Sunday, September 26, 2004
Will sterling survive the end of the North Sea era?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

A remarkable era for Britain’s economy is drawing to a close. Oil self-sufficiency, a huge bonus during a period of high and volatile energy prices, is coming to an end.

After a generation of oil-trade surpluses, the latest official figures show Britain is now running a deficit. What will be the effect of this?

Nearly 30 years ago, in June 1975, the first trickle of North Sea oil came ashore. Tony Benn and his wife boarded a hydrofoil at Tower Pier, were whisked down to BP’s Isle of Grain refinery in Kent, where he turned on a valve and the oil — fresh from the Argyll field — started flowing from a tanker berthed alongside.

Six years earlier what was christened the Arbroath field had been discovered, followed in 1970 by the giant Forties field and in 1971 by Brent, another huge field that gave its name to the North Sea’s benchmark crude oil.

Enormous technical obstacles were overcome to exploit the oil in what was an extraordinarily hostile environment that caused considerable loss of life.

The oil could not have come at a better time. The 1975 trickle was regarded as more of a curiosity than an economic saviour. The prospect of future oil revenues and exports did not prevent the IMF crisis of 1976, the closest Britain has come to bankruptcy in the modern era.

It did not, for several years, convince many people that the country was capable of turning itself from an economic basket case into something much more successful.

But North Sea oil had a profound effect. Benn, energy minister in the 1974-79 Labour government, predicted that it would transform the economy. So it did, although not in the way he would have wanted.

The maximum impact of oil came during the 1980s, the Thatcher era, when the oil-trade surplus peaked at more than £8 billion (equivalent to roughly £20 billion in today’s prices) and 10% of tax revenues came directly from the North Sea.

For many, strange as it seems with hindsight, the oil was unwelcome. It helped to push sterling, which became a “petrocurrency” overnight, to uncompetitive levels, exacerbating the savage shakeout of manufacturing in the early 1980s.

Sir Michael Edwardes, the then chairman of British Leyland (one of Rover’s many predecessors) spoke for many in industry when he said it would have been better to “leave the bloody stuff in the ground”.

If the manufacturing shakeout, which weakened the power and resolve of the unions, was essential to the story of Thatcherism, so was the defeat of the miners.

Would the Tories in the 1980s have been able to take on the miners without the cushion of North Sea oil? Probably not. Oil and Thatcherism were inextricably linked. One may not have been possible without the other.

The long-running debate about whether Britain squandered the North Sea windfall by not using it, Norway-style, to set up a trust fund for the future or rebuild the nation’s infrastructure, is misplaced. It was used, if only indirectly, to transform the economy in other ways.

Since then, while the economic impact of oil has subsided, the North Sea has continued to provide Britain with a useful cushion. When prices are high, as now, the Treasury gets a bonus in extra revenues — this year’s North Sea receipts will be roughly double the £3.6 billion predicted in the March budget. That helps to offset weakness in other revenues, and gives the chancellor the room to cut fuel duties or, as he has already done this year, postpone increases.

The contribution of oil to Britain’s balance of payments has also been extremely useful in a period in which the trade deficit has been deteriorating fast. That effect may not, however, be with us much longer. The most recent trade figures show that Britain had an oil deficit of £61m in July, compared with an annual surplus of £4.1 billion last year. Things do not usually deteriorate that quickly, suggesting something of a statistical aberration, and we probably have not seen the very last of the surpluses.

But time — and the oil — is running out. The UK Offshore Operators’ Association (UKOOA), which represents the industry in the North Sea, says oil production averaged 2.15m barrels per day (bpd) last year, down from a peak of about 3m bpd in 1999. Combining oil and gas, production peaked at the equivalent of 4.5m bpd and is expected to be 3.7m this year.

By 2007 the era of oil self- sufficiency will be over, and by 2010 oil and gas output will be down to a combined 2.5m bpd, the UKOOA says.

Current high oil prices are already increasing exploration activity in the North Sea. But the effect of greater exploitation of the remaining reserves will be to slow the pace of the production decline, not stop it. Britain is on the road to becoming an oil and gas importer again. This sits unhappily alongside the fact that we are also big net importers of everything else. The trade deficit on goods excluding oil was £46 billion in 2001, £51 billion last year and is on course for nearly £60 billion this year.

The consequences of an ever- widening, non-oil trade deficit and a shift into the red on oil do not bear thinking about. Or perhaps they do. If one effect of oil surpluses was to make sterling a petrocurrency, pushing it higher, the opposite must surely happen as the North Sea runs down.

Sterling has been particularly strong in recent years, not least because the markets have liked Bank of England independence and the rest of the government’s macroeconomic framework. It can only be a matter of time before the yawning trade gap pulls it lower.

In the meantime, the beginning of the end of Britain’s North Sea oil era raises other, equally important, questions about future energy supplies. Can we supply our energy needs without re-embracing nuclear power in a significant way? That is a question I shall consider very soon.

PS Economists have long had a jaundiced view of gold, partly because they remember the famous quote from John Maynard Keynes, who said it was “a barbarous relic”.

Actually, as Professor Geoffrey Wood pointed out last week, Keynes was not talking about gold itself but the gold standard (which Winston Churchill made the mistake of returning Britain to in 1925). Not only that, but while few would praise Churchill’s decision, the gold standard’s overall reputation has been somewhat rehabilitated in recent years.

Wood was introducing a study he co-authored with Forrest Capie and Terence Mills. It examined gold as a hedge against currency fluctuations. The result was gold did perform that function, the implication being that investors and central banks should have it as part of their portfolio.

Had the research been available a few years ago, it might have made Gordon Brown pause in his decision to sell 400 tonnes (more than half) of Britain’s gold reserves.

That decision was costly — the cumulative loss compared with the current gold price of more than $400 an ounce is over £1 billion. It also marked the end of the Bank of England’s role as supporter and lender of last resort for the London gold market. Britain is now 18th in the league table of official gold reserves, outranked by the Netherlands, Portugal, Taiwan and Venezuela.

That gold is a hedge against shifts in the dollar is not too surprising. Gold is priced in dollars, so when the dollar falls, its price naturally rises.

The same effect can be observed in the oil price. But does the gold price predict bouts of dollar weakness, inflation or general instability, as the gold bugs insist? This study merely shows that gold responds when currencies move, not that it anticipates such moves. To find out whether gold has predictive powers, say Wood and his colleagues, requires another study.

From The Sunday Times, September 26 2004

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