Learning to live without North Sea oil

North Sea oil: Learning to live without North Sea oil - at Moneyweek.co.uk - the best of the week's international financial media.

Last month, Britain recorded a trade deficit in oil for the first time since 1991, a sign that our days of energy self-sufficiency are nearly over, says Simon Nixon.

When was North Sea oil discovered?

Exploitation of oil and gas in the North Sea began in 1964. The earliest discoveries were of gas, but later exploration revealed large oil deposits. Between 1967 and 1974, 18 oilfields were developed and the first oil was piped onshore in 1975. By the early 1980s, Britain became self-sufficient in oil and, by 1985, the UK was producing 2.65 million barrels per day, making the UK the world's fifth-largest oil producer.

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Has this affected the UK economy?

North Sea oil and gas has been something of a mixed blessing for the UK economy. On the debit side, North Sea revenues gave a huge boost to sterling, turning the pound into something of a petro-currency, which was a disaster for the competitiveness of UK manufacturing. On the plus side, the revenues allowed the Government to reduce the huge balance of payments and budget deficits that had been the cause of so many of Britain's economic difficulties in the post-war era, when it had been forced to raise interest rates to defend sterling. Indeed, Jim Callaghan, prime minister in the late 1970s, claimed that whoever won the 1979 general election was likely to remain in power for many years, thanks to the windfall from North Sea oil and gas receipts.

Did North Sea oil make Thatcherism possible?

Some commentators think so. The money that flowed into the Treasury's coffers was crucial to enabling the Government to bear the cost of rising unemployment. Some economists believe that, without North Sea oil, the Thatcher Government might have been forced to abandon the strict monetarist economic policies that caused interest rates to rise to punitive levels in the early 1980s, and to scale back Thatcher's confrontation with the unions and privatisation programme, both of which contributed to soaring unemployment. On the other hand, Thatcher herself appears to attach very little significance to the role of North Sea oil in underwriting her economic reforms - in her autobiography, North Sea oil and gas merit just six passing references.

Has North Sea oil production passed its peak?

Yes. DTI figures show that oil production peaked in 1999 and has since fallen 23% below that level. Monument Securities says that, by 2010, production could be 50% below peak levels. According to the Bank of England, output of North Sea oil in the first six months of this year was down nearly 10% on this time last year. Britain will become a net gas importer in 2006.

How much longer will it last?

Much depends on the scale of investment in marginal oilfields, which in turn depends partly on the oil price. As the largest offshore oil-producing region in the world, the cost of North Sea oil production is significantly higher than that of other countries, and therefore depends on the willingness of Opec to keep the oil price above the cost of production to remain viable. But the Government is also to blame for a projected sharp fall off in investment, having raised the tax burden on North Sea oil. Nonetheless, the UK is expected to remain self-sufficient for oil to meet the country's own needs through to 2007/8. By 2010, the UK will produce sufficient oil and gas to meet more than 75% of its demand for oil and 60% of its need for gas.

What effect will this have on the economy?

It will lead to deterioration in the balance of payments, which will almost certainly trigger a fall in the pound. Royal Bank of Scotland figures show that Britain's surplus on oil trade stood at £5.7bn in 2002, shrinking to £4.1bn in 2003. In the first seven months of this year, it was just £955m. With oil export volumes now falling fast and import volumes rising 27% in the first half compared to last year, we are likely to see a deficit on oil next year. Export volumes of goods other than oil are also falling (they were down 1.6% in the first half) and import volumes are rising fast (up 4% in the first half). Economists fear that, even after a fall in sterling, Britain will struggle to close the gap. If the pound falls too far too fast, the Bank of England will have to raise interest rates to keep inflation at bay.

Where will we get our oil and gas from in future?

A number of projects are now underway to enable Britain to import gas. A £1.1bn pipeline is being built to bring gas from Norway and the Russian state-owned gas giant Gazprom wants to build a £3.3bn pipeline to bring gas from Russia under the Baltic Sea to the UK. Meanwhile, three liquid natural-gas terminals are planned that will enable the UK to import gas from the Middle East. Nonetheless, these projects will take time to come on stream, leaving the UK vulnerable to shortages in the interim. The chief executive of Tullow Oil has warned that Britain could face blackouts this winter if there is a long cold spell. On the other hand, experts say the projected fivefold increase in import capacity could lead to falling wholesale gas prices later in the decade.