The Treasury has issued a stark warning that the collapse in global oil prices could fuel inflation in the UK, even as it squeezes the life out of North Sea revenues. This is not the kind of price shock markets had been bracing for. Crude has fallen 30% in a month, a brutal repricing that should, in theory, deflate the cost of living. But in London's corridors of power, officials are sweating the opposite scenario: that the pound will suffer a capital flight, making imported goods more expensive and driving inflation higher.
Let’s run the numbers. The North Sea accounts for roughly 3% of UK GDP on a good day, but the tax receipts are concentrated: over £4 billion in 2023, money the Exchequer had already pencilled in for spending on hospitals and roads. With Brent crude hovering near $60 a barrel, the profitability of ageing fields evaporates. BP and Shell have already signalled they are pulling capital, and the Treasury knows that a full-blown exodus would trigger a fiscal black hole. But here is the twist. Lower oil prices should reduce the petrol component of CPI. However, the market reaction has been a flight from sterling. The pound has fallen 5% against the dollar in two weeks, a move that pushes up import costs for everything from German cars to Italian wine. Core inflation, stripped of energy, is still sticky at 4.5%.
This is a classic bottom-line dilemma for the Chancellor. If the Bank of England steps in to support the pound with higher rates, it will crush the mortgage market and slow the economy. If it does nothing, sterling slides further and inflation spikes. The yield on the 10-year gilt has jumped 20 basis points this morning, a clear sign that bond vigilantes are demanding a premium for holding UK debt. The Threadneedle Street crowd must be waking up to a nightmare they thought they had buried.
The irony is thick. Oil price collapses used to be the Treasury's dream scenario: lower inflation, more disposable income, higher growth. But that was before the UK became a net importer of refined fuels, and before the North Sea became a cash cow that needed to be milked dry. The transition to renewables, which the government has championed, is not happening fast enough to plug the gap. Now, we face a toxic combination: a shrinking tax base and an inflation impulse that is entirely imported.
To make matters worse, the fiscal rules are binding. The Chancellor has promised to get debt falling as a share of GDP by the end of the decade. With lower oil receipts, and higher spending on index-linked benefits, that promise looks more like a fantasy every day. The Office for Budget Responsibility will have to slash its forecasts for the next fiscal event.
I expect to see the usual chorus of industry lobbyists arguing for tax breaks to keep the oil flowing. Anything to avoid the shock of a terminal decline. But the market is already pricing in the endgame. Capital is flowing out of the North Sea, and once it goes, it rarely returns. The question is whether the Treasury can manage the landing without triggering a full-blown sterling crisis.
For now, the inflation narrative has flipped. It used to be about supply chains and wage demands. Now it is about currency weakness and the unravelling of a fiscal illusion. The bottom line is clear: the collapse in oil prices is not the free lunch investors expected. It is a bill that will come due in higher prices at the supermarket and lower returns on government bonds. The Treasury knows that, and the market is starting to realise it too. Watch the gilt market. It will tell you everything you need to know about the real inflation risk.
