Sean O'Grady: UK oil profits are largely an illusion

In theory, it would be all too easy for the Chancellor to postpone the 2p increase in fuel duty. This year, the Institute for Fiscal Studies revealed, the Treasury will receive a windfall of about £1bn from the increase in the price of oil and higher tax revenues from the North Sea. Next year the bonus will be £1.25bn. Some economists put the annual boost to the public finances as high as $9bn (£4.5bn), depending on the oil price.

By contrast, the cost of postponing October's planned increase in duty on petrol and diesel is a mere £550m. In principle, Alistair Darling could also help hard-pressed families by putting off the controversial increase in vehicle excise duty on older cars. The cost to the Exchequer of dropping the increase for older cars would be £465m this year, rising to £735m in 2010-11. Indeed, on the most optimistic estimates of the North Sea windfall, Mr Darling could go on to end child poverty, lower stamp duty for first-time buyers, raise the winter fuel allowance and announce all sorts of other voter-friendly reforms.

In his Budget in March, the Chancellor's estimates for revenues from the North Sea were based on the consensus view that the average price of oil over the next year would be $83.80 a barrel. Since then the price has touched $135, and independent observers forecast that the average price of oil over 2008-09 will be $103 a barrel. Tax revenues should increase commensurately in the UK's petrol-economy.

But Britain is not Saudi Arabia, and the North Sea oil tax windfall is largely illusory. Every reduction of 1 per cent in the national income pushes public borrowing higher by some £10bn, dwarfing any windfall from the North Sea. A full-blown recession, which is unlikely but possible, would push public borrowing over £100bn per annum, compared to £43bn now, and shred the Government's fiscal framework.

Should the price of a barrel of oil stay where it is or, still worse, reach the $200 a barrel level predicted recently by the president of Opec, the effects on the UK as a whole will be devastating. As in the oil shock of the 1970s, spending power is being sucked out of the economy. Stagnating output, thanks also to the credit crunch, and higher inflation because of the boom in food and commodity prices, are combining to squeeze wages, household incomes, profits and, ultimately, government revenues. The transport, distribution and retail sectors are being especially badly affected by inflation in fuel costs, with companies such as British Airways feeling the pain most severely.

There is scarcely a corner of the economy that will not be affected by the quadrupling in oil prices since 2004. Lower growth means lower tax revenues and an extra burden on the public finances. They were badly stressed even before the strain from the acquisition of Northern Rock and the £2.7bn compensation package for the abolition of the 10p rate of tax. The Government failed to raise taxes and rein in spending sufficiently during the boom, and is now badly exposed to exogenous shocks such as the oil-price hike and the credit crunch. Or, to use the vernacular, Gordon Brown is skint.

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