Unconventional oil and gas: Economic Impact Assessment and scenario development of unconventional oil and gas in Scotland

3 Our approach

3.1 Overview of approach

The approach we have taken to assessing the impact of UOG development in Scotland has been developed to meet the requirements of the scope of work provided to us by the Scottish Government and is consistent with similar studies undertaken to assess the impact of UOG developments in other countries (see survey of relevant research in Appendix B).

The key steps in the process are:

• To define the economic impacts to be evaluated as part of the study;
• To prepare a range of scenarios after discussion with stakeholders, for the development of UOG in Scotland and for how that development will impact business and the Scottish economy, in addition to considering the timing of those impacts as well;
• To evaluate how the development of UOG may impact other parts of the Scottish economy. These are often described as 'trickle down' or multiplier effects. We consider two multiplier effects:
  • Indirect effects: the indirect effects generated in the UOG supply chain; and
  • Induced effects: arising from the spending of those employed by the UOG industry and its supply chain.

We evaluate these multipliers using an analysis of the Input-Output tables prepared by the Scottish Government ^[19] . The Input-Output tables demonstrate the impact one sector of the economy (in this case UOG) has on other sectors. In the case of UOG, these impacts may be demand for materials and products from other sectors in the economy or by supplying a local source of fuel or feedstock to other sectors of the economy. Hence, we:

• Assess impacts on employment and GVA in Scotland;
• Consider impacts on taxation receipts in the UK; and
• Prepare a qualitative assessment of other factors to be considered as part of the economic impact assessment specifically:
  • The significance of the development of UOG resources in Scotland as a feedstock for industrial facilities, e.g. petrochemical companies in the country; and
  • Outline some of the other potential impacts that could arise from UOG development which could potentially feature in a cost-benefit assessment of UOG development in Scotland.

These steps are explained in more detail in the remainder of this section.

3.2 Defining the economic impact of UOG development in Scotland

Critical to our approach is identifying which economic impacts will be evaluated for the study. We have undertaken a broad review of recent research into approaches to Economic Impact Assessment and also studies that have been performed of economic impact of UOG in the UK and elsewhere. A bibliography of the work we have reviewed is included in Appendix A and a brief summary of the literature review is in Appendix B.

Typically, an Economic Impact Assessment is based on the costs (spend) from the sector under consideration and its benefits to the economy, Gross Domestic Product ( GDP) growth, jobs created, impact on the supply chain, etc. For the purposes of this research project we have not attempted to replicate a cost-benefit analysis which aims to fully quantify costs and benefits as this was not part of the scope of work requested by the Scottish Government. A key measure of economic impact is Gross Value Added ( GVA). GVA measures the difference between the total output or revenue of an industry and what it spends on intermediate inputs. Intermediate inputs are the goods and services used up in production ^[20] . GVA is the industry level equivalent of Gross Domestic Product ( GDP), the measure used to assess the size of an economy.

Table 3.1 overleaf lists the potential economic impacts from UOG development that could be considered as part of a broader evaluation of the costs and benefits of industry. The economic impacts considered for this study are based on the scope of work for this research project provided to us by the Scottish Government and are in the top left hand corner of Table 3.1.

3.3 Preparing a range of scenarios

We considered a scenario where exploration takes place with no production either because it is uneconomic or insufficient resources are in place.

Assuming that this exploratory phase was completed, we developed production and cost profiles for potential scenarios for Scottish UOG development, based on a number of assumptions. These scenarios were based on assumptions around:

• Recoverable resources;
• Likely production and costs profiles;
• Industry structure;
• Rates of technical/efficiency improvement;
• Gas and oil prices; and
• Inland consumption of fuels.

Table 3.1 Potential economic impact of UOG and how they have been conducted in this research project.

Economic impacts			Other considerations (impact not quantified as part of this research report)
Contribution to GVA/ GDP	}	Evaluated in this report	Impact assessment on: Environment (externalities - impacts on water, noise, light pollution, biodiversity, landscaping, air emissions and air quality) Visual amenity Tourism Agriculture Health related costs
Contribution to employment	}
Contribution to tax/government revenues	}
Supply chain, skills, training kills, training and development	}	Subject to commentary in this report
Local considerations	}
Community benefits payments	}
House price trends	}
Feedstock for other industries, i.e. specific facilities (petrochemical sector)	}
Health related costs	}
Renewables / power sector	}

Based on the above assumptions, total production, total costs and total revenues were derived and formed the basis of our Central, High and Low scenarios. Section 4 presents our scenarios in more detail and our detailed assumptions are included in Appendix C.

3.4 Evaluation of impacts of UOG on the Scottish economy

Underlying our calculations is an Input-Output model, which allows us to examine the flows of goods and services between individual sectors of the Scottish economy. It also enables us to capture the economic activity generated by employees of the UOG industry and its supply chain, spending their money. The analysis utilises a series of multipliers that are applied to the direct GVA and employment of the UOG industry. As there is currently no accepted definition or industry classification ( SIC codes) for UOG activities the model uses multipliers generated by KPMG using the Scottish Input-Output tables.

For the purpose of this report, we have adapted the existing Scottish Government Input-Output table to include a new column and row for the new Scottish UOG sector. The new column and row are designed to reflect:

• The Scottish UOG sector's demand for inputs from other sectors; and
• The demand for other sectors in the Scottish economy for the outputs of the Scottish UOG sector.

To identify which industries will face demand from the UOG sector, we have assessed the expenditure breakdown of the conventional oil and gas industry in the UK ( SIC 06-07) by looking at the UK Input-Output tables. Based on our analysis, we have assumed that the expenditure breakdown for the conventional oil and gas sector will be the same for the UOG sector.

Input-Output analysis is a widely used and transparent tool for assessing economic impact. However it has some limitations, which should be borne in mind in interpreting our results. Notably:

• We use the most recent Scottish Input-Output tables available published in 2012. While there will be changes to the Scottish economy since 2012, this is the most recent set of tables available.
• The numbers we present are gross impacts, they do not factor in any displaced activity in production of fossil fuels or behavioural responses caused by price differences. We do not expect significant levels of displacement given the relatively small scale of Scottish UOG development versus the size of the overall economy. The impacts will not be felt uniformly across the sectors of Scotland's economy. Sectors which experience the biggest impact outside of the energy sector are those that produce the intermediate inputs and capital goods (and services) for the UOG sector. The size of the industry is relatively small compared to the size of the Scottish economy and most of the sectors it is drawing on, which will minimise the size of displacement effects. With the trend towards reduction in the North Sea oil and gas sector, this has the potential to release resources in the economy which will also minimise displacement and crowding out effects as well.
• The model only allows a certain level of granularity in the analysis: there is, for example, no separate treatment of UOG construction, but only a generic construction sector.

The Input-Output analysis provides a basis for our estimates of Gross Value Added, employment and tax revenues supported by a Scottish UOG industry as detailed in our three deployment scenarios. Details of key assumptions can be found in Appendix C of this Report.

By using our Input-Output table analysis, we are able to report on the aggregate impact of UOG on the Scottish economy under the different scenarios. We are then able to generate a series of multipliers to quantify the economic impacts.

The study considers the potential direct, indirect and induced impacts of the UOG sector on the Scottish economy. Based on this analysis we assess the contribution to Scottish GVA/ GDP. This impact is driven by capital and operational expenditure on UOG projects. UOG spend can be attributed to specific industries by splitting the expenditure of the industry into component parts and identifying what other sectors of the economy that part of UOG expenditure will be placed with. From this, the indirect and induced effects can be calculated using the multipliers.

3.5 The impact on employment

The study considers how the UOG sector can affect employment in Scotland. The Independent Expert Scientific Panel (2014) estimated that the development of this industry could have positive impacts on employment for Scotland. The economic impacts from the potential development of the UOG sector could be dispersed across large areas of Scotland. This may include areas identified as deprived by the Scottish Index of Multiple Deprivation (2012). (See section 5.3 for more details).

A number of skills and direct roles could be required for the development of UOG. The EY study (2014) provides seven categories of direct roles and services considered critical for UOG development:

1) Drilling and completions;

2) Hydraulic fracturing;

3) Petroleum engineering, geosciences and environmental consultants;

4) Planning approval and permitting issuance, health, safety and environmental monitoring;

5) Operations management;

6) Construction; and

7) Office support.

We have estimated employment impacts by evaluating the jobs that would be needed directly by the spend in the UOG sector in Scotland, based on previous work by EY (2014) and the Institute of Directors (2013). We have also taken into consideration the indirect and induced employment effects on industries that form part of the supply chain through the Input-Output table analysis. These sectors include, but are not limited to, construction, repair and maintenance, electricity, gas, water transport, financial services, legal activities, architectural services, etc.

3.6 The impact on tax receipts across the United Kingdom

The activity of the UOG industry and its supply chain would lead to the generation of tax revenues. As part of the macroeconomic analysis we assessed the likely impact on tax revenues for the UK.

Based on total UOG expenditure (Scotland, the UK, rest of the world), we assess three sources of tax revenues from UOG development:

• Direct taxes;
  • On corporates developing UOG; and
  • On employees in the UOG and other impacted sectors income tax and NI.
• Indirect taxation ( VAT) on the goods and services purchased in the supply chain to support UOG development; and
• Local government taxation through business rates.

We have assessed total tax income from across the UK. We have modelled a series of assumptions to arrive at estimates of the key taxable financial streams and the associated effective tax rates. These broad estimates serve to illustrate the potential size of the tax revenue across the UK. These receipts have not been further split between Scottish and UK governments, as currently there is no allocation of tax receipts from the sector between Scotland and the remainder of the UK. It is important to note that a bespoke set of tax arrangements for UOG in the UK has not yet been developed. We have therefore assumed that the sector would face current rate of corporation tax. Outturn tax receipts would depend on the design of the tax regime for UOG.

3.7 Links to other Scottish Government research projects

The assumptions and scenarios in this study were used in other UOG studies (workstreams) commissioned by the Scottish Government, mainly the Climate Change Impacts study and the Decommissioning, aftercare and financial liability study. Some aspects of these studies are used in this economics study.

The climate change offers insight on whether the economic scenarios exceed the GHG targets.

The climate change study refers to the scenarios for Scottish UOG provided by this economic study.

The economic study also uses data developed by the decommissioning study, in particular regulatory costs involved with changing regulation. As well as scenarios and for UOG, there are other estimates from the economic study such as decommissioning and aftercare costs that are used within the decommissioning study.

There have been regular interactions between the different workstreams to ensure analytical consistency. This included a cross-project meeting on 30th March 2016 in Edinburgh.