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An Oil Fund for Scotland: Taking forward our National Conversation

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1 Introduction and Overview

Chapter Summary

  • Choosing Scotland's Future inspired a National Conversation on the type of government which best equips Scotland for the future. This report is the first in a series of reports being published as part of the National Conversation.
  • The North Sea represents a significant economic windfall and has generated £269 billion in tax revenue for the UK Exchequer. Unlike many oil producing countries, the UK has not invested any of this revenue in an oil fund.
  • This report sets out the case for establishing a Scottish Oil Fund. It examines the oil and gas industry in Scotland, surveys oil funds internationally and identifies lessons relevant to the operation of a similar fund in Scotland.

1.1. In August 2007, the Scottish Government published Choosing Scotland's Future to begin a National Conversation about which responsibilities are needed to allow the Scottish Parliament and Government to best equip Scotland for the future.

1.2. We recognise that there are differences of opinion over the options for reform and this is why we are currently engaged in a National Conversation to allow the people of Scotland to reflect, debate and then decide upon Scotland's constitutional future 1. Scotland's economic responsibilities and the ability to make important decisions for ourselves about the management of our resources to meet present and future needs is central to this debate.

1.3. This report is one of a series of papers which are being published as part of the National Conversation. The report examines the oil and gas industry in the UK and Scotland, surveys oil funds internationally and identifies lessons relevant for the operation of a similar fund in Scotland.

1.4. Oil and gas revenues represent a significant economic windfall and create new opportunities for countries with reserves. Their value is reflected in the numbers of jobs and level of investment directly supported by the oil and gas sector, and in the economic activity indirectly generated by the industry. Scotland has benefited significantly from the discovery of oil and gas reserves in the North Sea. The representative body, Oil and Gas UK, estimate that in 2008 the industry supported around 195,000 jobs in Scotland 2. Scottish firms operating in the sector are also very active abroad, generating significant exports, while the biennial "Offshore Europe" event in Aberdeen brings in more than 40,000 visitors per day, drawn from over 100 countries 3.

1.5. A large part of the direct benefit from North Sea oil and gas reserves flows to the UK Exchequer through taxation of oil and gas production. Under the current devolution settlement, responsibility for the oil and gas sector, including taxation and the regulatory framework, is reserved to the UK Government.

1.6. Since 1976-77, the UK Government has raised approximately £155 billion in direct tax revenue from oil and gas production. Adjusted for inflation, this is equivalent to £269 billion (2008 prices); or approximately nine times the annual Scottish Government Budget. These revenues have gone directly into the UK Exchequer, with successive governments using the windfall to fund public spending and to seek to reduce taxation across the UK. Although a number of previous UK Energy Ministers, including Tony Benn and Malcolm Wicks have advocated the benefits of establishing an oil fund, the UK is relatively unique among major oil and gas producers in not having created one 4, 5. The potential benefits of an oil fund have also been set out in the research undertaken by the Independent Expert Group to the Commission on Scottish Devolution chaired by Sir Kenneth Calman 6.

1.7. Oil and gas output from the North Sea peaked in 1999. However, there remain substantial resources for development, estimated at between 15.5 billion and 25.0 billion barrels of oil equivalent (boe) 7. The sector is also expected to continue making a significant contribution to the UK public finances. HM Treasury estimates that over the six years from 2008-09, North Sea revenues will generate approximately £45 billion in tax receipts compared to £41 billion over the previous six years 8.

1.8. Unlike other sources of a country's wealth and economic growth, oil and gas reserves are non-renewable and once a barrel of oil or cubic metre of gas has been extracted, it cannot be re-produced. The lifespan of oil and gas reserves varies from country to country. This may be many decades, especially if returns are used to finance increased exploration for new fields and assist the development of previously uneconomic fields. Ultimately, a point will be reached however, when oil and gas reserves have been exhausted.

1.9. Governments, therefore, have important choices to make in the use of any oil and gas windfall. The one-off nature of this windfall has led many countries to consider innovative ways of using oil and gas revenues to ensure they provide a lasting return for the economy. The main means of doing so is through the creation of an oil and gas fund into which a share of the tax returns from oil and gas production is invested over the long-term.

1.10. Both advanced and emerging economies have chosen to establish oil funds. Examples relevant to Scotland include the Norwegian Pension Fund - Global (valued at £214 billion 9), the Alaska Permanent Fund (valued at £19 billion 10) and the Alberta Heritage Savings Fund (valued at £8 billion 11).

1.11. The central stated purpose of such funds is sustainable resource management, ensuring that the returns from non-renewable oil and gas revenues can be converted into a renewable financial pool of wealth. Therefore a country benefits from the income generated by a pool of assets, rather than depleting the value of the assets themselves and enables future generations to share the benefit of a country's oil and gas reserves 12. The revenue from oil funds can also be used to assist in developing low carbon energy sources, thus providing an additional source of sustainability and inter-generational fairness. Furthermore a fund can assist in responding to short-term macroeconomic shocks by providing a revenue source to offset an unexpected fall in tax revenue or a sudden increase in expenditure. These benefits have been starkly highlighted by the recent economic crisis. During 2008 and 2009 oil prices exhibited significant volatility and public sector borrowing increased sharply throughout the world as governments tried to mitigate the effects of the downturn. In such circumstances an oil fund can shield a country from this volatility by providing governments with a revenue source to support their economies and offset falls in tax receipts.

1.12. Creating and growing an oil fund presents important economic and public policy challenges which must be managed carefully to achieve maximum benefits. Clearly, a large fund would require a significant share of oil and gas revenues to be saved, rather than spent in the short-term through the general government budget. This is likely to be especially challenging during periods where there are immediate short-term pressures on the public finances.

1.13. To ensure a stable and responsible pattern of investment in an oil fund over the long-term, a strong public finance framework is likely to be necessary. Such a framework can help to build public support for an oil fund and help manage short-term demands on spending and taxation. The financial framework for an oil fund can also be coordinated with macroeconomic policy to help maintain economic stability by ameliorating the effects of unpredictable flows of oil and gas revenues.

1.14. The experience of other countries suggests that full financial and/or political independence is not a necessary pre-requisite for the creation of an oil fund. Responsibility for natural resource taxation is devolved in many countries including the USA, Canada and Australia.

1.15. Whilst the Calman Commission on Scottish Devolution's final report did not recommend the devolution of oil and gas taxation, the Commission's Independent Expert Group argued that the taxation of oil and gas production considered to be within Scottish waters could, in principle, be devolved to the Scottish Government. The Expert Group's report noted that "Taxation of natural resources has some correspondence to property taxation. One key element of the tax base is that it is clearly immobile, and this in itself makes this an attractive tax base for a devolved Government" 13. The Expert Group also supported the principle of establishing an oil fund arguing that such a fund can be used to "address the issue of inter-generational equity by ensuring revenues are employed to maintain and even enhance the nation's capital stock over time" 14.

Overview

1.16. The report is structured as follows:

  • Chapter 2 discusses the importance of the oil and gas sector and opportunities for the future;
  • Chapter 3 considers the policy objectives for creating oil funds;
  • Chapter 4 examines international evidence on the operation of oil funds;
  • Chapter 5 outlines the main policy issues for a Scottish oil fund and requests your views on the policy choices raised in this report; and
  • Chapter 6 presents conclusions.