UK: Scottish Independence: What’s Next?

Keywords: Scottish independence, North Sea industry, BP, oil & gas

On September 18, 2014, residents of Scotland will vote on the question: "Should Scotland be an independent country?" The broad ranging implications of a "yes" vote cannot be understated, particularly for oil & gas companies operating in the UK North Sea. Many key players have publicly aired their views on independence, including BP's chief executive, Bob Dudley, who has warned of the "big uncertainties" that would face the North Sea industry in the event of a "yes" vote.

Why Does the UK North Sea Form a Focal Point for Debate?

The oil & gas industry is the United Kingdom's largest industrial investor; it supplies almost half of the UK's primary energy needs and employs hundreds of thousands of people. Current 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 at today's prices.

It comes as no surprise, then, that North Sea oil & gas forms one of the central talking points in the independence debate, with both sides keen to retain the advantages that come with the oil & gas industry, most notably the tax revenues.

This debate has intensified recently with the February 24, 2014 publication of a report by Sir Ian Wood, who is referred to by some as one of the founding fathers of the North Sea oil industry, on the recovery and regulation of UK offshore oil & gas. The Wood Report includes recommendations for a new regulator and a fiscal regime that promotes increased investment. It has been endorsed by both sides of the independence debate, acknowledging that the UK North Sea needs a new focus to maximise what is left of its economic potential.

Scottish Oil vs. UK Oil—Where Is the Line Drawn?

The line between Scottish and the (rest of the) UK waters must be established to see which resources (and, therefore, tax revenues) are located within which jurisdiction. It has been suggested by Professor Kemp, a leading expert on Scotland's oil & gas industry, that if Scotland were to become independent, the UK Continental Shelf (UKCS) should be divided on a geographical basis using a "median line." He describes this as the "obvious" choice, noting that this was used in 1999 to determine the boundary between Scotland and the (rest of the) UK for fishing rights. The median line is also what would be assumed using the United Nations Convention on the Law of the Sea. If Scotland were to obtain a geographical share based on the median line, it would control 90 percent of the United Kingdom's oil & gas resources.

Other methods of determination include drawing a line from the Scottish land border straight across the North Sea. It was this method that was used to create the separation between the applicability of English and Scottish laws. Professor Kemp notes that "Although lawyers could have a long debate about which method to use, in terms of economics, it does not make all that much difference."

To add confusion to the debate, the Shetland and Orkney Islands, whose waters contain up to 67 percent of Scotland's oil & gas reserves, are petitioning the Scottish Parliament to hold separate referendums on the islands, where they argue that they should be allowed to vote to remain part of the UK, join an independent Scotland or seek independence of their own.

A New Regulator?

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 need to rapidly establish equivalent organisations, which would likely prove to 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 (a beefed up DECC) be established with enhanced powers to encourage operators to share infrastructure and technology in order to maximise production from the North Sea.

A New Legal and Fiscal Regime?

In the event of a "yes" vote, the assumption is that the UK Petroleum Act 1998 (currently administered by DECC) and the licences already in issue will continue to apply to Scottish elds unless the Scottish Government elects to change the status quo. Therefore, any current production licences will be "grandfathered" (meaning 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 oil & gas licensing round.

It has been further suggested that any Scottish oil & gas licences would need to be held by a Scottish company or, at the least, a Scottish branch of a foreign company. If this proves true, it will require considerable restructuring of North Sea oil & gas groups.

Another issue is the treatment of "cross-border" fields—i.e., elds that straddle the line between Scotland and the (rest of the) United Kingdom. Cross-border elds will require treaties governing how these elds 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.

The expectation is that existing UK tax legislation would remain applicable throughout the territories until the Scottish government decided to implement independent legislation.

The recently published 19th oil & gas survey asked a wide range of operators, contractors and service companies which policy areas they needed more information on regarding the referendum. The most common responses were around issues of business taxation and scal policies. Scottish Ministers have stated that no changes in the scal regime would be made without consultation. However, in order to meet the increased investment recommended by the Wood Report, it seems likely that the Scottish Parliament will have to increase the obligations of its operators either through its licences or taxation.

Decommissioning—Who Bears the Cost?

Tax relief is available to North Sea operators to offset the cost of decommissioning offshore facilities at the point of decommissioning. This provides certainty as well as an incentive for investors. The UK government has questioned whether an independent Scotland could afford such tax breaks and incentives without the (rest of the) UK's resources.

A focal point of the decommissioning discussion will be whether the (rest of the) UK should contribute to the decommissioning costs of old oil & gas fields in Scotland or whether Scotland should assume the whole of this burden.

Given that the North Sea is now classified as a "mature asset," meaning that the best and most easily accessible reserves have already been extracted (some 40 billion barrels of oil or equivalent having been extracted since 1975), decommissioning costs are set to rise.

The impact of the reliefs to fund decommissioning will materially impact future revenues for an independent Scotland, unless some of that burden is shared by Westminster.

Final Thoughts

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

It should be noted that even if Scotland votes "no," changes in the UKCS regime are inevitable due to the continued devolution of power to Scotland and the findings and recommendations of the Wood Report.

Originally published Spring 2014

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