Westminster and Scotland Debate the Future of the UK North Sea Ahead of the Scottish Independence Referendum in September

by King & Spalding
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A referendum on independence will be held in Scotland on 18 September 2014 when Scottish voters will be asked, "Should Scotland be an independent country?" Alex Salmond, Scotland's First Minister and leader of the Scottish National Party (SNP), is leading the campaign for Scottish independence. Meanwhile in Westminster, the Prime Minister of the UK, David Cameron, is leading the "no to independence" campaign. The future of the UK North Sea has become a major battleground between the two leaders with both camps trying to persuade voters that they will do a better job of managing the UK's oil industry in the future.

This article (i) looks at the significance of the UK North Sea to the issue of Scottish independence; (ii) considers how the North Sea may be divided if Scotland becomes independent; and (iii) summarizes the different views of the UK and Scottish governments on how the UK North Sea should be managed in the future to maximize recovery from one of the most mature offshore basins in the world.

Scottish Independence

Since 1999 Scotland has had its own devolved government which is responsible in Scotland for all issues that are not explicitly reserved to the United Kingdom Parliament at Westminster by Schedule 5 to the Scotland Act 1998. These include the National Health Service (NHS) Scotland, education, justice and policing, rural affairs, economic development, and transport. Scotland has its own budget for matters falling within its control, however beyond those areas Scotland does not currently have an independent fiscal policy. Scotland already has its own independent legal system.

An independent Scotland's scope to develop a fully independent fiscal policy depends on a number of factors including the currency of an independent Scotland, and how the national debt will be divided between Scotland and the rest of the UK. The most important asset to be divided on Scottish independence is the UK North Sea oil fields. Oil and gas revenues are currently assigned to an economic region set up by the UK government which is called the United Kingdom Continental Shelf (UKCS). Tax revenues from the sale of UK oil and gas are currently collected centrally by the HM Revenue and Customs (HMRC) which has collected approximately £300 billion of tax revenues in the last 40 years. Over the last five years average annual tax revenue from oil and gas has been £9.4 billion, which represents 1.7 percent of onshore revenues for the UK in 2011-2012 and 20percent on onshore tax revenues for Scotland.

Dividing up the UK North Sea

How the reserves would be divided is a key question of debate and would have to be negotiated by governments as part of any agreement on Scottish independence. No discussion has yet taken place between the UK and Scottish governments on the detail of how reserves and revenues would be divided up.

Professor Alex Kemp of Aberdeeen University, a leading expert on Scotland's oil industry, has noted that the median line would be the obvious starting point for negotiations between Scotland and the rest of the UK for the division of North Sea oil and gas reserves. This means drawing a line on which all points are the same distance from the Scottish and the rest of the UK coastline. It employs the same principle as that espoused by the United Nations Convention on the Law of the Sea (UNCLOS) treaty, and is the method that was used when the North Sea was originally divided up between the UK and other countries in the 1960s. The most important North Sea treaty, signed in 1965, between the UK and Norway, used the median line method of determination. The median line approach was also used to determine the boundary between Scotland and the rest of the UK for fisheries after devolution in 1999. Applying the median line method, which is consistent with most international agreements, approximately 90 percent of reserves lie in Scottish waters.

However, Professor David Scheffer, Director of the Centre for International Human Rights at Northwestern University in the U.S., says: "I don't think anyone should say that the law of the sea is static on this issue of where do you draw the line in the North Sea that would determine who has jurisdiction over which part of the reserves. There is a popular presumption that the median line should be drawn and that would be favourable to London. There is a popular notion in academic thinking that automatically it is the median line. However, international law has always invited negotiation on how to draw that line." He also stated, "I don't think London should be under the assumption they automatically have the median line [and] they should not even have to negotiate it. I think that would be a serious mistake because Scotland could ultimately bring this to the International Court of Justice and perhaps prevail there with a different line."

Professor Kemp also referred to exceptions to the median line principle, noting departures in various settlements around the world, including judgments made by the International Court. He noted that "To complicate the matter slightly, in 1968, there was another line drawn from the border straight across the North Sea and that was for civil and criminal court problems. North of that line Scottish law prevailed and south of it English law prevailed. You might say we should use that line. The interesting thing is, from the economic point of view, it does not make much difference because there are just a handful of fields, and not very important ones now, between the median line and the line north of Berwick. Although lawyers could have a long debate about it, in terms of economics, it does not make all that much difference."

Rival Visions on the Future of the UK North Sea

Some 40 billion barrels of oil have been produced from the UK North Sea to date but production is declining. Production fell by 6 percent a year on average between 1999 and 2010 and since then it has reduced by almost 40 percent. A recent report published by OPEC said North Sea oil production fell to its lowest point since 1997 in 2013. In addition, investment in exploration is declining year on year. Critics have pointed the finger at the central government for the decline in investment, citing increases in corporate taxation of oil companies in 2002, 2006, and 2011, and delays in clarifying how costs of decommissioning rigs will be divided.

On 10 June 2013, Edward Davey MP, Secretary of State for Energy and Climate Change, commissioned retired oil tycoon Sir Ian Wood to conduct a review of UK oil and gas recovery and its regulation. In a final report published on 24 February 2014, Sir Ian Wood expressed the view that 12-24 billion barrels of oil and gas equivalent could still be produced from the UK North Sea but warned that investment in North Sea oil and gas will fall away sharply unless urgent action is taken to address serious underlying problems in the sector. The report also suggested that an overhaul of North Sea regulation by the UK government would deliver 4 billion barrels of additional production, worth up to £200 billion to the UK economy.

Alex Salmond says the SNP would do a better job than Westminster of exploiting remaining North Sea reserves, and that an independent Scotland would bring long-term stability to the industry. He cited 16 tax changes imposed by Westminster in 10 years, and the change in energy ministers on an almost yearly basis. He has pledged to put revenues into a national fund that would mitigate the effects of fluctuating oil prices on Scotland's economy and give Scotland cash to invest. Under the plans, about a tenth of oil and gas revenues – about £1 billion a year – will be put into an oil fund similar to the one operated in Norway. Mr. Salmond believes it could create a £30 billion sovereign wealth fund over a generation. The Scottish government's Fiscal Commission, in October 2013, said there was a "clear merit" in an independent Scotland setting up two oil funds – a short term stabilization fund to buffer the effects of volatility in the oil market and a long term savings fund to ensure future generations benefit from the wealth. However, some commentators say that an independent Scotland would start life with a large budget deficit, which could make it impossible to start an oil fund for some years. Many also believe that the SNP has overestimated how much more oil and gas can be produced. The Scottish government's prediction for oil revenues in 2018 is twice Westminster's estimate.

On the other side of the independence campaign, David Cameron is arguing that the best way to protect the UK's oil industry is to keep the UK together. "Because we are a top 10 economy we can afford the tax allowances, the investment, the long-term structure that is necessary to make sure we recover as much from the North Sea as possible", Mr. Cameron said. He also said, "For the past 300 years, Britain has led the way in finding new sources of energy. It is the strength of the UK's broad-based economy which can make the difference and ensure we can invest in our energy for the long-term future."

 Nina Howell
 London
 +44 20 7551 7543
 nhowell@kslaw.com

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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