24 October 2014

A Greek Tragedy #nlpoli

While you are busily mulling over the possible implications the drop in oil prices might have on the provincial government’s budgets,  distract yourself by pondering some of the other implications of low oil prices on the provincial economy.

The Paris-based International Energy Agency thinks that about 25% of Canadian energy projects would be in jeopardy if oil goes below US$80 a barrel and stays there for any length of time.  As the Financial Post noted in its report last week on the IEA opinion,  that would put a number of newer more expensive projects in Alberta and maybe in Saskatchewan in doubt.  Norway’s Statoil has already shelved an oil sands project.

Globally,  the low prices would also make about three percent of all energy projects dodgy propositions.  Some of those are deep water projects like those in the Orphan Basin offshore Newfoundland. The Orphan isn’t turning up in any of these global forecasts because people don’t know enough about the prospects there to determine if they are even commercially viable.

Not surprisingly, if oil prices stay where they are now or go even lower,  odds are that more expensive local offshore projects will take longer to bring into production.

But what some people may not have noticed yet is that a slowdown in western Canada would also have an impact locally.  As SRBP has been noting since 2006,  migrant labour is a significant part of the economy in many parts of the province.  A chunk of the labour force in the province currently working out west will likely have to come home where they will be looking for work. 

They might find it, but frankly, they might not.  A downturn in prices for things like iron ore  has already put some question marks over developments in western Labrador.  Other projects in the province, including Muskrat Falls, are already well underway so they may not be needing lots of labourers. 

Once those projects are done, that will be pretty much it and there’s not much behind it.  The economy lately has been driven largely by government over-spending. Between the massive debt the Conservatives have created over the past decade with their strategic idiocy and lower royalties from energy,  future governments won’t be able to follow the Wade Locke model and substitute unsustainable government spending for actual economic development and diversification.

That’s the essence of what the Conservatives have been doing, including in their ludicrously named Prosperity Plan, all enthusiastically endorsed by Locke.  Last week, Locke confidently predicted this down turn won’t last because, as the Telegram paraphrased it, “a lot of oil production relies on a higher price. Fracking and Canada’s oil sands, especially, need oil around $100 per barrel to make a profit.”

Problem.  According to the Financial Post’s story, only about three percent of the global supply needs prices that high to survive.  And as for that oil produced by fracking?  Well, that accounts for about four percent of the American supply.  The technical term for Locke’s comments is “wrong” in other words.

If prices go back up in the near future it won’t be because so much of the global supply is more expensive than the current prices.  In fact,  most of the projects in the world are very profitable over the long-haul at prices at or below where they are now. We could be at the early stages of a market correction that brings oil prices back down after a relatively long period of uncertainty that itself produced the high prices.  We’ve seen these kinds of corrections before.

If you read on through the Financial Post piece, you’ll see that even some of the deep water sites in places like Brazil remain profitable at these recent prices.  Deep water isn’t what makes the Orphan potentially unprofitable.  Cost discipline is the phrase you’ll see there as the reason places like Brazil remain profitable. 

Well,  price discipline isn’t necessarily what you get around these part.  Look at the massive cost escalation on Hebron caused to a sizeable degree by the provincial government’s own massively expensive and entirely unnecessary Muskrat Falls project.

Some of you have undoubtedly been counting up the number of strategic blunders in recent government policy that the prospect of low oil prices highlight neatly. That last one - needlessly driving up your own costs – is especially obvious.

Obvious now.

Maybe even a bit more obvious when the oil companies finally launched the Hebron project firmly underway over the past couple of years.  The price went up about 70% in just 18 months. 

Cast your mind back to the time in 2006 when the provincial government walked away from Hebron over a disagreement over what amounted to about $500 million. Not many people raised concern over what the Conservatives were up to. They just cheered on the rather vague need for “equity.”

All of this remains speculative.  We won’t know for sure what will happen, but we can see the fundamental strategic idiocy of the past decade. If the government hadn’t embarked on its orgy of spending, the government ministers and officials wouldn’t be excreting bricks in worry.  They’d have cash on hand and lots of economic activity going on.

And had they devoted their time to serious business like creating a stable, cost-competitive offshore industry,  we’d be looking at a future that could survive the ups and downs of the oil industry.  After all, it’s not like we hadn’t seen those ups and downs already in Newfoundland and Labrador and knew what to do in response.  The only people who didn’t seem to know that were the Conservatives. They seem to have come to office with poverty of knowledge, an abundance of arrogance, and, as it seems, a propensity to go bald-headed at things.

The result has been a mess that the people of the province will be paying for over the coming decades.  That financial reckoning is something that will come regardless of what the price of oil is five and 10 years from now.

Hubris has its price.