CMS

Whose oil is it anyway?

Question

What will an independent Scotland mean for the future of the UK North Sea oil industry?

Answer

Following the signing of the Edinburgh Agreement on 15 October 2012, a referendum on Scottish independence will take place in 2014. North Sea oil revenues will be one of the key areas of negotiation between Scotland and Westminster, should the people of Scotland vote for independence. The surrounding speculation has caused concern in the oil and gas industry, potentially adding a new layer of doubt to the already uncertain business of locating and extracting North Sea oil and gas.

Fiscal regime

The Scottish government estimates that there are the equivalent of 24 billion barrels of oil to be recovered from the North Sea. This would have a projected wholesale value of £1.5 trillion, with potential tax revenue for the state controlling those reserves of approximately £56 billion over the next six years at current rates. Control over North Sea oil and gas will therefore become a major battleground in the run-up to the independence referendum, with Scotland's fiscal future heavily reliant, according to the Institute of Fiscal Studies, on claiming roughly 90% of the geographical share of hydrocarbon revenues something which is disputed by the UK government.

If independence does happen, in the long term it would of course permit a Scottish government to pursue its own policies relating to upstream oil and gas activity in the Scottish share (be it geographic or otherwise) of the UK Continental Shelf. Licensing, taxation and other policies - such as those relating to third-party access to infrastructure or promoting investment in mature fields - would be independently dictated by Holyrood and may differ from policies and legislation applicable to the UK sector. This obviously creates an uncertain outlook for oil and gas companies operating on the UK Continental Shelf.

However, in the midst of this uncertainty, there has been a concerted effort to court the oil and gas industry's support for independence with favourable fiscal policies.

The Scottish government publically criticised the UK government's £2 billion tax windfall in March 2011 and, in response, proposed various alternatives aimed at reducing the tax burden on smaller, marginal fields. These plans include a Norwegian-style 'extended field allowance', which is a guaranteed minimum return on investment before any supplementary charge is levied, and a post-independence North Sea Fund which would see tax revenues invested in the area for future growth and development.

In 2012 Westminster attempted to mitigate industry bitterness from previous Treasury tax grabs by passing tax relief measures which exempt the first £500 million of income from a 32% tax rate and providing greater certainty on decommissioning (the process of taking redundant oil and gas installations out of service) tax relief. This has contributed to the number of project development approvals granted by the Department of Energy and Climate Change (DECC) virtually doubling between 2011 and 2012, and greater investment in developments and projects in the UK North Sea.

However, oil and gas companies will still want assurances that the tax regime applicable to the upstream oil and gas industry will remain stable, not just for the tax rate imposed but, crucially, the tax relief available for money spent on decommissioning UK North Sea oil and gas fields. The apportionment of the liability for this tax relief on decommissioning spend, estimated at £17 billion, is likely to be a fiercely contested issue for the two governments. However, the key for investors is not whether Westminster or Holyrood funds the tax relief, but that the current rate of relief is guaranteed (or bettered). Oil and gas companies will also want reassurance that they can recover any outstanding tax loss positions if their UK North Sea assets are transferred to a new Scottish tax regime.

Regulatory structure

Other issues still require consideration from North Sea oil and gas companies and investors. In the event that Scotland gains independence from the United Kingdom, early clarification of the status of the production licences already awarded by the UK government in what would become the Scottish sector would be required. In addition, a new regulatory body would need to be established to regulate oil and gas activity north of the border in much the same way as the Department of Energy and Climate Change (DECC) has regulated the UK North Sea in its various guises since commercial oil and gas activity began in the mid 1960s. Adequately replacing the expertise, systems and processes developed by DECC over this time will not be a straightforward task. Ultimately, upstream companies will want consistency and a smooth transition to ensure that additional administrative burdens and delays do not hinder the approvals process for upcoming projects and existing developments.

The industry will be aware (much to its dismay) that on 27 October 2011 the EC published draft legislative proposals for offshore safety, as it believes that "the likelihood of a major offshore accident in European waters remains unacceptably high". If implemented, these proposals would effectively centralise control of offshore health and safety and environmental protection in Europe, instead of allowing each national government to be responsible for regulating offshore activities in its own waters, as is currently the case. The status of EU regulation in an independent Scotland would therefore be a key issue for the sector, as it is uncertain whether an independent Scotland would automatically be an EU member or have to apply for membership. Therefore, offshore operators would need assurances that existing UK legislation and regulations would also have to remain in place until and unless they were replaced by new Scottish equivalents.

Outlook

As the offshore oil and gas industry is the United Kingdom's and Scotland's biggest investor, investing £11.4 billion in the North Sea in 2012 alone and with over 320 companies active in the region, the aim of both the Westminster and Holyrood governments, in the event of independence, must be to work together to minimise any disruption which might otherwise be caused by constitutional debate. Both governments must also look to offer the assurances and comfort needed to maintain and encourage this industry, the 440,000 jobs it supports and the levels of tax revenue it generates.

The effect an independent Scotland would have on the UK North Sea upstream oil and gas sector remains to be seen, but one thing is certain: if the Scottish people vote "yes" in 2014, the referendum is only the beginning.

Nicholas Edwards is a solicitor at CMS Cameron McKenna.

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