In Europe’s Sick Bay

Britain before North Sea Oil

Norman J. Smith

Abstract

This chapter ‘sets the scene’ in terms of the difficult UK Economic and Industrial Environment prior to the discovery of offshore oil and the expectations the latter engendered. The questions of how to catalyse a British offshore supply industry and to measure the effectiveness of government policy are raised.

Keywords

economic difficulties; industrial decline; balance of payments; major projects; supply sector

Although it may seem strange to devote the opening pages of a book about the North Sea offshore oil and gas industry to broad economic and industrial issues, it is important to do so. Appreciating the circumstances and perceptions of the time offers the prospect of an insight into the mind-sets of those who made the policy decisions 50 or so years ago.

When the offshore industry reached the United Kingdom (UK) in the 1960s, the country already had a well-developed industrial base and much prior experience in the exploitation of oil and gas. It was the domicile of some of the world’s largest exploration and production companies.

At the same time the British economy was facing considerable difficulties. It was inflexible in character – a result of government industrial policies, poor management, entrenched trade union power and a scarcity of venture capital. Governments became increasingly pre-occupied with a range of negative economic indicators such as balance of payment deficits, the public finances, poor productivity growth, strikes, increasing unemployment and rising inflation. There was a widespread perception that Britain was in relative economic decline. It became commonplace to speak of the combination of negative trends in terms of a ‘British disease’, which – unless cured – would condemn the UK to grow at a slower rate than its peers.

The long-term outlook appeared to be one of over-extension and continued relative decline, with short-term policy driven by the balance of payments and exchange rate considerations. Inevitably, once it became clear that this newly arrived industry was likely to add a significant increment to the nation’s resources and to make its most substantial impact by easing the balance of payments constraint, it became the focus of political attention. This attention was to be heightened by the hope that substantial economic benefits would flow to the areas closest to the oil and gas fields, many characterised by declining heavy industries and rising unemployment. From the early 1970s, government concern over security of oil supply – shared by the oil companies, whose interests were otherwise purely commercial – added another powerful driver.

Whilst there are grounds to criticise British government policies towards the offshore supplies industry, such criticisms need to recognise that, in addition to immediate crises such as the 1972 and 1974 coal miners’ strikes and the 1973 oil price hike, governments were heavily constrained by what were seen at the time as long-term economic problems of a structural nature. For investors in what was from the outset a costly and risky endeavour, having to address the high expectations of the government and the public whilst seeking to meet their own business objectives was challenging. It was not made easier by the fact that the very British industries to which it would be natural to turn to as suppliers, such as shipbuilding and major capital project construction, were clearly already facing great difficulties.

1.1 The british balance of payments problem

In the then world of fixed exchange rates and with the pound sterling still having the status of a reserve currency for many of the UK’s former dependencies, the most pressing of the constraints faced by British governments was usually the balance of payments. The balance of payments was thus commonly perceived as the main ‘driver’ of short-term government economic policy. Thus, the importance of the shift from being a net oil importer to being a net exporter, which followed the development of the United Kingdom Continental Shelf (UKCS), should not be underestimated, particularly because it also brought security of oil supply and increased government revenues in its wake.

During the period from 1947 to 1976, Kirby (1991, p. 23) recognised no less than eight cycles of boom and slump, a pattern that became known as the ‘stop–go’ cycle. Two of these, 1964–1967 and 1973–1976, respectively, saw the genesis of the British offshore gas industry and the most active phase of British offshore oil development. Conditions in both these periods were ‘extreme’ in terms of factors other than their protracted length, with correspondingly ‘extreme’ implications for government policy. The first was characterised by a perceived speculative severity that led to sterling devaluation in November 1967, although the current account was actually close to balance (Thirwall and Gibson 1992, p. 238).

The second period, during which the pound sterling was already floating freely, combined a domestic crisis with the international one that followed the Yom Kippur War of 1973, the associated steep increase in oil prices and the Arab oil embargo. At home, a government lacking a clear Parliamentary majority faced industrial unrest, a depreciating currency and rising inflation. On this occasion, the British government was unable to contain the crisis by its own efforts. In June 1976, it was announced that a Group of Ten Nations had loaned it $5.3 billion (Thirwall and Gibson p. 249), roughly $16.2 billion in 2008 terms. This loan formed part of Britain’s growing medium- and long-term foreign currency borrowings, which by November 1976 totalled about $18.5 billion (Arnold 1978, p. 327), over $56.5 billion in 2008 values.

Accumulated mainly in the previous 3 years, with the main repayments falling due in the 1980s when it was believed North Sea oil production would be at its peak, even this level of borrowing did not prove sufficient. At the end of the year Britain provided the International Monetary Fund (IMF) with a Letter of Intent containing commitments about the conduct of economic policy. In return, the IMF and the Group of Ten granted the country standby credits of $3.5 billion, or some $10.7 billion in 2008 terms, although these facilities never needed to be fully implemented (Wass 2008, p. 306).

Typically, balance of payment crises brought periods of economic expansion to a premature end through interest rate increases and associated fiscal and monetary tightening; sometimes more direct action was taken, such as the imposition of the import surcharge in October 1964. The resultant contraction in domestic demand reduced imports and took the pressure off the exchange rate without the need – except in 1949 and 1967 – to devalue the pound sterling. Even after the pound was floated in 1972, the fear of a deteriorating balance of payments being followed by the inflationary consequences of a weakening exchange rate was slow to disappear.

Although the improvement in the balance of payments permitted the reversal of the ‘stop’ measures and the resumption of ‘go’, the cycle reduced the long-term rate of economic growth and the productive potential of the UK because, in the view of Pollard (1984), the reduction of demand during ‘stop’ phases bore particularly hard on investment expenditure.

Pollard saw the origins of the ‘stop–go’ cycle in the legacy of Britain’s position as a victorious power in 1945. The government itself was responsible, in his view, because of its slowness to adjust to Britain’s reduced status in the post-war world when it ceased to be a global imperial power, leading to at least two pretensions.

The first was the maintenance during the period of fixed exchange rates of the Sterling Area, an arrangement through which countries – mainly former British dependencies and including a number of oil producers – used sterling as their international trading currency and held their foreign exchange reserves in London in the form of Sterling Balances. Although it need not always have worked to Britain’s disadvantage, commentators such as Pollard mainly regarded the existence of the Sterling Area and sterling’s status as an international trading currency as sources of weakness, amplifying cyclical balance of payment problems and constraining exchange rate policy by making the maintenance of a fixed parity a guiding principle of economic strategy.

The second was the government’s own expenditure abroad on military expenses, foreign aid, and the servicing of overseas loans required to finance earlier deficits. In this analysis, the underlying cause of the balance of payments problem lay in the inability of the private sector to generate sufficiently large surpluses to finance the official sector’s overseas deficits. Pollard (1992, p. 307) noted the total private balance was in surplus in every individual year between 1961 and 1970. Overall, its surplus for the decade totalled £6.45 billion. By contrast, the total current government balance was in deficit in every individual year and accumulated a total deficit for the decade of £6.14 billion. The position deteriorated in the next decade. Between 1971 and 1980 the total private balance was in deficit in three of the 10 years, although it returned a cumulative surplus of £17.44 billion. The total current government balance remained in deficit in...