Surging cost of oil could add £2.8bn to pre-election Budget

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The Independent Online

The massive rise in the price of crude oil may allow the Treasury to revise up part of its predictions for the public finances when it publishes its next forecast in November.

The massive rise in the price of crude oil may allow the Treasury to revise up part of its predictions for the public finances when it publishes its next forecast in November.

If oil stays above $30 - its current price - between now and the Budget in March, it could deliver an extra £2.8bn in North Sea revenue.

This would feed into the forecasts for the Budget outturn for the current financial year, which ends in April. Economists already expect the public finances to deliver a £10bn surplus just months ahead of a likely election, compared with a forecast of £6bn.

But the benefit could be offset by lower corporation tax as the higher oil price depresses profits for companies that depend on transport, and it may slow economic growth.

In the March 2000 Budget the Treasury raised its forecasts for North Sea oil and gas revenues in the current year to £4.3bn, nearly £1bn higher than the November 1999 Pre-Budget Report (PBR). This compared with £2.5bn in the year to last April.

This was based on assumption of an oil price of $22.40 a barrel, compared with a forecast in the PBR of $18.70.

Since the Budget the oil price has soared, recently hitting a 10-year high of $32 as supply curbs by the producers' cartel Opec coincided with a surge in global demand.

The Institute of Fiscal Studies, the independent analysts, said its "ready reckoner" formula showed that an increase of $1 translated into about £300m extra for the Chancellor. If the Treasury revised its price assumption to $30, this would deliver an extra £2.4bn.

IFS economist Carl Emmerson said: "It is a small amount, but it is very sensitive to the oil price." Total government spending in the current financial year is estimated at £376bn.

The Treasury pointed out that if it did not alter its assumptions in the PBR or the Budget, it would not benefit from a rising oil price. This is because of a conservative accounting standard that acknowledges a fall in the oil price below the assumption but disregards a rise.

There could be other benefits to the public finances from increased corporation tax paid by the UK's booming oil companies and from VAT on petrol. Treasury estimates show that while the price of petrol has risen from about 66p to 80p a litre so far this year, the Exchequer gained 1.9p in VAT receipts. According to the Petrol Retailers Association, 32 billion litres are sold every year, equivalent to a revenue boost of £600m.

But Mr Emmerson warned against factoring in extra revenue from corporation tax as the increase in the oil price increased the fuel bill for industry and cut company profits.

A strong oil price rise may also hurt the British economy - and those of other major industrialised nations - by hindering growth and adding to inflation. The recent surge in the oil price from below $10 at the end of 1998 to over £30 has fed through to inflation figures for the UK, United States and the eurozone.

Last week the European Central Bank used its monthly bulletin to warn that the oil price was a key threat to its inflation target.

On Friday figures for July showed that euroland inflation breached the 2 per cent target for the second month running, thanks to energy price inflation of 13.8 per cent. The problem is made worse by the weakness of the euro against the dollar, which is the trading currency for oil.

The US is growing increasingly concerned about the impact of a rising oil price on the economy. Figures earlier this month showed that stocks in the US, which is the world's largest consumer, fell at their sharpest rate for 24 years.

Analysts are worried that the US is not rebuilding stocks during the summer - when demand should be low - ahead of the winter, when stocks always run down.

Stephen Lewis, chief economist at Monument Derivatives in London, said: "Low UK oil inventories are a real threat to economic stability." He said oil inventories were held as an insurance against political or economic shocks of the sort that caused the global oil crises in the 1970s and 1980s.

Lombard Street Research, the analysts, calculate that unless the high prices constrain demand, the potential demand would require Opec to supply 30 million barrels per day, compared with its capacity of 32 million.

The one hope is that the technology revolution has ensured that the West's major economies are no longer as dependent upon a low and stable oil price as they were in other post-War decades.

Supporters of the New Economy believe that the proportion of the economy not dependent upon oil - internet retailers and business-to-business websites - will not be affected. On top of that, information technology enables oil companies to improve their distribution and so lower the need to keep down their stock levels.

However, the risk of a macroeconomic shock from a renewed surge in the oil price will undoubtedly outweigh the benefit to the Budget from the extra revenue.