Monday, 16 December 2013


Ask yourself this question: if the investment firm that manages your RRSP placed 33-50% of your money in the volatile commodities market, i.e. oil, would you not, at least, question its competence?  Likely, you would move your funds elsewhere. 

The Provincial Budget is annually predicated upon consistently high returns from the same volatile commodity.  NL has been bestowed a valuable natural resource; but we do have the responsibility to carefully manage its inconsistent value.  The international oil market is constantly under pressure and hence subject to significant price changes.    
For those reasons, just as we would expect a portfolio manager to insulate our most important investments from excessive risk, the Finance Minister ought to be guided by a set of policies that protects the public purse against the worse effects of volatility.         
The 2013-14 Provincial Budget Update delivered by the Minister, on December 2nd 2013, was a reminder that this Finance Minister is comfortable leading from the rear.  He has made it clear he plans no reform to the Public Service Pension Plan though the annual unfunded liability continues to mount. 

He will run deficits in a time of plenty.  He will do anything but make necessary financial decisions.  Now, he has acknowledged that changes to the current budget deficit, found in the Update, are purely accidental.
The Provincial Budget comprises 33% of direct revenues from oil royalties; related corporate and personal income tax and HST revenues raise Government’s oil related take to at least 50% of total revenues.   

By any standard, such a dependency on a single historically unpredictable commodity is too great.  Enhanced oil recovery from improved directional drilling techniques and changes to recovery methods of shale oil and gas have also changed the energy narrative to one focussed on peak “demand” from one, for two decades, preoccupied with peak “supply”.  Whether the Minister wants to recognize the fact or not the energy universe is changing.

The current price is just under $US 109.  Industry forecasters predict oil prices, out to 2017, at $US 90.00/barrel. That is not the direction that will embolden believers in the Finance Minister Tom Marshall’s crystal ball.  In this Province, every dollar of change in the oil price represents $20-25 million to the provincial coffers, depending on the level of the $US. 

The Minister needs to bring more certainty to a budgetary process that is now, at best, guess work.  Had NL a more diverse economy, one in which oil revenue represents a far smaller percentage of total revenues, the issue would be less urgent.  But, that is not the construction of our economy nor does it characterize our fiscal situation.

In his Fiscal Update, the Minister states the deficit will be $113.2 million less than forecast.  That means the forecast deficit will be down from almost $564 million to $450 million.   While the changed is welcomed he should not expect applause.  How did that reduction occur when oil royalties were off by $112.5 million, mining taxes off by just over $30 million and with collective agreements having added $62.5 million to public service pay packets? 

The Minister says it was the result of “unexpected delays” in infrastructure projects, an increase in Federal Government Transfers, and modest savings across departments. In other words, most of the savings were not ‘managed’ savings. In the Minister’s own words, they were “unexpected”.

Most significantly, oil production was off by 2 million barrels; a worse effect was forestalled by a slightly higher than forecast world oil price and by a more favourable USD-CAD currency exchange.

This Tory Government is unlikely to ever earn a reputation for adopting a ‘conservative’ approach to public spending.  That fact notwithstanding, NL’s Budget should not be constantly on a collision course with uncontrollable events.  The Minister needs to commit to a policy of discounting his consultant’s oil price forecasts, on an annual basis, by at least 10-15%.  Such an approach might offset the worst effects of volatility in both price and production.

The Minister should be content to allow any surplus, in consequence of this policy, to be applied against the debt which is the same as saying that any surplus can then be applied against the effects of an inevitable and unfavourably large price swing. 

Let it be understood, using such a discount policy, the Minister should be planning, at worst, annual balanced Budgets.  

This is hardly radical stuff in this era of historically high revenues.

Oil and Gas Financial Journal, a major source of data and analysis on the industry, recently made this comment in a story entitled OSLO: NEW OLD CITY:  “Despite the recent change of government, Norway knows that its oil and gas will not last forever, and plans to ensure that for as long as possible, its citizens will be able to benefit from this all-too-temporary good fortune.”

A small country, of just 5 million people, Norway has refused to let prosperity go to its head.  It has a far larger oil industry than ours but it understands that someday its vast oil fields will run out.  Our oil industry is already past peak production, notwithstanding recent discoveries; we should attempt to be wiser than recent budgetary practices suggest.

Though Governments change, the incumbent should not empty the cash register for fear the government that replaces it will spend all the savings.

As it stands, our Government’s approach to fiscal policy is to spend every cent it can get its hands on; if revenue from oil drops, causing a deficit or elevating the one currently forecast, it believes it should just borrow the difference. 

This is flawed thinking.  It is the practice of undisciplined and short-sighted leadership.

The Minister may feel his approach will enhance the Government’s re-election chances.  But, in time, the public may give far more credit to a Government more willing to lead from the front, than the rear. 

Given Tom Marshall`s track record thus far, like the reduction in the Budget deficit, that would truly be “unexpected”.