Oily Evasion

One of the regrettable developments of the 21st century is that you can’t read any authoritative brief on fiscal matters without stumbling over acronyms for bodies you’ve never even heard of. Two such are the OBR (Office of Budget Responsibility) and the CPPR (Centre for Public Policy for the Regions). Both have recent provenance and are at pains to claim strict political neutrality. They need to: decisions on your future will be argued, based on their figures. To date, their track record’s not good.

OBR was created in 2010 to provide independent and authoritative analysis of the UK’s public finances. It’s £2m budget (mostly wages) is run by Robert Chote who pulls down a cool £142k for that job. They produce forecasts for the economy and public finances, judge progress towards the Government’s fiscal targets, assess the long-term sustainability of the public finances and scrutinise the Treasury’s costing of Budget measures.

It publishes a variety of papers, the one of most interest to us today is their Economic and Fiscal Outlook, last published on 29th November 2011 but updated in March 2012. Underlying that paper were two earlier papers on 24th January 2011 providing Forecast of Oil & Gas Expenditure to 2016/17 and Long-Term Oil & Gas Projection to 2040/41. There is another paper on Scottish Tax Forecast that came out in March and you’d think would be relevant but, as it excludes oil, it’s hardly representative of the real Scottish economy.

CPPR is an academic research centre located in Glasgow University’s College of Social Sciences. The CPPR Director is Professor Richard Harris, a full-time member of staff in the Business School who holds the Cairncross Chair of Economics. Since its inception in 2005, it has published 29 Working Papers and 23 Discussion Papers and undoubtedly contributed to the debate. It published its most recent Pre-Budget Briefing on 12th September.

So far so neutral—but an alert independence cat found a flock of unionist pigeons hiding amongst OBR’s revised estimates for oil and gas published in the March 2012 revision above, processed through the CPPR and finally reported in the Herald on 13th July this year. In this revision, the OBR observe:

“The futures market suggests that oil prices will remain higher throughout the forecast period than we assumed in November, but that they will fall back more quickly than expected previously to $95 per barrel in 2016”.

Now, no-one should dismiss the forecasts implied by the futures market whose traders are ruthless in evaluating likely future pricing; their mortgages depend on them getting it right. But when we look at how well such forecasts have held up in the past and we start to evaluate some motives involved, it is appropriate to put supposed objective analysis under tight scrutiny.

Two years ago the OBR advised the Treasury that its expectations for oil prices in 2012 were around $84 a barrel. That was when WTI (West Texas Intermediate, the US yardstick) and Brent crude (the UK yardstick) were pushing $77 a barrel. This weekend, WTI is at $91.64 and Brent at $114.67. The difference can be explained by oil quality (sweet, as opposed to difficult-to-process high sulphur), more efficient sized wells and closeness to markets, minimising transportation costs. But, in short, OBR miscalculated by a whopping 25%.

By now, everyone knows that North Sea oil tax revenues—and therefore much of the theoretic initial economic vitality of an independent Scotland—depend on oil prices. Based on OBR numbers, the CPPR originally came up with a table showing short-term results for both the whole UK and for Scotland alone thus:

GERS Table (Including Oil) as Originall Published

This shows the UK descending into a negative GERS balance of -£144bn last year, with oil excluded (as 90% of it would be Scottish). This massive -10% balance compares to figures for Scotland that are -£10bn or -7.4%. In other words, a separate Scotland may show a negative balance but it’s only 3/4 of what it would be as part of the UK.

Such a powerful argument was not lost on HM Gubmint. During increasingly heated debates on independence over the last year, the OBR revised its figures. Downward. The CPPR followed suit, making no qualification of the basis upon which such alterations had been made.

Not only do such tables show what appear to be optimistic forecasts for the UK’s revenues within 5 years (by 73.5% while Scottish revenues rise only 60.4%) but they predict an independent Scotland and a UK both running 1-2% imbalances by 2016/17. In other words, Osbo’s right; hang tough; we’ll come out of this better together.

Aye, right.

There are many arguments as to what most affects future oil prices. Besides production levels and OPEC unity, the demand is usually considered to depend on the world economy. However, given that the stagnation in world GDP since 2008 has seen post-2007-peak oil prices rise steadily from a bare $60 to almost double that, such crude factors clearly don’t tell the whole story.

Not content with the favourable figures show above for the UK for the next five years, the OBR revised oil revenues down and published the following:

Consider these as Tables 3a and 3b—Revised Short-Term CPPR Table, based on FIO

The balance for the UK has improved marginally to -1.4% but for Scotland—even including oil, it has worsened to -2.6%. One reason why such figures as suspect is that, within hours of them being revised in July, UK government and opposition politicians were all over them like a rash.

LibDem Chief Secretary to the Treasury Danny Alexander: “The revised predictions proved Scotland was better off as part of the United Kingdom. There are many reasons for optimism about Scotland’s economic future, and oil and gas remain a big part of that. But a case for separation that relies on a declining source of income is sorely mistaken. Scotland benefits hugely from the income stability being part of the UK provides”.

Labour’s Shadow Scottish Secretary Margaret Curran: “the latest figures show Scotland would be better off rejecting independence in the upcoming referendum, expected in 2014. The oil and gas sector is very important, but production goes up and down, prices go up and down, and so it is foolish to base our whole economy on this alone.”

This reasoning was backed by Robert Rowthorn, Emeritus Professor of Economics at Cambridge University, who warned of problems caused by the volatility of oil revenues: “In the past 25 years oil prices have shown a great deal of volatility. Up to the early 2000s a barrel of oil was $25, then it jumped to $150, dropped to $50, rose back up to $150 and was now around $100.”

What caused these seismic changes in price predictions? OBR reported on July 12th of this year: “Our projections for oil and gas prices are also lower than last year…oil prices rise from $95 a barrel in 2016 to $173 a barrel in 2040. This compares with a projection in last year’s report of a rise from $107 a barrel in 2015, rising to $206 a barrel in 2040.” This is approximately an 11% drop.

But, as evidenced above, they projected 25% too low for the last five years. As with most economic projections, the professional way to report this is as a fan of possible outcomes spreading from today. Their chart for GDP takes this sensible approach and shows a range from 0% to 6% with the most likely outcome in the middle at 3%.

GDP “fan” Projection for GDP by OBR

Given that (if you remove the oil shock ‘bumps’) oil prices have climbed pretty steadily for decades, as shown in the logarhythmic chart below. Note the laughable price for most of the 20th century and the effectively steady climb since the 1973 oil shock.

Logarhythmic Chart of Historical Oil Price

The idea that oil is likely to fall or stay flat in price over the next five years when the entire Western business and social model is 90% dependent on cars seems, if not fanciful, then certainly a worst case scenario. Between 1972 and 2012, the oil price has risen by an average 10% each year from $2.30 to $91. And if we conservatively take just half of this historic average rise as the best case scenario, the new data as the worst and the original as the median, we arrive at a chart like this:

Projection of Oil Price % Increase for Worst (Revised OBR) Original (OBR) and Best (Half of Historic Increase)

The charts above already show the original and worst-case scenarios. Calculating the best would give a replacement table 4b as follows.

Table 4b—Same as the OBR/CPPR Tables above but using Half Average Oil Price Rise as a Basis

This appears just as plausible as the recent OBR/CPPR downgrading of future oil prices and therefore equally capable of demolishing the quotes above as the latter was in supporting them. This basis shows Scotland doing better than the UK in all of the five years projected. And, rather than downplaying oil’s positive contribution and harping on its volatility, the UK—and especially the OBR and CPPR—ought to be considering the up side potential of oil prices as well as the down.

Not to mention forever looking for bad news stories that might prop up the Union.

About davidsberry

Local councillor, tour guide and database designer. Keen on wildlife, history, boats and music. Stood for the Scottish Parliament 2011; lost by 151 votes.
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