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What lies beneath the seabed? That’s the €750bn question

Ivan Yates - Irish Examiner

LAST week, while filling in for Vincent Browne on TV 3, I stumbled across a current controversy.

I was not aware of what the 2011 Atlantic Margin Licensing Round was all about. Hosting a debate on our oil and gas regulatory regime meant that I had to research the topic. This meant reading copious data from Dáil debates, SIPTU policy document, Department of Energy analysis, recent articles and Indecon consultants’ expert report in 2007. Polarised opinions indicated this was a conflict between protecting natural assets for public gain versus the might of global oil conglomerates’ greedy appetite for profits.

The petroleum division of the department in 2006, speculated that Irish territorial waters could contain oil reserves to the equivalent of 10 million barrels. At the time the prevailing crude oil price was $75 a barrel. Hence, a potential €750 billion of wealth appears available. This forecast has proved to be a horrendous hostage to fortune for Minister Pat Rabbitte. Opposition parties, trade unions, columnists and energy analysts accuse him of selling out on our vital interests. One Labour councillor even accused him of “economic treason”. He maintains he is merely pursuing a pragmatic continuation of the previous administration’s quest for investment.

The context of this conversation is the prevailing state of the public finances. The dire situation of budget deficits, bailout, shortfall of tax revenue and austerity mean that any new source of wealth needs to be urgently grabbed. Perhaps a more enlightened approach would be to consider our prospects for 2050.

By then, instead of a ratio of 5.6 workers per retiree, as is the case now, there will only be 1.8:1. In four decades time, the cost of maintaining the elderly will have trebled to 15% of GDP. Unlike in the early 1990s, when we received the windfall of EU structural funds, there is no external bonanza available. The orderly cyclical growth of exports and enhanced output can hardly meet this added burden on the next generation. We need a long-term game changer.

The history of our hydrocarbon exploration regimes date back to Justin Keating’s legislation of 1975. He prescribed a 50% state stake in the proceeds of an oil discovery. This salved consciences of those who sought to protect our national resources. Due to minimal exploration activity, Ray Burke revised the licensing regime in 1987. A state shareholding and any royalty liability was dropped.

Instead, profits would be subject to corporation tax of initially 50%, which was subsequently reduced to 25%. Various rounds of licensing issued in 1992, 2002 and 2007. In summary, the level of development activity was a damp squib. 156 wells have been drilled. There have been no commercial oil finds to date, with two viable gas fields as Kinsale and Corrib sites.

The US Government Accountability Office assessed 142 states’ terms and conditions for relative ranking in terms of penalisation or incentivisation. We were found to have the second least onerous regime. Former Green Minister Eamon Ryan expounded strong policies of favouring renewable energy procurement, with a 40% electricity generation requirement from renewables by 2020.

He authorised the current licensing round last October, with the closing date at the end of May. 15 applications have been submitted and await an imminent awarding decision. The criteria set out by Indecon were based on a 25% profits tax with an additional 15% rent resource tax if the level of oil strike was substantial. There doesn’t seem to be an orderly queue of speculators lining up to exploit these concessions.

Oil has transformed Norway. In the autumn of 1969, an enormous oil field was discovered at Ekofisk. The Norwegians had no background in the sector. Over the past 40 years, they successfully asserted the rights of producer nations over global oil corporations (eg BP, Chevron, Total, etc). They introduced a 78% royalty payment scheme. They developed an indigenous oil industry and still retain 67% shares in Statoil. They have built up expertise and experience, applying it on a worldwide basis. Unlike in the Middle East, where oil has provided the basis for military conflict and corruption, Norway’s welfare state has been built on managing their energy resources. Russia and Venezuela have also developed their own independent and highly specialist oil industries. Britain’s public finances have been underwritten by North Sea oil for three decades.

What can we learn from Norway? The precursor to a tax take from oil revenues is a viable oil production business. 1,200 wells have been drilled in Norway, with 4,000 in UK territory. The economic equation for exploration combines geology and economics. Initial seismic analysis leads to exploration investment. The cost of drilling a well on average amounts to €70 million. Back in the 1970s, there was unbridled enthusiasm for buying shares In Atlantic Resources. That bubble burst on the rock of false optimism. The plain fact is that our levels of drilling are derisory. The present round of licensing covers an area of 250 km², set out in 1000 blocks. It appears any licence allocation relates only to 3% to 6% of our entire area. Any critique of our fiscal and non-fiscal licensing terms reveals a light touch approach. While the headline rates applicable can be up to 40%, a full tax write-off is available for all costs, which can extend as far back as 25 years before a well goes into production. Tax offset claims can extend to related costs for other unsuccessful wells, both in Irish waters and elsewhere. William Hederman estimates the marginal effective tax rate could be as low as 7%.

These computations would be relevant to the Corrib gas project. 11 years of delay with the planning process and local objections may result in Shell paying no tax, as the costs of the project have risen from $650m to more than $2bn.

Indecon’s analysis places heavy emphasis on issues of security of supply and onshore employment prospects. These may be ultimately irrelevant due to the advances whereby oil and gas can be transferred on floating pipelines or special tankers directly to their consumer destination. The Corrib experience is likely to deter other Irish onshore projects. The crucial question is to establish whether we can ever be an oil-producing nation. If so, the established international menu of options of state shareholding, royalties, taxation, joint ventures and shared contracts is readily adaptable to our circumstances. Everyone agrees we should maximise the net residue for ourselves. The great giveaway is irrelevant if there is no discovery. 100% of no oil equals zero public wealth.

One can’t help wondering, with fascination, what lies under the seabed. Original analysis was based on oil prices at $40 a barrel. Today’s price is $110. Oil resources are finite, whereas consumption appears infinite. At $140 for crude oil, along with new technology to facilitate deep sea production, we may reach a reasonable risk to reward ratio for investment. Securing prospectivity is crucial. Ideally we need an each way bet, whereby we can apply retrospective deductions on flows. Attempts to present the complex issues as clear-cut are emotive and facile. Past policies have failed. The next generations’ capacity to fund future fogeys may depend on the luck of the Irish striking liquid gold.

Posted Date: 
8 September 2011