2014

Should Scotland Secede from the UK?

A COST BENEFIT ANALYSIS

DANA MCMANAMON

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Contents 1. Introduction .......................................................................................................................................... 2

2. Objective ............................................................................................................................................... 2

3. Assumptions .......................................................................................................................................... 2

4 Economic Benefits & Costs ................................................................................................................... 3

4.1 North Sea Oil ................................................................................................................................. 3

4.2 Increased Renewable Energy Capacity ......................................................................................... 4

4.3 Tourism ......................................................................................................................................... 5

4.4 Debt ............................................................................................................................................... 5

4.5 Pension .......................................................................................................................................... 6

4.6 Agency Creation ............................................................................................................................ 6

4.7 Currency ........................................................................................................................................ 6

5 Cultural Benefits .................................................................................................................................... 7

6 Environmental Benefits ......................................................................................................................... 7

7 Results ................................................................................................................................................... 8

8 Sensitivity Analysis .............................................................................................................................. 10

6.1 North Sea Oil ............................................................................................................................... 10

6.2 Debt ............................................................................................................................................. 11

9 Conclusion & Recommendations ........................................................................................................ 12

10 Bibliography .................................................................................................................................... 13

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1. Introduction On September 18, 2014 Scotland held a national referendum during which voters decided

whether or not Scotland should be independent from the rest of the United Kingdom (UK). The

results of the election were 44.5% (1,617,989 people) in favor of independence, and 55.5%

(2,001,926 people) against (Scotlands Referendum, 2014). A total of 84.6% of the population

voted, a strong turnout compared to the UK average of 65.7% (International IDEA, 2011). Across

front pages of newspapers, on websites and radio shows, and in government reports, debates

about whether or not independence from the UK would be economically viable have been

underway over much of the last year. An independent Scotland will face a multitude of decisions.

The question remains, is Scotland better off alone?

2. Objective Though voters ultimately decided against independence from the UK, this analysis aims to

quantify the economic, social and environmental costs and benefits of Scottish independence to

arrive at a net present value (NPV) in favor of Scottish independence. Despite much uncertainty

about future scenarios the country will face, the objective of this analysis is transparency of

assumptions and methodology, and identification of the most material costs and benefits which

pose threats and opportunities for an independent Scotland.

3. Assumptions This Cost Benefit Analysis (CBA) has used a discount rate of 3.5%, in line with analyses

conducted by the UK Office for National Statistics, the UK Department of Environment, Food, and

Rural Affairs (DEFRA), and the HM Treasurys Green Book. Scottish citizens and the Scottish

Government have been given standing. The discount period is ten years, through 2024. A period

of ten years was used because the analysis relies so heavily on future oil and energy variables,

which cannot be accurately forecasted far into the future. The Scottish population is expected to

increase from 5.3 million in 2014 to 5.6 million in 2024 (ONS, 2013). Oil production is expected

to decrease from 50 million tonnes in 2014 to 32 million tonnes in 2024 (Office for Budget

Responsibility, 2014). Oil price per barrel is expected to increase to $128 USD per barrel (US EIA,

2014).

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4 Economic Benefits & Costs

4.1 North Sea Oil Scotlands most abundant natural

resource is North Sea Oil. Historically, Scotland

has shared sea oil tax revenues with the rest of

the UK despite the fact that the majority of the

resources are within Scotlands geographical

boundary (Scottish Government, 2013), as

depicted by the darker ocean shades in Figure 1.

Red dots represent off shore oil drilling facilities.

Green dots represent off shore natural gas

facilities. A primary assumption of this analysis is

that once independent, Scotland will claim rights

to tax the resource rent ($ value abstracted to be

sold) of all sea oil abstracted within its geographical

boundaries at a rate of 50% (Ambakederemo, 2009).

Table 1 Oil Projection Variables

In order to calculate the

future tax revenue flow

from North Sea Oil, a model

for future abstraction

quantities (decreasing at a

rate of 5% per annum) and

oil prices was created using

a template from the Office for National Statistics (ONS) in the UK (Khan, 2012), which uses the

forecasting framework set forth by the United Nations System of Economic and Environmental

Accounts (SEEA). The datasets in Table 1 were collated and analyzed to arrive at a Resource Rent

Value per Annum in the UK, to which a tax rate of 50% was applied to arrive at a total benefit

from sea oil for the entire UK. 80% of this total UK sea oil tax revenue was then allocated to

Oil Price Oil Income

Oil Production Operating Expenditure

Gas production Decommissioning cost

Capital Expenditure Consumption of Fixed Capital

Operating Expenditure Return of Capital

Exploration and Appraisal Net Capital Stock

Decommissioning Expenditure Resource Rent

Resource Rent Calculation Tax Rate

Figure 1 Off-Shore Oil and Natural Gas Fields Surrounding the UK

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Scotland based on a historic abstraction

ratio of approximately 80-20 for

Scotland to UK seas. Thus, Scottish sea

oil tax benefits totaled $57 billion USD.

Oil price, one of the most uncertain

and impactful variables, was estimated

using US Energy Information

Administration forecasts through 2040

for price per barrel of North Sea Oil (US

EIA, 2014). Figure 2 shows the future

projections of price per barrel under a high reference and low scenario.

4.2 Increased Renewable Energy Capacity North Sea Oil will not last forever, but luckily Scotland is well equipped with a landscape

which favors renewable energy. Currently, Scotland generates over 32% of the renewable energy

in the UK per annum, a number set to rise in the future with investment in infrastructure (Scottish

Government, 2013). Scotlands shores and oceans hold large quantities of untapped potential in

the form of wind and tidal energy compared to other countries in the European Union. Scotlands

installed renewable capacity has increased from 2,673 MW in 2007 to 6,592 MW in 2013, a 247%

increase over seven years (Scottish Renewables, 2013). For the purposes of this study it has been

assumed that an independent Scotland, weary of its reliance on North Sea Oil and global fossil

fuel trends, will invest largely in renewable energy as an independent state.

Currently, Scotland receives subsidies from the UK government for renewable energy

projects but when independent, the cost of designing, developing, building, and maintaining

renewable energy infrastructure will be Scotlands fiscal responsibility. To calculate estimated

future renewable energy infrastructure investment, it was assumed that first, Scotland will

accomplish its goal of 100% renewable electricity by 2020, and second, the costs will be borne by

Scottish citizens in the form of increased energy bills. A 2012 report titled Scotland Analysis:

Energy from the UK government suggests that the cost of electricity transmission network

Figure 2 North Sea Crude oil spot prices in three cases, 1990-2040 (dollars per barrel)

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infrastructure, tariffs, land procurement, and renewable contracts will amount to an additional

$113 USD per household per annum into 2025, or around $2.7 bn USD total.

In the preliminary delivery of this CBA analysis, tax revenue from sales of future

renewables was considered a benefit. Upon further review and analysis, the revenue flow to

Scotland associated with the sales of renewable energy will likely remain similar whether or not

it becomes independent. The future price of renewable energy and cost to produce are also so

uncertain that the calculations were removed from this analysis.

4.3 Tourism The UKs Value Added Tax (VAT) for industries related to tourism (e.g. accommodation,

attractions, and transportation) is one of the highest in Europe, at 20% compared to an average

of 10.8% (European Commission, 2014). Nineteen EU states apply a VAT rate of 10% or less. The

potential economic gains from lowering the VAT have been analyzed and published by

economists and government agencies. The Scottish Government has stated that if independent,

it would lower its tourism VAT to 5% in an attempt to boost the tourism industry. A report by

independent consultants Nevins Associates (2014) explores a scenario in which the UK lowers its

VAT rate to 5%. Under this scenario, tourism GDP is boosted. Calculations used to arrive at this

conclusion include VAT loss from reduced rates, VAT yield from increase in tourism, savings in

benefit payments from job creation, income tax and national insurance benefits, and corporation

tax revenues. The overall UK annual gains estimated from a reduction in VAT total nearly $1

billion USD. When this is apportioned to Scotlands tourism industry based on population,

Scottish annual gains total around $78 mn USD per annum.

4.4 Debt Public debt is the largest of the costs identified in this CBA and a significant and uncertain

issue to be addressed if Scotland secedes. This analysis assumes that an independent Scotland

will claim its debt as a percentage of the UKs overall debt ($1,377 billion USD) based on historical

taxes and spending ($100 billion USD) (Office for National Statistics, 2013). Another way to

apportion debt is based on population percentage, but because this is a less accurate reflection

of what Scotland actually spent in the past, the aforementioned methodology is favored in the

literature (Institute for Fiscal Studies, 2012). Another crucial assumption is that the debt itself will

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be paid back by Scottish citizens in the form of taxes whether or not Scotland is independent of

the UK, therefore the interest on the debt (3.2% per annum when the Debt-to-GDP ratio is less

than 60%), also known as the cost to finance debt, will be the cost to Scotland (Office for

National Statistics, 2013). This totals around $4.8 bn USD per annum.

4.5 Pension Because the Scottish population is aging faster than the rest of the UK, the cost to finance

pension per working age citizen is likely to increase if Scotland becomes independent (The

Secretary of State for Work and Pensions, 2014). A combination of demographic changes and

spending commitments means the additional cost per person for Scottish working age individuals

will increase by $125 USD per annum immediately after independence to an additional $360 per

working age person by 2030 (Bell, 2014). The increased in pension costs per person along with a

growing population total around $6 billion USD for Scotland over the next ten years.

4.6 Agency Creation An independent Scotland will no longer benefit from the services of UK agencies including the

Tax and Welfare System, the Defense Force, the Foreign Office, and the Intelligence Agency. The

cost of setting up these integral agencies is uncertain, thus an average estimate was taken per

agency from three sources including the London School of Economics, the Centre for Economics

and Business Research (CEBR), and the UK Government. Results range from $200 mn USD per

agency to upwards of $1 billion USD per agency. An initial investment (40% of total cost) upfront

is required during the first year to establish and invest in an agency, followed by operational costs

in the following years (Dunleavy, 2014).

4.7 Currency An independent Scotland will have to make a choice between keeping the pound sterling,

developing its own currency, or joining the euro. Cost estimates of a currency transition range

from $3.7 billion USD as estimated by the UK Department of Treasury, to $2.3 billion USD as

estimated by CEBR. There is a high level of uncertainty associated with both transitioning to a

new currency and policy decisions surrounding keeping the pound sterling, which the rest of the

UK has contended and supported at different periods throughout the last year. Because currency

transition is a choice and uncertainty is high, a conservative value of $0 USD has been assigned

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to this category and flagged for future review in the event that Scotland enters more serious

currency discussions with the rest of the UK.

5 Cultural Benefits Scottish citizens who desire independence (45% voted yes in September), stand to gain

cultural and heritage benefits if Scotland secedes from the UK. Feelings of national pride,

connection to an independent country, and responsibility for national treasures, culture and

autonomy are all valuable to citizens throughout the country. A study quantifying the Willingness

to Pay (WTP) for cultural heritage in Ireland found that each citizen was willing to pay just over

$66 2014 USD per annum to protect, fund, consume, and preserve national heritage (Simpson,

2007). A benefit transfer was conducted to arrive at a WTP value per Scottish citizen and this was

multiplied by 45% of the Scottish population. A total cultural benefit of around $281 million USD

per annum is estimated, increasing each year with inflation and as population increases.

6 Environmental Benefits Scotlands investment in renewable energy through 2024 suggests fewer greenhouse gas

(GHG) emissions per kWh as the electricity mix moves away from fossil fuel dependency. Section

2.2 outlined a future scenario in which Scotland achieves 100% renewable electricity by 2020. In

2012, Scotlands generation was comprised of 30% renewables, compared to 8.2% in England,

the UKs largest energy consumer. Scotland outsourced 10,717 GWh to England and consumed a

total of 30,827 GWh. This means that Scotland outsourced over 34% of what it consumed in 2012

(UK Government, 2013). It is clear that the rest of the UK relies heavily on Scotlands renewable

energy and as such, Scotland is sure to gain environmental benefits in the future in the form of

carbon savings when it extends its renewable electricity policy. Initial calculations to quantify the

total GHG emissions savings per kWh generated into 2024 required assumptions about future

renewable energy production by energy type, future renewable prices, future consumption

during peak hours, outsourcing during surplus times, and a number of other uncertainties that

would not have resulted in a robust analysis. Therefore, environmental savings in the form of

carbon cost have not been quantified in this CBA, though are present.

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7 Results & Recommendations The results of this CBA identify an NPV of $4,549 mn USD as shown in Table 2.

Table 2 Results1

Year

ENERGY AND UTILITIES CULTURAL GOVERNMENT AND STATE

TOTAL North Sea Oil Tax

Revenues

Additional Cost to Fund Renewable

Development

Cultural Benefits

Tourism Benefits

Agency Creation

Cost Pension Debt

2014 $9,700 $- $281 $- $(1,295) $(443) $(4,871) $3,372

2015 $8,605 $(70) $279 $75 $(83) $(471) $(4,707) $3,628

2016 $7,055 $(136) $276 $73 $(81) $(497) $(4,548) $2,142

2017 $6,266 $(198) $272 $70 $(78) $(519) $(4,394) $1,419

2018 $5,528 $(255) $268 $67 $(75) $(539) $(4,245) $748

2019 $4,794 $(309) $264 $65 $(73) $(557) $(4,102) $83

2020 $4,139 $(361) $262 $62 $(70) $(572) $(3,963) $(504)

2021 $3,565 $(355) $258 $60 $(68) $(585) $(3,829) $(953)

2022 $3,006 $(344) $255 $58 $(66) $(596) $(3,699) $(1,387)

2023 $2,507 $(333) $251 $56 $(63) $(605) $(3,574) $(1,763)

2024 $1,912 $(323) $247 $54 $(61) $(612) $(3,453) $(2,237)

TOTAL $57,075 $(2,684) $2,912 $641 $(2,013) $(5,998) $(45,385) $4,549

1 All results are expressed in 2014 $ mn USD.

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The benefits, however, are

diminishing into 2024 as sea oil

abstraction decreases and resources

decline. It is therefore recommended

that if Scotland moves forward with

independence, it invests heavily in

renewable sources to shift public

economic stability away from a

dwindling resource and onto the

renewable energy industry of the

future.

Figure 4 Costs and Benefits by Type

As highlighted in the chart above, North Sea Oil and Debt are the two largest contributors to

the benefits and costs of this analysis respectively. Due to their large weight, these two categories

were analyzed in section 8 of this report, the Sensitivity Analysis.

Figure 3 Deminishing Returns

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8 Sensitivity Analysis

6.1 North Sea Oil As discussed in section 2.1, the future of the North Sea Oil revenue stream is uncertain due

to unknown market forces (price, demand), the potential policy impact on fossil fuels, increasing

global quantities of stranded assets, and many more variables. Because of this uncertainty and

because North Sea Oil is the largest benefit of this cost benefit analysis, a simple sensitivity

analysis was run, changing price to see how a high, base case, and low oil price would affect

the results of the CBA. The results indicate that with a high and base case price, the NPV

remains positive, but with a low price projection the NPV becomes negative, as depicted in

Table 3 and Figure 5 below.

Table 3 Oil Sensitivity Cases

Low Base Case High

Price in 2024 75 125 205

CBA Results $(32,515) $4,549 $43,697 Figure 5 Oil Sensitivity Results

The sensitivity analysis highlights that the CBA is highly dependent on future oil price and a

slight drop in future price could turn the NPV negative, by $(32) bn USD.

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6.2 Debt When it comes to costs, Public Debt plays a large role in the results of the CBA. Given that

there are a number of ways to calculate debt and the decision hinges greatly on hypothetical

political decisions, a literature review identified three acceptable ways to calculate debt and its

associated costs, outline in Table 4 below.

Table 4 Debt Calculation Methodologies

Methodology Payback Approach Sensitivity Analysis

Category

Absorb tax (historical tax and spending) Pay back interest annually (3%) base case

Absorb tax (population distribution) Pay back interest annually (3%) high

Avoid tax (pay only when debt > 60% GDP) Pay back starting in 2021 low

Each of the methodologies listed in the table are viable and possible ways to pay back debt,

and as such the effect of each of these approaches on the NPV are likely outcomes of

independence (The Scottish Government, 2014). Using the low and base case debt interest

payments, the NPV of the project would remain positive, while using the high debt payment

option, the NPV would be negative, as depicted in Table 5 and Figure 6.

Table 5 Debt Sensitivity Cases

Low Base Case High

Debt Cost $(32,951) $(45,385) $(64,100)

CBA Results $16,983 $4,549 $(14,166)

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Figure 6 Debt Sensitivity Results

As with oil prices, debt and the method used to pay back debt and interest on debt has a

great effect on the results of the CBA. In the worst case, it makes the overall NPV $(14) bn USD.

9 Conclusion & Recommendations In conclusion, the results argue that Scotland should secede from the UK, with an NPV of

$4,549 mn USD. Despite conducting a sensitivity analysis and taking into consideration various

potential outcomes for scenarios such as future oil price and debt repayment plans, the true costs

and benefits of secession will only be seen the day independence is decided, once Scotland begins

finalizing policy and regulatory agreements with the rest of the UK, Europe and the world. Until

then, only speculation of results based on various options can be made. The CBA can be used to

argue for secession given future projections as outlined throughout this report.

Looking into the future, to 2024 and beyond, an independent Scotland would most crucially

invest in renewable energy, move away from dwindling North Sea Oil profitability, and focus on

refinancing debt.

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10 Bibliography Ambakederemo, Tari. (2009). How Does the Resource Rent Tax Balance the Interest of the Government and the Investor? (http://www.dundee.ac.uk/cepmlp/gateway/files.php?file=cepmlp_car13_50_988287761.pdf Bell, David (2014). State Pensions & Independence: Assessing the views of the Scottish, UK Governments http://www.futureukandscotland.ac.uk/blog/state-pensions-independence-assessing-views-scottish-uk-governments Dunleavy, Patrick (2014). Transitioning to a New Scottish State. http://eprints.lse.ac.uk/57708/1/Transitioning-to-a-new-Scottish-state-PD-ebook.pdf European Commission (2014) VAT Rates Applied in the Member States of the European Union. http://ec.europa.eu/taxation_customs/resources/documents/taxation/vat/how_vat_works/rates/vat_rates_en.pdf Institute for Fiscal Studies (2012). Scottish Independence: the fiscal context. http://www.ifs.org.uk/bns/bn135.pdf International IDEA (Institute for Democracy and Electoral Assistance) Accessed October 28, 2011, from http://www.idea.int/vt/countryview.cfm?CountryCode=GB Khan, J., Greene, P., and Hoo K. W. (2012) Office for National Statistics Monetary Valuation of UK Continental Shelf Oil & Gas Reserves http://www.ons.gov.uk/ons/guide-method/user-guidance/well-being/publications/monetary-valuation-of-uk-continental-shelf-oil-and-gas-reserves.pdf Nevins Associates (2014). The Fiscal Impact of Lower VAT rates on visitor accommodation and attractions in the United Kingdom (July 2014). http://www.cuttourismvat.co.uk/wp-content/uploads/2013/08/Tourism-Respect-VAT-Report-2014-07-04.pdf Office for Budget Responsibility (2014). Fiscal Sustainability Report. http://cdn.budgetresponsibility.org.uk/41298-OBR-accessible.pdf Office for National Statistics (2013). Public Sector Finances. http://www.ons.gov.uk/ons/rel/psa/public-sector-finances/index.html Scottish Government (2013). Energy Statistics for Scotland.

http://www.scotland.gov.uk/Resource/0044/00441050.pdf

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The Scottish Government (2014). What will Scotlands share of national debt be and how will it repay it? https://www.scotreferendum.com/questions/what-will-scotlands-share-of-national-debt-be-and-how-will-it-repay-it/ Scotlands Referendum. Accessed October 29, 2014, from https://www.scotreferendum.com/information/ Scottish Renewables (2013). Scotlands Renewable Energy Sector in Numbers. http://www.scottishrenewables.com/scottish-renewable-energy-statistics-glance/ The Secretary of State for Work and Pensions (2014). Scotland analysis: Work and pensions. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/304634/scotland-analysis-work-and-pensions-print.pdf Simpson, Keith (2007). Valuing Heritage in Ireland. http://www.heritagecouncil.ie/fileadmin/user_upload/market_research/Valuing_Heritage_in_Ireland.pdf US Energy Information Administration (EIA) (2014). Annual Energy Outlook 2014. http://www.eia.gov/forecasts/aeo/pdf/0383(2014).pdf UK Government (2013). Electricity generation and supply figures for Scotland, Wales, Northern Ireland and England, 2009 to 2012. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/266471/electricity_generation_and_supply.pdf