IF YOU think fracking is getting bad press, spare a thought for frittering. It’s having a torrid time.
Frittering is back as the great “no-no” of Scottish politics as the latest figures from North Sea Oil and Gas UK have re-ignited public debate about what to do with future revenues.
The sector is set to invest £13.5 billion on future extraction this year. And with between 15 billion and 24 billion barrels of oil equivalent (boe) still left to be extracted it’s not unreasonable to ask what we intend to do with the proceeds.
The SNP is clear: “frittering away” should not be an option. The UK government, it says, has frittered away some £300 billion in North Sea oil production taxes since the 1970s and has nothing to show for it. The critique is far from confined to the SNP, but shared by many as they ruefully survey the lack of any evident permanent legacy or landmark achievement from all the oil revenue received thus far.
Senior SNP spokespeople continue to urge the formation of a North Sea fund, similar in purpose if not in scale to that built up by our Norwegian neighbours. At $760bn (£488bn) it’s the biggest sovereign wealth fund in the world. See what you get when you don’t fritter.
Future UK revenues, of course, will not be as gushing as in the past. Production has fallen from its 1999 peak of more than 4 million boe per day to just 1.5 million last year. Oil and Gas UK is expecting that to fall by at least a further 8.5 per cent to between 1.2 million and 1.4 million boe for this year and continuing into next year.
As for tax revenues, the remaining oil is more difficult and more expensive to extract. Ever more sophisticated technology is needed – all tax deductible spending. Safety protocols have been tightened. And then there are de-commissioning costs – also deductible against tax. Even so, future revenues will still be substantial, fuelling calls for a sovereign wealth fund.
But the “frittering” critique is naïve, hypocritical and unfair. It is blind to the huge and relentless political pressures on all manner of urgent health and welfare needs and social improvement. And it is an indiscriminate judgment on the central mission of post-war governments to provide basic standards of education, health, welfare and social care.
UK public spending has risen from £63.6bn in 1976-77 (when North Sea oil production began to build) to £719bn today. Back in 1975 we were spending £5.3bn or 4.9 per cent of GDP on health. Today that figure is £124bn or 7.8 per cent of GDP. Education spending, though it has multiplied to £87bn, has held reasonably steady as a share of GDP (5.5 per cent) while spending on welfare including pensions has shot from 9.3 per cent of GDP to 15.4 per cent.
Sustaining all this in recent years in the face of the worst peace-time financial crisis since the 1930s has also required a huge increase in borrowing and in debt. Government debt has exploded from £46.4bn or 44 per cent of GDP in 1975 to £1.3 trillion or 90.7 per cent of GDP today.
The truth is that North Sea oil revenues have enabled governments to cushion the impact of recessions, finance a continuous increase in health and social welfare spending, scrap distorting subsidies (mortgage interest tax relief) while reducing the top rate of tax from 60 per cent to 40 per cent.
Put bluntly, we have needed those North Sea oil revenues to keep our welfare, health and pensions systems on the road. Any notion of cuts in these areas is a political no-no. As for current reforms to the welfare system – loudly opposed at almost every turn – these will only slow the rate at which such spending is rising.
Removing North Sea oil tax revenues into a long-term oil fund would mean commensurately less available for the social goods that all governments including the SNP have been keen to sustain. So how about putting the proceeds towards debt reduction? It would surely be the decent thing to reduce the debt burden on our children and grandchildren. But this would truly struggle against the relentless pressure to maintain public spending at current levels.
Nevertheless, the Norway example continues to draw envious glances. It has grown to a vast reserve fund while the UK wallows in debt. As John Stepek points out in Money Morning, the first big lesson is that “if you want to have a decent pot to retire on, you have to forgo some consumption today. You have to save”.
Contrary to private pension fund allocation in Britain, where regulators have cajoled the industry to sink massive amounts in bonds, the Norway fund has just 35 per cent in bonds, with 60 per cent in equities and just 5 per cent in property. It has automatic balancers so that a pronounced rise in any one asset class is corrected with a reallocation to other areas. Its preference for low cost and simplicity has resulted in no holdings in hedge funds, private equity, or even infrastructure investments. Yet since 1998 it has managed to make a real return (after inflation) of more than 2 per cent a year. How fortunate it is not in the Eurozone, where it would be raided to fund country bail-outs.
It would be tempting to think that the fund today is following conventional wisdom and investing heavily in “shovel ready” infrastructure projects to help the economy fend off the European slowdown. But an interesting feature caught Stepek’s eye. Norway now holds around 10 per cent of its stocks in emerging market countries – and aims to double that to 20 per cent, just when this area has fallen out of fashion.
A Scottish oil fund ignoring government strictures to finance infrastructure projects and investing instead in Asia Pacific would soon come under ferocious political pressure to “invest” at home.
But even before then, looking at the demographic pressures building up – especially acute on pension funding and healthcare – I suspect another outcome looks likely: an altogether more realistic view about “frittering”.