30 May 2009

How Icelandic are we, 2009 budget version

According to the Premier the relatively high price of oil at the moment is a good thing, with the prospect that it could wipe out the provincial government’s budget deficit. [Update:  an online story via CBC about the Premier’s comments.]

But could it?

Right at the start, everyone should recall that provincial revenues from oil are a function of the price per barrel of oil and total annual production.  The provincial royalty is a percentage of what you get when you multiply how much oil is sold by how much you get for each barrel.

So let’s look at production.

The provincial 2009 budget low-balls oil production.  It hit 125 million barrels in 2008 and while Dominion Bond Rating Service forecast a 15% drop, the provincial finance department forecasts a 21% drop to only 98.5 million barrels.

In the first month of the fiscal year – April – total oil production was slightly more than 9.1 million barrels.  At that rate, the offshore would produce 109.2 million barrels in 2009.

Compared to April last year, oil production is only down about 10%.  That means that the provincial production forecast could be off by more than twice the actual decline. 109 million barrels would represent a 13% decrease from 2008 – right in line with the DBRS estimate.

Then there’s price.

The budget forecast oil at US$50 a barrel on average.  Currently Brent is trading at about US$65 a barrel.

Sounds great, until you factor in the hidden gem:  the relative value of the Canadian dollar.  When the Canadian dollar is weak the provincial government can pick up a nice little premium by selling in American and then doing the conversion. 

At budget time, the Canadian dollar was worth a lot less.  As a result, that price of US$50 a barrel worked out to be around Canadian$60 to $62.50.

Brent crude is currently trading  at Cdn$71.50.  That’s because the Canadian dollar is trading at almost US$0.90. 

If you do the math on that – using today’s Brent price plus the more likely oil production level  - the whole thing works out to roughly $1.5 billion in oil royalties for the provincial treasury.  The budget forecast was $1.262 billion based on a smaller amount of slightly cheaper oil.

Meanwhile, the cash shortfall is $1.3 billion. Oil revenues would have to double, as they pretty much did last year, in order to wipe out the cash shortfall if the dollar hangs around its current treading level.

Even coming up with an extra $500 million or so on top of the extras already attained would mean you’d have to see the price of oil go higher still and the Canadian dollar slide down as well.

That might happen.

Then again, in the current environment, it doesn’t seem very likely.

We’ve been in this sort of dream land thinking before back in the spring when the budget came down. Back then, we used a higher oil production figure and a much weaker Canadian dollar in order to generate an extra $600 million in cash or thereabouts. 

But an extra $1.3 billion? 

Or even $750 million?

That would be pretty hard especially when other commodities like fish and minerals aren’t doing that well either and the forest industry in the province is shrinking faster than the family jewels on a crowd of Scandinavian men running from the sauna into an ice-covered pond.

At the very best, any optimism or pessimism about where the provincial deficit will wind up this year is a wee bit premature.  At the worst, reporting any sort of government speculation about revenues is irresponsible.

After all, these guys sat on a couple of billion in cash they never bothered to mention until this year.  It’s not like the provincial government has a sterling reputation when it comes to disclosing the facts of a matter.