31 July 2023

New drilling licenses could be too little too late for the North Sea


Today’s pre-emptive announcement on new North Sea oil and gas licenses shows that the Prime Minster is serious about energy security and the role of the offshore sector in the Net Zero transition – yet without further action, it might be too little, too late for the North Sea.  

The outline of Rishi Sunak’s more hard-nosed energy policy became apparent earlier this year, with a Whitehall reorganisation creating the new Department for Energy Security and Net Zero (DESNZ) – note the order of those two priorities. This was swiftly followed by the publication of a reasonably detailed energy security plan alongside the ‘Powering Up Britain’ policy paper. 

At the heart of Sunak’s latest energy policy intervention today was the revelation that around 100 new licenses are expected to be awarded to upstream oil and gas companies when the results of the 33rd offshore oil and gas licensing round are published in September. After an unprecedented four-year hiatus since the last round, this is welcome news. As too is the confirmation that a 34th and further licensing rounds were to be expected, and that project permissions will be accelerated. In essence, the Government aims to ensure we maximise oil and gas production from the declining North Sea basin. 

This makes perfect sense. Even by 2050, we will still be using vast quantities of oil and gas. Better as much as of this as possible is sourced domestically (if economical) rather than imported from potentially unfriendly autocratic regimes selling into volatile international energy markets. At present the UK is a significant net importer, with domestic production equivalent to 60% and 53% of oil and gas consumption respectively. More domestic production will also mean lower prices for consumers – especially when it comes to natural gas, which is less fungible than oil thanks to logistical impediments. We will need a thriving North Sea offshore industry to smooth what has so far proven to be a rather bumpy energy transition. 

In a similar vein, the belated confirmation of another two Carbon Capture and Underground Storage (CCUS) industrial clusters, Acorn and Viking, should be welcomed. CCUS is an industry where, thanks to the geography and geology of the North Sea, the UK has a natural comparative advantage versus most other countries. If CCUS does become a major global industry of the future (not a given, admittedly), then we are well placed to benefit – as long as we can sustain a skilled offshore engineering workforce and keep the infrastructure in place until that point. Much the same can be said about offshore wind and blue and green hydrogen.    

But there’s the rub. Before the Ukraine crisis, oil and gas companies in the North Sea paid a 30% ‘ring fence corporation tax’ and a 10% ‘supplementary charge’. But bowing to political pressure last summer, companies were then lumbered with additional ‘Energy Profits Levy’ (EPL) – a 25% and now a 35% windfall tax. True, a price floor was announced for the EPL in June, and in theory, companies can offset capital investment against the EPL. Nevertheless, with the EPL in the mix, the headline rate of tax being paid by oil and gas companies on their North Sea operations is now a whopping 75%. 

Arguably, this is not even the worst thing about the North Sea tax regime. The deeper problem is the uncertainty and instability generated by normalising the idea of windfall taxes. The return on investment (ROI) period for offshore projects is usually in the order of decades. For investors, long-term clarity is therefore vital when making these sort of decisions. 

And of course, capital is highly mobile. If you’re a major international oil company (IOC) in the offshore business, why invest in marginal North Sea fields and pay eye-watering rates of tax when there are far more lucrative opportunities out there? Other countries tax oil and gas firms heavily too, but then they have far better investment opportunities. 

As an oil company, you could for example plough capital into the so-called ‘Golden Triangle’ – the Gulf of Mexico, West Africa and South America – which contains numerous deepwater oil fields, a large slate of undeveloped fields and huge exploration potential. Conventionally, the main countries in the Golden Triangle were America, Brazil, Nigeria and Angola. But exciting new deepwater frontiers have been opened up in Guyana, Namibia and Mexico, unlocking vast new oil deposits for exploitation. Meanwhile, if you want to establish a leading position in global gas markets, you could invest in the colossal gas discoveries offshore Mozambique and Tanzania in East Africa, Senegal and Mauritania in West Africa, or Cyprus and Egypt in the Mediterranean – as Shell and BP have been doing. 

As things stand, investing in the UK sector of the North Sea looks like an increasingly steep opportunity cost for many oil and gas companies. More than a few have cancelled investment or announced plans to pull up sticks entirely over the last 12 months. Premature decline, disinvestment and deskilling of the workforce is a real risk, threatening energy security and the energy transition. Belatedly there has been some recognition of this in Government, with the announcement today including a call for evidence on designing a new long-term fiscal regime for the oil and gas sector. 

However, it remains to be seen how persuasive industry finds whatever plans result from this process. After all, it seems pretty likely that the next government will be led by Keir Starmer, perhaps with Ed Miliband holding on to the energy brief. In those circumstances, the best that North Sea operators can probably hope for is to be used as a piggybank for the funding of green boondoggles – even if Labour’s proposed response to the subsidies and protectionism of Biden’s Inflation Reduction Act (IRA) has now been substantially watered down.      

On one level, this is helpful for the Government. With Ed Miliband trying to accelerate the decline of the North Sea industry, ministers can point to potentially hundreds of thousands of jobs that Labour is putting at risk and draw a clear dividing line with Starmer’s hard green saboteurs. To a lesser extent, the Government’s North Sea plans also allow it to pillory the SNP, whose leaders have cooled on North Sea oil since the days when ultra-high oil prices were supposedly going to underpin an independent Scotland’s public finances. Of course, given the state of the polls, these measures might be futile gestures. 

Nevertheless, stabilising the North Sea tax regime, accelerating project permissions and maxing out North Sea oil and gas output are all policies that would be good for energy security, affordability and smoothing the energy transition, regardless of the political optics. Today the Prime Minister has signalled his intent to double down on his earlier commitment to energy security. Let’s just hope he can find a way to give North Sea operators the certainty they crave. 

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Karl Williams is Deputy Research Director at the Centre for Policy Studies.