Higher North Sea revenues: what impact on Scotland’s independence debate?

Government revenues from North Sea oil and gas production in 2022 are on track to be at their highest level in over a decade. This may give a boost to the campaign for Scottish independence in the short term.

Oil revenues have been a key part of the economic case for independence in Scotland for decades. The discovery of large commercial oil reserves in the Forties Field – 110 miles east of Aberdeen – came just three years after the election of Winnie Ewing, the first MP ever to be elected from the pro-independence Scottish National Party (SNP) in 1967.

Proponents of independence have argued that North Sea revenues strengthen Scotland’s fiscal position and control from Edinburgh would lead to better decision-making. This could include saving for future generations (like in Norway) and support for the transition to renewable energy sources.

Those against argue that an independent Scotland would inherit a weaker budget position than the UK as a whole and that oil revenues are likely to be insufficient to close that deficit.

How have North Sea revenues changed over the years?

Receipts from taxes and royalties on North Sea oil and gas production have fluctuated significantly over the last 50 years. These have followed peaks and troughs in world oil prices, trends in investment, levels of production and changes in the tax regime.

Currently, companies operating in the North Sea pay three different taxes on oil and gas production: including a ring-fenced corporation tax, supplementary charge and petroleum revenue tax (PRT).

Figure 1: North Sea revenues (£ million)

Source: Statistics of government revenues from UK oil and gas production, 2022

Oil and gas revenues peaked in the early 2000s, hitting an all-time high (in cash terms) in 2008/09. But adjusting for inflation, revenues were much higher in the early 1980s, amassing – in today’s prices – nearly £35 billion in 1984/85. To put that in context, total health spending in Scotland last year was around half that, at just over £18 billion.

In recent years, receipts have fallen sharply, driven by falling production and a relatively low oil price. At the same time, changes to the fiscal regime – which determines how revenues are shared between the government and energy firms – have reduced the government’s take on each barrel of oil produced.

These changes were designed to prolong investment in the North Sea as the basin enters its twilight years. Companies can also offset some of their tax liability for decommissioning.

Until recently, revenues from the North Sea were projected to raise less than £1 billion per annum for the foreseeable future (Office for Budget Responsibility, OBR, March 2021 forecast).

But Russia’s war in Ukraine and the spike in global energy prices have sparked a dramatic turnaround. Oil prices increased from $18.38 per barrel in April 2021 to $117.25 in March 2022. Over the same period, gas prices rose from £0.55 per therm to £3.14.

As a result, North See revenues jumped from just £500 million in 2020/21 to £3.2 billion in 2021/22.

In their March 2022 forecast, the OBR projected that North Sea revenues could rise further to £7.8 billion in 2022/23. This is well over ten times higher than pre-pandemic receipts and would be the highest fiscal return from the North Sea since 2010/11.

Others point out that the outturn figure for this year could be even higher (Phillips, 2022). Why? So far, oil and gas prices have exceeded the OBR’s March forecast.

At the same time, the UK government has increased the tax rate on profits from oil and gas production by 25 percentage points (through the energy profits levy or ‘windfall tax’). It is estimated that this alone could raise £5 billion in 2022/23.

How much North Sea activity takes place in Scottish waters?

Under the UK fiscal and regulatory regime, responsibility for North Sea revenues is ‘reserved’ to the UK government, and pooled for the benefit of the UK as a whole.

It is still possible to provide an estimate of ‘Scotland’s share’ of these revenues by measuring how much production, investment and profit are generated in waters that could be described as being ‘Scottish’.

In most statistical publications, the Scottish government uses the definition set out in the Scottish Adjacent Waters Boundary Order (1999), which paved the way for the devolution of marine policy. This is shown in Figure 2.

Figure 2: UK continental shelf and Scottish boundary

Source: Marine Scotland

Over the decades, the majority of North Sea production has taken place in Scottish waters. In 2019, 82% of total production (and 95% of oil production) is estimated to have taken place in the dark blue sector denoted as Scottish waters.

How important are North Sea revenues for Scotland's fiscal position?

Under the current constitutional settlement, there is no one government responsible for all public sector activity in Scotland. Nor is there a set of income and expenditure accounts that track all revenues collected from people in Scotland and money spent.

But each year, the Scottish government publishes a consolidated set of fiscal accounts for Scotland – the Government Expenditure and Revenue Scotland (GERS) report.

It includes both Scottish government and local government spending and tax revenues, but also UK government spending and taxes spent for and raised on behalf of the people of Scotland.

For context, Figures 3 and 4 illustrate the balance of devolved (i.e. Scottish government) versus reserved (i.e. UK government) expenditures and revenues in Scotland.

Figure 3: Devolved and reserved revenues, 2020-21

Figure 3 shows that over 64% of revenues in Scotland are set and collected by the UK government even after significant fiscal devolution through the Scotland Acts of 2012 and 2016.

In contrast, Figure 4 shows the share of expenditure in Scotland that is controlled by the Scottish government. Here we see the opposite picture, with the majority (55%) of public expenditure in Scotland now devolved.

Figure 4: Devolved and reserved expenditure, 2020-21

Each year, the GERS report attracts considerable attention given its relevance for the Scottish independence debate. It is regularly used to argue the case for or against Scottish independence.

It is important to note that they are based upon the current constitutional settlement. But there is widespread recognition that while any such estimates are subject to margins of error and most importantly different choices (depending on the decisions an independent Scotland may take on spending and taxes or the outcome of negotiations with the UK government on any transition and division of assets and liabilities), they remain the best place to start for analysis of what an independent Scotland’s public finances might initially look like.

Figure 5 shows the estimated difference between revenue and expenditure – the net fiscal balance – for Scotland since 1998.

Figure 5: Net fiscal balance: Scotland and UK, 1998/99 to 2021/22

Source: GERS, 2022

As Figure 5 shows, North Sea revenues have important implications for any assessment of Scotland’s notional ‘fiscal deficit’.

First, until the fall in revenues from 2010 onwards (see Figure 1 above), including a geographical share of North Sea revenues significantly improved Scotland’s estimated fiscal position.

Second, in most years, Scotland is estimated to have a weaker position than the UK as a whole – largely driven by higher spending per head – but this relative gap is closed (and even eliminated on occasion) when oil revenues are included.

What might the recent spike in oil revenues mean for the independence debate?

The Scottish government has announced plans to hold a referendum on Scottish independence in 2023 (although this is currently subject to a referral to the UK Supreme Court). As we set out in our series of articles earlier this year, debates over the economics of independence are likely to feature heavily in any prospectus, as they did in the 2014 referendum.

The most recent figures show that Scotland’s estimated budget deficit fell from 22.7% of GDP in 2020/21 to 12.3% of GDP in 2021/22. This is a reduction, relative to GDP, of just over 10 percentage points. The UK’s deficit fell from 14.5% of GDP in 2020/21 to 6.1% of GDP the following year – a reduction of just over 8 percentage points. The key reason for this relatively ‘better’ performance in Scotland was the increase in the value of North Sea oil and gas output and revenues.

Remember that revenues for 2022/23 are expected to be higher still. So, will this be universally good news for Scotland?

Whether Scotland’s fiscal position improves in 2022/23 won’t just depend on what happens to energy prices. Broader economic developments will also play an important role.

For example, in recent months, the UK government has announced a package of financial support for households to help them with rising energy bills, with more measures currently being announced. This will increase spending across the UK, including in Scotland. At the same time, if the economy enters a recession, this will weaken growth in tax revenues more broadly, while higher inflation will feed through to higher debt interest.

The net effects of all of this on the deficit are complex and, at this stage, uncertain. Nevertheless, it is very likely that the different factors affecting the public finances at the current time will be – in relative terms – ‘better’ for Scotland than the UK as a whole.

In short, the key beneficial public finance effects – oil and gas revenues – will be concentrated in Scotland, whereas the costs – such as higher spending or the effects of a recession – are spread across the UK as a whole.

The Institute for Fiscal Studies (IFS) estimates that oil and gas revenues would need to total around £14.5 billion this year for the Scottish implicit deficit to match that of the UK as a whole. They conclude that ‘such a figure is plausible, and may be exceeded’.

This may well change the context of debate around Scottish independence and be more favourable to the ‘Yes’ campaign.

But it is important to note that the long-term trend for oil and gas revenues is for a phased decline. Oil and gas production peaked in 1999 and remaining reserves are now in more challenging and costly areas of the North Sea.

At the same time, governments – including the Scottish government, in which the Green Party holds two ministerial positions – are committed to the transition from fossil fuels to renewable forms of energy, with the objective of reaching net-zero carbon emissions.

Conclusion

North Sea revenues are on track this year to jump to levels not seen in over a decade. Higher oil prices are likely to strengthen Scotland’s relative fiscal position vis-à-vis the UK as a whole, although it is likely that the overall public finances will weaken. Relying upon high oil and gas revenues is unlikely to be a long-term strategy for an independent Scotland’s public finances. Tough choices on tax and spending, and efforts to improve economic growth, will still be needed.

Irrespective of this outlook, Scotland – like many other countries – faces important long-term fiscal challenges associated with an ageing population and rising healthcare spending. Whether constitutional change will make these challenges easier or harder to solve is likely to be a key fault-line in any future debate on Scottish independence.