Gavin McCrone: Is an oil fund still feasible?

Had an oil fund been set up by the 1980s many of our present economic difficulties could have been avoided. Picture: AFP/Getty

In her article in this newspaper on Monday, Lesley Riddoch referred to “the McCrone Oil Report cover-up of the 1970s” and in the summer Rory Bremer, in his special programme about Scottish politics, referred to the “suppression of the McCrone Report”. I’ve begun to think it’s time I explained myself.

The document in question, which was obtained under Freedom of Information some years ago, was written in the run-up to the spring election of 1974; it is, therefore, ancient history now. It was written as briefing for incoming Scottish ministers, whoever they turned out to be. In the event they were Willie Ross and Bruce Millan. Was it suppressed? No. It was not written for publication. I was Chief Economic Adviser in the Scottish Office at the time and providing confidential briefing for ministers is what civil servants do.

What concerned me then was that the outgoing government, despite considering the matter for months, had failed to put measures in place to ensure that the state obtained an appropriate share of the revenue from North Sea oil once it started to flow. If there was a scandal, it was that this had not been done before the large fourth round of licensing. For this, ministers had been savaged in a report of the Public Accounts Committee. In the absence of such measures, all ministers were able to say in the weeks before the election was that they expected revenue from rent and royalties in the North Sea to amount to around £100 million a year by 1980. Under the rules that then applied, corporation tax could be offset against expenditure elsewhere in the world. The SNP had said that tax revenue of £800m ought to be obtained, but I estimated that, with an appropriate tax system, the revenue in 1980 could be of the order of £1,500m to £3,000m. This was based on published estimates of the expected output of oil. In the event, the revenue in the financial year 1980-81 was actually £3,900m and rose to a peak of £12 billion in 1984-85, but that was after the incoming Labour government had introduced petroleum revenue tax and taken a variety of other measures, such as setting up the British National Oil Corporation, to ensure an adequate revenue for the state. All that was wrong with my forecast was that it was too low.

I wrote a further paper two years later in which, among other things, I argued for a least part of the revenues to be paid into a special oil fund. As Alex Kemp’s The Official History of North Sea Oil and Gas shows, this was considered at length by the Callaghan government, and argued for by Bruce Millan, but they decided that in the exceptionally difficult economic circumstances of the late 1970s, they could not afford it. That was not really surprising, though in my view disappointing.

After the 1979 election, Kemp shows that an oil fund continued to be under consideration in the Treasury, but I am not aware of ministers collectively discussing it. That was when an oil fund should have been set up. The revenues started to become really large from 1980 onwards and at their peak of £12bn in 1984-85 were equivalent to almost £30bn in today’s prices. Failure to invest this money amounted to running down a capital asset to finance current expenditure. In my recent book I describe this as the mishandling of the greatest opportunity for the economy in the last half century. Had it been set aside in a special investment fund, when it was possible to do so, many of our present economic difficulties could have been avoided.

We are most unlikely to see oil revenues of that scale again. North Sea oil output peaked in 1999 at 137 million tonnes (slightly more than the mid- 1980s peak) and in 2011 was down to 57m tonnes. Opinions differ on the scale of future output though it is expected to continue at some level for maybe up to 40 years. The Office for Budget Responsibility forecasts a steady decline; others think output may temporarily rise above present levels before resuming the decline. Tax revenue, however, depends not only on output but on the price of oil in international markets and on the cost of producing it. Prices are impossible to forecast; costs of production are expected to rise as oil has to be harvested from smaller and less accessible fields.

Although it is now late in the day, I remain in favour of establishing an oil fund as soon as it can be done. But despite the recommendation in the recent report of the Government’s Fiscal Commission and John Swinney’s remarks about an independent Scotland setting up such a fund in 2017, I am sceptical that this could or should be done. A Scottish Government paper from the Office of the Chief Economic Adviser, released under Freedom of Information, takes a much more cautious line.

The inconvenient truth is that although Scottish onshore tax revenue is approximately equal to the UK average, public expenditure per head is over £1,000 higher. So tax revenue without the income from the North Sea would not cover present expenditure, if Scotland was relying on its own resources. In order to pay the oil revenues into a special fund, therefore, the onshore revenue and expenditure would need to be brought into balance either with a substantial cut in expenditure on top of the present cuts or by raising onshore taxes. Both of these would be painful. Theoretically, it could be done by improving the performance of the economy so that tax revenue rises. My hope is that eventually that will happen, but it will take time and no-one has convincingly shown how it is to be done.

Mr Swinney and the Fiscal Commission both argue that Scotland’s deficit will fall along with that of the UK as we come out of recession. Hopefully that is true, but even if it came down to 3 per cent of GDP, at which level it would be approximately equal to the growth of output and therefore would not increase the total of debt as a percentage of GDP, that would still be with the oil revenues. To get near to balancing the budget without the oil revenues, so that they can be set aside in a fund, would be very much harder and take longer.

It has been suggested that when it gets to that level the government of an independent Scotland could borrow to finance an oil fund. But as the paper from the Office of the Chief Economic Adviser shows, that could only make sense if the cost of borrowing was significantly less than the return on money invested in the fund. That is very unlikely. Over the years 2000-2011 the Norwegian oil fund has produced a return averaging 4.1 per cent a year, actually slightly less than the 4.4 per cent that the UK has had to pay on ten-year gilt-edged securities. An independent Scotland could expect to pay more because it would be a new borrower with no record on which the markets could base a view.

So while I would like to see an oil fund established, whether or not Scotland becomes independent, I am not holding my breath. The UK government is no more likely to do it than its predecessors. And if Scotland becomes independent, oil revenues could only be set aside for investment either if harsh measures are taken to balance the onshore budget, or if Scotland’s economic growth could be so substantially improved that oil revenues were not needed to balance it. How that might be done is an unanswered question.

• Gavin McCrone’s book Scottish Independence: Weighing Up the Economics was published in August by Birlinn, price £7.99