013), Export Table Scottish Government (November 2013) Scottish National Accounts Project (SNAP), Estimating Oil and Gas Flows for Scotland: Methodology, Initial Experimental Results, and Data Sources 10 Scottish Government (March 2014), Government Revenue and Expenditure Scotland, 2012-13 9

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4

OIL AND GAS IN NORWAY This chapter has been prepared by DAMVAD. It describes the impact petroleum activities along the coast of Norway have had on the welfare level of the Norwegian society. The discussion includes how political measures such as taxation and the facilitation of investments in new production sites and research and development (R&D) have contributed to create one of the world’s leading petroleum industries. The chapter also describes how important the industry has been in obtaining, and maintaining, the welfare level of the Norwegian society.

Two political measures characterise the success of the Norwegian exploitation of petroleum resources: •

the tax system with a marginal tax rate of 78 per cent, which secures the Norwegian government most of the revenues and stimulate investments and a strong national petroleum industry; and

•

the establishment of a petroleum fund and a spending rule, which have helped avoid ‘Dutch disease’ and secure the welfare level of future generations.

Today, the Norwegian petroleum sector is characterised by high production activity and optimism, and is crucial for maintaining the welfare level in Norway.

Not many people considered the Norwegian continental shelf as a place to find oil or gas in the 1950s, but the discovery of gas outside the Dutch city of Groningen in 1959 made Philips Petroleum interested. They tried purchasing an exclusive right for exploration and production activities on the Norwegian continental shelf.

The offer was $160,000 per month, which equals about 13 million NOK (£1.3 million) per month in 2013 prices11.

The Norwegian government turned down the offer, and claimed sovereignty over the Norwegian continental shelf in 1963. The resolution stated that the King (government) was the only person that could grant licences for exploitation of natural resources in the area. Norway, the UK and Denmark agreed upon a deal in 1965, dividing the North Sea between them based on median lines. The first licencing round took place the same year.

One year after the resolution, important decisions laid the foundation of the political framework, which would be important in the success of the Norwegian petroleum industry. Firstly, the Norwegian government agreed that most of the revenues should benefit the society as a whole. This resulted in a tax system, which secured a government take of 60 per cent. Due to economic rent, a revision of the tax system resulted in a 78 per cent tax rate in 1975.

The tax system not only secures the Norwegian government most of the revenues, but it also stimulate investments and continuous production growth.

Due to deductible costs, there are strong incentives to invest in R&D, explorative activities and new production sites. For a country with no or limited knowledge of the petroleum industry the tax system stimulated collaboration with competent foreign companies (and knowledge institutions), securing a strong inflow of knowledge and technology to Norway.

11

Given an exchange rate of 7.150 USD to NOK, which was the case in December 1959. Jan Tore Klovland.

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Secondly, a white paper in 1975 highlighted the importance of a strong national industry. However, there is a fine balance between a strong national industry and growth in production. When a country with large natural resources has no or little experience with exploiting a given resource, they will need to rely on foreign companies with the relevant knowledge. In Brazil for example, production was limited as long as the national oil company Petrobas had a monopoly position.

How Norway should handle their exploitation of potential petroleum resources was not straightforward. One alternative proposed in 1971 was giving the partly state-owned Norsk Hydro a dominant position. However, the Norwegian government decided to establish a state-owned company, Statoil, in 1972, which would not have a monopolistic position. The Norwegian government imposed a rule of 50 per cent national participation, which included Statoil, Norsk Hydro and the private Norwegian oil company Saga Petroleum.

In addition, direct government financial interests, State Direct Financial Interests (SDFI), contributed to significant cash flows, without limiting foreign involvement or investments in petroleum activities.

Since the discovery of the first oilfield, Ekofisk, in 1969, the Norwegian petroleum sector has added more than 9,000 billion NOK (£900 billion) to Norwegian GDP, and has played a major role in financing the Norwegian welfare state. The demand for high-tech products and services from the offshore petroleum industry has helped create some of the world’s leading clusters of contractors and suppliers along the coast of Norway, which in turn have strong effects on employment and value creation.

Norway is among the world’s leading exporters of both oil and gas, ranking seventh and third for oil and gas respectively. However, because of a small domestic market, Norway is not as dominant on the lists of the world's largest oil producers (ranking 14th in 2011), since countries such as the United States, Russia and China both produce and consume a lot more.

4.1

Political Framework and Regulations With increasing interest in petroleum activities in the North Sea, a Storting12 White Paper of 1974 stipulated the guidelines and principles for the petroleum sector’s position in the Norwegian society.

The main guidelines following the Storting White Paper 25 of 1974 were:

12

•

state revenues should be maximised, and allocated egalitarian to the society;

•

establish a state-owned production company (Statoil);

•

facilitate a strong Norwegian supply industry;

•

establish regulatory institutions responsible for a safe and environmentally responsible exploitation of the petroleum resources;

•

encourage strong unions in the petroleum industry in line with the existing practice in the Norwegian manufacturing industry;

The Norwegian Parliament

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•

limit the rate of production and investments with the goal of not outpacing other industries and securing future production activity.

The implementation of these guidelines was subject to conflicts and debate.

However, looking back, they have been crucial for the state of the Norwegian economy today.

4.1.1

Initial Measures Were Crucial The tax system outlined in the white paper of 1975 and the decision to encourage a strong national industry, without imposing a national monopoly, are two of the main reasons why the Norwegian economy has seen the development it has.

These measures not only secured the Norwegian Government large cash flows, but they gave both foreign and national firms an incentive to invest in both R&D and production activities. Learning from foreign experts on the area of petroleum exploitation made national firms adopt both technology and knowledge, building a strong national supply industry over time.

Following the agreement with Denmark and the UK in 1965, the Norwegian Government allowed foreign firms to conduct explorative activities. Norway implemented the same system as the existing policy in the UK, with licencing blocks of 500 square kilometres. Individual firms or groups of firms could acquire exclusive rights to undertake seismic explorations and drill production wells within the licenced block. The Norwegian Government allocated 22 production licences in 78 blocks to foreign firms or groups of firms in the first licencing round.

The discovery of Ekofisk in 1969 was the starting point of the Norwegian petroleum era. In the 1970s explorative activities was concentrated to the southern areas, before gradually opening blocks further north.

In the early licencing rounds foreign companies dominated both explorative and production activities. This changed in 1972 with the establishment of Statoil together with a rule of 50 per cent state participation in all production licences. The participation rule was later changed to individual consideration, and could be higher or lower than the initial 50 per cent.

Maybe the most important aspect of the resolution of 1965 was taxes and royalties. The Norwegian government designed the tax system in line with the existing taxation of petroleum activities in the UK, as well as existing corporate taxation in Norway. Royalties13 was preferred instead of ordinary taxation of profits.

Despite the positive demand for explorative and production licences, the Government decided, after a brief debate, to implement a 10 per cent royalty instead of the 12.5 per cent that was the case in the UK. The alternative presented in the debate was that nobody would invest in the Norwegian continental shelf.

The tax system outlined in 1965 would give the Norwegian state a lower share of revenues than the case was in the UK. The Norwegian government was risking a government take of less than 60 per cent in the case of discovering a major oil or gas reservoir. The initial level of royalties was part of a deal between with the

13

Royalties was a usage-based payment paid by the petroleum company to the Norwegian government.

Instead of getting a share of profits, which would have been the case with ordinary taxes, the state got a share of the production value.

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Norwegian government and representatives from the petroleum industry, which made it hard to change retroactively. However, there were no formal laws that prohibited the Norwegian government in changing the rates in future licencing rounds.

As a response to the oil crisis in 1974, where the price of oil quadrupled, the operators of the Ekofisk-field was looking at major profits. These profits were way above what was the case in other industries in mainland Norway. Huge profits was one of the reasons why the Norwegian government review the tax system, which resulted in the Petroleum Taxation Act in 1975.

The new act implemented a production fee, which varied between 8 and 16 per cent, a firm tax of 50.8 per cent related to the economic rent and an ordinary corporate tax of 28 per cent. The existing tax system is identical to the one implemented through the act of 1975.

Since taxes are calculated from earnings before interest and taxes (EBIT), investment costs are deductible. That is, a 100 million NOK investment in explorative activities will “save” the company of 78 million NOK in taxes. The same goes for investments in general. The tax system is a major incentive for firms to invest in new production sites, explorative activities, research and development and better exploitation of existing reservoirs. At the same time, a large share of revenues accrues to the Norwegian Government.

The increased taxes in 1975 could have scared foreign firms from operating in Norway. State-owned Statoil functioned as a backup plan in the extreme case of no foreign interest in Norwegian petroleum resources.

Stable political systems in Norway was another reason why taxation would be less of a problem compared to places like Argentina and Angola, which exposes foreign oil companies with severe risk14.

The Norwegian Government owns a share in several oil and gas fields, pipelines and onshore facilities through their State Direct Financial Interests (SDFI). Hence, SDFI secure the Norwegian Government large cash flows in addition to the tax revenues. However, the degree of ownership varies from one production licence to another and they do have to pay their share of the costs related to investments and operations. Prior to the establishment of SDFI in 1985, the State’s ownership consisted solely of the ownership of Statoil and the partly owned Norsk Hydro.

As of January 1st 2013, the state had direct financial interests in 158 production licences, as well as ownership in 15 joint ventures in pipelines and onshore facilities. The Norwegian Government now holds a 67 per cent share of Statoil, which was listed on the stock exchange in 2001. Ownership of two thirds of the company shares implied a dividend of 13.88 billion NOK (£1.4 billion) in 2012.

4.1.2

Investments in R&D Key in Enhancing Competitiveness Compared to other oil-producing countries in the southern parts of the world, Norway had some favourable preconditions for establishing an independent petroleum supply industry. Norway has a long history of shipping and maritime activities, which has contributed to the accumulation of technology and knowledge

14

One example of political risk is the sudden Argentinian nationalization of the Spanish oil company YPF in 2012.

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important when installing and operating oil and gas rigs in the demanding conditions of the North Sea. The industry had split views on what strategy that would develop and make use the relevant technology. During the oil crisis of 1974, the UK took measures to protect their employees, which in turn made the Norwegian Government enforce the national participation rule more actively. However, Statoil made the biggest contribution to the national supply industry through their priority of Norwegian suppliers instead of foreign firms.

Technology has played an important role in achieving an optimal and environmentally friendly exploitation of the petroleum resources in Norway. In addition to the favourable taxation of investments in R&D, several strategies, such as direct allocation of funds to the Research Council of Norway, is implemented to enhance collaboration between the industry, the Norwegian Government and research institutions to facilitate research and development.

To meet the challenges associated with efficient and prudent petroleum activities, the Ministry of Petroleum and Energy took initiative to establish a strategy called “Oil and Gas in the 21st century (OG21)”. The programme has helped oil companies, universities, research institutions, the supply industry and the authorities to agree on a joint technology strategy for oil and gas.

Another example of collaboration and cooperation is INTSOK, Norwegian Oil and Gas Partners. The initiative was established in 1997 following a period of falling prices of oil and reduced competitiveness of the Norwegian petroleum industry.

INTSOK aimed to facilitate cooperation between representatives from the petroleum industry, the Norwegian Government and universities on several issues concerning the competitiveness of the industry such as reducing the cost level, increased effectiveness of petroleum operations and internationalisation.

Today, the oil and gas industry along the coast of Norway is highly competent and internationally competitive. In addition, the Norwegian supply industry delivers advanced technology, products and services to both Norwegian and international customers. These firms is part of several technology and innovation clusters along the coast of Norway, and represent a major part of the demand directed towards other industries and secures employment and ripple effects in rural areas. Tax systems and a tight collaboration between the industry and the Norwegian Government has played a central role in this development.

4.1.3

Stabilising Inflation and Securing Future Generations’ Welfare Fear of the ‘Dutch disease’ was one of the reasons why the Norwegian government limited petroleum activities. The risk of increased inflation resulted in the establishment of a petroleum fund in 1990.15 Placing the revenues in stocks, bonds and real estate abroad together with a rule of spending would slowly phase the revenues into the economy and keep inflation low.

A combination of an initially high rate of production and oil prices rising relatively more than the fall in production resulted in large transfers to SPU already in the late 1990s. Since the Government only spends a share of the return on investments (long-term perspective), revenues from the petroleum activities is, on a short-term basis, isolated from actual production.

15

See fact box

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As of 2013, the SPU had assets of 5.110 trillion NOK (£511 billion), more than £100,000 per Norwegian.

The Government Pension Fund – Global (SPU) SPU was established in 1990 with the purpose of ensuring future generations’ level of welfare and as a measure to stabilise inflation. The State transfers net cash flow from petroleum activities to SPU each year, which started in 1996. The fund invests in bonds, stocks and real estate, which implies considerable interests and yield each year.

Petroleum revenues are phased into the economy by financing the structural non-oil deficit in the National Budget. The central government uses a guideline to keep the structural deficit at the funds’ expected annual real return of 4 per cent over time. This is the rule of spending implemented in 2000 that aims to not overheat the economy and secure the welfare level of future generations.

Net cash flows from petroleum activities - Non-oil deficit in the Nation Budget + Return on the SPU investments = Revenues for SPU

4.2

Economic Impact

4.2.1

The Petroleum Sector – A Major Contributor to the Norwegian Welfare State Since production started at Ekofisk in 1971, the petroleum sector has added more than 9,000 billion NOK (£900 billion) to the country’s GDP and the petroleum sector represents about a quarter of the nation’s total GDP, which is more than three times larger than the second most important contributor; other industries. At the same time, the petroleum sector only employs one per cent of total employment.

Value added from the petroleum sector has seen a remarkable development since the late 1990s. In 1998, the value added from the petroleum sector was at the same level as the manufacturing industry at about 175 billion NOK (£175 billion). Today, the petroleum sector represents slightly less than 700 billion NOK (£70 billion), while the manufacturing industry remains at their 1998-level.

Most of the GDP created in the petroleum sector, 67 per cent, is an excess return of inputs, that is, economic rent. Economic rent was one of the reasons why the Norwegian Government designed the tax system as it did in 1965.

Net cash flow to the Norwegian Government has increased from nothing in the early 1970s to about 350 billion NOK (£35 billion) in 2012. The net cash flow consists of dividends from the partly state owned Statoil, royalties and area fees, SDFI, environmental taxes and taxes on factor returns. Taxes and revenues from SDFI represent the majority of net cash flow from petroleum activities, as shown in the figure below.

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Figure 4.1 - Net cash flow from the petroleum sector, Bn NOK, 1972-2012 (Current prices)

500!

400!

300!

200!

100!

0!

"100!

Taxes! Environmental!taxes! SDFI! Royalty!and!area!fee! Statoil!dividend!

Source: Statistics Norway

In 2012, the petroleum sector represented 26 per cent of Norwegian GDP, 29 per cent of total net investments in real capital, 51 per cent of exports and 30 per cent of the state revenues. This illustrates how important the petroleum sector is for the Norwegian economy, and that it affects a wide range of economic indicators. At the same time, the petroleum sector only represents one per cent of total employment.

Given the small share of employment, the GDP represented by the petroleum activities does not have serious direct effects on the economy. However, it does put pressure on the general wage level of the economy, as the wage level is twice as high in the petroleum sector compared to the rest of the economy. This is a result of both government expenditure and direct demand from the petroleum industry to other parts of the economy. These effects are in turn limited through the petroleum fund and the spending rule.

Development in the value of GDP related to petroleum activities on the other hand, is important to the Government in the process of increasing the value of the SPU, which in turn determines the size of annual non-oil deficit on the National Budget.

Petroleum prices affects the state revenues together with the rate of production related to petroleum activities. Volatile prices will affect the Norwegian economy both trough state revenues and the level of spending from the SPU, as well as the direct effect on the foreign exchange rate.

The petroleum activity, which is dependent on the prices of petroleum as well, has a direct impact on the economy through its demand pointed towards other industries in mainland Norway. Demand from the petroleum sector mainly consists of investments, direct employment and products.

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Petroleum activities have clearly contributed to the development of the Norwegian economy since the 1970s. Even if it is hard to predict how the country would have developed without it, Statistics Norway shows that the Norwegian economy most likely would have followed the average development in other OECD countries in the period between 1979 and 1993 without the contribution from petroleum activities16.

Figure 4.2 - Petroleum sector share of various macroeconomic measures in 2012

Total exports

GDP

26%$ 51%$

Total investments

29%$

State revenues

30%$

Source: Statistics Norway

4.2.2

The Petroleum Sector – Road Ahead The level of petroleum production and the related economic activities are currently at a high level, although the production of oil and gas has declined for nearly a decade.

Statistics Norway expects a decline in revenues related to petroleum activities of 46.5 per cent measured in fixed prices in the period between 2013 and 204017.

Total demand for investments, employment (wages) and other inputs from the petroleum sector will decline with an estimated 0.4 percentage point annually until

16 17

Cappelen et. al (1996) Statistics Norway, report 59/2013, “Effects of the petroleum sector on the Norwegian economy”

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2040, which implies a reduction in the share of total GDP of two thirds compared to the level in 2014.

The considerable reduction in total demand will imply varying consequences for other parts of the economy. Affected firms will have to adopt, through increased exports or innovation based on existing technology and knowledge.

Even if the level of petroleum activities along the coast of Norway is cut in half by 2040, the Norwegian Government have accomplished two important goals through the implemented policies: •

facilitated the world’s leading petroleum supply industry, whose products, services and knowledge are sold all over the world; and

•

avoided the ‘Dutch disease’ through the establishment of SPU and the rule of spending. At the same time, future generations’ welfare is secured and more or less independent of the petroleum production activity.

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5

GLOBAL ENERGY SUPPLY AND DEMAND

5.1

Global Energy Demand Any analysis of the opportunities and challenges that face Scotland’s oil and gas sector must be undertaken with an appreciation of the global energy landscape.

By 2040 Asia Pacific and Africa are expected to be home to over 75% of the world’s population18. This statistic is just one example of how over the next three decades global economic power is predicted to continue to move from west to east. Rapidly increasing industrialisation and urbanisation within non-OECD countries, and the associated pressure for greater living standards, are expected to contribute to the fastest growth in energy demand ever witnessed.

Figure 5-1 – Predicted global energy supply and demand

Source: The outlook for energy: a view to 2040, Exxon Mobil, 2013

5.2

Global Energy Supply It is essential to grasp the role that hydrocarbons will play in supplying the world’s energy needs. The chart below illustrates that although energy produced by renewables other than hydro (wind, solar, tidal, wave etc.) may grow by more than 100% from today’s level, it will still account for less than 5% of total energy supply in 2040 with oil and gas remaining the world’s top two sources of energy.

18

The outlook for energy: a view to 2040, Exxon Mobil, 2013

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Figure 5-2 – Global fuel mix by decade

Source: The outlook for energy: a view to 2040, Exxon Mobil, 2013

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6

SCOTTISH HYDROCARBON RESERVES & VALUE

6.1

Production and Reserves The UK sector of the North Sea and other areas that are expected to produce oil in the future, like the area west of Shetland, is known as the UK Continental Shelf (UKCS). Around 90% of the offshore oil and gas sector is located in Scottish geographic waters.

Over the last 40 years, the UK oil and gas sector has produced the equivalent of 42 billion barrels of oil (bn boe). However, there are large reserves of oil and gas still to be produced.

New reserves are discovered each year so total production is now expected to be almost twice as much as had been predicted in the mid 1970s. In 1975 there were estimated to be 26 bn boe but 42 bn boe had already been produced by the end of 2012 and the UK Government estimates that there are at least another 12 bn boe to be produced (with industry projections of considerably higher production).

Figure 6-1 – UKCS Oil Production and Reserves Oil!&!Gas!Produc;on!&!Reserves!1975"2012!

Cumula;ve!Produc;on!(bn!boe)!

Reserves!(bn!boe)!

!55.0!! !50.0!! !45.0!! !40.0!! !35.0!! !30.0!! !25.0!! !20.0!! !15.0!! !10.0!! !5.0!!

19 75 !

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19 90 !

19 91 !

19 92 !

19 93 !

19 94 !

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19 98 !

19 99 !

20 00 !

20 01 !

20 02 !

20 03 !

20 04 !

20 05 !

20 06 !

20 07 !

20 08 !

20 09 !

20 10 !

20 11 !

20 12 !

!"!!!!

Source: Department of Energy & Climate Change, Historic UK Oil and Gas Reserves and Production (Data from “Brown Book” and DUKES)

6.2

Value Produced to Date Using the most recent publically available income, expenditure and taxation data from DECC and adding 2013 data from Oil and Gas UK, allows the following high level overview of historic income and expenditure on the UKCS to be estimated19,20,21. Since 1970 the UK has produced £1,081 billion worth of hydrocarbons from its offshore waters. Of this total £335 billion was spent on capital expenditure and exploration/appraisal activity, £198 billion went towards operational expenditure, £4 billion was spent on decommissioning, £313 billion went to the Exchequer in taxes leaving operators with £231 billion of post-tax cash. This is illustrated graphically below:

19

https://www.gov.uk/oil-and-gas-uk-field-data#ukcs-income-and-expenditure https://www.gov.uk/oil-and-gas-taxation#government-revenues-from-uk-oil-and-gas-production 21 Oil & Gas UK Activity Survey, 2014 20

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Figure 6-2 – Historic UKCS value

Source: Based on data from DECC and Oil & Gas UK

6.3

Reserves The UK’s remaining commercially recoverable offshore oil and gas reserves are widely accepted to stand at somewhere between 15 and 24 billion barrels of oil equivalent (boe)22. In July 2014 DECC reduced its estimate to between 11 and 21 boe, apparently to reflect recent low levels of exploration. However, some experts believe that the upper bound could be higher. For example, at the SCDI’s Oil & Gas and Scotland’s Future conference in February 2012 Malcolm Webb, Chief Executive of Oil & Gas UK, asserted “I personally suspect it will eventually be shown to be much greater than the 24 billion barrels we currently estimate”23.

There is also widespread acceptance that the vast majority of these reserves lie in Scottish waters. In its April 2013 report the House of Lords Select Committee on Economic Affairs stated “Most witnesses agreed that Scotland would gain approximately 90% of the oil and gas reserves.”24

6.4

Projected Future Production Between July 2012 and March 2014, the UK Office of Budget Responsibility (OBR) repeated reduced its long-term projection for oil and gas tax revenues.

However, even the reduced March 2014 estimate is for £100 billion in tax over the next 30 years. The OBR estimate is based on around 7 billion barrels of oil equivalent (the standard measure of reserves used) and on oil prices that decline to 2016 and then increase gradually. The OBR seems to out of step with other respected sources on both production and oil prices.

Future production of oil and gas from the waters surrounding the UK (the UK Continental Shelf, UKCS) will depend on a range of factors, including the quantity of reserves still to be tapped, the costs of exploration and production, expected returns on investment (which depend on future oil prices) and the public policy environment (including a stable taxation regime).

The oil economist Professor Alex Kemp of the University of Aberdeen has undertaken work on scenarios for future production. At an oil price of $90, production to 2050 is estimated at 17.5 bn boe, including 15.2 bn boe from the

22

Oil & Gas UK Economic Report 2013 Oil & gas and Scotland’s future – conference report, SCDI, 2012 24 The economic implications for the United Kingdom of Scottish Independence, House of Lords Select Committee on Economic Affairs, Apr 2013 23

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Scottish sector (Figure 6-3). At higher oil prices, higher levels of production would be expected, since greater investment in exploration would be expected and higher cost fields would become viable.

Figure 6-3 – University of Aberdeen Production Projections

25

Source: Kemp & Stephen, University of Aberdeen

25

Professor Alexander G. Kemp and Linda Stephen (November 2012), North Sea Study Occasional Paper No. 125, Prospects for Activity in the UK Continental Shelf after Recent Tax Changes: the 2012 Perspective, Aberdeen Centre for Research in Energy Economics and Finance, University of Aberdeen

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7

A PIVOTAL MOMENT – THE INDUSTRY IN 2014

7.1

Wood Review 2014 is a pivotal year in the history of the UK oil and gas industry. The recommendations made by Sir Ian Wood in his Review26 were unanimously accepted by the key stakeholders as being essential to help ensure that the UK maximises the recovery of its offshore hydrocarbon reserves. Clearly this is of enormous significance to Scotland as around 90% of the UK’s remaining offshore reserves lie within the Scottish Continental Shelf.

The Wood Review provides a concise summary of the state of the UKCS in 2014, the principal points being: •

the number of operational fields in the basin has increased from around 90 in the early 1990s to over 300 today, with an allied increase in the number and diversity of operators which has seen the number of operators increase by over 50% during the last decade;

•

exploration has decreased to disturbingly low levels. The reasons for the poor exploration performance are numerous. However, lack of funds available to small companies, drilling rig availability, cost inflation and uncertainty due to the unstable taxation system are broadly agreed as being the principal causes. Dealing with the exploration crisis requires the sort of collaborative approach between the Treasury, Regulator and industry, which has been sadly lacking on the UKCS in recent years;

•

production has declined dramatically, and more quickly than expected, over the last three years. The factors behind this drop are multifaceted, but the main cause has been a decrease in average production efficiency in the basin from 70% to 60% over the last three years;

•

as expected in a maturing basin new discoveries are typically smaller and more technically challenging, and hence more expensive, to develop;

•

technological advances have been an essential part of the North Sea story from day one. They will play an increasingly important role in ensuring that the economic potential of the UKCS is maximised;

•

the ageing asset base is becoming progressively more expensive to maintain. At the same time, maintaining assets and nurturing the development of new fields is essential if production is to be maximised;

•

small and medium sized operators, which have played a vitally important role over the last two decades injecting fresh ideas and practices, are finding it extremely hard to access finance.

The Wood Review is explicit about what needs to be done and why. When a study of this significance identifies the need for “a radical step up in how Government exercises stewardship of the UKCS, working closely with Industry” and the need for “urgent intervention in some areas to avoid significant value erosion” then everyone with an interest in the basin should take heed.

26

UKCS maximising recovery review: final report, Sir Ian Wood, Feb 2014

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At its core the Review concludes that maximising the economic benefits of the remaining reserves will require much greater collaboration between all sectors of the industry, the Regulator and Treasury. The foremost recommendation is that Government and industry create and implement a new strategy for maximising the economic recovery of oil and gas from the UKCS (MER UK). In addition it is recommended that the regulator is strengthened significantly, transformed into an arm's length body and given additional powers to ensure that the new MER UK strategy is delivered.

The Wood Review’s view of how government has managed the industry is most apparent when it points out that the current regulator is “significantly under resourced”, there has been “limited obligation to maximise economic recovery across fields or within regions of the UKCS” and “fiscal instability has been a significant factor in basin underperformance.”

From a positive perspective the Wood Review can be seen as a catalyst for profound changes that will ensure that Scotland’s businesses and people grasp the full benefits from the country’s offshore oil and gas reserves. In terms of a legacy for tomorrow’s Scots, Sir Ian has indicated what needs to be done; it is now up to today’s generation of business leaders, politicians and civil servants to rise to the challenge and deliver.

7.2

Industry Activity and Constitutional Change The 27th Licensing Round in 2012 witnessed the highest ever number of applications received in a single round – a strong signal that private industry is unfazed by a potential change in constitutional status in Scotland. While BP CEO Bob Dudley’s comment on 04th February 2014 that, “My personal view is that Great Britain is great and it ought to stay together”27 was covered widely by the press, his predecessor Tony Hayward’s comments on 18th February 2014 at International Petroleum Week in London didn’t attract as much attention. When asked what impact he thought independence would have on the oil industry Dr Hayward, now CEO of Genel Energy, replied “none whatsoever.” He continued, “our industry is very good at working with whoever happens to be in power. It’s what the industry does. My view is the industry will continue to invest and life will continue28.” Even a cursory review of BP’s global focus highlights that an independent Scotland would be amongst the most politically and economically stable of the nations in which BP invests.

The 28th Licensing Round, which closed for applications on 25th April 2014, attracted another 173 applications for around 370 blocks – which is amongst the largest response ever received. In the words of Michael Fallon, then Energy Minister, “there remains an extraordinary level of interest which is excellent news for industry and for the UK economy.”29

27

http://www.bbc.co.uk/news/business-26028481 http://www.energylivenews.com/2014/02/19/scots-independence-wont-affect-oil-industry-ex-bp-boss/ 29 https://www.gov.uk/government/news/north-sea-still-attractive-for-oil-and-gas-industry 28

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8

OPPORTUNITIES FOR THE SECTOR

8.1

Domestic Opportunities The successful implementation of the Wood Review’s recommendations will precipitate a range of opportunities across all sectors of the supply chain. When assessing industrial development opportunities, the fourth and final recommendation of the Wood Review is the most meaningful. It advocates that the new Regulator works with industry to develop and implement strategies across a range of areas including: •

exploration;

•

asset stewardship;

•

infrastructure;

•

technology (including Enhanced Oil Recovery and Carbon Capture and Storage);

•

decommissioning;

•

regional development plans;

•

data management; and

•

access to finance.

The new technology and operating practices required to implement strategies in the above areas will create opportunities to develop existing businesses and launch new ones. In the late 1970s around 50% of the global resource of offshore manpower and equipment was deployed in the North Sea30. This enabled many of the companies and individuals active then to play leading roles in international basins. Similarly, the work required to ensure that the mature North Sea basin is fully exploited must be used to further develop the already strong oil and gas export sector as other basins reach a similar level of maturity.

8.2

International Opportunities Research undertaken by SCDI demonstrates the importance of exports to the Scottish oil and gas industry. The latest figures reveal that half of the Scottishbased oil and gas supply chain’s sales, some £10 billion, was in overseas markets. This figure is expected to grow to more than 60% by 202031.

SCDI reflects industry’s views when it states, “Of all the growth sectors in the Scottish economy, energy is the largest. In a period of economic challenge, SCDI believes that investment in energy offers our strongest prospect of growth. This should be combined with efforts to anchor the associated supply chain here in Scotland and help it internationalise.”

By 2060 production from the Scottish Continental Shelf is likely to be relatively insignificant. It is imperative that an industry that today employs more than 200,000 people in Scotland is supported as it continues to internationalise.

30 31

Industrial policy: Lessons from the North Sea, Civitas, Dec 2013 Future Scotland – Energy, SCDI Apr 2013

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Scotland, and Aberdeen in particular, needs to nurture and anchor high-tech oil and gas companies that trade in international markets.

Opportunities exist the world over. Many successful Scottish companies have focussed on building business in high-potential countries with common cultural bonds (America, Australia, Canada and Norway) while others have targeted niches in potentially less stable but equally exciting areas such as Africa (North, East and West), the Middle East, and SE Asia.

Figure 8-1 provides an overview of the expected scale of the major international offshore markets. While the UKCS is currently the fifth largest market in the world it is declining in terms of global importance whilst numerous other markets are increasing. As well as providing opportunities, these growing markets will introduce hungry new competitors into the global arena as they nurture their own supply chains.

Figure 8-1 – Expected international offshore market spend 2013-2017

Source: Aker Solutions Capital Markets Day, December 2012

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9

RECOMMENDATIONS AND POLICY MEASURES Implementing the recommendations of the Wood Review promptly and in full is essential to ensuring that the remaining potential of Scotland’s offshore oil and gas reserves is maximised. The measures proposed should improve exploration success, production efficiency and reservoir recovery significantly.

The recommendations below are proposed as additional actions to help secure the greatest benefit for the wider Scottish supply chain. The recommendations are grouped into two themes, the first being macro level policy initiatives and the second an industrial development strategy.

9.1

Macro Level Policy Measures

9.1.1

Devolution of Regulation and Taxation Powers to Scotland No matter the outcome of the independence referendum, regulation and taxation powers should be devolved fully. Locating the new Regulator in Aberdeen, the nerve centre of the industry, is an obvious decision given the need for much greater collaboration between the Regulator and industry. The Treasury’s recent decision to ignore the pleas of many of the industry’s most prominent leaders to scrap the damaging bareboat chartering taxation change for drilling rigs and accommodation vessels is just the latest manifestation of bad advice or poor judgment within the department.

Devolving taxation powers to Scotland - either as part of full independence, a more federal approach or as an arm of the London Treasury based in Aberdeen would move responsibility for taxation closer to the people whose jobs and businesses depend on the continued success of the sector.

It is essential that the Treasury engages more openly with industry than it has over the last four decades. The long term benefits of a vibrant oil and gas sector far outweigh short term taxation gains.

At present the industry is heading towards a high percentage tax take, medium price, low production scenario which will result in relatively low levels of employment and government revenues. DECC’s latest long term production estimates predict that just 7 billion boe will be recovered by 2030 and 10 billion boe over the next 30 years – a long way short of the UKCS’s true potential32.

The Treasury must metamorphose into a responsive, forward-thinking, stakeholder willing to create a medium tax take, medium price, high production environment where employment, government revenues and private sector profits are all maximised.

9.1.2

Fiscal Stability is Essential, as is a Fiscal Regime that Matches the Challenges of a Mature Basin The need for governments to provide stable and predictable taxation and legislative frameworks is of paramount importance to ensure that investors are able to make long term investment decisions. Australia, Canada, the USA, Malaysia and Singapore are widely praised for their stable taxation regimes (the UK is not). In an industry where the competition for investment capital is global,

32

UKCS oil and gas production projections, DECC, March 2014

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mature basins such as the North Sea must adopt fiscal regimes that enable appropriate levels of investment to be secured. In addition, there is a consensus that fiscal policy should encourage the development of entrepreneurial exploration and production and service companies, whilst incentivising exploration to encourage the development of frontier areas and new exploration plays.

While the recently launched review of the UKCS fiscal regime is welcome, it is years too late and emblematic of successive governments that have not given the oil and gas industry the support and attention it deserves as the UK’s largest industrial sector. The US Department of Energy’s recent criticism of the 2011 tax hike33 echoes the broad consensus within industry.

A further example of instability and the lack of status that the oil and gas sector appears to have within Westminster is that latest cabinet reshuffle saw the introduction of the fourth Energy Minister in the last two years and the 13th in the last 15 years.

Although it was released after the consultation phase of this report, the Scottish Government’s Independent Expert Committee’s report34 included many proposals that are expected to gain support from industry. Key amongst these is the recommendation that the total value added (TVA) across the whole economy should be considered when making fiscal and policy decisions. Assessing TVA would provide a means of quantifying direct, indirect and induced activity.

9.1.3

Research and Development As part of a thorough review of the taxation system, consideration should be given to better incentivising at corporation level the development and deployment of new and existing technologies to enhance recovery, extend asset life and increase production. This would act as a carrot to balance the stick of licence termination that the Regulator may use in extreme circumstances. It should be remembered that innovation is best done by the private sector, and the SME sector in particular.

9.1.4

Exploration The government / industry PILOT initiative has established an Exploration Task Force with the remit of ensuring that exploration is maximised. The official figure for yet-to-find resources is between 3 billion and 9 billion boe and for undeveloped discoveries the figure is between 1 billion and 4 billion boe35. In a presentation given at the annual Petroleum Exploration Society of Great Britain PROSPEX Conference in December 201336 Co-Chair of the PILOT Exploration Task Force, Steve Jenkins of Cairn Energy, concluded that “abundant new and underexplored plays could yet yield significant resources.” The bulk of the new and underexplored plays identified lie in Scottish waters.

There can be no doubt that Scotland’s yet to find potential will not be realised with current levels of exploration. Altering the tax system to mirror the Norwegian regime, where a loss as a result of exploration expenditure can be recovered almost instantly, is widely regarded as a measure that would encourage greater

33

http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/10952376/Washington-blamesUK-tax-rises-for-collapsing-North-Sea-oil-hopes.html 34 Report of Scotland’s Independent Expert Commission on Oil and Gas, June 2014 35 Oil & Gas UK Economic Report 2013 36 www.pesgb.org.uk/media/uploads/events/prospex/.../04_SteveJenkins.pdf

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levels of exploration. Also, additional tax incentives should be considered for high priority plays or areas (e.g. fractured basement, West of Scotland). The oil and gas exploration measures announced in the 2014 Budget are nowhere near substantial enough to have a meaningful impact.

However, an enhanced taxation system is only one part of the solution. Other important factors that need to be addressed include building a better shared understanding of the basin-wide geology, sharing exploration experiences and reducing drilling costs. The PILOT Exploration Task Force has started to address a number of these issues and one of the new Regulator’s most important objectives will be to ensure that existing and new initiatives are delivered quickly.

In Norway Statoil fulfils a role as a font of cross-basin geological knowledge, and in Denmark their North Sea Fund plays a similar role on a lesser scale. On the UKCS individual companies have amassed significant knowledge of areas and plays, but this knowledge needs to be shared more efficiently than occurs at present. The enhanced Regulator may help address this weakness and a greater role could also be played by the BGS Energy Team based in Edinburgh. In addition better cooperation and coordination amongst operators during drilling campaigns could help reduce drilling costs.

Another area that should be studied is how harmonising drilling rig standards across all the major North Sea hydrocarbon producing countries (Norway, UK, and Holland and Denmark) might increase the pool of rigs available.

9.1.5

New Financing Solutions Must Be Developed Accessing capital is a significant issue, especially for the small exploration and production companies which are essential to the health of mature basins. Most of these companies currently find it extremely difficult to raise funds to cover early stage activities before reserves are proven.

One potential solution may be to create a hydrocarbon investment vehicle operated on similar principals to the Edinburgh headquartered Green Investment Bank, which seeks to counter market failures, help reduce perceived risk, address high transaction costs and ultimately increase the amount of capital in the renewables sector.

A Hydrocarbon Investment Bank could be tasked with both a domestic and an international remit covering exploration companies, operators and the wider supply chain. The Japan Bank for International Cooperation is just one example of a comparable body. The JBIC works in partnership with private financial institutions and its mission is centred on enhancing the international competitiveness of Japanese industry.

9.1.6

Attraction of HQs While many oil and gas operators and service companies locate their regional operational headquarters in Aberdeen, their corporate headquarters are often in another city – frequently London. If responsibility for regulation and taxation was devolved to Scotland there would be a logical reason for companies to relocate their headquarter functions to Scotland. Consideration should be given to incentivising this relocation at both individual staff level and at corporation level.

One example of this type of approach is Singapore’s Headquarters Programme which incentivises companies to use Singapore as a base for their regional and Scotland Means Business: Oil & Gas

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global operations. Improving the business infrastructure is another area that needs to be addressed in order to attract more corporations to Scotland.

Scotland’s air services, road and rail links, broadband connections and amenities are often cited as poor in comparison to those found in many other oil hubs.

9.2

Development and Delivery of a Long Term Oil and Gas Sector Industrial Development Plan A long-term Scottish oil and gas sector industrial development plan is required that far exceeds in scope, scale and ambition any of the myriad of existing strategies, business plans and similar initiatives.

Industry and government must develop a plan that is pragmatic, has a global focus and is designed to capitalise on Scotland’s natural advantages.

This needs to be industry-led and target orientated, with public sector support focussed on creating the wider societal changes necessary to underpin a buoyant Scottish oil and gas sector.

Existing organisations including OPITO, ITF and Scottish Enterprise already undertake world-leading work but they and many other bodies need to be given the framework and backing to greatly increase their output. They could deliver the excellent work that they currently do on a much larger and more significant scale given greater funding and support.

The plan should be focussed on short, medium and long term opportunities and led by a board comprised of senior industry figures with the verve and drive necessary to make a meaningful difference. Significant funding will be needed and this is addressed below.

9.2.1

Funding an Oil and Gas Industrial Development Plan In order to address technological challenges and boost the development of an indigenous oil and gas supply chain, the Brazilian Government introduced as part of its licensing regime a requirement on license holders in fields above a certain size to invest 1% of a field’s gross production income in research and development activities in Brazil. This was estimated to have channelled approximately US$500 million towards R&D activities in 2012, a figure that is expected to grow to US$2 billion per annum by 201737. In 2013 the range of activities that the fund could be targeted towards was enlarged to include other parts of the oil and gas industry including economics and business management and also the development of alternative energy technologies.

Consideration should be given to ring-fencing a percentage of oil taxation receipts to fund R&D, skills development, international business expansion support and other activities designed to foster economic growth. For example, 5% of taxation receipts would provide an average annual contribution of circa £250 million in a Medium Production/Medium Price scenario.

Today Scotland enjoys a leading position due to its long established industrial base, strong academic institutions and established support systems. The levels of aspiration and ambition in Scottish industry need to be raised and supported in a much more significant manner than they currently are.

37

Research And development in the oil & gas industry in Brazil, Tauil & Chequer Advogados, May 2013

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Scotland may have missed the opportunity to establish a sovereign wealth fund during the first half of its offshore oil story, but the opportunity remains to establish a world leading industrial support mechanism – led by industry but supported by wider societal stakeholders.

9.2.2

Education and Skills One of the many aspects of the oil and gas industry that make it an exciting and rewarding industry to work in is its truly global nature. Oil and gas professionals are in demand internationally and their skills are transferable around the globe.

Unprecedented growth-led demand for energy, along with an historic failure to maintain recruitment through cyclical troughs, have both contributed to shortages of skilled people in every oil and gas producing country.

In 2013 the Hays Oil & Gas Salary Survey collected data from over 25,000 industry professionals working in 53 countries from Algeria to Yemen. For the North Sea the key issue identified was the drain of talent to international basins intensifying skill shortages38. One of the challenges over the next decade is to ensure that Scotland develops a sizeable and sustainable pool of skilled workers with a global mind set. This workforce must be capable of meeting the technological challenges inherent in a mature home basin whilst simultaneously seizing opportunities in international markets. With a healthy home-grown workforce the Scottish sector will become more attractive to international investors as the cost escalation and project delays that plague the market today should diminish.

Tackling the skills issue will take a collective effort between industry and many arms of government, allied to a long term plan to develop the best oil and gas workforce in the world. Scotland holds a number of strategic advantages in skills, not least its cultural history of advanced engineering. However the trump card is OPITO, the Portlethen Headquartered global leader in oil and gas workforce development. As an industry owned and led organisation, OPITO has the commitment of industry and delivers pragmatic training programmes that address identified skills and training gaps.

The global opportunity for Scottish business is vast. However, international competition is powerful and growing increasingly potent by the day. Other nations are focusing on the oil and gas industry and implementing long term industrial development plans backed by serious intent and serious money. It is a sign of Scotland’s strong standing that government delegations from Indonesia, Iraq, Malaysia, Singapore, South Korea and Thailand have all spent time in the last year studying how the industry has developed and is supported in Scotland.

While Scotland should be proud that it is recognised globally as a centre of excellence in skills and people development, the danger of resting on our laurels should not be underestimated.

Today you will find Scots occupying leading positions in every country where oil and gas is produced, taking skills developed in the North Sea and applying them internationally. To ensure that this venerable trait continues will require a greatly increased focus on developing Scotland’s workforce. The framework exists to deliver the enhanced skills development programme needed; what is required urgently is a much greater effort between government, industry and the education

38

Global oil and gas salary guide, Hays, 2013

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sector to develop and implement an industry-led long term national skills development programme.

9.2.3

Scotland the Engineering Brand Talk to anyone who has played an active role in internationalising a Scottish oil and gas supply chain company and one message that you will hear consistently is the strong reputation that Scotland in general, and Aberdeen and the North East in particular, has earned for high quality engineering and efficient project delivery.

The power of this brand could be better harnessed and developed in a cross sector initiative.

9.2.4

Entrepreneurial Environment An issue that is relevant to every sector of the Scottish economy is encouraging and incentivising more entrepreneurial activity. Reducing the taxation burden and incentivising companies to grow Scottish headquartered businesses is crucial and something that could be addressed should additional fiscal and policy powers be gained via constitutional change. However, the key determinant is cultural and will depend on more people having the hunger, determination, drive, and belief to build Scottish-based businesses of scale.

9.2.5

Contracting Culture The UK oil and gas industry’s contracting culture, where many industry professionals work as self-employed contractors, can often stifle a company’s ability to plan for the medium term. This frequently has negative impacts on both organisational ethos and new product development. Clamping down on the abuse of the taxation system, while simultaneously incentivising genuine spin-off and start up activity, could help address the cost burden in the basin, stimulate entrepreneurial activity and increase the rate of new technology development.

9.2.6

National Champions and International Opportunities Scotland should look across the North Sea to Norway to learn lessons from how the Norwegian oil and gas industry has grown a dynamic and enduring export sector.

In Norway Statoil plays a crucial role. Founded in 1972, today Statoil is 67% owned by the Norwegian state with the remainder floated on the Oslo and New York stock exchanges. In 2011 Statoil was ranked Number 1 in the Fortune 500 for social responsibility and number 9 for innovation – rubbing shoulders with the likes of Apple, Google and 3M39. Operating out of 36 countries, with annual revenues of around US$90 billion, many observers point to the role that Statoil plays in helping to support the development and internationalisation of Norwegian technologies and companies. Gaining access to new markets via an existing customer is a common experience for supply chain companies – proving the adage that the best new customer is a happy existing customer.

There is strong support for the implementation of a Team Scotland approach where individual supply chain businesses collaborate with one another and also cooperate with both operators and the public sector. Additionally, Scotland needs to grow more companies of significant global scale and then encourage these firms to act as national champions. Over the last four decades too many

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https://www.regonline.com/custImages/260000/268589/BjarteBogsnes04-18BBRTHouston.pdf

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successful Scottish founded SMEs have been acquired by multi-national firms based outside of Scotland. A strong supply chain, anchored in Scotland while operating internationally, is essential for the long term sustainability of Scotland’s oil and gas sector.

Creating a Scottish equivalent of INTSOK, the Norwegian industry/government partnership dedicated to expanding Norwegian businesses into international markets, would build on the excellent work that Scottish Enterprise and Scottish Development International currently undertake. Part of this could include tailoring the world-leading GlobalScot initiative towards better supporting the internationalisation of Scottish firms. Given the increasing dominance of national oil companies (NOCs), a significant effort should be made to build relationships with the key NOCs as well as the independent oil companies, which have historically been the focus of most internationalisation effort.

NOCs today control around 80% of the world’s oil reserves40. Central to the strategy should be the fact that NOCs focus on more than production with local economic development and wider societal benefits from education, research and development and employment creation important considerations. Aberdeen and the North East is often used as a case study for how to develop an oil and gas industry from scratch. The numerous stakeholders who have contributed to this success need to be harnessed and coordinated to target international opportunities holistically.

40

Sovereign wealth funds and national oil companies, PWC, Nov 2013

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N-56 aims to provide a new locus for Scotland’s business community to work with government and others throughout the country, to plan a more prosperous future for the whole of Scottish society.

The ultimate aim is to ensure that Scotland attains a position among the top five advanced economies in the world.

If you would like to learn more about N-56, its aims and activities, please visit our website www.N-56.org

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Scotland Means Business

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