30 July 2015

More ways to lose than win #nlpoli

“What this province needs is not just someone with the brains to figure out what's wrong with our economy,” future Premier Kathy Dunderdale wrote in 2002. 

“What this province needs is someone with the guts to start doing something about it for a change.”

Dunderdale’s letter to the editor of the Telegram appeared on April 1, 2002.  She was praising Danny Williams, not surprisingly.  The then-opposition leader had savagely attacked the government during debate in the House of Assembly on the annual throne speech.

No more give-aways, was their cry.

You can hear the words ringing in your ears all these years later.

Or maybe what you are hearing is the clanging of heads people come to grips with the experience of the Danny-Kathy leadership team compared to the hype that preceded it.


Amazingly enough, right before an election Danny Williams and natural resources minister Dunderdale announced they had a deal with a bunch of companies to develop the Hebron project.

A big feature of the deal, the proof of their guts to get more was the super royalty they tacked onto the standard provincial royalty regime.  If oil went above US$50  in any month after the project hit pay-out, the provincial government would get extra cash.

"You know,”  Dunderdale told CBC at the time, “ it's going to be a long time by anybody's estimates that we're ever going to see oil less than $50 a barrel. “

Dunderdale explained that the provincial government "gave something on the downside which is low-risk to us to achieve a very high gain on the upside."  The give-away she was talking about was the part o the deal that gave the company a flat one percent annual royalty  from the time of first oil until the companies recovered all their project costs. 

The royalty scheme from the time Kathy was writing letters to the editor imposed a gradual increasing in royalty that topped out at 7.5%.  It worked very well in projects like Hibernia, White Rose, and Terra Nova. 

Back when oil was cheap,  then-Premier Roger Grimes had floated the idea of a royalty break for the companies as a way of offsetting the costs of the very expensive project.  Williams, Dunderdale and the rest of the Conservative gang tore strips off Grimes for even thinking about such a give away.

By 2007,  though, Dunderdale was rationalising a give-away. It won’t matter, she argued since we’d be into the fat of the new super-royalty so fast, you’d never even notice. 

“A long time by anybody’s estimate” turned out to be two years.

And then a year or so after that, oil was back down around US$50 a barrel.

And now five years after that,  oil has been back down around and below US$50 a barrel so often that it seems almost like 2005 again.

With lower oil prices, the very expensive Hebron project will take longer to hit payout – and big royalties – than Old Twitchy and his sidekick allowed back in 2007.  It was a realistic expectation given the long history of commodity prices that go up and down.  Apparently the big-brained duo missed that little and had the guts to do something.

What they did is illustrated in this little comparison SRBP around the time K and D signed the Hebron deal.The total royalty before payout under the generic royalty and the D and K deal.  The estimate is using a price of oil that would extend the initial royalty period to about a decade.  It also assumed first oil in 2017.

The line on the top goes up like that because the royalty was tied to cumulative production. The more of their costs the companies got back,  the more the people who owned the oil – that is, you and me – should get more cash.  That’s why the royalty went from 2.5% to 5.0% and then to 7.5%.  It’s a simple idea and it took people with  - supposedly – far fewer brains and far less guts than Kathy and her pal to figure out.

Compare the total of $890 million for the generic royalty before pay-out with the paltry $190 million Kathy and Danny’s idea would get you.  Bear in mind, that $190 million isn’t the total for that last year.  It is the total for the whole decade.  $19 million a year.

Then we get to pay-out, the time when the royalty scheme estimates l the companies have recovered all their costs bringing the oil to production.

But hang on, sez you, oil isn’t below US$50 a barrel.  This super-royalty would cut in if the field was in payout today.

Well, no.

You see the self-styled geniuses with guts tied the super-royalty to the price of a type of oil that we don’t produce. The super-royalty is tied to the price for West Texas Intermediate. Our light sweet oil is priced like Brent crude from the North Sea. WTI has been down below US$50 lately while Brent has been above it. 

What that means, in practice, is that our oil could be above the trigger point but we’d get nothing for our earlier give-away because Danny and Kathy made the bizarre decision to fixate on a specific price. It’s like betting at a casino that you will hit one magic number. There are many ways to lose and only one way to win.

The Hebron scenario is actually a little worse. Hebron has a lot of heavy crude that doesn’t market at Brent prices. Hebron crude will sell for less because it is more costly to refine and yields less down the road. That makes the Hebron royalty a double whammy.  With WTI below US$50,  we’d lose out on the light sweet crude at Hebron and we’d get the extra smack for the heavy stuff. 

Even if the eggheads had used Brent as a trigger,  we would stand to make proportionately more off the discounted heavy Hebron oil when Brent is above US$50.  As it is, we stand to lose twice.

The next time you see anyone connected to the current provincial administration talking about brains and guts, just remember the story of Danny, Kathy,  Hebron and that April Fool’s Day letter in 2002.