Lower oil and gas prices set to hit Scotland’s underlying public … – ifs.org.uk

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Scotland’s underlying fiscal position is set to improve by much less than expected last year, as oil and gas prices fall back.
This comment updates our projections of Scotland’s underlying public finances in light of the latest Office for Budget Responsibility forecasts from the March 2023 Budget – which include a significant downgrade to oil and gas revenues.
The Office for Budget Responsibility (OBR) published its latest forecasts for the economy and public finances alongside the Budget on 15 March. These showed an improvement in the underlying public finance outlook for the UK as a whole, although the Chancellor decided to give away rather than bank most of the spoils. Other forecasters have also revised up their growth forecasts in recent months, although most – including most notably the Bank of England – are not as optimistic about the UK’s growth prospects as the OBR. 
Part of the upwards revision to growth prospects is due to the recent fall in oil prices and especially gas prices from their 2022 peaks. This fall is expected to be sustained over the next few years, although gas prices are expected to remain substantially above their pre-Ukraine-conflict levels. This means that while overall tax revenues over the next few years have been revised up, oil and gas revenues are now expected to increase by much less than in the OBR’s November 2022 forecast. 
Then, the combination of higher prices and the introduction of higher tax rates (the ‘energy profits levy’) was forecast to lead to oil and gas revenues of £15 billion in 2022–23, rising to almost £21 billion in 2023–24. Now the forecast is for revenues of closer to £11 billion and £10 billion in each of these years. This is still a massive increase on levels just a few years ago (revenues amounted to less than £1 billion in each of 2019–20 and 2020–21) but is a significant downgrade nonetheless. 
Given that the vast majority of UK oil and gas production takes place in the waters off Scotland, this decline in forecast revenues has a particularly significant impact on the outlook for Scotland’s underlying public finances. We have therefore updated our projections of these using the OBR’s latest fiscal forecasts.  
As we discussed in our previous figures in December, while projections of this sort are always subject to significant uncertainty, this is particularly true in the context of high energy prices. 
Alongside these assumptions on revenues from oil, gas and electricity producers, our projections assume that Scotland’s onshore tax revenues and government spending per capita move in line with the OBR’s forecasts for the UK as a whole. Our previous update explains why we think this is a reasonable baseline scenario.  
Figure 1 shows the OBR’s March 2023 forecasts for the UK’s budget deficit (dark red) and our latest projections for Scotland (dark blue). It also shows the OBR’S November 2022 forecasts for the UK (light red) and our previous projections for Scotland based off these earlier forecasts (light blue).  
Let us focus first on the UK figures (the red lines). The OBR’s forecast for the UK’s budget deficit in 2022–23 (equivalent to £2,250 per person) is a little lower than what it expected last November (£2,620). Over the next few years, borrowing is forecast to fall, running at or just below that which was forecast in November.
Figure 1. Projected Scottish and UK fiscal balances, £s per capita, 2021–22 to 2027–28
Note: The UK’s budget deficit is now estimated to have been lower in 2021–22 than was thought in November 2022. We reduce the Government Expenditure and Revenue Scotland (GERS) estimate of Scotland’s deficit in that year by the same cash amount per person to avoid this distorting comparisons. 
Source: Author’s calculations using OBR Economic and Fiscal Outlook March 2023 and November 2022, GERS 2021–22, ONS Population Projections and assumptions discussed in text. 

If we instead focus on Scotland (the blue lines), the picture is rather different. The latest projections imply Scotland’s underlying budget deficit being much bigger than those based on the OBR’s November 2022 forecasts. For example, whereas our last set of projections were for Scotland’s deficit to decline from the equivalent of £4,340 per person in 2021–22 to £1,600 in 2023–24 as a result of a surge in oil and gas revenues, our latest projections are for Scotland’s deficit to fall to £3,200 per person over the same period. In aggregate terms, this means the projected Scottish deficit in 2023–24 has been revised up from £9 billion to closer to £18 billion. 
The changes for later years are smaller but still notable. Thus, while lower oil and gas prices are a key factor behind a modest improvement in the short- and medium-term outlook for the UK’s public finances, it has led to a notable deterioration in the outlook for Scotland’s public finances. 
Figure 1 also shows that whereas based on the OBR’s November forecasts we projected that Scotland’s underlying budget deficit could fall below that of the UK as a whole in 2023–24, that is no longer the case. If 100% of the UK’s oil and gas revenues are assigned to Scotland and onshore revenues and government spending move in line with the OBR’s forecasts for the UK as a whole, the underlying Scottish budget deficit is set to be around £1,300 per person more than that of the UK as a whole in 2023–24. This gap could then grow to £2,400 per person by 2027–28 as oil and gas revenues further decline. This would mean Scotland’s underlying deficit being just over 7% of GDP in that year – around 5.5 percentage points higher than the forecast UK-wide figure (1.7%). 
As part of the UK, Scotland’s underlying budget deficit is subsumed within the wider UK budget deficit. Under independence, that would change.
The Scottish Fiscal Commission’s first Fiscal Sustainability Report, published two weeks ago, shows that if Scotland remains part of the UK, the Scottish Government faces a difficult long-term fiscal outlook as rising spending pressures place strain on the public finances of the UK as a whole. In addition, the design of the Barnett formula means it is likely to be less generous to Scotland, as time goes by, than has historically been the case. 
Our latest projections remind us that independence would be no panacea for these challenges – indeed, Scotland’s larger budget deficit means that unless economic growth and hence tax revenues could be boosted, tax rises or spending cuts would likely need to be even larger. That is why economic policy and economic growth are at the heart of debates about the effects of independence on Scotland’s public finances, and hence the taxes people could pay and the services they could expect to enjoy post-independence. 
Associate Director
David is Head of Devolved and Local Government Finance. He also works on tax in developing countries as part of our TaxDev centre.
Phillips, D. (2023). Lower oil and gas prices set to hit Scotland’s underlying public finances [Comment] Institute for Fiscal Studies. Available at: https://ifs.org.uk/articles/lower-oil-and-gas-prices-set-hit-scotlands-underlying-public-finances (accessed: 3 April 2023).
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