13 November 2008

The burst bubble

Only a few short weeks ago, Premier Danny Williams was claiming that Newfoundland and Labrador would be largely immune from the global economic crisis because it was protected by some sort of magical fiscal bubble.

On Thursday, Williams acknowledged that the bubble burst:

"But going out next year [2009] and the years forward … once you get into the $60 range, then you are starting to look at deficit situations."

Of course to anyone paying attention, Williams' magical bubble claim was preposterous:

  1. The provincial government knew for some time  - pre-dating the October 2003 general election - that oil production would decline this year and every year from here onward.
  2. The Auditor General, among others, has warned as recently as this past spring that massive increases in public spending since 2005 built on highly volatile  - and hence unreliable - commodity prices were unsustainable in the long run.
  3. In October, Dominion Bond Rating Service changed the trending on the provincial government's finances from positive to stable with a cautionary note in its detailed analysis about the heavy dependence on volatile commodity prices.
  4. Historic trending, coupled with an analysis of the causes of high oil prices in recent years, strongly suggested a correction would occur.  it was only a question of when the correction would occur.

New wells at White Rose and Hibernia will not restore oil output to the peak level, no matter what the price.  Rather it merely slows the rate of decline.

Hebron is not around the corner.  Even if it is sanctioned within the next twelve months, Hebron will not come on stream until sometime after 2018.  At that point, it will merely replace White Rose, Terra Nova and Hibernia which by that time will have ceased production or be on the verge of being tapped out.  One field cannot replace three.

Of course, we are already looking at deficits on a cash basisBond Papers readers have known that for months.  There have been a series of posts highlighting economic forecasts of extremely poor growth in gross domestic product, forecasts that have only forecast even further shrinkage in the economy. 

On top of that, however, several specific posts addressed in detail the factors contributing to the current and future economic problems to be faced:

  • On 27 October, a post described exactly the scenario the Premier confirmed on Thursday. In fact, that post underestimated the scope of the problem by assuming a much higher premium for oil sold in American dollars and then converted to Canadian dollars on a 30% premium.  The Canadian dollar has been trading at a 20% and Brent crude is trading - as of this writing - at around US$51 to $52.  That would translate to about $700 million less in oil revenue next year than this year.  This year's budget already projected a cash deficit of $414 million on current and capital account.
  • A 12 March post titled "We live in a fiscal house of cards" describes the massive spending increases over the past four.
  • A 21 March post titled "What goes up must come down" described the shaky foundation on which the spending was built.
  • A 25 March post titled "Hebron and old people" highlighted two fiscal challenges well known to the provincial government that would boost spending at the very time that - even without a massive economic downturn - would strain the treasury.  One - the impact of demographics - has been known for decades and is unavoidable.  The other - debt for oil projects - was discretionary.

That last one is only one major item which will add to the provincial government's financial burden.  The money needed for the 5% shares of Hebron and White Rose, and possibly for a 10% share of Hibernia South will have to be borrowed, either from lenders or from the other partners.  That debt is not optional any more and in the case of Hebron, there will be no revenue for at least a decade from that project which would make the debt self-sustaining.

Any cuts to government spending in the coming months and years will further tighten the local economy and consumer spending.  The St. John's housing market, for example, is enjoying a boom built almost entirely on public spending.  Some have credited projects like Hebron but since that project doesn't exist yet, it's hard for it to generate anything but marginal economic activity. 

Nor has the St. John's market, for example, been buoyed by remittance workers.  Some of the boom can be traced to that source but the major beneficiaries of migrant labour revenue have been in areas like Stephenville or the Great Northern Peninsula.  St. John's remains a company town and the company is the provincial government.  Hack its spending, either in salaries, programs or capital works and you hack into the local service and retail sectors. Hack into those sectors and consumer spending, another staple of government revenue, will decline as well.

Nor can the provincial government look to other construction projects to boost the economy.  NLRC's refinery is dead.  The gas facility is rumoured to be still on track but until sod is broken, it remains nothing more than speculation.  Harvest Energy's expansion at Come by Chance has been shelved. The Lower Churchill project is also more talk than reality.

More than anything, the looming provincial government financial mess should put paid to the fairy tale that the current administration practices anything looking like prudent fiscal management.  To the contrary, it has shown repeatedly that there is little if any strategic planning to its spending beyond the need to present the best face to the polls or to have spending match income.

The current administration ignored any criticisms of its approach and specifically.  It emphatically rejected constructive alternatives to its spend-happy approach such as creating an investment fund from some non-renewable resource revenues. 

A former finance minister once forecast annual deficits of a half billion dollars a year. His successor borrowed $1.0 billion to fund public sector pensions.  The Premier himself committed to meet any future deficits with increased public debt.

By all appearances, he will get his wish.

The people of Newfoundland and Labrador will get the bill.

It didn't have to be this way.