Who exactly are the OBR and are their forecasts on oil believable?


  By Martin Kelly
The Scottish media has made much of the debate over the worth of Scotland’s oil and gas sector to the country’s economy. 

The phrase “if you include North Sea Oil” usually accompanies mention of Scottish GDP in years for which figures are available.  The phrase itself is bizarre, given that no country would exclude any of its revenue stream contributors when seeking to quantify its economic health.

  By Martin Kelly
The Scottish media has made much of the debate over the worth of Scotland’s oil and gas sector to the country’s economy. 

The phrase “if you include North Sea Oil” usually accompanies mention of Scottish GDP in years for which figures are available.  The phrase itself is bizarre, given that no country would exclude any of its revenue stream contributors when seeking to quantify its economic health.

However the real debate isn’t whether Scotland currently contributes more per head to the UK Treasury, but whether after independence the oil and gas sector would continue to generate the revenue it currently does.

The media characterise the debate over projected wealth from the North Sea as a ‘he says/she says’ dispute.  On the one hand we have the ‘independent’ Office of Budget Responsibility (OBR) and on the other we have the Scottish government.

According to the OBR, oil and gas revenue is volatile and likely to drop immediately after 2014 – coincidentally straight after the independence referendum.  Unionist parties and other groups, such as the Centre for Public Policy Research base their own forecasts on the OBR figures.

The BBC also rely heavily on the OBR figures in its own coverage of Scotland’s potential oil wealth and consistently use it in order to challenge figures put forward by the Scottish government.

But just who are the OBR and what is its purpose?

The OBR didn’t exist prior to the 2010 UK General Election.  The body was the brainchild of UK Chancellor George Osborne.  The Office for Budget Responsibility (OBR) was established in 2010 to provide independent and authoritative analysis of the UK’s public finances.

It consists of a three member committee, the members are:  Robert Chote, Steve Nickell and Graham Parker.

Some commentators have opined that the pessimistic revenue forecasts provided by the OBR are politically motivated and have little to do with reality.  Given oil forecasts importance to the independence debate there may be something to this, but rather than simply dismiss the OBR it is probably better to look at its track record in order to establish credibility, or otherwise.

Having done so it is my belief that any OBR forecasts should come with a government health warning – so appalling is their track record.

In December 2011, just months after being formed, the body was forced to revise UK growth figures from an initial projection of 2.5% growth for 2012, down to just 0.7%.

Appearing before a Commons Treasury Select Committee, the OBR chief Robert Chote was accused of using “guesswork” after a series of revisions for years up to 2016 led to the ‘disappearance’ of £65 billion from the UK economy.

Pat McFadden, a former Labour cabinet minister, questioned what the point of the OBR was.

“These are drastic changes, these are not minimal changes.  If you got it so wrong a matter of months why should anyone believe what you have got to say this time or the next time?”

Mr Chote was forced to concede that the chances of OBR predictions being “bang on the nail” were “practically nil”.

Appearing alongside Mr Chote in front of the same committee, fellow OBR member and economist Sir Stephen Nickell predicted that snow over Christmas 2011 would reduce the chances of the UK slipping back into recession.

Sir Stephen said: “If you have a huge bout of heavy snow before Christmas that will almost probably rule out a double-dip recession because GDP will fall in the fourth quarter (of 2011) and bounce back in the first quarter (of 2012).”

In fact, heavy snowfall over the period was blamed for the lack of growth experienced throughout the UK and into New Year.  The UK officially entered a double dip recession in April 2012 after figures showed two consecutive quarters with negative growth.

In March 2012, just before official figures showed the UK had entered a double dip recession, an OBR report said:

We still expect the economy to avoid a technical recession with positive growth in the first quarter of 2012, although another fall cannot be ruled out given the volatility of quarterly output estimates. We forecast that GDP will grow by 0.8 per cent this year, the same rate as in 2011.

There was more:

We forecast growth of 2.0 per cent in 2013 (revised down from 2.1 per cent in November), picking up to 2.7 per cent in 2014 and 3.0 per cent in the final two years of the forecast.  We still assume that potential output will take until 2014 to return to its long-term average growth rate of around 2.3 per cent a year, as the financial sector and credit conditions take time to normalise.  The key risks that we identify to our forecast are the situation in the euro area and a further spike in oil prices.

In fact the OBR now forecast 0.6% growth for 2013 and 1.8% for 2014.

The OBR has cut its growth forecasts repeatedly since it was established in 2010, when it was expecting 2.8% growth for 2013.  Almost four fifths of the growth originally forecast by the OBR for this year has simply vanished.

It doesn’t take a genius to work out that the OBR has a less than exemplary track record when forecasting economic growth for the UK.

But it’s oil forecasts that bring the body to the fore in Scotland where the economy is central to the independence debate.

In the March report we have cited, the OBR makes mention of a possible spike in oil prices resulting from “political tensions in the Gulf region” which could raise oil prices “significantly” in the short term.

In its report it said:

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.  Prospects for oil prices remain a significant uncertainty and the possibility of a further temporary spike in prices represents a risk to our forecast.

Later the report adds:

We have also made a significant downward revision to our forecast for UK oil and gas revenues, due to lower expected production and higher capital expenditure.

The OBR forecast that gas prices would follow oil, but with a six month lag.  In short, what it says about oil will eventually come to pass with gas prices also.

It added:

Relative to our November forecast, oil prices (which we assume to move in line with futures prices) are expected to be around $13 a barrel higher in 2012 and $4 a barrel higher in 2016. Despite this, we have revised down our forecast for oil and gas revenues in each year from 2012-13.

…We expect oil and gas revenues to fall in each year of the forecast, with revenues in 2016-17 less than half those collected in 2011-12. The fall in 2012-13 primarily reflects lower oil production and higher capital expenditure.

In fact, despite hitting a low of $90 in June 2012, the price of a barrel of crude oil has remained comfortable above $100 since – averaging easily $110.

Aside from its dreadful record when forecasting economic growth, is there anything else that might call into question the credibility of the OBR?

The OBR now claims oil and gas will generate £33bn up to and including financial year 2017/18 which is around £9bn lower than the Scottish Government’s own cautious analysis, published in a report earlier this month, which forecast £42bn.

However, as reported by Newsnet Scotland, respected oil economist Professor Alex Kemp recently described the OBR’s forecasts as “contrary to the evidence from the industry.”

But what is this evidence, and does it back up Scottish Government claims of a second oil boom?

Last week, a little reported interview on the day of George Osborne’s budget was given by Trisha O’Reilly of UK Oil and Gas.  In the interview the industry spokesperson said that a firm commitment on decommissioning by George Osborne in his budget would free up money which would be used for re-investment.

This, said Ms O’Reilly, would extend the life of mature fields by up to seven years which would allow an extra 1.7 billion barrels of oil equivalent to be extracted which would generate – at $100 a barrel – £110 billion for the UK economy.

It wasn’t just Ms O’Reilly who backed up Scottish government claims of a second oil boom.

This month, in an interview with energy magazine ‘Enterprising Energy’, the Chief Executive of Oil and Gas UK, Malcolm Webb said that tax revenues can now be confidently expected to rise over the coming years.

Mr Webb described investment in the sector as being “the strongest in over three decades” which followed “two disappointing years brought about by tax uncertainty”.

The Oil and Gas UK chief echoed the remarks by his colleague and welcomed the “improvements in the tax regime” that meant more oil and gas reserves are now commercially viable.

Now here’s the interesting part.  According to Mr Webb, the old tax regime meant that few exploration wells (21) were drilled over the last three years, which meant that in 2012 not enough barrels were discovered to replace those being produced.

However, over the next three years the number of exploratory wells is expected to rise to 130, which coupled with new technology will see a rise in the number of barrels discovered.

Taking into account the two to three year time lag between investment and production and the record investment in 2012 and even greater investment expected in 2013, then according to Mr Webb a significant upturn can be expected over the next three to four years – “rising to approximately two million barrels of oil equivalent per day by 2017.”

“By way of example” he says, “the projects approved in 2011 and 2012 alone will over time produce more than two billion barrels of oil and gas, generate £100 billion value for the economy and an additional £25 billion in production taxes for the Exchequer.”

Challenging claims that the sector is running down, Mr Webb added: “The North Sea oil and gas sector, contrary to what some sources say, still has a long productive life ahead of it; we estimate 50 years or more.”

In the debate of OBR versus industry then as First Minister Alex Salmond said, to determine where the truth lies you “follow the money”.

Poor forecasts will cost the OBR no more than a dent to its barely three year old reputation, and thus far the body has accumulated such an array of dents that Arthur Daly would find it a difficult sell.

The oil and gas industry are investing hundreds of billions of pounds in the North Sea, and has decades of experience in the sector.  The industry’s expectations are also pretty much in line with Scottish government forecasts.

Any commentator presenting both these groups as having equal credibility in the debate over the potential worth of Scotland’s oil and gas is being more than a tad mischievous.  The sector is worth trillions of pounds, it could transform a newly independent Scotland and set the nation up for generations.

The clear evidence of a forthcoming oil boom might also serve to explain just why, despite its claims on oil dominating BBC Scotland reports, nobody from the OBR has yet been interviewed to justify their oil forecasts.

The OBR’s head was though interviewed by Andrew Neil on the Sunday Politics Show on March 24th, but no mention was made of its pessimistic oil revenue forecasts.