07 January 2013

The Hebron Complications #nlpoli

The partners in the Hebron project sanctioned the development on New Year’s Eve and announced the decision on Friday.

The new cost estimate to build the gravity base and bring the oil field into production is $14 million.  As CBC noted on Friday, the capital cost estimate for the project increased from $8.3 billion to $14 billion over the past 18 months.  That’s a 69% increase for those doing the math.

“But much of the increase of billions relates to increased construction and drilling costs,”  CBC reported on Friday, “ plus current market and foreign exchange rates.”  The partners expect to produce first oil from the field in 2017.

The Hebron project will be competing with the Lower Churchill project for labour in an already tight market.  Both projects are on the same timeline. 

Higher Costs.  More Temporary Workers.

That will likely have some significant implications.

Perhaps the biggest implication will be cost.  Expect them to keep going up. To give you a sense of what that could mean just look at the 2010 and 2012  Muskrat Falls cost estimates and increase each by 69%.  You’d now wind up with a project that would cost $8.45 billion and $10.48 billion.

The second biggest implication is in the provincial work force. The local labour supply can’t meet the demand for new workers and ones to replace retirees.  A 2009 study by Memorial University’s Harris Centre noted a significant increase in the number of temporary foreign workers in the province since about 2005.  The numbers were below the 2003 peak but the previous uptick in foreign workers was associated with earlier offshore construction.

Expect more of that. Hebron could become the first fly-in, fly-out offshore construction project.

Keep an eye out for some other things.

Unless the development agreements prevent a change after sanction or they’ve already passed the point of no-return,  the Hebron partners could look to shift as much construction activity outside the province as it can. Chunks of the two topsides modules currently planned for the province could go to the American Gulf coast where labour is readily available and construction costs would be cheaper.

Taxpayers Foot the Bill

One potential mitigating factor is the huge break on cost recovery the Hebron companies received thanks to the 2008 development agreement.  Instead of the escalating pre-payout royalty regime that dates from 2003, the provincial Conservatives gave the companies a flat one percent royalty payment until the companies recover development costs.  The higher the costs at the front end, the longer it will take the province to collect significant royalties. 

Then-natural resources minister Kathy Dunderdale explained the reason for the give-away in 2008:

“The rationale behind these changes was the companies needed some downside protection if the price of oil went very, very low.”

It also protected the companies against cost increases, as it turned out.  As Premier, Kathy Dunderdale explained that last year:

"All of that project gets paid off before we start to earn more royalties," she added. "So people of the province end up paying one way, or the other, either through the treasury or through Nalcor."

As it turns out, the people of the province will pay both ways.  They will have to forego royalties thanks to the Conservatives’ 2008 give-away on front-end Hebron royalties. 

Plus the taxpayers will cough up increased costs through Nalcor.  The Crown-owned energy companies owns a 4.9% equity stake.  That works out to almost $700 million of the current $14 billion estimate.

And that gets tacked on top of the cost of Muskrat Falls, which local taxpayers are completely responsible for paying.