UK: RESURGENCE OF THE DRILLING FIELDS - NORTH SEA OIL. - Surprisingly, this year's North Sea oil production will exceed output at any time during the 1980s. Resulting revenues, however, will not. David Smith explains why - and why it isn't such a bad thi

Last Updated: 31 Aug 2010

Surprisingly, this year's North Sea oil production will exceed output at any time during the 1980s. Resulting revenues, however, will not. David Smith explains why - and why it isn't such a bad thing.

North Sea Oil, as everyone knows, was discovered in the 1960s, developed in the 1970s and exploited in the 1980s. But it now seems a distant memory. Politicians trade in insults about the extent to which the oil wealth was squandered in tax cuts and an unsustainable consumer boom. The days when the pound could accurately be described as a petrocurrency are long gone.

Conspiracy theorists would even put part of the warmth of the relationship between Ronald Reagan and Margaret Thatcher down to the fact that, when the security of Middle East oil supplies was in doubt, Britain's North Sea became a safe and pivotal source of supply. So what did happen to the oil, and why do we hear relatively little about it now?

The answer is somewhat surprising. Quietly, North Sea oil is booming again. This year's production, at around 125 million tonnes, will not only be the biggest on record but it also represents a rise of some 25% on last year. Nor is this a flash in the pan. New fields will maintain a healthy level of output, of between 110 million and 130 million tonnes a year, until the end of the century.

The strong rise in North Sea oil production has once more made the distinction between the onshore and offshore economy an important one. When Kenneth Clarke raised interest rates in September, the first sustained increase in five years, it was in response to a strong rise in gross domestic product, of 3.8% in the second quarter compared with a year earlier. Chancellors know that when the GDP numbers start pointing to growth rates of almost 4% it is time to start pressing down on the brake. The figures were, however, heavily influenced by a sharp rise in oil output (up 36%) last year. Stripping out this effect gave a more modest non-oil GDP rise of a little over 3%. As in the early 1980s, oil has been exaggerating the economy's growth performance.

The need for any distinction between the offshore and onshore economies is disputed by some. Norman Lamont, when Chancellor of the Exchequer, greeted the first rise in GDP after the long 1990-92 recession without equivocation, even though the larger, non-oil component was still declining at the time.

Nor is its GDP impact the only effect of rising North Sea oil output. The high-quality light oil produced off the Scottish coast is in demand worldwide. By contrast, Britain has to import heavier oil to produce the right refinery mix. But netting out these two trades leaves Britain in profit. Oil exports will be worth around £7 billion this year, against imports of £3.5 billion.

So why the lack of fuss? There are two reasons. The first is the fact that the North Sea is now a mature oil province. This means that employment, on the rigs and for onshore construction work, is much more stable. The initial impact of the oil boom in the 1970s and 1980s was to provide a lifeline for Britain's be-leaguered shipyards. But as we have seen since, this lifeline would only stretch so far. Not that there has been no onshore effect from the latest increase in North Sea activity; Aberdeen has had the unusual experience of two separate boom periods.

The second change has been in the value of oil to the rest of the economy. Although there have been several recent periods when world oil prices appeared to be on the verge of making a comeback, the reality of excess global supplies (and the prospect of even more supply when embargoed Iraqi production comes back on stream) has kept prices down. The Organisation of Petroleum Exporting Countries (OPEC) has had a target price of $18 a barrel, but indiscipline among its members and the fact that oil demand has been weaker during the recovery than that for other commodities has tended to keep prices below this level.

This means, for example, that in real terms oil prices are only 20% to 25% of the level they reached in the aftermath of the Iranian revolution in the late 1970s. It was that surge in oil prices, remember, in combination with high UK interest rates, which sent the petrocurrency pound to levels which helped kill off large sections of British industry. The big crack in oil prices, though, came in 1985-86, with a fall from $30 to under $10 a barrel, followed by a partial recovery. Again, real prices are now only a third in dollar terms what they were then. And, since sterling has recovered against the dollar, the sterling price of oil has fallen by even more.

This means that the North Sea, despite record levels of output, no longer provides very rich pickings for the Exchequer. Before oil prices cracked in the mid-1980s, North Sea revenues were worth around 10% of the Government's total tax income, and 3% of GDP. In current prices that implies around £20 billion of annual revenue.

This year, revenues will struggle to reach £2 billion, a tenth of their equivalent level in the mid-1980s. To the extent that oil was a golden goose for the Exchequer, as it was in the first half of the 1980s, it is no longer.

We should not, however, shed too many tears over this. The last thing that the economy wants is for real oil prices to return to the levels of 10 years ago. The beneficial effect on oil taxation and the oil component of the balance of payments would be more than outweighed by negative effects elsewhere. For a start, the benign inflation environment would be seriously threatened. For another thing, we would have to accept sterling regaining some of its petrocurrency status, whatever exchange rate was justified by the competitiveness of the rest of the economy.

The present position, indeed, is rather comforting. Oil revenues and the North Sea's contribution to the balance of payments are welcome bonuses, but they are not central to our long-term survival. Instead, we should celebrate an unsung success story, and hope that it persists.

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