2 Economic Impact

2.1 The oil and gas extraction industry has had a significant impact on the UK economy since substantial production of gas started in the late 1960s. The importance to the economy and National Accounts resulted in the start, in 1976, of a quarterly inquiry covering all oil and gas exploration and production licensees and also contractors and agents providing services unique to the industry. Contractors include companies employed in drilling or operating platforms for the licensed operators, but not companies whose principal work is classified to other industrial sectors such as seismic work or construction.

2.2 The contribution of the industry at any time is affected both by production and prices. During 1998 falling prices and expectations of continued low prices caused real concern to the industry.

2.3 Gas production rose steadily until the mid-1970s, remained fairly static until 1989, then increased each year to reach a new record annual level in 1998. Oil was first produced, in any significant quantity, in 1976. Production climbed sharply between 1975 and the mid-1980s, but fell back because of the Piper Alpha tragedy in 1988. Oil production began to recover in 1992 and, with a particularly strong rise in 1994, reached a peak in 1995. Over the next two years, oil production fell back slightly, but has grown to a new record annual level in 1998. Trends in both oil and gas production are illustrated in Chart 2.1.

Chart 2.1 Trends in the production of oil and gas, 1970 to 1998

2.4 The annual average price received for gas by UK Continental Shelf (UKCS) producers rose in most years until 1991, before dropping back a little for the next two years. Since 1994, prices have remained fairly static between 16 and 17 pence a therm, and only moved down a little in 1998. The average price received in 1998 was some 16.2p/therm compared with 16.7p/therm in 1997. These annual prices for sales of oil and gas from the UKCS are shown in Chart 2.2

Chart 2.2 Average oil and gas prices from UKCS sales, 1976 to 1998

2.5 The annual average price received for oil rose rapidly between 1978 and 1984 but then fell sharply. Prices rose in the latter half of 1990 due to the Gulf crisis, but since then have been affected by the weak world economy and uncertainty on the restoration of Iraqi production. Oil prices fell sharply at the end of 1997 largely due to troubles in Far Eastern economies and hit a fifty-year low in real terms in December 1998. The last such low was during the Great Depression in the 1930s. The average oil price received by producers from sales of UKCS oil was just under £60/tonne in 1998, some third lower than the £87/tonne received in 1997.

2.6 The price fall during 1998 resulted from a number of factors which moved crude oil supply in excess of demand. The ongoing effects of the Asian financial crisis combined with periods of unseasonably mild weather in the Northern Hemisphere to dampen oil demand growth. On the supply-side, both OPEC-led production cutbacks and the impacts of reduced cashflows on non-OPEC production proved to be too little, too late to support oil prices.

2.7 Looking at the almost continuous decline in oil prices since early 1997, it is hard to understand today why the continued fall was not foreseen. Part of the reason is the unexpected collapse in oil demand. Chart 2.3 illustrates the change in a typical demand forecast between August 1998 and February 1999.

Chart 2.3 Changes in forecast oil demand

2.8 UK National Accounts changed during 1998 to conform to the European System of Accounts (ESA95). The most noticeable effect on the oil production sector is that the new national accounts consider exploration and appraisal expenditure (E&A) as capital investment, rather than a running cost as under the old system. This means that the new oil sector accounts show both gross capital formation and trading profits (now known as operating surplus) some billion pounds higher than under the old series.

2.9 The National Accounts now measure the contribution of industries in Gross Value Added (GVA) at basic prices rather than Gross Domestic Product at factor cost. Chart 2.4 shows that the industry share of total GVA rose between 1992 and 1996 with increased production but has fallen since then under lower prices to around 1.7 per cent.

2.10 Since the start of major development in 1965, the industry has generated operating surpluses totalling some £237 billion of which over £102 billion, including £23 billion E&A, has been re-invested in the UK oil industry. Including licence fees, £89 billion has been paid to the Exchequer.

SALES

2.11 Oil has been the largest component of the sector’s sales, which are shown in Chart 2.4. Sales rose steadily to reach a peak in 1984. Sales declined sharply with the fall in oil prices at the end of 1985, and fell again in 1988 due to lower oil prices and the loss of sales from Piper and associated fields, picking up between 1991 and 1996 with rising oil and gas production. The total income of the sector fell back for the second year running to some £17 billion in 1998. The fall was almost entirely due to sales of oil and natural gas liquids (NGLs) which fell to £8 billion. Proceeds from the sale of gas rose slightly to £5.3 billion. Other income of operators and production licensees continued the rise since 1990 to stand at nearly £1.5 billion in 1998. The income due to contractors and exploration licensees rose to £2.2 billion. This rise was largely due to an increase in the number of companies classified to this sector with the trend to use of contractors. Figures for sales and income since 1988 are shown in Appendix 5.

Chart 2.4: UKCS oil and gas sector sales 1976 to 1998, and contribution to GVA

INVESTMENT

2.12 Expenditure on exploration and appraisal (E&A) in 1998 is estimated at £0.8 billion, some 36 per cent lower than in 1997. The number of well starts fell markedly from 96 to 80 (from 82 to 59 excluding sidetracks), initially due to high drilling rig costs and then to falling prices.

2.13 In early 1999, the DTI conducted a survey of operators’ intentions to drill offshore exploration and appraisal wells. Operators were asked to assign to each well a probability that the well would be drilled. The survey showed that, after allowing for probabilities, operators expect to drill some 27 E&A wells in 1999, and 32 in 2000 - see Table 2.1. These intentions are much lower than recent E&A drilling figures, showing the effect of low oil prices. The survey shows slightly more optimism for 2000, although expectations are half the level of 1998 except for West of Shetland which is the same as in 1998.

Table 2.1 Intentions to drill E&A wells: from DTI 1998 Survey

Note: The fall in intentions for 2001 reflects operators’ natural uncertainty about drilling so far into the future.

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2.14 Far less rigs are contracted for E&A wells in 1999 and 2000 than in the previous survey, with around half the previous percentage under contract despite fewer expected wells. Surprisingly, there are still some fears of rig shortages, though virtually only on deep water semi-submersibles.

2.15 Production investment (ie other than on E&A) in the mineral oil and natural gas extraction industry (including contractors classified under the sector) rose sharply in real terms in the early 1970s to peak in 1976. This investment was buoyed by increasing oil prices from 1979 until their fall at the end of 1985, when it declined in real terms until 1987. Investment reached near to £5 billion between 1991 and 1993 with the development of an unusually high number of large projects and fell, not surprisingly after these high levels, to some £3.75 billion in 1994, before recovering again to some £4.4 billion in 1995, 1996 and 1997.

2.16 Production investment rose in 1998 to some £5.1 billion. Including E&A, it formed around 17 per cent of total UK industrial investment, and just over 4 per cent of gross fixed capital investment.

2.17 Operators and other licensees engaged in exploiting the oil and gas resources of the UKCS provide figures on development, exploration, and operating expenditures. Where possible, these expenditures are split between oil and gas fields. However, where gas is produced in association with oil, it is difficult to draw a meaningful distinction between oil and gas costs. Figures for the period 1988 to 1998 are presented in Appendix 5, together with the criteria used for splitting oil and gas costs.

Chart 2.5 UKCS production investment, 1976 to 1998 with intended expenditure to 2000

Table 2.2 - DTI Capital Expenditure Survey 1998

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COSTS

2.26 Operating costs for oil and gas extraction are estimated to have risen only slightly to £4.2 billion in 1998, despite a marked rise in production. Thus operating costs per barrel fell again after the rise in 1997 had spoiled the reductions seen since 1991. This is shown in Chart 2.6, which gives operating costs per barrel in real terms. The fairly continuous rise from 1976 to 1991 is not unexpected as unit costs of fields rise when production begins to fall. Also, new fields often pay to use existing infrastructure so that operating costs are high but capital costs are reduced. Appendix 5 gives operating costs by year. The changes in categories reflect the increasing use of contractors.

Chart 2.6: Unit operating costs in 1998 prices, 1976 to 1998

2.27 To take account of both capital and operating costs, estimates have been made of the field life cost per barrel for all oil and condensate fields which have been approved, taking into account associated gas produced with oil - see Table 2.3. These overall estimates, which are rounded to the nearest £0.5/barrel, are based on the estimated production and costs of the fields together with their equity share of pipelines and terminals, before the payment of royalty and taxes. They include the costs of development and operation over the expected life of the fields, but exclude abortive exploration costs not attributable to individual fields. A real return on capital of 10 per cent is assumed. The figures can therefore be interpreted as the constant real oil price which would yield a pre-tax real rate of return of 10 per cent.

Table 2.3 Unit costs of fields at 1998 prices

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2.28 The industry responded to the fall in oil prices at the end of 1985, and brought the cost down slightly to £13.5 a barrel for oil fields starting production in the period 1986 to 1990, and, under continued weak oil prices, managed to reduce costs substantially, to £9 a barrel for the period from 1991 to the present. Continued efforts have resulted in further cost reductions so that the average costs of fields under development are estimated at £7 a barrel. The overall cost of all past and future production of all oil and condensate fields in production is around £10.5 a barrel.

2.29 The equivalent calculations for gas fields also show a large rise in costs for fields starting between 1980 and 1985, the success of efforts to reduce costs since then, and the need for continued cost reduction. The equivalent cost for all gas fields in production is some 13p/therm.

EMPLOYMENT

2.30 The offshore oil industry has been responsible for the creation of many new jobs. Revised Office for National Statistics (ONS) figures show that employment classified to the sector was some 27,000 in 1978, peaked near 37,000 in 1991, then fell sharply to 25,500 in 1995 but recovered to near 29,000 from 1996 onwards. ONS estimate that sector employment was some 28,400 in 1998. This is shown in Chart 2.7.

Chart 2.7: Employment in the oil and gas sector, and employment offshore, 1978 to 19978

2.31 Many oil related jobs such as construction workers are classified to other industries and are not included in these figures. This means that these figures are not coincident with numbers employed offshore.

2.32 An annual survey of the number employed offshore on rigs and platforms was started in 1967 and showed just over 1,000 workers. The number rose steadily through the 1970s to 12,500 in 1978, before falling back in 1979. From 1980 onwards the survey included workers on pipe-laying vessels, crane barges, supply and standby vessels. The new survey showed 22,000 workers offshore in 1980, the number rising until 1984, then falling until 1986. Thereafter offshore employment rose to peak at 36,500 in 1990, after which there was a general downward trend as companies attempted to reduce offshore employment to reduce costs. However, the 1993 figure was unexpectedly high due to the number of large fields under development on the day of the survey. Again, in 1995, a relatively high number of gas fields was being prepared for production.

2.33 These surveys are co-ordinated by the Inland Revenue, with the support of industry provided through UKOOA, as the main purpose was to assist with tax compliance in the offshore oil and gas industry. Aggregated results are distributed to government and industry bodies and are used, for example, by the Health and Safety Executive and UKOOA to calculate accident and safety statistics. In recent years the Inland Revenue recognised that the survey was not fulfilling its main purpose of assisting with tax compliance offshore, and approached industry to seek their support for change. The proposed modifications assisted an industry initiative to improve the accuracy of accident statistics, and the changes were introduced in the September 1996 survey. In their 1996 survey, the Inland Revenue estimated that the number of people employed offshore was some 26,850, of which 1.6 per cent were women and 92 per cent were UK nationals.Estimates for the 1997 survey gave offshore employment at some 23,000, of which 1.5 per cent were female and 93 per cent were UK nationals (97 per cent were from the EU). Offshore employment figures are shown with oil and gas sector employment in Chart 2.7. Table 2.4 shows the employment figures for 1996 and 1997 by type of work. From the latest survey, the Inland Revenue estimate that the number employed offshore in 1998 was some 25,500.

Table 2.4 Offshore Employment in 1996 & 1997 by type

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2.34 A survey by the Scottish Office and Scottish Enterprise estimated that in 1995 some 47,000 jobs were accounted for by companies in Scotland who were wholly involved in oil and gas production, and a further 17,000 mainly involved (ie having 80 to 99 per cent of activity related to oil and gas production). These figures have not been updated, but Scottish Enterprise have made available to Scottish companies a CD-ROM model aimed at aiding decision making concerned with upstream expenditure.

2.35 Aberdeen City and Aberdeenshire Councils estimated that in 1996 some 46,000 were in oil related employment in NE Scotland. An interim ‘Monitoring Report’ in 1998, before the oil price drop, suggested that this employment would decline from 45,200 in 1997 to 38,000 in 2006. A full report is intended for 1999.

2.36 A report commissioned by UKOOA published in March 1998 estimated, on an analysis of input-output data for 1995, that a total of 382,000 jobs depended directly or indirectly on the UKCS, with 126,000 of these based in Scotland. Of the total, 31,000 are estimated to be directly associated with offshore activities, 118,000 with suppliers and prime contractors and 101,000 with their sub-contractors and others further down the supply chain. The report adds a further 132,000 jobs estimated to depend on the spending of employment income by those in these 250,000 directly and indirectly supported jobs.

BALANCE OF PAYMENTS

2.37 The direct impact of oil and gas production has improved the UK balance of payments considerably. By 1980 the indigenous production of crude oil began to equal demand from UK refineries, and the effect of this can be easily seen in the visible trade balance. In 1980 oil contributed £0.3 billion of the UK visible trade surplus of some £1.3 billion. By 1985 visible trade was in deficit by £3.4 billion, with oil contributing a positive £8.0 billion. The contribution of oil declined with the fall in prices, but has always remained positive. The contribution has fallen each year since 1996, and in 1998 is estimated at some £3.0 billion in a total deficit of £20.6 billion. Chart 2.8 indicates the oil balance and the total visible trade balance, both on a balance of payments basis.

Chart 2.8: Visible trade balance, 1976 to 1998

GOVERNMENT REVENUES

2.38 The Government’s objective is to maximise the benefits to the nation from the exploitation of its hydrocarbon resources. The fiscal regime is designed to extract economic rent and secure a fair share of profits for the nation, while offering stable, attractive and economically sound investment conditions to the oil industry.

2.39 Receipts to the Government from taxes and royalties on oil and gas production (including licence fees) reached a peak of £12.2 billion in 1984/85 (equivalent to £21.9 billion in 1998/99 prices). Receipts subsequently declined with the fall in oil prices and are estimated to have totalled some £2.6 billion in 1998/99. Since 1964/65, the Government has received a total of £88.8 billion in money of the day or £152 billion in 1998/99 prices. Exchequer receipts since 1964/65 are given in Table 2.5 and illustrated, together with oil prices and total oil and gas production in Chart 2.9; in the chart, receipts and oil prices are both shown in constant 1998/99 prices.

Chart 2.9: Government receipts from UKCS - with oil prices, and production 1976/77 to 1997/98

2.40 Following the Chancellor’s announcement in his March 1998 Budget that he planned consultation on specific proposals for changes to the North Sea fiscal regime, the Government continued to monitor changes in oil prices. The Chancellor announced on 7 September 1998 that in view of the current low level of oil prices he had concluded that it was not right at that stage to proceed with reform along the lines envisaged in the Budget day announcement.

2.41 However, proposals for a number of technical changes to the fiscal regime which will help North Sea oil and gas companies were announced in the March 1999 Budget. The Finance Bill includes provisions:

	to ensure that, where a company sells an interest in a PRT-exempt gas field, the PRT exemption can continue to apply to the buyer: this corresponds to the way in which the Inland Revenue has applied the law in the past and will prevent an impediment to the transfer of interests in fields producing PRT-exempt gas;
	to allow companies the option of deferring the date on which they are required to make some PRT returns; and
	to remove an anomaly in the PRT pipeline election legislation to allow fairer competition for the transportation of non-UK oil and gas through North Sea pipelines.

Table 2.5 - Taxes and Royalties Attributable to UK Oil and Gas Production and Gas Levy

Notes:

1. Licence fees include receipts from fees for onshore and offshore petroleum exploration and production licenses, including initial and periodic payments and tender receipts from offshore licensing of £37 million from the 4th round in 1971/72, £33 million from the 8th round in 1982/83 and £121 million from the 9th round in 1984/85.
2. Supplementary Petroleum Duty (SPD) was introduced with effect from 1 January 1981 by the 1981 Finance Act and lapsed after 31 December 1982; it was payable at the rate of 20% on the net value of oil and gas produced under UK licenses less an allowance per field of 1 million tonnes per year; it did not apply to PRT-exempt sales of gas to the British Gas Corporation.
3. Advance Petroleum Tax (APRT) is included with PRT. The net PRT repayment in 1991/92 and low net receipts in 1992/93 resulted from high tax-relievable expenditure claimed on some fields.
4. The level of Corporation Tax receipts in 1993/94 reflects low liabilities in 1992 (paid in the following financial year) and repayment resulting from lower settlements for earlier years.
5. The ACT (Advance Corporation Tax) Set-off is estimated because the dividends attributable to UK oil and gas cannot be separately identified from other dividends.
6. Mainstream Corporation Tax (CT) equals CT before the ACT Set-off less the estimated ACT Set-off.
7. The yield from gas levy is not included in total Government revenues because it is categorised as a tax on expenditure rather than on income from oil and gas production.
8. Provisional estimates; the figures for 1998/99 are consistent with the Financial Statement and Budget Report 1998-99 (March 1999).

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Next Chapter

Title | Table of Contents
Chapter 1 | Chapter 2 | Chapter 3 | Chapter 4 | Chapter 5 | Chapter 6 | Chapter 7 | Chapter 8 | Chapter 9
Appendix 1 | Appendix 2 | Appendix 3 | Appendix 4 | Appendix 5 | Appendix 6 | Appendix 7 | Appendix 8 | Appendix 9
Appendix 10 | Appendix 11 | Appendix 12 | Appendix 13 | Appendix 14 | Appendix 15 | Appendix 16 | Appendix 17
Index Map | Plate 1 | Plate 2W | Plate 2E | Plate 3W | Plate 3E | Plate 4W | Plate 4E | Plate 5W | Plate 5E | Plate 6
Plate 7 | Plate 8W | Plate 8E | Plate 9W | Plate 9E | Plate 10W | Plate 10E | Plate 11 | Plate 12 | Legend
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