Crumbling Britain: oil and gas

The UK is an island of coal set in a sea of oil and gas – if I am allowed a little hyperbole and the odd long word this morning. It has taken a unique ability to make a mess that we end up importing large quantities of gas, worrying about the recent surge in world oil and gas prices, and worrying about our own security of supply.

We extract less oil, gas and coal than we could for a variety of reasons. Most of them relate to actions and inactions of the government.

The main reason we are getting less oil and gas out than our geography would suggest is taxation. The government has tweaked and changed the oil tax system in a number of ways, all designed to take more money from the industry. The politics of this are good. Oil companies are assumed to be too big , too powerful and too profitable, so hitting them in the pocket book can be popular. Many people don’t see it is happening, more don’t care if it is, and some positively welcome it. It would be an unusual politician whom went on TV or radio to argue for higher oil company profits or lower oil company taxes, at a time when the stated nominal profits are large.

However, to understand the shortfall of oil and gas production we do need to understand the nature and purpose of oil company (or for that matter any company’s) profits. The oil companies are in the main very large companies that have invested huge sums of money. They need large sums in profits to justify and remunerate these investments, and to pay dividends to our pensions and savings funds who are the main owners of these companies. More importantly, these companies have the opportunity to invest in a wide range of risky new ventures around the world. At any given time there are more projects than there are people, cash and machines to undertake them. The oil companies have to choose, and they will choose those projects and territories where the opportunity to make a good after tax return seems best. High taxes, or unstable taxation regimes where the changes are always upwards, put oil companies off investing.

The North Sea province is relatively mature – that means the easy finds have been made. It is getting dearer and dearer to find new oil and gas though there is doubtless n new oil and gas to be found. It is also getting dearer to get more of what has been found out of the ground. Oil companies leave some of the crude in the wells, as it is do difficult to bring it to the surface. The UK could make it more worthwhile to find more fields and exploit existing ones more fully by cutting tax rates. It might not reduce the revenue much or at all once the new schemes are brought on stream.

The problems with coal are different. It is difficult to get planning permission for opencast coal mining as it is not much fun living near an opencast mine. There is still a belief deep down in traditional Labour that the only mine that counts is a nationalised deep mine with miners travelling to the face on conveyors. There is also a modern ambivalence about how much coal we want to burn, with indecision about the clean coal technology which is going to be needed to bring coal back as a serious part of our energy supply.

The government should look again at the road blocks to bringing out more coal and more oil, and gas. Many of us do not look forward to increasing dependence on the Middle east and Russia, and would rather spend some money on the technology and exploitation of domestic resources, than get dragged into yet more difficult politics in dangerous countries.

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13 Comments

  1. Acorn
    Posted August 6, 2008 at 11:54 am | Permalink

    Some will be aware that our friends in the EU introduced the Large Combustion Plant Directive (LCPD), which kicked in on the first of January this year. There was a significant shift from burning coal to burning gas on that day, for electricity generation. Those coal fired plants that have opted out of the LCPD – not fitting flue gas cleaning – have changed their availability and price to fit the reduced running ours dictated by the LCPD.

    This makes our gas demand, particularly through next winter, even more dependant on our European "friends". It will be interesting to see how high the price will have to go to keep the gas flowing across the North Sea to the UK.

    See; Winter Consultation Report 2008/9 from NGC.
    http://www.nationalgrid.com/NR/rdonlyres/4B475A5C

  2. Richard
    Posted August 6, 2008 at 2:21 pm | Permalink

    Here, here. It's staggering that Britain is a net importer of O+G when there are very substantial stocks nearby.

    If the current government had bitten the bullet sooner and licensed more nuclear reactors we'd have been able to cut our dependency almost to the point of being a net exporter rather than suffering constant price rises every time the Russians threaten to shut the European pipelines or whenever the Iranians announce their latest missile test…

    More nuclear, with some wave, tide and wind power is the mix we should be aiming for.

  3. Neil Craig
    Posted August 6, 2008 at 2:28 pm | Permalink

    Coal is very cheap on the world market. For example Dubai has built 4 x 1,000mw coal generators which they will fuel with Australian coal paid for by their oil. This is an economically wise deal. Incidentally that means they will be producing 3 times more electricity per person than Britain & at about 1/4 the price per kwh.

    John describes well how the role of "windfall" profits acts as an economic guide to invest more in oil or anything else. The idea being put around by Labour backbenchers & the BBC, that more taxes on oil companies would reduce prices is economic illiteracy.

  4. Johnny Norfolk
    Posted August 6, 2008 at 4:38 pm | Permalink

    At last someone saying it as it is.very refreshing. Another labour disaster that we are all paying for
    .How can the English have voted them in power 3 times.
    No investigation from the BBC of course.

  5. backofanenvelope
    Posted August 6, 2008 at 6:22 pm | Permalink

    We are constantly told that power stations are going to expire. As a matter of interest, how firm are these forecasts? Could the expiry of the nuclear plants, for instance, be postponed? Could we have a programme of refitting plants of all types to extend their lives?

  6. Derek W. Buxton
    Posted August 6, 2008 at 7:34 pm | Permalink

    Re Patrick, London,

    "Incinerate all waste to provide the heat required by power stations."

    I seem to recall that a large incinerator was built next to a power station in Scotland. It was intended to burn, I think, waste board from an adjacent plant, all nice, neat and tidy. Except that after being built some regulator stepped in and stopped the plant dead, it was waste and so could not be burnt. I lost touch with the story after that but I know the plant was closed for some time and whether it opened again I do not know. So, good idea but watch out for the regulators, an EU regulation if I remember correctly.

    Derek Buxton

  7. Chuck Unsworth
    Posted August 6, 2008 at 10:40 pm | Permalink

    Absolutely the right move for where we are now. The pity is that we did not, decades ago, recognise that placing our faith in the good intentions of other nations is simply a hostage to fortune.

    It's my view that we should at that time have gone all-out to explore and exploit the nuclear energy options. I get to see Dungeness fairly regularly. It has suffered years of neglect – in all senses.

    And now the French have pulled out – but perhaps we ought to have anticipated that, too, in the light of history….

  8. Stuart Fairney
    Posted August 7, 2008 at 9:31 am | Permalink

    You know, the Iranian regime is rightly laughed at because of their need to import petrol despite sitting on the world's second largest reserves. Thye now ration petrol for their citizens. such a staggering failure is a mark of the stupidity and political suicide of their leadership.

    And here we are, in a not dissimilar situation. Quite remarkable, and again because of bad politics and lack of foresight.

  9. Letters From A Tory
    Posted August 7, 2008 at 11:02 am | Permalink

    In principle I agree, but the investment in cleaner technologies must be increased at the same time to avoid dependence on fossil fuels in general.
    http://lettersfromatory.wordpress.com

  10. Freeborn John
    Posted August 7, 2008 at 11:41 am | Permalink

    The cost of extracting oil in the Middle East is only $1-2 a barrel which would have been the market price for many decades had not OPEC limited production to keep the price closer to $20. The cost of production in the North Sea was about $18 and most of it was sold for marginal gain at close to the OPEC set level. Now the combination of dwindling stocks and Asian demand has pushed the market price well over $100 a barrel, but the cost of production in the North Sea also climbs as remaining reserves are in difficult sites.

    It makes no sense to encourage North Sea production at any marginal cost below today’s market price when the price in future years is only going to rise, i.e. no point to spend $98 getting a barrel that sells now for $100 when we might get $200 for it in future. It is far better from a political perspective too to use up whatever oil is to be had from unpredictable regimes in Russia & the Middle East first and keep ours for later rather than the other way around. The UK government should therefore discourage North Sea production by withholding North Sea licenses for later day or at least taxing the production very highly.

    • Neil Craig
      Posted August 7, 2008 at 12:56 pm | Permalink

      The assumption that oil is going to be rarer 7 thus more expensive in future is probably not going to be bourne out. Apart from finding more in the 75% of the earth that is ocean or finding massive amounts of adiobatic oil there is the strong probability that when we have GM'd plants & algae to produce oil it will be available in unlimited quantities. GM'd biofuels will be very much more efficient & thus cheaper than buying maize & converting it.
      http://alfin2100.blogspot.com/2008/02/first-trill

    • Stuart Fairney
      Posted August 7, 2008 at 1:59 pm | Permalink

      Freeborn John

      This is surely nonsense. Your argument amounts to "don't exploit a resource today because it might be worth more tomorrow"

      The holes in this logic seem to me at least to be clear. First, there is no certainty that oil prices will be higher in real terms in five or ten years than they are now, Second, if a company can get cash for an asset today, they have the opportunity to use that cash today to invest in whatever they consider commercially prudent. All companies prefer certain cash today to possible receipts at some point in the future. Thirdly, I think in our lifetimes, we will see the end of the petrochemical age. This won't be because the world runs out of oil, it will be because better technologies will replace it, (in the same way the stone age didn't end because we ran out of stones). So I think it prudent to extract whilst we need it and it is valuable.

  11. Freeborn John
    Posted August 7, 2008 at 7:14 pm | Permalink

    Neil & Stuart:

    I think the assumption that oil prices will rise in the medium-to-long term is not unreasonable because there is a finite amount of the stuff. Even if demand could be reduced the supply will still be exhausted at some point. We can expect short-term fluctuations, but the price will in general rise inexorably as we approach the point at which it runs out.

    I also think it unlikely that there will be a shift away from petrol to another form of power so long as there are cheap oil supplies left. Such a change is only likely when individual car drivers feel that the pain of driving around in a glorified golf buggy that needs charging every night is less than the pain felt in the wallet when filling up a conventional petrol car. In addition there are other uses for oil (e.g. plastics production, etc.) that form part of the demand for it.

    If there were a true free market in petrol and countries like Saudi Arabia & Russia were as reliable as domestic production then I would agree with you Stuart that what I recommend makes no sense. The logical thing to do in that case would be to use oil from the lowest cost production sites first (e.g.. those in the Saudi desert) until they are depleted and then work through progressively more difficult locations. Production from the North Sea would certainly not have occurred yet if the world were like this because getting oil from the bottom of gale-swept seas only ever made sense in the context of prices kept artificially high by OPEC for oil that literally spurts out of the desert. The price of oil today finally seems to reflect a real balance of supply & demand, but it is still the case that most oil comes from countries that are unstable or which are prepared to their oil & gas as a means to exert political influence over us. If energy is to be used as a political weapon against us by the Russians or others then oil reserves might be compared to bullets or gunpowder, such that we should aim to keep ours in reserve while others use theirs up. There may be an upfront cost in restricting UK production now, but (i) this cost will be borne by the whole world and not just UK petrol consumers, and (ii) if I am right that the price of oil will rise inexorably as world reserves decline then such an approach would actually be to our long-term profit as UK output would be sold at higher levels in the future.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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