Guest post written by JM
Authors Note:
Authors Note:
Initially,
I had planned this series in three parts. Of the two already posted, the first dealt with provincial government spending and the second with
revenues. The proposed third part was originally intended to contain a long term sustainability plan for the province.
This last piece of work has proven much more difficult to write in comparison with the first two posts,
which were heavily annotated with statistics and graphs. In the course of writing, I found it difficult to be thorough without raising the plethora of issues
the province currently faces. As a
result, the script has grown to over 20 pages, and it is still not
finished!
Uncle
Gnarley has kindly provided space throughout this summer, to
continue this colloquy. I expect it will comprise an additional six to eight posts. The new plan will conclude with a single
post in which the various parts will be reflected in a single reference.
As Uncle
Gnarley cherishes debate, I would be grateful if readers submitted their ideas
in the comments section.I have examined
the numbers in detail. I am convinced it will be a challenging road
to return to balanced budgets.
We need debate
in this province if the solution to our fiscal problems are to truly reflect
the views and interests of all sectors of our society.
The government needs ideas and, likely, the Opposition parties, too.
Thank you
for your continued interest. JM
The Budget Colloquy
Part 3: Whistling Past the Graveyard
No More
“Oil prices should reach a long-term equilibrium of $90 per barrel, but it is impossible to predict when prices would return to those levels… Oil prices were poised to remain volatile in the mid-term” Ben van Beurden, CEO, Shell
“This is my fifth rodeo. We’re going into a world that’s going to be characterized by lower, gradually rising prices and a lot of volatility.” The shift for ConocoPhillips away from billion-dollar projects that take years or decades to complete is rooted in a belief that crude prices could gyrate wildly for years to come. Any price recovery in the near term will be modest, as slowing U.S. production helps push up prices to between $70 and $80 a barrel within three years” Ryan Lance, CEO ConocoPhillips
“I’m planning for five years of low oil prices, in the low $60s per barrel” - Scott Sheffield, CEO, Pioneer Natural Resources
"We're planning for $60 oil. I think there's still a lot of 'whistling in the graveyard' mentality.… One could hope for $75 oil but you've got to plan for lower." Stephen Chazen, CEO, Occidental Petroleum
“We currently expect oil prices (Brent) to average around $75 per barrel for this year, below the global marginal cost of production due to the current oversupply scenario, and increase gradually towards the $85 per barrel mark over the next two years, as the supply becomes tighter due to the recent cutbacks in capital spending by almost all major oil companies and the growth in demand picks up to more normalized levels” R.A. Walker – CEO Anadarko
We've assumed prices for 2017 of around $80 per barrel and then a careful rise after that” Eldar Saete, CEO Statoil
Historians
will view 2014 as the year in which the historical supply – demand relationship
was reestablished for oil. The shift was driven
by a number of factors though the chief reason is technological advance.
On the
supply side, proven technologies in horizontal drilling and fracking are
unleashing vast reserves of shale oil and gas.
On the demand side, machines that require oil are becoming much more
fuel efficient; curbing consumption in the developed economies. In the new economies of
Asia, demand for oil is slowing in those regions, too..
In so many
ways the collapse in oil price is a technology story. The result is that price growth from 2007 to 2014, a period in which oil averaged over 100 USD/barrel, can be
viewed as an anomaly. We are now in for
a prolonged period of volatility in which the lower prices echo the 20 year
period following the oil crisis of the 1970’s.
Figure 1 clearly communicates that the oil price spike from 2006 to 2013
may well be considered just a spike.
Figure 1: Inflation Adjusted View on Oil Price
A
geopolitical crisis can always change the price equilibrium. But, as is evident
from the quotes that prefaced this post, oil companies are adjusting for a
fundamental shift in the present oil economy. They are cutting staff, and reducing costs to an extent which
documents their belief the slowdown is not a short term phenomenon.
Due to our
exposure to the oil and gas sector, Newfoundland and Labrador will be
particularly hard hit by the downturn. The province has been caught flat-footed. The collapse in current oil revenues (i.e.
royalties) have had a dramatic impact which is being mitigated by massive
government borrowing. However, as the
price remains depressed for longer periods, the reductions in other revenue
sources (Income tax, sales tax) will only exacerbate the revenue shortfalls. Alas, the long term solution is not sustained
borrowing.
The oil price collapse has necessitated the requirement to have a
serious conversation and an action plan for our future. A dose of fiscal reality, perhaps, is just
what this province needs.
A Record of Stimulated Unsustainability
The Progressive Conservative Government started out
with good intentions to manage the new energy fueled wealth. They began their tenure, in 2004, with a
reduction in government spending. In
2007, they generated a long term plan to shape an energy strategy. Contained within the Energy Plan was a projection
for long term oil prices, as shown in Figure 2.
Figure 2: Long
Term Oil Projections – 2007 Energy Plan
By 2008, the government had forgotten about
those long term projections. They began to
make long term decisions based on short term oil prices. Taxes were cut, government spending was
increased by 35%, and infrastructure projects were initiated. The fiscal policy changes were enabled by
peak production and record oil prices, which occurred simultaneously.
In consequence of all this stimulus, the
provincial government took a fundamentally strong economy and made it “white
hot”. Salaries were raised at a pace far outpacing
inflation. It fueled a real estate boom, and caused an increase in the cost of
doing business in Newfoundland and Labrador.
It impacted our long term competitiveness on the global market.
The
government’s economic advisor, Wade Locke, said the stimulus was a good thing.
In
2013, it was difficult to argue otherwise.
People were making small fortunes from real estate valuations; new
graduates in skill trades and professions could look forward to six figure
salaries after a couple years of getting their ‘ticket’.
But, the boom was unsustainable.
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Related to this article:
Related to this article:
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Now, in 2015, it is clear that the
government did exactly what it should not have done.
Fundamentally, they initiated stimulus during the
boom. They made long term policy changes,
such as increasing the size of the public service, based on a short term spike
in oil prices. They implemented major
public works projects at the exact time that we were executing mega projects. The measures
contributed to cost overruns on Hebron, and on other offshore developments. The inflationary impacts will be the cause of lower royalties
when those facilities come on line.
Oil and government policy, from 2006
to 2010, initiated an unprecedented boom.
However, it was the stimulated expansion that fundamentally destabilized
the long term economic stability of the province. Now, as we commence a predicted contraction
of the economy (i.e. a recession) following the completion of several mega
projects, the collapse in the oil price will only serve to magnify all those
negative impacts.
We need to ask: what should the
government be doing in terms of fiscal policy?
Continued Stimulus
or Expenditure Cuts?
The prevailing economic thought is to take advantage of low interest rates, and fuel stimulus to “ride out”
the economic downturn.
Despite the claim of an “austerity
budget” the government is actually increasing spending in 2015. They are borrowing heavily to fund both
infrastructure and for current account (program expenditures). The
2015 Budget is, in fact, a stimulus budget; it just happens that the stimulus is
less than in the previous five budgets!
Let's ask, therefore, is continued stimulus the
correct action to take?
Or, should the government of
Newfoundland and Labrador make long term adjustments to reflect the new oil
reality, and to correct the fiscal imbalance?
Based upon the analysis provided in Part
II of this series, it is clear to the Author that the government should be
basing their mid-term policy on annual revenues in the $6.8 billion range. The Finance Minister is
projecting long term spending in the $7.5 billion range. As shown in
Figure 3, in the absence of any real reduction in government spending, or a major increase in oil prices, we will be running $700 million deficits for the
next five years.
To correct it, we must first recognize that we have one.
The government refuses any such acknowledgement.
They are happily whistling past the graveyard.
Figure 3: Author’s
Forecasted Revenue – Versus Provincial Government
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Editor's Notes:
Part IV of this series, entitled “The Refined Charlatan”, will be posted next Thursday.
JM" is a researcher and writer. he is a frequent contributor to Uncle Gnarley Blog offering analysis of the Muskrat Falls project and other issues, including the fiscal position of the Province. JM's essays include: IN NALCOR WE TRUST, Delusion and Deception (Part III), and The Snow Job (Part I). The very latest Posts, on the 2015-16 provincial Budget, include IT'S THE SPENDING STUPID and The Budget Colloquy (Part 1): Put Him In The Round Boat Til He's Sober and The Budget Colloquy (Part 2) Revenue Projections: Close Your Eyes, Make a Wish, Hope for the Best. Having chosen to retain his anonymity, JM is prepared let his articles be judged on the research and argument each contains.