Monday, 20 October 2014

OIL REVENUES: DON'T WORRY. BE HAPPY!

Bobby McFerrin’s light-hearted lyric “Don’t Worry, Be Happy” seems perfectly suited to Dr. Wade Locke’s analysis, as he explained it to James McLeod of the Telegram last week, on the future of oil.  Dr. Locke is an Economist and Professor at Memorial University.

Indeed, why would we worry when the ass is coming out of the Provincial Budget!

The slide in the world price of Brent Crude, closing at US $86.16 per barrel on Friday October 17th, is a significant event and not because people will save money at the gas pumps. 

Since oil’s decline began just a few weeks ago, a host of oil producing nations including Saudi Arabia, Iraq, Venezuela, and Russia among others, whose budgets rely on $100 plus oil, have expressed concern that they will feel the sting of lower revenues. While none could forecast the exact day or week that a major correction on the markets might occur, all knew it was coming.

The fact that the U.S. will become energy self-sufficient by 2030 or earlier is old news.  Unlike the Saudis, few oil producing nations have maintained a rainy day fund.

Newfoundland and Labrador is just as reliant, on a relative basis, as many of the countries mentioned.  Oil directly generates 33% of the Province’s budgetary revenues.  The figure does not reflect proceeds from corporate, personal taxes and HST associated with offshore related jobs, construction and services. In fact, oil’s impact on the Treasury may represent as much as 50% of revenue or more when the labour pool doing the round trip to Fort McMurray is assessed.

In the 2014-15 fiscal-year, the Minister of Finance based forecast revenues on US $105/barrel. Every dollar means roughly $30 million to the Treasury.  $85 oil represents a revenue drop of $600 million dollars annually. The forecast deficit this year was $537.9 million at the start. What will it be now?  HSTHH

  
Dr. Wade Locke shrugged off the impact of the oil price decline while acknowledging to the Telegram, he "didn't see this coming". He correctly notes the impact of “fracking” along with a weak European economy. But he is right on little else.

Dr. Locke suggests fracking needs $100 oil to make a profit.  Lower prices, he believes, will force some of these projects to be stalled causing “less supply” followed by higher prices at which point, ostensibly, everything will be in balance. He suggests, and I quote: “oil prices will go back up…a hundred dollars is a reasonable number...”  

The Professor might have been correct a few years ago when commodity prices responded predictably to cyclical trends in economic growth and recession or squabbles among/with OPEC Members.  But much has changed within just a few years. 

Locke's thinking is the ‘don’t worry, be happy’ approach Nalcor used to justify Muskrat Falls. Nalcor assumed $135-150/barrel oil giving the “Inter-Connected” a $2.2 billion advantage over the “Isolated Island” Option.  Where do you think that equation stands now?

Dr. Locke seems frozen within Nalcor’s Muskrat paradigm; one for which he was a major ‘booster’.   

Recent reports suggest extra-long horizontal drilling—up to 2 miles - is improving oil production rates by 50-100% with only a 20% increase in costs. In addition, fracking is being carried out at a frenetic pace and getting more efficient.   

Maria van der Hoeven, executive director of the International Energy Agency (IEA), an organization that advises governments and industry, has a different take than Locke.  She is likely a person who knows.  "Only a tiny minority of shale oil production would be affected by the slump in prices to near-four-year lows. Some 98 per cent of crude oil and condensates from the United States have a breakeven price of below $80 and 82 per cent had a breakeven price of $60 or lower," van der Hoeven told Reuters, a news agency.

The IEA's chief economist went a step further: "There's not one single drop of oil which cannot be produced for commercial reasons with today's price" said Fatih Birol in an interview with the Wall Street Journal.

Scotiabank Economist Patricia Mohr, writing in the Bank’s October 16, 2014 Global Economics Newsletter, approaches the issue a little differently though the impact of her numbers is equally unmistakeable. Writes Mohr: “While US$90 is clearly too high to slow U.S. exploration & development, we believe that prices at the US$80 mark (if sustained for more than 3-6 months) would have an impact.” 


$100 oil again? Not even $90 oil, in many experts’ view.

Van der Hoeven’s and Mohr’s statistics are frightening for this Province (unless you drive a Hummer), but they are not the only ones that give rise to uncertainty in future oil prices.
According to the IEA, US output has been keeping pace with Saudi output at 11.5 million b/d and is set to exceed it this fall, for the first time since 1991.  American crude, prohibited from sale on the international market since the Arab oil embargo of the 1970s, is now competing with other producers. 

A story in the Wall Street Journal on September 30th noted that an oil tanker out of Alaska is the first in what Citibank "expects to become an armada" remarking that  Alaskan crude could reach 100,000 barrels a day. More export permits are expected to be approved by the U.S. Government as shale oil production continues to ramp up. 

America’s shale oil revolution has arrived.  Countries and Provinces, like ours, that failed to prepare for this day now find themselves in a pickle.

Can we rely on Saudi Arabia to come to our collective rescue?  The Saudis have stated they are no longer prepared to play ‘swing’ producer, as other countries feed an oil market driven out of balance by shale technology. The Saudis have "slashed" oil prices to Asia even as China's growth has slowed. 

A Bloomberg story on Friday, October 17th reports that the Saudis and Kuwait have halted a jointly operated oil field, producing 300,000 barrels/day, ostensibly for environmental reasons.  The move may help stabilize prices for now. But at the rate oil is entering the market, including from Libya and even from Iraq apart from the U.S., suggests, if the measure is intended to reduce supply, it will not work for long. 

Citibank's Global Head of Energy Strategy, Seth Kleinman, told CNBC $50-60/barrel is really where you need to do damage. He says if the Saudis want to have a war with U.S. shale producers they can win it at that level but they will have to suffer a lot of pain in the process.

The plethora of international energy analysts who hold contrary views offer reason why we should worry about Dr. Locke’s forecasts and how they get used by the Government. 

His 'everything will be fine' analysis may be suited to politicians willing to believe in the 'tooth fairy', as they contemplate a bare cupboard in advance of an election. But if it is typical of the advice Nalcor and the Province receive from him, it won’t do much for a public hoping for bare-fisted approaches to public spending even if they recoil at the pain of imposed fiscal prudence.  

The new Finance Minister, Ross Wiseman, has already warned, via the Telegram’s James McLeod, the Budget “is a living document”.  This, ostensibly, is code for ‘a bigger deficit this year and forget any notion of a balanced Budget next year’.

One thing is clear: the fiscal ‘black swans’ are gathering, as expected.     

The Government has spent every cent it could get its hands on.  Watch it borrow the money oil fails to generate.

Dr. Locke’s comments seem perfectly timed to prepare the public for a Government all too willing to postpone leadership. It's fine to enjoy the lyrics of Bobby McFerrin but, in this Province as elsewhere, Government revenues equate with oil, and that is too important to be left to spin. 

So, I'm not about to sing Dr. Locke's tune “note for note”; but as for Bobby McFerrin....  

In every life we have some trouble
When you worry you make it double
Don't worry, be happy

Ooh, ooh ooh ooh oo-ooh ooh oo-ooh ooh ooh oo-ooh
(Don't worry)
Ooh oo-ooh ooh ooh oo-ooh

(Be happy).  

6 comments:

  1. And oil burning as a main source of heat on the island jumped from 18 to 21 percent of all households, from 2010 to 2013. And that is before price reduction that come with cheaper oil. Just great for gains in electricity demand, needed to justify MF. But.....be happy.

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  2. Well written sir! Good reading for anyone interested in the "Black Gold" economy.

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  3. Des GP about $135-$150 oil as the benchmark for MF justification (backed by Wade) that would 'save' ratepayers $2.2 billion*.
    *Make that $1.4 billion cheaper with the last MF financial update by Nalcor*
    $1.4B cheaper based on $135-$150 oil (with a 50 year projection) what is the equation used by Nalcor so we can change the oil variable?
    Oil prices at $150 - you know the price of oil when the world economy collapsed: Sounds like a reasonable assumption to make.

    Besides the price of oil Nalcor's energy demand forecast denies demographic and economic realities.

    NLs population is set to drop 50,000-70,000 people in the 2030s or a 10% drop in power customers.

    Demand will remain = with when the kWh cost of energy skyrocketing - Even Wade has a disclaimer about increased energy costs to demand: Every 20% price increase there is a 5% demand decrease.

    Note that Wade DID NOT use this at all in his Harris Center presentation as his energy forecast had exponentially increasing energy demand. 10500 GWh by 2041 12500 GWh by 2067 (I don't think Wade verified this himself just accepted Nalcor at their word/data)

    5000 GWh is the current residential demand. 5000 -10% due to population decline (X 0.9) = 4500
    4500 -12.5% with 50% cost increase in energy (X 0.875) = 3937.5 GWh.
    In the 2030s residential demand will drop by a staggering 1000+ GWh down to 80% from our current demand.

    With a 20% residential demand drop shortly before UC contract expires Nalcor has placed a millstone around ratepayers necks. The millstone takes the form of a take or pay PPA from MF - there's a 2% annual price hike as well.

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    1. AC, you show a 20 percent drop in energy sales, 12. 5 percent due to price increases and the balance from lower number of customers from population loss. Studies suggest that for electric heating the loss in energy sales due to higher prices of 50 percent would be considerably higher then 12.5 percent. Then these are those who will convert from baseboard heat: already more are using oil heat and there is a large gain in wood burning, from 11 to 19 percent of the total. Heat pumps are now only used in about 2 percent of residential units, so currently a minor effect. But since these reduce energy for heating by 60 percent, higher energy costs will drive many to convert to this all -electric high efficiency heat. Add these to you calculations and the picture is much worse. Winston Adams

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  4. High Demand for electricity, High Oil prices to justify that electricty. Key inputs used in the MF business case were questionable. It is just coming to fruition. The management of Nalcor must be held accountable.

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  5. Where are promoters (Williams, Skinner, Dunderdale, Marshall & Kennedy)? Where are the cheerleaders (Kent, Lane et al.)? Where are the reassurances that everything is under control? Hardly a day went by without one of the above lining up on the radio to tell us what a wonderful project this will be for all. Now nothing. These people need to be held to account.

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