Renewables to suffer from falling oil price

With the economy bound to be one of the key election battlegrounds, Holyrood asks a number of economists to sum up Scotland’s economic outlook for the year ahead.

In our latest Economic Commentary published in November, we concluded that elements of a balanced economic recovery were starting to fall into place in Scotland. Investment was picking up, reinforcing the continuing growth of household spending, while the balance between exports and imports – net trade – continued to be a drag on the economy.

However, there were signs that growth was beginning to slow, both in Scotland, the UK and the wider global economy. While investment was picking up there was uncertainty whether the growth in aggregate – and particularly household – demand would be sustained due to falling real wages, rising levels of household debt, the prospect of more substantial UK fiscal austerity to come, and concerns that the global economy had fallen into a state of permanent demand deficiency, or secular stagnation.

Against that background, we forecast reasonable growth of Scottish GDP in 2015 of 2.2 per cent but slower than our forecast for 2014 of 2.7 per cent. Growth in 2016 was expected to weaken further to 2.1 per cent. The recovery was therefore forecast to continue but at a slower pace, subject to certain risks such as a further weakening of demand and growth in the eurozone economies.

As we approach the end of the first month of the new year, we need to ask if anything has changed. The answer is yes!

The biggest change affecting economic growth prospects has been the dramatic fall in the price of oil, by more than 50 per cent in the last six months, with Brent Crude at $48 on 12 January and likely to drop further.

Falling oil prices serve to boost growth by making input costs cheaper and by raising the real value of household incomes: we pay less for a tank of petrol or diesel for our cars and so have money left over to spend on other things.

Scotland should benefit from the boost to growth in the UK and wider world economy from falling oil prices in 2015. But as an oil exporting economy, growth should be expected to slow directly as a result of the lower oil price: the demand for oil is price inelastic so the value of oil sales and hence Scottish incomes and domestic demand will fall directly on that account. Exploration may also be deterred so investment offshore and on the mainland is likely to fall. Sadly, jobs in the industry will almost certainly be lost. 

Scotland’s renewables industry could be affected quite badly if the fall in the oil price is sustained: it will become less price competitive and hence there could be reduced demand for renewable energy and less investment in the industry. It might also deter investment in future renewable technologies such as wave power. And Scotland might suffer disproportionately compared to the UK because of the relatively greater importance of renewables to the Scottish economy. Yet there is a view that oil and renewables are not strong substitutes. If that is correct, with oil primarily used to produce transportation fuels, and renewables primarily to generate electricity, then the impact on the renewables industry may be much less than some, including myself, had previously thought.

In summary, the Scottish economy will continue to recover in 2015, with more GDP growing reasonably strongly but a little weaker than last year. It is difficult to assess what the net effect of the fall in the price of oil on the Scottish economy will be. However, what we can say is that Scotland’s economic performance will deteriorate relative to the UK in 2015 due to the oil price fall.

Professor Brian Ashcroft, Fraser of Allander Institute University of Strathclyde