All the talk has been of late upon the mass spending cuts and the possibility of QE mark 2. Why? Because the UK needs to cut its deficit, and because the financial based UK market appears to be starting to struggle once again. But are spending cuts and QE2 the only options to help bring the UK’s balance sheet back into order and return the UK to growth?
Well I say no, as though spending cuts are needed, I feel that there is an option available that could aid these cuts that should have been taken advantage years before now.
The UK North Sea production has been falling year upon year, and the UK coal production has been steady at a very low rate since 1992 when the UK coal industry was basically ended by the UK government. This means that the UK must import all its commodities, oil, gas, copper, iron, diamonds, coal etc. This amounts to a large amount of money leaving the UK every year via imports, with UK exports not anywhere near making up for this deficit. Worse, as the North Sea begins to dry up this deficit will only grow, but it does not have to be this way, as if the government were willing, the UK could become so much more sufficient, and get much more resources out of the ground. To explain, it is possible with government backing that the UK could substantially increase oil and gas, and coal production. In terms of where this money could come from, why not use the tax money earned from the North Sea which is a mere US$2.5-$5bn a year depending on the oil price, thus unlikely to make much difference to the coffers when considering the benefits it will bring. To explain:
UK Coal industry
The coal industry died in the UK in the early 1990’s, to explain why. Initially in the 80’s the government wanted to close some non-profitable mines, and whether they were right to do this or not (I am abstaining from any opinion on this matter as it is not the point), the fact remains that the unions went too far in fighting this, and in the end forced the government to fight so hard that there was no real coal industry left in this country. The final act of this war came in 1992, when Michael Heseltine, then President of the Board of Trade (Industry minister) decided that coal mining in the United Kingdom had no future. This meant that in an instant 30,000 jobs went, with 31 coal mines being closed (more than half the countries). This came at a terrible time for Britain, sending the country into an even deeper recession, and brought the country up in arms. The move also led to the British mining unions launching legal action against the government, this was a battle in which they won, with the High Court ruling that the decision to shut the mines was an unlawful breach of both British and European employment law. But though the unions won the court room battle, they lost the war as what the High Court actually ruled was that the manner in which the pits had been closed was illegal (they found that the government had broken a consultation agreement with the miners that placed decisions about closures at the discretion of an independent review), but the scale of the closures were ruled perfectly legal, meaning that the government had finally won its war against the mining unions. So the reason that the coal industry ended up being shut was a mix of fighting between the unions and the governments, and the governments short sighted view that the North Sea would provide much better for the UK than the coal industry (the less said on this view, the better!).
In terms of what remains of the UK coal industry, in 2009, of the 60m short tonnes of coal the UK used, 40m short tonnes were imported. The UK’s production of approximately 20,000 tonnes of coal a year has been pretty much flat for years now. But this does not need to be the case, because the UK has enough coal reserves to last for 200 years, and these reserves could be produced economically, albeit most at low margins. Therefore with government backing the UK could restart the coal mining industry, and thus end its reliance on imports, and in the process, not only create jobs, but stop £4bn needlessly leaving the UK economy every year, therefore boosting consumption, tax receipts, and lowering the trade deficit.
To explain a little further with an example, over the next twenty years, if the coal price remains static with demand (both unlikely), £80bn will be lost over this period to other countries. But if the UK invested in the coal industry, even if the coal mines cost £20bn to come online, and only ran at break even, the UK economy would still be £60bn better off over the twenty year period. Therefore the only way for the UK not to be better off would be if the mines were loss makers. But if the government decided to take ownership of the mines, they would literally only need to break even for the government to be better off (they may even be able to be better off if they are run at a loss). To explain the economics of this, £500m is spent bringing a 5m tonne per annum mine online, net the UK government would have spent likely approximately £400m (any wages paid, equipment purchased would all be taxed, thus they would get the money back). Next let’s assume the mine only breaks even in net profit terms, meaning with a coal price of US$100 per tonne, revenue would be US$500m per annum. This would mean that the UK would be saving $US500m a year from leaving the economy; the government would be earning higher tax revenue from the workers at the mine, and from the purchase of any equipment, petrol, diesel etc. Also let’s say that there are 800 employees, these workers would have cash which they could inject back into the economy, boosting both tax receipts and business. Meaning over the life of the mine, let’s say its fifteen years, for a cost of £400m, the UK would be $US7.5bn (£4.4bn) better off with a self sufficient mine operation in place (net profit break even does not mean cash flow break even, with the assumption being that the mine can run itself via the cash flow earned each year), now that looks like a good use of money to me.
UK oil and gas (North Sea)
The UK oil and gas sector peaked in the late 1990’s and has been dwindling at a substantial rate since, with production now less than a third of the peak, with the UK now actually being a net importer of oil and gas rather than a net exporter. In 2009 the UK used approximately 3,088 bcf a year of natural gas, of which it imported 1,450 bcf, against production of 2,058 bcf (this number continues to fall year upon year – in 2005 it was 3,115 bcf). This leads to a short fall of 420 bcf, meaning that £420m leaves the economy every year, and this number will only rise if something is not done. In terms of oil, in 2009 1.7m bopd was used, whilst production was only 1.4m bopd, this means that every day US$22.5m leaves this country, and every year US$8.2bn leaves the economy with the oil price at US$75 (All production and usage figures come from this link). Does it have to be this way, possibly, as the UK reserves are limited, but that still does not mean that the UK cannot improve its level of sufficiency in the oil and gas sector.
To explain at current estimates, the North Sea has an estimated 20bn+ in reserves left, but this number could be increased. An example of how the UK could do this would be by investing in the North Sea would be using Carbon Capture, the way this works is by squirting surplus CO2 from factory chimneys down into exhausted fields, so forcing more oil up the wells (click here for more on this). A low ball estimate of how much extra oil this could bring from the North Sea would be 3bn barrels (better still this oil would be near carbon neutral). This would mean that with an oil price of US$80, US$240m (£170m) could be saved from leaving the economy over a twenty year period. In terms of the tax received, if you just consider income tax and possible corporation tax, its amounts to a possible £60bn being added to the UK’s coffers over this period, that is £3bn a year (assuming 20 years). But this does not take into account the effect that the job creation would have (increased consumer spending), and the increased cash in the economy (increased business and consumer spending), all of which would help the UK GDP and deficit.
In terms of the cost of this, as it would likely be a private and public backed venture, making value for money should not be an issue.
Also in case anyone is worrying about the validity of the venture, this technology is proven, and dates as far back as the 1970’s when it was first introduced in Texan oil fields. Also the technology was meant to be used in this country, but the UK government took a very short sighted view (a common occurrence it would appear), as Alistair Darling in 2007 allowed the deal for the technology to be introduced in Scotland to fall through, even though they had the backing of majors like BP and Shell (click here for more on this). Also the technology is being taken up in the Middle East, further proving its viability. Though unlike the UK coal industry, there is a very short timeframe available for action, as if action is not taken soon, it will be too late as all the infrastructure needed to make this work around the North Sea will be gone, and once it is gone there is no way back.
To conclude, if you assume that the UK just does the things that I have mentioned (i.e. the coal and North Sea), with the benefits starting to flow from 2015, over a twenty year period, the UK could save £250bn from leaving the UK economy, this equates to £12.5bn a year, with the tax benefits likely being at least £4bn a year. Thus for an outlay of likely less than £40bn over a 20 year period, they would earn £80bn in tax and keep £250bn in the economy. Just to note, of course the figures mentioned are just guesses, but I can see no reason why the coal industry with government backing could not be viable, nor can I see why the carbon capture could not be, with the backing of majors proving it. Therefore in my view things like this should really be looked at, as energy self sufficiency is only going to become more important in the future, and at current the UK is looking like it is going to get left behind.