Most countries waste their petrodollars. They don’t put them back into investment – they squander them on things that do not, in themselves, create value.
In developing countries the squandering might be on a flashy palace or, in the west, it might be on subsidising universal benefits, unnecessarily free services or any other non value-creating project.
The imperative of reinvestment
It is critical that this money is used to re-invest. Consider the UAE – that is what they have done. They have built Dubai, Abu Dhabi and Emirates airline as part of the project to create a real hub and to create reasons to be there beyond the sand and the dwindling oil.
They have some hugely ambitious carbon neutral city projects as well. Look at the Masdar City initiative in Abu Dhabi, for example.
For Scotland, its oil and gas reserves are a real asset but they are time limited – and the remaining reserves are and progressively will be the most difficult and expensive to extract – which will see prices soar.
The risk Scotland runs is selling independence to voters in the 2014 referendum on promises of all sorts of transient goodies, continuing universal benefits, free higher education and free health – all to be paid for from oil and gas revenues.
All that this can do is to create a short term feel-good bubble and leave the country with nothing in the tank when that bubble bursts.
The hard fact is that we should plan not to spend one single petrodollar on anything which is not hard-nosed future-building.
Choices. consequences and politics
The key is a structural transformation in the economy – cutting costs, creating value – governed by a national plan to build a future sustainable on the new and forward-facing assets the last petrodollars can bring into existence.
Using oil to maintain the status quo of a culture the Scottish Labour leader has straightforwardly called ‘the something for nothing culture’ would be historically irresponsible, a weak waste of the last opportunity to build an economic raft.
The dedication of the petrodollar to future-building would be unpopular, since we are already well into the culture of promises of good times for all, come access to Scotland’s oil.
This unpopularity offers immediate hostages to political fortune.
Any government of a Scotland with control of the oil and gas industry in its waters and working to create the necessary long term economic step change with the accruing revenues, would struggle to survive without cross-party agreement on a national development plan.
In the larger interests of the country, such an agreement would have to be made.
This would need to be an agreed 25 year plan, covering the period from access to control of the industry [under whatever political system] to the effective dying away of the goose with the golden eggs.
These resources are finite, so the imperative is the maximisation of the impact of every dollar in creating an economic transformation in short order.
Scotland might also choose to leave some of the reserves in place as a hedge against dependence on others after oil has generally run out, giving us an independent reserve source.
Juggling with oil – the issues
The key issues dictating the national management of this industry, in this last phase of its existence, centre around the balance a government wishes to maintain between keeping the energy source [and economic activity] flowing and keeping a strategic recoverable reserve as a hedge against the transition period to other energy sources.
A parallel issue in this is the amount of revenue the state needs returned from the industry to, as we advise, drive its planned investment programme over the remaining period of supply of these resources.
If the very real environmental issue of disposal of toxic fluid wastes and protection of the water supply can be resolved – acceptably and transparently – there is every case, in energy supply and in generating economic activity, f0r exploiting Scotland’s potential reserves of shale gas.
The role and impact of taxation
Tied into extraction from both traditional and shale reserves and into accruing state revenues is the issue of the tax regime for the industry.
This is at once the generator of state revenues and the control device against over exploitation of the reserve.
Because the focus of this series of articles is explanatory, we’re not going into the minutiae of North Sea Tax but the summary position is that operating companies pay Corporation Tax on profits; and also pay a royalty tax based on the amount of the resource they extract.
From the companies’ position, a key issue is the stability of the tax regime. Because of the scale of the investments and the complexity of operations, they have to be able to plan ahead according to stable cost criteria over the long term.
Thus industry runs on 20-30 year investment cycles, planned to make, say, a 10% rate of return. If a country suddenly takes additional bites out of this return, then obviously it is unpopular, destabilising and leads to changes of direction in the industry. This is why it is important for governments to be trusted by the industry.
Governments have a habit of suddenly chucking in additional taxes in this area, which has been shown to be detrimental to the industry and consequently to the Exchequer.
In 2011, UK Chancellor George Osborne’s unexpected tinkering with oil industry taxes destabilised the industry’s financial planning and saw the UK lose out as investment was consequently switched to countries like Egypt and Ghana, which had become more competitive.
Deloitte showed that drilling in the North Sea dropped by 52% in the second quarter of that year.
Andrew Moorfield, global head of oil and gas at Lloyds Banking Group, a key lender to the sector, explained at the time: ‘When assessing credit risks, the industry considers both the political security of a country and the predictability of its tax regime. As an AAA-rated country, the UK has traditionally scored well on both counts, but is now performing poorly on the second.’
Moorfield pointed to Ghana – an emerging oil producing country – which has worked closely with the Norwegian oil ministry to develop a stable tax regime that ensures an acceptable allocation of profit between the state and foreign investors.
Its tax regime is based around petroleum sharing contracts with 35% corporation tax and a 3%-10% royalty tax, depending on the underlying commodity being extracted. This is agreed contract-by-contract, giving investing companies greater tax stability and transparency over the life of the project.
West Africa’s Gabon also uses a predictable service contract-based tax regime that has been stable since 1983. Egypt has a predictable petroleum-sharing contract regime combined with 40-55% corporation tax, unchanged since 2005.
Mr Osborne later reversed the changes he had made and reverted to stability, adding some tax breaks, noted above, with markedly positive results seen in the North sea.
Obviously, the more benign the tax regime, the more the companies have to invest – and this is where the strategic raising of the tax rate can be used deliberately to direct extraction rates and protect the reserve.
Norway and Scotland
Norway has been quite savvy with its oil and gas reserves.
Their taxes are sky high, like 80% on foreign investment – which they route back into their state fund for the future.
As a result of this tax regime they have not exploited that much of their reserve. if you tax in a regime that takes a total of 80% with oil at $100 a barrel, operators will only extract resource which costs less than $20 to extract – otherwise there is no point.
Not to have exploited much of the reserve sounds good but gives rise to a couple of issues. Government will not have the capital to invest in exploration and development; and they probably don’t want to take that risk anyway.
Scotland really needs to partner with big oil – but if you tax them too much they will not make money out of it and hence will choose to invest elsewhere.
The tax breaks in the North Sea recently have increased the number of smaller investors and hence increased the recoverable reserve. It’s all about the balance.
Scotland would have to look at that situation and play with the numbers to see where the balance is.
It might consider nationalising some of the asset to create employment, mandating Scottish workers and graduates to work on it and thereby building and retaining genuine engineering skills. This is the secret to Scotland’s future.
On the balance issue, there is a strategic argument around the assurance of supply. For example, Scotland might guarantee gas fired power stations from its own gas for 4 million people for a period to avoid importing.
But then, this way, you won’t make any money so you need to balance up what you need to reinvest. That decision would probably be made once you have your national plan and you know what development you want to focus on.
There is an equation on tax versus how much people invest. For example, if oil sales make $100 a barrel, then you will only extract the amount which is profitable at $100 a barrel.
If extraction costs then go up to $110 a barrel, logically you will stop production.
If, however, the price goes up to $200 you would work to find a lot more recoverable barrels – and your effective resource would go up again.
That is what is happening in the North Sea. The price goes up;. Companies put more money into extraction.
And you will get technological leaps because the more that can be extracted more cheaply than anticipated, the more the profit motive will uncover a greater recoverable reserve.
This means that the North Sea could be innovative in how to extract maximum resource from existing fields – and such knowledge is exportable.
In summary
The juggling in the state’s management of the oil and gas resource lies in maintaining a strategic balance between the key factors.
This involves balancing the revenue generation for capital investment to drive the agreed national plan against the impact of the chosen tax regime on investment in exploration, development and extraction by the oil companies – and considering how much of the reserve Scotland might choose to keep in reserve.
The key point is to plan to route every single petrodollar through the economy for investment in the creation of value; and not to spend any of it on annually recurring revenue needs. These must be met from other tax revenues.
That highlights the imperative to look rigorously at costs, to prioritise the needs and vulnerabilities any civilised society must protect and to be courageous enough to identify and cut or remove expenditure on any other.
What is involved here is the strategic direction of available resources to drive the national plan, accepting that everything cannot be supported and that some things will be left to market demand to carry on at whatever level or not.
These consequential issues focus attention on the cultural change Johann Lamont has already identified. Bringing about this change would be complex and necessarily incrementally built. It would involve education, employment, the benefits regime and a more independent balance between individual and collective responsibility.
Such matters will emerge from the following articles in this series.
This and subsequent articles in the series will be linked to the foot of the introductory article published on 31st December 2012: Scotland’s economic future: the brave or the grave.
Note 1: There is another aspect to the need for stability in tax regimes in the oil and gas industry – and one that directly affects most of us personally. Most people have their pension in the FTSE which is heavily oil weighted – so you want your homegrown companies to do well.
Note 2: According to Bloomberg, Norway’s $660 billion sovereign wealth fund, the world’s largest and based on oil revenues, returned 4.7% in the third quarter of 2012, making $29 billion – and it deposited 80 billion kroner more of oil revenue into the fund in that quarter. The return to the fund’s target return of 4% came after a drop to 2% and as global stock markets recovered after central banks from the U.S. to Japan stepped up efforts to stimulate growth.
Note 3: ‘Petroleum sharing contracts’ are not about sharing the petroleum itself but about sharing the profits from an extraction contract. For those interested in the detail of this revenue sharing arrangement, there is a straightforward account in Wikipedia here and an e-book here which includes a focus on the issue.
Pingback: Argyll News: Scotland’s economic future: the brave or the grave | For Argyll
The explanation of the relationships between oil & gas exploration & production and taxation is very interesting – particularly the comments on the need for stable and balanced tax strategies.
The further comments, on the need for cost cutting in the fields of education, health and the benefits regime, are fair enough if they are fair – but there’s surely some comment missing here – on the role of the Scottish banking system in the economic health of this nation.
The colossal financial mess caused by lack of banking regulation isn’t all down to behaviour in the city of London; Scotland’s (and particularly Edinburgh’s) lauded financial sector was found to have been seriously lacking, and this needs addressing just as much – if not more – than reform of the health service, benefits regime and education funding.
‘Hard nosed future building’ and Johann Lamont’s culture change should surely involve more than just trimming the welfare state, it needs trimming the rampant greed and self-interest in the banking sector that’s done so much to damage this country – and to damage its reputation.
It’s maybe not surprising that the political opinions of someone expert in the workings of the oil & gas industry should seem to echo the American Republican line, but this isn’t America.
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To clarify – this was a team effort, with a senior figure from the oil and gas industry as one of the team – and who is not aligned with American Republican perspectives – as was no one else involved.
The reconfiguration of specific services is overdue and unavoidable in any sustainable economy but would have to be based on fairness and on real protection of the genuinely vulnerable.
There are other issues here too, which involve culture change – which can only sccessfully be managed strategically over a given time and not as the crude slam-dunk our term-governed political system tends to dictate – which is why cross party agreement to a national plan would be necessary. Johann Lamont’s move has to offer hope that cross-party agreement on fair changes in benefits and free services is achievable in good faith. The required timescale is why we have said already that such a culture shift would have to be incrementally built.
The banks issue is a huge one and we agree utterly that reform here would have to be a core part of overall national redirection.
It’s a very complex issue which we’re working on and when we’ve unravelled it, we will get to it.
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There is no such thing as “free” services – they are all paid for.
Lamont’s move is nothing more than her folowing orders from her bosses in London, she is only interested in doing as she’s told to do – without any thought in the slightest.
She highlights this by using the rather ignorant and imbecilic “something for nothing” phrase -all this demonstartes is that someone wrote her script and she stupidly read it out – no thought needed or involved.
The above phrase is straight out of the Tory handbook on bashing the welfare state
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Recent official figures indicate that the Norwegian economy is more oil dependent than Scotland’s. Denmark has no large oil revenue. In both cases their welfare states are as well developed as Scotland’s, so the relationship between exploitation of a finite resource and a welfare state are not mutually dependent.
The rate of personal taxation is not the issue; it’s quality of life and individual net worth after tax. According to the World Bank, IMF and the CIA all Nordic Countries score highly on these tests. If you visit them you are immediately struck by the cost to us but it,’s hard to find shops selling cheap quality or charity goods which would indicate that the population has plenty of disposable income to sustain the local shops.
Many new shops have opened in Oslo, Helsinki and Stockholm over the last five years. Having visited all this past year I don’t recall seeing an empty shop in the cities’ centres unlike Buchanan Street.
Today a report indicates that in an international comparison for university research and development Finland and Sweden are first and
second with Scotland fourth and Denmark eighth. In the same report Scotland has three university in the top global 100 while the Nordic countries have five.
The key to our economic future is developing the spin-off manufacturing sector from our universities to create the global players we need to create
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A key point in the infrastructural development already in place in Norway and in Denmark. Because of the fragility of the A83, we know a lot about Norway’s substantial tunneling systems.
Scotland has so much of this to do – which is why the one-off oil revenue opportunity simply must be pressed exclusively into the service of investment and value creation.
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The SNP are quick to mention all that is good about Norway but do you ever hear them telling the Scots what the price of booze is in Norway?
It looks like they don’t want to tell the heaviest boozers on the planet that a half litre of been can cost 10 euros or £8-10p at todays exchange rate. It would certainly not help their slim chances of persuading more that 30% of the population to vote yes in the separation / independence referendum. At these prices, no need for minimum pricing in Norway.
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Have you any idea of the wages in Norway?
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It is considered that wages are higher in Norway but so is the cost of living. You pay around 30% tax, spend 27% on rental housing and pay NOK250 or US$45 for one large take-way pizza.
Given the current exchange rate is 9.01 Krone to the pound, it can be seen that the cost of living is exceptionally high just like the cost of their beer. I don’t think that your average Scot would be buying many pizzas on their stagger home from the pub at these prices. It is recorded that a family of four can struggle to live off one parents average wage in Norway. Hence, both parents find a need to work in Norway.
The average salary, which runs between 45,000 NOK to 50,000 NOK (£36,500 to £40,000) is slightly higher than the UK but certainly does not cover the higher cost of living in Norway.
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Where are the empty shops on Buchanan St? How many?
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By all measures Norway is a very successful country. It has one of the world’s highest Human Development Index ratings.
As a measure of something an HDI rating is a statitical weighting of earnings, level of education and healthcare longevity. Put simply if you get the income, get the education, and deliver the healthcare, then you get a high HDI.
However, another measure of something is that of the GINI index which is a measure of income inequality where the scale runs from 0 to 1. A measure really of whether in a country one person has all the wealth or whether all the people have the wealth.
Norway again scores very highly on this, and given these indicators, and the general observation from visiting the country that all is well, one can see why folks look towards Norway as being the type of country they would like Scotland to be.
A positive vision of a way forward, it is so unfortunate that there are people who disparage this as an aspiration for Scotland to emulate.
But Norway is not the only succesful small country doing well, and we ignore these success stories at our peril.
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Who wants Scotland to be like Norway? I don’t. I want Scotland to be like Scotland. We also need to remember that Norway has a work culture and not a benefits and booze culture.
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And what exactly is Scotland like? And how can she be like herself when she is a governed from the City of London and the home counties for their own benefit?
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Gorach, you certainly come across as being a typical SNP supporter who is paranoid, paranoid, paranoid with London and Westminster to blame for everything.
We know that Scotland has a major alcohol problem, has a massive sectarian problem with a large number of its population happy to live on benefits. No doubt you will say that Westminster / London are to blame for these problems as well?
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so many armchair generals,
excellent article newsroom. I do this for a career so i understand the delicate balance between investment and extraction and also the geopolitical influences which determine where and when substatial captial is invested.
i lived in norway for 2 years, my 2 eldest chikdren speak norwegian, jeg snakker lit norsk. norway is no utopia. let me tell you the hard truth it is an exceptionally expensive contry to live in. in the uk we have a culture which is substatianlly different to that of the scandanvian countries.
putting the alcohol prcing thing to one side ( which is incidentially down to doctors prescribing alchol as an antidespresan in the 1920 and 1930 in the region )
norway has maintained its sovereign welath fund through taxation. i was taxed at 47.5% of my earnings. So where i worked 60-80 hours per week for some months at a time. 30-40 hours if that went to pay my tax bill. and before sime one says that its not possible to work that many hours in norway as the trade unions wouldnt allow it. as a manger you are not covered by such legislation.
the cukture of the scandanvian countries is significantly differen to that of the uk. there is an excellent blog call My little Norway, which others have visited here, which gives an insight. norwegians are proudly insular and independant but dont expect any banter at the train station annaspect of scottish life which i love.
in short i lovd working in norway ( as ourmaninoslo ) but i would nt wish to spend the rest if my life there. if the brave new world view is that scotland shoukd be become a new norway then i’ll not be coming back.
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I’m with you, Banasheil, let’s stay with benefits and booze. A work culture is something we need not aspire to if the SNP keep giving money away. (All written with tongue in cheek!)
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Well said Lowry. I am happy to sit back and take all the freebies that the SNP wants to throw at me which will help to boost my very large bank balance.
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Malts in the Grand Hotel in Oslo great value! In Tromso you get free coffee in the pubs!
Off topic but great importance to the Argyll economy is the threat from the UK Borders Agency which is hacking the cruise liners off big time by it’s insistence on one to one interviews with passengers if they wish to disembark at a UK port for few hours visit.
Oban, Luss, Helensburgh and many other tourist facilities stand to lose out if cruise ships get fed up and go elsewhere.
Another reason to vote YES!
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Graeme McCormick thinks that the Grand Hotel in Oslo is great value. On their website great value = £36 for a Sunday brunch. Maybe great value if you are like Rupert Murdoch, Brian Souter, Donald Trump or one of the other millionaire friends of Alex Salmond and have plenty money to throw away. I can’t see many Scots on their benefits or not wanting to pay £36 for brunch plus over £8 for a half litre of beer. £88 for a couple to have brunch with one drink is outrageous. Maybe that is what Graeme wants to see in a separated / independent Scotland?
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Sorry, but you are coming across as a trifle obsessed with what the Norwegians pay for certain goods. They do have a better standard of living compared to us in Scotland. Perhaps we should aspire rather than denigrate?
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How boring of you…..
I’m sure the inhabitants of some countries think we pay to much for goods and services too.
It’s a trifle ignorant to look at and lambast Norwegian prices, based on what wages are in Scotland DOH!
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So, do you mean that, if independence wins the day, the SNP will open the doors to drug peddlers via the Scottish ports? Not only will we get more freebies and benefits, we can look forward to rocking and rolling our time away as high as kites. It gets even better!
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how do you know that teh SNP will be the government of an independent Scotland?
Are you some sort of fortune-teller – no need to answer that, they’re charlatans and liars too
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Lowry, why do Unionists want to be little Englanders and so unwelcoming?
Benashell
Brunch at Claridges is somewhat more expensive
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Graeme and the other Nats keep shouting about Norway now (no longer the Circle of Prosperity (not much prosperity in Ireland and Iceland these days)) and how Scotland could be just like Norway. Unfortunately they try to hide the fact that prices in Norway are sky high. What on earth Claridges has to do with the argument is beyond me. A half litre of beer still costs over £8 and you will still pay over £20 for a take away pizza in Norway and that is not from a Claridges quality hotel.
Typical of the Nats that Graeme has got to bring everything back to England / the english when he talks about “little Englanders” being “so unwelcoming”. If we are honest, we would admit that Scotland can be very unwelcoming to outsiders and that does not just relate to the abuse that our english neighbours have to put up with when they move to Scotland. If Graeme was honest, he would admit that Scotland is not the welcoming country that we would try and make the rest of the world believe.
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Think you’ll find that if you get rid of your rampant ignorance, you’ll get to know that both Ireland and Iceland’s economies are growing at a much faster rate than the Uk one.
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Who will be first to discover who Sam is?
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who really cares – apart from you that is.
Sam is actually the name I’m known by – so why should I change it on here
I suppose you are going to say you were registered at birth with the name benashell, wonder who you are – some ignorant LIEBOOR troll in a piss-poor disguise
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Oops, looks like Someone’s Nerve is Particularly raw!!
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More likely they’re just not impressed by someone hiding behind a contrived name who’s sniping at them for doing the same – when in fact they’re not. If you snipe at people you shouldn’t be surprised if they return the compliment, with interest.
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au contraire bumshell – just treating you with the contempt you so much deserve.
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