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This latest CPPR Briefing Note looks at the past and future prospects of the North Sea oil and gas industry and how these prospects affect public finance options for Scotland.

North Sea revenues will be a very important element of the future finances of a Scottish government if there is a shift towards full fiscal autonomy (FFA) or to independence. Both positions are viable but both have significant implications for public spending which have not yet been fully developed. It is essential that prior to any referendum in 2010 this area is better understood.

HEADLINES – NORTH SEA REVENUES

• The Scottish Government’s latest Expenditure and Revenue Statement (GERS) highlights the importance of North Sea tax revenues as a contributor to funding public expenditure. Total tax from the UKCS1 is forecast to reach £9.9 billion for 2008-09, something achieved only twice since 1985-86.

• This level of revenue is based on the Treasury’s oil price assumption of $84 per barrel (£42 per barrel), 34% lower than the average price already achieved in 2008 of around $112 per barrel (£57 per barrel).

• To inform the current debates on greater fiscal powers for Scotland, the potential independence referendum in 2010 and the possible size and shape of any proposed future Oil Fund, greater clarity is required on what is the
potential size of Scotland’s share of North Sea tax revenues. Kemp & Stephen estimate Scotland’s geographical share was between 82% and 84% during the period 2002 and 2006 and is anticipated to rise to between 88% and 90% between 2007 and 2013.

• Even as oil prices continued to rise, in both dollars and sterling terms, total North Sea revenues fell back in 2006-07 to £9.1 billion from £9.7 billion in 2005-06. This illustrates the importance of both rising and high sterling oil prices in helping to maintain North Sea tax revenues as production continues its downward path.

• Applying its entire geographical share of North Sea tax revenues in recent years would greatly reduces Scotland’s overall fiscal deficit, but it does not eliminate it. Assuming Scotland’s public sector net fiscal balance is reasonably accurate, rising North Sea tax revenues are also required to help support Scotland’s public finances. However, these revenues can be highly variable in nature and so difficult to predict.

• This poses problems for any Government seeking to plan a public sector expenditure programme. Alternatively, it may be desirable for Scotland’s share of North Sea tax to be used to develop an Oil Fund, in order to support expenditures that can be varied as the Fund varies. However, used in this way greater clarity on how any fiscal deficit is to be funded is required.

• Although the North Sea as a source of tax revenues is growing in importance, it is incumbent on those seeking to utilise them more directly to explain what their contribution in the future is likely to be, how the associated uncertainty can be accommodated in any budget proposals and how any related Oil Fund is expected to be funded given Scotland’s current fiscal position.

HEADLINES – NORTH SEA REVENUE FACTORS

• Forecasts for Scotland’s share of North Sea tax revenues in the future will be based not only on the future level of oil and gas prices but also on the level and timing of capital and operating costs, production rates, tax rates as well as the
geographical location of reserves. Given the relatively high degree of uncertainty surrounding a number of these factors, tax revenues arising from the North Sea are equally likely to be uncertain. Future public spending predicated on Scotland’s North Sea tax revenues would therefore require very careful planning.

• Capital cost efficiencies in the UKCS are falling and the operating cost per unit of production is rising as the more difficult to reach oil and gas in targeted. So, although oil prices are high, higher gross revenues are now required to encourage continued development of existing as well as new production.

• North Sea oil and gas production have both peaked; 1999 in the case of oil and 2000 for gas. Since then output has fallen 44% and 27% respectively. Gas now accounts for over 45% of the total hydrocarbons produced (on a barrel of oil equivalent basis) in the North Sea. Forecasts for oil and gas production are for continued decline. BERR forecasts oil production to fall by between 2.5% and 8% per annum between 2007 and 2013 and gas by between 2.5% to 9% per
annum. Kemp and Stephen forecast slightly lower rates of decline; 2.5% per annum for oil and 5.8% per annum for gas. The IEA’s most recent report suggests oil production will fall over 10% alone between 2007 and 2008.

Recommendations and Next Steps

The Scottish Government should seek to:

• Expand the Kemp and Stephens work to identify what future North Sea tax revenues might accrue to Scotland over time and over a range of oil and gas prices, provide an assessment of how variable they are likely to be and finally produce a ready-reckoner to evaluate the revenue effects caused by changes in key Kemp & Stephen model assumptions.

• Provide greater detail on what possible options there are for a Scottish Oil Fund including, inter alia, the timing of its development and for what such a fund might be used.

• Provide more detail on how Scotland’s fiscal deficit might be brought more into balance in the event of some of the North Sea tax revenues are utilised by an Oil Fund.

Report authors comments

Jo Armstrong, main author of the report, highlighted that “Today’s report highlights some of the crucial questions that hang over the role of the North Sea in Scotland’s future finances. While it helps clarify some of the picture, large gaps in our knowledge remain and need to be filled in over the next 2 years.”

John McLaren, said “While the prospects for North Sea oil and gas tax revenues will always be uncertain, there are important public finance issues where greater clarity from Scotland’s political parties would help voters better understand future options.”

Director of CPPR Richard Harris commented that “CPPR is determined to make every effort to open up the debate on Scotland’s economic and public finances options under full independence or full fiscal autonomy prior to any referendum. To this end today’s report is another vital step forward to enhancing our knowledge. We welcome any feedback on this publication.”

The full report is available on the CPPR website: http://www.cppr.ac.uk/media/media_86366_en.pdf.

Contacts:
Jo Armstrong – 07740 440766
John McLaren – 07851 426498
Richard Harris – (contact via CPPR)
http://www.cppr.ac.uk

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First published: 7 August 2008