Feds, Quebec announce joint deal on offshore resources

Natural Resources Canada news release:

“The Honourable Christian Paradis, Minister of Natural Resources, and Nathalie Normandeau, Quebec Deputy Premier, Minister of Natural Resources and Wildlife and Minister responsible for the Northern Plan, today announced that the Governments of Canada and Quebec have reached an important accord on the development of oil and gas resources in the Gulf of St. Lawrence.

"This is an important day that is the result of a great deal of hard work," said Minister Paradis. "Under a co-management framework, Quebec will derive significant financial benefits from resource-related activities. This accord is a concrete example of the two Governments collaborating to create jobs, energy security and economic opportunity in resource communities in the regions of Quebec and Canada. The Government of Canada will continue to work with Quebec to ensure the responsible and sustainable development of our natural resources."

"This is an historic day for Quebec. After more than 12 years — and thanks to the tremendous work of our two governments — we are very proud to announce that the Province of Quebec has an agreement that will give us 100 percent of the revenues from the development of our oil and gas in the Gulf. It's truly a great day for Quebec," said Minister Normandeau.

The Quebec government is undertaking a strategic environmental evaluation before allowing the development of oil and gas in the Gulf of St. Lawrence. The results of this evaluation will be known in 2012.

Since 2006, the Governments of Canada and Quebec have achieved several milestone collaborations. The accord is a key element in the continuation of that work.

The accord will be implemented by means of mirror legislation that will be tabled by the federal and provincial governments before the Parliament of Canada and the National Assembly of Quebec. The accord will be implemented in steps, and rigorous environmental assessments will be conducted before any oil and gas development begins.”

- srbp -

North Amethyst pumps first oil

A few things to note about the news that the White Rose extension field – called North Amethyst – pumped its first oil this week;

1. It took only four years to go from discovery to production. reducing the time from discovery to production is huge for the future of the offshore industry.
2. Tiebacks.  Expect to see more of them as Terra Nova dries out, for example.  Floating platforms are the most cost-effective way to exploit the numerous small fields that have already been discovered offshore. The gang at Terra Nova and eventually at White Rose can just float their hulls around, hook up to underwater pipes and pump the crude cheaply, efficiently and in a way that should be as environmentally sound as oil production can be.
3. An established royalty regime is a key part of promoting development.  That’s what worked for this deal and helped speed up development. Thankfully, while the 2007 energy plan called for a complete overall of the royalty regime, the generic regime is still in place.  Given the rate the current crowd do things, we wouldn’t see a royalty regime to replace the current one for decades.  As it is, the existing, pre-2003 royalty regimes – not the Old Man’s tweaks – are producing the lion’s share of offshore cash these days.

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Freedom from information: Talk about low-balling

Oil production in the first four months of fiscal 2009 is down about 23.5%  - on average - compared to the same period in 2008.

But Hibernia payout and current oil prices mean that the offshore oil patch is on track to deliver about the same revenue to the provincial coffers in 2009 as it did last year.

That’s $2.5 billion for those who are keeping score.

Compare that to the $1.2 billion in oil revenues forecast in Budget 2009.

That also means the provincial budget will be on balance overall.

Of course,  that also means the provincial government still has a couple of billion sitting in the bank doing nothing but collecting modest interest.

So why exactly is the provincial government still opposed to a setting up a sovereign wealth fund  - like Norway or Alberta - to ensure the people of the province get the maximum benefit from their resources?

When you think about it, that makes it hysterically funny  to see the federal Dippers trying to buy votes in the province by talking about “fairer” Equalization.  Are they promising Alberta Equalization hand-outs too?

-srbp-

Hibernia Southern Extension MOU Assessment, Part I: Royalty - some potential added cash plus a cap

While Danny William’s radio tirade/meltdown is rapidly eclipsing his own good news announcement nationally, there is interest in assessing the details of the Hibernia South Extension memorandum of understanding based on the official news release and news reports on the day of the announcement.

Caveats

As with Hebron, the final agreement may yield some details which were not readily apparent when the MOU was announced.   As well, and as with Hebron, key portions of the deal are likely to be hidden from public view.   With that said, we still have enough information to make some observations about the proposed development deal.  In this first post, we will look at the royalty regime.

General

Overall, this agreement represents a transformation from Williams Mod 1 to Williams Mod 2 in the government’s approach to offshore oil development.

Williams Mod 1 (pre-2o06) was essentially a variation pre-1984 provincial government thinking and emphasised:

• increasing local benefits especially through forced development of refining and downstream production;
• some additional revenue from federal transfers, and
• an undefined “equity” interest which is essentially analogous to the old petroleum corporation.

Williams Mod 2 (post- 2006) places the greatest emphasis on additional government revenue through the most obvious source:  enhanced royalties. This is especially clear in the Simms encounter where the Premier states:

The reason we’re caught up in the oil, it’s not the oil, it’s the black gold that’s out there, it’s not the petroleum, it’s not the oil and gas, it’s the revenue that it brings to us, so that we can deal with problems in the fishery, so that we can take care of the Abitibi workers, so that we can build new hospitals and new long terms care facilities, so that we can build new schools, so that we can lead the country in poverty reduction, and it goes on and on and on. Surely you – presumably – run a municipality. You must know the importance of revenue, and where that revenue comes from – if it comes from business, whatever form of business it is, or if it comes from residential real estate, it goes into your coffers now so you can do all the wonderful things that need to be done. [Emphasis added]

Government-induced infrastructure has been effectively abandoned as evident in both Hebron and Hibernia South and the equity portion has also been capped artificially at 10%.  In Hibernia South, the second GBS or other production facility has been discarded for the most economical production method (slant drilling from the original GBS and tie-backs to the original GBS).

This effectively adopts the philosophy that guided resource development after 1985 and is best seen in the 1990 Hibernia agreement and in the subsequent developments at White Rose and Terra Nova.

As much as Danny Williams may like to complain about those who offer alternative views to his own, this basic approach has been noted before – including in this corner – as an alternative to Williams Mod 1. 

The easiest, most efficient means of enhancing government revenue is through adjustments to the royalty regime.   Revenue is needed to meet the demands for program spending and infrastructure development today. Regular readers of Bond Papers will recognise the refrain.

Hibernia Southern Extension Royalty Regime

The base for the three-part royalty is the existing Hibernia royalty regime as concluded in 1990 and modified in 2000. 

This sets the rate after simple payout (achieved a few months early) at 30% Tier 1 royalty with a further 12.5% Tier 2 royalty triggered by profitability.

This is the royalty rate – 42.5% -  that produces the bulk of the cash.

The royalty regime for the southern extension is cut into three parts.  There is no explanation as to why the rate is structured this way. The backgrounder provided with the news release does not explain the structure clearly.

Part I:    For the 50 million barrels or so that will be drilled directly from the Hibernia gravity base structure, there is the 42.5%  that already exists in the Hibernia royalty regime established in 1990 and modified in 2000.

There is no price trigger for this since the original royalty regime did not tie provincial government revenues to oil prices directly.

Part II:  For the portion of the project that is under the original production License 1001 (PL 1001), the basis is the original Hibernia royalty regime (maximum 42.5%, not tied to price).

In addition there is a further 7.5% royalty when prices for West Texas Intermediate (WTI) are above US$50.  Above WTI at US$70 there is an additional 5%. 

There is a cap on the royalty however: 

Should supplementary royalty payout be achieved under the terms of the original Hibernia contract be achieved, the top rate will be 50 per cent.

It would appear that once the project has triggered the Tier 1 and Tier 2 royalties (42.5%),  only an additional 7.5% is available beyond that irrespective of price. 

Part III:   There is a similar 50% cap in the new areas, i.e. the ones covered by PL 1005 and Exploration License 1093 (EL 1093).  The cap is achieved by reducing the incremental royalty tied to price (WTI at US$50) from 7.5% to 2.5%.

Observations

Overall, this represents a complex arrangement that modifies the existing royalty regime slightly. The complexity may be due in part to the highly diversified interests in the three licenses, especially EL1093.

In many pricing scenarios, then, the maximum available royalty from what is described here as Part II of the regime  would appear to be the same as under the existing Hibernia regime, i.e. 42.5%.

On the face of it, the Part II and Part III royalty structures offer an identical outcome.  Additional information would be needed to explain how the structure works and why it is in place.

The provincial government revenue figure offered in the announcement  - $10 billion – is apparently derived almost entirely by applying the existing Hibernia Royalty Regime to an environment in which oil prices are considerably above the average price that existing during the initial phase of the project.

-srbp-

Money Update:  Premier Danny Williams told CBC’s David Cochrane today that the estimate of $10 billion of provincial revenue from Hibernia South is based on an estimated average oil price of $83 over the next decade.

There is something suspicious about the government calculation though since Williams claimed on Tuesday that five times as much oil left in Hibernia as in Hibernia South would net the province only slightly less cash than Hibernia proper even though both projects use essentially the same royalty regime:

We expect a further $13 billion from the remaining main field production and this extension adds an estimated $10 billion more in revenue for the province…

Offshore royalty audits “Behind, big time”: Dunderdale

In July 2006 when Danny Williams accused ExxonMobil of denying the provincial government access to the books for the Hibernia project there was a lot more to the story either than what he said or than just his fit of pique at the failure of talks to develop Hebron.

Williams put it in another context altogether at the time, claiming the company had reneged on a commitment to “audit process to validate statements by the company that the Hibernia project was not meeting the owners’ expectations.”

As it turns out, the reality – revealed almost three years later by the province’s auditor general in his annual report for 2007 (year ending 31 March 2008) -  is that the provincial government was and is behind in its own audits of offshore oils project reports:

… At October 2008 [sic], there were 87 annual royalty and eligible project cost submissions made by project
owners for which the Department has not started any audit work. No royalty or eligible project cost audits have been conducted on the Terra Nova or White Rose projects since production started in 2002 and 2005 respectively.

On top of that the department’s audit manual was approved in 2000 but hasn’t been updated in the intervening seven years.

The auditor general also revealed that the department had quietly dropped its 2006 demand for access to the Hibernia books claiming they could adequately assess the issues without the company’s documents.

Each of the 15 companies operating offshore are required to file monthly and yearly operating reports with the provincial government.  They must also file an audited financial report annually on project costs.  All these are used to calculate royalties paid to the provincial government’s royalties and benefits division of the natural resources department.

The majority of the outstanding audits, shown in the chart at left taken from the auditor general’s report,  are for the period after 2003.

In early 2006  - the year Williams made his accusations against ExxonMobil and the year before the one audited by Noseworthy – then natural resources minister Ed Byrne told a House of Assembly committee that his department was experiencing staff problems in the division of his department responsible for the royalty and cost audits. 

MR. E. BYRNE: Difficult not only to attract, difficult to maintain. A lot of this, too, is part and parcel of the energy policy review that is ongoing and the dedicated resources we put to that. Within the Department of Natural Resources, the energy division is most challenged, more than any other division within the department, on not only recruiting but maintaining.

We had senior petroleum auditors who left for double the salary. We recently had an ADM who took a job in Calgary. I do not know what his salary was or what he was offered. He was making a competitive salary here, but it was a significant offer. Those are issues that the deputy and government struggle with everyday. Anyway, that is part and parcel of the change in direction there.

Within the local oil patch the migration of senior, experienced public servants to the private sector caused a great deal of chatter.

The problem hasn’t gone away.  Last May, natural resources minister Kathy Dunderdale told the House of Assembly’s Resources Committee that there had been a number of vacancies in the audit division and that the department was hiring outside contractors to take up the slack. She said the audits were “Behind, big time.”

The department’s deputy minister  - Chris Kieley - told the committee:

For those three projects [Hibernia, Terra Nova and White Rose], and with the increased activity, every year we are doing audits but, because of the turnover in staff, because of the resources that were assigned to that particular piece in previous years, the audits were behind; so, this past year and the year before we have made a particular effort to get those audits up to date and we have used outside assistance through auditing firms to help us do some of those audits. So, we have a combination now of outside accounting firms helping us get the audits up to date and we have our own staff working on the audits as well. We are working on a number of different audits now with all our projects at this point.

Kieley also insisted in May that

“[w]e are within the timelines prescribed by legislation (inaudible) the Hibernia royalty contract, but we are behind and we are putting extra effort into this whole piece to get caught up. When I say behind, we have not lost any ability to audit these. What we are saying is that we would like to get them up to a closer time frame.”

Auditor General John Noseworthy noted in his report that the Hibernia audits completed had revealed $8.66 million owed to the provincial government.  In her testimony to the resource committee, natural resources minister Kathy Dunderdale insisted, however,  that “there has been nothing earth-shattering that we have come across to this point.”  The completed audits done in May 2008 are almost identical to the ones listed as finished by the auditor general in his report.

Noseworthy also noted that the department had committed to completing all outstanding audits by 2010. At the same time, though noted that even the 2008 schedule was off, largely due to staffing problems within the natural resources department.

In 2008, the work plan was amended to move 2400 hours of work scheduled for White Rose to 2009 as a result of audit work done for Hebron.  As of October 2008 – half way through the fiscal year - an external contract for an auditor had not be let for 2008.

The 2008 audit plan was based on 1400 hours for four staff positions supposed to be filled by the start of the fiscal year.  By October 2008, one position was still vacant.  Another was filled in July and only two of the original four planned were in place in April 2008. Associate deputy minister Pierre Tobin gave the resource committee a different version at the committee hearings in May.  Rather than disclose that two audit positions were vacant, he left the committee with the impression the division was “almost fully staffed”:

That would be, in the past year, a number of auditors, but those positions have since been filled for the most part. There would also have been a couple of development officers and a couple of economists. We are almost fully staffed, particularly in the royalty audit section. We are down one person out of upwards to a dozen, I guess; we are doing really well there. [Emphasis added]

-srbp-

"Reality Check" reality check on Equalization and the Family Feud

The crew that put together's CBC's usually fine "Reality Check" can be forgiven if they missed a few points by a country mile in a summary of the Family Feud.

Forgiveness is easy since the issues involved are complex and  - at least on the provincial side since 2003 - there has never been a clear statement of what was going on.  Regular Bond Papers readers will be familiar with that.  For others, just flip back to the archives for 2005 and the story is laid out there.

Let's see if we can sort through some of the high points here.

With its fragile economy, Newfoundland and Labrador has always depended on money from the federal government. When they struck oil off the coast, the federal government concluded it would not have to continue shelling out as much money to the provincial treasury. N.L.'s oil would save Ottawa money.

Not really.

Newfoundland and Labrador is no different from most provinces in the country, at least as far as Equalization goes.  Since 1957 - when the current Equalization program started - the provincial government has received that particular form of federal transfer.  So have all the others, at various times, except Ontario.  Quebec remains one of the biggest recipients of Equalization cash, if not on a per capita basis than on a total basis. Economic "fragility" has nothing to do with receiving Equalization.

In the dispute over jurisdiction over the offshore, there was never much of a dispute as far as Equalization fundamentally works.

Had Brian Peckford's view prevailed in 1983/1984, Equalization would have worked just as it always has.  As soon as the province's own source revenues went beyond the national average, the Equalization transfers would have stopped.

Period.

That didn't work out.  Both the Supreme Court of Newfoundland (as it then was called) and in the Supreme Court of Canada, both courts found that jurisdiction over the offshore rested solely with the Government of Canada.  All the royalties went with it.

In the 1985 Atlantic Accord, the Brian Mulroney and Brian Peckford governments worked out a joint management deal.  Under that agreement - the one that is most important for Newfoundland and Labrador - the provincial government sets and collects royalties as if the oil and gas were on land.

And here's the big thing:  the provincial government keeps every single penny.  It always has and always will, as long as the 1985 Accord is in force.

As far as Equalization is concerned, both governments agreed that Equalization would work as it always had.  When a provincial government makes more money on its own than the national average, the Equalization cash stops.

But...they agreed that for a limited period of time, the provincial government would get a special transfer, based on Equalization that would offset the drop in Equalization that came as oil revenues grew.  Not only was the extra cash limited in time, it would also decline such that 12 years after the first oil, there'd be no extra payment.

If the province didn't qualify for Equalization at that point, then that's all there was.  If it still fell under the average, then it would get whatever Equalization it was entitled to under the program at the time.

The CBC reality check leaves a huge gap as far as that goes, making it seem as though the whole thing came down to an argument between Danny Williams and Paul Martin and then Danny and Stephen Harper.

Nothing could be further from the truth, to use an overworked phrase.

During negotiations on the Hibernia project, the provincial government realized the formula wouldn't work out as intended. Rather than leave the provincial government with some extra cash, the 1985 deal would actually function just like there was no offset clause. For every dollar of new cash in from oil, the Equalization system would drop Newfoundland's entitlement by 97 cents, net.

The first efforts to raise this issue - by Clyde Wells and energy minister Rex Gibbons in 1990 - were rebuffed by the Mulroney Conservatives.  They didn't pussy foot around. John Crosbie accused the provincial government of biting the hand that fed it and of wanting to eat its cake and "vomit it up" as well.

It wasn't until the Liberal victory in 1993 that the first efforts were made to address the problem.  Prime Jean Chretien and finance minister Paul Martin amended the Equalization formula to give the provincial government an option of shielding up to 30% of its oil revenue from Equalization calculations.  That option wasn't time limited and for the 12 years in which the 1985 deal allowed for offsets the provincial government could always have the chance to pick the option that gave the most cash.  It only picked the wrong option once.

The Equalization issue remained a cause celebre, especially for those who had been involved in the original negotiations.  It resurfaced in the a 2003 provincial government royal commission study which introduced the idea of a clawback into the vocabulary.  The presentation in the commission reported grossly distorted the reality and the history involved. Some charts that purported to show the financial issues bordered on fraud.

Danny Williams took up the issue in 2004 with the Martin administration and fought a pitched battle - largely in public - over the issue.  He gave a taste of his anti-Ottawa rhetoric in a 2001 speech to Nova Scotia Tories. Little in the way of formal correspondence appears to have been exchanged throughout the early part of 2004.  Up to the fall of 2004 - when detailed discussions started -  the provincial government offered three different versions of what it was looking for.  None matched the final agreement.

The CBC "Reality Check" describes the 2005 agreement this way:

The agreement was that the calculation of equalization payments to Newfoundland and Labrador would not include oil revenue. As the saying goes, oil revenues would not be clawed back. Martin agreed and then-opposition leader Harper also agreed.

Simply put, that's dead wrong.

The 2005 deal provided for another type of transfer to Newfoundland and Labrador from Ottawa on top of the 1985 offset payment.  The Equalization program was not changed in any way. Until the substantive changes to Equalization under Stephen Harper 100% of oil revenues was included to calculate Equalization entitlements.  That's exactly what Danny Williams stated as provincial government policy in January 2006, incidentally.  The Harper changes hid 50% of all non-renewable resource revenues from Equalization (oil and mining) and imposed a cap on total transfers.

As for the revenues being "clawed back", one of the key terms of the 2005 deal is that the whole thing operates based on the Equalization formula that is in place at any given time. Oil revenues are treated like gas taxes, income tax, sales tax, motor vehicle registration and any other type of provincial own-source revenue, just like they have been as long as Equalization has been around.

What the federal Conservatives proposed in 2004 and 2006 as a part of their campaign platform - not just in a letter to Danny Williams - was to let all provinces hide their revenues from oil, gas and other non-renewable resources from the Equalization calculations.  The offer didn't apply just to one province.  Had it been implemented, it would have applied to all. 

That was clear enough until the Harper government produced its budget 18 months ago. What was clear on budget day became a bit murky a few days later when Wade Locke of Memorial University of Newfoundland began to take a hard look at the numbers.

Again, that's pretty much dead wrong.

It became clear shortly after Harper took office in 2006 that the 100% exclusion idea from the 2004 and 2006 campaigns would be abandoned in favour of something else.  There was nothing murky about it at all. So plain was the problem that at least one local newspaper reported on a fracas at the Provincial Conservative convention in October 2006 supposedly involving the Premier's brother and the Conservative party's national president. That's when the Family Feud started.

As for the 2007 budget bills which amended both the 1985 and 2005 agreements between Ottawa and St. John's, there's a serious question as to whether the provincial government actually consented to the amendments as required under the 1985 Atlantic Accord.

The story about Equalization is a long one and the Family Feud - a.k.a the ABC campaign - has a complex history.  There's no shame in missing some points.  It's just so unusual that CBC's "Reality Check" was so widely off base.

-srbp-

$794 million deficit: the ABCs of provincial government budgeting

If crude oil averages US$87 per barrel through the current fiscal year (ending 31 March 2009) and the government performs exactly as budgeted in every other respect too, the provincial government will wind up with a deficit of more than $794 million this year.

That's right.

Almost eight hundred million dollars in the hole.

It's not a state secret.

Your humble e-scribbler did not have to go through any contortions - mental or otherwise - to figure it out.

The figures are there, in black and white, in the provincial government's current budget.  Hidden in plain sight, you might say.

But no, some of you are saying, the provincial government is forecasting a surplus of a half a billion dollars. The media reported it in April and they've kept saying it so it must be true.

Yes, the did and they have.

But that isn't the official budget of the provincial government approved in the House of Assembly any more than all the talk by politicians about surpluses the past few years was accurate either.

That forecast was done separately by the department of finance and repeated by the finance minister countless times.  It is based - evidently - on the hope that oil would actually spend most of the year well north of US$87. They were hoping on oil revenues being almost double the $1.7 billion used to make up the budget. An extra $1.3 billion would wipe out the forecast deficit and leave another $500 million or so besides.

The recent drop in oil prices below US$100 could throw that hope out the window, coming as it does a little less than half way through the fiscal year.  Oil would have to drop quite a bit further than its current price in the mid nineties to wipe the anticipated surplus out entirely, but don't count on there being too much cash left in the till next April.

There are a couple of reasons for that beyond the drop in revenues compared to the Atlantic City dice roll projections. 

For starters, if revenues are already up by about $800 million or so, government might be able to bring in something close to a balanced budget. Any less than that and something's gotta give to stay in the black.

The other thing is that - contrary to the popular view - government hasn't actually produced a real surplus in three years.  Again, eyes are rolling, but all you have to do to see the truth is look at the government's annual financial statements.

Last year, for example, the government spent every nickel it originally budgeted, every penny of the $1.5 billion surplus and on top of that had to borrow another $88 million just to make ends meet.

Just to make it really plain, that table above is  taken from a Bond Papers post last June that lays the whole thing out in a picture.

This administration, like pretty well all the ones before, likes to spend public cash.  If there isn't enough coming in, hitting up the banks is just as good as money earned in other ways.

As the Auditor General pointed out in his report earlier this year, the provincial government has consistently boosted public spending based on the mountains of oil cash flowing.

They've  built the province's spending on some pretty shaky ground, namely highly volatile commodity prices.

At the same time, very little attention has been paid to paying down the large amount of debt - the accumulated deficits - that now runs upwards of $8.5 billion and is expected to climb higher this year.

That's the table at right, with the figures taken from the finance department's budget document, The Estimates.

For those of you whose mind has not just boggled into the "off" position, this has some pretty significant implications for what is going on in the province.

The province's finance minister told reporters today that salary expectations from groups like the nurses are based on high oil prices.

No, they aren't. 

High public expectations for new spending and public sector union salary demands are based on the government hype about its own financial plans and its own cash flows.  The people of the province believed all the stuff about surpluses and happy days finally being here. They believed because that is what they were told by politicians.

People have even been lulled into believing that the Hebron project - all $28 supposed billion of it  - is coming right along any day now. 

The reality is starkly different.

Oil revenues will decline over the next decade because of dwindling production and prices that are returning to something approaching the norm.  The three existing fields will be well on the way to shutting down by the time Hebron gets into production.

Rather than adding to current cash flows - as most people likely believe - Hebron will simply take up some of the slack from that dwindling production.  If construction starts on Hebron in 2012, the cash from its oil won't hit provincial coffers until about a decade from now.

The reality is that the next decade is going to be considerably more difficult than people imagined;  difficult that is for the provincial government.  They have made a rod to beat their own backs by creating a climate of expectations that simply can't be met with likely revenues.  At the same time - through the energy corporation and the equity stakes - they've committed to a steady stream of new government borrowing over and above what it may cost to sustain the existing spending levels after the oil money drops off.

There's nothing overly complicated about the whole business.  The information is readily available to anyone who cares to look.

Understanding what is going on today and what looks very likely to happen?

Well, that's as easy as A-B-C.

-srbp-

Risky Business 2: Provincial government cost/revenue estimates

The Telegram front page today carries a story on the provincial government's revenue estimates for the Hebron project in three scenarios.  The scenarios use oil at an assumed average price over the life of the project at US$50, US$87 and US$113 (constant 2008 dollars). The story is also available online.

Given that oil prices haven't averaged anything near US$87 or US$113 over the past 25 or 30 years, that US$50 a barrel estimate in constant dollars is probably a little closer to the likely performance of oil prices sometime after 2018.  In that scenario, the provincial government estimates revenues at $6.8 billion, including $5.4 billion from the revised royalty regime.

That royalty regime keeps royalties at a constant 1% up to simple payout and then provides for an additional 6.5% in any month after simple payout in which prices average above US$50 for West Texas Intermediate at Cushing, Oklahoma.

To see the impact of oil prices on the revenue projections using the revamped royalty regime, all you have to do is lop one measly dollar off the assumed average price. At US$49 - a 2% drop from the government's assumed average price -  the province's royalty take drops by at least $1.25 billion.  That's 23% less. Factor in the loss from the changed royalty regime, which government estimates at $105 million at the average price of US$50 a barrel and the loss climbs.

The provincial estimates see the 4.9% equity position generating $800 million for the energy corporations oil subsidiary at the US$50 price assumption. This appears to be based on total costs for the company of $600 million over the life of the project (construction to decommissioning).

Based on the provincial government's own estimates of costs for acquisition and the construction phase, that would assume the OilCo's share of all production and decommissioning phase costs at $200 million. That works out to a total projected cost of $4.0 billion for ongoing operations of the rig, exploration, delineation and production drilling after first oil and whatever share of decommissioning costs the oil company will bear.  It would also have to include any fees and charges for handling the sale of crude which represents the OilCo share of production.

Low-balled costs?  Could be. Bond Papers' preliminary estimate of lifecycle costs for OilCo came in at about twice the amount apparently used in the provincial government calculations. Bond Papers used a figure of $10 billion as the cost of operations expenditures and production phase drilling, and decommissioning costs, including the $250 million for a liability guarantee.

Fixing an accurate estimate of the costs after first oil would help refine the calculations.  That may be difficult, though, since the acquisition agreement between the provincial government and the oil companies hasn't been released to the public.  It might become somewhat easier when and if a development application is filed with the offshore regulatory board.  That application would include a forecast of drilling activity for the production phase.

-srbp-

 

Related:

1. "Hebron second royalty: a second view".  (August 2007) Examines the Hebron royalty, as originally presented in the memorandum of understanding, using an assumed average price in constant 2005 dollars.
2. "Hebron basic royalty: a preliminary assessment" (August 2007)
3. "Masters of our domain: Williams concedes on royalties". (August 2007)
4. "Masters of our domain: province lowers royalty for Hebron pre-payout phase". (August 2007)
5. "History repeating itself".(August 2007).  Notes the impact of changing assumptions on the price of oil on perceptions of the "value" of a deal.

What happens after every climax?

Quick.

Without looking it up or asking your own yaks-milk-is-pink fountain of otherwise useless information:

1.  Name the three astronauts on Apollo 12.
2.  Name one of the astronauts on Apollo 14.
3.  How about the three on Apollo 18? 
4.  Was there an Apollo 18?

Don't feel bad. 

As amazing as it seems, few people know much about one of the most spectacular achievements of the human species:  putting people on the moon even for brief stays.

Even at the time, public interest in space travel faded not long after Apollo 11 reached the moon and Buzz Aldrin and Neil Armstrong bounced around on its surface in July 1969.

Now think about last spring's provincial budget.  For all the magicality and splendiferousness of it, the whole thing garnered the government maybe 48 hours of half-decent media coverage.  The punters didn't really talk it up much either, except maybe the bootie call of a thousand bucks for every new member of the race brought into the world.

Instead, the news and much public commentary these past eight or months have been filled with less than happy stuff for the provincial government.

Part of that is the natural shift in public expression that takes place with any government that's been in office more than a few months.  By five years people will naturally change gears from cheering to either moaning or indifference. As Brian said to the ex-leper:  "There's no pleasing some people."  And more to the point, people just aren't wired to endlessly praise government or feel good about what's going on.  They like to bitch.

Another part has been the series of events that would actually warrant some public unhappiness.  Pick an issue.  There isn't one of them - contrary to the view of at least one person on the cbc.ca/nl website comments - that isn't a legitimate news story.

Another part of the current media environment, at least when it comes to good news, is the simple fact that when you've already announced good news, the re-announcement of the announcement of the news just loses its grip.

People spent years getting ready for men to walk on the moon.  They followed the development of the project.  The vicariously shared the highs like all the successful Mercury and Gemini missions and they shared the sorrows, like the deaths of three astronauts aboard Apollo 1.  But once Neil and Buzz put toe one on the moon, that was the climax of the whole thing. 

After a climax of any kind, it's all down hill from there.

Last spring's budget was a big unsurprise.  Good news budget after good news budget and astonishing surpluses (even if not quite surpluses after all) piled on surpluses just get a bit repetitive after a while.  Imagine if Cleary and the Red Wings win the cup next year how much excitement there'll be.

Hebron may wind up being kinda the same thing.  When it didn't happen, well that was news.  It had all the elements, good and not so good:  controversy, power, drama, money, conflict, disappointment.

When the Premier announced a memorandum of understanding on the project last August, in polling season and right in the middle of the longest undeclared election campaign in provincial history, there was excitement.  People talked about it for weeks after.

So when the final Hebron deal is announced in the middle of a couple of by-elections and during polling season alter this month, don't be surprised if it is a media flurry lasting all of a couple of days.  Odds are it will lead the news that night, but by the next day expect something else to hit. In short order, it will become the Apollo 12 of government announcements.

Now that's not to say the final deal won't be good news.  It pretty much will be, unless something happened since last August to make - for instance - the local benefits potential is less than first appeared. We won't know the impact of the altered royalty structure until well after first oil, which is likely to take place sometime closer to 2020 than not.

But you see, Hebron's already been announced once last August.  Then it was,  in essence,  re-announced in June. For all the hoopla that will accompany the media event, the people directly affected by Hebron are just waiting for the whistle to signal the start so they can get working.

And unless there's something else coming along behind it that hasn't been talked up and talked over for years, odds are the next big announcement will have the same news impact.

It's just what happens after every climax.

-srbp-

FY 2008 budget set already: annual charade becomes accountability farce

Any organization looking to influence provincial government spending in the budget for Fiscal Year 2008 can cancel their plans.

The budget is set.

An announcement Thursday by two cabinet ministers of capital spending for the fiscal year starting in April is proof the spending program is already done and likely has been done since well before Christmas, if not before the last general election in October 2007.

The announcement included a little jocular disingenuousness on the part of one minister:

Included in the money is $73 million for the 2008-09 provincial roads improvement program. That's a 10 per cent increase over the $66.5 million the program got last year.
"I hope I don't give Finance Minister (Tom) Marshall a heart attack today because I'm going to be looking for another 10 per cent over and above my $66.5 million," [transportation minister Diane] Whalen joked.

Tom knows all about it. So does everyone else in cabinet, most likely.

Otherwise, Diane wouldn't have been able to make the announcement.

And the pre-budget "consultations" usually organized by the finance minister?

No sign of those yet, but when they do come they will have returned to what they were when Brian Tobin's crew started them in 1997: a charade.

White Rose observations

The provincial government and the White Rose partners revealed some further detail of the White Rose expansion project on Monday.

Some observations/questions:

1. The bulk of the financial return to the provincial treasury is from the old generic royalty regime established in 1996.

2. There is no real discussion of the "equity ownership" and what it means.

With the exception of a few general references, there is no discussion at all of what is entailed in the "equity". There is no discussion of acquisition costs or other liabilities associated with it, nor is there any discussion of what - if any - management rights accrue to the energy corporation our of this stake.

There is a reference to a processing fee on "its", i.e. the energy corporation's, oil but no indication of what that means in general terms.

3. What is the "processing fee" for?

Under the agreement, the province’s energy corporation will pay a ‘processing fee’ of $3.50 a barrel on its oil.

This is essentially a fee to ensure processing capacity on the Sea Rose FPSO.

The floating production, storage and offloading vessel for the project has the capacity to handle production from the field at the approved rates. It can store and process at established rates. There is no obvious reason for the provincial government to pay a set fee per barrel to ensure capacity exists.

If this fee is one applied to all operators, then this is an operating cost, not a cost related to acquisition of an equity interest, it has been presented.

If it is an operating cost, it certainly isn't clear if the fee represents the total energy corporation share of operations or if it is a specific amount related to a certain aspect of operations. A "processing fee" of this type is sometimes applied on leased FPSOs where the vessel owner is actually reimbursed a lease rate and an additional amount for processing from the company renting the platform.

The fee may be related to a process of "deeming" what part of production belongs to the provincial government, even though the production is co-mingled with the total production. That appears to be the case, given the implication of the next sentence in the backgrounder: "To get the crude to market, there are a number of marketing arrangements already in place with existing facilities, and the province’s energy corporation will be able to tap into those."

Essentially, the energy corporation would receive the value of a quantity of oil less operating, capital and any other costs rather than receive a specific quantity of oil that it could then take to a refinery and market directly. The quantity of oil would be "deemed" or established based on a set of accounting rules.

There's nothing unusual or necessarily problematic about such an arrangement; it would just mean that the energy corporation could not necessarily load up a series of tankers and move the crude to a refinery of its choice.

So what is the fee really all about and what other fees and charges are being applied to the energy corporation?

3. There is no indication publicly of what the energy corporation will pay as part of ongoing operations expenditure or what share it will bear, if any, of phase-out or emergency response costs.

4. Will energy corp pay its portion of the provincial oil royalty on its assets? How will that be handled?

-srbp-

Skinner-ma-rinky-dink opinions from two cabinet ministers not worth heeding

Brian Peckford irritates some cabinet ministers.

"I really think that we've really dropped the ball on the whole fishery issue in Newfoundland. I really, really do," he said in a recent interview.

"I think we have not, as a province, argued relentlessly and weekly pursued a fisheries strategy which would allow us to have ... an Atlantic Accord on the fishery.

"Because what we did on the Atlantic Accord was we put the jurisdiction away, even though we lost in court. We got it back through the back door."

Peckford's crime is voicing an opinion, according to finance minister Tom Marshall and Kevin O'Brien, the fellow heading up the oxymoronicaly-named department of government services. The two ministers called VOCM's morning talk show to express their disapproval of the fellow who, as both took pains to note, doesn't live here any more.

Said Marshall: "Well that's exactly, and, you know, to live out there [in British Columbia] and then come in here and tell us we're doing it all wrong is a bit much."

Oh deary.

A bit much for a fellow who served as premier through a very difficult decade to dare offer an observation not merely on the performance of one administration but of the lot of us and the crowds we've elected.

Go read Peckford's comments, linked above, and then read Marshall's observations, transcribed in their entirety below.

"We seem to have one mindset when it relates to the offshore and a ... less-than-stringent approach to all the other areas - even those that are under our jurisdiction."

Peckford is hardly telling tales from school. One need hardly look very hard to see this double-standard applied. No subsidies for the oil industry - supposedly - and a heaping of something called 'equity' for the provincial government. By contrast, the forest industry gets at least $30 million in subsidies of one kind or another and when a mill closes and another shuts down a machine, the whole affair warrants scarcely a whimper from the most combative premier since...well...Brian Peckford, compared to the unholy tirade unleashed on oil companies.

Over in the fishery, meanwhile, the current provincial government enthusiastically facilitates the destruction of the only vertically integrated, internationally competitive company in the lot. Somewhere in there, the bits and pieces are sold off to a consortium that includes Icelanders, another lot is sold back to the Brits and the Nova Scotians walk off with the marketing arm and brands it took years to build.

All of these are resources, as most scarcely need reminding and yet oil is treated as some sort of sacred possession by the current administration. The fishery and forestry? Not really quite as sacred.

For his part, Tom Marshall tried to argue against Peckford on other matters. Marshall failed, of course, since most of what he said was utter nonsense. Like the bit about offshore revenues, the stuff which apparently the provincial government wasn't as fixated on as Peckford suggested:

You know, I really don't know. I mean there was, there's been two stories here. One came out of the, one was in The Telegram, I think, on the weekend. It talked about, you know, the Atlantic Accord and how everything is flowed out of the Atlantic Accord. And the Atlantic Accord that was negotiated back then was certainly an important document. I mean it did, it did share the management. Even though the federal government was determined by the courts to have jurisdiction over offshore oil and gas, it said that Newfoundland would be, Newfoundland and Labrador would be the principal beneficiary. But it wasn't working. It wasn't working as it was. We weren't seeing the benefits because we were losing them under the equalization formula. Whatever we were getting on the oil and gas we were losing under the equalization formula. So what Premier Williams did in '05 in the Atlantic Accord in '05, I mean that was the key document that made the difference because what he accomplished was that for every dollar we were losing on the oil and gas we got an offset payment from the Department of Natural Resources in Ottawa. We got this offset payment that made us whole. And as a result of what Premier Williams did in '05, the Atlantic Accord '05, you know, this year we're showing 305 million, which is allowing us to forecast a surplus of 261 billion, I'm sorry, 261 million and to p ay down some debt and that's what's made the difference. I mean Premier Williams has made the real difference here because we weren't getting rich before under the first part of the Atlantic Accord, but that's not to say that it wasn't, you know, a great document.

Under the 1985 Atlantic Accord, Tom Marshall and his colleagues get to set provincial government revenues from the offshore and collect every nickel of them. They keep every nickel of them as well. $16 billion worth of nickels from Hebron alone, as Marshall's colleague has claimed, and not a single one of those nickels, nor the pennies either, has ever been taken by any other government.

Not a one.

Anyone who claims otherwise is telling fibs.

The 2005 deal delivered the princely sum of $2.0 billion in a cash advance. The deal expires when the province ceases to qualify for Equalization and, as regular readers of Bond Papers will know, the advance will not be drawn down completely when the deal expires.

The entire basis of the provincial government's current fumbling in the oil industry comes from powers contained not in the 2005 deal but in the 1985 Atlantic Accord. When the 2005 deal is a moldering memory, the 1985 agreement will continue to deliver, as it has delivered since it was signed.

All that Brian Peckford has done in a series of interviews with local media is offer his views - based on experience - on issues related to resource management. He has a right to speak his mind and only the most churlish of churls would question his inherent right in a democracy to speak.

But Peckford is no ordinary voice. His voice drips of the experience of hard knocks and whether or not one supported him at the time or agrees with him now, he has every right to speak his mind. he earned the right and he should be heeded. One must not slavishly accept his every syllable, as some - like Marshall and O'Brien - must do for their master, but there are other legitimate perspectives than the one currently typed out as talking points from the Eighth Floor's blackberries.

It would be a mistake, however, to think that Marshall and O'Brien are hurling missiles at Peckford merely for speaking out or merely at their master's behest. What Peckford has hit on, with respect to the fishery, for example, is a deep-seated problem within local politics. While politicians have known for some time what must be done in the fishery, it is very difficult to get them to act. There is no stomach in the current administration as there has been no stomach in many administrations for taking the necessary measures to turn the fishery into an economically and environmentally sustainable part of the local economy.

It hurts to have that pointed out, apparently.

Otherwise Marshall and O'Brien would not have received their blackberry marching orders and thus ordered, skinnered themselves on to the open line shows to offer a rinky dink attack on a fellow most Progressive Conservatives in the province should be venerating. [Perhaps they do and that bothers some of the current crowd, too. But that is another story.]

Every thinking person in the province would do well to consider Peckford's advice.

It is the voice of experience and, as we should all know by now, experience counts.

Talking points thumbed out of someone's blackberry - likely from a junket to Rio - don't.

-srbp-

RANDY SIMMS: We are going to go now and say a very good morning here to the Finance Minister and Chairmen, President of the Treasury Board, Tom Marshall. Good morning.

TOM MARSHALL: Good morning Randy.

RANDY SIMMS: How are you doing?

TOM MARSHALL: I'm not too bad. I'm here in Corner Brook and I was just reading The Western Star today and I say former Premier's, Brian Peckford's remarks.

RANDY SIMMS: And your hair stood on end.

TOM MARSHALL: Well, what's left of it did. The, you know, the comment I read, I mean it's mainly about the fishery and I'll leave my colleague, Tom Rideout, and those with more, know more about the fisheries that I certainly do to comment on that aspect of it, but my difficulty is with the comments that, where Peckford said it's a mistake for the province to focus its efforts on the blossoming offshore oil and gas industry at the expense of everything else. And he goes on to say that we, I don't know who he's referring to as we, seem to have a one mindset when it relates to the offshore and a less astringent approach to all the other areas, even those that are under our own jurisdiction. Now, Randy, you know, every time I've been on your show and your colleagues' shows, and I've been going around the province given these, you know, talking about the budget and the main point, you know, the one thing that we're doing as a government is clearly set out in the budget and it's set out in the speech from the throne, and that's a recognition that the non-renewable resources are going to be gone day, that they're finite. One day they're going to be gone and that we've got to take advantage of this window of opportunity to transition our economy into a more diversified economy that, you know, that relies on our renewable resources. The whole energy plan talks about, you know, taking advantage of the non- renewable energy resources we have now to make sure that we have renewable energy resources for the future. And for someone to come in and say that we're only focused on the offshore, clearly has no understanding of what this government has been doing and what the very essence of this government is.

RANDY SIMMS: But, really, there is an impression out there, Minister. You know, as I said to your colleague, Mr. O'Brien, earlier today, there is an impression out there, right or wrong, and it could be equally wrong as it is right, that this government does not focus, I'm going to call it, on the older more stayed industrial realities in the province. We seem to be caught up in the sexiness of oil and gas. Now, and that impression, I think, is out there in the market, isn't it?

TOM MARSHALL: Well, you know, if you're going to say that, I mean I don't know what, you know, what the media focuses on. You know, they don't focus on everything that government does, but I mean the whole reality of our budget and our speeches from the throne and the, you know, the thrust of what this government is doing is recognizing that, look, we've only got a window here and we have to diversify our economy because those non-renewable resources are going to be gone. So we've talked about, number one, we got to pay down the debt. Now previous governments left, you know, the people of this province today saddled with a massive debt of over, almost, just under $12 billion. So we have to take advantage of the surpluses that we have to try to address that while we can. We're also lowering taxes to try to make the province more competitive. I mean to attract investment, to attract people that are going to create jobs, you have to have a competitive tax structure and we did that in the last budget. We're also focusing on not only investments in our traditional industries like the forestry, and we pumped a lot of money into forestry, you know that, there's over $30 million went to aid the forestry industry in this province, investments in aquaculture on the south coast, but we're also focusing on the knowledge economy. We're making major investments now in research and development.

RANDY SIMMS: Ok, so why do you think with all of this going on and he being aware of this as, he being Brian Peckford , being as aware of this as anybody, why would Brian Peckford at this point in his life and the life of this province and government want to come out and be this critical?

TOM MARSHALL: That you'll, I have no idea. You'll have to ask him that.

RANDY SIMMS: Well speculate. Why do you think?

TOM MARSHALL: You know, I really don't know. I mean there was, there's been two stories here. One came out of the, one was in The Telegram, I think, on the weekend. It talked about, you know, the Atlantic Accord and how everything is flowed out of the Atlantic Accord. And the Atlantic Accord that was negotiated back then was certainly an important document. I mean it did, it did share the management. Even though the federal government was determined by the courts to have jurisdiction over offshore oil and gas, it said that Newfoundland would be, Newfoundland and Labrador would be the principal beneficiary. But it wasn't working. It wasn't working as it was. We weren't seeing the benefits because we were losing them under the equalization formula. Whatever we were getting on the oil and gas we were losing under the equalization formula. So what Premier Williams did in '05 in the Atlantic Accord in '05, I mean that was the key document that made the difference because what he accomplished was that for every dollar we were losing on the oil and gas we got an offset payment from the Department of Natural Resources in Ottawa. We got this offset payment that made us whole. And as a result of what Premier Williams did in '05, the Atlantic Accord '05, you know, this year we're showing 305 million, which is allowing us to forecast a surplus of 261 billion, I'm sorry, 261 million and to p ay down some debt and that's what's made the difference. I mean Premier Williams has made the real difference here because we weren't getting rich before under the first part of the Atlantic Accord, but that's not to say that it wasn't, you know, a great document.

RANDY SIMMS: What, it's the basis on which everything else flowed, but, you know, is it, I'm going to speculate a little bit here, is it possible that Brian Peckford is throwing a little criticism at the provincial government because of his recent appointment by the feds?

TOM MARSHALL: Look, it could be, but Newfoundland and Labrador is making tremendous headway under the Newfoundland government and to say we're only focused on oil and gas, well now that it's not going to be there forever and that's why we're doing the things that we're doing under the Premier's leadership.

RANDY SIMMS: But you. . .

TOM MARSHALL: And for him to say that we're focusing exclusively on oil and gas would be the same as saying that when he was office he focused exclusively on growing cucumbers, and we all know that's not true. But it's an asinine comment to make and he has to be held to account for it.

RANDY SIMMS: And so, obviously, you're critical of it. I guess all members of the government are critical of it because, like I said, I heard from your colleague, Kevin O'Brien, already this morning on this matter. You know, but again, as I say to you, and I think it's, you know, it might be an unfair comment, I accept, but, nonetheless, there's truth in the feeling, in the statement that there's a feeling in the community at large that this is a government preoccupied with oil and gas and not spending enough time and effort on traditional industries like fishery. I think that that's a feeling in the community. It might be totally unfair though, Minister, I accept that it might be an unfair feeling.

TOM MARSHALL: I strongly. . .

RANDY SIMMS: And I know you're going to argue that point.

TOM MARSHALL: I would strongly disagree with that.

RANDY SIMMS: Yeah, but I don't know whether Peckford, you know, who is Peckford sitting in Vancouver these days to tell us one way or the other what it is?

TOM MARSHALL: Well that's exactly, and, you know, to live out there and then come in here and tell us we're doing it all wrong is a bit much. And now in fairness to him, you know, I mean sometimes there's a quote in the paper and maybe that's not what he said, but based on what he said as quoted I talk umbrage of the comment and I think he's wrong. And, you know, not focusing on the fishery, I mean I come from a district where the fishery is not a major industry, as you know, and , you know, I can tell you that from the time that I spend at the Cabinet table, I mean fishery dominates the discussion at our Cabinet table and there's no doubt or question about that. The forestry is taking up a lot of our time.

RANDY SIMMS: Well, you know. . .

TOM MARSHALL: But also more importantly, which we're focusing new areas, we're trying to take advantage of, you know, research and development and things we did in aquaculture on the south coast, you know, things that we're doing here in Corner Brook with the Centre of Environmental Excellence, with the new position, I mean open up the paper and you see the new positions going here into Corner Brook in R & D under the, you know, Institute of Biodiversity and the Centre of Environmental Excellence. There's about five or six new positions here and these are jobs based on the knowledge economy, not based on the old natural resource economy.

RANDY SIMMS: Ok, let me ask you this while I got you. All right, I know that there's a financial report coming down, what, at the end of this week?

TOM MARSHALL: Well it, you know, the Premier will be back and the report, I'll discuss it with my Cabinet colleagues and then they'll, will determine whether it's going to, when we come out publicly and announce it. RANDY SIMMS: I understood that it was going to happen this week.

TOM MARSHALL: Well, you know, I've learned in government that when I'm told it's going to happen on a certain day I don't believe it until I'm out there actually saying, ok.

RANDY SIMMS: Ok, 261 million, you're low balling it, aren't you?

TOM MARSHALL: Well I certainly didn't low ball it. I, you know, I said, you know, you always hear the criticism of governments because they go out with these low numbers and then when the numbers actually come out they say, oh, look, we did so much better. I didn't want to do that. I want to try to be as accurate as we can. But it's extremely difficult, of course, because, you know, the oil prices jump all over the place and I mean who would have thought that oil prices have gone, would go to where they've gone today. You know, we rely on Pure Energy Corporation out of New York. They're very highly regarded and very respected and they told us the average would be, you know, when we were doing our budget, they told us the average price for the year would be about $58.60. Now we get quarterly updates for them. We also get two custom reports a year from them and, of course, their suggestions are going up, but at the time we did the budget that's what they told us. Also, production numbers we don't control and also who knew that that dollar was going to go the way it is because every time the dollar goes up a cent our revenues are negatively impacted. But it certainly doesn't offset the benefits because of the higher oil prices.

RANDY SIMMS: You, as Minister of Finance, do you want to see, and I know the central bank is looking at taking a run at the dollar to try and bring it down to a more reasonable level, which would mean a drop in interests rates, are you taking a look at that? Are you chairing them on and do you want to see that happen?

TOM MARSHALL: Well, you know, quite frankly, I mean monetary policy is left to the Bank of Canada and, you know, they don't consult with me. They're an independent organization that determines monetary policy.

RANDY SIMMS: I know, but on the outside looking in thinking that every, that every penny, that every buck is another, you know, few million.

TO M MARSHALL: Yeah, but it works the other way. . .

RANDY SIMMS: It works the other way for us as well, every penny up costs. . .

TOM MARSHALL: Yeah, but I mean I do have major concern for the manufacturing sector, you know, especially the forestry sector here in this province. I mean in Ontario they've lost, what, 150,000 jobs.

RANDY SIMMS: I guess that's where I'm trying to go, Minister. I'm trying to get inside your head here a little bit to say, you know, all of this issue about fisheries and about forestry and about all of these other concentrations, the reality of it is we need a lower dollar to do that and that's going to have to some degree, is it not, at the expense of oil and gas revenues?

TOM MARSHALL: Yes it, yes, you know, I mean I would certainly a dollar that is fixed or pegged in relation to the US dollar to try to keep our dollar lower than the US dollar because of the fact that we are an economy that relies heavily on our exports. But that's something that, you know, that the Cabinet would have to deal with all together. I'm expressing my own view here.

RANDY SIMMS: Sure, sure, absolutely, absolutely. Well, Minister, thank you for this, this morning.

TOM MARSHALL: Randy, thank you. Good talking to you.

RANDY SIMMS: Good to talk with you again, as always.

TOM MARSHALL: Thank you. Bye.

RANDY SIMMS: Take care. Bye, bye. Minister Tom Marshall; he's Minister of Finance, he's President of Treasury Board and he's not that happy with former Premier Brian Peckford over his comments on the weekend and in the paper today.

Deconfusing the royalty confusion

In Friday's National Post, Premier Danny Williams said:

With regards to criticism of modifications to the basic royalty, it is important to note that the change is the difference between 2.5% and 1% -- not between 7.5% and 1% as reported by Mr. Coyne -- in addition, we still maintain the 5%, and in some cases 7.5%, level of royalty once costs are recovered.

For those familiar with the provincial generic royalty regime, this would create some confusion since the situation described by the Premier is not how the existing generic royalty regime works.

The generic royalty regime provides for a basic royalty that increases from 1%, through 2.5%, 5% to a maximum of 7.5% depending on when the project achieves simple payout. Under provincial petroleum regulations, simple payout occurs when cumulative gross revenue and incidental revenue exceeds the sum of allowable pre-development costs, capital expenditures, operating expenditures and basic royalty paid.

After simple payout is achieved, the royalty paid is the greater of the basic royalty rate (assessed on gross revenue) or the net royalty rates of 20% and 10% after an allowed rate of return.

In order for the adjustment to basic royalty in the pre-payout phase to be the difference between "2.5% and 1%" - as the Premier states - the Hebron project would have to recover its eligible costs within the first two to three years of production or less. His comment assumes an extremely optimistic scenario.

The Premier referred to total costs of between $7 and $11 billion in the 22 August announcement. Taking that as the amount to be recovered (pre-development plus development plus operating expenses and royalties fixed at 1% annually), and given the scenarios contained in two previous Bond Papers preliminary assessments, cumulative gross revenue would exceed $7.0 billion after about three to four years.

At that point, the basic royalty under the generic regime would likely about 5.0%. Thus the difference between Williams' Hebron and the generic regime would be the difference between 1% (Williams) and 5% 9generic). If costs are higher and the time to simple payout is longer, then the generic regime would likely reach 7.5%.

At the same time the Premier said that : "in addition, we still maintain the 5%, and in some cases 7.5%, level of royalty once costs are recovered". This is correct, however, under the existing petroleum regulations, those rates would apply - and the province would collect that revenue - only in a situation where the basic royalty produced more revenue than the Tier 1 and Tier 2 net royalties. Presumably under the Williams regime, this would also include the Tier 3 royalty.

In other words, in a scenario where the basic royalty was paid at 5% or 7.5% after simple payout, none of the much higher rates on net royalty - including the Premier's new Tier 3 - would be paid. This point is explained by provincial government documents.

The royalty regime appears to have been adjusted for Hebron as indicated in the 22 Aug news to a flat 1% royalty due at the commencement of production. This replaces the generic regime that started at 1% and would likely have increased to 5% or more by the time of simple payout. At the same time, the regime under the proposed Williams' Hebron regime is, to paraphrase natural resources minister Kathy Dunderdale, a decision to forego revenues (royalties) in the initial years of production for possible royalties in the later stages.

This is an understandable compromise given the cost issues in the project, but it does reduce the initial royalty accruing to the province likely by between 4% and 6.5%. Any revenue foregone in the initial phase of the project may be recovered subsequently but only as long as prices for oil stay above $50 per barrel for WTI (Tier 3 royalties apply). Again, depending on how the Tier 3 royalty works this may be an understandable compromise. Unfortunately there is insufficient information in the public domain to assess the potential performance of the Tier 3 royalty.

The revenue accruing to the energy company does not offset this royalty concession. in the initial stages of production, the provincial energy company will be recovering its own share of the development costs. it is also liable for operating expenses, provincial taxes, federal taxes and other costs.[Note: see below] Thus any revenue, it collects must be assessed on a net basis.
Royalties are received by the provincial government acting as the resource owner (100%), without any liabilities; the net and the gross are identical figures. The provincial government collects and retains 100% of royalties with no revenue from royalties accruing to the federal government.

-srbp-

Note: Under s. 41 of the 1985 Atlantic Accord, Crown corporations receive no exemptions or special treatment with respect to taxes and other payments to the federal and provincial Crowns.:

Crown corporations and agencies involved in oil and gas resource activities in the offshore area shall be subject to all taxes, royalties and levies.

As a result of the Hebron memorandum of understanding, the Government of Canada will collect revenues from the provincial government's share of overall revenues which it ordinarily would not collect. These come in the form of federal corporate taxes, for example.

So how much is fair, exactly?

When it comes to oil and gas royalties, there's a debate in Alberta.

There's no debate in Newfoundland and Labrador. Mostly there's a pile of misinformation, most of it flowing from the provincial government.

Well, for those who like to think to thoughts, to dare to be different and - oh, horrors - consider that the Powers-That-Be might just not be right about everything, here's another perspective, via the Globe.

Note particularly, the chart on the left comparing various jurisdictions.

-srbp-

Budget 2007: a quick look at the numbers

The Government of Newfoundland and Labrador forecast record spending for 2007, at more than $5.5 billion.

Some quick observations based on a simple breakdown into the good, the bad and the ugly of the budget:

The Good

Tax cuts and increased program spending.

All good in an election year and make no mistake: this is an election budget.

People will be happy and the provincial government is certainly counting on people's immediate sense of contentment to see the current administration re-elected with an overwhelming majority.

No region of the province is untouched by extra cash. No person will be left out of the tax breaks or other benefits.

The source of the cash: all the supposedly bad deals signed before 2003 by previous administrations, Liberal and Conservative.

Windfalls from high oil prices produced the supposed miracle of deficit slaying. Everything in this budget, indeed every budget increase since 2003 has been based on high oil prices.

Thank you Brian Mulroney and Brian Peckford. Thanks to the administrations that developed Voisey's Bay and the offshore oil fields at Hibernia, Terra Nova and White Rose.

The latter field is expected to hit payout in FY 2007. As a result, royalties will jump to 30% on the price of each barrel.

The Bad

This budget forecasts a spending increase 5.6% from Fiscal Year (FY) 2006. It also projects increased spending of 4.7% and 4.2% over the subsequent two fiscal years.

That's bad since it exceeds the rate of inflation by more than double in FY 2007. The Bank of Canada forecasts inflation to run at 2.2% in 2007 and at 2.7% for each of the two years after.

Prudent fiscal management would hold spending to at most the projected inflation rate. That doesn't mean program spending would need to be curtailed in important areas, nor does it mean the provincial couldn't afford tax cuts to bring provincial rates in line with Atlantic Canada. Rather it would simply require the provincial government to make some clear choices in what it considers important, rather than fix every problem by more spending.

Even in FY 2004 when the current administration proclaimed the province to be in a financial mess, it still introduced a budget that increased spending from the previous year. Spending has increased every year since. That's not going to be sustainable given the absence of a major new development at Hebron, which would have achieved first oil as production from at least two of the other fields slackened.

As it stands currently - and unless there are supersecret talks on Hebron no one is talking about - Hebron won't be producing oil for another decade or more. In the interim, the impact of demographic changes throughout the province will increase pressure on the provincial treasury at a time when the province's coffers will not be seeing significant new cash flowing in.

The current and forecast spending increases are based on optimistic projections for the price of oil in the medium term. Any downward trend in commodity prices (oil, minerals etc) will quickly make the consistent spending increases since 2003 unsustainable. Fiscal reality in those circumstances - taking less money in than is flowing out - would require program cuts, job losses and/or tax increases to correct.

Our plan is to continue this responsible approach in the years that follow to ensure we are increasingly strong, less reliant on the whims of others and more reliant on
ourselves.

The whims referred to are likely those supposed whims of the Government of Canada. This budget - like all recent budgets - builds itself on the whims of international commodities markets. Which one is less reliable?

More bad. Per capita spending will be $10, 871 per person in the province, assuming a population of 512, 000. It will jump to $11, 878 per person in FY 2008 putting Newfoundland and Labrador on par with Alberta for per capita provincial government spending. Drop the population below 500,000 and Newfoundland and Labrador will be outspending Alberta, the richest province in the country.

The difference is that Alberta isn't carrying around the per capita debt Newfoundland and Labrador shoulders, which, as noted below using the finance minister's own words, limits the provincial government's options in dealing with any financial setbacks.

That level of per capita spending is unsustainable in the long run. As a recent Atlantic Institute for Market Studies assessment concluded:

If the province fails to reign in its whopping per capita government spending (about $8800/person [in FY 2006]) and super-size me civil service (96 provincial government employees /1000 people) it will quickly erode any gains from increased energy revenues.

The Ugly

As much as the provincial government talks about the large public sector debt, so far it hasn't done anything to deal with it.

Finance minister Tom Marshall described the issue accurately in the budget speech, saying:

The most significant fiscal challenge facing Newfoundland and Labrador is the burden of debt we inherited, the highest per capita net debt in Canada, more than double the national average. High debt loads mean high interest payments, whether for a family or for a government. Reducing debt frees up money to spend on programs and other priorities.

All government has done is produce a net reduction in the debt by a mere $70 million in FY 2006 and forecast a further reduction of $66 million in FY 2007. At that rate - i.e. $70 million per year - the province will be debt free in 2178.

If there is a budget surplus in FY 2007, as currently forecast, most if not all should be committed to reducing the public debt. Anything else is whistling past the graveyard.

Government's reported success in reducing the debt to GDP ratio has come not from strong fiscal management by government but in growth in GDP driven primarily by commodity prices. Lower the GDP - as in a drop in commodity prices - and those apparent gains will vanish.

There's another ugly element in the budget reporting and that is in the misleading presentation of revenue from the 2005 agreement with the Government of Canada. It will not produce additional cash for the treasury in FY 2007 despite the claim by the finance minister that "[w]ithout the 2005 Accord negotiated by our Premier, we would be receiving $305.7 million less than we are getting this year."

In reality, that cash has already been received and spent on shoring up the teachers' pension plan. That was sound financial decision, but the provincial finance minister cannot claim double credit for the money.

Statement I in the FY 2007 Estimates shows the reality. A modest $49 million surplus on current and capital account forecast for FY 2007 becomes a $255 million shortfall once the $305 million from the 2005 cash advance is deducted.

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Terra Nova back in the cash

High oil prices mean that the Terra Nova oilfield has recovered recent refurbishment costs on the production platform and is now pumping higher royalties into provincial coffers, six weeks ahead of schedule.

The provincial government now receives 30% of the price of each barrel of oil produced under the royalty regime established with the provincial government.

Under the Atlantic Accord (1985), the Government of Newfoundland and Labrador sets royalty and other revenue rate for the offshore. It receives and retains 100% of the amount it sets. in addition, the provincial government continues to receive federal transfers for a fixed period under terms set out in the 1985 Accord and in a 2005 add-on deal between the Government of Newfoundland and Labrador and the Government of Canada.

Brown and browned off

Give credit for the title to CBC television's supperhour news and the banter between the anchors after a segment on Premier Danny Williams' comments on Wednesday about the ongoing racket with Ottawa about Equalization and offsets.

Williams was back in the province today after spending a couple of weeks someplace sunny.

Brown he is, thanks to a tan.

Browned off?

Well, that's a local expression for being annoyed or upset.

In a scrum with reporters on Wednesday, Williams called for finance minister Jim Flaherty to resign. Williams also tore strips off federal fish minister Loyola Hearn - the regional minister for Newfoundland and Labrador - as well as Conservative members of parliament Fabian Manning and Norm Doyle.

One of the consistent problems for anyone trying to figure out the whole issue is what the federal government has actually done. Skim through the initial budget documents and one would have a hard time finding any reference to a cap being applied to both the 1985 Atlantic Accord and to the 2005 offset agreement. What you will find is the following reference to Equalization:

A fiscal capacity cap to ensure that Equalization payments do not unfairly bring a receiving province’s overall fiscal capacity to a level higher than that of any non-receiving province.

Many people in Newfoundland and Labrador - your humble e-scribbler included - took this to mean that the existing offset agreements, both of which are tied to Equalization and are limited in duration, would still operate until such time as Newfoundland and Labrador exceeded the national per capita fiscal capacity as determined by whatever Equalization formula is in effect.

It appears that Memorial University economist Wade Locke worked on the same assumption for his initial analysis, even after extensive discussions with federal officials. Danny Williams certainly appears to have taken that meaning from the federal budget. He told a CBC radio audience on March 26 that the province would likely opt for the O'Brien formula by 2009. That would be consistent with Locke's assessment, made public two weeks after Williams made those comments

It seems as well that federal fisheries minister Loyola Hearn had a similar impression. He assured Newfoundlanders and Labradorians that once they saw the details, their initial fears would be allayed. That was what he said on March 22. As recently as last Friday, he said much the same thing. Hearn is a smart old politician and he is just too smart to fall into the sort of trap that his predecessor John Efford built for himself and then jumped into.

That perspective on the offset agreements changed on Monday with Jim Flaherty's admission that in fact the federal government would be unilaterally applying caps to the agreements. Of course, in the process, Flaherty had to savage a few facts, but that seems to be a common feature of public life these days.

Taken altogether, it's easy to understand Danny Williams' latest anger. He's right, by the way: Flaherty jerked everybody around. The federal finance leprechaun has been too cute by half. Williams hasn't pointed it out - and he likely won't, but the changes to the 1985 Atlantic Accord have far more serious implications than anything else.

That deal is not just a simple piece of legislation to be changed at a whim. It represents the basis on which Newfoundland and Labrador derives all its oil and gas benefits. The federal legislation enables a landmark agreement in federal-provincial relations and the offset benefits - temporary and declining are a part of the package of financial benefits it contains. The Equalization offsets were intended to provide additional cash to Newfoundland and Labrador on a temporary basis to allow for economic infrastructure development that, frankly, hasn't really been possible until recently.

Williams winds up with a few of problems as he looks at the current federal-provincial mess.

Biggest among them is that he simply has absolutely no means of communicating seriously with the federal government. His last potential allies - the three Conservative MPs - are all dirt under his feet. Williams started the whole mess with Harper at least last October in Gander, and as much as he insists he did the right thing, kicking the Prime Minister in the crotch - publicly - isn't designed to win any friends.

And friends are needed in politics. Even if people aren't friends, you at least need them to not be enemies. Politics is about the art of the deal, about maximizing gains inside a realistic set of options. It's not about Mr. Right, to steal a phrase. Sometimes it's about Mr. Right for Now. Perfect isn't ever possible, but there are plenty of really good possibilities short of perfection. you can cut those deals - good, beneficial deals - on a range of issues if your head is screwed on properly.

But if all you do is set fire to their underwear, the odds of winning people over is slim. When you take to their Stanfield's with a flamethrower, well don't be surprised if they don't invite you over to dinner to meet the kids and the rest of the family. Be surprised if they don't look for a restraining order.

On another level, though, Williams' fundamental argument isn't designed to win converts from among the non-converts. We've said it before. For the federal government and for mainlanders generally, we need to explaining what is in it for them. The Premier hasn't been able to do that, at all.

The weakness of the whole Equalization argument about clawbacks - as fraudulent as it is - takes away the one selling point: we make money; you make money. Instead, them making money becomes a crime. They - the undifferentiated foreign exploiting demons - take what is ours and, according to Williams, by God he will get it back by force if necessary. Any wonder people have tuned out?

Of course, it really doesn't help when your finance minister rejects deficit and debt fighting all the while you are holding out a big debt as one of the big reasons you need federal hand-outs.

Danny Williams lamented recently that mainlanders don't seem to understand how prosperity here benefits there, wherever there is.

Well, the real test of his abilities as a Great Negotiator and a politician will be in how he tackles that challenge.

It's his job to explain the point. He can do it.

The question is will he.

Doing an endless repetition of one of his first interviews - three freakin' years later - just isn't cutting it so far.