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Energy - Taking forward our National Conversation


4 What Scotland could look like

Chapter Summary

  • This part of the paper considers some of the options that could be considered if Scotland were to possess greater responsibility for energy matters.
  • Some of the options may be possible under a position of devolution max where all significant policy responsibilities as well as fiscal autonomy are devolved to the Scottish Parliament but Scotland remained within the UK.
  • Other options would only be available under full fiscal autonomy in an independent Scotland.

4.1. Energy is slightly different from other sectors, as it would be possible to have in principle, under devolution max, an energy framework that at first glance was broadly similar to that under independence. However, there are likely to remain some differences. In particular this paper emphasises the importance of Europe and engagement with the EU, and furthermore, there may still be differences between the two scenarios in terms of the ability to develop fiscal policy.

4.2. Currently, while Scotland can engage directly with many European countries, at the formal European Union level, Scotland currently has no authority and must engage with the EU through a UK filter. Under devolution max, Scotland's interests would continue to be represented in the main by the UK government in their position as a Member State. Under independence, however, Scotland would be a Member State of the EU in its own right.

4.3. As highlighted in "Fiscal Autonomy in Scotland: The case for change and options for reform" 18, while devolution max represents the maximum form of tax and policy devolution short of an independent Scotland, with for example Scotland having control of North Sea oil and gas revenues, several factors would continue to constrain policy:

  • Intra-national rules and guidelines
  • Rules/agreements with UK government.

4.4. It should again be stressed that this paper does not commit the current or future Scottish governments to any particular policy choices or expenditure decisions. Rather it is intended to set out some of the options, benefits and implications that greater ability to make decisions on matters relating to energy could bring to Scotland. Energy is a wide-ranging topic and covers a number of different areas, and this paper does not present all the policy options and choices within energy. The paper focuses on five main areas:

  • Engagement with Europe
  • Energy Regulation
  • Assistance to Consumers
  • Renewables and Low Carbon Infrastructure and Investment
  • Oil and Gas Taxation

Engagement with Europe

4.5. Scotland has a major contribution to make to EU and international energy policy, benefiting our communities, workers, citizens and industry. Despite some progress in putting Scottish energy on the map in recent years, the need to work through a UK filter can diminish the Scottish role, even if UK and Scottish interests coincide, as they often do. Experience of joint working on matters such as low carbon energy research and development show that an active role for Scotland strengthens rather than undermines UK energy objectives within the EU. And it ensures that the real and substantial Scottish contribution to carbon reductions reflects Scottish circumstances. But while joint-working is of course to be welcomed, it still means that Scotland's voice is often not heard to its fullest extent.

4.6. As an example, EU law requires energy markets to have an economic regulator who seeks to balance the different interests of competitiveness, security of supply and sustainability. EU law also requires Member States to work towards a common energy market, through interconnection, cross border standardisation and regulatory co-ordination and co-operation. The UK regulatory system was set up to manage competition in energy markets in a different constitutional climate and does not reflect Scottish, or EU conditions. In particular, the integration of the Scottish electricity market into the England and Wales market through the British Electricity Trading and Transmission Arrangements brought some short term benefits to Scottish companies and consumers but also created longer term difficulties which are increasingly becoming acute, with the potential to impact on developing and delivering Scotland's energy potential.

4.7. Giving the Scottish Parliament full responsibility over energy would allow the development of a regulatory framework which reflects Scottish conditions and promotes sustainability, increased trade and consumer protection and helps a key sector of the Scottish economic sector to evolve, develop and grow.

4.8. The Scottish Government has already made substantial progress in recent years in engaging actively with Europe on energy issues and has made energy a long term priority for European engagement. 19 But its ability to engage directly in Council of Ministers business where Member States take important decisions is severely constrained and would remain so under devolution max. Only under independence would Scotland play a full part in EU energy policy, as do our neighbours Ireland and Denmark. And only under independence would Scotland be seen as an equal partner in any cross-border structures which are set out elsewhere in this paper. A case study on the energy market in Denmark is in Annex B.

EU Single Market on Electricity & Gas

4.9. Under European Union rules independent national regulatory authorities have been established in each EU country to ensure that suppliers and network companies operate correctly and actually provide the services promised to their customers. Based on yearly reports by the national regulators, the European Commission is monitoring the market closely, identifying obstacles and shortcomings. Since 2003, heads of the national energy regulatory authorities meet in the European Regulators Group for electricity and gas. Among other things, EU rules cover the effective separation of supply and production activities, harmonisation of the powers of national regulators, better cross-border regulation and effective transparency. Further challenges include the harmonisation of market rules, as well as the creation of an environment for new investments. A new Energy Regulatory Agency has now been agreed and will start work in late 2009 or early 2010.

4.10. The EU is also working to improve the infrastructure required to transport energy as efficiently as possible to where it is needed. EU legislation aims to make the market accessible for all suppliers and eliminate barriers to cross-border trade. The importance of this work has been identified in the EU Strategic Energy Review in 2008/9, which among other things identified the North Sea grid as a strategic priority for EU investment in order to promote renewable targets as well as diversity and security of supply.

4.11. The EU single market in electricity and gas promotes trade in products as well as free trading between companies within the wider EU, and consumer protection. Strong provisions are in place to ensure non discrimination between companies operating in the different markets, ensuring a level playing field between the different interests wherever they do business within the EU. The new Renewable Energy Directive permits trading in renewable electricity and the principle that renewable support schemes can be paid to exporting countries if it helps an import dependent country meet its own targets. It also requires Member States to ensure that the charging of transmission and distribution tariffs does not discriminate against electricity from renewable energy sources. This will present a substantial challenge to the current UK approach as it is significantly out of alignment with the direction of travel at EU level.

4.12. The development of greater trading is promoted by regional groupings. The UK works with Ireland and France to promote market integration, as do groupings in Benelux and Germany and in Scandinavia. Regulators work together across frontiers to promote market integration. There is, for example, a single Scandinavian electricity market, and a new single market has been put in place in Ireland. Examples of how these systems work are in Annex A.

4.13. Under independence, Scotland would be freer to develop policies which are more in line with the European approach and ensure that renewable energy is not discriminated against in the manner that we believe it is currently.

Energy Regulation

4.14. The Commission on Scottish Devolution considered the issue of electricity supply and concluded that the current model of a UK wide market was the best way ahead to ensure security of supply and allow consumers to have access to a competitive and modern energy market, as well as ensuring that obligations and targets are met. However there are a number of examples where independent countries can operate a common electricity transmission and distribution system. For example a single electricity market now exists between the Republic of Ireland and Northern Ireland. And cross-regulatory relationships and agreements now exist between a number of countries. For example, Annex A of this paper provides additional detail on the pooling arrangements that exist between a number of Nordic countries. These clearly demonstrate that agreements and co-operation between individual countries on energy market regulation is possible.

4.15. Having greater responsibility over regulation would mean that Scotland would be able to adopt policies and regulatory frameworks which would be more appropriate for its own situation and importantly would recognise more closely the particular advantages that Scotland possesses. Under either devolution max or independence Scotland would also be able to negotiate directly within wider pooling structures to ensure that its interests were better protected than they are at present when responsibility for setting energy regulation is held in London. For example, the Scottish Government has consistently argued that the current model of Transmission Charging, the model by which electricity generators have to pay to enter the electricity transmission system, disadvantages Scotland.

Box 2: Transmission Charging

The existing approach to energy regulation for access and use of the UK electricity grid works against the interests of Scotland's energy industry and impacts on delivery of Scottish, UK and European renewable energy and climate change policies and targets.

The approach currently adopted by National Grid and the UK energy regulator Ofgem puts Scottish electricity generators at a significant disadvantage. Application of a locational charging methodology by Ofgem levies higher charges on generators furthest from the main centres of demand for connection and use of the UK electricity grid. This favours generation in the Southern part of the UK and presents an inbuilt bias in the UK transmission regulatory system against Scottish based generation. As a result, Scottish generators produce 12% of UK generation, but account for 40% of the transmission costs, or about £100 million per year more than their proportionate share. The Scottish Government has already made the case for an alternative transmission methodology based on a flat rate charge for all generators, irrespective of where on the grid network they connect. We will continue to press for improvement to the current system.

There is also a risk that Ofgem and National Grid will introduce a locational approach to balancing of transmission system constraints that would target constraints costs on Scottish generators behind the one constrained interconnector boundary in the UK - i.e. the Cheviot Boundary interconnector between Scotland and England. National Grid figures suggest this could target costs of between £50 million to £100 million in 2009/10 solely at Scottish generators, with significant increased costs continuing while constraints remain on the interconnector. This could further disadvantage Scottish electricity generators.

It is clear that the existing approach fundamentally undermines delivery of an open and level playing field in the UK energy market and will impact on delivery of Scottish, UK, and European renewable energy targets. It is also clear the current approach works against the Scottish Government's key aims of putting Scotland at the forefront of growing the renewable energy sector and connecting, transporting and exporting Scotland's remarkable renewable energy resources to the rest of the UK and Europe.

An independent Scotland would have the ability to deliver a regulatory framework that better promotes a fair and equitable electricity market, protects the interests of the consumer and encourages renewable energy generation in Scotland, rather than discourages it.

What is wrong with current regulatory approach?

4.16. When gas and electricity were privatised, the government empowered the electricity and gas regulators (later Ofgem 20) with a set of primary duties which indicated that the principal regulatory priority in both industries was to promote competition in supply. However, when the detailed rules were being set up on how regulation would apply, it was agreed that a consultation mechanism would be established which left much of the responsibility as to how the rules would operate in the hands of the companies. This is one of the reasons why it is difficult to change the locational charging rules, since the industry situated primarily in the south of the country has a vested interest in opposing any change.

4.17. After a dozen years of regulation on that basis, these priorities were significantly adjusted by the government in its Utilities Act 2000. This set out new duties for Ofgem that prioritised social and consumer-related issues. The Act established the new priorities within a legal framework that was both more complex and less transparent than the one that had existed at privatisation. Its centrepiece was a mission statement, described as Ofgem's principal objective; to protect consumers' interests, wherever appropriate by promoting competition. There were also additional provisions containing social, economic and environmental needs and interests that Ofgem had to consider, or was able to take into account, in regulating the industry to protect consumers.

4.18. Further duties were added by the Energy Act 2004, in relation to sustainable development and the principles and practice of better regulation. Ofgem's duty to contribute to the achievement of sustainable development was introduced in 2004. In 2008, the Energy Act promoted this duty, placing it on an equal footing with other duties to meet reasonable demand and financing authorised activities. The Act also highlighted that Ofgem's principal objective, to protect the interests of consumers, refers to future as well as existing consumers. These changes underline Ofgem's important and developing role in shaping the future of gas and electricity industries in a sustainable manner.

British Electricity Trading Arrangements ( BETTA)

4.19. On privatisation in 1990, two PLCs, Scottish Hydro Electric and Scottish Power, took over the operation of the generation, transmission and supply systems in their respective areas, and Scottish Nuclear Ltd took on the nuclear stations in Scotland. Because of the historic separation of the Scottish from the England and Wales national grid, the Scottish system was run as a largely separate system under the regulation of the Office for Electricity Regulation ( OFFER, now Ofgem).

4.20. In 2005, the British Electricity Trading Arrangements ( BETTA) were introduced to create a single Great Britain electricity system. These arrangements include single frameworks for trading, dispatch and transmission access and pricing. National Grid is now the independent system operator for all of the GB transmission system, with Scottish Hydro (now part of Scottish and Southern Energy, based in Perth) and Scottish Power (now part of the Iberdrola Group) retaining ownership of the transmission assets.

4.21. The effective operation of BETTA is hampered by substantial constraints on the transmission system within Scotland and between Scotland and England. The renewable potential will only be achievable with major transmission investment. The existing approach to locational transmission charging fails to take account of the changing nature of electricity supply patterns where there needs to be a significant increase in renewable electricity generated. Given that Scotland has the majority of such resources, the current system is bad for Scottish based generation but it is also placing a barrier in the way of Scottish and UK renewable electricity targets.

4.22. There are a number of ways in which the current system could work better. Improvements to the payment model, which have been proposed by Scottish based generators working together with the Scottish Government, have been put forward to Ofgem. In addition reform of the existing transmission geographical zones could also be considered which would help to mitigate the problem.

4.23. Similarly the way in which obligations are placed on energy companies to promote energy efficiency and carbon reduction favour investment in England rather than Scotland. The Scottish Government is working with Scottish based bodies to argue for changes to this system. But the UK government, perhaps because of the high degree of industry consultation that is part of current operational structures, seems very unwilling to respond to this issue and change policy to reflect the way Scottish, UK and EU priorities have changed fundamentally in recent years. There seems to be a major institutional barrier to accepting Scottish specific solutions. The one size fits all approach does not fit the evolving Scottish energy landscape and goes further than is required to meet common interests in trade and investment.

How would energy regulation operate if regulatory responsibilities were exercised in Scotland?

4.24. Detailed decisions on how the regulatory structure would work would be for the Scottish Parliament. But it is possible to outline some basic principles which would apply.

  • Firstly, the aim of energy market regulation in Scotland would be compatible with EU wide rules and would promote trade with the rest of the British Isles and beyond, a level playing field for companies and encourage, rather than discourage renewable energy development.
  • The regulator would seek to apply Scottish specific solutions to issues such as transmission access and energy efficiency, in a manner which promotes trade with the rest of the UK and further afield, and which reflects the need to change the remit and objectives of Ofgem and the need to promote and incentivise the investment required in order to maximise our renewable potential.
  • The regulator would apply the rules in a manner which achieves consistency and fairness across the British Isles and in wider dealings with the EU but recognises Scottish specific conditions in the detail of the application of policy.
  • Transmission infrastructure, both onshore and offshore would be operated by an Independent System Operator, who would be independent from generation.

4.25. There are a number of options around how any future regulator could be structured. They could take the form of independent bodies as in the case of Ireland and in Scandinavia. Another approach could be a cross-border regulator which would be responsible to both the UK and Scottish Parliaments. Direct Scottish representation in the EU and in the regulatory group will also ensure that Scottish specific issues are properly reflected in EU decision making.

How would funding operate?

4.26. As a major exporter of low carbon energy Scotland will benefit from the premium paid to renewable and other forms of low carbon energy across EU regulatory boundaries. As far as investment in new facilities is concerned, the current approach to the funding of energy investments within the scope of Ofgem requires funding to come from consumer energy prices. Ofgem has a formula for approving investment on a needs basis and is currently revising that approach to take account of the requirement to move towards the 2020 targets, with a recognition that in certain circumstances, for example in respect of electricity grid upgrades recommended by the Electricity Networks Strategy Group, that some upgrades can take place in advance of needs being met. This is an improvement on the previous system, but still implies a reliance on short term finance. Given the scale of the network investment that would be required over the coming years, it will be important to ensure that all available sources of finance are used to spread the cost over current and future consumers more effectively, including longer term finance through borrowing from bodies such as the European Investment Bank. Such a project could also receive investment from a Scottish Oil Fund.

Assistance for Consumers

4.27. A key priority for the Scottish Parliament will be making energy markets work better for the Scottish consumer. This will include measures to promote oil security by extending resilience planning across the country and considering how to extend the gas grid in a cost efficient manner to increase diversity of supply for Scottish consumers currently excluded from the benefits of network gas. It will also cover measures to reduce energy demand for heat through boiler replacement, developing renewable heat and distributed energy schemes. It will also provide more opportunities to deliver and promote energy efficiency, microgeneration, combined heat and power (and district heating) and sustainable transport in a manner suited to Scottish conditions and resources.

4.28. It will be just as important to ensure that the system of regulation promotes competition, efficiency and consumer interests with regard to energy supplies to consumers. Despite Ofgem's efforts, its recent probe into the operation of the market showed that there continue to be significant problems and that prices for some consumers are not under sufficient market pressure. Moreover, the current pricing structure acts as a disincentive to provide stable energy services to the consumer. Furthermore, the energy system should provide greater support to the reduction of energy demand, in order to deliver benefits to consumers and economy. There is a real need to reconcile market based energy efficiency incentives with active promotion and legislative measures through an integrated approach, which would be delivered more effectively by a body based in Scotland and responsive to Scottish concerns. A particular focus should be the reworking of the market mechanisms to incentivise the provision of energy services as opposed to simply units of gas and/or electricity thus allowing companies to compete on the basis of the quality rather than the quantity of services they provide to the public and industry.

4.29. The Scottish Parliament would also be able to develop programmes and support mechanisms which are more appropriate to the needs of Scotland, taking account of differences in housing stock, tenure, and weather patterns. Currently, a higher proportion of people in Scotland are classed as being in fuel poverty, live in flats or hard to treat houses than across the UK as a whole. The Scottish Government is currently restricted in its ability to ensure that energy efficiency schemes reflect this position. Another example of this is the issue of fuel derogation for remote rural/ island communities, an issue which the Scottish Government currently has little control over, but which it has repeatedly asked the UK government to act upon. Greater powers would allow us to reflect the geographical nature of Scotland in this policy area.

Carbon Emissions Reduction Target - CERT

4.30. The primary scheme for supporting households in Scotland to undertake energy efficiency improvements is the UK government initiative, Carbon Emission Reduction Target ( CERT). This places an obligation on energy supply companies to promote reduction in carbon emissions by, for example, providing households with subsidised energy efficiency measures such as cavity wall and loft insulation. CERT also has a role in tackling fuel poverty with a proportion of the measures being delivered to a 'Priority Group' of low income, disabled and elderly consumers.

4.31. There is no current obligation on energy suppliers to deliver a minimum amount of CERT activity in Scotland. The current obligation requires only that energy suppliers deliver a set amount of carbon dioxide emission savings anywhere in the UK. As it is cheaper for energy suppliers to deliver improvements such as fitting loft insulation in built up urban areas, in practice this means that Scotland, with a higher proportion of its population living in rural and remote areas than the rest of the UK, has lost out. Scotland should have received 8.9% share of CERT spending based on per capita investment but actual investment was only 6% between 2002-2005 (Source: Scottish Government).

4.32. Although the scheme objectives are consistent with Scottish policy objectives, because the design of the scheme is based on UK rather than Scottish geographical and climate averages Scotland does not receive the full benefit, equivalent to an investment shortfall in the current programme of around £18m per annum. This is frustrating the delivery of our Energy Assistance Package, and our Home Insulation Scheme both of which rely on the energy suppliers delivering CERT across Scotland.

4.33. This is within the context of Scotland enduring harsher climate conditions than the rest of the UK. We have a colder climate and therefore a greater potential to make carbon dioxide savings. There are also greater levels of fuel poverty in Scotland that warrant a greater deployment of energy efficiency measures.

4.34. While Scotland can call on the UK government to change the scheme to better reflect Scottish interests, under current devolution arrangements it has no authority to ensure this happens - and to date the system continues to reflect Scottish interests poorly. A Fair Share for Scotland

4.35. The Scottish Government has already presented its concerns to the UK government on CERT and its new Heat and Energy Saving Strategy 21 which sets out options on the future of any CERT type measure (post 2012) aimed to achieve whole-of-house energy efficiency across all of the UK by 2020.

4.36. We have argued that we are delivering a more cost effective approach to the delivery of energy efficiency by combining our social and environmental spend through co-ordinating our fuel poverty and energy efficiency programmes. This is demonstrated through our support for the Energy Saving Scotland advice network, which is managed by the Energy Saving Trust, and through which our Energy Assistance Package and Home Insulation Scheme are also delivered.

4.37. The simplest way to cost effectively and significantly increase the uptake of energy efficiency would be for energy regulation to be devolved so that we could use the mechanisms that we have put in place to deliver more equitable and co-ordinated energy efficiency programmes in Scotland. These proposals are discussed further in our response to UK government's Heat and Energy Saving Strategy.

Renewables & Low Carbon Infrastructure


4.38. Our ambitious renewables targets, and the benefits that will flow from these being met, will require the right kind of infrastructure; such as ports, harbours, test facilities, heat networks, grid upgrades. These are the essential foundations upon which our new energy industries will be built. Getting these elements right and delivering them on time will require joined up working across and between the public and private sectors. It will also require major investment. One means of providing this would be to use funds previously collected in Scotland to promote renewable energy - the Fossil Fuel Levy fund ( FFL).

4.39. The Fossil Fuel Levy fund currently stands at £171.8 million 22, and remains unspent in an Ofgem bank account. This matter has been the subject of continuous correspondence from Scottish Ministers and officials to UK government counterparts since May 2007, with the most recent correspondence on this issue being in October 2009.

4.40. Treasury Ministers thus far remain adamant that no flexibility can be found to the Treasury rules on Departmental Expenditure Limits ( DEL), and that FFL surplus resources, if released to Scotland, would not be additional to Scotland's block grant, which the Treasury would therefore reduce by a corresponding amount.

4.41. If the FFL funds were released according to the Treasury's interpretation, Scotland would therefore receive no additional monies, and the benefit would instead accrue to the Treasury itself. We have a concrete set of proposals in hand for how the FFL could be invested to increase Scottish renewables capacity, thus helping to meet renewables targets here in Scotland and across the UK, and for them to help transform the renewable energy sector in Scotland, and we continue to press for a flexible solution (for example a temporary increase in DEL cover), which would make the funds truly additional.

Carbon Capture & Storage ( CCS)

CCS is the process of capturing and separating carbon dioxide emissions generated during the combustion of fossil fuels in power stations or industrial processes, and their transportation (via pipeline or ship) to be deposited permanently in sub-surface geological formations.

4.42. The Scottish Government is supportive of the development of Carbon Capture and Storage technology, which we believe has the potential to reduce carbon emissions significantly, thus contributing towards our climate change targets while also helping to ensure security of supply by providing another low-carbon source of electricity to complement the development of our renewable potential.

4.43. Scotland is well-placed to take a lead in its development and commercialisation. We have the knowledge and expertise in our universities and industry, the infrastructure in the North Sea, and the strong leadership in government necessary to make this happen and achieve our ambition of a low carbon energy economy.

4.44. The Scottish CO 2 Storage Study launched by the First Minister on 1 May 2009 highlighted the offshore potential of the North Sea Scottish sector to store emissions for the next 200 years. The report also highlighted some of the possible transport routes and costing that could be developed as part of any future network (Figure 3 below). Some follow up work to this project, involving a range of partner organisations, has since commenced. In both cases, the Scottish Government has been the largest single contributor to the research work.

4.45. We are also strongly supportive of the Scottish Power led consortium at Longannet which is part of the existing UK government competition for a post-combustion coal CCS demonstrator. However we are keen to see other projects being developed in Scotland and believe that a number of locations in Scotland are ideally placed for development.

4.46. We have worked closely with the UK government on a number of CCS issues. For example we are working with them on legislation to ensure Scottish projects benefit from the funding announced in the 2009 UK Budget, where the funding of up to 4 CCS demonstrator projects was proposed via a levy on electricity generation. We have also worked closely with them on a number of regulatory and policy issues relating to the consenting process for thermal power stations.

4.47. However many of the aspects of CCS policy including funding fall to the UK government. The Scottish government is therefore restricted in some of its ambitions in this area. For example, while collection of the proposed levy will be a matter for the UK government and aspects of it allocation will require involvement from the Scottish Government, our inability to directly consider funding options for CCS projects places a barrier in its development.

4.48. An example of this was the proposed CCS pre-combustion gas demonstration project based at Peterhead. The project, which would have involved extracting carbon from gas landed at the St Fergus terminal, with the carbon being pumped back into the Miller field to help enhanced oil recovery ( EOR), and the hydrogen being used for power generation at the power station in Peterhead, owned by Scottish and Southern Energy ( SSE). It would have been a world leading project which would have provided both an excellent opportunity to develop and demonstrate this technology as well as providing a significant economic opportunity for Scotland.

4.49. The project was abandoned in 2007 and is now proceeding in Abu Dhabi. The principal reason for the abandonment of the project in the view of the Scottish Government was the indecision and subsequent failure of the UK government to agree to fund the cost of the proposed project. While there was undoubted cost to the public purse, the level of support would have borne broad comparison with that available for other forms of low-carbon electricity. We remain disappointed by the loss of the Peterhead project.

4.50. Having greater powers over energy matters would give the Scottish Government more flexibility in considering assistance and support, including funding options for such projects.

4.51. Regulation of the capture, transportation and storage aspects of the process is complex with a range of functions falling to the Scottish Ministers and the Secretary of State for Energy & Climate Change. These functions then interface with other regulatory or licensing bodies such as SEPA, the Crown Estate and the Health & Safety Executive.

4.52. Scottish Ministers have executively devolved responsibilities to consent the capture plant at the power station, executively devolved responsibilities to consent CO 2 pipelines onshore, and full devolved competence to license CO 2 storage both onshore and offshore out to the 12 mile limit. Beyond the 12 mile limit, however, where the greatest potential for CO 2 storage lies, the responsibilities to license belong to the UK Secretary of State who is also responsible for the offshore oil and gas licensing arrangements. These overlap heavily with the CO 2 storage licensing regime and constrain the activities of Scottish Ministers where potential CO 2 stores cannot be licensed when an existing oil and gas licence is in place.

4.53. The overlapping of these regimes and the arbitrary boundary of the 12 mile limit create a complex regulatory framework for developers, and increase the number of potential permits that they are required to secure. To overcome this, the Scottish Ministers and the Secretary of State have negotiated a memorandum of understanding to ensure cooperation and exchange of information in all aspects of the CCS chain. It would be far simpler, however, if all of the offshore CO 2 licensing responsibilities out to the 200 mile limit in waters adjacent to Scotland were held by the Scottish Ministers. This would be further enhanced if Scottish Ministers had full responsibility for oil and gas licensing, as argued elsewhere in this paper, creating a seamless regulatory framework for carbon-based energy activity in the Scottish offshore area.

Figure 3: Summary of Proposed CO 2 Transportation Routes

Figure 3: Summary of Proposed CO2 Transportation Routes

Source: Scottish Centre for Carbon Storage 2009

Oil & Gas Taxation

4.54. Although it is a mature sector, there is no doubt that oil and gas remain of vital long-term importance to Scotland, both in terms of helping to ensure security of supply through the exploitation of remaining resources, and ensuring that the sector continues to be a significant contributor towards the Scottish economy. An active role for the Scottish Government in providing regulatory certainty for the oil and gas industry will anchor it in the Aberdeen area as an international hub of offshore expertise and provide the platform for successful diversification into low carbon energy supply.

4.55. Key opportunities in the oil and gas exploration sector include:

  • Improving depletion rates and promoting enhanced oil recovery
  • Worldwide marketing of Scottish oil services expertise
  • Sustainable use and decommissioning of the oil and gas infrastructure (including for carbon storage)
  • Encouraging diversification of skills from the sector into low carbon growth opportunities such as carbon capture & storage and marine renewables
  • More secure and better use of fiscal revenues, including the proposals for an oil fund

4.56. In July 2009, as part of the National Conversation, the Scottish Government published a paper on establishing an oil fund in Scotland. 23 The main points from the report are set out below.

Establishing an Oil Fund in Scotland

4.57. A significant number of countries with major oil and gas reserves have created 'wealth funds', also known as 'oil funds', into which they have invested a share of the returns from their oil and gas reserves.

4.58. The basic function of such funds is to enable sustainable financial resources management, allowing returns from non-renewable oil and gas revenues to be converted into a pool of renewable assets, which can then be used to generate wealth long after a country's oil and gas reserves have been exhausted. Oil funds can also act as a short-term stabilisation mechanism to provide fiscal stimulus when economic growth slows, or to offset temporary falls in tax receipts.

4.59. Many oil producing countries and regions have established oil funds. For example, Norway first transferred resources into its oil fund in 1996 and now has investments worth £274 billion 24. Similarly, Alaska has operated an oil fund for over 30 years and has used it to accumulate over £20 billion in assets 25. However, despite a number of previous UK Energy Ministers, including Tony Benn and Malcolm Wicks, advocating the benefits of establishing a similar fund, the UK is relatively unique among major oil and gas producers in not having created one 26.

4.60. DECC currently estimate that there are between 11 bn to 37 bn boe of oil and gas reserves remaining in the North Sea 27. The sector will thus remain an important part of the Scottish economy for many years to come. Based on the average price of oil and gas forecast by the US Energy Information Administration, between 2009 and 2030 these remaining reserves may have a wholesale value of between £650 billion and £1.1 trillion 28. Therefore, while the stock of remaining reserves is declining, the value is likely to increase with the possibility that the associated economic benefit may not have peaked.

4.61. Research by Professor Alex Kemp and Linda Stephen from the University of Aberdeen suggests that Scotland's estimated geographical share of the North Sea will account for approximately 90% of the revenue from the UKCS over the coming years. Therefore, the potential value of an oil fund for Scotland could be substantial. Under the current devolution settlement, North Sea revenue is reserved. However, successive UK governments have failed to take the action necessary to ensure that future generations benefit from the economic windfall from Scottish oil and gas. Devolving North Sea taxation and production to the Scottish Parliament would allow Scotland to take responsibility for its own natural resources and ensure that they provided a lasting benefit for the country.

4.62. There are also major opportunities in encouraging the oil and gas supply sector in Scotland to diversify into both carbon capture & storage, and marine and offshore renewables, including the current major opportunities in supplying offshore wind farms in the southern North Sea.

4.63. The UK regulatory framework does incentivise renewable investment in electricity supply through the Renewables Obligation Certificate ( ROC) mechanism but does not at present provide adequate incentives for investment in other low carbon energy, especially clean coal and carbon capture.

The North Sea Fiscal Regime

4.64. The Oil Taxation Act of 1975 established the basic framework for the taxation system of the North Sea oil and gas sector.

4.65. While the regime has evolved over time, there has been in recent years increased calls for a fundamental review of the taxation system as the oil and gas sector in the North Sea matures. The system is also highly complex, with various allowances, reliefs and deductions which differ according to types of expenditure, age of fields, year of expenditure and are subject to various volumes and safeguard allowances. There have been calls for a more transparent and less complex framework.

4.66. The amount of remaining reserves, technical capabilities and future oil and gas prices will ultimately determine the level of investment and production in the sector. However, the taxation regime is also an important determinant of ultimate recoverable reserves.

The Current Regime

4.67. The current taxation regime is made up of three instruments discussed below:

  • Petroleum revenue tax ( PRT): PRT is charged at a rate of 50% on field-based profits from oil and gas extraction on fields given development approval prior to March 1993. From this time, PRT was abolished for all new fields. Within the PRT system, there are a series of deductions for certain expenditures incurred, including exploration, appraisal, decommissioning and development costs.
  • Corporation tax ( CT): Ring-fenced corporation tax on upstream oil and gas is charged at a rate of 30%. In 2002, a Supplementary Charge ( SC) of 10% was introduced; lifting the effective corporation tax rate, i.e. CT and SC, to 40%, while from January 2006, the SC was increased to 20% making the overall tax rate 50%. There are a series of deductions for exploration, appraisal, and development costs, while PRT is itself deductible as an expense against corporation tax and the supplementary charge.
  • License Fees: The UK government grants licenses for operators to "search and bore for and get" petroleum in specified areas for a set period of time. Operators pay an annual fee for holding these licenses. License fees are charged at an escalating rate on each square kilometre that the licence covers, although there is a ceiling on the level of fees charged.

4.68. Currently the overall top marginal rate on fields subject to PRT is 75% (0.5 + 0.5 (1 - 0.5)) and for fields not subject to PRT it is 50%.

4.69. At the 2009 Budget, following consultation the UK government announced a range of measures to reform the taxation regime of the North Sea sector. The principal element of this package was a 'field allowance' designed to incentivise investment in the smallest and most technically challenging fields. The allowance will work as an additional tax break, up to a specified amount, for companies operating in particular fields 29.

4.70. Proposals for a field allowance have received a cautious welcome from the industry 30. A number of oil and gas companies have however, intimated that the proposals are not ambitious enough 31. The actual number of fields which these changes are expected to impact upon is likely to be relatively few.

Options for Reform

4.71. The key challenge for the oil and gas taxation regime in the future is to balance taxation revenues, environmental objectives and ensuring sufficient incentives are in place for continued development and exploration in the North Sea.

4.72. There have been calls for a more simple and transparent system of taxation for the North Sea. In addition, as the North Sea sector continues to mature, a number of commentators and business organisations, including Oil and Gas UK, the body which represents the offshore industry, have urged reform to encourage continued exploration and investment. In addition many have also suggested that the relatively complex set of taxation arrangements which exist in the North Sea are a reflection of an environment of large projects and significant infrastructure investments. A future taxation regime needs to take account of the maturity of the sector and the fact that future developments are likely to be smaller in nature and may often by technically challenging to develop. A balance therefore needs to be struck between ensuring that tax revenues are appropriate and reflect economic rents while also ensuring that production is maximised.

4.73. Future fiscal approaches are also likely to need to take into account the issue of decommissioning costs which will be of increasing importance in the coming years. Again there is a balance between ensuring that owners and operators of assets undertake the appropriate level of decommissioning which reflects the economic rents they have obtained over the years while ensuring that decommissioning does not become a disincentive to continued operation in the North Sea. In addition, there could be some opportunities for the alternative use of infrastructure and assets, such as for carbon capture and storage and renewable energy.

4.74. The Government Economic Strategy specifically highlights the current importance of the oil and gas sector to Scotland's economy and in particular the development of the supply-chain focusing upon high-value, internationally-orientated activities. It is important, however, to see energy in its entirety as a key sector of the sustainable economic growth of the Scottish economy over the next 30 years and beyond.

4.75. The Scottish Government would seek to develop a fiscal system which would be appropriate for the circumstances of the North Sea as it currently stands while also ensuring that revenues are appropriate and reflect the exploitation of a valuable and non-renewable resource.

4.76. Independence would allow the Scottish Government to work with industry to develop a fiscal regime that balanced competing objectives and ensured predictability and efficiency alongside a reasonable return for the public exchequer.