Questions about Oil and Gas

I have a new role at work involving the editing of research briefings written by my colleagues John McLaren and Jo Armstrong at the Centre for Public Policy for Regions. For the time being my role is limited but I am looking forward to working with them closely on new briefing papers and research projects in the future.

Their new paper is called ‘Analysis of Scotland’s Past and Future Fiscal Position’ (1) and takes up the fascinating and important debate about future oil and gas tax revenues and their potential impact on the fiscal balance in Scotland. Read the briefing paper – it is an important contribution.

The economics of oil and gas breaks new ground for me. The issue is fundamentally whether the sector’s tax revenues can make an important difference fiscally and whether they can constitute a separate cumulative ‘oil fund’ following the Norwegian example. There are also two related arguments – one is whether a non-oil or mainland fiscal balance can be achieved (thus allowing the growth in the fund to consolidate) and perhaps most importantly, understanding the uncertainties inherent in predicting future tax revenues.

This latter controversy has been stoked by work published in the Scottish Government’s recent Oil and Gas Analytical Bulletin. This includes a range of scenarios for the future, all of which predict higher revenues (some considerably higher) than those associated with a recent OBR ‘official’ forecast. Higher revenues are clearly important to the future Scottish economy and could make important in-roads into the deficit.

What the new briefing paper by John and Jo does so well is that it identifies the key areas of uncertainty that make oil tax revenue prediction so hazardous, whoever is making the prediction.

In a context of long-term falling production followed by bottoming-out of output, but recent higher levels of new investment, what are the critical unknowns?

• Most analysis assumes we are dealing with the geographical share of oil and gas going to Scotland, rather than the population share. This notional split is critical to the revenues raised because the geographical share yields 94% to Scotland, while the population share only returns 8.4%. Most people including analysts assume that the geographical share will prevail – but it will be a subject for negotiation, even if indirectly, in the negotiations, following a ‘yes’ in the referendum.
• We do not know what future critical exchange rates will be (£/$).
• We do not know what future oil and gas prices will be (and what will happen to underlying fundamental drivers in the global marketplace).
• We do not know how new investment and production cost efficiencies will translate into profitability and hence final output.
• Even with high prices and production levels, tax revenues are less than they might be expected to be, as a result of the level of tax expenditures incentivising investment and helping to advance decommissioning of older oil fields.

The combination of these uncertainties makes it highly challenging to try to come up with robust forecasts for prices, production and tax revenue. Take all the scenarios and estimates with a pinch of salt, and, as the authors suggest, look for fan charts, cautious central estimates and sensitivity analysis around the edges.

1. http://www.gla.ac.uk/schools/socialpolitical/cppr/currentpublications/#d.en.67114

A Housing Budget

It would be premature to judge a Budget before the smoke clears and the technical papers have been properly assessed. Nonetheless, the housing sector is coming to terms with a series of major housing and mortgage interventions aimed at stimulating the market (owned and rented), promoting housebuilding, mortgage lending and more affordable supply. There is, it would also be fair to say, a degree of controversy amidst the welcome focus on housing.

What has been announced?

• The Help to Buy scheme provides an equity loan to facilitate home-buyers (and not just first time buyers) purchase a 95% loan to value mortgage on a new build home via a 20% interest free equity loan. This is a temporary measure supposed to operate for three years only.
• The mortgage guarantee scheme is a commercially priced government scheme that guarantees a portion of default losses should participating high loan to value loans fail. This runs for the first seven years of the loan and is for all buyers and extends to existing homes as well as new ones. It can also apply to re-mortgaging. The scheme is also temporary and will only operate for the next three years.
• The Government is also expanding the affordable homes guarantee scheme to generate a further 15,000 homes in England.
• As was much trailed, there will be more support for the RTB in England, shortening the qualifying period to three years and extending the maximum discount in London to £100,000.
• A commitment to introduce the ‘pay to stay’ market rents scheme for high income social tenants
• A big increase in the market renting build to rent scheme.

There is much discussion of these initiatives and rather than repeat what I have already read and agree with (e.g. lets see the details, watch out for inflationary market effects and other worries about 95% loans) – I would make a number of different points.

First of all, the enhancement of the RTB is just ideology unbound. It is an unnecessary diversion of resources. And it is unlikely to be able to generate one for one matching for new social housing from capital receipts. But then it is not really about housing, is it?

I also struggle with that other attention-grabbing social policy: the notion of high-income social tenants paying market rents. In many respects it is a classic austerity government policy of its time. Outside of Greater London are there that many social tenants who earn £60,000 or more? Is it good value for money when one considers the cost of setting it up and running it? Might not income ceilings for entrants be simpler and more reasonable (particularly in high demand areas)?

Second, following past criticism, buy to let is to be excluded from the new mortgage market initiatives but not, strangely remortgaging. Helping people secure a better mortgage deal is not a bad thing but to what extent will it divert scarce resources away from house movers and first time buyers?

Third, it would not be Budget day without a political spat between Westminster and Holyrood.  This time the Scottish Government is outraged that the apparent net boost in spending to Scotland (a cut in current spending outweighed by increase in capital) may not be what it first appears because much of the capital element turns out to be part of the UK equity loans mortgage initiative and in effect repayable loans. These do mean more resources for Scotland but not more funds for the Parliament to use with discretion (i.e. it is not devolved). This story is live as I write and we will see how it develops in the next few hours and days.

Finally, it looks like Government is getting into the indemnity insurance market based on the new mortgage guarantee proposal. This is a form of co-insurance which looks incredibly like the old mortgage indemnity guarantees. It is odd how things turn full circle. It was the Major Government who cut ISMI and promoted the creation of a market in mortgage payment protection insurance. Now, the Cameron Government is effectively standing in for a (failed) market in indemnity guarantees. Will the State do better than private provision of MIGs? It will also be interesting to see whether the commercial fees involved are passed on to borrowers (as they were in the 1980s)? As a temporary provision only the obvious question arises as to whether the State could facilitate a market solution for co-insurance indemnities in the longer term?

Constitutional Niceties

In the week when we will find out the precise date of the independence referendum I wanted to air a couple of constitutional niceties that don’t seem to get much coverage. I am by no means a lawyer, nor do I not think of myself as being particularly a traditionalist. I do however think there is something wrong or at least inconsistent in two of our recent constitutional reforms affecting Scotland – in at least how the State has gone about making those changes. The two cases in point are: Scottish tax-raising powers and the proposal to allow 16-17 year olds to vote in the referendum (and tacitly accepted by both UK and Scottish Governments).

The 2012 Scotland Act that emerged from the ‘unionist’ parties (and originally the Calman Commission) did some good things, for instance, (a) providing some additional tax devolution of new taxes such as the replacement of Stamp Duty Land Tax with what will be a Scottish Land and Buildings Transaction Tax; and, (b) opening the door for the Scottish Government to borrow for capital purposes (though limited as a share of annual budgets and subject to Treasury controls).

However, I always thought that the decision to devolve a large chunk of income tax collection and widen the devolved income tax raising powers, while fine in substance, was something of a constitutional anomaly.  It is true that the old 3p tax varying powers were in all probability redundant. During the 2007-11 Minority Government, John Swinney admitted to the Scottish Parliament that he had let lapse the 1997 referendum powers for the Scottish Parliament to vary income tax by 3p in the pound (these powers were never used though the SNP had briefly considered using the 3p in the pound a some kind of national substitute to replace the council tax – though wisely quickly dropped the idea).

The new system enacted by the 2012 Act will work as follows: the HMRC-levied UK income tax rate in Scotland would be reduced by 10p in the £ at each income tax rate and the new Scottish rate will be added to the now lower UK income tax rate. The Scottish Parliament will be able to choose to levy the same UK overall rate (i.e. by levying the rate at 10%) or could choose to increase it or reduce it, with consequent effects on public finances and (allegedly) economic behavior.

My point is that there seems to be a fundamental asymmetry here. The original tax varying power was created by a referendum and therefore would appear to possess a superior constitutional weight or authority relative to normal legislation. But it was in 2012, nonetheless, swept away by Westminster legislation that gave Scotland the new powers identified above. The Welsh voted against tax-raising powers in 1997 but of course are now considering greater powers for their Assembly. How should decisions on their constitutional position over fiscal powers be determined? Enshrining a constitutional power by dint of a referendum and then replacing it  (with different powers) by parliamentary legislative process – does seem at the very least to be inconsistent.

Turning to the voting age – I have no problem with 16 and 17 year olds voting but I do think it is a major constitutional electoral reform and to pilot it as part of a critical referendum on the constitution prior to any learned commission or substantial debate about the issue seems like fairly opportunistic deal-making and establishes precedent with no prior way to test the idea (e.g. in local or European elections). How committed are UK politicians to 16-17 year olds voting in all elections in the future?  It is a strange way to modernize constitutions.

Don’t we need a proper consistent basis for determining how we change constitutional practice? We may or may not need a written constitution (an issue for the status quo, a more federal UK or for an independent Scotland) but surely prior to that debate we need a consistent way of settling how substantive changes to constitutional relationships are to be done, taking account of the basis of previous decisions? Reading the London press you would think this was a purely UK-EU debate but it applies a little closer to home too.

A Scottish Affordable Homes Programme?

Speaking at the CIH Conference in Glasgow, the Scottish housing minister, Margaret Burgess, was reported to be considering a form of Scottish Affordable Homes Programme (AHP) for the post-2015 period. One can speculate the extent to which this is simply floating different ideas to see how they are received. Or, it may actually be something at a more advanced stage of development. It is certainly the continuation of the longstanding search for new ways to provide more non-market housing with less public funds (and still constrained private finance).

Most of the attention on the speech focused on the welcome initiative by the Government to set up a sector-wide working group to discuss in broader terms options for more housing supply – including the Scottish AHP. It will also explore closely related core elements of non-market housing models, namely, affordable rents, financial capacity and subsidy rates.

This is all to the good – but I remain intrigued by the possibility of a Scottish AHP. It is worth doing the thought experiment. First, what are its key features in England?

• Much lower grant per unit (of the order of £22,000).
• Reliance on ‘sweated equity’ – essentially drawing on the balance sheet growth housing associations enjoyed prior to the Global Financial Crisis.
• Rents on new build in the programme are set at up to 80% of the Local Housing Allowance, depending on the depth of affordability problems i.e. councils in London have demanded rents at often levels closer to 65% (if they are willing to participate in the first place).
• Local deals were often premised on utilising section 106 planning agreements – which have of course now been significantly undermined by subsequent policy changes to encourage market supply.
• Additionally, participating providers can provide cross-subsidy by reletting vacant properties at higher AHP rents. Steve Wilcox estimated that to square the AHP finance circle, about three properties need to be relet on average for each new AHP unit. Among other things, this drives the proverbial coach and horses through the previous decade’s social sector rent restructuring.

There is much critical scrutiny of the English AHP. Good (sceptical) overviews are to be found in the relevant 2012 reports by the House of Commons Public Accounts committee and the DCLG select committee.

The English model raises big questions for Scotland. Do we have sufficient housing association financial capacity (and sweated equity at that) to make much lower grant rates worthwhile – and is that the best use of that capacity? What would this mean for the composition of development in terms of the providers who could work on this basis? Would AHP not create yet another niche in an already crowded social-affordable housing landscape? How acceptable would the sector find the new build rent levels and what about revenue subsidy based on higher rents for relet property? Would councils support the scheme through the use of Section 75 agreements (or might it vary across the country, as was the experience in England)? The English system will deliver large volumes – can that be achieved in Scotland and just what scale is involved? Both the Innovation Fund and Round 1 of the National Housing Trust each produced a little more than 600 units. Is that what we are talking about, or, like in England, is the wholesale replacement of the main housing association programme being contemplated?

Whether or not AHP is indeed part of this forward look, the new working group will have its work cut out. I wish them well and insofar as they are looking at AHP I hope they draw fully on the evidence from the experience in England.

Revolving funds that could ease Logjams

There are several financing problems facing developing housing associations in the current environment. Most importantly, they often confront difficult borrowing terms and conditions at precisely a time when capital grant (e.g. in Scotland) has been reduced in size significantly and also re-profiled to making grant payments, typically, at the end of the project. This way of working means that housing associations have to manage the development finance and site acquisition aspects of building homes out of their own pockets and this risk can, at the margin, seriously inhibit new supply. 

There may be organic or bottom-up ways to reduce this logjam. Research for the Joseph Rowntree Foundation [1] suggests that where there is an environment that promotes collaboration and solidarity (a term widely used in Europe), it may be possible for associations collectively to find solutions.  While it is true that many of the larger associations are to be found more at the contestable or competitive end of the spectrum (another emerging theme of the research), this need not be the case with community-based or other well-defined specialist social purpose organisations.

We looked at a surplus fund run by Danish housing associations (the Building Fund). This is a national policy that has been in place since the 1960s with individual contributions based on a proportion of surpluses and used to help pool rents, later to fund improvements and ultimately to subsidise new build.  This later use was its undoing because the Danish government simply reduced their contributions thereby cancelling out net extra funding to social new build.

The point is that a trust run by, for example, community-based housing associations could build up a revolving fund based on an agreed levy on surpluses, which could in turn be used to meet the upfront costs of developments. This spending would be recycled back into the fund when grant payments are made on the development.  This may only be a small-scale initiative but could provide the initial funds to be ultimately self-sustaining. Tony O’Sullivan has written about similar revolving fund models in the Highlands providing land for social housing. [2]

The main hurdle concerns the politics of housing association reserves and surpluses. It is well known that there are tensions concerning the space housing associations operate in between public and private sectors. They receive public grants, they are regulated by state agencies and enjoy relatively favourable credit ratings (despite recent events) but they are legally independent, often charitable bodies. Consequently, there is much dispute over claims on their reserves or surpluses, even after we get past the proportion of those surpluses and reserves that are designated or reserved to meet future obligations.

However, in evidence from the Glasgow and West of Scotland housing associations to the Scottish Parliament [3], it emerged that community-based associations are willing to discuss voluntary proposals to use free surpluses creatively for common objectives, especially (by extrapolation) where they can retain governance control over the uses of the trust’s fund and it is for obvious community social purposes.

This will not change the world but nonetheless a modest collectivist approach through a locally controlled trust could help to unlock development finance problems in places like Glasgow.  Should the financial constraints ease in the future, there would be many other potential community uses of such a model.

1. Gibb. K, Maclennan, D and Stephens, M (2013) Innovative Financing of Affordable Housing: International and UK Perspectives. Joseph Rowntree Foundation: York. Published March 2013 by the Policy Press.
2. O’Sullivan, A (editor) (2010)Affordable housing in Scotland: A Radical Rethink Volume 2. Chartered Institute of Housing Scotland: Edinburgh.
3. http://www.scottish.parliament.uk/parliamentarybusiness/CurrentCommittees/57606.aspx

London Calling (Is Anyone Listening?)

Rising waiting lists and estimates of housing need tell us clearly and consistently that more non-market housing supply is urgently needed. Adding to our number of homes is, however, often confounded by a trinity of problems: a much reduced subsidy-funded programme and accompanying lower subsidy rates; rents at the wrong level (too high for tenants and too low for investors) and, of course, housing benefit reform.

Nowhere is the problem more pronounced than in London. In the year to end March 2012, Greater London built more than 16,000 non-market units. Despite this achievement, private rents and house prices remain much higher than anywhere else in the country. Waiting lists are high and rising (more than 366,000 in 2011), unmet need worsens (homelessness acceptances grew by 27% in 2011-12 alone) and the 2011 Census suggests population is rising strongly. Indeed, the overall picture is an imbalance of more households than homes.[1] Despite major efforts across the sector, the problem is likely to get worse.

Yesterday morning I spoke at a housing sector seminar run by Future of London and the Joseph Rowntree Foundation. Ostensibly, my focus was on reviewing international and cross-UK innovative financing models of affordable supply. However, I came away with a number of broader messages about the plight of housing in London.

First, there is controversy about the desirable composition of new supply between market, intermediate and social housing. The growing net deficit may suggest a case for prioritising the injection of more market housing across London and more intensive use of the large social housing stock (24%). This would focus on more need-based allocation of vacancies for social housing and wider use of income ceilings for affordable housing. This can be done and would help on several fronts but it is not a particularly attractive prospectus for the poorest in need in the capital.

Second, I think there is an important distinction to be made here between stocks and flows. The stock of London’s social housing is large but the key question is what dent will relets make in waiting lists? Will this be as effective as new social supply?  Relying to a greater extent on vacancies in a system characterized by chronic excess demand sounds like a slow way to eat into the problem, even if it does switch to a more priority-based allocation.

Third, fingers were pointed at features of the planning system constraining housing supply.  In part, this was about the perceived failure of S106 agreements to deliver more non-market housing. More basically, it represents a private sector sense that the planning function has not delivered enough new sites for development. There was also a view that supply is concentrated in certain parts of London in a way inconsistent with the actual geography of need (which is more dispersed).

Fourth, many commented on (or lamented) the long-term shift from supply-side to demand-side subsidy for non-market housing and highlighted the latter’s exposure to risk in the form of austerity or ideology-driven welfare benefit cuts.  One delegate made an interesting contribution comparing the reliance on demand-side subsidy to PFI – low public capital outlay initially but considerable risk in the form of long term on-going revenue costs. Will the current housing model turn out to be as bad a bet?

Many of these points share a common strand: inconsistency in policy and action locally. This is true of the supply mix, the often ‘incomprehensible’ rent variations facing tenants making choices (as one person said), allocation systems, and S106 practice  – to name four. Can London’s leaders build a more consistent system from the bottom-up but still reflect local variety of preferences and encourage local experimentation and innovation?

Politicians and practitioners are understandably focused on delivering their current affordable supply targets for London. But we should not let it obscure the long-term requirement to tackle the housing pressures documented earlier.

Nor is this just a matter for London. The capital’s housing sector performs an integral role in the world city’s economy and it matters hugely to the rest of the country, and not just adjacent regions. We can’t afford to either let housing dysfunction continue in London or to imagine that all points North are somehow unconnected and independent – they are not.

1. All figures from: Ben Harrison, Joanna Wilson and Jennifer Johnson, Future of London (March 2013) Changes to Affordable Housing in London and Implications for Delivery. Joseph Rowntree Foundation: York (www.jrf.org.uk)