Friday, 14 December 2012

Finance Minister Does Not Understand Risk

The Budget Update, delivered yesterday, December 13, 2012, by the Finance Minister, acknowledges the mulitude of risks attacking the declining health of the Province's Teasury; otherwise, it ignores them.  He gives no advice to the Government either, as it trundles towards sanctioning an outsized and risky megaproject.  The Minister is not a decision maker.  He should go.

Many great projects get passed over because the risk/reward ratio is simply unattractive.  In business, it is a fact of everyday life.  On paper, an idea may first appear sound; the assumptions are reasonable, cash flow analysis is excellent, pro forma rate of return, on both equity and investment, are within an acceptable range, financing is available on reasonable terms.  Then a decision is made to scrap the idea! Why? What went wrong? The answer is sometimes even good investment ideas get placed on the backburner.  Regardless of how inherently sound they may be, they carry risk, sometimes too much risk. 

Given the Finance Minister's tale of woe, let's consider this theme further.

A prudent company will not only assess the intrinsic viability of a proposed investment, it will consider the company’s ability to deal with the consequences of failure.  Stuff happens, much of it beyond our control. The practice of risk management will identify the most serious potential problems and propose safeguards against trouble.  It might, for example, compel an investor to let a greater number of shareholders participate.  Alternatively, the project might get scaled down or cancelled altogether.  The state of the international economy may be a threat; public debt may be already too high.  The size of the labour pool or the availability of essential technical skills may be inadequate.  Wage inflation, caused by an overheated economy, may result in significant cost overruns and necessitate more capital or cause lower returns. Could I be referring to the Muskrat Falls Project?
If the decision is not to proceed, a logical question to ask is whether the particular service/product can be gotten another way.  “Lowest cost option” is a goal of every business.  It is a benchmark against which the next most acceptable alternative can be measured.  In other words, an entrepreneur doesn’t risk the shop to achieve the optimum result when a modest compromise is available.

If you recall, Nalcor’s proposal ostensibly provides a $2.2 billion  saving relative to the ‘isolated island’ option.  The DG-3 numbers added $1.2 to the capital cost plus nearly $1 billion financing costs, during construction, which were deliberately excluded. Of course, arguably, costs within the ‘isolate island’ option are higher also, but that Option, an incremental response to more current demand forecasts, has been completely ignored.  Still, risk assessments can occur only if there is full disclosure.   
While most people view government borrowing with apathy, we ought to remember that governments and as a consequence, their constituents too, are impacted by changing market conditions. These days virtually every national news report names a government that is dealing with financial distress. The origin of the problem, if traced, can be linked to the lack of appropriate consideration of risk and the failure to make major financial decisions on a timely basis. 

As if to confirm such a failure, the Minister of Finance, only now, in the ninth month of the fiscal year, is ready to acknowledge what has been evident from the beginning.  And, still he has no decisions at hand.

The scourge of democracies is that access to debt permits governments to postpone prudent decision making in the expectation that a later government will impose the fiscal discipline they lack. In common parlance, we call it ‘kicking the can down the road’.  In this Province, we have been doing that for years.  The current government is one of two that has enjoyed high revenues, yet, still cannot muster the willingness to resolve an operating deficit that has already become 'structural'.   
Public servants can tally up the cost of public demands; but establishing benchmarks and setting limits (management) is the job of a government. 

In this context, any risk assessment of the Muskrat Falls Project will recognize our small population and the size of our current fiscal challenges.
Our Provincial debt is $10.8 billion, $21,600 for every man, woman and child. Muskrat Falls, which initially is expected to supply a mere 15% of electricity needs, will bring our per capita debt to over $35,000.  Is this what you had in mind in closing the door on less risky options? The local economy suffers from a very narrow base. Offshore oil revenues are actually closer to 50% of total revenues than the oft touted one-third figure, when you consider personal income taxes and other indirect revenues that would not get collected, in the absence of oil.

Lower world oil prices, this year alone, has already pushed the operating deficit to $725.8 million; unexpected delays with the Terra Nova oil platform achieving full production or some other unforeseen issue  could expose bigger fiscal problems.  Our neighbour to the south stands at a precipice called the ‘fiscal cliff’.  The jury is still out as to whether the Eurozone’s weakest economies will be salvaged. Economic hiccups, in China, have already claimed its first causality with a local connection, the Cliff Resources Bloom Lake Expansion. Others are worried. These risks are completely beyond our ability to influence.  But, our ability to spend is not!

One black swan would place us on the precipice of our own fiscal cliff, two would tip us over.  This small population has no cushion with which to break the fall.

As we slide inexorably towards MF sanction, our economic vulnerabilities are more exposed than ever.
Perhaps, we are just larger than ourselves. 

If it had a convincing story to tell, the Government would not minimize disclosure, pillory critics or refuse essential parliamentary debate. Risk assessment is no laughing matter; except to those who don’t worry because it is not their dime. The bond rating agencies will not be pleased.

A prudent banker would show this Finance Minister the door.


  1. Excellent commentary. Many people point to Tom Marshall as being a "gentleman" and a person of integrity. I don't know Mr. Marshall personally and I would be inclined to agree with that assessment overall.

    However, I do have major concerns with his performance as Finance Minister, over the past several years. He has allowed, or been cajoled, into spending billions more than he and his colleagues should have, during the heady days of excess oil revenue. There was a moment in time when they had the opportunity to put the brakes on excessive spending and set money aside for times when the economy needed some of it.

    He is being prodded along toward, as you describe it, our own fiscal cliff. Sadly, all too few of our people are awake to that fact; the level of apathy in this province is beyond me, given the good information available. Those who profess to be confused are, in my opinion, simply too unmotivated to find out for themselves why this project is such a disaster. They will not ever find out from the government's propaganda machine but there is ample evidence to show it is a fatally-flawed project.

    Thanks for doing your part to try and inform and educate.

  2. The consevative fiscal performance has been an unmitigated failure. The pundits may blame marshall and dunderdale. However, the seeds of this problem were planted in 2006. That is when the government started to progressively increase government spending. People forget... But Loyola Sullivan left provincial politics. The rumors were because of the spending spree that Premier Williams put the province on. Sullivan knew the spending projections were unsustainable, and not in the best interest of the province. Sullivan remembered the lean times of the 90's.

    Now we are suffering the consequences of poor decisions, and the general lack of desire to upset the electorate. It is unsustainable.

    Now we are on the verge of a major 6.4 billion dollar committment. You have effectively summarised the issue in my mind. The risk is not worth the benefit.

    If goverment just took the 2 Billion they are contemplated investing as equity, and used it to lower our debt, it would result in 100 million a year in immediate savings.

    Then we need to look at the options. But as Winston Adams so often proclaims the solution is simple. Reduce consumption. Problem solved.

    Maybe Winston should move to Calgary or New York. Then the guys at Nalcor would pay him 400 $/hr and call him an expert.

    The winds of change are starting to blow in the province.
    I for one look forward to the completion of this chapter in our history.

    The title of the chapter will be referred to by historians as "The Decade of Lost Opportunity"

  3. I know I sound like a broken record on this, but I just read todays, Dec 15 Telegram editorial "Old News".It discusses electricity demand forecast and I posted a comment, ending with "It's not the lights, stupid, its the heat" The premier this week in the House dismissed any risk to Muskrat revenue,saying as long as people continue to pay their light bills everything will be fine. Light are 120.00 per year compared to 2070.00 for heat, on a 3000.00 a year total bill. And there is the very cost effective option to save 65 percent on heat, 30 percent on the total bill.Only the stupid or very poor will not jump ship for the efficiency option. Just one more risk being ignored. Some journalist should ask the government MHAs if they intend to switch to efficient heat? A public poll would help quantify the extent of the risk to Muskrat revenue. Winston Adams