17 October 2014

Double-down Locke #nlpoli

“I didn’t see this coming,”  Memorial University economist Wade Locke told the Telegram’s James McLeod the other day. Locke was talking about the dramatic drop in oil prices over the past week and a half.

The day before, Locke was on VOCM’s morning talk show dismissing this low oil price stuff as just a passing thing.  No biggie.  And while everyone else is figuring the government is headed farther up a financial shit creek of Amazon proportions, Locke was absolutely confident that prices would go back up and all would be right. 

Sure, government might have to do some trimming, Wade offered, but they should do it gradually over time.  Like losing weight, he said.  If I told you that you had to lose 10 pounds, it would be hard to do it quickly.  But over time, much easier to do.

There’s something truly laughable about Locke’s metaphor because basically Wade is to sound management of public money what a Double-Down from KFC is to heart-smart nutrition.

The Conservatives have been relying heavily on Wade Locke’s advice over the past decade to provide the veneer of credibility for their simple policy of maintaining public spending as high as they can.  The Conservatives are addicted to spending and Locke is their enabler. 

They even hired him in 2013 to advise on the budget after they’d had some disasters forecasting oil prices.  Not surprisingly, Locke ditched the more realistic aspects of his 2011 presentation that there were serious financial problems the government had to face.  In 2013, he was talking about how things were only going to get better.

On VOCM and in the Telegram, Locke was basically reciting the same lines he had last year. There are lots of oil and minerals. We can sell them and there will always be cash.  Short term, there might be pain but in the medium term and beyond?  Things are only going to be good. 

Look at what Locke is doing and you will see the fundamental problem with his approach:   Locke assumes that prices will only go up.  Here’s how your humble e-scribbler put it in 2013:
The reason Locke got it wrong is that he used a faulty assumption:  things are always getting better. Oil prices only go up, it’s just a matter of how high. Even if the government has a problem, everything else will be humming along. 
Locke’s done the same thing before, incidentally, even during the 2008 downturn.  High oil prices and a big project in Labrador.  Definitely. From Wade’s lips to Hisself’s ears. It doesn’t matter that Locke took the future oil price projections from an international analysis company. The point is that the assumption was predictably, knowably flawed.  
As it turned out,  his forecast for mining development was also flawed.  And, while Locke hinted at Muskrat Falls, we would discover a few months after this presentation that Locke unreservedly endorsed Muskrat Falls based on an equally flawed assessment of that project as proposed by Nalcor.
Locke’s comments in the Telegram and on VOCM reflect the same basic faulty assumptions.  There are also some factual errors.  He overstates the break-even price for shale oil by about 20%, for example. 

He also seems to misunderstand the problems in Venezuela.  They may be having financial problems today but, historically,  rentier states like Venezuela haven’t followed the sort of text-book naive economics that Locke assumes.  By the theory,  suppliers should reduce supply when demand drops. That way prices will go back up and they will make more money. 

Except that if Venezuela needs cash flow or Saudi Arabia needs to defend its market share – as it does apparently -  the states will actually sustain production and sell at a loss if need be in order to keep things going.  We shouldn’t put too much faith in these guys acting like Wade’s text-bookish assumptions would have it.

If Wade thought about it for a bit, he actually has a good model close at hand to explain the kind of thinking that happens in the real world.  As prices drop,  Newfoundland and Labrador isn’t talking about slowing production.  They plan to keep the taps wide open because they need cash.   What’s more, the Conservatives know they need to keep production going at a high rate.  That’s why the Conservatives are talking about rushing Orphan Basin oil into production even though we don’t even know enough to determine if it is even commercially viable. 

Commercial viability is that break even price thing.  That applies in a free market like the United States.  Those companies doing the drilling have to answer to shareholders and shareholders want to make money.  But Locke’s friends at Nalcor and around the cabinet table don’t think like that. They will spend public money to do things that make no economic sense. That sort of thing happens in other parts of the world as well.

Ultimately, though,  Locke’s inability to forecast oil prices isn’t the problem we should be talking about.  Nor should we be concerned about the fact that the current drop in prices might mean some cuts in the next budget. What we should be focusing on is the sheer idiocy of the policies that Locke and his Conservative friends have implemented that have made the province vulnerable to relatively minor fluctuation in oil prices.

Locke can describe the fundamental problem.  He did so in 2011:
Although there was some money paid on the debt (e.g., the $2 billion upfront payment from the 2005 Atlantic Accord was used to offset the unfunded liabilities associated with the teachers’ pension fund), it was still at unacceptable and unsustainable levels ($8.7 B in Budget 2011-12). As well, public expenditures grew at levels that could not be sustained unless revenues continue to grow at unbelievable and unexpected levels.
Despite understanding that, Locke continues to enable his Conservative friends to sustain the same policy of overspending. The result is that between the annual budget and Muskrat Falls, public debt these days is something on the order of $18 billion.  Look at it another way.  In 2011, the provincial government had a cash surplus in its budget.  The 2012 budget was in the red to the tune of $183 million.  The next year, the cash deficit was a little over $700 million.

And in 2014, if the government forecasts come out exactly as predicted last March,  they will run a deficit of $1.3 billion – almost twice the deficit of the year before.

Talk about double down.