Oil and polls #nlpoli

Two things for Tuesday after a monster snow storm.

Oil:  Brent crude hit a low of $52.50 before rebounding to finish Monday at just below US$55 a barrel.  Newfoundland light, sweet crude trades at Brent prices.

West Texas Intermediate was even lower.  It settled at $43.88 with global production staying high and analysts fearing a glut.

Thus is a reminder of the folly of Conservative policy that ignored historic trends and did nothing to hedge against a rainy day. The people who made the stupid decisions and the people who gave them the crappy advice should be dragged through a public inquiry and account in public for their decisions and advice.

Thinking about the Unthinkable #nlpoli

Only a decade ago, voters turfed Roger Grimes and the Liberals from office as punishment for – among other things – signing a deal to develop a nickel mine even though it was a really good deal.

[Not one teaspoon, they said, echoing a line Brian Tobin used.  Better to leave the ore in the ground than do a deal that involved any ore leaving the province unprocessed]

But leave the oil in the ground rather than pump it out?

Unthinkable. 

That’s curious because leaving the oil in the ground is a valid policy choice for any government, including one in Newfoundland and Labrador.

Oil and Democracy #nlpoli #cdnpoli

Michael Ross contends there is a relationship between oil revenues and democracy.  Crudely put:  oil hinders democracy.

First, the oil-impedes-democracy claim is both valid and statistically robust; in other words, oil does hurt democracy. …

Second, the harmful influence of oil is not restricted to the Middle East. …

The third finding is that nonfuel mineral wealth also impedes democratization. …

Ross has a couple of simple tables comparing the relative reliance of some national economies on oil and non-fuel minerals.  in both cases you just calculate the export value of the minerals as a share of gross domestic product.

In 2011, the provincial GDP was $33 billion.  Of that, the province produced and exported about $10.7 billion in oil and $4.6 billion in non-fuel minerals.  That gives an Oil Reliance number of 32 and a Mineral Reliance number of 14.

To put that in perspective,  Ross’ calculation using 2006 figures for oil producing countries puts Newfoundland and Labrador on the same rank as Qatar and Saudi Arabia, both of which scored 33.85. It puts the province behind Brunei, Kuwait and Nigeria but miles beyond Libya (29.74), Iraq (23.48) and Venezuela (18.84)

Norway scored 13.46.

The Mineral Reliance score puts Newfoundland and Labrador at the fourth highest spot among the countries on Ross’ chart. Third place belongs to Bahrain (16.39), while fourth on the chart is occupied by Chile at 12.63.

Canada as a whole scored only 2.2.

Before you get too excited, the relationship between oil and democracy is a wee bit more complex, as Ross relates.  Let’s just look at those simple calculations first.  We’ll get back to the other ideas Ross discusses in his new book The Oil Curse.

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Undisclosed risk (September 12, 2007)

[Editor's Note:  This is a post originally scheduled for publication in September 2007.  For some reason, it never appeared. Here it is, as originally written.  Note that some of the links may not work].

Take a look at the energy plan consultation document released in November 2006.

Try to find any reference to changing the province's generic oil royalty regime.

You won't find one.

The Petroleum Trigger Point #nlpoli #nlvotes

West Texas Intermediate crude is hovering around a price that some analysts say puts some oil sands in doubt.

Meanwhile, North Sea Brent crude  - the price used to benchmark local crude -  is running about $25 a barrel higher.

Crude prices are tied to fears of a second recession following hot on the heels of the 2008 one. Regular readers of these e-scribblers will be familiar with that idea, plus the related notion that the American economy won’t recover with oil as high as it is. 

Notice a couple of things here. 

First of all, recognise the problems  any drop in oil prices will cause for the provincial Conservatives ongoing plans to spend and spend and spend.  Offshore production is headed downward anyway.  Provincial government revenues will go down as well and that will bring with it all sorts of other problems.

Second of all, notice the big difference between WTI and Brent.

Here’s a little thought likely no one had before. Recovery or no recovery, recession or no recession, we could see  a time in the not too distant future when WTI slips even further downward.

Like say, at or below US$50 a barrel.

That would be below the threshold for the so-called super-royalties that the provincial Conservatives stuck in a couple of offshore development deals.  They tied super-royalties to WTI even though local oil is sold based on Brent prices.

Forget that Brent would be trading well above that WTI price below US$50.  The provincial government would wind up losing out on huge gobs of cash in that scenario.

That’s one of the problems with linking what resource owners get for their resources with a single trigger point.  You get a set-up that only works when prices stay high.

And if they drop, as they likely will during a recovery or during a major recession, then the provincial government will have some very serious problems.

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Making the Most of Our Energy Resources, Part II – Oil and Gas in the Future

Without new oil and gas discoveries, the Newfoundland and Labrador petroleum industry will dry up within a couple of decades.  There hasn’t been a significant discovery in the offshore since the 1980s, with the exception of one find in the Orphan Basin.

The problem isn’t a lack of oil or gas.  The geological estimates back up the notion there is plenty more to find. The problem is no one is looking for it hard enough to find it. 

To give you a sense of how low exploration levels are now compared to a couple of decades ago, take a look at this slide.  It’s taken from Wade Locke’s recent presentation for the Harris Centre. 

Low exploration levels is one of the most important problems facing the oil and gas industry.  It’s not a new problem.  It’s not the only problem.  There are others, all of which centre on the basic challenge of how we can make the most of our oil and gas resources now and in the future.

Here are some basic ideas that can help us to get there.

For starters, Newfoundland and Labrador has to be an attractive place for investment, exploration and development. Oil and gas is a highly competitive industry, especially in the exploration sector.  There are only so many exploration dollars to go around.  There are only so many rigs to go around and there are plenty of places in the world where companies can find oil and gas, develop it, get it to market and make a lot of money.

Sending delegation after delegation to oil shows in places like Houston doesn’t produce a single new exploration well. What the local oil and gas industry needs is a stable, predictable environment.  That is something they haven’t had for a while.

One of the easiest things for the provincial government to do is set an offshore oil royalty regime and a gas royalty regime.  The provincial government had an oil royalty regime but the 2007 energy “plan”  to replace it with something else.  Not surprisingly for the current administration, there is no sign of a new oil royalty regime four years after they promised it.

Ditto a natural gas royalty regime. The current administration promised one in 2007 but they still haven’t delivered.  In fact, the provincial government has been working on development of a gas royalty regime for the past 14 years and still they haven’t managed to produce anything but a discussion that went nowhere.

With the royalty regime set, there’s no need for the provincial government to hold up any developments while it “negotiates” with a developer.  That’s the sort of thing one might expect in a banana republic.  It isn’t what happens in mature economies.

In the same way, the provincial government should set – or allow the offshore regulatory board to set – basic rules for local benefits.

The current administration held up the Hebron development and in the end settled for a royalty regime only marginally better than the generic regime. But any gains on so-called super royalties were offset by give-aways on the front end of the royalty structure and on local benefits in the form of research and development spending commitments.

Standard royalty and benefits regimes that work across a variety of price ranges and that work fairly for the resource owner  - i.e. taxpayers - and the developer will promote stable economic development.

The provincial and federal government should also implement a policy of merit-based appointments to the offshore regulatory board.  The Canada-Newfoundland and Labrador Offshore Regulatory Board is one of the most important agencies in the province. The most recent fiasco with efforts to stuff a former political staffer into a job she was unqualified for highlight the potential damage that politicians can do to an important official body.  At the very least, the provincial government should advertise for applicants for board appointments based on well publicized criteria. Board appointees should serve for fixed terms and each appointment should come with a publicly available expiry date. The offshore board is no place for political hacks and cronies.

While the offshore oil and gas industry is well developed, the oil and gas industry that lies exclusively within provincial jurisdiction is not.  As a way of encouraging development of a well-managed industry within the borders of the province, the Government of Newfoundland and Labrador should develop a regulatory board to administer lands, manage reservoirs, serve as a repository for information on oil and gas and generally serve as the focus of industry regulation from the three mile limit inward. 

The new oil and gas regulator should complement the work of the offshore board.  Naturally, the new board will assume some of the roles assigned to the old provincial petroleum directorate as well as ones that have grown up within the oil and gas division of the natural resources department. The new onshore regulatory board should also administer new, standard royalty and benefit regimes for any future developments.

Other elements of the 15 ideas (and more) also will apply to the oil industry.  For example, breaking up the energy company and either privatizing it or forcing it to function like other companies would break its strangle-hold on the local business environment.  This would inevitably allow for new life and energy in a sector that is rapidly becoming stagnant.

Without new life in the province’s energy industry,  the future looks bleak.  Staying on the current path is not a practical option. 

These are a few ideas to stimulate life and growth and to create a future for the province and its people that works.

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Crude at US$60 in 2011: forecast

Now there’s a thought sure to frighten the bejeebers out of any ruling political party headed toward an election and a leadership racket, planning on spending voters into a stupor along the way and knowing the oil production on which it depends for revenue is also on the downward slope.

It’s only one projection mind you. 

Capital Economics forecast that crude prices will head downward in 2011 as the Untied States economy recovers.

The National Post reported at the end of October:

Julian Jessop, analyst with the London-based firm, predicts the price of a barrel of oil will slide to US$60 a barrel by the end of 2011 as the U.S. dollar recovers and global demand disappoints. This would be the same level as prices in the first half of 2007, before oil went into a bubble that touched highs of almost US$150 a barrel in the summer of 2008.

Interesting thought, that.

Very interesting indeed.

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Math problem: oil production, oil prices and oil royalties

“Back of the envelope calculations”,  a recent Telegram story assured us all, “put royalties for the first three months of the [current] fiscal year on pace with government’s $2.1-billion target.”

But, the Telegram headline says, that’s because “surging production” is offsetting “softer” prices.

Unfortunately, the Telegram didn’t see fit to show us the back of the envelope so no one can tell exactly how they came to that conclusion. It must be a provincial government envelope, though because the numbers don’t quite add up.

As forecast

As it looks,  revenue projections are likely to be on target with the forecast.

The provincial government’s oil royalty is a function of oil prices and production. The Telegram reported  - quite rightly - that the provincial government forecast oil royalties of $2.1 billion based on total production of 90 million barrels and and average price of oil at US$83 a barrel.  The provincial government also allowed the Canadian dollar would be close enough to the American dollar that there wouldn’t be any sizeable windfall from a cheap Canadian dollar.

The Telegram also reported that oil production is on track to come in around 101 million barrels.  The offshore regulatory board’s actual figures for the first four months of 2010 (April to August) show oil on track to hit 99 million barrels. Still, that’s 10% above the government’s spring forecast.

As for crude oil prices, they have not averaged US$83.  The Telegram puts the average price of Brent crude at US$80 a barrel the week the story appeared. This is where it gets interesting.

For the first four months of the current fiscal year, Brent crude has averaged US$77.71 a barrel. That’s about six percent below forecast.  If you take out the April average of $84.98 – because it is the only month averaging above $80 dollars this year – you get an average price about 10% below the government’s forecast average.

With production above and price below, the one pretty much cancels out the other.

No surge

Production isn’t actually surging, though.  In fact, production at about 100 million barrels is only slightly above last year’s production total of around 97 million barrels. As for price, there’s no surge there either.  The average currently showing in 2010  - including April - is only about a dollar above the 2009 fiscal year average.

In other words, everything is tracking to bring in the same average price and the same yearly production as 2009. The provincial government forecast an increase in royalties to $2.1 billion from $1.8 billion. 

All three fields should be in payout and according to the pre-2003 royalty deals, that means they’d be paying more to the provincial treasury.  Hibernia didn’t hit payout until June last year, so it appears the extra cash is solely the result of having the big field paying higher royalties for a whole year instead of just part of it.

That means that the slightly higher royalties are coming from old development deals, not from something happening to oil prices and production.

Still on track for another big cash deficit

And what does that mean for the provincial budget? if you relied only on the  Telegram story you might be fooled into believing that the provincial government might balance its books this year.  It might do so using accrual accounting, but there won’t likely be a balanced budget on a cash basis.

In fact, the current fiscal year looks a lot like the last one, including the fact everything is on track for another whopper of a cash shortfall.

For some unfathomable reason, the Telegram decided you didn’t need to know that the provincial government’s budget forecasts a cash deficit of nearly a billion dollars. Nor did they mention that last year the provincial government had a cash deficit of about $500 million. 

Instead, they left you with the Pollyanna-ish view that everything is looking great.

Maybe it is, but one thing is for sure:  it has nothing to do with “surging” oil production or “soft” oil prices.

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That’s gotta hurt, too: oil prices edition

The provincial government’s 2010 budget – due to pass the House of Assembly by next Monday – is based, in part, on crude oil average about US$83 a barrel for the entire year.

Just to make sure everyone is keeping a sharp eye on the unsustainable Tory financial ball, the budget forecasts a cash deficit of about $1.0 billion. That would eat up just about all the surplus cash on hand.  As a result, the net debt, which was hidden from prying eyes by all the surplus cash would spring back into full view in all its $10 to $12 billion splendour.

And if the following year’s budget needed some propping up, the provincial government would be back in the markets looking for some bank will to see the public debt balloon even larger.

But oil is trading this past week down in the neighbourhood of US$70 an the dollar is still pretty close to par.  Production is slightly below last year’s so there doesn’t seem to be much hope extra production would generate extra cash.

Oil is now the major source of provincial government income by quite a margin.  It’s about twice the amount the government gets from federal transfers which  - when piled together is the next biggest source of income at about $1.2 billion.  Oil royalties, forecast at $2.1 billion is about two and a half what personal income tax, the next largest provincial government’s own revenue source, brings in.

There are a couple of things to take away from all this.

First of all, when Danny Williams talks about putting the province’s finances in order such that there is less dependence on Ottawa, he’s pretty much jerking everyone in the province around. 

Nothing – and let’s say that again for good measure – n-o-t-h-i-n-g, not a single, solitary, flipping thing Danny Williams and his cabinet have done in provincial government spending since 2003 has put the provincial government on a secure financial footing.  To the contrary, they have put the provincial government in an incredibly precarious financial position even compared to when they took office.

The facts on this speak eloquently for themselves in both the fragility of the economy and unsustainable level of public spending. When he announced in early March that balanced budgets were no longer a target for his administration he pretty much confirmed that none of his claims about sound fiscal management were close to being accurate.

Second of all, bear in mind if oil stays at current prices, the cash deficit is more likely than not going to be about $1.0 billion and we are yet again staring at the prospect of one of the largest if not the largest cash deficits in provincial history.

Put all the faith you want in people who forecast triple digit oil prices as the way of the future.   Oil is not going to be the saviour of this province if its government keeps spending the way it has been spending.

It’s that simple.

So as all things out there go sour for the current administration, as it faces the prospect of hundreds of millions of dollars in costs from the Abitibi expropriation fiasco, as investment interest in the province dries up, the parlous dependence of the provincial budget on oil prices just adds to the pressure.

Imagine what things will be like a year and a bit from now when voters troop to the polls.

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Hibernia benefits overestimated: economics prof

“The oil industry success we enjoy today is not what many expected… many people could not believe in the vision of Newfoundland and Labrador as a successful oil producing province.”

Whoever wrote those words for Kathy Dunderdale to read at the re-announcement of the Hibernia South project could hardly know the truth of them.

Nor could the writer likely understand how close to home some of those negative nellies were.

As managing editor of the Telegram in 1992, Bill Callahan believed the project was best scrapped since it represented “large-scale exploitation of non-renewable petroleum resources without adequate or perhaps any return.”

Then there was Peter Fenwick. The former New Democratic Party leader lambasted Hibernia in 1992 as a “give away”:

The money we taxpayers are throwing away on Hibernia is equal to a hundred Sprung greenhouses.  In future, Brian Peckford, Clyde Wells and Rex Gibbons will be vilified by generations of Newfoundlanders for the enormous waste of taxpayers’ money.  Unfortunately we, and the rest of Canada will be stuck with paying for it with our tax dollars.

None, though, could match the pessimism, negativity and sheer crap about Hibernia coming from none other than Wade Locke. 

Yes, that’s right:  Wade Locke,  the same Memorial University economist who is the darling of the current provincial government administration and who was, it should be said, looked on rather favourably by their Tory forefathers in their day too.

As Locke told The Telegram’s Pat Doyle in September 1990, only a few days before Wells, Gibbons, John Crosbie and others signed the final agreements in St. John’s that started the Hibernia project rolling:

"While it may be true that the sun will shine one day, it does not appear that 'have-not' will be no more because of Hiber­nia."

Those words by Wade Locke, an assistant professor of economics at Memorial University, appear to sum up the realistic view now held by experienced observers on the potential benefits of the large offshore project.

But that wasn’t all. 

Locke was extremely pessimistic about the revenue likely to come from the project:

"That is, each dollar of offshore oil revenue going to the provincial trea­sury will result in an increase in the province's ability to spend by two to three cents," Mr. Locke said.

Provincial government estimates suggest the equalization payments would fall by somewhere in the range of 90 to 95 cents.

Mr. Locke said using his calcula­tions, if the project were to generate 13.8 billion In direct revenue for the treasury, for example, after adjust­ing for equalization losses and equali­zation offset grants, the province's net fiscal position would have changed between 176 million and $114 million over the life of the project or an average of $3 million to $4 million in net revenue a year over the 26-year project.

To put that in perspective, Mr. Locke noted the province expects to spend $3.3 billion In the current fiscal year.

“This means that the average net revenue from Hibernia is equivalent to about one tenth of one per cent of the 1990 projected government expen­diture,” said [Locke in] the paper [printed in the Newfoundland Quarterly.]

"Thus, one should not expect that the provincial government will, as a result of Hibernia, have an enhanced ability to improve our road system, education services, health services or any other government services that are of primary concern to the aver­age Newfoundlander."

Yes, when you read stuff like that you just have to chuckle at all the Kreskins who took turns peeing all over the Hibernia project. Heck even Dunderdale and her boss used to refer to it as a massive give-away.  Used to, that is, until they used the deal as the basis for their own negotiations over the extension project.  The old Hibernia deal actually delivers the largest bulk of the cash they claim will come from the extension.  Honesty would prevent Dunderdale and her crowd from doing anything but acknowledging the old deal for its value.

Meanwhile Locke now gets invited to speak in glowing terms about the great offshore oil industry at an event marking the 25th anniversary of the deal on which it is all based:  the 1985 Atlantic Accord.

And that original Hibernia deal they all loved to hate? 

Well, based on the same numbers used by the provincial government and quoted by CBC in the supper-hour news tonight, that 1990 deal will produce more money for the people of Newfoundland and Labrador than Hebron, the White Rose extension and Hibernia South combined.

And it exists today, unlike the Lower Churchill dams or mythical aluminum smelters drawing power from them.

The billions coming from Hibernia will continue for more than another decade to pay for road improvements, education services, health services and any other government services that are of primary concerns to ordinary Newfoundlanders and Labradorians. 

The money from Hibernia has helped wean Newfoundland and Labrador from its financial dependence on hand-outs from Ottawa. The dignity and self-respect that comes from that accomplishment alone was worth the gamble. The only people who seem to lament that fundamental change in the province and its people are those who never did  - deep in their hearts - look forward to the day when the hand-outs stopped. How laughable that some of those people get credit for a change they fought against.

The creation of a new industry and the transformation of a people.

That’s not too bad for a project whose benefits an expert told us were overestimated.

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Brent Price Comparisons

For those who have been following along with the discussion of oil prices and provincial government revenue, it’s interesting to compare the price of crude oil at comparable parts of the fiscal year.

On Monday, as you may recall, we took a look at production.  As the chart showed, offshore oil production in 2009 is well below production last.  It’s so far down in fact that the provincial finance department’s predictions for 2009 might prove to be as accurate as the work of some late-night television psychic.

Well, prices are not doing much better.

Here’s a rough look at daily spot prices for Brent crude for the period 01 April to 30 June in both 2008 (blue) and 2009 (red).

Basically prices in the first three months of 2009 were running about 50% below the same period in 2008.

So prices were down by something on the order of 40 to about 50% and production was down by 14% in April, 39% in May, and 18% in June.  That pretty much guarantees that revenues would be off as well compared to the previous year. 

Sure enough,  figures obtained from Natural Resources Canada confirm that. Figures for September confirmed the general pattern for the first half of the fiscal year. Oil revenues are running about 15% below the provincial government’s budget forecast.

Not 15% below the December fiscal update that talked about bringing in something like $1.8 billion in oil royalties but 15% below the budget forecast of $1.26 billion.

Provincial government oil royalties are a function of  production, the royalty formula and the exchange rate for the Canadian dollar.  In the front end of the fiscal year there was a bit of a premium for a cheap Canadian dollar.  But as the Canadian dollar has climbed against the American greenback during the past six months, any premium that resulted from selling oil in U.S. funds and then converting to Canadian dollars vanished. 

And if you look at the actual royalty figures it’s pretty clear that the improved royalty rate coming from Hibernia in payout couldn’t offset the drop in production, the drop in price and the shifting exchange rate.  That’s a clue to the magnitude of the change in oil revenues.  Even with all three fields in the optimum royalty condition, royalties are well down in 2009.

Just to keep close track of all this, your humble e-scribbler will have to go looking for the October and November royalty figures later this month  That way it will be much more clear if the trends established in the front end of the year are continuing. Odds are they have carried on, despite the claims from the finance department in December.

As a last point, consider that a forecast by the Canadian Association of Petroleum Producers in 2009 showed offshore oil production declining in Newfoundland and Labrador over the next five to seven years.  There’s a bit of a peak close to 2020 and then things trail off again as some of the older fields dry up.

 

That’s the sort of information that should be guiding provincial government budgeting. Revenues aren’t going to be climbing ever higher.  Demands for essentially services will, however, and the costs associated with that will rapidly escalate. This is an old refrain around these parts as regular readers well know.

That doesn’t mean there have to be spending cuts;  it just means there has to be greater fiscal discipline, consistent and prudent planning and some serious attention paid to reducing the province’s debt load. In other words, the provincial government needs to be doing exactly the opposite of what it has been doing for the past three years.

There is hope.

Until last fall, you’d never have heard a cabinet minister admit what your humble e-scribbler and others have been saying for years.

But first Paul Oram and then others admitted the provincial government’s fiscal plan  is unsustainable.

Acknowledging there is a problem is the first step toward doing something about it.

Let’s see what happens.

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Oil production down by almost 29% in first half of FY 2009

Oil production in Fiscal Year 2009 (Apr 09 – Mar 10) is on track to fall below even the low-ball estimates used in the spring provincial budget. 

The provincial government estimated oil production in 2009 would be 98 million barrels.  That’s 21% below 2008, based on the production for Calendar Year 2008 (Jan to Dec) of 125.3 million barrels.*

Actual production in the first half of the fiscal year was 44.5 million barrels (mbbls), according to figures available from the Canada-Newfoundland and Labrador Offshore Petroleum Board.  Average monthly production has been 7.42 mbbls.

By comparison, in the first six months of FY 2008, production was 62.5 mbbls with a monthly average of 10.41 mbbls.

Oil production from the three fields offshore was down 41% in August 2009 compared to August 2008.  There was also 39% less oil pumped in May 2009 and 34% less in September 2009 on a year over year comparison.

Total oil production in FY 2008 was 123.4 mbbls.  That means that production in the second half of 2008 was actually below production in the first half of the year.

While it isn’t inconceivable that production will ramp up between September and March, it seems unlikely to hit the 2008 average production level of 10.41 mbbls per month. 

That’s about what would be needed to generate any significant oil revenues above the budget projections, and using current prices.

	FY 2008	FY 2009	% +/-
Apr	10, 616, 444	9, 116, 213	-14
May	11, 403, 549	6, 915, 304	-39
Jun	8, 978, 865	7, 374, 739	-18
Jul	11, 288, 144	8, 629, 918	-24
Aug	11, 085, 392	6, 537, 149	-41
Sep	9, 400, 105	6, 164, 639	-34
Cumul 6 mo	62.5 mbbls	44.5 mbbls	-28.8
Avg per mo	10.41 mbbls	7.42 mbbls	-28.7

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*  21% of the actual fiscal year production would be 97 million barrels.

Lack of royalty regime hampers further oil development

Not surprisingly, some people attending the NOIA conference in St. John’s are wondering what is next on the horizon.

As CBC reports, there is much talk of developing smaller fields in the Jeanne d’Arc basin.

There is also the recent announcement by StatoilHydro of a significant oil find at its Mizzen property, farther offshore than the three existing projects and Hibernia South and Hebron both under development.

Regardless of its size, Mizzen poses a number of challenges, not the least of which is the cost and technical issues of developing a field – even one of upwards of three billion barrels of oil – in deep water.

There are at least two others.

One is the impact of the United Nations Convention on the Law of the Sea (UNCLOS). Mizzen is well outside the 200 mile exclusive economic zone but may not lie outside the definition of the continental shelf.   If this is the case, the coastal state – namely Canada – would be required to set aside a portion of the revenue (maximum seven percent) from any development for distribution to the other states which are party to the convention.

Article 82

…

2. The payments and contributions shall be made annually with respect to all production at a site after the first five years of production at that site. For the sixth year, the rate of payment or contribution shall be 1 per cent of the value or volume of production at the site. The rate shall increase by 1 per cent for each subsequent year until the twelfth year and shall remain at 7 per cent thereafter. Production does not include resources used in connection with exploitation.

That’s potentially a significant cost to both Newfoundland and Labrador and to the companies.

That links to the other problem, namely the absence of an oil or gas royalty regime in the province.  Hibernia, Terra Nova, White Rose and Hebron all have royalty regimes.

The 2007 energy plan wiped out the existing generic oil regime. While the plan promised to replace it and issue a new gas regime, neither has emerged in the intervening years. There is no sign of either coming in the near future.

Even the development of smaller fields on the Jeanne d’Arc basin not associated with the existing projects is affected by the lack of a royalty regime.  The Hibernia South agreement is proposed using the Hibernia royalty regime developed in 1990 and amended in 2000, with some minor amendments.  Other projects would not have that as a basis, nor would it have the Terra Nova, the generic regime used at White Rose or the amended generic regime used for Hebron.

As Danny Williams said in 2005, oil companies don’t like risk.  Really though it isn’t that they dislike risk as much as they prefer predictability.  Even a volatile political climate is manageable, but when it comes to money, the companies like to have a good picture of what their costs will look like over time. That’s where an established royalty regime comes in handy.

In the meantime, some exploration will continue.  Seismic is pretty straightforward.  But when it comes to drilling holes and maybe looking at production, the lack of a predictable financial regime tends to make oil companies skittish.

The situation today is much the same as it was three or four years ago.  There are more exploration and development prospects for Big Oil than there is available capital.  They will put their money where they can figure out the financials.  Anything they can’t calculate  at all will go to the bottom of the pile in favour something somewhere else, even in a part of the world where the politicians in charge change with the sound of gunfire.

Now that Hebron and Hibernia South are pretty much done, the provincial government should turn its attention to restoring stability in the offshore financial regimes.

Above all else, that is what will determine the location of the next project or if there is a project at all.

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NL crude production forecast: 2009-2025

From the Canadian Association of Petroleum Producers, projected total annual oil production offshore Newfoundland and Labrador.  The CAPP report provides estimates of daily production which have been extended for this chart by multiplying by 365.


The downward production trend is unmistakeable.  The increase in 2017 represents the increase from Hebron and Hibernia South.  The two year delay in signing the development deal postponed the extra production which would have replaced dwindling production from other fields.

To give a sense of the implication of this chart, total royalty revenue in 2016 would be US$400 million.  If we assume a 20% premium for an 80 cent Canadian dollar, that works out to Cdn$480.  Compare that to the estimated $1.265 billion in Budget 2009.

Any added revenue that may come from the Hebron royalty regime would not arrive until sometime after 2020.  Even then, added revenue from the so-called super royalty only comes in any month when the average price for West Texas Intermediate crude is above US$50 per barrel.

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What drives current oil prices?

Some people will tell you that resurging growth in the Chinese economy is pushing oil prices up and will sustain high oil prices into the future.

That’s an interesting notion given the demand statistics.  take a look at daily consumption figures from nationmaster.com.  The figures here jive with a commentary by CBC Radio’s business consultant during an interview with On the Go’s ted Blade’s Thursday afternoon.

Now admittedly they are from 2007 but they show that American daily oil consumption is about thee times that of China.  Those figures have changed relatively over the past couple of years since both the American and the Chinese economies have taken a hit and the hits are connected.

There’s still an oil glut on the world markets, by the way, despite cuts in production at OPEC.

So why are oil prices high?

It seems that prices are relatively high for the same reason that helped drive oil to historic highs last year.  A weak American dollar coupled with questions about the American economic recovery are pushing speculators into the oil markets again. 

At some point, though, the markets will correct, just as they did last year. High oil prices will delay the American recovery and likely exacerbate the demand versus supply imbalance. In a world of tight money, the world can only sustain that situation for so long. 

At that point, just as in the mid-1980s, expect a second downward drop in oil prices after the initial steep slide.

Closer to home, that likely means any hopes of oil powering the provincial budget out of deficit might be a bit premature at best.  At worst, a dramatic drop in oil prices – like say to about half where it is now – or a delayed American recovery will only increase the deficit problem in the years ahead. 

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How Icelandic are we, 2009 budget version

According to the Premier the relatively high price of oil at the moment is a good thing, with the prospect that it could wipe out the provincial government’s budget deficit. [Update:  an online story via CBC about the Premier’s comments.]

But could it?

Right at the start, everyone should recall that provincial revenues from oil are a function of the price per barrel of oil and total annual production.  The provincial royalty is a percentage of what you get when you multiply how much oil is sold by how much you get for each barrel.

So let’s look at production.

The provincial 2009 budget low-balls oil production.  It hit 125 million barrels in 2008 and while Dominion Bond Rating Service forecast a 15% drop, the provincial finance department forecasts a 21% drop to only 98.5 million barrels.

In the first month of the fiscal year – April – total oil production was slightly more than 9.1 million barrels.  At that rate, the offshore would produce 109.2 million barrels in 2009.

Compared to April last year, oil production is only down about 10%.  That means that the provincial production forecast could be off by more than twice the actual decline. 109 million barrels would represent a 13% decrease from 2008 – right in line with the DBRS estimate.

Then there’s price.

The budget forecast oil at US$50 a barrel on average.  Currently Brent is trading at about US$65 a barrel.

Sounds great, until you factor in the hidden gem:  the relative value of the Canadian dollar.  When the Canadian dollar is weak the provincial government can pick up a nice little premium by selling in American and then doing the conversion. 

At budget time, the Canadian dollar was worth a lot less.  As a result, that price of US$50 a barrel worked out to be around Canadian$60 to $62.50.

Brent crude is currently trading  at Cdn$71.50.  That’s because the Canadian dollar is trading at almost US$0.90. 

If you do the math on that – using today’s Brent price plus the more likely oil production level  - the whole thing works out to roughly $1.5 billion in oil royalties for the provincial treasury.  The budget forecast was $1.262 billion based on a smaller amount of slightly cheaper oil.

Meanwhile, the cash shortfall is $1.3 billion. Oil revenues would have to double, as they pretty much did last year, in order to wipe out the cash shortfall if the dollar hangs around its current treading level.

Even coming up with an extra $500 million or so on top of the extras already attained would mean you’d have to see the price of oil go higher still and the Canadian dollar slide down as well.

That might happen.

Then again, in the current environment, it doesn’t seem very likely.

We’ve been in this sort of dream land thinking before back in the spring when the budget came down. Back then, we used a higher oil production figure and a much weaker Canadian dollar in order to generate an extra $600 million in cash or thereabouts. 

But an extra $1.3 billion? 

Or even $750 million?

That would be pretty hard especially when other commodities like fish and minerals aren’t doing that well either and the forest industry in the province is shrinking faster than the family jewels on a crowd of Scandinavian men running from the sauna into an ice-covered pond.

At the very best, any optimism or pessimism about where the provincial deficit will wind up this year is a wee bit premature.  At the worst, reporting any sort of government speculation about revenues is irresponsible.

After all, these guys sat on a couple of billion in cash they never bothered to mention until this year.  It’s not like the provincial government has a sterling reputation when it comes to disclosing the facts of a matter.

 

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10 years to turn around: Newfoundland and Labrador oil royalties

Oil started flowing from the Newfoundland and Labrador offshore a little over a decade ago but in that short time, provincial oil royalties have propelled the provincial government unprecedented financial wealth.

The royalties are set by the provincial government under the 1985 Atlantic Accord.

The table at left comes directly from the auditor general’s annual report for the fiscal year 2007 (ending 31 March 2008). 

Note that the auditor general consistently misreports the fiscal year and this can lead to considerable confusion.

The year called 2003 in the table is actually 2002;  the auditor general labels the year by the calendar year in which it ends, not begins.  Thus, the auditor general writes FY 2002 as “2003” since the end of the year is March 31 2003 

The noticeable jump in royalties from Hibernia show the impact of skyrocketing crude oil prices coupled with the escalating percentage royalty applied to the project before payout. 

Hibernia still hasn’t paid out, that is, the initial costs haven’t been recovered, but between 2004 and 2005 – actually 2003 and 2004 - royalties doubled.

That same approach applied to each of the other two projects currently in production.  In those projects, the high price of crude oil allowed the operators to recover development costs in two to three years.

The trebling of royalties in 2006 (actually 2005) from Terra Nova and the astounding jump at White Rose in 2008 (actually 2007) are entirely due to the combined impact of the royalty regimes negotiated before calendar year 2003 and historically high crude oil prices.

In order to correct this confusing date labels and to give you another visual of the royalties, the chart at right shows the royalties by project for each fiscal year (correctly labelled).

The projected cumulative royalties for the current fiscal year will be over $2.2 billion, up from the more than $1.7 billion collected in 2007.

However, lower oil prices and lower production puts likely oil royalties for 2009 at a level only slightly higher than what Terra Nova itself contributed in 2007.

That should give a sense of the fiscal problem facing the provincial government.  As noted here before, though, that’s a problem entirely of its own making.  The provincial government has consistently boosted spending to meet the astronomically high revenues.

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Crude breaks 40 – on the way down

West Texas Intermediate for January settled at US$36.22 in trading in New York despite a cut in production announced by the Organization of Petroleum Exporting Countries (OPEC). 

Brent crude, the benchmark used for Newfoundland and Labrador crude, finished the day at US$43.60. Longer term futures  - out to 2015 - showed varying declines, even though the current trading price ranges considerably higher than that for front month crude. [Long term charts:  WTI and Brent]

On the New York exchange, January crude finishes tomorrow.  February was more active, settling at less than US$44.

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The Gospel according to Chip Diller

Newfoundland and Labrador is usually one of the last places to catch a trend.  Doesn't matter if you are talking fashion or, in the latest version, government economic and fiscal policy, it seems to take a while for things to catch on here.

Late on Friday afternoon newly minted finance minister Jerome Kennedy issued a news release trumpeting a credit rating by Standard and Poor's as proof of the provincial government's "fiscal prudence and sound policies". 

Well, maybe catch up is the better word.

There isn't a government left in the developed world that is still pushing the sound fundamentals media line now almost two months after the start of the current global economic crisis.  No government is claiming some sort of credit for being able to weather a storm that, in many minds, is far from over.

Well, no government except the one here.

If you want to understand why everyone else's tune has changed, take a look at the five year trending in crude oil prices. You can find an example in the WTI futures box on the right hand column.  Click on the "5Y" symbol. 

Four years to get up to US$147 a barrel and a mere four months to tumble below US$50.  The steepest declines have come in just the past two months.

The speed of the price collapse should be a clue to analysts that the assumptions used before July to predict that oil would remain at unprecedentedly high prices for the rest of time were faulty.  The security premium, supply concerns and overheated speculation drove prices to the peak last summer but in addition to all that the superheating of the global economy, fueled by loose American regulations pushed things beyond anything that would be considered normal and rational.

In other words, the price of oil has been artificially high for a very long time. Given that markets have a way of correcting themselves at some point, it was really only a matter of time before a correction - a downturn - took the heat out of things.  The only thing that couldn't be foreseen, and that's about the only thing, was how steep a correction was coming and how it might last, but come it would as surely as it has come at every juncture in the past.

Fewer and fewer analysts are holding to the old projections, some of them dating back several months. Some of the more influential sources, such as the International Energy Agency, are forecasting high prices.  However, many are revising their short term projections markedly downward.  Deutsche Bank, among others, is projecting crude at US$40 per barrel by April 2009.  One analyst  - Robin Batchelor - who in May 2008 predicted high oil prices well into the future is now likening the current climate to one 30 years ago:

"On the upside it always overshoots and the same is true on the downside. What I’m looking at is the commodity supply and demand equation; long term there are still supply issues but on the demand side we’re facing downdraft," he points out. "The last time we had a fall of that magnitude was in 1979/80/81."

While Batchelor for one has not abandoned his high price forecasts, he has certainly altered his view dramatically. The reason is simple.  While he and others once assumed ever increasing demand, the current correction may alter the demand side of the price equation that can't be seen right at the moment. If the current downturn lasts well into 2009, as most expect, the IEA, among others, will likely go back and rethink their projections just as they revised their assumptions three years ago when they thought US$50 a barrel was the peak.

Closer to home, though, the hope in the old assumptions remain strong close to home. This week, economist Wade Locke told Memorial University's student newspaper The Muse that:

“The longterm [sic] price forecast is still in the $80- to $90-range for oil and that will not affect Hebron, White Rose Extension, or Hibernia South. Even if [oil] prices were to stay around $60, these projects would likely proceed,” he said.

Locke's comments are a useful segue to an interesting aspect of the local view from the provincial government and its supporters.  Locke certainly falls into that category and the similarity between his comments and those of the finance minister are striking.  With that quote from The Muse in mind, take a look at this one from the release on the credit rating:

"Our economy remains strong and the current economic downturn should not affect development of new oilfields including White Rose Expansion, Hibernia South and Hebron," said Minister Kennedy.

The phrasing is similar, much like the similarity in early October between Locke's and the Premier's references within days of each other to the government being able to meet and exceed its current budget targets even if oil falls to $10 a barrel.

But what's more interesting in these two comments is that neither is completely true and in the wider context of Locke's comments on a bright future based on oil wealth, they constitute a fixation on oil as the source of economic salvation not seen in this province since "1979/80/81."

Let's deal with the projects first.

The White Rose expansion is a relatively modest project.  With its development costs already recovered, oil would almost have to hit prices lower than the historic 1992 price of  US$8  per barrel to make it economically dodgy.

The Hibernia South extension is also not a pricey project measured in terms of the original Hibernia project or Hebron.  However, there is no development application yet and a decision to proceed would certainly be affected by oil prices significantly lower than the current ones.

In all likelihood, the project will go ahead given that the oil companies have at their doorstep a provincial government willing to invest hundreds of millions of very scarce tax dollars in the expansion since that ultimately lowers their cost.  Given they will have recovered their initial costs by the time the new fields come online, their profit position would improve immensely in such a scenario while it would be the junior partner who would see a relatively lower return on investment. Low oil prices - especially below the foolish fixed price trigger of the current government's oil super-royalty regime  - won't affect them as much as it would the new kid in the oil patch.

Hebron is the most costly of three projects and the one most likely to be affected by a long period of low prices. Analysts seem to agree that the current price climate makes investment in high cost ventures like offshore heavy oil, deep water projects and oils sands less attractive.  Hebron's reported financial tipping point  - US$35 per barrel - is well below that of an oil sands project but stop and look at current prices.

There's a reason why the companies insisted on a clause in the Hebron agreement which gave the partners  - and the partners alone - the right to take up to a decade to sanction the project.  Current Hebron timelines are merely works in progress, subject to revision is the financial climate changes.

The upside for Hebron is that the companies managed to secure several significant concessions from the provincial government as hedges against a drop in oil prices. Those concessions make it more likely the project will proceed.

First, they secured the decade to sanction with no penalty for deciding against proceeding. They have time to decide and there is no real cost for delaying if the numbers don't add up.

Second, they won the royalty concession that dropped the pre-payout royalty to a fixed 1% as opposed to the escalating scale of the old royalty regime.  The energy minister herself heralded this as a major feature of the new deal.

Third, they were able to tie the super-royalty to a fixed price below which no extra cash was paid to the provincial treasury.  By the government's own estimate, oil prices averaging US$50 a barrel over the life of the project produced less than half the royalties of a high oil price.  Drop below that magic fixed trigger and the provincial share drops accordingly on top of the front-end royalty concession but from the company standpoint they can guarantee low possible costs across the board.

Fourthly, they secured significant fabrication concessions in the agreement.  Most of the topsides work will be done outside the province anyway based on what appears to be a huge miscalculation by the provincial government's negotiating team. 

On top of that, however, the management arrangement  - including the provincial government as junior partner  - would enable the companies to ship virtually all the topsides work and associated engineering outside the province in order to lower the costs and complete the project on time. If oil prices stayed low enough long enough and construction costs stayed high enough, it may well be worth the companies' while to pay the modest penalties for changes in the work commitments to get the deal done, even if they had to pay the penalties at all.  A renegotiated contract arrangement with the provincial government's energy company and the government that changed the work commitments would likely never be made public under the revisions to the energy corporation act passed last spring.

The companies may well get their projects, but the return to the provincial treasury and the overall impact on the local economy may turn out to be far smaller than originally promised.

The fundamental problem in all this is the fixation on oil projects which has led the provincial government and its supporters to tie government finances to the price of a barrel of oil.  Despite all assurances to the contrary, the next several years may be see provincial government fiscal problems as unprecedented as the surpluses of the past two or three years. Unlike those surpluses, however, the problems won't be figments of an accountant's bookkeeping methods.

Beyond that, prosperity for the province as a whole, in Locke's view, appears to be driven entirely by a couple of oil projects which, it must be noted, have a fixed life span.  Neither Locke nor Kennedy - who echoed Locke's definition of prosperity - have not realized the folly of resting everything on the a very slippery commodity.  

Oddly enough, it fell to Donna Stone, president of the St. John's Board of Trade to sound a very small warning bell against this very situation.  Board of trade presidents are not known to buck the government line so her words stand out.  As Stone told the Rotary Club of St. John's:

“This still gives us some cause for concern, however. Given the volatility of oil prices, the province should look at a long-term plan that will diversify our economy and make us less dependent on this ever-changing commodity,” Stone said.

Stone is absolutely right.  Almost 20 years ago, the provincial government realized exactly that and implemented a broadly-based strategic economic plan to hedge against such dependence.  That plan has been tossed aside in the  past four years.

The consequences may prove to be dire and no amount of assurance that all is well will save us from the them.

Just remember what happened to Chip Diller.

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Alberta commission recommends banking oil cash

A commission struck to advise on how the Alberta government should handle its oil revenues is recommending the provincial government devote more to the Heritage Savings Trust Fund.

The Alberta Financial Investment Planning and Advisory Commission said in its report that Alberta needs to boost the size of the fund to $100-billion by 2030, compared to just $15.8-billion now.

Bear in mind that Alberta can bank extra cash since it has already eliminated the provincial government's accumulated debt load.  It also salted some of its revenues in the Heritage Fund.

Meanwhile, the current provincial administration has opted to spend all its oil revenue and specifically rejected the idea of an savings or investment fund or indeed of actually reducing the provincial government's debt burden.

The argument about devoting some oil revenue to savings and investments is compelling:

“To preserve today's prosperity and pass on the benefits to current and future generations of Albertans, we urge [the government] to make savings the new fiscal anchor for Alberta,” the commission said.

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