Is Newfoundland and Labrador a “Petrostate?”

Falling oil prices have directed attention towards Canada’s oil-producing provinces, including Newfoundland and Labrador (NL). While lower gas prices should be a boon to most Canadians, Newfoundlanders look warily to oil’s plunging market price as a sign of harder economic times. In fact, the provincial government recently forecasted $916 million in the red–much higher than previously anticipated.

The provincial government in NL projected 2015 to feature surpluses and fiscal expansion. NL has been benefiting from oil exploitation for the better part of the last decade and has joined Canada’s club of “have” provinces in the wake of a veritable economic boom. Resource extraction can confidently be identified as the sole cause of this boom–as is the case in other provinces such as Saskatchewan–and with it comprising close to 37 per cent of provincial GDP, one may wonder if NL is a “rentier” province and victim to the associated “resource curse” that often plagues naturally abundant states.

Terry Lynn Karl’s influential work on the ideas of rentier states and the “paradox of plenty” provides insight into the case of NL. The former refers to a polity that derives a substantial portion of its revenues from indigenous resource extraction and sale, while the latter refers to the paradoxical effect of resource abundance: weak economic development and overspecialization in extractive industries, corrupt state institutions, and poor governance. Rentier states often suffer from “Dutch Disease,” i.e. when the manufacturing or agricultural sector in a particular country (or jurisdiction) declines in the face of rising natural resource exports, which results in rising wages and currency appreciation. Ultimately, this phenomenon makes exports from other sectors more expensive, weakening their competitive advantage. States like these are often awash with cheap money, encouraging patronage politics, populism and voter apathy à la “no taxation, no representation.” Dependent polities are much at the mercy of global markets, and their dependence on energy exports can exacerbate economic shocks. Moreover, governments in petrostates have little incentive to invest in long-term growth plans or economic diversification.

In Nigeria, for instance, oil wealth has often led to widespread corruption and nepotism, in addition to deterioration of institutional strength. In Russia, it has aided in authoritarian consolidation by Vladimir Putin, while the country is facing a recession as oil prices fall precipitously. Gulf Cooperation Council states also have massive youth unemployment and unsustainable entitlement schemes plague young monarchies struggling to diversify their economies.

Newfoundland has had a long history of dependence on singular sources of income. The fishery, for example, had long dominated the Island’s economy and continued to do so until the 1990s when it suffered a veritable collapse that devastated the province. Much like oil, global seafood markets were subject to flux and rested on global fish prices. Nonetheless, it laid the foundation for Newfoundland’s consistent dependency on external forces for prosperity, which reduces the incentive to develop human capital and diversify the economy. More damaging is that patronage and nepotism in the province became widespread. Eventually, NL began receiving large amounts of federal assistance and, as Kimble Ainslie argues, a distinct political culture of dependency developed in the province.

Dependence shifted from federal money to oil rents as the wells began operating in the early 2000s. Under Danny Williams’ leadership, Newfoundland and Labrador’s coffers filled quickly–and public spending rose in sync–as the province’s economy began to boom. Infrastructural investments under Premier Dunderdale and social spending under Premier Davis did not slow as oil prices began plummeting. In response, the Davis government has abruptly cancelled proposed spending and the future is uncertain, but not necessarily dire.

The legacy and conditions for rentierisme are certainly there, but can one be sure that contemporary Newfoundland and Labrador really fits the petrostate bill? I will explore this question in Part Two.

Leo Plumer is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in economics and political science at McGill University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Atlantic Canada must make tough energy decisions

Over the course of the past decade, energy issues have become louder and louder in Atlantic Canada; today, energy policy has recently often been the single biggest file for governments in the region. With the Muskrat Falls megaproject, shale gas exploration, and the Energy East pipeline have come a number of decisions Easterners must make—these decisions will play a large part in shaping the region’s economic future.

Let’s first examine the Lower Churchill Project. The project is often simply referred to as “Muskrat Falls,” the waterfall that is being developed for electiricty generation. Muskrat Falls will be owned by Nalcor, which the NL government created in 2007 as a publically-owned electricity-market monopolist. Through its subsidiary NL Hydro, Nalcor has the sole right to supply and sell electricity in the province. And despite the fact that government’s Lower Churchill development plan includes the construction of a Maritime link that connects NL’s electric grid to the mainland’s without passing through Quebec, the NL government has severely restricted interprovincial trade.

By denying Newfoundlanders and Labradorians other electricity options, the province’s government has given Nalcor the power to raise its rates at a whim. This power allows for the construction of the Muskrat Falls project, which will cost $7.7-billion.Without its monopoly, Nalcor would not be able to pay for the project: many economists think the project in uneconomical. In fact, NL’s Public Utilities Board (PUB) could not conclude that the project was the province’s least-cost energy option, stating that there were “gaps in Nalcor’s information and analysis.”

Because of the project’s high costs, the NL government will have to borrow $5-billion—that is, nearly $10,000 for each of its of its residents. With these potential consequences for the both the province’s debt and its electrical rates and output, the NL government’s management of Muskrat Falls will have serious ramifications for the province far into the future.

Muskrat Falls also has ramifications for Nova Scotian energy markets. Emera, Nova Scotia’s publically traded energy corporation will cover 20 per cent of the Maritime link’s cost in exchange for 20 per cent of the electricity produced at Muskrat Falls. Further, Nalcor will be able to use Emera’s transmission rights to sell electricity in the Maritimes and New England.

New Brunswick (NB) faces an equally dramatic energy situation. Two issues dominate energy discussions in the province: hydraulic fracturing (or fracking) and TransCanada’s Energy East pipeline. Tests for shale gas, which NB Premier David Alward hopes will be extracted through fracking, have prompted locals to (often violently) protest. Fiscally, however, potential fracking revenues seem to be the NB government’s only way to pay for its current level of services without raising taxes or adding to the provincial debt, which is approaching $12-billion.

Although New Brunswick’s fracking debate has been Atlantic Canada’s loudest, shale-gas extraction proposals have also provoked argument in NL and Nova Scotia. Recently, the NL government imposed a moratorium on fracking until it has consulted the public and conducted reviews. Nova Scotia has had a fracking moratorium for about two years, though it is set to expire this summer.

New Brunswick can also expect to benefit from the construction of the Energy East pipeline, which will bring Albertan oil to Saint John’s Irving Oil refinery. The most noticeable gains from project will take place during its development and construction: a report by Deloitte found that the pipeline will boost New Brunswick’s GDP by $1.1-billion in this period. And during its 40-year operations phase, the pipeline project will add $1.6-billion to the province’s economy, though it will only directly create 121 permanent jobs.

With Muskrat Falls, NL is taking a significant fiscal risk and trapping consumers with the hope of becoming an energy power. Any jurisdiction that allows fracking must balance the benefits of increased economic activity and royalties with potential environmental harm and local frustrations. And the Energy East pipeline could give NB the sort of economic and fiscal boost it needs. Energy may enrich Atlantic Canada, but squandering it may breed regret.

Michael Sullivan is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute

Dealing with Oil Money: learning from Newfoundland and Labrador

With both a new premier and finance minister, the Government of Newfoundland and Labrador (NL) has begun to prepare its 2014-2015 budget in earnest with consultations that run throughout the month of February. NL’s newly appointed Minister of Finance Charlene Johnson will present the budget to the province’s House of Assembly in the coming months.

Last year, NL’s provincial government projected expenses roughly $500 million greater than revenue, which contrasts starkly to the province’s seven-year period of surpluses between 2005 and 2012. This year, the provincial deficit will likely be smaller due to cost-saving measures taken last year under the Dunderdale administration.

In part, NL’s fiscal troubles are due to declining oil royalties. The provincial budget is largely dependent on offshore royalties, which constitute over $2 billion in revenue of the province’s total of $6.392 billion, as estimated in the 2013-2014 budget. However, annual offshore oil production in NL peaked in 2007 (although new discoveries could boost figures in the future). Due to declining production, in addition to the emergence of new technologies, such as hydraulic fracturing, the province altered its price projections for a barrel of oil from $124 to $105. Royalties from future projects are also unreliable because volatile oil prices determine whether developments are profitable and, ultimately, reign in government revenue. With the upcoming Hebron project, for instance, the expectation is that production will plummet after 2020.

These developments demonstrate that buttressing long-term fiscal arrangements on temporary and volatile resource revenue is imprudent. In many cases, governments benefit politically from spending more or taxing less. However, lapses in revenue can compel them to pursue these benefits even spending increases or tax cuts are unsustainable.

If governments did not spend this revenue on programmes, though, where would it go? A number of alternatives exist.

The first alternative, based on Thomas Paine’s idea of a “citizen’s dividend,” involves equally distributing among a country’s population the rents received from private industry using public resources. Although Paine built the notion of a citizen’s dividend using common ownership as a foundation, the citizen’s divided can be justified on fiscal grounds. Giving royalties to citizens, rather than funnelling it back into government programs, would prevent disproportionate increases in the size of the public sector. Such decreases are problematic, as political incentives preclude the ability to lay-off workers in the future.

The second alternative reflects the Alberta Heritage Savings Trust Fund, which received initially 30 per cent of resource royalties within the province. In NL’s case, and in many other jurisdictions, debt reduction would take the place of a savings fund. Saving allows governments to pay less in interest payments or even earn money from lending. A model similar to Alberta’s, which stipulates mandatory savings, would undermine government attempts to boost spending in order to win short-term political gains.

Choosing either of the two options would conceivably help NL’s provincial government end its fiscal dependence on resource royalties. The current system encourages the government to borrow political capital from future governments by boosting spending when resource money is available. This incentive structure has adverse effects on certain individuals. For instance, laying off public sector employees hired on the assumption that their new position was stable due to budget cuts. Creating rules that govern the use of royalties would mitigate these unfortunate developments.

Michael Sullivan is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute