March 27 (Bloomberg) -- The Falklands’ first commercial oil discovery will make the islands in the South Atlantic rich, bringing the British territory of 2,563 people $10.5 billion in tax revenue over 25 years.
As the bounty transforms the fishing and tourism-dependent economy, tensions may worsen with Argentina, which claims sovereignty over the islands and their mineral wealth. The Latin American country last year threatened to sue any company involved in Falklands drilling and its foreign minister said yesterday the islanders have no right to self-determination.
The local government is already starting a wealth fund to manage the cash. On the agenda: paving the main highway from the airport to the capital of Stanley, improving the port to take larger ships and reimbursing the 60 million pounds ($90 million) the U.K. spends annually on soldiers, jets and ships to defend the islands, which Argentina attacked in 1982.
“In times of recession, it’s difficult for people in the U.K. to justify spending money on a small population on the other end of the world,” said Andrea Clausen, 41, who owns a transport business and is a member of the Falkland Islands Chamber of Commerce. “But as long as Argentina claims the Falklands in its constitution, the threat won’t go away.”
The offshore Sea Lion oil discovery may generate government revenues of about $160,000 per person each year when it starts production 2017, according to Edison Investment Research. That’s equivalent to the after-tax income of a top 1 percent earner in Britain, figures from the Institute of Fiscal Studies show.
Britain has no claim on the windfall, which will change life on the islands in ways residents are struggling to grasp. Falkland officials in December visited Norway and the Shetland Islands to learn lessons from similar funds, to avoid inflation or poor financial management.
The discovery “will no doubt be transformational for the islands, increasing government revenue several times over,” Mineral Resources Minister Stephen Luxton said in an interview. “What we’re looking for in a sovereign wealth fund is long-term economic security, a second string to our financial bow to the fishery,” he said, referring to the territory’s commercial fishing business.
It’s the islands’ decision about whether to spend money from oil revenue on defense, an official for the U.K. foreign office said, who declined to be identified in line with government practice. U.K. spending per islander is close to the median British salary of 26,500 pounds last year.
Oil wealth may prompt Argentina to step up pressure on the U.K., which first settled the islands in 1766, to resume talks over sovereignty. President Cristina Fernandez de Kirchner has said the Falklands’ status perpetuates colonialism.
The U.K. rejects Argentina’s claim. A referendum last month saw all but four Falkland citizens vote in favor of staying British, three decades after Argentina invaded and Margaret Thatcher went to war to retake the territory.
Fernandez asked her countryman Pope Francis to help persuade the U.K. to open talks on sovereignty of the islands, a day before he became the 266th bishop of Rome.
Foreign Minister Hector Timerman said yesterday that the Falklands referendum was illegal and wasn’t recognized by the United Nations. The U.K. rejected an offer by Secretary General Ban Ki-moon to mediate on the dispute.
Sea Lion contains about 400 million barrels of oil, according to Rockhopper Exploration Plc, the explorer that made the discovery three years ago. Premier Oil Plc, a U.K. oil company, agreed to take over operating the field last year with a $1 billion investment. Premier expects spending up until first oil, still four years away, to be about $3 billion.
Rockhopper rose 0.7 percent to close at 152.8 pence as London today. Premier gained 0.2 percent to 394.8 pence.
Based on the Falkland’s tax regime, which gives the local government 33 percent take from corporation taxes and production royalties, the islands can expect to receive $3.9 billion in royalties and $6.6 billion in tax revenue over the life of the field, according to Edison Investment Research, a consultant. That equates to about $4 million per islander, or $160,000 per person a year over the 25-year life of the field.
Those figures may increase further if more oil is found around Sea Lion or if gas finds to the southeast of the islands drilled last year are deemed to be commercial. Falkland Oil & Gas Ltd. sold part of its assets to U.S. producer Noble Energy Inc. and Italy’s Edison SpA, a unit Electricite de France SA that’s unrelated to Edison Investment Research. Borders & Southern Petroleum Plc said in January that its Darwin prospect probably holds 210 million barrels of condensate, a light crude associated with gas production.
“There’s strong potential for more reservoirs to be discovered and developed,” said Ian McLelland, head of oil and gas at Edison Investment Research in London. “In time, it’s not unreasonable to think that there will be significantly larger discoveries than Sea Lion.”
The Falkland government is still in the early stages of planning and hasn’t made any decisions about how to spend the money, Luxton said. He said the first infrastructure projects would probably be a new deepwater port and upgrading the main road between the airport and the capital.
Argentina’s invasion sparked a 74-day conflict in which 255 British and 649 Argentine military personnel died, along with three islanders. The U.K. now maintains 1,200 military personnel in the British Falklands garrison.
“As far as many Falkland Islanders are concerned, using some of the money for defense would be something popular,” Luxton said. “In Norway, they didn’t encourage domestic investments to prevent inflation in the country. We haven’t got into detail yet, but these are the kinds of things we’re thinking about.”
Norway started its sovereign wealth fund in 1990. It’s now the largest in the world, with about 4 trillion kroner ($715 billion) in assets after returning 13.4 percent in 2012.
Shetland, the group of U.K. islands north of Scotland’s mainland that Falkland officials also visited last year, set up the Shetland Charitable Trust in 1976 to manage the influx of money from the discovery of North Sea oil.
The Falkland Islands also saw revenue rise quickly in the 1980s as commercial fisheries were built. The government on its website boasts that the economy, based on fishing, agriculture and tourism, is self-sufficient except for defense.
The islands have already made an initial deposit into a new Oil Development Reserve of 8.3 million pounds, according to the Sovereign Wealth Fund Institute, a Las Vegas-based consultant on public investors. The Falkland Islands have the smallest population of any of the funds listed on the organization’s website.
The Falkland authorities have a good track record, said Clausen, who’s lived there since she was three. Islanders are mostly confident that the oil money won’t be squandered.
“People may be a little bit nervous, but they’re equally excited,” she said. “They want to know that our way of life won’t be destroyed by the impact of oil, and that it will be carefully managed.”
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