Oil Royalty and Oil Price Forecasts (2015) #nlpoli

Don Mills says people in Newfoundland and Labrador have a false impression of the state of the provincial economy.

Wade Locke says Mills is full of it.

To bolster his argument, such as it is, Locke released a raft of pretty charts a couple of weeks ago.

One of them included a slide showing projected offshore oil production. (right)

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.

The cost of not doing the math #nlpoli

Natural resources minister Jerome Kennedy admitted over the weekend that he had not done the calculation to figure out if the equity stake in Hebron was worth the cost compared to just a change in the royalty regime.

CBC’s David Cochrane put the question to Kennedy after seven minutes or so of Kennedy’s recitation of talking point after talking point about the Hebron project and the impact of the massive increase  in costs.  In response to Cochrane’s relentless, detailed questioning, Kennedy tried every folksy analogy in his arsenal of banalities.  He talked about putting away money for your children’s education.  He tried the bland admonishment that the government would look after the future, not just do what was immediately popular. 

Kennedy even tried to suggest questions about public finance  - and the impact of spending billions on resource projects – should go to Tom Marshall.  Since the provincial government struck a deal with the Hebron partners in 2007, the estimated cost of the project has tripled.  Cochrane noted the cash commitments.

And finally with his acknowledgement he hadn’t done the math himself, Kennedy blinked on a basic element of the provincial government’s strategic plan.

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.

-srbp-

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.

- srbp -

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.

- srbp - 

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.

- srbp -

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.

-srbp-

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.

-srbp-

Province may lose big-time in Hebron royalty give-away

According to the Telegram, the Hebron partners won’t be filing their development application for the project until December 2010.

That’s a full year behind the original schedule but the companies claim it won’t impact anticipated first oil in 2017.

This is the second change to the project in two months.  The full implication of cancelling pre-drilling still hasn’t been determined.  It appears to have been dumped to avoid significant challenges posed by dropping the gravity base structure onto a pre-drilled template.

But the wider implications are still uncertain.  Pre-drilling would have allowed the project to get to full production very quickly.  As it is, production wells will now be drilled from the single derrick planned for the Hebron GBS. It took Hibernia five years to hit full production and that was using two derricks.

Delays in hitting full production will affect the timeline for the project to hit payout and that will affect the provincial government’s royalty take over the life of the project.

In signing the Hebron deal, the provincial government agreed to a flat one percent royalty until the project recovers its development costs (payout).  The generic royalty and the regime used for Hibernia and Terra Nova used a sliding scale that saw the provincial share increase steadily to a maximum of 7.5% based on cumulative production.

In 2007, natural resources minister Kathy Dunderdale said the flat royalty was a way of giving the companies insurance against low oil prices:

“The rationale behind these changes was the companies needed some downside protection if the price of oil went very, very low,” Natural Resources Minister Kathy Dunderdale said.

“So, that was the tradeoff [sic] for us — to give them protection if oil prices really plummeted, to get a gain if prices were high, above $50. So, we traded off some risk on the low end for significant gains on the other end.”

The provincial government’s entire assumption about the royalty give-away seems to have been based on the idea that payout would occur quickly.

But if oil prices remain high, the period during which the basic royalty remains at just one per cent shortens significantly.

“Normally, in terms of the basic royalty, even under generic, you go through those stages pretty quickly,” Dunderdale noted.

However, even at relatively high oil prices, lower production rates would drag out the time needed to pay off development costs.  And – looking at it logically -  the provincial government would lose significantly more in the process. That’s a point Dunderdale didn’t mention in 2007.

Dunderdale did mention the price of oil, which appears to have been a huge factor in provincial government thinking.  In exchange for the flat royalty give-away at the front end, the provincial government banked on recouping its losses if oil stayed above US$50 per barrel.  As Dunderdale told CBC in August 2007:

"You know, it's going to be a long time by anybody's estimates that we're ever going to see oil less than $50 a barrel," Dunderdale said. "We gave something on the downside which is low-risk to us to achieve a very high gain on the upside."

The “long time” turned out to be two years. [Time Travel Update:  or is Mathematically Challenged?  Oil hit 50 bucks a barrel within a year or so of her  great pronouncement.  it was less than 40 bucks a barrel a few months after that.]

The Hebron changes in December raise once more questions about the assumptions used by the provincial government in negotiating the royalty regime.    Slower time to full production could stretch payout to 10 years or more.  The provincial government appears to have operated on the assumption that oil would remain high throughout the initial production and post-payout phases.

A decade to payout is one one of the implications noted in Bond Paper’s preliminary look at the Hebron royalty.  The following chart used a relatively low price for oil and assumed high development costs.  It didn’t consider any delay in getting to full production but did anticipate taking a decade to hit payout.

-srbp-

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.

-srbp-

If it looks too good to be true…

While gross domestic product in Newfoundland and Labrador is now forecast by the provincial finance department to shrink by 8.5%, finance minister Tom Marshall today forecast he expected to receive $520 million more than budgeted last year in oil royalties.

That’s pretty much typical of the incongruity between what the  “mid-year” financial update said about the economy and Marshall’s prediction of higher than expected revenues.

Here’s a summary of the 2009 economic performance to date in Newfoundland and Labrador, as presented by the finance department:

• Real gross domestic product is now expected to decline by 8.5% compared to 2008.  That’s worse than the 7.7% drop forecast last spring.
• Oil production in the first nine months of calendar 2009 is down 20.6% compared to the same period in 2008.
• Despite that, the revised budget projection is for an increase in oil production to 101 million barrels by the end of March 2010 compared to the spring projection of 98 million barrels.
• The value of oil production is expected to decline by 45% compared to last year.  That’s on a calendar basis. 
• Government oil royalties on an accrual basis is expected to be $1.813 billion, an increase of $520 million over the forecast in Budget 2009.
• The value of mineral shipments is expected to be down by 56% compared to 2008.
• Mining employment down by 9% compared to 2008.
• Paper production is expected to be about 47% lower than in 2008.
• Retail sales and personal income are up slightly compared to 2008.

Some quickie observations:

Apples and oranges comparisons: Most of the economic information presented in the update compares performance over a calendar year while the budget works on a fiscal year. 

To illustrate how this can have a distorting effect, consider that oil production in the first three months of calendar 2009 remained at 2008 levels of 10 and 11 million barrels per month.  However, during fiscal 2009 thus far (starting in April) , monthly production has averaged about 30% below that.  The first three months artificially inflate the average for the calendar year compared to the fiscal year.

Triple the year-to-date oil revenues and then some:  As BP reported earlier, oil royalties in the first half of fiscal 2009 (Apr to Sep) totalled about $488 million.  September’s royalties were 60% below the monthly average needed to hit the spring budget projection of $1.3 billion on an accrual basis.  Overall, royalties are running about 15% below forecast.

The fall update now projects oil royalties at $520 million higher than forecast. That’s 40% higher than forecast, despite the prediction that the value of oil production will be down by  45% and that production will be down by at least 20%.

Oil royalties are function of price and production.  Even if the royalty rate is higher in 2009 than 2008, lower production and lower average prices should produce lower royalties. 

As it is, the revised oil royalty is only 8% below 2008’s figure despite a projected 45% drop in value and a 20% drop in production.

A missing chunk:  On page nine of the budget speech from last spring, then finance minister Jerome Kennedy blamed the deficit on two things:  the impact of the stock market on pension investments (about $380 million) and lost Equalization revenue owing to changes in the formula for 2009.  That part was supposed to account for about $414 million.

There isn’t a single word about the pension plan investments and their current valuation in the update.

Hmmm.

Read the fine print:  While things might just turn out to be as rosy and wonderful as the budget forecast, it might be useful to bear these words in mind.  They come from page five of the budget update document itself:

However, at this time, there are four months remaining in the fiscal year, and there are many factors and uncertainties which may impact year end results.

Uh oh.

This wouldn’t be the first government that blew smoke to try and keep consumer wallets open through a rough patch.  There are plenty of things in this budget update that don’t add up.  Maybe they aren’t supposed to unless you realise that this update was less about the facts and more about the torque.

Whatever happens, we’ll know for sure in the spring.

-srbp-

September oil royalties 60% below budget forecast average

High prices and better royalty rates on Hibernia didn’t offset oil production declines in September for the Newfoundland and Labrador offshore.

According to figures released to Bond Papers by Natural Resources Canada, Newfoundland and Labrador’s oil royalties for September were $40, 290, 252.18. 

That’s only 40% of the $105 million monthly average needed to meet projections in the spring budget. The provincial government  forecast oil royalties of $1.262 billion for Fiscal 2009, or about $105 million per month.

As reported in November,  figures obtained from Natural Resources Canada showed provincial oil royalties were down almost 60% [on average] so far in 2009 compared to 2008 and were running [on average] 15% below provincial budget forecasts released in March of 2009. [In September alone, revenues dropped to 40% of the average needed to meet 2009 budget projections]

Oil production is down about 29% from last year. September oil production from Hibernia, Terra Nova and White Rose totalled 6,164, 839 barrels of light crude according to the offshore regulatory board.  October production was slightly more than 6.9 million barrels, about the same as May 2009 and continuing the trend thus far for the new year.

If those trends continue for the rest of the fiscal year, oil royalties for 2009 will come in at less than $1.0 billion. Without cuts to spending or increased revenue from other sources, the provincial government will have a hard time not to exceed its record forecast deficit of $1.3 billion on a cash basis.

-srbp-

[Words and a sentence added for clarity]

Oil royalties down 57% from 2008; 15% below budget so far for 2009

Forget the bubble, the imaginary protection Newfoundland and Labrador supposedly enjoyed from the global recession.

Forget any prospect of another windfall year in 2009 like the one in 2008.

The prospect of a balanced budget  - let alone a slashed deficit - could be dim if provincial oil royalty figures thus far in the fiscal year hold true to the end of March 2010.

According to figures released by the federal natural resources department (NRCAN), Newfoundland and Labrador averaged $89.6 million a month in oil royalties for the first five months of 2009. 

That’s about 57% below the average monthly 2008 oil royalties, based on $2.5 billion over 12 months.

It’s also 15% below the projected oil royalty figure contained in 2009 Estimates.  If that trend continues, the provincial oil royalties would come in at around $1.08 billion instead of  the $1.262 billion forecast in the Estimates. 

Budget 2009 projected a $1.3 billion cash shortfall on a cash basis (The Estimates) and a $750 million shortfall on an accrual basis (The Budget Speech).  In 2007, the current provincial government quietly reversed the practice established in 2003 and began to report the province’s budget using both accrual and modified cash accounting.

Without significant changes in other revenues, dramatic spending cuts or a combination of both, it’s going to be tough for the provincial government to avoid a deficit this year and it may well wind up with a larger deficit than forecast.

While other areas of the economy may be performing better than expected, it’s doubtful they be able to generate the added revenue for the provincial treasury  that came from oil within the past few years. 

Borrowing would seem to be inevitable, whether it was borrowing from banks or borrowing from the $1.8 billion in temporary investments the provincial government had on hand last spring.  Some of that $1.8 billion is committed to other projects, however.

The table below shows the monthly oil royalty figures for April to August 2009 as well as the offshore oil production from April to September and the average royalty per barrel for each month. 

Month	Royalty  ($)	Production (barrels)	Average royalty amount per barrel ($)
Apr	94, 344, 222. 11	9, 116, 213	10.34
May	77, 970, 776. 28	6, 915, 304	11.25
Jun	97, 572, 585. 54	7, 374, 739	13.23
Jul	89, 287, 050. 27	8, 629, 918	10.34
Aug	49, 851, 328. 75	6, 537, 149	7.62
Sep	N/A	6, 164, 839	N/A
Total	448, 461, 684. 47*	44, 738, 162**	N/A
Average	89, 692, 336. 89*	7, 456, 360**	N/A

* First five months

** Six months

The August royalty total is particularly low due to decreased production at White Rose for planned maintenance. The September figure may also be low due to scheduled maintenance. 

The production figures are taken from the Canada-Newfoundland and Labrador  Offshore Petroleum Board website.

Bond Papers tried unsuccessfully to get the information from the provincial finance department before contacting NRCAN.

-srbp-

Freedom from Information: oil royalties version

After two e-mail requests to the provincial finance department yielded nothing but delays for two weeks, a simple e-mail to the federal natural resources department produced information on the provincial oil royalties the provincial finance department had trouble releasing.

And it only took four working days.

The request on October 21 to the provincial finance department was simple enough:

What is the total offshore royalty received by the provincial government from 01 Apr 09 to 30 September 2009?

The first response (October 23) from the department spokesperson said:

The information you are requesting is provided at the end of the year in the public accounts and can be made available to you at that time.

Of course, the estimates are publicised at the end of the fiscal year but the audited financial statements  - the public accounts -  for 2009 won’t be released until February 2011. 

That seemed like an unusually long and unnecessary wait for information that should be readily available.

Oil royalties are collected each month by the federal natural resources department (NRCAN) under the terms of the 1985 Atlantic Accord.  The amounts collected are set by the provincial government through its own royalty regimes for Hibernia, Terra Nova and White Rose.  The royalties collected are turned over in their entirety to the provincial finance department monthly.

A second request (October 23) to provincial finance asked for the reason the information was being withheld.   The reply to that inquiry came on November 4, 2009 and gave a new, more curious response:

For the particular timeframe of your request, the department is still receiving the relevant information.  When the data collection is complete, the information will be made available. 

Still receiving information?  Now that’s a bit of an odd idea since the finance department should be in the process of completing a mid-year financial update for public release.  The figures on oil royalties would be sitting right there on someone’s computer, presumably since they form a very big part of the provincial government’s annual revenues. 

If nothing else, finance officials produce monthly statements of account showing revenues and expenditures both for government as a whole and for individual departments.   It would be exceedingly strange if the finance department didn’t have the figures for at least April to August. 

As it is, your humble e-scribbler went looking for the information in October.  It might have been a bit optimistic to get even the September figures.  At this point – early November - provincial officials should have September done and October should be well on the way.

But nothing at all until the whole thing was complete?  Highly unusual, to say the least.

Your humble e-scribbler turned instead to NRCAN.  An e-mail inquiry to the NRCAN manager of media relations on November 5 for the year to date oil royalty figures produced the response on November 9:  the oil royalty figures for April to August 2009.  September is in the pipeline and even October might be available within a few weeks.

It was that simple and that fast.

-srbp-

NALCOR may be exempted from offshore royalty payments

If the provincial government acts on a provision of the Hebron fiscal agreement, the government’s own energy corporation could wind up paying nothing to the provincial treasury in royalties.

That would set it apart from any other offshore interest holder,  including the federal government’s Canada Hibernia Holding Corporation (CHHC).

Under sections 8.4 of the Hebron fiscal agreement, the Hebron partners agree that the provincial government can “make amendments to the Petroleum and Natural Gas Act”…, “make amendments to the Royalty Regulations” or “make an agreement pursuant to section 33 of Petroleum and Natural Gas Act…to adjust, vary or suspend OilCo’s liability for the payment of royalties on oil produced from the Lands”  that would be different from the arrangements with the other project partners.

That provision  - which could see the province’s own oil company pay nothing at all in royalties - might also violate the agreement that is the basis for the province’s offshore wealth.

Under section 41 of  the 1985 Atlantic Accord memorandum of understanding between Ottawa and St. John’s,  “Crown corporations and agencies involved in oil and gas resource activities in the offshore area shall be subject to all taxes, royalties and levies.”

That section was intended to put any Crown corporation operating offshore, federal or provincial,  on the same footing as a private sector corporation.

That section applies to CHHC and should also cover NALCOR Energy.

The provision of the agreement appears to take advantage of hasty 2001 amendments to the Petroleum and Natural Gas Act which gave the provincial government the ability to make an agreement on royalties that differed from the generic royalty regime.

Although the changes to the province’s fundamental oil and gas law were substantive, the entire set of amendments passed through the House of Assembly in a single evening with only three speakers.

Energy minister Lloyd Matthews described the changes as “administrative.”  He did not give any detailed discussion of any amendment, and simply glossed over the section on royalty agreements – the new section 33 – as if it was nothing more than a change of numbering.

John Ottenheimer, the opposition energy critic at the time and now the chair of NALCOR Energy’s board of directors,  spoke on the bill but made absolutely no reference to the details of the changes concerning royalties and variance to royalty arrangements.

That’s surprising given that the opposition leader at the time had already begun to speak publicly against give-away resource deals. Section 33 set the legal stage for just such a give away.

Jack Harris also spoke on the bill, spending considerable time criticising the existing royalty regimes.  He made no reference to the substantive changes the bill made to the Petroleum and Natural Gas Act.  That’s surprising since section 33 gives the government the right to sign a royalty deal which wasn’t even as lucrative as the existing regimes which he was criticizing. 

Then opposition leader Danny Williams made no comment at all on the bill during debate.

There’s no way of knowing at this point if a similar provision exists in the deal on Hibernia South. Details of the fiscal agreement on that project have not been made public.

-srbp-

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.

-srbp-

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.

-srbp-