Gas revenues – what to do with them, once you have them

Brian Lee Crowley

The offshore revenue battle pitting John Hamm and Danny Williams on the one hand
against Paul Martin and the federal government on the other is an important one, but it only gets us halfway to where we need to be on the east coast.

The premiers of Nova Scotia and Newfoundland and Labrador are holding firm to their demand that Ottawa stop clawing back the bulk of the revenues that come from the offshore. Because these provinces have played their political cards well, they are likely to win the battle overall, although perhaps not in every detail.

But the more important question is what you do with the money once you’ve got it.

To Atlantic Canadians used to living with high taxes, high debt and painful provincial budgets, the question will doubtless appear strange. But suppose Newfoundland and Nova Scotia win their battle and get hundreds of millions if not billions of dollars in revenues in the next few decades as a result. Why wouldn’t they just spend it on schools and health care and roads?

Because natural resource revenues have some very peculiar qualities. As former Alberta finance minister Jim Dinning likes to say, non-renewable natural resource revenues are non-reliable revenues. Prices for these commodities can fluctuate wildly. A couple of years ago The Economist newspaper, a well-informed observer of the world economic scene, was predicting $10 a barrel oil. Today, oil trades perilously close to $50 a barrel.

It’s the same for natural gas. In the last few years natural gas has been as low as $3 per thousand cubic feet, while the main U.S. benchmark price in recent months has been between $5.50 and $6.60 U.S. In Alberta, which gets a lot of revenue from these resources, every 10 cent change in the price of natural gas means $142-million more or less to spend. A couple of years ago, they did their provincial budget based on the then reasonable assumption of $5 for natural gas. Within a few months the price had fallen to $3. That meant a revenue shortfall of nearly $3-billion.

That’s why Jim Dinning calls these revenues non-reliable.

But government spending has a rather different character; it is highly reliable. When governments spend money, it tends to be in regular and long-term commitments.

They hire teachers or restaurant inspectors or surgeons or museum administrators. Those people expect to be paid every two weeks, period. They expect annual pay increases, improved working conditions, fringe benefits and pensions. And once you hire them, you have to put them somewhere, so you need buildings as well as electricity, heat, cleaning and other services.

And of course these employees are highly unionized and their contracts are quite inflexible. They are likely to be quite stoney-faced if the government pleads low natural resource prices at bargaining time. But if prices (and therefore government revenues) are high, they certainly expect a cut.

That’s why it is always a fatal mistake to treat natural resource revenues as if they were just like income or sales taxes. Spending commitments made when prices are high are a nightmare for governments when prices fall. The asperity of the conflict between Newfoundland, Nova Scotia and Ottawa is due in large part to the high prices these offshore resources are fetching in the marketplace. The provinces want to spend these revenues. But unless they act carefully and deliberately, they will simply sow the seeds of miserable and draconian budget cuts when the inevitable price collapse comes.

That’s not all. Resource royalties are unlike income and sales taxes in another way.

Those other taxes simply take a slice off infinitely renewable economic activity. But natural resource revenues represent the sale of our natural capital assets. That natural endowment belongs to all provincial residents, including those who are not born yet. It would be a terrible and tragic mistake to squander it on ordinary spending. It must be treated as capital, and reinvested, so as to confer benefits on each province’s citizens over a long period of time.

That means it should be used exclusively for two things. One of them is debt reduction. When you are heavily indebted, as we are, it makes sense to sell some assets to relieve the pressure of interest payments and free your income up for more productive purposes.

The other thing we should do is to create a heritage fund. The provinces should invest the capital, and only spend the income it generates. That smoothes out the huge fluctuations in natural resource revenues, while creating an asset that can be invested in things that confer long-term benefits, like genuine infrastructure, medical research, and top flight facilities for our schools, colleges and universities.

Because every province in the region potentially has offshore petroleum resources, we should all be praying Danny Williams and John Hamm win this battle with Ottawa.

we should pray too that every province does the right thing with the money. Our children will judge us on the choices we make.