05 April 2006

Hebron: Did Williams kill the $10 billion fatted calf with last minute gamble?

Some additional information on the failed Hebron deal came to light on Tuesday in the House of Assembly.

The Hebron project was a $5.0 billion construction megaproject that would have delivered an estimated $10 billion dollars in royalties to the provincial government over the life of oil production.

Following are Premier Danny Williams' remarks with notes and comments after each. The posting runs more or less sequentially as Williams responds to questions from Opposition House Leader Kelvin Parsons.

If you want the truly surprising information, skip to the section marked "*".

1. On the equity position:
"...A critical milestone for them on equity was 5 per cent. Five percent and above jeopardized the joint venture agreement. There was extra voting rights. There were other rights and privileges that were above 5 per cent. Our preference would have been to obtain, at least, 8.5 per cent. That was our original goal because that is a benchmark which has been set by the federal government in the Hibernia project and that was a number that we were trying to achieve. However, in order to try and reach an agreement with these companies, we moved to the 4.9 per cent position because that was a position that they felt was acceptable to all the partners...."
Comment: This is interesting because for the first time the premier has indicated both the preferred size of the equity position (8.5%) and the subsequent position he contends was agreed to by all parties (5%).

Most interesting is the revelation that the province proposed a 4.9% since this level precluded the province from holding voting rights that would affect the original joint operating agreement.

This acknowledges two things. First, the province would not have held a full equity position in the project, thereby begging the question of what exactly the Premier was seeking so stridently and why.

Second, since the equity position was placed below 5% in order to avoid affecting the joint operating agreement the Premier implicitly confirmed the partners contention that equity was a new condition placed on the Hebron project by the province after April 2005.

2. The cause of the collapse:
"...we basically had a tentative agreement on equity and on super royalty on Thursday evening. The matter on which it broke down, which I explained yesterday to the House, was they reverted to the January 26 position, which is investment tax credits which were in the range of $400 million to $500 million, which was something that we had virtually assumed was off the table and was gone. They then reverted to a position of two months ago, which was absolutely unacceptable to the Province."
Comment: It is interesting that the Premier chose the words "we had virtually assumed" when discussing the issue of the investment tax credit and the sales tax credit on fuel purchases related to the development. Ordinarily, the parties to a negotiation would exchange plain language statements of what had been agreed to. Such an exchange would be particularly important if, as the premier contends, there was an agreement on Thursday evening. This approach is intended to avoid the very circumstance - potentially a misunderstanding - which seems to have occurred.

Apparently in this case a detail significant enough to cause the deal to fall apart was "virtually assumed" to have been eliminated. When one assumes one makes an ass...

The overall approach here may be similar to the slipshod way the province handled discussions with Ottawa in 2004. The federal and provincial governments did not begin negotiations (exchange proposals and position statements) until October. Detailed talks took place throughout November and into December, with Williams making a dramatic pre-Christmas explosion not unlike his media scrum on Monday.

This comment by the Premier begs one of the major questions surrounding the Monday disaster: how could $500 million scuttle a deal that would deliver to the provincial government royalties equal to or greater than the total provincial debt ($10 billion)?

* Alternate explanation: The Premier killed the deal by adding equity and insisting on it.

Later in Question Period, the Premier described the collapse this way:
Then when they send a memorandum into us, the memorandum gets cute and basically comes back and says: Oh, yes, but we want all the terms that are in the January 26 agreement, with the exception of these two. So, we basically said that is not on. Because what would have happened then, that would have clawed back everything that we gained. We would have ended up with an agreement that was basically less than generic, which is exactly what your government was prepared to accept some two years ago.
Comment: In this section the Premier refers to a January 26 agreement. Williams is normally careful in the words he uses. To refer to January 26 as an agreement may be taken as deliberate or at least a reversion to terms he has used in private.

Note that the Premier had previously referred to January 26 as being merely a position taken by the Hebron partners. (See Point 1 above)

Also, the Premier refers to the companies as having brought back the January 26 agreement less two clauses. The Premier's contention up until this point has been that it was the addition of two clauses to the late March agreement that caused the collapse.

This is significant since the Premier's new version suggests a foul-up on the part of the provincial negotiators ("we had virtually assumed") with the magnitude of the error only becoming apparent once a final summary was exchanged.

These comments by the Premier also reinforce the contention that equity was a last-minute addition to the agreement. Note that Williams did not publicly make equity a condition of a deal until after 26 January. Check that in a previous Bond Papers posting, "Hebron, the premier and getting a deal".1

Ultimately, though, this particular description of the collapse raises significant doubts about the Premier's account of events. On a deal with provincial revenues on the order of $10 billion with hundreds of millions of dollars of added benefits for the private sector in the province, it is curious that the addition of $500 million in short-term tax concessions would completely negate every other gain the Premier had supposedly made.

If the Premier had negotiated such a remarkable agreement, then by his own account, $500 million would turn this deal into one that involved the province getting less revenue than provided in the generic royalty regime.

On the face of it, this seems preposterous.

These comments make more sense if we interpret these remarks to mean that after a period of discussion with the Premier on so-called super royalties and something being called an equity position, the companies rejected the Premier's efforts to change the January 26 agreement.

Instead, their final position was to insist on the January 26 agreement already reached, including tax concessions but "without these two elements", that is super royalties and equity of any size.

The reference to "clawed back everything gained" would refer to the loss of equity and super royalties which, in fact might not have been gained at all.

This is consistent as well with a comment in a presentation made by Chevron's Mark Macleod in February 2006. One of Macleod's bullet points in a slide show on Hebron indicated that the companies were "re-evaluating potential for development". The language is telling. The project is not being evaluated. There are no discussions to finalize an agreement. In February 2006, the Hebron partners are evaluating the project once again for development.

The only comments the Premier would need to clarify is on the January 26 agreement producing royalties of less total quantum than the generic regime.

3. The cost of buying out ExxonMobil's 38% interest in Hebron
"...Having said that, with regard to the price that the government is prepared to pay for Exxon Mobil'’s interest, we are dealing in hundreds of millions of dollars here. I am not prepared to announce to Exxon Mobil today what we are prepared to pay them...."
One would expect that the price for the major shareholding in a project like Hebron would comprise costs incurred to date, possibly a portion of the $5.0 billion construction costs and almost certainly compensation for future earnings on revenues from oil sales.

To give some sense of what gross revenues would be on Hebron, the current value of Hebron oil, based on US$50 per barrel oil would be $35 billion. Even using a discounted price heavy oil running US$15 lower than that, the field is worth $24.5 billion. It is difficult to imagine ExxonMobil selling its interest for the hundreds of millions the Premier claims it would cost.

1 During the offshore revenue talks in 2004, the premier consistently shifted his public position once agreement had been reached on certain points. It was not until Ottawa stood firm in October 2004 that Williams came to the table and negotiated a final deal. Several posts on this can be found here.

It is not unusual, for example, for the Premier to claim that an agreement existed when no negotiations had taken place, that there was an agreement when evidently there was not one, or that, as in this case, the other party was being perfidious. careful examination usually reveals something closer to the truth than the Premier's often contradictory statements.