Jeremy Warner's Outlook: Oil majors have bit more life in them yet

That old chestnut again. The story that BP is exploring the possibility of a mega-merger with Shell to create the Western world's largest oil company does at least have the merit of once being partially true. Exploratory talks were indeed held a year or two back when John Browne was chief executive of BP. They were one of the things that convinced the BP board that Lord Browne had been too long in the job and needed to be reined in.

The story should be given even less credence today than it was back then. Not in a month of Sundays are US and European regulators going to allow any such merger - or at least not without disposals so large that they would undermine much of the transaction's purpose. So why has the rumour come bouncing back? With the City advisory fees on any such deal likely to be almost as humongous as the merger itself, this may be a question more of hope than realistic expectation.

Yet the thinking behind such an apparently monstrous marriage is not entirely without foundation. The world's reserves of oil and gas are not in any danger of running out any time soon, but we may be quite close to so-called "peak production". Some of the world's biggest known sources of hydrocarbons, are, moreover, increasingly closed off to the Western oil majors. To the Middle East must now be added Venezuela, and perhaps Russia too, whose mood has turned distinctly hostile.

This may be as much a function of the high oil price as anything else and is certainly nothing new to the oil industry. Buoyant oil revenues have allowed countries such as Russia to spurn the Western capital and expertise that in more austere times they so desperately needed. Some of this may come back with the next downturn.

Yet the bottom line is that the oil majors are struggling to replace their reserves at anything like the same rate as they are expending them. For the oil majors at least, the oil truly does seem to be running out. The sort of successes in far-off lands being reported by smaller players such as Cairn, though not to be sneezed at, would only amount to a few days' production for the big boys.

For all the success BP has achieved in Angola, the Gulf of Mexico, and more recently Libya, it is still not enough. What's more, there has been a marked deterioration in the terms of entry. Libya has extracted a high price for allowing BP back. Both Shell and BP are being forced to agree more onerous terms in Russia.

The question for directors of both companies is whether this is a permanent shift, or just a cyclical one which will abate when the oil price falls back to a level where foreign participation is more appreciated. An added complication is the arrival on the energy scene of some highly aggressive Chinese players with priorities that are much more national and strategic than commercial. They too are distorting the terms of trade.

For the oil majors to answer these pressures by eating each other none the less seems to me to amount to a strategy of despair. It is no kind of a solution to the problem of asset replacement simply to buy your nearest rival. The cost synergies would keep the bottom line growing for a while longer, but eventually the same problem would return in magnified form. If rumours of a merger between BP and Shell seem exaggerated, those of the impending death of the oil majors look equally implausible. They may be past their zenith in terms of profits and influence, but even in run-off they remain mighty powerful beasts.

Britain is top for inward investment

It is not just rich Russians and terrorists who seem to find Britain so attractive nowadays. According to figures published yesterday by the newly renamed Department for Business, Enterprise and Regulatory Reform, we are still second only to the US at attracting investment projects from overseas companies.

No fewer that 1,431 of these rushed to our shores last fiscal year, up 17 per cent on the year before, creating nearly 37,000 jobs and safeguarding a further 42,000. Quite a bit of this activity is acquisitions and the expansion of existing facilities, but there were also 600 genuinely new investment initiatives, creating a total of 20,000 jobs.

Some of the biggest were from India. As if bringing coals to Newcastle, ICICI bank has created more than 1,000 call-centre jobs in Belfast, bringing closer to reality the bizarre prospect of Indian banking customers phoning Northern Ireland to check up on their overdraft limits. Reverse outsourcing is ever more common, with Britain a major beneficiary.

It was only a little while back that Sir Digby Jones in his old guise as director general of the CBI would routinely lambast the Government for the supposed damage that tax and regulation were doing to British competitiveness. Now minister for trade and investment, he yesterday trumpeted our business flexibility as a key strength that had helped underpin the flood of foreign money, but then Sir Digby always was better at cheer leading than barbed criticism.

So what's behind this continued success? One reason, as John Hutton, the new Secretary of State for Business, Enterprise and Regulatory Reform, pointed out, is the "multiplier effect", whereby success builds on success. With 15 years of uninterrupted growth under its belt, the British economy has become one of the most stable in the world. It is also one of the most free and open, making it as easy to get your money out as in. Well regulated capital markets make up another big chunk of the jigsaw, providing both the liquidity and the integrity that international investors demand.

And so to tax. That too is relatively benign when it comes to foreign investment in Britain. As we have learned from the debate on private equity and non-domiciled tax status, this is a Government that leans over backwards to make the tax regime competitive internationally in so far as foreign capital and expertise is concerned.

More pertinent, perhaps, is the tax system's growing lack of competitiveness when it comes to existing British companies and business. For them, the tax regime feels far less comfortable. Paradoxically, while the whole world seems to want to come to us, those already here are ever more determined to get out.

Blame PM for rise of private equity

Thanks to the engaging Jon Moulton of Alchemy Partners, private equity fared rather better before the Treasury Select Committee at yesterday's hearing than it did on the previous occasion. This time, it wasn't just taper relief that was under attack, but the supposed damage that debt leverage may be doing to the tax base more generally.

This line of attack is by no means new and has always struck me as a bit of a red herring, since the corporation tax that companies avoid by loading up with debt is merely transferred on to the debt holders, who would normally have to pay tax on the interest they receive. Some of these debt holders will be based offshore, so leverage may indeed cause some limited tax "leakage", but in the round it is probably not as great as private equity's critics suggest.

Even so, there is some validity in the argument that private equity is little more than a form of tax arbitrage. For the private equity owners, it is a lot more tax-efficient to have the company financed through debt than equity, as well as less risky. Yet to think of this phenomenon as some evil capitalist conspiracy is entirely wrong.

As Mr Moulton pointed out yesterday, by abolishing the tax credit on dividends, our own Prime Minister, Gordon Brown, did more to increase the relative merits of debt over equity than the markets were ever capable of achieving on their own. The rise of leverage is a worldwide phenomenon, so Mr Brown cannot be entirely blamed for the march of private equity. Yet his influence is a notably positive one, none the less.

One private equity boss has had a T-shirt printed which on the front reads "I am a private equity executive", and on the back adds the qualification "... but I am not a paedophile". If the Treasury Select Committee has awkward questions to ask, it should be directing them not at the likes of Damon Buffini, but at the former chancellor who made it all possible.

j.warner@independent.co.uk