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Scottish independence: What would the implications be for the oil and gas sector?

Friday, January 18, 2013
from Brodies LLP

On 15 October 2012, Alex Salmond and David Cameron signed an agreement providing for a referendum on Scottish independence by the end of 2014, ending the doubt about whether the Scottish Parliament had the power to set up such a vote. This allowed the focus to turn from the process to the issues, which may affect the oil and gas sector more than most.

Perhaps the most important issue for the sector is also one of the most controversial for the politicians - the division of the UK's North Sea Exclusive Economic Zone (EEZ). North Sea revenues would be hugely important to the finances of an independent Scotland, and the figures would depend largely on the location of the boundary. However, we are unlikely to have a definitive answer on where this boundary might lie pre-referendum.

Recently, the Institute for Fiscal Studies (IFS) reported on the likely fiscal position of an independent Scotland, concluding that a 'geographic' split of North Sea oil would leave an independent Scotland in more or less the same position as at present, though more vulnerable to the volatility of North Sea oil revenues, while a 'population-based' division of the revenues (i.e. Scotland getting about one-tenth of current UK revenues) would require some difficult spending choices to be made. Any assessments of a 'geographic' division must, however, depend largely on the location of the boundary. Unfortunately for the purposes of the debate, that is as much a political question as a legal one and so would probably only be resolved in negotiations between the UK and Scottish Governments in the event of a vote in favour of independence.

In any such negotiations, one would expect the Scottish Government to argue for the boundary to be drawn as far south as possible, while the UK Government would want to retain as much of the current UK zone as it could. These two positions would each be underpinned by distinct legal approaches:

1) A line running almost directly east from Berwick, currently used to decide whether Scots or English law applies off-shore. This is favoured by the SNP because the Scottish area contains the overwhelming majority of UK reserves.

2) A line running broadly north-east from Berwick before turning eastwards at about level with Carnoustie, based on the principle of equidistance (i.e. if a point in the North Sea is closer to the Scottish coast than the English then it would be in the Scottish zone, and vice versa). This would put a smaller majority of North Sea oil production (and an even smaller majority of gas production) within the Scottish zone. The SNP objected when this approach was used in 1999 to set the limits of the Scottish Parliament's power to regulate fisheries, no doubt with the independence issue in mind.

International boundaries are often set using the equidistance principle, which is the 'geographic' approach used in the IFS's report. However, other approaches can be used - the history of the North Sea's division includes a dispute between Denmark and the Netherlands, on the one hand, and Germany on the other. The Germans were unhappy with the boundaries of their zone under the equidistance principle, and ultimately a combination of diplomacy and an International Court of Justice decision resulted in a larger German area. That shows the potential for any division of the UK EEZ to depend at least as much on political issues as legal ones, which in turn suggests that the issue is unlikely to be resolved before the referendum. The UK Government has already said that it will not 'pre-negotiate' in advance of the referendum on the terms on which independence might take place.

Wherever the boundary was drawn, all fields on the Scottish side of the line would, of course, be subject to Scottish taxation and regulation. This may be of even more interest to the industry than the boundary itself, so what might the sector expect?

In 2011 the Scottish Government criticised the UK Government's increase in the supplementary charge, and proposed several options for reducing the tax burden on marginal fields. These proposals included a Norway-style "extended field allowance", or a guaranteed minimum return on investment before the charge applied. The Scottish Government has also proposed a post-independence fund which would invest a proportion of North Sea revenues for future use (though others claim that all revenue would be needed just to fund current spending).

The industry will be aware of the current suggestion that off-shore safety might become an EU responsibility, and the status of EU regulation in an independent Scotland would be a key issue for the sector. Debate is currently raging on whether an independent Scotland would automatically be an EU member or have to apply for membership, but it seems very likely that Scotland would (sooner or later and on one set of terms or another) be a member of the EU. EU regulation would therefore continue to apply, even if Scotland had to temporarily exit the EU on independence (in which case the Scottish Government would want to maintain compliance with EU law pending a decision on its application to re-join). Existing UK legislation and regulations would also have to remain in place until and unless they were replaced by new Scottish equivalents, but one question that may be of real interest to the industry is whether the current decommissioning arrangements would be maintained. In particular, would an independent Scottish Government adopt the agreements entered into by the UK Government on decommissioning tax relief?

A successful oil and gas sector would be vital to an independent Scotland, which makes the extent of the 'Scottish zone' and the potential regulation and taxation of the industry key issues for both sides of the debate. The industry may therefore have a very strong hand to play over the next two years.

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from Brodies LLP

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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser. More

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