22 August 2007

Waiting for the "real deal": deconstructing the Hebron announcement

"That's the details...That's where the deal gets done. That's where the off-ramps are. That's where the security is for the people of Newfoundland and Labrador. ... We want to see the real deal."
Danny Williams, Leader of the Official Opposition, June 2002

At 10:00 AM on August 22, 2007, Premier Danny Williams will hold a news conference and announce a miracle.

[Update 0745 hrs 22 Aug: According to CBC Radio's David Cochrane, the news conference will take place at 11:00 AM or noon. Bond papers understands it will involve only Premier Williams. As Cochrane indicated, there is no final and binding legal agreement but rather a general statement of principles (see below). Cochrane compared the situation to Voisey's Bay (again, see below), and acknowledged that there may not be an agreement reached. Cochrane dismissed the prospect given that both sides need a deal.]

The Premier will announce a deal to develop Hebron in which he negotiated every single one of his demands successfully at no or virtually no cost.

The reality is starkly different, if for no other reason than what the Premier is likely to discuss on Wednesday is not a complete agreement but rather a memorandum of understanding [MOU], a statement of principles to guide further talks that in itself is not legally binding on either party. According to some indications, the MOU will be kept confidential.

The details of the development agreement for Hebron remain to be negotiated.

The Hebron announcement will be starkly different from the position Danny Williams took as opposition leader in 2002 on the Voisey's Bay deal, although the circumstances are virtually identical.

As a Canadian Press story put it in June 2002:
But critics on the opposition benches warned a monumental bungle is in the making because the vote [in the House of Assembly] dealt with an 18-page statement of principles, not a legally binding commercial agreement.

"It's the worst ... document I've ever seen," Conservative Leader Danny Williams said outside the legislature. "It's not even a legal document because it's not legally enforceable. We as a people are being insulted by being asked to vote on this."

The legal text, which could comprise up to 150 pages of dense terminology, will be drafted by lawyers behind closed doors later this fall.

For the past nine days, Williams insisted the final text, not statement of principles, should be debated and put to a vote in the legislature.

"That's the details," he said. "That's where the deal gets done. That's where the off-ramps are. That's where the security is for the people of Newfoundland and Labrador. ... We want to see the real deal."
Effectively, Newfoundlanders and Labradorians will be voting on a Hebron statement of principles come October 9 but without the details which, as Danny Williams himself put it five years ago, is "where security is for the people of Newfoundland and Labrador."

It would be even more ironic - if that is even possible - were the Premier to make a comment along these lines on Wednesday: "We're completely satisfied we have all of the provisions that we need, all of the stop-gap measures, all the guarantees."

To give a sense of what likely won't be known on Wednesday with any certainty, consider these points:

1. Super-royalty: There will apparently be a provision covering special royalties while oil is priced above a certain dollar amount per barrel. There has been no public discussion of how this would work and hence there is no calculation of how this regime will interact with the other royalty regime.

It is conceivable that the province's existing royalty regime has been supplanted by an entirely new one - never publicly disclosed - complete with different triggers, different calculations and therefore different potential cash values to the provincial treasury.

Wade Locke's assessment of Hebron royalties of $8.0 to $10.0 billion over the 20 year lifespan of the project may well need to be replaced by an entirely new set of calculations.

Unless details of the royalty regime are released, there will be no way for an independent analyst, such as Locke, to assess any provincial government claims about royalties.

2. Equity stake. There will be a 4.9% equity position for the provincial energy company, according to media reports. Expect the provincial government will pay a fair market price - yet to be determined - for the stake and that the energy company will also bear its share of project development cost and downstream liabilities.

Those points have been at the heart of the oil companies' position on equity. The Premier has essentially accepted them already publicly when he stated that the provincial government would pay fair market price.

The problem for the public will come in assessing the real value of the equity stake. Premier Williams gave it a net value of only $1.5 billion over the life of the project based on discussions up to April 3, 2006. It is possible that in accepting operator risk - something the province has eschewed until now, apparently - the net cash value of the equity stake will be near zero.

The Premier has never publicly indicated any other value to the province of the equity stake and establishing an oil company.

[Update: CBC's David Cochrane attributed to Premier Williams acquisition cost of $150 million to the equity position. On the face of it, this is ridiculously low. If Hebron development cost were $5.0 billion, then 4.9% of that alone would be $245 million.

Added to that cost must be the share of other downstream costs and liabilities. If getting into the oil business on a project like Hebron - estimated gross value of US$25 to US$35 billion- was that cheap, everyone would be in it. ]

3. Local benefits: One of the major issues in the 2005/06 negotiations was apparently the amount of work to be done within the province. This remains an significant issue, made more acute by outmigration since April 2006.

Any provisions of the agreement which establish local benefits as work commitments must take into consideration the local labour market and the local industrial capacity in the context of a major construction project at Long Harbour, the likelihood that the Lower Churchill will start within the next three to five years, and the possibility that one or two other major construction projects at the northeastern end of Placentia Bay would also tax the local industrial capacity.

One way of coping with the issue would be to allow work - such as the topsides - to be shipped out of the province for completion based on certain conditions being met. As well, the provincial energy company may opt to slow work on the Lower Churchill or allow that project to export components or outsource supplies to ensure that Hebron can meet its first-oil target.

Since there are a limited number of facilities in the province capable of constructing some of the larger project components, a project such as the Joint Support Ship for the Canadian navy, might take a facility such as the Marystown yard out of contention for one or the other project.

The superheated Alberta construction marketplace has already taxed some aspects of the national labour supply. Challenges would exist in finding enough skilled workers in a relatively tight time frame to complete the planned and potential major projects across Canada, including the ones listed above.

4. Conflict of interest: Bond Papers raised this issue specifically focused on Ed Martin, the chief executive of Hydro who headed the 2006 negotiating team. The conflict remains, even though this round of negotiations appears to have been headed by the Premier himself.

Fundamentally, any political demands that insist on work being done in the province have to be paid for by some party.

Given that the provincial government is almost certain to become an operator, it is now faced with the dilemma. As an operator, it would seek to lower costs and thereby maximize profit which would flow ultimately to the provincial treasury. As a provincial administration interested in maximising local work, it would seek to maximize that local work irrespective of costs.

Until now, those interests were aligned: lower costs meant higher royalties.

Beginning with this agreement - when and if the details are finalized - the provincial government faces an internal conflict of interest not seen since the Peckford administration and negotiations on Hibernia.

How that conflict is resolved will determine much of the value of the final agreement, when and if it is reached.

5. There has been no public discussion of potential research and development work related to Hebron, let alone what the requirements might be.

6. Tax concessions: One sticking point for the provincial government in 2006 was a demand by the companies for a sales tax exemption for the construction phase of the project, similar to an exemption granted to Hibernia, as well as the creation of an investment tax credit.

Tax concessions - although not characterised as such - might form a part of this agreement as a mechanism to lower operator costs on an already difficult and costly project.

7. Dates and timelines. Some 18 months have already been lost on the project. The operators disbanded the project management team in 2006.

That team now must be assembled again.

The details of the agreement with the provincial government must be negotiated.

A development application must be submitted to the offshore regulatory board. The board must review the application, adjust portions and hold public hearings before the project can be sanctioned.

Even allowing some concurrent work, it is likely that first oil from Hebron will not be achieved much before 2014.

8. Hibernia South. As much as the parties attempted to downplay it, it appears that the provincial government's rejection of Hibernia South development was linked to collapse of the Hebron talks.

Some aspect of this MOU may include a side agreement to expedite development of Hibernia South, with the province essentially abandoning any demands for additional royalties and developments from the 300 million barrels of oil in the Hibernia extension. Hebron - the subject of the current discussions - is estimated to contain slightly more than 500 million barrels of heavy, sour crude oil.