Over two years ago now, March 11, 2013, I published this mayo615 blog post on the Alberta bitumen bubble, and the budgetary problems facing Alberta Premier Alison Redford, and the federal Finance Minister Jim Flaherty at that time, both of whom were surprisingly candid about the prospect for for ongoing long term budgetary problems for both the Alberta and Canadian national economies. Fast forward two years to today, and the situation has essentially worsened dramatically. The current Alberta Premier Jim Prentice is facing another massive budget deficit, just as Alison Redford predicted two years ago, and has been forced to call a new election. The most glaring difference in my mind is that there is no Jim Flaherty, and there is no candid talk coming from the current Finance Minister, Joe Oliver, or anyone in the Harper government, on this issue or when a new federal budget may be expected. Meanwhile, according to the Bank of Canada’s most recent report, the Canadian economy continues to plummet into a black hole.
Originally posted March 11, 2013:
The Canadian media (CBC, Globe & Mail, Canadian Business) have been buzzing with analyses of Alberta Premier Alison Redford’s pronouncement last month that the “Bitumen Bubble,” is now crashing down on the Alberta economy, and potentially the entire Canadian economy. The Alberta budget released last Thursday, March 7, acknowledged a multi-Billion dollar deficit from this year, and “even larger declines in the next several years,” due to forecasts for significant price decreases for “Western Canada Select“ (WCS), the market term for the Alberta oil sands. This is contrasted with “West Texas Intermediate“ (WTI) which is also known as the standard for “light sweet crude,” which is much cheaper to refine. Canadian Finance Minister Jim Flaherty echoed the impact of reduced oil sands revenue on the federal budget, by warning of significant cutbacks in federal spending as well. The impact of this sudden change in the prospects for the Canadian petroleum industry and for government oil tax revenues, will likely also have serious implications for the BC economy, jobs growth, business investment, consumer spending: essentially the Canadian economy as a whole will suffer.
As an Industry Analysis case study for Management students, how did this happen, why was it not foreseen? Why weren’t foresighted policies put in place, and what are Alberta and Canada‘s strategic options now?
The June 25th, 2006, CBS News 60 Minutes report by senior CBS News Correspondent Bob Simon, can be taken as a convenient departure point for this analysis.
Video (1min 52 sec.) CBS 60 Minutes: 6/25/2006: The Oil Sands
The so-called “proven reserves” of oil in the Alberta oil sands are estimated to be 175 Billion barrels, second only to Saudi Arabia’s estimated 260 Billion barrel reserve. In the CBS video, Shell Canada CEO, Clive Mather estimates that the total may be as large as 2 Trillion barrels, or eight times that of Saudi Arabia. The CBS 60 Minutes report at the time in 2006, was considered so positive, that it was eventually shown in an endless loop in the foyer of Canada’s Embassy in Washington D.C., at Canada House in London, and elsewhere around the World. The Alberta oil sands were seen as the harbinger of a great new era of Canadian economic progress and wealth.
Since that time a variety of external market factors, and long-standing failures of Canadian government policy have converged like Shakespeare’s stars, to turn this Pollyanna scenario into the national disaster it has become for Canadians.
Perhaps the single most important point in this discussion is that Canada has historically been a natural resource based economy, which has led to complacency and neglect of investment in innovation. Innovation is the most important determinant of business competitiveness and economic prosperity in a world of global markets and rapid technological change. Canada’s overall investment in R&D in science and technology has been below the OECD average for decades, and continues to decline year to year. As a consequence, Canada has also fallen sharply behind the United States in productivity. Essentially, there has been a “robbing Peter to pay Paul” mentality in Canada with regard to investment in the future of the Canadian economy. So long as we can simply dig a hole and ship the rocks or oil overseas we are doing just fine, thank you very much!
In a serendipitous coincidence, the current events in Venezuela have provided a parallel to the petroleum industry issues in Canada. Yesterday, the HBR Blog Network published a post by Sarah Green. Ms. Green interviewed Francisco Monaldi, Visiting Professor of Latin American Studies at the Harvard Kennedy School. Professor Monaldi is a leading authority on the politics and economics of the oil industry in Latin America.
During the HBR Blog interview, Professor Monaldi referred to the “resource curse” of Venezuela, also citing Canada and Saudi Arabia as suffering from the same malaise. Venezuela has done all the wrong things under Chavez, and consequently the Venezuelan economy is in shambles. Monaldi cited Chile, who also had a natural resource boom, but are creating a national stabilization fund by not putting all of the money back in the economy at once, a counter cyclical policy almost unheard of in Latin America. A similar scenario of reinvestment in innovation has occurred in New Zealand, whose government has sought to reduce its vulnerability to over-reliance on natural resource exploitation.
A Canadian Broadcasting Corporation interview March 7th on The Current with oil industry expert Robert Johnston, and CBC business columnist Deborah Yedlin, revealed that the Venezuelan Orinoco crude is actually very similar to Alberta WCS, but it does not require massive destruction of the land. Transportation routes to U.S. refineries designed to deal with extra heavy crude have been up and running for years. The U.S., despite the political tensions with Venezuela, is currently the single largest customer for Venezuelan extra heavy crude. In The Current interview yesterday, both Johnston and Yedlin admitted that the Alberta oil industry was ” very uneasy” about their competitive situation vis-a-vis Venezuela. Yedlin also underscored Canada’s “resource curse” and the failure to diversify Canada’s investment in innovation and technology.
Alberta oil sands, by contrast, are completely land locked, and the Alberta producers are in the midst of an unsavory political wrangle over two pipelines, which has brought undesired attention to the other problems with Canadian bitumen. Without at least one pipeline, the Alberta oil sands industry is in a questionable state. Should the United States elect not to approve the Keystone XL pipeline to the Gulf of Mexico, Canada’s only viable remaining option would be to sell the oil to China. Some Canadians are taking the position that Canada “should” sell the oil to China. The Harper government is now hypersensitive to China’s interest in the oil sands. Others have suggested that we should refine the oil ourselves, but it is cheaper to send it to Texas than to build refineries in Canada. According to Yedlin, Canada is now locked into the urgent need for the pipelines, with no other options or strategy.
The argument can be made that Canada should have been implementing policies like those in Chile or New Zealand years ago, anticipating the boom and bust of the global petroleum market, and socking away money to deal with it.
The most recent 2012 OECD Economic Survey of Canada also serves to underscore the urgent need to change our national policies with regard to natural resource exploitation and investment in innovation to improve our performance in global productivity.
As the oil boom and high value of the loonie have pushed wealth westward, Canada’s productivity growth has been relatively flat in recent decades, and has actually dropped since 2002. Meanwhile, as the OECD observes, productivity growth south of the border has risen by about 30 per cent in the last 20 years — a gap that is causing Canada to lose competitive ground.
“Canada is blessed with abundant natural resources. But it needs to do more to develop other sectors of the economy if it is to maintain a high level of employment and an equitable distribution of the fruits of growth,” study author Peter Jarrett, head of the Canada division at the OECD Economics Department, said in a press release.
Meanwhile, yesterday, Friday, March 8th, the Globe & Mail published a scathing criticism of federal Natural Resources Minister Joe Oliver for characterizing the Alberta oil sands industry as the “environmentally responsible choice for the U.S. to meet its energy needs in oil for years to come.” G&M Journalist Tzeporah Berman wrote, “At a time when climate change scientists are urgently telling us to significantly scale back the burning of fossil fuels, having a minister promote exactly the opposite really does feel like being told that two plus two equals five.”
Our most respected national journal simply reached the end of its patience with Canadian government “doublespeak.” Every independent study, including one from the U.S. Department of Energy, has found that the oil sands are one of the World’s dirtiest forms of oil, producing three times more emissions per barrel produced and 22 per cent more greenhouse gas emissions than conventional oil (when their full life cycle of emissions, including burning them in a vehicle are included). The problem is simple: the massive “energy in versus energy out” equation simply does not work for oil sands. Large amounts of natural gas and water are required simply to prepare the bitumen for transport to refineries. Yet our government continues to wave its arms in a desperate attempt to divert attention from the facts, rather than to deal with the facts. One would think that our national government by now would have a reality-based strategy to deal with major economic and political issues of this scale.
This discussion has barely touched on the opposition to the two pipelines, Keystone XL and Enbridge Gateway, attempting to move the landlocked tar sands out of Alberta. This is a strategic market issue that should have been addressed years ago, but was not. The thorny issues of both pipelines are now a rod for Alberta’s own back. Considering the market competitor Venezuela, with comparably unattractive “extra heavy crude,” but having existing transport, the prospects for Alberta are not favorable, and it has finally sunk in for Alberta oil executives.
The long awaited U.S. State Department Draft Environmental Impact Assessment (DEIA) on the Keystone XL pipeline, released early this month, was written by oil industry consultants which have raised significant concerns of a serious conflict of interest in their findings. The Executive Summary of the State Department DEIA took a decidedly neutral position, saying that the pipeline would have “no effect” on the development of the Alberta oil sands. But buried in the report were findings that argue against the need for the pipeline. The recent developments in Venezuela and the increasing energy independence of the United States were not factored into their findings.
The DEIA specifically evaluated what would happen if President Obama said “no” and denied Keystone XL a permit. It concluded that not building the pipeline would have almost no impact on jobs; on US oil supply; on heavy oil supply for Gulf Coast refineries; or even on the amount of oil sands extracted in Alberta. If these findings are accurate, then one must ask why it is necessary to build the Keystone XL pipeline.
So in conclusion, how could the Canadian federal government not have foreseen this calamity, and prevented it? Could it have been the giddy euphoria of the 2006 CBS 60 Minutes report? The only best solution, investing government oil revenue into innovation and technology R&D, may no longer be a viable option.
In such a situation, what would you do to address this crisis for the Canadian economy?