Copyright of the Daily Oil Bulletin 2018
Analysis: Government Needs To Act Now To Maintain Alberta Advantage
Alberta needs to get its financial house in order.
If we don't, we will lose our Alberta Advantage at a minimum. There are two extreme models for the use of oil wealth by major oil exporting countries — Norway on the positive side and Venezuela on the negative one. Unfortunately, the model we've been following since Peter Lougheed stepped down as premier in 1985 has tended to be more like the Venezuela one.
On the one extreme, Norway has saved much of its oil wealth since the early 1990s, not just to act as a shock absorber during periods of low oil prices, but to share its non-renewable oil wealth with future generations of Norwegians as well. The country’s Oil Fund, the largest sovereign wealth fund in the world at US$1 trillion, was ironically modeled on the Alberta government’s Heritage Fund.
On the other extreme, since the Chavistas gained power in 1999, Venezuela has generally spent more than it earned from its oil revenue, high oil prices or low. As of now, Venezuela and its state-owned oil company Petroleos de Venezuela (PDVSA) have racked up between US$120 billion and $140 billion in foreign debt. Early in the week of November 13, two rating agencies — Fitch and Standard & Poor’s — declared Venezuela and PDVSA in “selective default” on their debt, despite the country having the largest proved oil resource in the world.
Alberta has been more like Venezuela than Norway since 1985, failing to save to protect us from an extended period of low oil prices, let alone save for future generations. The Heritage Fund stands at roughly the same level today as when Lougheed left office — $17 billion versus $14 billion — and that doesn't take into account inflation.
The government of Rachel Notley tabled its latest three-year budget for Alberta on March 16, 2017. As recommended by former Bank of Canada Governor David Dodge, the New Democrats’ budgets have been based on the Keynesian principle of adjusting spending to balance against the business cycle. A great idea if you saved for the rainy day, not so good if you didn't.
Alberta’s gross debt was $33.3 billion at the end of 2016-17, compared to $11.9 billion when the New Democrats took office in 2005. Based on their calculations, the province’s gross debt will be $71.1 billion at the end of fiscal 2019-20. The Notley government claims it will balance the budget by 2023-24, although there is no clear sign of them doing so, let alone achieving the surpluses required to pay down the rapidly rising debt.
The Alberta deficit is forecast to be $7.2 billion in 2019-20, the fifth consecutive year of multi-billion dollar deficits, but down a third from this year’s projected gap. Giving the New Democrats the benefit of the doubt, and assuming a straight-line decline in the deficit from 2019-20, Alberta’s gross debt will be $85.5 billion at the end of 2023-24.
This is a big number with a big financial burden. The Notley government estimates that it will take $2.3 billion to service the provincial debt in 2019-20, more than triple the $776 million in its first year in office. Assuming a 3.5 per cent interest rate in 2023-24, the same rate as implied in the budget for 2019-20, the province will have to shell out $3 billion to service our gross debt, similar to Alberta’s current budget for Community and Social Services.
And if anything, the cost of servicing our debt will likely be higher than the implied 3.5 per cent rate for two reasons — the end of a 35-year credit down-cycle and additional downgrades to our credit rating. After having a coveted triple-A rating as recently as December 2015, Standard and Poor’s has cut Alberta’s credit rating four rungs to A+ over three downgrades. For each one percentage point increase in the interest rate, add more than $850 million to the province’s annual debt servicing cost.
What got us into this mess? A combination of overspending and under taxing is the culprit. According to the Fraser Institute, if the government had simply kept spending growth to the combined rate of population growth and inflation, Alberta could have had fiscal surpluses every year between 2008-09 and 2016-17 — many of these were boom years for oil prices — instead of fiscal deficits in eight of the nine years. Government spending increased an average of 7.1 per cent per year over the 2004-05 to 2015-16 period, compared to revenue growth of just 4.6 per cent.
According to Trevor Tombe, a University of Calgary economics professor, if the province taxed our citizens at the same rate as British Colombia, the second lowest tax jurisdiction in Canada, the Alberta government would generate $8.7 billion in additional revenue, almost closing this year’s budget gap.
Could Alberta be saved by another oil price boom? Based on price sensitivities associated with the budget, WTI crude prices would have to be around US$90 per bbl to simply balance the province’s budget, let alone pay down our debt. Barring a major conflagration in the Persian Gulf region — a modest possibility, but not one we should bet our financial future on – this is not going to happen.
In at least the medium-term, crude prices are capped in the US$60/bbl to $70/bbl range by rapidly rising United States light-tight oil production on the supply side, and in the longer term by the global campaign against carbon emissions and the rise of electric vehicles on the demand side.
Some economists have suggested that Alberta could simply grow its way out of its rising debt problem. But strong economic growth in the future would likely require significant diversification of our economy, given the relatively poor outlook for oil prices — and an even worse one for natural gas prices — something we have failed to do in the past despite relatively full coffers and our Alberta Advantage. Diversification is easier said than done.
And Alberta has one major strike against it for companies that can locate wherever they please, such as most high-tech companies, a cold climate. Believe it or not, many people don't like living in minus 40 C — or minus 40 F for that matter — if they have a choice. On that note, just as many people emigrated from Canada to the U.S. in the 1880-1920 period as immigrated to our country, but of course, that was before central heating.
We can't have our cake and eat it too. Just ask the Venezuelans. It's time to get our financial house in order. Through a combination of spending cuts and tax increases we could still maintain an Alberta Advantage.