The British Election's Biggest Economic Impact May Be On Oil, Not Brexit

This is source I found from another site, main source you can find in last paragraph

As Britain continues to digest the results of the snap election that the ruling Conservative government surprisingly called three years ahead of schedule, most of the analysis before the vote and since has focused on the impact on Brexit negotiations, which are due to commence soon. Also receiving a lot of press is a new and unexpected threat to the integrity of the Northern Ireland peace accord if the Conservatives do in fact make a deal with a regional conservative Irish Unionist party, breaking British neutrality in N. Ireland politics.

These are very important matters, of course. Surprisingly little, however, has been written about the vote's potential impact on the Oil (NYSEARCA:USO) market, which I believe is being underestimated. Or to be more accurate, the impact of this vote or the next vote, which will in turn impact the oil market, is being underestimated.

This is an economic forum, not a political one. In this case, however, the economic implications for British North Sea oil are largely driven by political factors. This article will therefore first, as briefly as possible, summarize the relevant political forces at play, then examine the current economic arrangements, then finally explain why a surprisingly rapid and significant shift may be in the offing.

North Sea Hangs In The Balance

The thesis of this article is simple: North Sea production has the potential to be curtailed rather drastically over a relatively short period of time if the political situation in the British Isles develops along a certain, entirely plausible, path. This has implications for the oil market as a whole as well as some of the major players in the North Sea specifically, including BP (NYSE:BP) and Shell (NYSE:RDS.A) (NYSE:RDS.B).

While the British Parliament which has been elected was hoped to serve a full five years this time, another major ballot - or two - may take place before that term is up. In the first place, the lack of a majority in Westminster might send the whole country back to the polls, perhaps even before the end of this year. One expert puts the odds of another general election before the end of 2018 at 80%.

IndyRef 2 Or Are They Through?

Meanwhile in Scotland, emotions are still running high as voters reflect back on an independence vote that some now regret, in light of the EU withdrawal vote that subsequently followed over the objections of most Scottish voters. This was thought likely to produce a second independence referendum which would reverse the result of the first and actually put Scotland outside the UK.

The outcome of the general election has dealt a serious blow to such ambitions, but it is too soon to write them off. Especially if things proceed poorly - from the Scottish perspective - in London. The substantial repudiation of the SNP by Scottish voters - down 19 MPs and receiving only a third of the popular vote - has been admitted by even SNP leaders to be a reflection of the Scottish voter's exhaustion with the SNP's independence obsession.

But that exhaustion could receive a fresh burst of energy with a sudden surge in socially conservative or "hard" Brexit legislation from the new coalition. As I am writing this, coalition negotiations still aren't finished, but the clear trend is towards a Conservative-led coalition. Assuming the re-election of Prime Minister Theresa May and the continuation of Brexit plans, expectations are building that another independence referendum, less than five years after the last one, is indeed on the table, and now even the expected outcome.

The impact of this on oil is that North Sea oil production would follow Scotland out the door, and come under the jurisdiction of the new government. And far from being a simple accounting exercise, that has massive implications for the North Sea's future. Simply put, a British government which doesn't really talk much about the North Sea will nevertheless keep production going. While a Scottish government that loves to hype the North Sea's potential will almost certainly be forced to commence a massive shutdown shortly after independence.

Fighting The Next Big Vote

Of course, that only matters economically if it passes this time. Remain campaigners say they will win again, by fighting differently this time.

Instead of number-based arguments about the economic disruption independence will cause - far less persuasive when Brexit is going to upend everything anyway - they will focus on the nationalist undertones of the Scottish independence campaign. It's unlikely anyone will try to tie the left-wing SNP to Donald Trump and the Republican Party, but that will probably be the implicit pitch to voters who by and large despise the new American President: "nationalism, that's what Trump believes in, you know."

It's anyone's guess whether this will work. Everything has been scrambled the last few years, with some No voters crossing to the Yes camp and Yes voters entering the No camp. This is as a result of both Brexit, and the fact that the Scottish economy has changed so much already.

SNP And The Barnett Formula

There is a reason the (considerably) left-of-center Scottish National Party has risen to such prominence in Scotland, to the point of winning 56 of the 59 Scottish constituencies at the British general election in 2015. Politically, Scotland believes in more government intervention than does the rest of the country, with government spending at considerably higher levels per-capita and as a share of GDP.

Scottish voters focus considerably on the bread-and-butter issues of keeping this spending flowing. In the last referendum campaign, Alex Salmond, the previous First Minister of Scotland, boasted that Scottish spending would actually go up after independence because of billions of pounds of oil revenue that would not have to be shared with the British Treasury.

Had that come to pass, however, it would have had to be offset against a considerable stipend the rest of the country, principally England, already pays to the Scottish regional government to fund that spending. Under the so-called Barnett Formula, Scotland receives a disproportionately large share of funds dispersed from the central government in London, far in excess of the taxes they pay in. Obviously in the event of independence, those disbursements would cease.

Closing The Argument

It used to be a closely fought debate which of these two pots of money - the Barnett money Scotland would lose or the oil tax money it would gain - was larger. Needless to say, it's not anymore. The collapse in oil prices over the last three years has eviscerated the tax revenues Scotland could hope to take from the North Sea, while disbursements from England under the current system continue.

Even the SNP's own economic commission, set up to advise on possible economic strategies in the case of independence, has thrown in the towel on the North Sea, saying that any future White Papers on independence - like the one the government is suspected to currently be formulating - should assume no tax revenue from North Sea sources.

That, for all intents and purposes, should have been the death knell for Scottish independence. Scotland's revenue position has deteriorated drastically since the last referendum. The "country," which represents about one-twelfth of the British economy, last year ran a budget deficit of £15 billion, equivalent to 9.5% of Scottish GDP. Given that Britain as a whole ran a deficit of about 4%, that puts the rest of the country at about 3.5% sans Scotland. So Scotland's deficit is nearly three times the size of the rest of the country's.

However, Brexit raises strong emotions on both sides, including in Scotland, so despite the economic difficulties the SNP seemed determined to forge ahead. The election has given them pause, but again, the coalition being assembled is almost tailor-made to exasperate and antagonize the Scottish voters.

North Sea Tax Deficit

Sorry for the long wind-up, but it's important to have this context to understand the future of North Sea oil. After forty years of tapping North Sea oil for over £300 billion in tax revenue, the North Sea actually became a net drag on the British Treasury last year, with the British government paying out more in tax credits for oil production than it got from oil taxes.

The reason for that is two-fold. For decades special levies have been imposed on North Sea production by the British government. Those levies are now being revoked, reducing the amount of tax profitable producers owe while all producers continue to receive credits. The second reason is decommissioning costs.

After oil production is completed it still costs a lot of money to clean up the drilling site, and oil companies are legally obligated to pay those costs when they sign an oil lease. After decades of large profits, North Sea future oil profits and future decommissioning costs are now projected to be almost exactly equal going forward. However, under tax law decommissioning costs can be partially offset by private firms "clawing back" taxes paid on prior profits. This means the government can expect tax revenue to be a net zero from here on.

Out With The Old Means Out With The New

The importance of these various subsidies goes beyond just keeping open the fields that are being subsidized. North Sea oil production is also tightly interlinked. Many of the more viable fields that might be expected to continue production are built off of the infrastructure of older, more depleted fields.

Those fields are often producing oil at a small loss even with the subsidy help. Without the subsidies it is no great leap to think many of them would shut down. But those fields cannot be shut down without also shutting down the more viable fields.

When fields shut down, however, their decommissioning costs do not suddenly disappear. Quite the contrary; costs that were expected to be incurred years in the future are suddenly moved forward to the present as production stops and decommissioning begins ahead of schedule.

Adjusting The Model For Independent Scotland

Finally and lastly, we must take all these facts I have described and project them into a Scottish independence situation.

If Scotland separated, taking all the factors I just listed in summary, this is what would happen.

First, the Barnett Formula disbursements would stop, and independent Scotland would immediately be faced with a massive budget deficit.

Second, North Sea oil would come under the jurisdiction of the Scottish government, which would be faced with increasing its budget deficit to pay for decommissioning clawbacks and other tax subsidies currently paid by the British Treasury.

Third, as such subsidies proved unsustainable - a small economy like Scotland could not sustain a 10% GDP deficit for any considerable period, and subsidies for oil would be among the most vulnerable spending in the Scottish electorate - and were abandoned, old depleted oil fields would shut down.

Fourth, newer oil fields attached to them would shut down with them.

Fifth, the loss of tax revenue from profitable fields would produce a higher deficit, and steps three and four would repeat.

Bait And Switch

These stresses could be further exacerbated by the decommissioning costs. Remember, shutting down production early doesn't reduce such costs, it merely pulls them forward in time. So while production profits are going down, decommissioning costs are not. This would take the net zero balance of future tax revenues and clawbacks and transform it into a net liability, as production profits fall and clawbacks for shutdowns do not.

But how would such clawbacks be paid after independence? Remember, the clawbacks are merely repayments of taxes already paid by profitable companies. You pay on the front end for all the oil you sell, and then you get some of the money back when you go clean up your field.

But the taxes were paid on the front-end to the British Treasury. Following independence, the companies would presumably go to seek clawbacks from the new Scottish Treasury. Which didn't actually collect the original taxes, and therefore doesn't have the money to repay the companies with.

How this would be handled is unclear, but one possibility is that Scotland itself would seek to front-load as much decommissioning as possible in whatever transitional period may exist between the independence vote and independence itself, to get the British Treasury on the hook for as much as possible. That would mean shutting down production, since obviously decommissioning can't commence until production stops. This, too, could cause a rather sudden decline in North Sea production.

Conclusion

In summary, Britain remains in a state of political and economic flux a year after the Brexit referendum. This turmoil has potential implications for the oil market, as the future of North Sea oil drilling likely depends in no small part on whether or not it remains part of a Britain able to fund its continued operation or becomes part of a much smaller Scotland with an almost double-digit GDP deficit, which would almost certainly require an early shutdown to North Sea operations. While the outcome of an independence referendum is too close to call right now, and while it's still possible a referendum doesn't happen at all, the real impact of the election upon the oil market almost certainly lies in how it affects the next vote to come.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This is source I found from another site, main source you can find in last paragraph

Source : https://seekingalpha.com/article/4081911-british-elections-biggest-economic-impact-may-oil-brexit

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