Yesterday on the blog we ran a piece that highlighted, through the use of the sectoral balances approach, that the Scottish macroeconomy looks completely different depending on whether we include oil and gas revenues or not. If we include Scotland's geographical share of oil and gas Scotland is a very rich country indeed. If we do not they are quite poor.
In that blog post we mentioned that even if an independent Scotland does get access to their geographical share of the North Sea oil reserves there still may be substantial macroeconomic instability due to the instability of oil revenues. Some readers wondered just how volatile these revenues might be.
Below we have included a graph that shows Scottish oil and gas exports as a percentage of GDP, Scotland's net exports as a percentage of GDP and finally the Brent oil price. (All data on Scotland is taken from the Scottish government statistics database while the Brent oil price data is sourced from FRED).
As we can see, Scotland's trade balances is dominated by oil and gas exports. When the latter rise/fall so too does the former. We can also see that Scotland's trade balance is, for this reason, extremely sensitive to movements in the oil price.
We should also note something rather important about the measures. Since we have measured oil and gas exports against GDP and since GDP is generally growing, in order for oil and gas exports to continue to buttress Scotland's trade surplus they must continuously grow in lockstep with GDP growth.
This means that, in order for Scotland to maintain a persistent trade surplus, either the price or quantity of oil and gas sold abroad must increase sufficiently over time to keep pace with GDP growth.
The fact of the matter is, however, that the amount of oil and gas Scotland sells abroad does not grow continuously over time. In part this is reflective of the fact that in order to increase the supply of oil sold abroad Scotland must make new oil and gas discoveries, and in part this is reflective of the fluctuations in the oil price.
The following graph maps the percentage change in total oil and gas exports against the oil price. What we see is a high degree of sensitivity of oil and gas exports to the price of oil.
Particularly concerning is that as the oil price has stopped climbing in the last three years the year-on-year increase in oil and gas exports in Scotland has fallen and even gone into the negative. This suggests that in the past decade Scotland has been relying on rising oil and gas prices to ensure that their oil and gas exports grew at pace with GDP.
This provides strong evidence for what we wrote about yesterday: namely, that an independent Scotland needs an extremely flexible macroeconomic framework which can deal with such potential shocks. To this we would now add that they also require a long-term plan because, as oil and gas reserves dwindle and price increases peter out, Scotland will need to replace this source of exports with new industries that are attractive to foreign buyers.