Thursday, December 14, 2006


I posted this on Irish Election.

Come and listen to a story about a man named Jed A poor mountaineer, barely kept his family fed, Then one day he was shootin at some food, And up through the ground came a bubblin crude. Oil that is, black gold, Texas T.

Sadly for us no one in Ireland is going to find some bubblin crude about the place so we have to make do with what we got. One of the big issues for a nation now a days is energy security. While renewables need to be a bigger part that picture we also can not ignore the benefits gas/oil supplies would give us. So we really need to maximise our resources. So how is the best way to do this. Is it the present system, or were we had, ripped off by Ray Burke and his Fianna fail Cronies.

One off the points many people make is that we should have had our own gas exploration company and that everything should be in national hands. And that does sound really good. Image all that money being put into schools, health tax cuts. It would be savage. However there is a but.

First off there is only 1 successfully operated gas operation in Ireland. That is the Kinsale Gas field (It is actually 3 locations all near each other). And it has paid in royalties about 150 million euro to date. Now the royalties from the Kinsale field are charged at about 6%. So that means that the total value of the field is to date about 2.5 Billion. Now about 121 test drillings have been made on Irish territory. Now the cost of a test drill in the Atlantic is quiet high due to the water depth (the North Sea is a lot shallower thus cheaper). It is about 20 million to drill a test hole. So that means the cost of drilling that many test holes would be 2.4 billion. Now those calculations are quiet crude really. Obviously inflation has meant that the cost of drilling has increased. But also as technology has improved the drilling is probably more efficient and thus cheaper in relation to inflation. Also some of the drilling has taken place in cheaper to drill places like shallower waters and Cavan (Seriously :) ) but more or less the cost would be well into the Billions. Also the value of the royalties are also effected by inflation (i.e 6% now is greater then 6% in the 80s) and indeed the current high prices of gas compared to low 80s/90s prices when Kinsale was at it’s height. So I can’t really say what the actually money spent on drilling in Irish waters is, but it probably was quiet substantial also the royalties figures do not include the value of money gained from corporation tax which was first at 50% and later at 25%. Which means we got more then 150 million.

So the calculation needs to take in a lot of different values and amounts of money. But I would wager that the actually money that it would actually require to drill 121 test holes compared to the money made from Kinsale is probably not that much different. Certainly not a country changing windfall, indeed when you throw in the value of royalties and corporation tax take and the cost for a Semi-State to develop the technology, expertise and platforms to explore that the shells of this world have, I have to wonder does the cost of Kinsale cover the cost of exploration? Remember the 121 test holes were split over many companies each with equipment and expertise. If Bord Gais was out drilling holes would we be much better off? Also would political pressure come to bear? Would people be saying “Why is there so much drilling in Mayo, my constituency should have some drilling too”

Now we also have the Corrib Gas field which is about 60% the size of Kinsale. (Kinsale is not particularly big by international standards.). Since the royalties were got rid of we will not have the equivalent income of €150 million that the Kinsale brought in. So why were royalties got rid of?

Well when the royalties (1987) were removed the oil market was quiet low. Thus lowering demand and lowering prices. In 1982 the UK removed royalties in 1986 Norway did for new fields. Denmark and Holland also did. Now these countries have far far better strike ratio’s then Ireland. So does it make sense that these countries charge no royalties and Ireland to charge royalties? Where would you invest. A place where you had a 1 in 30 chance of striking and have to pay royalties or a place where you have a one in three chance to strike and pay no royalties? That is why Ireland had to get rid of royalties in the 80s, it was a competitive environment.

Now back to the Corrib Field as of 2005 Shell has spent 500 million euro on developing the Corrib Gas field which has yet to yield any gas. But as you can say that this would produce a profit for a semi-state body as the above calculation I did was up to the present day. But what happens if we continue to drill at the same rate as we did before. With the same 1 in 30 strike rate (we have had 4 commercial strikes 3 of them off Kinsale the other Corrib hence some say we have a 1 in 50 strike rate) eventually we are going to come to the same situation where the gain vs expense is not clear. So then we come to the high taxing and high licensing idea.

In the comments of this post. William referred to the ability of companies not to pay tax as they can transfer the profit out to tax havens and Keith mentioned that extraction rights are given away for free. So I will deal with those 2 points. Firstly I don’t have knowledge of Irish tax law but maybe someone can help me why is it that they would transfer their profits in Ireland where they do not in Norway where according the Norwegian Petroleum Directorate the corporation tax and special tax, accounts for about 90% of the tax from oil? What would be different? And also from that link it can be seen that the remaining royalties (phased out this year) combined with area fees (extraction rights) account for only 4% of the tax take from oil. Indeed not only do the Norwegians allow for companies to write off costs against the corporation tax (like in Ireland) but they can also write off their area fees against the corporation tax (same link as phasing out). So going by the country that most people put up as the beacon of how to use oil money. The most money you are going to get is from Corporation tax. So why should we be different?

The main difference between the Norwegian and Irish example is that along with the corporation tax (28% in Norway with write off of area fees so similar to 25% here) you pay 50% the special tax ( they are considering halving it to encourage more exploration.) for non-marginally profitable fields (marginally profitable fields get an uplift of 30 % of investments whatever that means, to shelter from the special tax.) And the Carbon tax which is another debate for another day. That 50% is the difference between the 2 countries. So companies pay 50% to get a 10 times more probable big strike. Are put another way. Say ever field is worth 7 billion after corporation tax. In Norway you will earn 70 billion minus 35 billion special tax i.e 35 billion vs 7 billion earned in Irish waters. For the same initial investment. (Actually shallow waters in North Se amake the initial investment cheaper).

There is also the argument that we should leave it in the ground until the price rises so high that we make more money. But when the price of gas rises (and we can already see this happening) the market is going to move to renewables and the gas will stay in the ground, it is not oil it can not be used in cars (We have tried) it is replaceable. The market for gas probably will not exist in 25 years time. We might as well cash in when we can.

The Celtic tiger owes its self to competing with tax rates. We under cut other countries because it was the only thing we could offer that they could not. And it worked spectacularly. We are in the same situation right now. Drilling in Norway is like trying to find a Daniel O Donnell fan in a bingo hall, drilling in Ireland is like trying to find a Daniel O’Donnell fan at a Metalica concert. We cannot expect to get the same treatment for an inferior product. We have to under cut and that is what we do. Considering that many of the big companies Elf, Total, BP et al have left Irish Shores maybe this not the time to ask are we giving away resources to cheaply. Maybe the question is are we too dear? Because in the end of the day it is better to tax something low then tax nothing high.


Godwhacker said...

Great Post/Article!

Pavement Trauma said...

At last! Somebody gets it. Great stuff,

I have this vision of all the anti-sHell bloggers freezing cold, desparately warming their hands on the output vents of their computers when Russia turns off the gas at the other end of the big pipe. And then writing something blaming it all on big business.