Scottish Independence

Scottish Independence

August 11, 2014
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I am in the uncomfortable position of having my crude oil trading book cited on a pro-Scottish Independence  campaign website, http://www.wealthynation.org/a-letter-to-the-first-minister/. This despite the fact that I have been tying myself in knots for weeks trying to avoid giving an opinion on whether I am for or against Scottish independence. What I think is irrelevant: I have not lived in Scotland since 1981 so I do not even have a vote on 18th September.

The reason I appear to have been quoted at all is because of my non-partisan view that the fortunes of Scotland are linked to the future price of oil and I consider that future price to be fundamentally unforecastable.

If Scotland was my client I would give the same advice that I would to anyone else who is exposed to the oil price: look at the future based on an oil price assumption that is the most realistic one you can come up with taking into account market history and your state of knowledge of events that are likely to influence the price of oil henceforth. Call that your base case assumption. Then look at how much more or less you could achieve if the oil price was, say, 20% higher or 20% lower than your base case assumption.  This is probably not a bad set of scenarios against which to test the budget you would need to implement your preferred policies or activities going forward.

If I was advising “Project Scotland” in the same way I advise oil development projects I would say that if the current forward oil price curve is better than your base case oil price assumption, then use the market to lock in at least your base case price to guarantee that you can finance the policies that rely on the price being at least as good as that base case.

But I am not advising “Project Scotland”. Even if I was, I would steer clear of suggesting that any “Scottish National Oil Company” should hedge the future price of oil, using the regulated futures or OTC forward, swaps or options markets, for the purpose of underwriting an Independent Scotland’s budget.

A little knowledge is a dangerous thing in the market. This was demonstrated in spades when the Office of Budget Responsibility said “our oil price forecast moves in line with the average of futures curve over the ten working days to February 27, 2014, for the next two years,…”

The forward oil price curve is a powerful tool if you use it and actually take action to lock in the future price it represents. If you do not act on the information it provides then it is no more than a fleeting indication of the mood of the market on any given day.

It may be the case that a sovereign state could interact with markets to guarantee by hedging the budget necessary to be able to implement the State’s policy preferences.  But that would require an extensive debate of the policies that are being underwritten and a full appreciation of the potential “cost” of hedging that would be incurred if the market moved in favour of the hedger’s underlying unhedged physical position.

If Scotland achieves independence there may be a role for a proactive oil price management strategy to be approved and reviewed by the Scottish Treasury for implementation by, perhaps, a Scottish National Oil Corporation. Until that day the forward oil price curve has no role in the independence debate other than as one of a myriad of factors informing the choice of a base case price and tax revenue assumption that should be tested with high and low case sensitivities.

As for my views in the independence debate, if anyone is interested, I’ll let the bard have the final word:

“Had we never loved sae kindly,

Had we never loved sae blindly,

Never met—or never parted,

We had ne’er been broken-hearted.”

 

It’s a sair fecht!