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Britain's oil bounty is running dry

Although Gordon Brown urges the members of the Opec oil producing cartel to increase production to bring down prices, he will be quietly rubbing his hands with glee at the benevolent effect dearer energy is having on the UK's public finances. With all the taxes levied on the North Sea oil and gas industry he, like previous chancellors, stands to make billions from the rise in prices which yesterday saw Brent crude break through the $50 a barrel level for the first time.

But Mr Brown should enjoy it while it lasts. The fact is UK oil and gas, which has given a big boost to the economy for the past two and a half decades, is running out fast. At current rates of extraction, the last drop of oil could be sucked out of the North Sea fields in about 10 years' time.

Oil output is already down by a quarter since peaking in 1999 at about 2.8m barrels per day (bpd), although the current production of 2.1m bpd is in line with the average of the past 20 years. At the present rate of decline, according to the UK Offshore Operators' Association, the country will cease to be self-sufficient in 2007, production will drop to 1m bpd by 2010 and dry up little more than five years later.

Britain is also running out of gas from the North Sea. Given that a large chunk of the country's electricity generation depends on gas, the shortfall will have to be made up by imports.

"You can see that production levels of oil and gas have dropped sharply over the last two years and that is set to continue, with fundamental consequences for the economy," says David Page, an economist at Investec bank in the City.

He is talking about everything from employment and tax receipts to the balance of payments and the pound.

The motorist will probably emerge fairly unscathed, as the impact on pump prices should be minimal. Many European countries have no oil of their own but do not pay more at the pump than British drivers.

Oil has kept the British economy lubricated since the late 70s when production started. It has provided tax revenues of almost £200bn over that period in today's prices, equivalent to a fifth of current-day gross domestic product and nearly half of one year's current tax receipts. North Sea tax revenues were about £5bn a year be tween 2000 and 2003, equivalent to nearly 2p off the basic rate of income tax.

Mr Brown had pencilled in about £3.6bn of revenues for the current year on the assumption of an average oil price of $31 a barrel for London Brent. But with oil prices having jumped more than 65% since the start of the year, revenues will be nearly double the Treasury's estimate.

Last year the oil and gas industry in Britain accounted for about £23bn, or 2.5% of the economy. It directly employed 260,000 people.

Britain is still a significant producer of oil and gas. Last year it was the world's 11th largest oil producer and fourth largest gas producer. It has been self-sufficient in oil for the past 20 years and that is likely to continue for another three, at which point the UK will become a net importer.

The decline is showing up in data from the Office for National Statistics. Last month it reported a deficit on trade in oil of £61m in July. Although small in terms of Britain's trading position and though it has since been revised to a small surplus, it was the first deficit since August 1991 and alarmed the City and political circles.

From now on, monthly oil trade deficits will become a regular feature. As recently as two years ago, a monthly surplus of £500m was the norm.

The loss of this export surplus might not matter if the country had a trade surplus or was at least in balance, so it would have the chance to export more of something else to make up the shortfall. This is by no means guaranteed.

"Since an oil surplus is something we are going to have to live without we need to start compensating for diminishing oil output by improving the non-oil account," says Geoffrey Dicks, an economist at the Royal Bank of Scotland.

He has a point. The UK's balance of trade is deep in the red. The goods trade deficit was £47bn last year and £46bn the year before.

Even throwing in the traditional surplus in services trade, or "invisibles" such as insurance and banking, the total trade deficit has been around £30bn for each of the past three years. If the country has to import all its oil and gas in 10 years' time, that will not help the balance of payments.

But it is important to keep a sense of perspective. Although large, the oil and gas sector has remained constant in size while the economy as a whole has been growing strongly for the past decade, reducing the relative importance of the energy sector.

Likewise, some 10% of government tax revenues used to come from oil. Now that figure is less than 1%. And the 260,000 who work in the industry represent less than 1% of the 28m jobs in the economy.

And, says Mr Page, the impact of oil running out will not be a sudden shock as it will take place over a number of years. The economy is probably flexible enough to adjust to the change, as it has to a gradual decline in the manufacturing sector.

There is another crucial element of Britain's oil history that economists and manufacturers say has been a negative for the economy.

Being an oil producer gave Britain a petro-currency status, meaning the pound has been stronger than it would otherwise have been, making it more difficult for manufacturers to sell their products in export markets.

"Having oil has not been an out and out joy because there have been negative effects on the manufacturing sector from the strong pound," says Mr Page.

"So the implication of losing oil would be that the pound should become weaker over a period of years which would be good," he says.

So, ironically, a decline in oil and gas production could yet end up benefiting manufacturing through stronger exports. What goes around comes around.

Editorial Notes: The oil peak is in sight for Great Britain, and the Guardian struggles to find a silver lining. This article is the first of a three-part series on the UK and oil. The Guardian has a section devoted to oil-related articles at www.guardian.co.uk/oil/0,11319,608464,00.html -BA

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