Here's to the crazy ones, the misfits, the rebels, the troublemakers, the
round pegs in the square holes... the ones who see things differently -- they're
not fond of rules... You can quote them, disagree with them, glorify or vilify
them, but the only thing you can't do is ignore them because they change
things... they push the human race forward, and while some may see them as the
crazy ones, we see genius, because the ones who are crazy enough to think that
they can change the world, are the ones who do.

Steve Jobs
US computer engineer & industrialist (1955 - 2011)

Sunday, May 13, 2012

Newfoundland and Labrador - To be or Not to be?

The capacity to borrow, or pay debt, is the number one issue driving the world financial markets. It has been for some time. What plays into that? The first is demographics. In a world economy based on consumption of goods the larger your base of consumers the better. However, the age groupings of those consumers, their family sizes, etc also come into play. Secondly, the ability of those consumers to consume is crucial. Large, older populations that have reached their ability to pay for goods they have consumed, or are consuming, renders them somewhat irrelevant to the financial markets of the world that need to expand to remain relevant.

These are the primary reasons why the previously very third world countries of Brazil, India, China, etc are now the new engines of world consumption. They have large, young populations that have relatively low debt levels and similar expectations. International corporations, financial and otherwise, understand that the future is there. The Western World, the "old frontier", has essentially reached its limit of borrowing capacity compared to that which it produces - so its on the decline. You can see it everywhere in Europe, and we saw it dramatically in the US in 2008 til present. We even see it in Canada as a kind of microcosms of the world. Alberta and Saskatchewan, fired by resources consumed in the developing world, have experienced wage inflation which has in turn created housing inflation. That inflation has led to property equity increases, on paper, that have not been earned or paid for. Meanwhile, Ontario, Quebec, and for the most part Atlantic Canada decline.

Thomas Mulcair, federal NDP leader, recently referenced the situation as the "Dutch Disease". Essentially, the rationalization of the national economy toward resource based inflation that in turn causes a massive loss in traditional industries. The "petro dollar", created by high fuel prices, leaves most of your other industries unable to export internationally. It's very political in Canada's case as it pits region against region. So while Mr. Mulcair was 100% right in his analysis, the Premiers of British Columbia and Saskatchewan attacked him for saying it.

Newfoundland and Labrador reflects both of these realities. While on the one hand it has realized offshore oil wealth that has fueled one third of all government spending in the last five years, on the other hand it has all the negatives that are affecting the rest of the western world. It has the worst demographic/age outlook of any political jurisdiction in the western world - and that's saying something. It has fifty percent of its population dispersed over its rural area. Despite its new found oil wealth the majority of its population works for between $10 to $15 dollars per hour in non-unionized sectors. Its government and resource based, unionized labour sectors, inflate the average wage levels - deceptively so. Its property values have increased in the Avalon area, and Labrador, allowing homeowners to leverage new debt on "sudden equity", while its rural areas suffer stagnation or decline in real estate values - thereby restricting the amount those people can borrow.

Then there is the case of the Newfoundland and Labrador government. It has seen its general revenues, driven by oil/mining and high taxes, swell. In 2001-2002 the government held, at the end of the fiscal year, $ 510.2 million in cash and temporary investments. These funds were invested at between 1.00% and 4.85%. Its gross debt was $10.65 billion, minus $1.73 billion in assets, for a net debt of $8.92 billion. Its unfunded pension liabilities, for public service pensions, was $3.391.6 million. Its revenues for the year were $3.9 billion and its expenses were $4.5 billion. The population for 2001 was 512,930 with an average age of 38 years of age.

Fast forward to 2011-2012, and the oil boom province. At the end of the fiscal year the government held $2.21billion in cash and temporary investments. Theses funds were invested at between .20% and 7%. Its gross debt was $13.1 billion, minus $5 billion in assets, for a net debt of $8.1 billion. Its unfunded pension liabilities, for public service pensions, was $2.67 billion. Its revenues for the year were $8.13 billion  and its expenses were $7.53 billion. The population for 2011 was 511,036.

It's easy to see that in the last decade government revenues and expenditure have risen substantially. This despite the decline in population, and the fast aging population in the western world. It is also noticeable that the cash on hand at the end of the fiscal years has dramatically increased. Its also interesting to note that despite the one time $2 billion payment given to former Premier Williams on account of the Offshore Accord, which had to be directed to debt (unfunded pension plans) by agreement of the parties, that the unfunded public pension liability has actually substantially increased since 2005 - when the payment was received. It's also shocking to note that, despite all the oil revenues, the province's gross debt has actually grown by almost 30%.

The bottom line is that the government of Newfoundland and Labrador has just been undisciplined - period. It has ignored the very real international, and even national, financial lessons provided in the last many years. It follows the financial thinking of making the books look good to the banker, while hiding the many inherent weaknesses its lack of financial discipline has had on the province's true financial picture. The Conference Board of Canada recently stated that Newfoundland and Labrador's offshore oil revenues would decline rapidly after 2020 - eight years from now. Despite this, offshore oil revenues are not being used to retire debt. In fact that debt has grown - and will continue to do so. It has taken the rather childish position of "having money in the bank" as opposed to funding its unfunded pension plans. It has tried to leverage its money to super inflate certain sectors of the economy like hydor, mining and oil, while watching the majority of the economy suffer "all of the costs of inflation but none of the benefits."

A final, but telling example. The province had, at the end of 2011, an equity investment of $1.28 billion in Nalcor - its energy crown corporation. It claimed assets worth $2.6 billion. It made, on operations, a total of $77.5 million net. Contrast that with the Newfoundland and Labrador Liquor Corporation.  The province had a total equity position of  $62.3 million. It claimed total assets of $91.6 million. It made, on operations, $132.013 million - of which it turned over $132 million to the province's general revenue fund. Nalcor did not return one cent to the fund. Given that the province intends to proceed with the Muskrat Falls Hydro development, and the estimated price tag for that is between $5 billion - $8 billion (financing costs not included), and given the rate of return on investment to the people of the province of Nalcor's operations, and given the overall financial and demographic picture of the province as laid out above, one is left questioning the credibility of the government's position. Sinking clear profit (oil) into a business that can not produce a substantial return (Nalcor) is the worst thing that could happen to the people of Newfoundland and Labrador.

After all, would it not make more sense to arrange a power purchase agreement with Hydro Quebec to supply power to mining developments in Labrador? The infrastructure would then be in place for the 2041 hand over of the Upper Churchill to the province at a much reduced cost. The mines would get their power and the province would get their royalties. Let's not forget the average life span of an iron ore mine is 25 years. In the mean time, precious oil revenues could be used to pay off the provinces debt, which includes a number of large borrowings at 10% interest carrying forward for the next thirty years. Eliminating debt would also allow the province to reduce or even eliminate provincial sales taxes and gasoline taxes. That would encourage both public and corporate participation in the economy for the long term, and not just on a mega project by mega project basis. It would also place Newfoundland and Labrador in an enviable position nationally and internationally of being one of the few places left in the western world that has the capacity to consume debt - should it choose to.

Sadly, this is a tipping point in our history. A once in a historic lifetime opportunity to fundamentally alter the province's future, and most importantly the lives of the people that live here. A moment in time when real discipline could transform the province from a state of survival to the place to be. As I see it, we are half way through that moment in time and the important (beyond window dressing) fundamentals of Newfoundland and Labrador's economic future have been badly misplayed. The incessant, childish one-up-man ship approach of the province's political characters is only upstaged by the delusional dreams of those that are duty bound not to lead their people into this kind of future. Accountability is screaming its absence - at all levels.


  1. One thing I think you have overlooked is the intervening power of the Quebec Innu on any project running through hydro-quebec

    this is a way for provincial government to avoid compensating the quebec innu the way they have in the labrador case....pretty frustrating on the quebec end i imagine, given the innu people technically should have an equal share in the resources crossing the labrador/quebec border

  2. Actually, I'm pulling for the Innu, and in particular their legal challenge to Muskrat Falls.The PUB's determination that the Quebec Innu need not be consulted before allowing Nalcor to proceed on Muskrat Falls plan was just putting the inevitable off for someone else to deal with in my opinion.My only hope is the Quebec Innu's primary concern is for the environmental effects and not just fighting over revenue sharing.We need Aboriginal peoples to hold onto that traditional role of keepers of the environment they have always held.


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