31 January 2005

Comment on the Provincial Government backgrounder

Following is taken from the backgrounder accompanying today's new release from the Government of Newfoundland and Labrador. I apologize for the length, but hey, it is a complex subject. I will leave aside the Premier's speech and the news release since he largely repeats the same misrepresentations and factual distortions on which the provincial government argument has been built.

Someone has asked for a more dteailed discussion of the deal, I suspect out of concern that Paul Martin has, in a phrase, "sold the shop". Although I'd hesitate to put it in these terms, I'll try and give a federal/provincial scoresheet tomorrow (01 Feb 05) that gives the objectives obtained by each government and at what cost, political or financial.

In general, this agreement represents the structure and principles of the December 22, 2004 offer from the Government of Canada with modifications typical of what is normally achieved in any negotiating process. In general, the principles of the October proposal carry forward into the December proposal; the major difference is the method used to calculate the offset.

In practice, the October formula should have produced the same financial result for the provincial government as this agreement does. The argument on the quantum produced was based solely on the price per barrel of oil, not on the method of calculation. The notion that the October deal was less lucrative than the December proposal is a completely erroneous interpretation by the Government of Newfoundland and Labrador, repeated without question by local news media.


100% guarantee

Newfoundland and Labrador will receive 100 per cent of our offshore revenues, free from any clawbacks while we are an equalization-receiving province, for the full life of the agreement (subject to meeting conditions of the second eight-year renewal triggers). [Comment: As presented, the provincial government has accepted an offset in the first two years which is actually less than direct revenues. They key aspect of this section is that the offset continues only as long as he province qualifies to receive Equalization; this is definitely not what the province sought and therefore represents a significant gap between goal and result. While the province may resume offsets if it qualifies again for Equalization within the first eight years, this is highly unlikely to occur. If the province no longer qualifies for Equalization in the second eight-year phase, the offsets drop to zero within two years.]

Enhanced protection when off equalization

Newfoundland and Labrador will still receive the full benefits of the protection offered by the Atlantic Accord. The existing Accord's offset mechanism has been extended by one year to cover the full first eight-year term. During the second eight-year term, should the province no longer qualify for equalization in any year, it will receive 66 per cent of the previous year's offset payment in year one and 33 per cent in year two. Should the province requalify for equalization, the 100 per cent offset will be restored. If the province comes off of equalization again within that time frame, the transition is reset. [This is largely a theoretical protection. If the provincial government no longer qualifies for Equalization within the first eight years of this deal, then the declining offset provisions of the original Atlantic Accord apply. Getting rid of the declining offsets was the central part of the original provincial proposal in February 2004. In the most likely scenario, the province will not qualify for Equalization within the next three to five years and therefore will likely not qualify for the second eight-year offset period.]

$2 billion floor

Newfoundland and Labrador will receive an up-front payment of $2 billion (plus interest), which represents a floor on future additional offset payments above and beyond the existing Accord offset payments. This floor essentially protects the province from a decline in oil prices between $30-35US/barrel. In other words, offset payments for the first eight years will be no less than what they would be if the price of oil remains constant between $30-35US/barrel and the level of production remains at the forecasted levels. While minimizing risk to the province, this provision in no way restricts the province's ability to benefit from oil prices above this range. It will also minimize the risk of a steep decline in offset payments in years in which the province no longer qualifies for equalization. [Floor or ceiling? Take your pick. The $2.0 billion is a single amount. The interest noted in this paragraph results solely from an investment of the money received, not an additional transfer from the Government of Canada. If the province spends all $2.0 billion in a week, then it collects little or no interest. In the most likely scenario, oil prices will remain well above US$30 per barrel over the next five years and therefore the provincial government will cease to qualify for Equalization. If oil prices are well above that level, the claim that this in no way restricts the ability to benefit from high prices is misleading. High prices will push the province off Equalization. No offsets will flow under this agreement so the province reverts to the Atlantic Accord benefits (ability to set own revenues). This agreement did not enhance this situation - this is the situation that already exists! The province sets and collects its full share of direct revenues. In the ordinary course, the Equalization program protects provincial governments from steep declines in Equalization. Hence a rapid decline in offsets is simply the loss of one parachute from a two-parachute braking system.

Given the way Premier Williams has referred to this lump sum, it is not clear that the amount will actually be transferred to the provincial government in toto. It would appear that the provincial government is somehow restricted in what it can draw from a fund to be established. It may be that this amount will be deposited in the Canada Offshore Fund account already established to transfer oil revenues collected on behalf of the provincial government by Natural Resources Canada and that the province will be restricted in how much may be drawn down on an annual basis. Only the full text of the agreement and the implementation legislation will make this clear.]

All new projects are included

The benefits of this agreement will apply during the sixteen-year term to any new oil and gas discovery that is developed within its 16-year term, including Hebron-Ben Nevis and yet-to-be-discovered fields in the Orphan Basin, Laurentian Sub-Basin and offshore Labrador. [This provision applies only if the provincial government still qualifies for Equalization and qualifies for the second eight-year offset period. Otherwise, the projects are not covered. In the most likely scenario, they are not offset. This represents a loss from the June 5 agreement and from the December agreement which guaranteed a separate offset for Hebron-Ben Nevis. Bear in mind that the total amount of the cash advance is a little more than double anticipated direct revenues from White Rose. The initial goal was to double the revenues from all four projects. The post-June 10 goal was to double revenues from current and future discoveries.]

Guaranteed payments for 2004-05 and 2005-06

The equalization system is undergoing review on a national basis, with a new system to be established starting in 2006-07. As part of this review, equalization payments for 2004-05 and 2005-06 have already been determined. Therefore, it has also been possible to determine the value of the new offset payments under the Agreement in Principle. For the fiscal year 2004-05, the value of the additional offset payment to provide this 100 per cent offset will be $133.6 million. For the fiscal year 2005-06, the value of the additional offset payment to provide this 100 per cent offset will be $188.7 million. [The value of offset payments under this agreement for the first two years should not be dependent on the amounts already determined for Equalization. The offset is supposed to be based on actual revenues received and operates separate from the Equalization program. in fcat the Accord offsets in the original document are calculated on a 10 province standard. Given that oil prices are much higher and therefore revenues are much higher than forecast, these amounts fall far short of what a genuine 100% offset would be. In practice, though, this section is mooted by the lump sum payment of $2.0 billion. Therefore, it is curious that these specific amounts are highlight. Based on current estimates provincial direct revenues from oil production for Fiscal Year 2004 would be over $300 million, not the $133.6 million suggested here.]

Review mechanism for offset payment calculation

As part of the national review of equalization, the federal government will consider the recommendations of an independent panel and introduce changes to the equalization program starting in 2006-07. Given that the new offset arrangement between Newfoundland and Labrador and the federal government is dependent on the mechanics of the equalization system, our agreement contains a clearly-worded principle on how the 100 per cent obligation will be honoured, in light of any changes to equalization. As well, if the province disagrees with the federal government on how the offset payments have been calculated starting in 2006-07, the province can request that the federal calculations be audited to ensure they are consistent with the 100 per cent principle. [Without the actual wording of the clause, there is no way of assessing the accuracy of this claimed benefit.]

16-year agreement

This agreement ensures that Newfoundland and Labrador will continue to receive 100 per cent of our offshore revenues while we are an equalization-recipient province for 16 years, subject to meeting certain fiscal indicators after the first eight years. The province must receive equalization in 2010-11 or 2011-12, and our per capita debt servicing costs cannot become lower than that of at least four other provinces. These conditions only apply at the end of year eight, to determine whether the second eight-year period will be triggered. [As noted above and elsewhere, in the most likely scenario, the provincial government will cease to qualify for Equalization within the first eight year period. Theoretically, it is a 16 year deal. Theoretically, pigs can fly.]

Review mechanism after 16 years

This agreement provides for a review mechanism after sixteen years. The federal and provincial governments agree that no later than the beginning of the sixteenth year of the agreement, the two levels of government will jointly enter into a review of the agreement. [Any agreement would normally include a "re-opener" clause. Theoretically, as a matter of legal principle, the Upper Churchill contract can be re-opened based on the agreement of the signatories. If one party refuses to amend the agreement, then only a specific clause can force amendment under specified conditions. In practice, if a future Government of Newfoundland and Labrador or Government of Canada refuses to accept the results of a review, then this clause is completely meaningless.]

Most favoured agreement provision

Should the Government of Canada enter into a new offshore petroleum resource revenue agreement with another province or territory that is more beneficial to Newfoundland and Labrador, the province can opt to commence negotiations to revise this agreement. [Grammatically, this paragraph is a nonsense. It is almost impossible to conceive of a situation in which any provincial government would negotiate an agreement that actually proves more beneficial to another province than it does to itself. The Upper Churchill deal is an extremely rare exception, of course. If this clause applied in that instance it would actually apply to Quebec which, of course, wouldn't want to renegotiate a deal from which is all ready "more beneficial". hence the nonsense of the above paragraph. Throughout this entire year of Accord discussions, there is ample evidence that provincial government officials have difficulty communicating effectively in plain English. Either that or Humpty Dumpty works for the Government of Newfoundland and Labrador. 'A word shall mean...']