28 October 2005

The hard and the easy: Abitibi and government subsidies

In dealing with Abitibi Consolidated, the Williams administration faced a Hobbesian choice. Had it followed through with Premier Danny Williams' pledge from July, mills in Grand Falls-Windsor and Stephenville would now be shutting down with the loss of more than 700 jobs and the loss of over $500 million in newsprint sales from the local economy.

With the choice it made, the Williams administration is committed to subsidizing a particular company at a rate which exceeds or almost exceeds the government revenue generated by the company.

Forest Industry Context

The decision to subsidize Abitibi Consolidated must be seen in the context of the forest products industry. As noted in The Economy 2005, the newsprint industry has been facing a combined problem of significant declines in demand and excess production capacity in high-cost locations that have combined to reduce prices.

Provincial exports of newsprint declined by 6.3% in 2004 compared to 2003. The largest market for local newsprint is the United States market, however, North American demand for newsprint has declined 16% since 1999 with prices declining as well.

Since 1994, newsprint prices have declined by more than US$100 per metric tonne. While there have been periodic increases and decreases, the price trend since 1994 has been downward.

The forests of Newfoundland cannot support the demand for fibre from the four machines currently operating in the province without being supplemented by a variety of costly alternatives. Labrador offers ample supplies of raw material, however the costs of shipping the wood to mills located on the island remain as prohibitive as they were when the Labrador Linerboard mill opened in the 1970s.

The Williams-Abitibi deal: a net loss to the Treasury

For an administration elected to end resource giveaways, the Williams subsidy to Abitibi becomes even more striking as an aberration when one considers the impacts on the provincial treasury.

Underestimating the size of the subsidy: While the government's news release stated the agreed subsidy for Abitibi Consolidated was $10 million annually, Premier Williams comments in interviews shows that the annual amount of subsidy will be between $10 and $12 million annually according to a formula based on the Stephenville mills profitability and the cost of power. The Premier's estimate of the total cost of the subsidy is $175 million, although simple math would show the maximum to be $180 million.

The actual cost may well be higher than the government indicates. Prices for power are likely to increase over the life of the agreement and the subsidy appears to be tied to the Stephenville mill's profitability. Given the long-term trends in the newsprint industry and the particular issues at Stephenville, it appears more likely than not that $10 million represents a minimum annual subsidy as opposed to an average or a maximum.

Spending $1.50 to put a 50 cent cucumber on the market: Based on Budget 2005, the 215,000 members of the provincial workers each generated $7660 in direct tax revenue for the provincial government, for a total of $16.47 billion.1 Therefore, the 282 Abitibi employees in Stephenville produce approximately $2.16 million in tax revenue. The company operation itself pays $7.0 million in taxes annually, according to Premier Williams, for a total of $9.16 million flowing to the provincial government from the Stephenville mill.

If we take $12 million as the likely annual subsidy, the provincial government will actually lose almost $3.0 million from this agreement. If the actual figure is $10 million, then the losses are lower but they are still losses. Only if the cost of electricity decreases across the board in the province or the Stephenville mill becomes suddenly profitable will the provincial government actually see any return on its annual investment, let alone a sizeable one.

The only way to make this agreement a significantly profitable venture, based on available information, is to accept the provincial government's contention that the Stephenville mill actually produces an economic impact of 900 jobs.

This job multiplier effect offered by the provincial government seems high in comparison to similar manufacturing businesses in other provinces and states, where a multiplier effect of less than 2.0 appears to be typical.

At that multiplier rate - 282 jobs yielding 564 total jobs - the province would net $1.1 million in revenue if the subsidy were held at $10 million. At the higher government subsidy figure of $12.0 million, the loss to the provincial treasury is on the order of $700,000 per year.

Your oil money at work

While there is no doubt the Williams administration faced a very difficult range of options in responding to the announced closure of the Stephenville mill, it should always be borne in mind that it is the nature of government to make choices between sometimes very difficult and unpalatable options.

The choice Premier Williams made was to transfer provincial revenue from offshore oil - a non-renewable resource - to a private sector company to secure several hundred jobs. At the same time, the transfer will produce, at the very best, a negligible net cash return to the provincial treasury.

It does secure the jobs for the short-term and admittedly this reflects a political choice as to what this administration values. However, it should be noted that the medium- to long-term prospect of keeping the existing level of newsprint production on the island, and in particular at Stephenville, remains unsecured. It may prove impossible to sustain four newsprint machines - three at Abitibi's operations and the one at Corner Brook. Abitibi may close the Stephenville mill within the next five to 10 years in any event given its own financial position and developments in world markets. It will almost certainly close the Number Seven machine at Grand Falls-Windsor to reduce costs at that mill and to free up a cheap source of fibre to meet the other problem at that mill.

By taking oil money to prop up other industries, Premier Williams is taking a leaf directly from the Brian Peckford play book. Peckford promised repeatedly in the early 1980s that oil money would allow for a restructuring of the fishery. He went so far as to promise that oil cash would let the province buy sports equipment and build new recreation facilities in rural areas of the province.

It is interesting to note that in this instance, the Premier's agreement with Abitibi does not include any mention of the simple, and obvious, approach to fixing Stephenville's power problem, as proposed by Abitibi some months ago. Abitibi proposed construction of two new hydroelectric plants on Abitibi's Exploits watershed that would generate 60 megawatts of power dedicated to the Stephenville mill.

Government rejected the idea initially, claiming that Abitibi was seeking control of a plant that Newfoundland and Labrador Hydro would build and pay for. This claim ignored several key points. First, there was the persistent rumour that Abitibi actually proposed a lease-back arrangement by which it would purchase a significant or controlling interest in the mills. Second, even if that deal had never been offered, as natural resources minister Ed Byrne stated, government does not appear to have considered the possibility of investing oil money into a long-lasting, tangible asset - the generating facilities.

In the meantime, government has committed to studying ways of offering Stephenville long-term, low-cost power. But a commitment to study does not equal a commitment to act. What it has committed to is spending money from a non-renewable resource without gaining very much that is tangible and genuinely secure over the long haul.

Mill workers in Stephenville can be assured of jobs for some undefined period, as some will undoubtedly point out, but that will come only if the workers grant significant further concessions to Abitibi on their collective agreement.

It may well be that what these concessions will buy is a temporary reprieve.

Or, as one wag put, what we may see here is not merely an end to resource give- aways but the start of a policy that pays a company to take our raw materials for their profit, in exchange for a few hundred jobs in rural Newfoundland and Labrador.

Hobbes may well be smiling.