With large petroleum deposits off its coast, Newfoundland and Labrador is the beneficiary of an impressive geological jackpot. However, the drop in the price of Brent crude over the past 12 months, from over $100 a barrel to under $45, has illustrated the pitfalls of heavily relying on a volatile commodity to supplement public revenue.
But if the province is serious about maximizing the long-term potential benefits from this resource, it needs to start saving now.
Saving oil royalties has a threefold advantage: it addresses the worst effects of price volatility; it increases the value of the asset; and it ensures intergenerational equity so that future residents can enjoy the benefits.
Spending oil revenue as soon it comes in simply depletes the asset. It also leads to a troubling dynamic where high oil prices leads to poor spending choices and lower prices leads to deficits that must be paid with more debt, higher taxes and cuts to the public service. Then, of course, is the moral issue of spending revenue now to benefit current residents at the expense of future residents.
Saving oil revenues in a publicly owned investment fund can help overcome such a roller coaster of a dynamic. Once the principal is protected with inflation proofing, the interest from a savings fund can be spent on anything, ranging from tax cuts to new infrastructure.
Examples abound of jurisdictions that have successfully saved their royalties and maximized their returns. In Norway, a 100 per cent royalty contribution rate, beginning in 1996, has seen the Government Pension Fund Global grow into an $882-billion asset.
Even Alberta, which has haphazardly contributed to its own Heritage Fund, has seen its $18-billion worth of contributions, spread over four decades, develop into a $35-billion return. If done right, savings can be lucrative.
The provincial budget for Newfoundland and Labrador this year predicts a $1.1-billion deficit and a shrinking economy for four more years. And that was based on oil selling for $65 a barrel. Today it is around $49. With oil revenues now accounting for 17 per cent of all revenue — down from a third in 2013 — the province’s debt will have to climb to at least $11.5 billion this fiscal year, a leap from roughly $8 billion in 2012. Debt servicing costs alone are expected to run in excess of $1 billion a year by 2018-19.
In order to maintain high levels of spending amid such volatility, the provincial government is faced with having to increase two percentage points to the HST, and fees on government services. Moreover, some 1,400 civil servant positions will be cut through attrition. But it need not be this way.
By learning from the examples of other jurisdictions, Newfoundland and Labrador can escape the worst excesses of price volatility, transforming a non-renewable resource into a permanent renewable asset. Creating a savings fund will take some time. The first several years will require the government to build up the fund to a level where the savings are equal to or greater than the incoming resource revenue stream. It is also imperative that the fund be insulated from political machinations through the establishment of an arm’s-length management board.
In the short-term, the provincial government will have to stabilize its spending; this may require painful public service cuts and tax hikes, but the long-term gains would be worth it several years down the line when the province has a stable fund, and the ebbs and flows of budgeting can be managed and contained.
Similarly, when the treasury is finally insulated from the ups and downs of energy commodity prices, a public discussion should be had as to how Newfoundlanders and Labradorians would like to see the fund’s dividends used, be it on infrastructure, tax cuts, or a mixture of both.
If we are serious about maintaining sustainable public services and infrastructure while avoiding the highs and lows of price fluctuation, the province needs to start saving. The time to take action is now.
Brian Peckford was premier of Newfoundland and Labrador from 1979 to 1989. Jeffrey F. Collins is a research associate with the Atlantic Institute for Market Studies and co-author of the report, A Good Problem to Have: Lessons for Atlantic Canada from Alberta’s Experience with Natural Resource Revenue.
