Monday, 3 September 2012

NL Finance Minister Gets Downgrade (PART 2)

Last time, I discussed the Dominion Bond Rating Service (DBRS) Report which confirmed the “A” credit rating of the Province. The Minister of Finance, in making that announcement, noted a comment by DBRS that, he said, was proof of why the Government should proceed with Muskrat Falls.

Uncle Gnarley obtained a copy of the full DBRS Report and caught Tom Marshall being selective; too selective for a Finance Minister.  Transparency is an important watchword; people have a right to know what their government is up to and how important agencies, like DBRS, feel about the fiscal management of our economy, especially the budgetary process, over which the government has substantial control. 
When government decisions go awry or they engage in bad management practices, the public should not be shielded from the result by 'bafflegab'.  It is part of the reason we are rightfully upset about the recent amendment to Bill 29, the Act governing public access to information. 

This week, let’s look at what DBRS had to say about the NL Budget, our current fiscal position and how the Muskrat Falls project will play a key role in economic forecasts.

Many critics, including this one, have expressed concern that for at least the last five years provincial budgetary expenditures have grown by 8% annually; this in an economy that relies upon cyclical oil prices to generate a third of government revenues; more likely over fifty percent,  when indirect oil revenues are added. These matters were not overlooked by DBRS.
Finance Minister Tom Marshall
The DBRS Report was less about what the government is doing well.  It was more about sending a message about the risks of the Muskrat Falls project and offering a blunt assessment of what future Budgets should seek to correct.  
For the sake of brevity, I have chosen a few of the most critical excerpts:

Page 1, quote: DBRS notes that the price of Brent crude has been significantly below the budget assumption of US$124.12/barrel for much of the current year. Unless oil prices recover sharply, this represents a significant downside risk to fiscal projections.

Referring to the small $44 million surplus planned for 2014-15, the DBRS proposes a “DBRS-adjusted” deficit of approximately $400 million and states, on Page 2, quote: In order to meet this target, spending restraint will be necessary as program expenditure growth averaging more than 8% over the last five years is incompatible with declining revenue.
Page 3, DBRS cites four main challenges to the Provincial economy. Here are four quotes:

(1)    The Province’s economic and fiscal results are heavily dependent on the oil industry, with approximately 33% of revenues in 2011-12 coming from petroleum royalties.  This does not take into account the significant other fiscal revenues that are directly or indirectly derived from the industry. Such dependence complicated the budgeting process….

(2)    While resource-based industries have injected vitality into the economy, a lack of diversification stands as perhaps the greatest impediment to ratings improvement.

(3)    Unfunded pension liabilities remain sizeable….and are expected to grow to $3.4 billion in 2012-13.

(4)    It is not yet clear how the Province intends to finance its portion of the estimated $4.4 billion construction cost of the Muskrat Falls hydroelectric facility…..the Province’s rating could come under stress….
Note too, that DBRS analysis is based upon a capital cost that is far less than the most recent $8.5 billion estimate, if the former Minister of Natural Resources can be believed. Two more comments ought to be noted:

Page 4, quote: Based on historical levels of capital expenditure, DBRS-adjusted deficits of $850 million and $400 million are estimated for 2013-14 and 2014-15, respectively. In order to achieve these goals, expenditure growth is budgeted at 2% in 2013-14 and 1% in 2014-15. DBRS considers these targets ambitious.
Page 4, quote:  ….DBRS-adjusted deficit for 2012-13 could climb to over $1billion if the average price  (of oil) remains at ($106.55 per barrel average) level.

These quotations are noteworthy for their clarity as well as for the level of concern raised. They require no embellishment or interpretation.
However, as DBRS noted, in addition to the issues affecting several forthcoming budgets, financing the Muskrat Falls project is a major concern.

Imagine if those oil revenues don’t get back up to stratospheric levels for the next few years (or decline further).  Imagine an $8.5 billion Muskrat Falls project, as is now being discussed in official circles.  Now, imagine $8.5 billion project with overruns! 
The Province will have to come up with the ‘equity’ portion of the project, just as you would, if you were buying a home.  The $2 billion it had squirrelled away for the purpose is already being eroded according to some reports; continuing current account deficits will erode the balance. 

The Province’s equity portion of the Muskrat Falls project is expected to be in the range of 40% of estimated project costs plus any overruns.  Do the math. We will exclude Emera's share of the project. 40% of $7.3 billion = $2.92 billion.  If we add 20% for cost overruns (which is likely very inadequate), that’s another $1.46 billion. Conservatively estimated, the Province’s equity requirement will be at least $4.38 billion.  Do you have any idea where that money is going to come from?
If you think that spending on health, social services and other programs won’t be affected or public service staffing levels won’t be trimmed, think again!  

Perhaps, this Blog is beating a drum no one wants to hear; perhaps, people have heard enough negative Reports over many years and want to hold on to the sweet sound of good news and economic positivism. They just don’t want it to end. Perhaps.
Still, I suggest we should hear the facts, no matter how grim, while we still have the fiscal flexibility to change flawed thinking.  

The Muskrat Falls project, the inevitable cost overruns along with his refusal to fundamentally change the fiscal spending behaviour of the Government should remind the Minister of the mythical Icarus, whose failure to take advice brought him too close to the sun. The Minister's wings may not melt, as did those of Icarus, but they will surely be clipped.   

Last time, I gave the Minister of Finance a “C”.  Having reviewed his performance  again, for this week’s Post, it seems the Minister is in for a downgrade.  I suggest a “C-“.