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Oil revenues

Oil revenues: declining, volatile, unpredictable 

Chapter summary

  • Division of North Sea oil assets will probably fall between the current population-based analysis used by the UK Treasury, and the Scottish administration’s claim for a geographic split. The administration would be unwise to assume a best-case outcome.
  • North Sea oil production has declined steeply. While most analysts assume production will shortly stabilise at 1.2-1.7m barrels a day, the days of peak production are long gone.
  • It is widely accepted that the North Sea oilfields are mature and in long-term decline. Given the hostile deep-sea geology, North Sea oil is expensive to extract.
  • The importance of oil revenues to the UK Exchequer is modest, at less than 2% of the total tax take. Thus the UK is well able to endure the volatility of oil prices. However, for Scotland oil would be critical. In 2012/13 oil revenues would have accounted for more than 10% of Scottish tax revenues, down from 17.5% the year before. Such swings would be very difficult for a separated Scotland to manage.
  • The UK’s population is approximately 11 times that of Scotland: thus the oil multiplier is of very great significance to the Scottish economy, while its loss, although significant to the rest of the UK, is not of critical importance. 

Separatism is oil-fired, but Scotland’s economy is not

It is beyond the scope of this paper to predict the legal settlement, in terms of oil revenues, should Scotland split from the UK. However, the Scottish Government’s estimates are based on its assumption that Scotland will receive a geographic share, which is the most optimistic assumption possible.

There are several potential outcomes, depending on negotiations and on international law. However, any settlement will probably fall somewhere between the current population-based analysis, used by the UK Treasury, and the Scottish Government’s claim for a geographic split.

The Scottish Government would be unwise to assume the best-case outcome.

The attitude of Orkney and Shetland is also unknown. If the islanders were to decide to separate from Scotland just as Scotland might separate from England, much of the oil to the north of the Scottish land mass would fall furth of Scotland’s territorial waters.

In reality, the oilfields in Scottish waters are UK assets achieved by UK investment and extracted by UK and global companies.

The impact of two scenarios will be examined: a per-capita split and a geographic split In Scotland’s oil revenues.

Screen Shot 2014-09-16 at 15.53.36

First, as can be seen from the chart above, in recent years North Sea oil production has been in steep decline. While most analysts assume that production will shortly stabilise at 1.2-1.7m barrels a day, the days of peak production are long gone.

It is widely accepted that the North Sea oilfields are mature and in long term decline. It is estimated that 42 billion barrels of oil have been produced in the North Sea since 1964 and that 24 billion recoverable barrels remain. Given the hostile deep-sea geology, North Sea oil is expensive to extract. For example, oil from the Saudi fields typically costs $2-3 a barrel to extract. According to Oil and Gas UK, the average extraction cost in the UK fields in 2011 was £17, or $28 a barrel. North Sea oil profitability is much smaller and much more cyclical than that of Saudi Arabia’s low-production-cost fields, limiting the potential to tax production.

Screen Shot 2014-09-16 at 15.54.52

 

The chart above looks at the price of a barrel of oil since 1993. Oil remains a highly volatile commodity, with pricing based on a number of variables, including global demand, supply constraints, geopolitical concerns (Saudi, Iraqi, Iranian or Nigerian stability, to name but four) and the power of the OPEC cartel. To base economic prosperity and public spending choices on volatile future oil revenues is not a prudential or sustainable strategy.

Screen Shot 2014-09-16 at 15.56.09

The chart shows that, as a result of fluctuating production and oil prices, revenue streams from oil have been highly volatile. Indeed, no other tax stream has proven as unstable or as hard to predict as oil revenues. This unpredictability is most unlikely to diminish. Already the Office for Budget Responsibility has cut its projection of expected oil tax revenues between 2019/20 and 2040/41 from £51.9 bn to £39.3 bn. Whether or not that forecast proves to be correct, Scottish oil production is in structural, long- term decline, reserves are falling, extraction costs are high and the price of the underlying commodity value highly volatile. Oil is great to have but it is no panacea, and no sound basis for long term economic prosperity, regardless of what share of its revenues Scotland negotiates. Yet oil would be critical to the Scottish exchequer.

The importance of oil revenues to the UK Exchequer is modest, at less than 2% of the total tax take. Thus HMG is well able to endure the volatility of oil prices. However, the chart below, based on the most optimistic scenario from the Scottish Government’s perspective, shows just how critical oil is to the Scottish tax take. Between 5% and 21% of total tax revenues since 1990. In 2012/13 those revenues would have accounted for 10.2% of Scottish tax revenues, down from 17.5% the year before. Such swings would be very difficult for a Scottish Government to manage.

Screen Shot 2014-09-16 at 15.57.11

The UK’s population is approximately 11 times that of Scotland: thus the oil multiplier is of very great significance to the Scottish economy, while its loss, although significant to the rest of the UK, is not of critical importance to it.

If oil revenues were split on a population basis, Scotland would be running an unsustainable fiscal deficit. Scottish public spending cannot be £3000 per household higher than the UK average when Scottish gross value-added is little more than nine-tenths of the UK average.

However, should Scotland succeed in getting a geographic share of UK oil revenues, Scotland’s fiscal position might be barely manageable in the short term, although it would still be one of the weakest in the EU. However, the economy would be highly cyclical and dependent on the price of oil, a variable clearly beyond the control of the Scottish Government. Price volatility and dwindling oil reserves mean the Scottish Government cannot rely on oil revenues for meeting its heavy obligations to pay for pensions, welfare, health and education.

In terms of tax revenue, the loss of Scotland would make little difference to the rest of the UK. Even assuming that all oil revenues were lost to the UK, the UK tax base would fall by only 2%. It is a separated Scotland that would be at risk, first in negotiating a satisfactory share of seabed resources, and secondly in controlling public finances so as to withstand downturns in the highly cyclical oil price.

on September 16 | by

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