Lessons from the Rock: Oil Revenue, Government Spending, and Public Debt

Newfoundland and Labrador has experienced tremendous economic growth in the last decade. GDP per capita, for instance, has increased significantly and is currently above the national average, personal earnings are at record-high levels, and most importantly, the province is no longer a “have-not” province under the federal equalization programme.

Largely thanks to booming oil production, Newfoundland and Labrador has set a benchmark for short-term economic growth. Yet, with oil prices plummeting, the provincial government has implemented a freeze on discretionary spending and placed additional restrictions on public sector hiring. Given the recent expansion of the province’s public sector, however, it is important to consider whether spending restraint is achievable, or whether the provincial government’s decision is simply too little, and too late.

nl public sector employment

In the past ten years, oil revenues have been a major staple of the province’s budget. The most recent budget, for instance, projected offshore royalties to bring in $2.4 billion, representing roughly 36.45 per cent of total projected revenue. Equipped with this enlarged, volatile revenue source, however, the government has continuously increased spending, rather than having enacted measures to improve the province’s position in the long-run, such as paying down the province’s public debt or creating a savings fund.

Between 2005 and 2011, for example, public sector employment increased by nearly 8,000 jobs–17 per cent in six years, which is a rate much larger than that of private sector job growth during the same period. Since 2010, however, offshore royalties have fallen and forecasts suggest a steady decline over the next twenty years. Ebbing royalty flows stem from the end of federalization equalization payments, as per the Atlantic Accord, and the falling value of oil production.

This combination of increased spending and faltering offshore revenues spell fiscal trouble for Newfoundland and Labrador. It is, therefore, important for the government to consider important cuts to the public service to ensure sustainability, lest the provincial government compound the public debt.

If recent history is any indication, it is unlikely that the provincial government will pursue substantive reforms. Instead, projected expenditures are set to increase in the next decade. But with oil prices hovering roughly $40 lower than the budgeted $105 USD per barrel, fiscal consolidation is highly important.

The government attempted to curb spending in 2013 by cutting nearly 1,200 public sector jobs, implementing a long-term public sector hiring freeze, and announcing plans to conduct an efficiency review of postsecondary institutions. But after public backlash, the provincial government reversed many of these decisions, such as lifting the hiring freeze. The efficiency review was also never completed. In fact, the most recent provincial budget features rising expenditures, adding $808 million to existing net debt.

Of course, cutting the public sector is politically sensitive and it requires serious deliberation, but if the provincial government chooses to base spending on volatile revenue sources, it also needs to cut expenditures when receipts fall. These jobs would be lost in the short-run, but in the long-run, consolidating the province’s fiscal situation will lower the public debt burden and consequent spinoff effects will provide benefits for every resident of the province.

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

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

Beyond Moratorium: Hydraulic Fracturing’s Future in Newfoundland and Labrador

Hydraulic fracturing–otherwise known as, ‘fracking’–has become a major topic of debate in policy circles, scientific discourse, and popular discussion. This method of extracting oil and gas, used since the 1940s, involves pumping a mixture of water, sand, and various chemicals into bedrock in order to extract the desired resource.

Fracking south of the border inspires much of the debate within Canada. The United States is set to achieve energy independence in an estimated twenty years, largely because of shale-gas extraction, as technological innovation makes it profitable to extract resources that previously were not worth extracting.

Now, the debate rages in Newfoundland and Labrador (NL). The provincial government recently announced a moratorium on hydraulic fracturing after proposals to extract oil and gas on the province’s west coast arose. Government officials cited the need for additional review and regulation as reasons for implanting the moratorium.

As with all debates concerning resource development, the question is not, ‘are there environmental harms?’ Most human activity–farming, building dams, deforestation, etc.–inflicts some environmental damage. Rather, we must ask, “Do the benefits outweigh the harms?”

What are the benefits of hydraulic fracturing in NL’s context?

First, it would provide an economic boost to a part of the province left behind in NL’s offshore boom. Oil and gas extraction would create high-paying job opportunities for locals and reduce dependence on government transfer programs. It would also drive growth in the region and increase government revenues, contributing to potential future budget surpluses.

Nevertheless, government should learn from its past mistakes in dealing with revenue from hydraulic fracturing. NL’s government dramatically increased public spending when offshore oil royalties increased, making services including healthcare and education dependent on a potentially volatile source of revenue. Fracking royalties, therefore, should not justify further spending hikes.

Regarding fracking’s environmental impact, water is the most common concern: hydraulic fracturing requires large amounts of water to extract resources and purportedly threatens local water supplies when ‘fracking fluid’ leaks.

If water miles below the Earth’s surface is contaminated, there is a less chance of public harm; however, if fracking affects surface water, there is an obvious danger to the drinking water supply. Preventing such pollution should be among the priorities of NL’s regulators.

Concerns about both ecological sensitivity and ecotourism also exist. Regulators must determine a way to monitor the effects of fracking on neighbouring ecosystems and punish firms that destroy public property.

It is conceivable that hydraulic fracturing could threaten tourism about Gros Morne National Park, which one company proposed drilling in. However, the need for a park-specific ban does not necessitate a province-wide ban. And, within Gros Morne, it might be possible to restrict fracking and its potential externalities to Green Point, the proposed development site.

In advancing with hydraulic fracturing, the NL’s government should balance smart regulations that minimize externalized harms while facilitating economic growth. After revisiting its regulations, the province should consider allowing the technique and add fuel to the fire of its economic ascent.

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