07 June 2005

Singing a new song on the offshore

Premier Danny Williams recently delivered a message to oil companies looking at offshore Newfoundland and Labrador, telling them that he will expect better revenue returns for the province on future projects including Hebron-Ben Nevis.

The financial section of the National Lampoon had a commentary on the whole issue yesterday, warning the Premier that maybe he needs to take a different approach to avoid scaring away oil company investment.

When the Premier talks about offshore resources being given away at a discount in the past, he is likely engaging in a certain level of hyperbole - exaggerating for effect. This is the Premier's stock in trade.

That said, the only example where this might be true is in the case of Hibernia where his predecessor Conservative government traded government revenues - i.e. royalties - for a seven- year construction project on the gravity based structure (GBS). In fact, the government insisted on the GBS mode of production specifically to satisfy its policy of fostering as much spin-off work in the province as possible.

What Brian Peckford and his associates quickly learned was that provincial economic benefits are not a bottomless pit; jobs and royalties are linked. To go a step further, the context of the development has much to do with the outcome. By the time the Wells administration took office, the negotiations were largely concluded. The province still had to put cash concessions on the table in order to start a project that was widely held to be unattractive financially for many of the participants.

No one anticipated oil at US$50 per barrel.

But here's the difference between the Upper Churchill, for example, and the offshore: government revenues are tied to the price per barrel of oil. Thus, there is a built- in escalator clause that the Upper Churchill agreement simply does not have.

Even if the provincial government continued to apply the generic regime to Hebron and all future projects, its direct revenues would rise and fall with the price of oil. That feature of the real Atlantic Accord and the province's own royalty regime is why this government has been able to reap windfall revenues from increases in oil prices.

That is exactly how the oil companies make their money. In the case of the offshore, since the oil companies are taking the financial risk of development that have naturally, and logically, claimed the reward for their free-enterprise risk-taking.

Premier Williams can easily talk of taking a tough stance on negotiating. That is not simply because he is a tougher or smarter guy than his predecessors. Rather, his current stance is supported by the financial benefits that have come from the decisions by his predecessors. Mr. Peckford and Mr. Wells faced provincial finances that were abysmal. In 1991, for example, the debt to GDP ratio - a common indicator of fiscal health - rivaled that of any developing country. Today, by virtue of economic developments in the past 15 years and prudent fiscal management by his predecessors and record oil prices, the current Premier is not strapped for cash to keep the lights burning in his office.

Circumstances make everything different.

For those watching the Premier's offshore policy, the challenge is to figure out what he is doing. His policy manual from the last campaign spoke of secondary and tertiary processing from things like oil refineries as a way of boosting local benefits. Peckford used to say the same thing.

But we do not know if Premier Williams is talking about departing from a regime in which basic royalties are not fixed and everything becomes a subject for negotiation. That is the way the Peckford administration approached the matter, arguing that reduced royalties were more than offset by the added economic activity from GBS construction and by the groundwork laid for future development.

The same argument - looking at the total package versus a single element - is potentially attractive today. Notice, however, that what appeared to be splendid in 1988 is being used, predictably, by a new government as an example of a give-away. Which is true, 1988 or 2005? The logic then is the same as now; we should look at the total package rather than focus on government revenues alone.

Proper evaluation by the public would depend on wide disclosure of the details of the discussions and personally, I'd put stock in a more detailed and thoughtful review of the past than the Premier's hyperbole allows. The Premier's political statements are one thing; what government policy ought to be may be something else.

If we look at the recent offshore discussions, they have been touted as having achieved every one of the government's objectives. A closer assessment shows quite clearly that while they are remarkable on a number of levels they fell far short of the goal stated in the Premier's own letter to the Prime Minister on June 10, 2004.

Looking for more is fine. If looking for more means that, in practice, we'd go back to a Peckford-esque world in which government gives and takes behind close doors, then we may want to take a closer look at what is going on.

The reason has to do with where the lasting benefit comes from when we talk of offshore oil development. Government's primary interest should be in maximizing government revenues. After all, that is the money that will be used to provide essential services. As soon as government starts mandating that a company produces local jobs, the companies will look for a subsidy - effectively lower provincial government revenue - for any jobs not in their own business plans.

The jobs created by a smelter in the case of Voisey's Bay or a refinery in the case of offshore are far less than the direct revenues the government has to give up in order to get them. The jobs also run out, sometimes quite quickly; the Hibernia GBS jobs died within seven years.

But look at the cash flowing from the oil itself. It rises and falls with the price of oil, but in the current case that has been enough to boost our provincial government to the point where it will be a "have province" by any reasonable measure. There is cash flowing enough to pay down debt and replace buildings and other infrastructure, all of which produces a lasting measurable benefit. The current boom will last for the next three to five years by most current estimates and will add about over a billion dollars in oil revenue to provincial coffers next year alone. How many refineries would it take to equal that?

The problem with Premier Williams' new approach to the offshore - if there is a problem - is not that he is scaring away investment. The Hebron consortium is merely negotiating; after all, the position is preposterous. On the one hand they say high oil prices make the field attractive. On the other they say the difficulties of the field require require a change to the royalty regime. A deal will be reached; there is money enough for all.

The problem with the Williams' approach is a familiar one: we simply don't know what he means. If we do not know what he means, we cannot accurately judge success or failure.

But for the Premier, the personal problem is much more substantial.

Williams clearly wants to be the best Premier ever. Obviously, anyone can bamboozle the masses in the short-term; Peckford did it with ease. Ask the average Newfoundlander or Labradorian about Peckford these days and you won't find anyone giving him due credit for the good he did. Peckford went from messiah to pariah before he left office and today he serves as little more than the whipping boy for his successor.

The problem for Williams is a simple one: a reputation built on spin usually crashes, sooner rather than later.