Scottish independence: 'A tilt to the upside'

The issue of gas an oil is at the heart of the independence debate

As all investors should know, asset valuations can go down as well as up.

On Monday, Alex Salmond was reminding his critics that the opposite is also true.

Yes, oil and gas tax revenue is a volatile basis on which to base your budgets. But it isn't just volatile to the downside.

The First Minister was setting out his government's assessment of what an independent Scotland might expect to make out of oil and gas.

He was starting a new week, after one in which an unhelpfully candid ministerial look at Scotland's public spending profile was leaked.

That was on the same day that falling oil revenue projections left Scottish independence plans with a relatively small deficit now, but a problem emerging in the future.

The soberly-titled Oil and Gas Analytical Bulletin was an attempt to get back on the front foot.

If, as his critics claim, it was conjured out of thin air as a response to last week's events, then some of the first minister's team are not bad at magic.

It seemed more substantial than that. This had the look of a document that was on the way at some point this year, though it may have been brought forward to respond to political pressure.

It also reflects the fact that Alex Salmond is an oil economist to trade. If he ever appears on Mastermind, this is a likely specialist subject.

He likes to keep some practice in. So this counter-attack was well rooted in independent advice and evidence, even if it was very light on showing its workings.

An element of the bulletin was dedicated to underlining the size of Scotland's oil and gas reserves as a share of the European Union total.

Would rising values in oil and gas add to public coffers in an independent Scotland?

For the record, it's reckoned Scotland has 57% of the EU's oil reserves, ahead of Italy on 10%.

It's less clear about gas, but Scotland may have the second biggest reserves after the Netherlands.

It's hard to see that this comparison has any relevance to anything much, except perhaps to make a political point about the attractiveness to the rest of the EU of having Scotland as one of the club.

That's a point that's been repeatedly made, though it's not clear why it should be so persuasive to other EU members. The club is, after all, about trading much more than it's about resources.

Unduly pessimistic

Of much more significance is the assessment of where oil prices, production and tax revenues may be going, taking the period from 2012 to 2018.

The Scottish government was taking issue with the Office of Budget Responsibility, claiming that its advice to the UK government is unduly pessimistic about the industry.

If so, that is probably because the OBR has been influenced by recent trends in production. It has fallen much faster than expected over the past two years, and the OBR has extrapolated from that.

It may be paying less attention than the Scottish government to the announcements by the industry of recent big investment and of investment intentions.

They point to, at least, a halt in the falling rate of production, and perhaps a significant increase.

Liquid markets

On the oil price, the OBR uses the futures market as a guide, pointing to a fall from more than $110 per barrel (it's been unusually steady for a couple of years) to around $92 in 2017-18.

The Scottish government view is that the futures market is insufficiently liquid to provide a clear-sighted view towards the end of this decade.

In other words, there aren't enough players or funds in the market to set meaningful price signals. If there were, they wouldn't only be reading Mr Salmond's latest bulletin.

They might also be reading documents from the International Monetary Fund, the US Energy Department, the OECD (the richer country's economic club) or from the UK Department of Energy and Climate Change (DECC), with its Fossil Fuel Price Projections.

Mr Salmond's people have been scouring them. And they mostly point in one direction - what the IMF calls "a tilt to the upside".

DECC suggests a price per barrel of between $93 and $151 by 2020, with its central forecast at $123.

'Unlikely to be smooth'

Probably the most dramatic outlook is the OECD, which started this month asking the question; will the oil price start rising again?

The answer from the Paris-based economists is an emphatic "oui".

It foresees an end to the downturn, along with emerging economies picking up the pace, returning global demand to slightly below its growth rate leading into the 2008 crisis.

With growth, demand for energy continues to rise. The OECD does not foresee supply keeping up, even if it surpassed its discovery rate in the past decade, and that's despite the evidence of America's shale oil boom.

It makes assumptions about how fast people cut consumption as prices rise, and about people shifting their energy use away from oil and gas.

Then, economists crunch through the algebra. (Try it for yourself, on page 12, and good luck.)

The conclusion: by 2020, it's calculated that oil prices are heading for at least $150 per barrel and up to $270. It's central scenario planning points to $190.

That's a rise of 7% per year, though not in a straight line. "The expected rise in the oil price is unlikely to be smooth," it points out.

"Sudden changes in the supply or demand of oil can have very large effects on the price in the short run."

If that's any guide, it makes the Scottish government's assumptions - that the oil price will stick around $113, without allowing for inflation - look rather conservative.

And that seems to be exactly the way it wants to look if these claims of increased revenue are to have political traction.

Mind the spending gap

What, then, if you take the mid-range figures from St Andrew's House?

It concludes that Scotland could have a total of £48bn more tax revenue over six years to 2018, compared with the OBR projection of £31bn.

That gives you an idea of the scale of difference. But what effect would it have on the public finances?

If you apply this week's Scottish government figures to the most recent assessment from the Centre for Public Policy for Regions, and assume that spending plans stay as they are, you find that the next few years would see fiscal deficits shrink at a gathering pace.

At £9.8bn and £8.6bn, the deficits over this year and next year would remain bigger than the most recent one, for 2011-12, which was published last week.

That's partly because the pattern of increased production is not going to feed through until the later of the six years covered in the bulletin.

By 2015-16, the deficit would be down from a current OBR-based projection of £9.5bn to one of £6.1bn.

The following year, it would fall from 7.7bn to £3.5bn, and the 2017-18 year would fall from £6.6bn to £1.5bn.

That would be a big improvement in the fiscal picture, at around 1% of gross domestic product. But note that it's still a deficit.

Fuel poverty

Two other factors worth mentioning - one is that the huge investments going into offshore developments are partly because of confidence in the sector, but also because extraction is very expensive.

And if costs continue to rise as they have been doing, then that is an issue that could constrain this boom.

Finally, those who delight in the idea of a soaring oil price filling the coffers of an independent Scottish government - or any government, for that matter - might wish to consider what an oil price above $150 per barrel might do for the rest of the economy.

Even if it created a surplus, consider the political pressure to use that for cuts to road fuel duty; on the impact of reduced activity and jobs in energy-intensive industries; or in mitigating the effects of fuel poverty?