Falling oil prices and the Scottish economy

Since its record high of $140 a barrel in 2008, the benchmark Brent crude oil price has plunged to around $40 a barrel (i). We examine the threats, opportunities and outlook for Scotland.

Why is the oil price so low and what impact is it having on Scotland’s economy? Alex Kemp, Professor of Petroleum Economics at The University of Aberdeen, identifies a number of factors behind the oil price slump.

“Continued rapid growth in production from the US, particularly in domestic shale oil, has put the market under downward pressure,” he explains.

“On top of that, demand isn’t growing very much in the world and in the Middle East, production in Iraq has been growing quite noticeably despite having a civil war. Then we had the announcement from Saudi Arabia that it was determined to keep market share [by maintaining production] – so there has been nothing to keep prices up.”

The immediate effects can be seen in Aberdeen and the wider North-East economy, where companies are cutting investment and jobs.

“It’s clear that quite a few thousand jobs have already been lost in the sector as whole, so it’s quite serious,” Kemp continues. “On the ground up here, hotel occupancy has fallen and hotel room rates have gone down, albeit from a very high level previously. There are fewer people at the airport and house prices at the top level have seen a reduction. We’re also seeing empty offices.”

Fuelling growth

The flip side is that businesses and consumers are also benefitting from low energy costs.

“For just about every other sector, this is a positive development,” says Donald MacRae, Chief Economist at Bank of Scotland.

“Agriculture for example has been faced with falling prices for its goods and one of the only positive trends is the fact that fuel prices have fallen,” MacRae says. “The likes of hospitality and tourism will also benefit. Most sectors all use energy to a lesser or greater degree and if the low oil price is going to remain, that means energy prices will stay the same or even fall.”

“That’s good news and will feed through to consumers filling up at the pump and noticing quite a difference in price. This in turn maintains consumer spending and will have an effect on growth. So overall, we have to try and balance the negative impact of the low oil price around Aberdeen and the North-East with the overall positive effect on the rest of the economy all around Scotland.”

MacRae estimates that the impact on Scotland’s economy will be broadly neutral, with a small net positive impact for the UK as a whole. Bank of Scotland’s latest oil and gas sector report found that more companies were planning to create than shed jobs. In response to the low oil price, companies were looking more closely at mergers and acquisition opportunities, international expansion and diversification – including onshore shale oil and gas production.

Falling revenues

David Bell, Professor of Economics at the University of Stirling, notes that one of the biggest losers from the low oil price is the government.

“Part of the story is that annual tax revenues from oil were previously averaging £7bn to £8bn a year,” Bell says. “The Office of Budget Responsibility is now forecasting that revenues will be nearer £0.5bn and will flat-line there until the 2020s. So that’s a very big loss for government revenues and it messes up the UK government’s tax and spend plans a lot. It would mess up an independent Scotland’s tax and spend plans even more.”

The negatives were most visible around Grampian and the Highlands, Bell adds, including redundant rigs in the Cromarty Firth because there was no exploration activity. Workers were also seeing changes in the terms and conditions of their contracts and suppliers of offshore services such as support vessels, engineers and diving specialists were all being hit.

“On the other hand, Scotland is enjoying the fact that petrol and diesel prices are about 40p per litre down on their peak and that’s good for business, because it means their costs are down,” Bell adds.

Outlook and opportunities

If the oil price remains low, the oil and gas sector itself could benefit from falling production costs.

“There are a whole lot of fields not yet in development in the North Sea that have been put on ice,” explains Professor Kemp at Aberdeen University. “In a year or two in our modelling, we’re saying that even without a price increase, you’ll have significant cost reduction. That means these projects could be reassessed and could start going ahead.”

If investment plans continue to be cut sharply, the oil price may also rebound naturally in the next few years as supply falls.

Looking ahead, what key factors could affect the oil price?

“Clearly some of the decisions taken by the Saudis will be important in terms of how long they can sustain a low oil price, because it does have an impact on their ability to fund government spending,” says MacRae at Bank of Scotland.

“Then there’s the overall prospects for the world economy. The International Monetary Fund has reduced its forecast for world growth, but it’s still just over 3%, which is reasonable. The other thing is how the whole supply side, including shale oil in the US, is affected by the oil price being so low. In my view the jury’s still out on whether they’ll continue to produce the same amount of oil forecast with the price being so weak.”


FOOTNOTE:

(i) Energy & Oil prices, Bloomberg.com, 15/12/15

This article has been provided to Bank of Scotland Private Banking by external/third party contributors and contains their views as at December 2015 and should not be relied upon as fact and could be proved wrong. The information and opinions may not be accurate after this date. The views expressed may not reflect the views of Bank of Scotland plc.

Bank of Scotland Private Banking assumes no responsibility for the content or any reliance upon the content of the third party websites detailed in this article.

The forecast of future figures or events is not a reliable guide to actual future figures or events and cannot be guaranteed.

Bank of Scotland plc. Registered office: The Mound, Edinburgh, EH1 1YZ. Registered in Scotland, no. SC327000. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority under number 169628.

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