Oil and Gas Analysis

With all the furore over the Grangemouth complex, Scotland’s oil and gas industry has been in the spotlight. The Institute for Fiscal Studies said that the oil reserves would be a major factor in maintain Scotland’s post-independence economy. Both sides of the argument are accused and accuse each other of under or over estimating Scotland’s reserves. But Scotland’s oil and gas is bigger than Scotland itself; it’s part of a worldwide industry, one that is highly interconnected. I’m going to consider what will affect Scotland’s oil over the next year.

Ireland

Countries don’t come much closer than the Republic of Ireland and Scotland; a sort of double act where both think the other’s the sidekick. Whilst Scotland was once the one with the oil, now Ireland is eyeing its own hydrocarbon industry. A lot of focus and investment is pouring into Ireland to go after the bounty of oil that may lie under Ireland’s section of the Atlantic and the Irish government is preparing an (overgenerous) allowance of tax breaks for companies prospecting in the country’s territory. It’s in early days, and things don’t always go as planned, but big things can be expected from Ireland.

How does this affect Scotland? Well, big discoveries in the North Sea and Northern Atlantic could point to additional oil discoveries for Scotland. There is a constant stream of information about the North Sea’s oil supplies and this isn’t the place to try and prove or disprove any of it. Pessimists are always quick to point out declining production rates from the North Sea, but new discoveries are still being made. Look at the new Enochdhu Field off of Aberdeen. So long as the North Sea as a whole is in the spotlight, it means potential new investments for Scotland, as well as new technologies to exploit its tired existing fields and qualified personnel to work them.

However, Ireland’s oil success could work against Scotland. If Ireland has its own oil and gas boom, like Scotland’s in the seventies, it would become a direct competitor with Scotland. This would result in both countries selling their hydrocarbons at a lower price and therefore lower profit. But it would also have the knock on effect of drawing investments away from Scotland. If Ireland’s oil boom comes before Scottish independence, or even not long after (a relatively unlikely event) then Ireland could brain drain a lot of Scotland, the UK and the EU’s qualified oil workers.

Personnel

Speaking of qualified workers, it’s hard to understate how important they are. Every industry needs people. As a rule, better people mean a better industry. And for the highly specialised oil and gas industry, having a qualified workforce is vital to its success. Maintaining world-class oil and gas workers is Scotland’s biggest challenge to maintaining a world-class oil and gas industry.

The recent strike at the Grangemouth Refinery illustrates just how important workers are to the oil and gas industry. The strike puts a huge strain on not just Scotland’s, but the entire UK’s oil supply. They can’t just be replaced at the drop of a hat. It also shows the financial challenges facing Scottish oil sector workers. The plant was able to force the workers to take a reduction in pay, at a time when oil workers’ salaries are expected to increase by 15%. If Scotland can’t offer competitive pay packets, then it can expect its oil industry to atrophy.

The last article also brings up the important issue of a skills shortage facing the oil industry. Scotland will need to start offering up attractive incentives to potential students to study to work in the oil industry. An independent Scotland would need to remain in the EU in order to enable immigrants with useful skills to come and work in Scotland. Any potential competition in Europe will hamper skilled immigrants from choosing to base themselves in Scotland. Whilst I’ve discussed what Ireland could do, all of Europe, including Scotland and the UK is casting envious eyes at America’s shale revolution. This could result in an increased demand across all of Europe for skilled workers, which will force up wages and drag workers away from Scotland.

Shale

The biggest development in the world’s oil and gas industry in the last decade has been the US shale gas boom. It has caused gas prices across the world to dip and could turn the US into a net exporter of gas for the first time in years. It means that every country in the world is now desperate to create their own shale gas revolution.

Whilst Scotland has its own shale to exploit, it lies in Scotland’s most heavily populated regions. And it’s nothing compared to the rest of Europe, where prospective shale basins cover the whole of Belgium and the Netherlands, or the Baltics, or Romania. And while Europe is Scotland’s most important market, China and Russia are also looking to take advantage of their own shale.

Obviously, if everywhere starts producing gas, then Scotland is going to find itself with a moderately worthless commodity. Gas prices will plummet and most customers will prefer to utilise their own resources over imports. However, as most countries have found, the US was the perfect storm for shale. Europe is mired in political difficulties, with the European Parliament now demanding a full environmental impact assessment be performed before hydraulic fracturing can take place. Even China, which has the right mix of deposits and political will has found itself hamstringed by a lack of water. Whilst America pioneered the technology needed to exploit shale gas, it also brought the environmental risks to the world’s attention. Legal difficulties and protests have left Europe’s shale gas in the ground. As it stands, within the next few years at least, Scotland’s oil won’t be competing with a worldwide shale gas explosion.

Another side effect of all the shale gas available in the US has affected the flow of investment from big oil companies. Marathon has sold off its assets in Angola and Libya; Hess has sold its stake in Azerbaijan’s ACG field; and ConocoPhilips has seen fit to get of its stake Kazakhstan’s Kashagan Field, the second largest gas field in the world. They don’t need to invest in remote and unstable regions when there’s abundant gas right on their doorstep. How will this affect Scotland? Well, it means that European and Asian oil companies will have a feast of lucrative stakes in developing markets. However, the countries’ state oil companies are looking increasingly interested in shouldering the burden of developing their own resources. One way, investments will flow to developing markets and away from Scotland. The other, limited opportunities around the world will make Scotland an attractive market to develop.

Russia and China

Russia is currently the biggest producer of oil in the world. Whilst this should make the Kremlin very happy, it seems to be more of a cause of headaches. Russia is seen by its customers as a political liability, it’s battling with Ukraine as a transit country, its gas supplies are amongst some of the most expensive available to European customers thanks to unfavourable long-term contracts, and perhaps worse, it faces a major shortage of customers. It lacks major, year round ports to supply LNG (although big projects are in the works to rectify this) and its neighbours in the Caucasus Mountains, Central Asia and Iran have more than enough black gold themselves. If only there was an energy-hungry emerging superpower sharing a border with Russia.

China could easily be Russia’s saving grace. However, they’ve been locked in a struggle over pricing agreements for years, and it has only been recently that a deal has begun to progress, let alone develop to the point where infrastructure is being built. However, with Russian strongman Igor Sechin now in control of Russia’s state-owned oil company, a concrete deal is very likely to materialise in the near future.

What does this mean for Scotland? Well, with Russia now able to use China as leverage against Europe as a new customer, it is likely that European customers will find themselves with an increased price for Russian hydrocarbons. However, a big part of the delays over a Russian-Chinese deal is China’s demands that it should receive the same price as Europe for oil and gas. As such, with prices being the same in both regions, Russia won’t need to play favourites. Also, Russia has spent a huge amount on building infrastructure to secure gas supplies to Europe, bypassing unreliable Ukraine. It is unlikely that Russia’s long-term strategy for Europe will be to build pipelines to the continent and then turn off the tap. But this development should push up gas prices in Europe, which will mean a higher price for Scotland’s resources, a major boon post-independence.

Southern Gas Corridor

Europe has some of the highest energy prices in the world. Being a resource-depleted peninsula means that the continent is in a constant battle to keep itself supplied with energy. But with energy-hungry and cash-rich Asia sucking up LNG supplies, political unrest disrupting countries like Syria and Libya, and Russia throwing its political weight behind its significant and expensive hydrocarbon resources, Europe is running out of options.

But there’s one choice that might prove Europe’s saving grace; Azerbaijan. This small country on the Caspian Sea has spent more than a decade trying to develop its oil and gas potential, including its immense Shah Deniz gas field. The biggest obstacle has been trying to negotiate with the EU over supplies, specifically, how to get the gas to Europe. The EU didn’t want to commit to buying Azerbaijan’s gas until a pipeline was built, and Azerbaijan didn’t want to build a pipeline until the EU was committed to buying its gas.

That all changed this year when the Trans-Adriatic Pipeline (TAP) pipeline was chosen to transport Azerbaijan’s vast gas resources to Europe. Turkmenistan and Kazakhstan (who possesses the world’s second largest oil field, Kashagan) are also pushing to develop their own resources and build pipelines to Europe.

Assuming all plans come to fruition, Europe will spend 2020-forward inundated with gas supplies. This could easily cause the price of gas to fall across the continent. The UK and Europe are Scotland’s core markets. Geography limits many of Scotland’s potential markets; East Asia is too far away and America has too much of its own gas. Caucasian and Central Asian gas supplies will bring down prices in Europe. This may not be too much of a crisis for Scotland, since energy prices in Europe are generally some of the highest in the world. Energy prices are set to rise in the short term, meaning that Scotland would enjoy as honeymoon period after independence, with Europe hungry for Scotland’s oil and gas. But it will hamper longer term investment and the development of any potential North Sea fields left to be exploited.

Norway

Since the financial crisis meant Iceland, Ireland and other small European countries no longer provide an attractive example for Scotland to follow, the SNP now point to Scandinavia as the model for an independent Scotland. Since Norway has the world’s largest sovereign wealth fund in the world, it does seem logical to want to imitate the other oil-rich European nation.

As such, any development in Norway’s management of its oil wealth is worth following. Unfortunately, it is hard to tell what exactly is or will happen to the fund. It moves at a glacial pace and make its decisions based on long-term projections, not to make a quick bit of cash.

Whilst it is perhaps unlikely that Scotland’s wealth fund will grow as big as Norway’s, to the point that it becomes unwieldy to use, it will be worth watching to see how the Norwegian model develops. With the global economy becoming more complicated, the fund may have trouble adapting to a more dynamic market. Of course, it hasn’t failed yet.

But imitating the success of Norway’s sovereign wealth fund will have an ideological knock on effect. That the fund survived the financial crisis where the likes of Lehman Brothers did not points at a fundamental strength of the state-run model versus the private one. The fast moving, risky financial style that caused the crash is at odds with the slow, measured pace of the fund. If Scotland moves towards a wealth fund, it will result in an ideological shift away from the free market consensus of UK politics, which will most likely endure in an independent England. If state-mandated financial policies gain strength, than the case for Scottish independence will grow with it. If not, then the notion of a Scottish sovereign wealth fund will grow to seem like a child’s impractical desire to imitate its elders.

Renewables

Scotland has set itself an ambitious renewables target; to generate 100% of its electricity from renewable energy sources by 2020. Whilst this is not an impossible task, since Norway, Albania and Iceland (Scotland’s ex-poster boy for aspiration) have met or nearly met this target in Europe. However, it is still a major task for Scotland, since, as of 2012, Scotland was only producing 39% of its electricity from renewable sources. Scotland still has a mountain to climb if it wants to meet this target.

What does this mean for Scotland’s oil and gas industry? Well, the greater the percentage Scotland produces from renewables, the more oil and gas it can afford to export. This will result in a real economic boom for Scotland. Furthermore, if Scotland starts producing an excess of electricity, it will be able to export that as well. However, whilst infrastructure is limited, England is still a big market in and of itself, and there was talk of building a link between Scotland and Scandinavia, though that could be off the cards.

This is all assuming everything goes as planned. Green technology is still in its infancy, and there can be new developments that will greatly affect its future efficiency. Worst of all, there are concerns about the lifespan of green power sources, notably wind turbines. And this is on top of all the subsidies used to incentivise the construction of these machines. With energy prices rising, and David Cameron eager to blame this on Ed Milliband’s polices for subsidising green power, this could result in a backlash against green energy in Scotland, setting back the SNP’s 2020 target. The worst case scenario will see Scotland stuck with inefficient technologies compared to the rest of the world, facing a costly bill to replace them and failing to
recoup their losses from generous subsides.

The final issue is to remember that Scotland isn’t acting in isolation. The same green revolution that could sweep Scotland will also sweep the rest of the world. If Scotland starts replacing petrochemicals with renewables, what’s to stop all its potential markets from following suit?

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