Should Alberta’s oil dependent government start hedging to safeguard its revenue?
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With its budget deficit swelling and oil boom-and-bust cycles expected to accelerate, given the growing experience of other oil-dependent jurisdictions like Mexico, it’s an idea that should at least get due consideration. Saskatchewan and Newfoundland and Labrador, both dependent on oil revenue, should also be aware.
It’s certainly a less intrusive way to manage oil shocks than forced economic diversification, entering debt or raising taxes C the levers being used today by Rachel Notley’s NDP government to outlive the downturn.
Tim Pickering, president and CIO of Auspice Capital Advisors Ltd., a commodities and alternative investment trading firm located in Calgary, said this type of program will make Alberta’s revenue more stable and more predictable.
“Any entity which has a lot riding on the revenues from the source like crude oil should consider the risk management aspects of that,” Pickering said at a conference now organized through the Canadian Energy Research Institute.
“The reasons which have been thrown around because of not hedging are poor reasons,” he explained. “If it’s cost, that could be mitigated. If it’s deficiencies in understanding, education can happen. If it’s a lack of expertise within the government, there are numerous experts out there. Which is something which continues to be accepted by commercial players forever.”
Alberta’s third-quarter fiscal update, published last month, provides a glimpse at how much the province is vulnerable to oil price swings. The province expects a $6.3 billion deficit for that 2015/2016 fiscal year, according to non-renewable resource revenue of approximately $2.5 billion. The deficit is expected to widen to a lot more than $10 billion in fiscal 2016/2017. Prior to the oil crash, in 2014/2015, Alberta had a budget surplus of $1.1 billion, based on almost $9 billion in non-renewable resource revenue.
Pickering said Alberta could hedge by selecting a benchmark that is representative of the bulk of government revenue and creating a vehicle to protect that. Plenty of counter parties would be keen to consider risk from oil volatility off Alberta’s hands, he said.
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The program wouldn’t help Alberta in the short term, given oil prices remain depressed and it’s not a good time to lock in, however the province can instruct the public about the benefits and charges of hedging therefore it is ready to move ahead when oil prices recover.
Pickering said Alberta hasn’t given hedging a fair chance because it relies too much on advice in the same group of investment banks – “which I take strong exception to and i believe we ought to change.”
“A significant number of governments have previously done it – Mexico, Chile, texas,” Pickering added. “There are enough examples to create mtss is a credible idea.”
In Mexico, hedging is longstanding strategy to safeguard oil revenues. Canada’s NAFTA partner produces a couple of.3 million barrels each day, and hedges in regards to a third of that. Alberta produces the same volume from the oilsands alone, while Canada produces about four million barrels a day from all sources.
In its hedging program for 2016, Mexico paid US$1.09 billion to ensure a minimum of US$49 a barrel to cover 212 million barrels of oil.
In its program for 2015, Mexico ensured a typical oil cost of US$76.40 per barrel, covering 228 million barrels at a cost of US$773 million.
Bloomberg estimated Mexico would reap a payout of around US$6 billion from the 2015 oil hedges, surpassing the payout it received in ’09 of US$5.1 billion windfall after oil prices plunged using the global financial crisis
Counterparties included banks like Morgan Stanley, Citigroup Inc., JPMorgan Chase & Co and Goldman Sachs Group Inc.
Not all governments happen to be successful with hedging. Ecuador kept in oil sales in 1993 and didn’t try it again after realizing losses that became controversial.
That risk is one of the reasons Alberta hasn’t pursued hedging, said Mike Ekelund, assistant deputy minister, resource revenue and processes, in the Alberta United states doe.
“It’s challenging if you are on the wrong side of a hedge,” he explained, noting hedging could be more appropriate to protect revenue sources for any project.
Harold ‘Skip’ York, vice-president of integrated energy at consultancy Wood Mackenzie, said governments are usually shy about hedging because they don’t comprehend it or don’t appreciate it’s not about creating money, but about stabilizing income.
Alberta should consider whether to make a move different in the next upswing, he explained.
Like in the private sector, the federal government should be prepared for praise for getting the trade right, and pilloried to get it wrong.
Either way it might get revenue stability, which is better than swimming in cash when times are great, or severe belt-tightening when times are bad.
ccattaneo@nationalpost.com
Twitter.com/cattaneooutwest
