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Uncertainties face the UK if Scotland says yes to independence

Mayer Brown looks at some of the possible implications of Scottish independence on the energy sector

On Thursday, residents of Scotland will vote for or against independence. The broad-ranging implications of a yes vote cannot be understated, particularly for oil and gas companies operating in the UK North Sea. Many key industry players have publicly aired their views on independence, including BP chief executive Bob Dudley, who has warned of the "big uncertainties" that would face North Sea operators in the event of a yes vote.

The oil and gas industry is the UK's biggest commercial industrial investor, it supplies almost half of the UK's total primary energy needs and employs hundreds of thousands of people. The most up to date estimates are that the North Sea's remaining commercial reserves could be up to 24 billion barrels of oil equivalent, worth approximately £1.5 trillion ($2.4 trillion) at today's prices.

It comes as no surprise that North Sea resources form one of the central talking points between the Scottish National Party and Westminster in the independence debate, with both sides keen to retain the advantages that come with the energy industry, most notably the tax revenues.

This debate has intensified recently with the publication of a report on 24 February by Sir Ian Wood, the founder of offshore services company the Wood Group, on the recovery and regulation of the UK offshore sector. The Wood Report included recommendations for a new regulator and a tax regime that promotes increased investment. Both sides of the independence debate have endorsed it, acknowledging that the UK North Sea needs a new focus to maximise what is left of its economic potential. Therefore, whichever way the vote falls on 18 September, the key recommendations of the Wood Report will have a material impact on future operations in the North Sea and need to be considered alongside the implications of the independence debate.

If Scotland says yes, the two governments will need to agree the division between Scottish and the UK waters in order to establish which oil resources, and therefore tax revenues, fall within which jurisdiction. One suggestion is that if Scotland becomes independent, the division between it and the rest of the UK should be along a "median line". This is the obvious choice, according to some, as it was this line that was used to determine the boundary between Scotland and the rest of the UK for fisheries in 1999. The median line is also what would be assumed using the United Nations Convention on the Law of the Sea. If the median line is used to separate the two jurisdictions, it would result in Scotland controlling 90% of the UK's oil and gas resources.

There are various other methods that could be used to separate the two jurisdictions, another one being to simply draw a straight line from the Scottish land border across the North Sea. It was this method that was used to create the separation between the applicability of English and Scottish laws. Professor Alex Kemp, an expert on Scotland's energy industry, said: "Although lawyers could have a long debate about [..which line to draw], in terms of economics, it does not make all that much difference."

Figure 1: Scottish oil
Figure 1: Scottish oil

Another issue is the treatment of cross-border fields, those which straddle the Scottish and the rest of the UK line. Trans-boundary fields will require treaties to be entered into between Scotland and the rest of the UK, governing how these resource-rich areas should be divided and governed fiscally and otherwise. In particular, the treaties would need to consider whether losses incurred in one territory could be offset against profits in the other.

A number of administrative organisations have jurisdiction over North Sea operations, most notably the Department of Energy and Climate Change (DECC) and the Health and Safety Executive. In the event of a yes vote, Scotland would have to move fast to establish equivalent organisations. This would likely be a complex process involving the transfer of large volumes of information and heavy recruitment of staff in what is already a competitive industry.

Irrespective of the discussions on Scottish independence, the Wood Report has recommended that a new North Sea regulator, under the control of a beefed-up DECC, be established. The report said this body would have enhanced powers to, for example, encourage operators to share infrastructure and technology in order to maximise production from the North Sea. It seems therefore that whichever way the vote falls, a new version of the current regulator is likely to come into play in the near future.

The recently published 19th Oil & Gas Survey, carried out in part by Strathclyde University, asked a wide range of operators, contractors and service companies working in the North Sea which policy areas they needed more information on regarding the Scottish referendum. The most common responses were related to business taxation and fiscal policies. It is clearly an area with which the industry is concerned and one to which neither side of the debate seem to have provided much of a response.

The Petroleum Act 1998 establishes the regulatory regime applying to oil and gas exploration and production in the North Sea and is administered by DECC. Under that law, all oil and gas resources are reserved for the UK government, but the secretary of state, through DECC, grants licences to oil and gas companies to explore and produce oil and gas in the North Sea. In the event of a yes vote, the assumption is that the Petroleum Act and the licences already issued by DECC will continue to apply to Scottish fields unless the Scottish government decides to change the status quo. Therefore any current production licences will be "grandfathered", which means they'll continue, in spite of any new regulation. The future is less certain for exploration licences and the possibility remains that they could be re-tendered in a new licensing round.

It has been further suggested that any Scottish licences would have to be held by a Scottish company or, at the least, a Scottish unit of a foreign company. If this was to happen, it would require considerable restructuring of North Sea energy companies.

Scottish ministers have stated that no changes in the fiscal regime would be made without consultation. However, it seems likely that the Scottish parliament will have to increase the obligations of its operators either through its licences or taxation in order to meet the increased investment recommended by the Wood Report.

The expectation is that existing UK tax legislation would remain applicable throughout the territories until the Scottish government decides to implement independent legislation, and no clear indication has been made as to what, if any, policy changes there may be.

Decommissioning policy is a major factor for any company operating in the North Sea. The province is now mature, with about 40 billion barrels of oil equivalent extracted since first production from the North Sea in 1975. Many fields are nearing the end of their producing lives, and will require decommissioning once shut in. Scottish parliament estimates put the cost of decommissioning at £40 billion by 2040.

Tax relief is available to North Sea operators to offset the cost of decommissioning facilities. This is critical for investors in the North Sea as it enables providers to meet the overall costs of decommissioning and provides certainty that those costs can be met.

The UK government has questioned whether an independent Scotland could afford such tax breaks and incentives without the rest of the UK's financial resources.

Another focal point of the decommissioning discussion will be whether the rest of the UK should contribute to the decommissioning costs of fields in Scotland or whether Scotland should assume the whole of this burden. The cost of funding decommissioning will have a material impact on future budgets in an independent Scotland, unless some of that burden is shared by Westminster.

It certainly is an interesting time for the North Sea oil and gas industry. With the lack of certainty surrounding the Scottish referendum, North Sea companies are finding it increasingly hard to plan ahead. The worry is that this may hinder investment in the North Sea, particularly in respect of older fields, until the issue is resolved.

In the event of a yes vote, Scotland will need to move quickly to provide greater certainty on the future of the North Sea to those doing business there. Even if Scotland votes no, changes in the North Sea are inevitable due to the continued devolution of power to Scotland, as well as the implementation of the Wood Report, which is vital to ensure continued investment in the North Sea.

Robert Hamill, partner, and Rebecca Bothamley, senior associate in the corporate group at Mayer Brown

 

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