OVER the past few weeks developments in the world oil market have delivered three hammer blows: one to the North Sea oil industry, one to the SNP’s financial projections and one – altogether more immediate and worrying – to the finances of the UK government.
The oil price has not just dipped, it has swooned – by $32 or 28 per cent to a four-year low from its summer peak of $115. Barring a miraculous turnaround in the price, we face a slump in North Sea capital investment and a contraction across the wider oil services industry. Last week the North Sea oil industry group Oil & Gas UK warned that capital investment in the North Sea could halve by 2017 unless there is urgent reform of the tax regime.
But there are wider ramifications. The fall in the oil price – and in tax revenues – is creating mayhem at the UK Treasury. Officials are scrambling to re-write tax and borrowing projections ahead of the Chancellor’s Autumn Statement, due on 3 December.
All this comes on top of an already worsening budget deficit, with the total for the year so far running well above a year ago. The prospect now? Yet more government borrowing and debt looks in store. Pre-election promises of spending boosts and tax cuts look even less credible. Instead there is a growing likelihood of tax increases – with the return of the fuel duty escalator at the top of the list. The oil price needs only to fall just a few dollars from today’s Brent crude spot price of $82.36 a barrel to $75 to put a tax rise at the petrol pump on the agenda.
How far away and long ago the referendum campaign visions now seem of a high-spending independent Scotland fuelled by buoyant oil revenues. Last week Scottish Secretary Alistair Carmichael cited Treasury analysis showing that the fall in the oil price to $82 a barrel would mean revenues £8.7 billion lower than forecast by the Scottish Government for the three years from 2016 to 2018.
The lowest oil price included in Scottish Government oil revenue forecasts issued in May was $99 a barrel in 2016-17, with most of the SNP administration’s scenarios based on a price of $110. Now it all looks like fairy dust.
Carmichael was less forthcoming about the implications for the coalition and its budget planning. Figures from HM Revenue & Customs show corporation tax revenues from the North Sea have fallen from £4.4bn in 2012-13 to £3.6bn in 2013-14.
These followed on from figures published in June that showed total overall tax revenues from North Sea oil and gas fell from £6.1bn in 2012-13 to £4.7bn in 2013-14. Somehow, from somewhere, George Osborne has to conjure up magic billions from elsewhere for his Autumn Statement to work. His plan to cut the deficit this year already looks unrealistic after another jump in government borrowing in September pushed the deficit 10 per cent higher in the first half of the year. In the first six months of the tax year borrowing totalled £58bn, up £5.4bn on the first half of last year.
Against this background we are heading back into deeply troubled waters for the UK’s finances. The demands for the Scottish Government to be given more borrowing powers add to the sense of a political elite – south and north of the Border – detached from reality.
No-one denies North Sea oil is a fantastic boon, and will continue to be so. But with it comes the risk of basing near-term government spending plans on an asset whose price is so volatile. Opec’s long-range prediction is that oil prices will average $177 a barrel, driven by rising global populations and rapid Asian economic growth. And it may be that Saudi Arabia will tighten supply at the Opec meeting on 27 November. But the near-term price is subject to so many other influences – lower demand in China, Middle East geopolitics, the impact of US shale gas and global growth slowdown – that it is impossible to predict with certainty. Finance ministers – Scots or UK – cannot construct spending budgets based on assumptions of a high and stable price. Now this truth has struck home on the projections of both governments with the force of a demolition ball.
Here in Scotland a lower oil price has coincided with sharp cost increases for the industry, driving down pre-tax returns for the UK sector to their lowest level for four years. Last month Oil & Gas UK submitted evidence to a Treasury consultation pointing to what it called “the deteriorating economics” of the mature UK Continental Shelf.
Such warnings could be brushed aside as self-interested special pleading. But the price has since kept falling, while industry unit costs rose by 26 per cent last year. Oil & Gas UK chief executive Malcolm Webb last week said: “Profitability on the UKCS is insufficient to maintain the uncompetitive high tax rates of 62 – 81 per cent paid by production companies.
“Last year total UKCS expenditure exceeded post-tax revenues; this year it is heading in the same direction. This is not a sustainable situation. Without swift action, capital investment is set to halve by 2017.”
Now come warnings that the UK government might restore the unpopular fuel duty escalator system. Three years ago George Osborne introduced a fuel stabiliser system as oil prices surged above $115 a barrel. He said the escalator – it allows petrol duty to increase by the level of inflation plus 1 penny per litre – could be re-introduced if prices fell below $75 a barrel. As Stephen Glaister, director of the RAC Foundation, warned last week: “Ironically, some of what motorists have gained from falling oil prices could be taken by the Chancellor. If the cost of oil drops just a few more dollars, and Mr Osborne sticks to his 2011 plans, then fuel duty is in line for a 1.7p a litre increase. That is unlikely to go down well with 38 million drivers who have recently had some relief at the pumps.”
Rising government revenues? A shrinking deficit? An independent Scotland with a budget surplus and an oil investment boom? And happy motorists? Not one of these can be guaranteed in the volatile, see-saw world of global oil. «
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