North Sea Oil and the referendum


Output and taxation in relation to North Sea oil and gas activity has an important role to play in the economics and finances of a potentially independent Scotland says CPPR’s John McLaren.  For this reason there is continual speculation from both the Yes and No sides of the referendum campaign on what the future prospects are for the North Sea.

The Centre for Public Policy for Regions (CPPR) has produced a series of papers looking at aspects of this issue (see our website at – www.gla.ac.uk/schools/socialpolitical/cppr – and in particular our most recent in depth analysis of key North Sea oil and gas issues in the paper ‘Analysis of Scotland’s past and future position – Reflections on GERS 2014, the Scottish Government’s Oil and Gas Bulletin and the 2013 UK Budget’).

The bottom line is that in terms of the onshore economy, Scotland has been performing in a very similar manner to the UK for some time, hence output per head of population is at similar levels for the two countries.

However, in terms of the public finances of an independent Scotland the position is less straightforward. This is because, whilst an economic performance , comparable to the UK should mean that Scottish tax revenues, per head, are also roughly in line with those for the UK, Scotland’s spending per head on government services is well above the UK average.

This gap between Scottish revenues and spending is currently met via the UK funding allocation system that is in place (the Barnett system). Outside of the UK this ‘extra’ funding source would disappear, to be replaced by offshore, North Sea, tax revenues.

At present (2012-13) North Sea revenues are of such a scale as to pretty much match what is otherwise received from being part of the UK. In the future it could be higher or lower, depending on a wide variety of variables, but in particular production and price levels.

With regards to production, this peaked around 1999 and recent years, 2011 and 2012 in particular, have seen large falls in North Sea output.

There is now much divergence of opinion amongst forecasters over whether there will be a degree of bounce back (e.g. Oil & Gas UK) from these falls or just a levelling off for a few years at current output levels (e.g. OBR). Much of the current divergence in various production forecasts is based on the degree to which traditionally bullish industry forecasts are reduced by applying negative contingencies.

At this stage it is impossible to know what the answer will be. However, in considering the future it is worth bearing in mind certain long term trends.

Successive UK governments, as well as independent forecasters, have repeatedly underestimated the long term life of the North Sea in continuing to be economically viable.

However, such pessimism has not applied to medium term forecasts of North Sea oil and gas production. Here the bias is the other way round with repeated over-predictions of oil and gas production levels. For example, the Office for Budget responsibility (OBR), using DECC’s oil production predictions, have been overly optimistic in every set of projections made since its inception and Oil & Gas UK have been similarly over optimistic since at least 2008.

In their latest long term ‘Fiscal sustainability report’ on the UK, OBR included high and low price and production scenario variants up to 2040-41. Even using the high variants for both price and production, at no point do North Sea UK tax receipts return to their current (2012-13) level. On the other hand they could still be worth up to a substantial £4½ billion by 2040-41 based on the high price and production variants (or around £2 billion using the central projections for price and production levels).

Equally, the higher output figures projected by Oil & Gas UK are unlikely to result in tax revenues returning to even the levels seen in recent years unless prices also rise. Such a high oil price scenario could also result in offsetting, negative, effects on Scotland’s non-oil sectors, although these are difficult to estimate.

Overall, as it is generally agreed that production is on a long-term declining trend, the downside risks over the level of future NSO revenues, in comparison to current levels, prevail.

On the prices side, the future is even less certain and oil and gas prices remain highly unpredictable.

Besides production and price issues, future North Sea tax take is also complicated by the degree, and timing, to which investment (not only to allow new reservoirs to be exploited but also to maintain the integrity of the aging pipeline and platform system) and decommissioning costs can be set off against tax liabilities.

All this implies that North Sea taxes are not a ‘bonus’ but an essential part of post independence funding. It also implies that no surplus oil tax revenues are available to allocate to a Sovereign (Oil) Fund, or at least not without tax increases or budget cuts.

While only time will tell what the final outcome will be, from a budgetary position it seems sensible to use a cautious projection for tax revenues, with any “out-performance” being used either as part of a ‘stabilisation fund’ or to lower Scotland’s level of borrowing.

So far the current Scottish Government has not clearly stated how it would deal with North Sea tax revenues post independence; will it save them for future generations or use them now to fill the funding gap that arises from leaving the UK?

It is a difficult question to answer but that is all the more reason why a convincing answer needs to be forthcoming.

Beyond the NSO uncertainty, an important conclusion to draw from this discussion is the importance in differentiating between the output of an independent Scotland and what level of public spending that output would allow for, based on current rates of taxation.

John McLaren

CPPR, University of Glasgow

 

 

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