Scotland’s fiscal position: an update in light of the OBR’s March Forecasts

Perhaps unsurprisingly, the OBR downgraded forecasts for North Sea revenues for the next five years in its Economic and Fiscal Outlook published on the 18 March. In part, this reflects the direct impact of the fall in oil prices which have been the subject of much discussion in recent months. But other forecasting changes – like reductions in oil and gas production forecasts –, and the announcement of cuts to tax rates on profits from the North Sea, have also contributed to reductions in forecast revenues. This means, if anything, the reductions in forecast revenue are even more dramatic than was anticipated.

Table 1 shows that the OBR now forecasts North Sea revenues to average around £0.7 billion a year between 2015–16 and 2019–20, rather than the £2.6 billion a year it anticipated just a few months ago. It also shows the contribution of various factors to those forecast changes.

Table 1: Net fiscal balance (% of GDP), UK and Scotland, 2013–14 to 2015–16

Source: OBR March 2015 EFO

On average, over the next 5 years:

• Falls in forecast oil and gas prices have reduced forecast revenues by £1bn a year;
• Falls in forecast production have reduced forecast revenues by £1bn a year;
• Other modelling changes have reduced forecast revenues by about £0.7 billion a year;
• Tax cuts have reduced forecast revenues by about £0.3 billion a year;
• And a fall in forecast (tax deductible) investment and operation expenditure offsets around £1.1 billion of these falls a year.

Last week we published projections for Scotland’s net fiscal balance based on the OBR’s December 2014 forecasts for revenues. How much of a difference do the new forecasts make to these projections? Table 2 shows the original and updated forecasts for both Scotland and the UK as a whole.

Table 2: Net fiscal balance (% of GDP), UK and Scotland, 2013–14 to 2015–16

Source: GERS, 2013–14, OBR December 2014 EFO, OBR March 2015 EFO and author’s calculations.

Under our earlier projections based on the OBR’s December 2014 forecasts, Scotland’s North Sea revenues were projected to fall from around £4.0 billion in 2013–14 to around £1.8 billion in 2015–16. This would have given Scotland a deficit of around 8.0% of GDP in that year. Using the same methodology, the OBR’s March 2015 forecasts imply Scotland’s North Sea revenues will fall to around £0.6 billion in 2015–16. This would mean Scotland’s budget deficit would be 8.6% of GDP in that year.

In contrast, OBR forecasts for the UK as a whole are effectively unchanged – the budget deficit for the UK as a whole is still expected to be 4.0% of GDP in 2015–16, despite the reduction in North Sea revenue forecasts. Scotland’s projected deficit in 2015–16 is now 4.6% of GDP higher than that for the UK as a whole. In cash terms this is equivalent to a gap of £7.6 billion. Unless oil and gas revenues were to rebound, onshore revenues were to grow more quickly than in the rest of the UK, or government spending in Scotland were cut, a similar sized gap would remain in the years ahead.

Why do the forecasting changes affect Scotland and the UK as a whole so differently? There are two reasons.

First, and most importantly, because most North Sea revenues are estimated to come from the Scottish portion of the North Sea (84% in 2013–14), and because the onshore economy and tax-base of Scotland is much smaller than that of the UK as a whole, a fall in this revenue stream has a much larger impact on Scotland’s fiscal position. For instance, the reduction in forecast revenues in 2015–16 is equivalent to around 0.8% of Scottish GDP but only around 0.1% of GDP for the UK as a whole.

Second, is the fact that the fall in oil and gas prices may have a positive impact on the onshore economy (by reducing energy costs, for instance). For the UK as a whole, this positive impact on the onshore economy may be big enough to more than offset the direct impact of lower oil and gas prices on North Sea revenues (A recent report by PWC suggests this is the case). This seems much less likely to be the case for Scotland – which accounts for the majority of the UK’s North Sea output and revenues, but only a small (close to population) share of onshore output and revenues.