Oil funds and the public finances

The Scottish Government's Fiscal Commission Working Group has published its second report to Scottish Ministers. This report considers how an independent Scotland could most effectively manage the tax revenue received from oil and gas extraction

The report argues that countries with large reserves of oil and gas have often established short-term stabilisation funds and long-term savings funds to meet these objectives:

Short-term stabilisation funds provide a mechanism to buffer the budget from year on year variations in oil and gas tax revenues. They entail saving a proportion of tax receipts in a fund during years when receipts are higher than expected, and withdrawing from the fund in years where receipts are low. They therefore provide a liquid source of funding to help protect the budget, and in turn the provision of public services, from fluctuations in oil and gas tax revenues.

Long-term savings funds allow countries to save a proportion of the tax revenue generated from oil and gas production for future generations. By doing so, a savings fund enables the returns from finite oil and gas revenues to be converted into a permanent pool of financial wealth that will generate income flows from interest payments, dividends and rising asset values. If carefully managed these revenue streams can lead to a permanent source of income that can be utilised long after oil and gas production has stopped.

Such funds are common among oil and gas producing countries. Of the 20 largest oil producers in the world, the vast majority operate some form of national or sub-national Sovereign Wealth Fund, with the UK being a notable exception. Norway provides a good example of how a country can effectively manage its oil and gas revenues and the report argues that their experience offers a number of important lessons for Scotland.

While the debate on the financial consequences of independence goes on, most objective commentators accept that Scotland's revenues would be greater immediately after independence, if you take into account a geographical share of UK oil. However, the problem with oil revenues is that they are both price volatile and finite. 

In this context, it seems a perfectly reasonable proposal to establish a stabilisation fund to balance the books from good oil price years to bad ones. Of course, in the current state of the public finances there isn't a surplus to pay into the fund.

The second proposal is more problematic. In principle an oil fund is an excellent idea as the Norwegian experience shows. The UK should have established one rather than Thatcher squandering the resource on unemployment in the eighties.

However, as the Fiscal Commission report concedes, it is unlikely that any Scottish Government will be in a position to contribute revenues to the fund for a number of years at best. By the time the inherited deficit is at a manageable levels, it is unlikely that there will be much of a surplus.  The notion that we will be in a position to contribute to such a fund in 2017/18 seems highly optimistic.

The report also states that, "The ultimate aim for a long-term savings fund should be for Scotland to run some form of onshore budget balance". The financial consequences of this for public services are far from positive in all but the most optimistic fiscal scenarios.

So in summary, the stabilisation fund is a solid proposal, but the longer term oil fund is only practical in the most optimistic view of post-independence financial scenarios.