An independent Scotland could become an energy industry powerhouse

September 12, 2014, 3:20 PM UTC
Cabinets From Both UK And Scottish Governments Meet In North East Scotland
A picture shows section of the BP ETAP (Eastern Trough Area Project) oil platform in the North Sea, around 100 miles east of Aberdeen, Scotland on February 24, 2014. The British cabinet will meet in Scotland for only the third time in history to announce plans for the country's oil industry, which it warns will decline if Scots vote for independence. The fate of North Sea oil revenues will be a key issue ahead of the September 18 referendum to decide whether Scotland will end its 300-year-old union with England, and is expected to be the focus of Prime Minister David Cameron's cabinet meeting. AFP PHOTO / POOL / ANDY BUCHANAN
Photo: WPA Pool—Getty Images

Scotland would be wise to wave goodbye to the United Kingdom and vote in favor of independence.

While there are both positives and negatives to cutting the cord with Westminster, there is one factor in particular that should tip the scales in favor of the “Yes” camp—energy. Nearly all of the U.K.’s North Sea oil fields, as well as half of its natural gas fields, would end up under Edinburgh’s control, turning Scotland into an energy exporting powerhouse.

London has done a poor job managing the North Sea, leading to sharp declines in production across the board. An independent Scotland could wipe the slate clean and ensure that future profits made from the North Sea are responsibly reinvested in the region to support greater production down the line. If done carefully with an eye on the future, Scotland could end up in a much better place economically then were it to remain shackled to England.

Markets in the U.K. went haywire this week after a survey showed Scots were more likely to vote in favor of an independent Scotland. It was the first time in the last few months leading up to next week’s independence referendum that the so-called “Yes” vote in Scotland beat loyalists in a poll. The markets had largely ignored the Scottish issue ever since U.K. Prime Minister David Cameron said he would allow the Scots to vote on independence. Like Cameron, investors were fooled into believing that Scotland would vote overwhelmingly to remain a part of the U.K. But with the vote now just a week away, there is a very real chance that the U.K. could break up—for real.

U.K. loyalists are trying to scare voters into submission by arguing that Scotland would end up a financial mess if it were to break from the U.K. They say an independent Scotland would be broke, as it regularly spends more than it takes in. The fiscal deficits would add up, saddling the tiny nation of just five million people under an enormous amount of debt, which would be made infinitely worse after Scotland’s “portion” of the U.K.’s massive national debt is transferred over to Edinburgh’s balance sheet. Furthermore, there are questions as to how Scotland would even pay its debt, or, for that matter, pay for anything. Surely, Scotland won’t be allowed to keep the pound, right? As for joining the euro, what if Brussels doesn’t even allow Scotland to join the European Union? What then? A possible trade and currency union with Iceland?

These are legitimate concerns that voters should think about when they go to the polls. Unfortunately, no one has the answers to these questions right now. Westminster was so sure that the Scottish vote would fail that nothing has been mapped out as to how and when Scotland would secede. But it is not like this is the first time a country has broken from the United Kingdom. The Republic of Ireland did it 100 years ago and it turned out fine.

But for many Scots, the choice to secede from the U.K. is purely emotional. They want to solidify their culture through the establishment of a modern nation-state, costs be damned. Luckily for the loyalists, most voters aren’t die-hard Scottish nationalists. While the latest polls still show the separatists beating the loyalists, around half of those polled remain “undecided.”

Yet even with all the risks (real and imagined), undecided voters shouldn’t be afraid to back an independent Scotland. While Scotland’s economy isn’t the best at the moment—with an unemployment rate of around 10%—that could change if Scots were allowed to directly control their finances. Like Ireland, Scotland could reform its tax code to be more business-friendly, especially to its largest industry—energy. Independence would give Scotland the opportunity to rebuild, rethink, and refocus the energy sector to better serve the interests of the Scottish people.

Scotland’s energy prospects: Far from dead

It has been nearly 40 years since oil and natural gas were first discovered off Scotland’s coast in the North Sea and, despite views to the contrary, the industry is far from dead. Brent Crude, one of several types of oil found in the North Sea, remains the international benchmark for pricing oil, putting the North Sea at the center of the oil trading universe. Scotland could capitalize on the Brent brand by recruiting energy trading firms to relocate to Aberdeen, Scotland’s energy capital, with the intention of creating a European energy trading hub. With the right blend of tax incentives mixed with just the right amount of regulatory oversight, Scotland may be able to pull energy traders away from places like London and Switzerland. If the Scots played their cards right, they might even be able to attract ancillary financial services, creating a new financial center.

But to turn Aberdeen into an energy hub, Scotland needs to make sure that the oil keeps flowing. The U.K. portion of the North Sea (known as the U.K. continental shelf, or UKCS) is estimated to have between 30 to 40 years of productive life left in it. It is holding between 15 billion to 24 billion barrels of oil equivalent (boe), 91% of which falls within Scottish territorial waters, according to Professor Alex Kemp of Aberdeen university, a senior academic on the North Sea.

Using the higher end of that estimate, the “Yes” campaign, led by Alex Salmond, the leader of the Scottish National Party (SNP), is telling voters that Scotland’s oil reserves could be worth £1.5 trillion ($2.4 trillion), assuming oil goes for $100 a barrel. But Salmond, who just happens to be an oil economist by trade, knows very well that Scotland won’t be seeing all that money. Oil and Gas U.K., an industry trade group, estimates that runaway expenses associated with drilling could cost up to £1 trillion or $1.6 trillion over the next 40 years or so, leaving a gross profit of £500 billion ($800 billion). Let’s then say that half that money goes to the oil companies (the U.K. oil tax is 50%), which then leaves just £250 billion ($400 billion) left to distribute to the Scottish state. Spread that out over 40 years and Scotland would only be taking home around £6.25 billion, or $10 billion, per year.

Scotland’s annual budget was around £65 billon ($104 billion) last year, meaning that energy would cover just 10% of the independent state’s bills. While that isn’t a trivial amount of cash, it’s isn’t a huge amount, either. In any case, the energy industry has a huge positive knock-on effect on the overall economy. A large portion of that £1 trillion cost outlay gets recycled into the Scottish economy. Around 10% of Scotland’s workforce is connected to the energy industry in some way, with over 2000 energy-related businesses in Aberdeen alone. If just half that cash were to stay in Scotland, it would serve as an enormous contributor to the young nation’s GDP.

The “No” campaign is trying to downplay the importance of Scotland’s oil wealth, arguing that the North Sea couldn’t yield anywhere near the amount of oil the Scots believe is left below the ocean floor. But oil reserve estimates are normally very conservative as they must take into account some major unknowns, such as energy prices and technological change. Indeed, Kemp believes he could be underestimating the region’s reserves by as much as 12 billion boe, meaning that there could as much as 36 billon boe or more left in the UKCS. If all of that were oil, and it all sold today for $100 a barrel, and 91% of the take was Scottish oil, then Scotland’s reserves could actually be worth as much as $3.27 trillion, more than double the amount that the supposedly over-optimistic “Yes” campaign is estimating.

Energy comebacks: It happens, quite a bit

Sounds crazy? Well, not really. Technology can have a major impact on reserve life. In 2003, Houston-based Apache Corp purchased BP’s stake in the prolific Forties field in the North Sea for $880 million. BP’s engineers had concluded that the field had only 144 million barrels of oil equivalent left that could be economically extracted. But thanks to advances in drilling and seismic mapping technology, Apache was able to squeeze much more oil out of that field. By 2013, Apache had extracted around 200 million boe from the Forties field and identified 114 million boe that could be economically extracted down the line. That’s more than twice what BP had originally believed was left in the field, which is roughly in line with the spread between Kemp’s two top estimates.

The Apache story isn’t uncommon. The same thing happened in the shallow waters of the Gulf of Mexico a decade ago and is happening now in the Permian Basin of West Texas. Fields considered tapped out have been resurrected by smaller oil companies, usually due to a mix of new technology and a strong oil price. This phenomenon is playing out in the U.S. with the “shale revolution.” After years of steep declines, U.S. oil production has made an astounding comeback, up 60% from its lows in 2008. This is due to recent advances in drilling technology, namely hydraulic-fracturing (fracking) and horizontal drilling.

In the U.S., fracking has been limited to onshore development but there is a chance that it could be used offshore to help revive Scotland’s energy industry. The Kimmeridge Clay, a massive geological formation in the North Sea, was apparently formed at the same time and under similar conditions as the Haynesville shale play in Louisiana, according to a report by Kimmeridge Energy, a boutique energy firm based out of New York. They believe the Kimmeridge formation has comparable properties to many of the big shale plays in the U.S., making it a ripe candidate for fracking. With as much as 50% of the oil and gas generated in rock, Kimmeridge Energy believes there could be around one trillion boe that could be put to use with the help of fracking.

If Kimmeridge wasn’t underwater, chances are a dozen energy companies would be clamoring at the chance to drill. Offshore fracking has never been attempted, at least not on a large scale in ultra-deep waters, but that is unlikely to deter energy companies from looking into the prospect sometime in the near future.

If the “Yes” campaign is victorious in next week’s vote, Scotland will need to start delivering on its “oil dreams.” Reforming the tax code to allow explorers to deduct losses immediately could help jumpstart newfound interest in the North Sea. Scots also need to decide how they want the oil industry to operate. Should private companies be allowed to roam free in Scottish waters as they do today, or should the entire industry be nationalized? Should a Scottish national oil company be created, which would take the lead on projects and work in conjunction with the private energy companies?

At this point, the structure of Scotland’s energy industry isn’t as important as the opportunity. North Sea energy production is far from dead and could easily rebound in the next few years amid rapid changes in energy technology. This could mean more money for Scotland, which could eventually set up a sovereign wealth fund to invest the state’s energy profit. Overall, though, Scots will have a tough choice when they go to the polls next week. While backing independence may not be the safest option, it may ultimately prove to be the most lucrative.