Questions about Oil and Gas

by Ken Gibb

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.